This Week’s Fed Decision Takeaway and Rate Hikes To Come, May 4, 2017

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The Fed made no changes to interest rates this week, as expected.

Fed Decision Takeaway

The Fed statement almost perfectly met our “Meets Expectations If” scenario, as the Fed acknowledged the slight loss of economic momentum since March, but stated it viewed the slowing as only temporary, and left the door firmly open for a rate hike in June.

Looking specifically at the statement, the Fed said yesterday that economic activity had “slowed” compared to “expanded at a moderate pace” in March. But, in the second paragraph, the Fed said the loss of economic momentum appears to be “transitory,” and signaled the recent underwhelming data won’t make the Fed deviate from future rate hikes.

Underscoring that point was the fact that the Fed said risks to the near-term economic outlook continue to be “roughly balanced,” which is Fed speak for “we can hike rates at any meeting going forward.” Bottom line, the Fed was not spooked by the recent soft data and it is not deterring them from any future rate hikes… yet.

From a market standpoint, there was a mild “hawkish” reaction, not so much because the statement was hawkish, but instead because there was nothing dovish in the statement. That’s what markets have become conditioned to expect. The Dollar Index drifted to the highs of the day 30 minutes after the statement while the 30-year Treasury erased small gains and closed fractionally lower. Stocks drifted slightly lower, but selling was mild. Overall, the Fed statement was not a market mover.

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Tom Essaye on “The Bell” Podcast with Paul Sweeney and Adam Johnson

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Bullseye Brief with Adam Johnson, Paul Sweeney and Tom Essaye

I was a guest on Adam Johnson’s podcast “The Bell” last week. We talk with Paul Sweeney of Bloomberg Intelligence, “the man who’s turning Wall Street research upside down”. There are big changes in the research industry and Sweeney is on the leading edge of those changes. We also talk about “Animal Spirits” vs Hard Economic Data, Earnings and Employment, Mortgages being back under 4% here in Fed Week.

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Another Oil Plunge, Futures Down, May 3, 2017

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Oil futures sank 2.74% yesterday, with a large portion of the losses coming in the final hour. The catalyst for the decline was a collection of analysts’ estimates for this morning’s EIA report that started to come in showing more substantial builds in product inventories even though oil stocks are supposed to fall.

RBOB gasoline futures have been leading the way lower since they topped out on April 12. In fact, since that day, futures have only notched one single gain (that is three weeks with just one positive trading day). Gasoline futures now are within 3% of their 2017 lows, and if the downtrend continues that will be a headwind on the rest of the energy space.

Oil futures came within 1% of their 2017 lows yesterday and the momentum is clearly with the bears. Yesterday’s move was amplified by a “stop run” as futures broke through the March lows in the June contract. But in an encouraging sign of weakness, futures were unable to rebound.

On the charts, futures broke through a longstanding technical uptrend line that dated back to early August. That is another sign of technical weakness in the market.

In doing some cross-asset analysis yesterday, there was evidence that the inverse correlation between oil prices and long bond prices is resurfacing. As a reminder, for a period of time back in early 2016, long bond futures were trading almost exclusively off of the price of oil (specifically when WTI had a $20 handle). The reasons were twofold.

First, low oil prices are a drag on inflation readings, which would have dovish implications for Fed policy (long bond positive). Second, long bonds benefited from a safe-haven/fear bid as lower oil prices increased the risk of small producers defaulting on loans, many of which were issued by southern and central regional banks. Ultimately, contagion fears weighed on regional banks and the broader financial sector collectively. Now, it is not clear whether this is happening again as it was only one day of trading so far, but it is something to keep in mind going forward. If oil declines cause a sharp break lower in longer-term interest rates, that will weigh on stocks.

Bottom line, the fundamentals (rising US production and still-overflowing global stockpiles), technicals (new five-week lows), and market internals (bearish term structure) all continue to favor the oil bears right now, and the idea that we are in a “lower for longer” price environment still stands.

Oil and the rest of the energy complex is, however, near-term oversold, and we could see a volatile short covering rally given the right catalyst. Such a move would likely be short-lived, and if we were to see a continued move into the low $40s or even high $30s that would have serious implications for all asset classes (as in early 2016).

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FOMC Preview and the Next Rate Hike, May 2, 2017

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There is virtually no chance the Fed will hike rates at tomorrow’s meeting, as the chances were slim before the recently disappointing economic data. Now, those chances have declined to near zero. The key question tomorrow is: Just how forcefully will the Fed telegraph the next rate hike?

The answer to that question, taken in the important context of the recent slowing of economic momentum, will decide whether the FOMC decision pushes stocks higher, or whether we see a retracement of the recent gains.

May FOMC Meeting Preview + Next Rate Hikes

Hawkish If: The Fed clearly signals a rate hike is coming in June. Right now, Fed fund futures are pricing in about a 70% chance the Fed does hike rates, but that’s not a consensus expectation, yet. If the Fed specifically points to the “next” meeting in tomorrow’s statement (as it did in the fall of 2015 and 2016) as the likely date of the next rate increase, you will see markets react hawkishly as a June rate hike is not a foregone conclusion. Additionally, if the Fed is still intent on hiking rates in June despite recent economic data disappointments, that might imply a Fed that is more hawkish than previously expected.

Likely Market Reaction: Withheld for subscribers. Unlock with a free two-week trial of The Sevens Report.

Meets Expectations If: The Fed slightly downgrades the assessment of the economy in paragraphs one and two, but also says any slowing of activity is likely only temporary (it’s the temporary part that is the key). Markets expect the Fed to acknowledge the modest loss of economic momentum, but not to make too big a deal out of it.

Likely Market Reaction: Withheld for subscribers. Unlock with a free two-week trial of The Sevens Report.

Dovish If: The Fed materially downgrades economic commentary in paragraph one and downgrades the outlook on inflation, and in doing so materially reduces the chances for a June rate hike. Specifically, to be dovish we would need to see 1) A downgrade of both the growth and inflation language in paragraph one, plus no mention of it being temporary. The net effect would be to remove the expectation for a June rate hike.

Likely Market Reaction: Withheld for subscribers. Unlock with a free two-week trial of The Sevens Report.

Wildcard to Watch

Fed Balance Sheet. As we have covered, the reduction of the Fed’s balance sheet is an important but under reported topic that could result in a more-hawkish-than-anticipated Fed. Specifically, the major questions facing the Fed regarding the balance sheet are:

1) When will the Fed begin to reduce the balance sheet (2017 or 2018)?

2) What securities will the Fed stop buying (just Treasuries or Mortgage Backed Securities, too)?

3) How will the Fed stop reinvesting proceeds (all at once, or gradually)?

How these questions are answered will determine whether the Fed balance sheet is a hawkish influence on markets (yields up, stocks potentially down).

I (and almost everyone else) do not expect the Fed to touch on this in this week’s meeting. However, if the Fed does address this topic, it will come in paragraph five of the statement. Any change there will likely have hawkish implications on markets tomorrow, but again any changes are unlikely.

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Last Week and This Week in Economics, May 1, 2017

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Economic data continued to underwhelm last week and the gap between soft sentiment surveys and actual, hard economic data remains wide, and that gap remains a medium term risk on the markets.

The Sevens Report - This week and last week

Last week in Economics – 4.24.17

Looking at the headliner from last week, Q1 GDP, it was underwhelming, as expected. Headline GDP was just 0.7% vs. (E) 1.1%, and consumer spending (known as Personal Consumption Expenditures or PCE) rose a mea-sly 0.3%. But, the 0.7% headline met the soft whisper number and that’s why stocks didn’t fall hard on Friday.

That GDP report came on the heels of another underwhelming Durable Goods number. The headline missed estimates but the more importantly, New Orders for Non-Defense Capital Goods ex-Aircraft rose just 0.2% vs. (E) 0.4%, although revisions to the February data were positive.

Meanwhile, inflation metrics firmed up last week. First, the PCE Price Index in Friday’s GDP report rose 2.2% vs. (E) 2.0%, while the Employment Cost Index, a quarterly gauge of compensation expenses, rose 0.8% in Q1 vs. (E) 0.4%. Those higher inflation readings were why you saw the dollar rally pre-open Friday despite the disappointing GDP report.

Bottom line, the economic data over the past several weeks hasn’t been “bad” and it’s not like anyone is worried about a recession. But, the pace of gains has clearly slowed, and until we see a resumption of the economic acceleration many analysts were expecting at the start of 2017, any material stock rally from here will not be economically or fundamentally supported (and remember, it was the turn in economic data back in August/September that ignited the late 2016 rally. Yes, the election helped, but the momentum was positive before that event, so economics do matter).

This Week in Economics – 5.1.17

Economic data this week could go a long way towards helping to resolve the large gap between soft sentiment surveys and hard economic data, given the large volume of economic reports looming this week.

First, it’s jobs week, so we get the ADP Employment Report on Wednesday and the official jobs report on Friday. We’ll do our typical “Goldilocks Jobs Report Preview” on Thursday, but after March’s disappointing jobs number, the risks to this report are more balanced (it could easily be too hot if the number is strong and there are positive revisions, or it could be too cold and further fuel worries about the pace of growth).

Second in importance this week is the Fed meeting on Wednesday. The reason this is second in importance is because it’s widely assumed the Fed won’t hike rates at this meeting (June is the next most likely date for a rate hike), although the Fed has turned slightly more hawkish so there’s always the possibility. We’ll send our FOMC Preview in Wednesday’s report but the wildcard for this meeting is whether the Fed gives us any more color into how it plans to reduce its balance sheet. If the Fed does reference or start to explain how its plans to reduce its balance sheet, that could be a hawkish surprise for markets.

Finally, we get the global manufacturing and composite PMIs this week. Most of Europe is closed today for May Day so just the US ISM Manufacturing PMI comes today, with the European and Japanese numbers out tomorrow. Then, on Wednesday, we get the US Service Sector PMI and global composite PMIs on Thursday. The global numbers should be fine but the focus will be on the US data. In March we saw a loss of positive momentum in these indices but the absolute levels of activity remained healthy. If we see more moderation and declines in the ISM Manufacturing and Non-Manufacturing PMIs in April, that will stoke worries about the overall pace of growth in the economy and that will be a headwind on stocks.

Bottom line, this a pretty pivotal week for the markets. On one hand, if economic data is strong and the Fed a non-event, the S&P 500 could push and potentially break-through 2400. Conversely, if economic data is underwhelming and the Fed mildly hawkish, we could easily see last week’s earnings/French election rally given back, and the S&P 500 could fall back into the middle of the 2300-2400 two months long trading range.

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Political Update for Investors, April 27, 2017

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Political Update for Investors

Trading yesterday was driven by multiple political-related headlines. Politics reasserted itself on the market narrative on Wednesday, helping stocks initially rally following renewed hopes for an Obamacare repeal/replace bill, and after the Trump Administration unveiled a significant (though expected) tax cut plan.

Yet despite the media focus on those two events, any actual progress with healthcare or taxes remains unlikely (and didn’t get better yesterday). The third piece of political news, an investigation into aluminum imports by the Commerce Department, was the most important (yet underfollowed) political development for markets yesterday.

I cover each issue below, cut through the noise, and get to any likely market influence. The bottom line is that despite generally favorable headlines, all the political news yesterday was a mild net negative for stocks.

Trump Administration Tax Cut Plan.

What Happened: The Trump Administration unveiled a sweeping tax cut proposal that included a 15% corporate rate, just three individual tax brackets, doubling the standard deduction, and repatriating overseas profits.

Why It Matters: Corporate tax cuts remain the easiest catalyst for a stock breakout, but unfortunately the tax plan revealed yesterday is very unlikely to pass Congress, and the reason is simple: There is no offset to the reduced revenue from lower taxes. As such, this plan will increase the deficit, and that likely means Democrats can filibuster the bill. Going forward, unless a tax plan contains some material offsets to reduced taxes (like border adjustments) then passage of any big tax cuts remains unlikely in 2017, and that’s stock negative.

How Markets Reacted: Tax-related headlines can still cause a pop in markets, but only a credible plan that can pass Congress will be a bullish gamechanger. (For more market insights in your inbox by 7am each morning, sign up for a free 2-week trial at 7sReport.com.)

Healthcare Bill (Obamacare repeal/replace).

What Happened: The details were fast and furious on this yesterday, but as of this writing it appears the House will vote on the bill potentially this weekend, and odds of passing are decent.

Why It Matters: Passage of an Obamacare repeal/replace increases the chances of tax cuts also passing, as it will increase Trump’s political capital and provide more revenue to offset tax cuts. However, even if this bill passes the House, the chances of passage in the Senate in the current form remain slim. So, while a potential moral victory, it won’t significantly increase the chance of healthcare reform, and as such I don’t see it as a bearish gamechanger for healthcare ETFs (XLV, IHF, IBB).

How Markets Reacted: Stocks (including health care names) largely ignored this news, as again the likelihood of any Obamacare repeal/replace becoming law remains slim. (For more market insights in your inbox by 7am each morning, sign up for a free 2-week trial at 7sReport.com.)

Tariffs and Trade.

What Happened: Yesterday the Commerce Department announced an investigation into aluminum imports. No tariffs were announced, but it certainly looks to be moving in that direction. This announcement comes one day after Commerce levied taxes on Canadian soft lumber imports. Additionally, a Politico story hit midmorning that President Trump was close to signing a document notifying Mexico and Canada that the US intends to withdraw from NAFTA within six months. The document does not guarantee a US exit (they can change course), but it is a necessary legal step to begin the process. Since yesterday the White House has said it’s not preparing this document yet but didn’t squash the idea all together.

Why It Matters: These trade events yesterday (and this week) are actually the most important political events of the week, not because of their immediate impact (Canadian lumber and aluminum tariffs don’t mean a trade war, and the NAFTA announcement is likely for negotiating leverage), but it does remind markets of Trump’s potentially disruptive trade policies. That matters, because right now markets have not priced in any trade-related headwinds, so this does represent at least a modest risk to the bullish narrative.

How Markets Reacted: All the trade headlines weighed slightly on stocks during the late afternoon, but the current headlines simply aren’t bad enough to warrant an outright reversal in stocks. (For more market insights in your inbox by 7am each morning, sign up for a free 2-week trial at 7sReport.com.)

Bottom Line on the Political Update for Investors:

Material “gaps” remain that must be filled if the S&P 500 can sustain a meaningful breakout above 2400, including 1) The gap between political expectations and political reality, 2) The gap between too-low Treasury yields and very high stock prices (although that’s narrowed some-what this week, but not enough), and 3) The gap between soft economic surveys and hard economic data.

In the very short term, investor sentiment seems skeptical, and the market acts as though investors are more afraid of missing a breakout than they are a break down (similar to what we saw when the S&P 500 broke through 2300). So, the “pain trade” looks higher short term and that’s helping stocks.

But given valuations (the S&P 500 trading nearly 18X 2018 earnings), I don’t think sentiment alone is enough to push us decidedly through 2400 without positive resolution on some of these gaps. That means we need 1) Actual progress on tax cuts (which didn’t happen yesterday), 2) A rally in the 10 year above 2.40%, or 3) Better economic data starting today.

I am therefore sticking with my call that the 2300-2400 broad trading range in the S&P 500 should hold, and I would not be chasing stocks at these levels.

Cut through the noise and understand what’s truly driving markets, as this new political and economic reality evolves. The Sevens Report is the daily market cheat sheet our subscribers use to keep up on markets, seize opportunities, avoid risks and get more assets.

The Case for Investing in Europe (Updated), April 25, 2017

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The Case for Europe, Updated

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European indices and ETFs exploded to new 52-week highs yesterday following the expected French election results. The likely removal of that French political risk overhang reinforces our bullish thesis on Europe, especially given some wobbling in US economic data recently.

On March 21 we presented “The Case for Europe,” which was our bullish thesis on Europe as a tactical investment idea. Since we presented that piece, the three Europe ETFs we recommended have rallied an average of 4.2% vs. the S&P 500 just being flat over the same period. We think that outperformance from Europe can continue for the coming months, so we are presenting an updated “Case for Europe,” and reiterating our bullish stance on three Europe ETFs.

Bullish Factor #1: Compelling Relative Valuation. The reasoning here is simple. The S&P 500 is trading at the top end of historical valuations: 18.25X 2017 EPS, and 17.75X 2018 EPS. There’s not much room for those multiples to go higher, and if we get policy disappointment or the economic data loses momentum, markets could hit a nasty air pocket.

(Specific data and ETFs withheld for subscribers – unlock with free trial: 7sReport.com) 

So, while it’s true Europe should trade at a lower multiple vs. the US given the still-slow growth and political issues, those discounts are pretty compelling. In a world where most equity indices and sectors are fully valued, Europe offers value.

Update: The valuation gap still remains and European indices trade at a still steep discount to the S&P 500. We continue to think we can see multiple expansion in Europe that can help European stocks outperform their US counterparts.

Bullish Factor #2: Ongoing Central Bank Support. This one also is pretty simple… the ECB is still doing QE. The ECB is still planning to buy 60 billion euros worth of bonds through December of this year. That will support the economy, help earnings and push inflation higher, all of which are positive for stocks.

Update: The ECB reacted dovishly to perceptions that it might prematurely end QE or raise rates, and with inflation metrics still uncomfortably low, the chances of a hawkish surprise from the ECB anytime soon are low.

Bullish Factor #3: Overblown political risk. We’ve been talking about this for a while, but the fact is that political risks in Europe are overblown, and just like people underappreciated risks in 2016, I believe they are now overreacting to Brexit and Trump by extrapolating those results too far.

Going forward, there are really two important elections this year: France and Germany.

Update: Macron beat Le Pen in the first round of voting, and according to both the Harris and Ipsos polls taken right after voting on Sunday, Macron holds a large 64% to 36% ad-vantage ahead of the May 7 election.

Turning to Germany, they will have elections in September, and Social Democrat leader Martin Schulz will challenge Merkel for the Prime Minster position. Schultz is a former President of the European Parliament, and he’s not anti EU at all. So, if he wins, from an EU outlook standpoint, it isn’t a negative. Now, I’m not going to get into the details of his politics, because they aren’t yet important for this investment. The bigger point is that it’s not really a problem for the European economy if Schultz wins.

Bottom line, we’ve done well in international investments in the past (Japan during Abenomics, Europe when they started QE), and we believe this is another opportunity to outperform.

How to Play It: (Specific data and ETFs withheld for subscribers – unlock with free trial: 7sReport.com) 

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Last Week and This Week in Economics, April 24, 2017

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Last Week in Economics – 4.17.17

April economic data started with a bit of a thud as all three April reports missed estimates last week. And while on an absolute level the numbers imply economic activity remains “fine,” the lack of additional progress is contributing to growing doubts about the strength of expected economic reflation (and that’s why bond yields are lower than most expect).

Last week’s headline economic report, flash April Manufacturing PMI, missed expectations at 52.8 vs. (E) 53.9, and declined from the March reading. Likewise, April Empire Manufacturing and Philly Fed also missed expectations and declined from very high readings in March.

Now, to be clear, on an absolute level all three readings show continued economic growth, but again it’s the pace that matters. Stocks have priced in reflation, but the loss of momentum in economic data undermines that thesis, and that’s why stocks have grinded sideways now for six weeks.

Meanwhile, the gap between soft sentiment surveys and hard economic data remained wide. March Industrial Production beat estimates but that was only because of strong utility production given the March blizzard. The manufacturing sub-component declined and badly missed estimates, again providing non-confirmation for the still high (in absolutely terms) manufacturing PMIs.

Bottom line, economic data wasn’t outright “bad” last week, but it didn’t help reinforce the expected reflation trade, and that did at least partially stoke concerns about the pace of growth. Meanwhile, economic data didn’t help close the gap between hard and soft.

This Week in Economics – 4.24.17

The slow drip of economic data continues this week (next week is the big one), although given the precarious nature of the bond market (10-year yields signaling a potential slowdown) all economic data is at least partially important.

With that in mind, the most important number will be Friday’s Employment Cost Index. Inflation is a key component of the reflation trade, and any broader uptick in inflation has to come from increased wages. In Q1, wage data in the government jobs report wasn’t particularly strong. So, if the Employment Cost Index shows no real uptick in wage pressures, that will further undermine the reflation trade.

Other important data next week includes the first look at Q1 GDP (which will be lucky to hit 1%) and Durable Goods. Starting with GDP, it’s not going to be a strong report, but if consumer spending (PCE) is stronger than expected that will be a silver lining. Meanwhile, Durable Goods offers yet another opportunity for hard economic data to meet surging sentiment surveys, and in doing so close the gap between strong soft data and lackluster actual data. Other notable data points this week include Pending Home Sales and Existing Home Sales, both of which will be under more scrutiny following the disappointing Housing Market Index and Housing Starts numbers from last week.

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French Election: The Good, Bad & Ugly. April 21, 2017

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This Sunday is the first round of voting in the French election, and the event has the potential to move markets depending on which two candidates come in first and second. Yet before getting into the expected results, I want to give some background on how the election works and who is running.

How It Works: The French election almost always has two rounds of voting. The first round, which occurs Sunday, contains all major candidates. If one candidate gets more than 50% of the vote, he or she be-comes president. However, because there are always so many candidates in the first round, this almost never happens (last time was in ’95).

So, the two top finishers from the first vote then face a run off in round two, which will take place two weeks from Sunday. Whoever wins that second vote becomes the French president. So, Sunday’s vote is important because it will determine which two candidates will advance to the second round on May 7.

Who Is Running: There are four candidates you need to be aware of: Macron, Fillon, Le Pen and Mélenchon. From a market standpoint, Macron and Fillon represent the status quo. The market would be fine with either winning the French presidency (i.e. no immediate sell-off).

That cannot be said for Le Pen and Mélenchon. To keep this simple and short, if Le Pen wins, the chances of a “Frexit” (France leaving the EU) go up considerably, as she is a far-right, anti-EU candidate. Conversely, Mélenchon is a far-left socialist. While he would keep France in the EU, his economic and social policies lie uncomfortably close to outright socialism. That clearly would not be good for the French economy, or French stocks.

Facebook - French Election

Election Results Scenario

The Good: Macron and Fillon Finish 1 & 2. Both are considered reasonably centrist, and the status quo in France would continue. Likely Market Reaction: (Withheld for subscribers. Unlock with a free trial — no credit card needed: 7sReport.com.)

The Bad: Le Pen or Mélenchon Finish 1 or 2. Based on polls, it’s likely that Le Pen will come in first or second in voting on Sunday, while Mélenchon is more of a dark horse. Likely Market Reaction: (Withheld for subscribers. Unlock with a free trial — no credit card needed: 7sReport.com.)

The Ugly: Le Pen and Mélenchon Finish 1 & 2. This is extremely unlikely based on polling, but as 2016 taught us, anything can happen. This is the market’s worst-case scenario, as it would introduce material political and economic risk into the European and global economies. We would view this result as a bearish gamechanger, and would likely exit HEDJ and EUFN longs. Likely Market Reaction: (Withheld for subscribers. Unlock with a free trial — no credit card needed: 7sReport.com.)

Bottom Line: From a macro standpoint, and for our position in HEDJ specifically, anything other than the “Ugly” scenario shouldn’t pressure markets materially. And while the “Bad” scenario will extend the possibility of political risk in France, all the indicators say that either Macron or Fillon will be the next French president—and that will only reinforce our bullish Europe thesis.

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S&P Fails at Key Resistance

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The S&P 500 tested but failed at an important downtrend resistance line on the daily chart yesterday, and that leaves the current path of least resistance lower until that technical level (2360) is violated on a closing basis.