Oil Plunge
WTI crude oil futures plunged well over 3% yesterday as the steady trend of climbing US oil production continues to weigh on the fundamental backdrop of the market.
Tom Essaye on “The Bell” Podcast with Kenneth Polcari and Adam Johnson
I was a guest on Adam Johnson’s podcast “The Bell” last week. We talk about the reality of tax reform, tax trade, geopolitics, and the bond market, straight from the NYSE Floor. We were also joined by Kenneth Polcari, Director, O’Neil Securities, director of NYSE Floor.
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Are British Elections a Bullish Gamechanger for the Pound? April 19, 2017
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The pound was the big mover on Tuesday as it surged 2.2% following PM May’s call for elections in June. (As a bit of background, May calling for snap elections means that in the next few days Parliament will be dissolved, and then there will be national elections for all Parliamentary seats over the next six weeks).
The news took markets by surprise, but it is a politically savvy move by Ms. May. Right now, in part because a swell in national pride following the official start of Brexit, PM May is very popular. Calling for elections now will capitalize on that popularity, and help her Tories (Conservatives) increase their majority in Parliament.
From an economic standpoint, however, this isn’t likely to have much of an actual effect. Like the Republicans in the US, the Tories are viewed as the “pro-business” par-ty, so there was a knee-jerk positive reaction. However, Brexit will be the major influence on the value of the pound and the British economy over the next few years, not internal politics. Besides, as we’ve seen with Republicans here in the US, just because a party has power doesn’t mean it can actually get anything done!
Bottom line, the pound has surged to multi-month highs and clearly broken resistance at 1.25, and there’s more short covering to come. But, I do not view Tuesday’s events as a bullish gamechanger for the pound or British stocks, and if anything I’d be inclined to sell the pound if it approached 1.30 vs. the dollar.
For now, though, standing on the sidelines is warranted.
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Gold Futures Pull Back
Gold futures rallied into resistance/our initial upside target just shy of $1300 yesterday before risk-on money flows spurred a reversal as fear bids unwound.
Last Week and This Week in Economics, April 17, 2017
Last Week in Economics – 4.10.17
The two important economic numbers came out Friday when markets were closed, so they didn’t receive much attention, although they should have. Both numbers (CPI and Retail Sales) further eroded the reflation trade thesis and will increase worries the economy is losing momentum.
Starting with retail sales, the headline on this number was plain ugly. March retail sales declined 0.2% vs. (E) 0.0%. Almost as importantly, February retail sales were revised down to -0.3% from the previous 0.1%. As longer-term readers know, we generally disregard the headline and instead look at the “control” group retail sales, which is retail sales ex autos, gasoline and building materials. That control group gives us a better read on truly discretionary spending.
Here the numbers are a bit better. Control retail sales rose 0.5% in March vs. (E) 0.3%, but February was revised lower from 0.1% to -0.2%. So, considering revisions, the March number wasn’t a beat.
Bottom line, this number is not good for stocks. Consumer spending was the engine powering the Q3/Q4 2016 economic acceleration, and the sluggishness in consumer spending now is extending beyond what we would consider normal slack following a big acceleration. These are not the kind of numbers we would see if a bigger economic acceleration is looming.
Turning to CPI, it also undermined the “reflation” trade in the near term. Headline CPI dropped -0.3% vs. (E) 0.0% while core CPI declined -0.1% vs. (E) 0.2%. Additionally, the year-over-year core CPI reading dipped from 2.3% in Feb. to 2.0% in March. This soft CPI reading isn’t a damning number, and clearly the trend of inflation is higher. Yet markets need modestly higher inflation and better growth to power stocks higher, and last week’s numbers did not suggest that’s happening.
Bottom line, this week now is very important, as it will go a long way to resolving the now-glaring discrepancy between still sluggish “hard” economic data and surging “soft” economic sentiment surveys.
Finally, to make this a bit more real, Friday’s numbers resulted in the GDP Now for Q1 dropping to just 0.5%. That type of economic growth simply cannot support stocks at these levels, and as such we should expect Friday’s data to further pressure bond yields and the dollar, which will increase stock headwinds.
This Week in Economics – 4.17.17
This week is important for markets because we will get a much more definitive answer to the question of whether the pace of economic growth is losing momentum. How that question is answered will go a long way to determining whether the S&P 500 takes out the March low of 2322, or if stocks can bounce.
To that point, the most important economic releases this week all contain March data, and the most important report will be the flash manufacturing PMIs out Friday, followed (in importance) by Empire Manufacturing (today) and Philly Fed (Thursday). The reason those numbers are so important is because it’s April data, so they will give us the most current view of the pace of economic activity in the US. If they further imply there is a loss of momentum, that will further undermine the reflation trade and hit stocks. Conversely, markets need strong data this week to help reinvigorate the reflation trade thesis.
Looking beyond those March data points, the next most important report this week is March Industrial Production. This number is important because a wide gulf still exists between “soft” sentiment -based data, and “hard” economic numbers. Industrial production is the next opportunity for some of that “hard” economic data to move higher and begin to close that gap.
Bottom line, we’re coming to a head on the debate over soft vs. hard economic data, and whether the recent economic acceleration can last. While there aren’t a lot of numbers this week, what data we do get is important to resolving that debate… and that will move markets.
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.
Did Trump Just Kill The Reflation Trade? April 13, 2017
Did Trump Just Kill The Reflation Trade? An excerpt from today’s Sevens Report.
President Trump, in an interview with the WSJ yesterday, appeared to change his policy on the Fed and interest rates. Specifically, Trump said he thought the dollar was getting too strong, that he favored a low interest rate policy, and he was open to keeping Yellen as Fed Chair. It was the second two comments that caught markets attention and caused a “dovish” response in the dollar and bond yields (both of which fell).
The reason these comments were a surprise was because it was generally expected Trump wouldn’t keep Yellen and was in favor of a more hawkish Fed Chair and appointing more hawkish Fed governors (there are currently three vacancies on the Fed President Trump can fill).
So, the market was expecting Trump to be a hawkish influence over the coming years, but yesterday’s comments contradict that expectation.
Going forward, from a currency and bond standpoint (the short term reaction aside) I do not see Trump’s comments as a dovish gamechanger for the dollar or rates. Yes, near term it appears the trend for the dollar is sideways between 99.50ish and 102 while the 10-year yield has broken below support at 2.30%.
But, I don’t see Trump’s comments sending the dollar back into the mid 90’s, nor do I see them sending the 10 year yield below 2%.
I also don’t expect this dovish reaction to be a material boost for stocks, because dovish isn’t positive for stocks any more (in fact the comments are causing the stock sell off this morning—more on that in minute).
Bigger picture, the longer-term path of the dollar and bond yields will be driven by growth, inflation and still ultra-accommodative foreign central banks.
Better economic growth (either by itself or with policy help) is the key to the longer-term direction of the dollar and rates (and we think that longer-term trend remains higher).
However, in the near term, his comments sent the 10 year yield decidedly through support at 2.30%, and that is causing stocks to drop as Treasury yields continue to signal that slower growth and lower inflation are on the horizon. And, since the market has rallied since the election on the hopes of better growth and higher inflation (i.e. the reflation trade) this drop in yields is hitting stocks.
The violation of support in the 10 year yield at 2.30% is important and a potentially near term bearish catalyst for stocks. If the ten year yield doesn’t stabilize and make some effort to rally over the next few days, a test of 2300 or 2275 in the S&P 500 would not shock me.
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Dr. Copper Flashes a Warning Sign
Copper futures, which are often looked at as a gauge of economic growth expectations or a leading indicator for a growth-speculation rallies in stocks, broke down to fresh three month lows yesterday. The technical violation is a clear warning sign for risk assets in the near term.
Geopolitical Update: Bearish Catalyst or Excuse?, April 12, 2017
Geopolitical risk has reared its head over the past week, but while the potential military showdowns in Syria or North Korea are the focus of the media headlines, in reality these events aren’t so much direct risks on stocks as they are a reminder of just how priced to perfection the stock market is right now.
Getting more specific, it’s not that anything really got worse yesterday in Syria or North Korea (and if anything,Tillerson heading to Russia may help calm tensions). But rising geopolitical tensions are simply piling on right now along with growth and policy anxiety.
That said, there is always the possibility of more military action in Syria and/or North Korea, so I want to cover each situation briefly and review which sectors and assets are winners and losers during periods of heightened geopolitical stress (should we see one).
Syria: All about Russia. The Syrian situation is important from a geopolitical standpoint, because it indirectly pits the US against Russia. For context, Syria is in the middle of a horrific six-year civil war. The Syrian government and rebels have fought to a standstill for the last several years, thanks to Russia’s arming of the Syrian government and (likely) the US’ arming of the Syrian rebels. Given those proxies, sensationalists out there tout the possibility of the US and Russia getting involved in a military conflict due to their opposed positions.
That is the big fear; however, it is very, very unlikely that will happen. Syria simply isn’t that important to either nation, and apart from the human tragedy (which is quickly approaching Biblical standards for those poor people) that situation is much more bluster than battle.
North Korea: All About China. While Syria gets the headlines, North Korea is considered the much bigger actual geopolitical risk. The reason is partly because its leader, Kim Jong-un, is viewed as mentally unstable, and because the country has low-grade nuclear weapons.
This week, the situation has escalated after President Trump sent a US naval carrier group to patrol the waters off the Korean peninsula, a not-so-subtle reminder that the US is watching. But what likely prevents this standoff from becoming something more serious is China.
China basically funds North Korea’s economy, and it has long been believed that the only way to get North Korea to comply with international demands is through China.
From a geopolitical standpoint, it is very unlikely North Korea would launch a preemptive strike against the US, Japan or anyone else for fear of losing Chinese economic support. So again, while there are dangers, the likelihood of actual military conflict is low.
What It Means for Stocks
As we learned in 2016 with Brexit and Trump, just because something is viewed as being low probability doesn’t mean it won’t happen! With that in mind, there will be specific sector winners and losers if we see further elevated geopolitical tensions.
Sector Winners of Increased Tensions. Withheld for subscribers. Unlock with a free trial of the Sevens Report.
Sector Losers of Increased Geopolitical Risks. Withheld for subscribers. Unlock with a free trial of the Sevens Report.
Going forward, we don’t think geopolitics will be a major influence over stocks (and don’t think yesterday’s sell-off was caused by geopolitics). But as we said Monday, even a small uptick in geopolitical risks with valuations stretched and markets this optimistic could exacerbate any earnings, economic or policy-related pullbacks in stocks.
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Fed Balance Sheet Primer, April 11, 2016
An excerpt below from today’s subscriber edition of Sevens Report.
Fed Balance Sheet Primer
Markets remain consumed by politics and geopolitics, but really the biggest macro surprise so far for 2017 came from the Fed last week, with the realization that they could begin to shrink their balance sheet in 2017. That event has potentially hawkish implications for bonds (bonds lower, yields higher), the dollar (higher) and stocks (increased headwind).
We initially warned about this possibility back in mid-March in our FOMC Preview. And, as we said back then, you’re going to be reading a lot more about this in the coming weeks, so I want to cover this topic more fully so that everyone has proper context.
Why Is The Fed Balance Sheet Important? The Fed balance sheet has ballooned over the past eight years given all the bonds it has purchased through the various QE programs. Unwinding that balance sheet without up-setting asset markets is quickly becoming the Fed’s highest priority.
To get specific, right now the Fed reinvests all the proceeds from a matured bond on its balance sheet—but that’s going to change. If the Fed gets $100 million in short-term Treasuries redeemed, right now it simply buys $100 million worth of new Treasuries. But when the Fed stops that reinvestment, that $100 million wouldn’t go back into the bond market, removing a source of demand.
The point is that when the Fed stops reinvesting principal, that will be potentially bond negative/yield positive, and that process needs to be managed very carefully considering the size of the balance sheet ($2.4 trillion in Treasuries, $1.7 trillion in mortgage backed securities).
When Will the Fed Stop Reinvesting All Bond Proceeds? Until last Wednesday, the unanimous answer would have been “2018.” But, following the Minutes, it’s looking more likely that the Fed could begin to end reinvestment of proceeds in December 2017.
Very Hawkish If:… Hawkish If:… Neutral If:… Dovish If:…
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What Will the Fed Stop Buying? Right now, the Fed rein-vests proceeds from both Treasuries and Mortgage-Backed Securities (MBS), so the question facing markets is whether the Fed will stop reinvestments in just one of these two securities, or whether it will stop reinvestments in both. Until the Minutes, it was assumed the Fed would only begin halting reinvestments in MBS (that way they could further support Treasuries, the more critically important market).
Hawkish If: … Neutral If: …
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How Will the Fed Stop Reinvesting Proceeds? The major question here is whether the Fed will slowly reduce the amount of reinvestment gradually, or whether it will just halt reinvestments all together. To illustrate the point, if one week the Fed has $100 million in bonds paying off, will they reinvest $50 of the $100 and reduce that number gradually over time, or will they just not reinvest any of the $100?
Given Fed history, a gradual reduction is what everyone expects; however, in the Minutes they talked about zero reinvestment, and it seems like the Fed is getting a bit antsy to get policy closer to normal.
Hawkish If:… Neutral If:…
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Bottom Line
This topic isn’t exactly exciting, and it won’t grab the headlines, but it is shaping up to be one of the bigger market influences in 2017. The reason why is simple: No one knows what’s going to happen to the bond market once the Fed begins to remove itself. On a percentage basis, it’s not like the Fed dominates the daily trading in Treasury markets. Yet sentiment is a funny thing, and the Fed needs to manage the unwind of a $4.1 trillion balance sheet successfully, because the potential for some sort of a market dislocation (especially in the age of algorithms and HFTs) isn’t insignificant. So, please keep this primer as a reference point, because I would be shocked if the Fed balance sheet doesn’t cause some sort of volatility in 2017 (beyond just the Wednesday reversal the news caused last week).
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Tom Essaye on “The Bell” Podcast with Dan Wiener and Adam Johnson
I was a guest on Adam Johnson’s podcast “The Bell” last week. We talk auto sales, free tuition, and a lot more.
We were also joined by Dan Wiener, editor of the The Independent Adviser for Vanguard Investors, who shares his 5 favorite funds and most “liquid” investment.
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