Your Weekly Economic Cheat Sheet

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Last Week

The market needed economic data last week to show that the global economy wasn’t as bad as markets had come to believe over the past month, and the data delivered.

On the growth and inflation fronts (the two main areas of concern for risk assets), data last week were solid if unspectacular (but helped correct sentiment, which had been getting almost exponentially worse each day).

The data started good last week as Chinese Q3 GDP was 7.3%, slightly under the 7.5% “target” but better than expected. And, importantly, it was comfortably above the 7% GDP “Maginot Line” that determines when concerns about Chinese growth become a significant headwind on risk assets.

But, the October flash manufacturing PMIs really helped calm nerves about the global recovery. Again, while not spectacular, they were definitely better than feared. At a 10K-foot level, the data last week showed the global economy is still recovering, and not contracting again, as expectations for German and Chinese PMIs were for both numbers to fall below 50 (signaling contraction) but both surprised to the upside.

The highlight was the German data (remember Germany is now “Ground Zero” for European economic worries. German manufacturing PMI rose 51.8 vs. (E) 49.5, while the Chinese data hung on, rising to 50.2 vs. (E) 49.9.

The broader EMU PMI was also a beat at 50.7 vs. 50.0 (but again showing expansion) while the U.S. number was a slight miss at 56.2 vs (E) 57.0—but the important thing is that, at an absolute level, activity in the manufacturing sector is still brisk.

Turning to inflation (and specifically worries about dis-inflation/deflation), the September CPI was also steady. Month-over-month CPI rose +0.1% vs. (E) 0.0%, and the year-over-year change in “core” CPI (which is the most important metric to watch) was unchanged from August at 1.7%. Again, while unspectacular, the data implied the dis-inflation threat in the U.S. isn’t increasing, which is a positive.

This Week

We get more important data on growth and inflation this week, but the most important event of the week will be the FOMC meeting Wednesday.

I’ll preview it as we get closer, but the almost universal expectation is for the FOMC to end QE (as expected). Where expectations differ, though, is what the statement will look like. Specifically, the big question is whether the Fed will remove the “significant time” statement or the “significant underutilization of resources,” thereby making the statement slightly more “hawkish.”

Given recent events with inflation and the global economy, the market is very interested to see if this has made the core of the FOMC more “dovish” or if they appear intent to stay the course. Given the rally in stocks, a slightly “dovish” statement has been priced in already.

After the Fed, the focus this week will be on inflation. The second most important event this week will be the October flash EU HICP, which comes Friday. Europe remains the major source of risk to global equities, and we need positive news on that front.

In the U.S. we also get an important inflation indicator Friday, via the “Core PCE Price Index” contained in the Personal Income and Outlays Report. The Core PCE Price Index is the Fed’s preferred measure of inflation, and for dis-inflation worries to recede further, we need to see the year-over-year number hold firm like in CPI.

Also, we get the quarterly Employment Cost Index Friday, which provided a big surprise to markets back in June when wage costs jumped higher. Remember, wage inflation begets broad inflation, so this will be watched to see if wage increases continued in Q3.

If those numbers are good, that will go a long way toward easing deflation worries in the EU and dis-inflation worries in the U.S.

From a growth standpoint, the first look at Q3 GDP comes Thursday, with expectations currently sitting just under 3.0%. Other than that we Durable Goods tomorrow and some more housing data (Pending Home Sales today, Case-Shiller tomorrow) and weekly jobless claims, which continue to hover at a near-15-year low.

Bottom line this week will be important from a Fed expectation and deflation/dis-inflation standpoint. If the Fed is dovish and the inflation numbers are steady, it will support a further rally in equities.

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Markets Today

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What’s Inside Today’s Report:

—  Four reasons stocks rebounded (and what it means going forward).
—  Weekly economic cheat sheet.

Futures are very slightly negative but are being weighed down by European shares (specifically Italy), which are declining following the bank stress test results and some more lack luster German data.

Despite the stock reaction (which seems more like digestion of last week’s rally) the ECB stress tests weren’t bad. In total less than 1/4 of the 130 banks “failed’ and 9 were in Italy, which was expected. Capital shortfalls were also lower than expected.

In Brazil, incumbent Dilma Rousseff won a close election and Brazilian futures are sharply lower in reaction (markets wanted pro-business candidate Neves).

It will be pretty quiet today, as there are only two economic reports: October Flash Services PMI (E: 58.0), Pending Home Sales (E: 0.8%).

Earnings also continue to roll on but already a lot of the “systemically important” names have reported, and the influence on earnings on the market will start to wane throughout the week.

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What You Need to Know About the Deflation Threat

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What You Need to Know About the “Deflation” Threat

We are on the eve of another CPI report. As we look back over the last month, the surprise steep decline in the September CPI release was one of the catalysts that turned this market lower, as focus shifted squarely to dis-inflation and the stronger dollar.

But, it’s important to point out that what we have seen over the past two months in the U.S. was a commodity-led decline in inflation statistics … not full-scale deflation. For those of us who were in the business in 2008, we’ve seen what real deflation looks like (at least as close we ever want to get to it). Major indicators of monetary conditions, credit, economic activity, consumer spending, etc. are NOT showing dis-inflation. CPI is showing dis-inflation, mainly because of commodity prices.

Much has been made of the decline in the 5-year inflation break-evens (the difference in 5-year TIPS yields and 5-year Treasuries). Yes, it is true they have declined sharply. But, keep in mind TIPS are priced off of headline CPI – so as headline CPI drops (with oil and other commodity prices), then the attractiveness of TIPS also drops. Again, that’s because it is directly tied to headline CPI. Case in point, if you look at a chart of DBC (the commodity ETF), you’ll see it closely mirrors the drop in 5-year inflation expectations, and that’s not just a coincidence.

Two very reliable indicators of deflation (which I learned to follow during the ’08 crisis) are the adjusted monetary base and revolving consumer credit.

Adjusted monetary base is one of the most useful barometers of the stock of available money in the U.S. It’s accelerated to a new all-time high and is considerably higher than it was just a year ago, thanks to QE.

Revolving consumer credit (think credit card debt and other consumer-based lending) has exploded so far this year.

So, while things may change in the future, obviously, neither of these indicators are signaling we are seeing any sort of a deeper deflation threat.

PMIs are at multi-year highs. The six-month rolling average of payrolls is at multi-year highs. Durable goods, retail sales, housing prices, etc. are all fine. Weekly jobless claims hit an 14-year low last week.

Nothing in the economy that I can see is screaming dis-inflation, other than CPI and (potentially) the yield curve, which has flattened. But, I believe what’s going on in the bond market is a confluence of the short end selling off in anticipation of the Fed Funds hike next year (so short term rates go up), and the long end rallying as European money flows into Treasuries given their relative value (so long rates decline, flattening the yield curve). If we see a global deflation/depression, then obviously the U.S. won’t be immune, but my point here is to show the difference between real deflation, and commodity price-led dis-inflation.

Bottom line, there is a silver lining to this commodity-led dis-inflation, as it’s a positive for the U.S. consumer. And, over the next few days, we’re going to be laying out a case as to why we think a theme for the remainder of the year is the “return of the U.S. consumer” and why consumer-related stocks (finance companies and select retailers) can outperform if the broader market stabilizes.

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Weekly Economic Cheat Sheet

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Last Week

We got a lot of data and central bank speak last week, but not a lot changed from a macro standpoint—except we were reminded that the U.S. economic rebound remains very much intact, despite mixed data. And, that was an incremental positive late in the week.

Despite that strong finish, things were ugly to start last week. Retail sales slightly missed expectations, falling     -0.3% vs. (E) -0.1%. The “control” group, which is retail sales less autos, gasoline and building materials, met expectations, declining -0.2%. But the previous month was revised lower, from a +0.4% gain to just a +0.2% gain.

Also early last week Empire State manufacturing, which is the first data point from October, plunged, dropping 6.17 vs. (E) 20.50. New orders, the leading indicator in the report, went negative for the first time in months.

And, despite retail sales being just a small miss and Empire State being historically volatile and not very correlated to national manufacturing activity—in a market that was nervous about growth everywhere—these disappointing reports definitely contributed to the stock market declines, as people (inappropriately) began to get nervous about U.S. growth.

But, the data late in the week helped calm some nerves. Industrial production beat expectations (up +1% vs. (E) +0.4%), the manufacturing subcomponent (which is the important part of the release) was a slight beat, and Philly Fed stayed strong (20.7 vs. (E) 20.0) and importantly contradicted and potentially invalidated the bad Empire State report. Finally, weekly jobless claims plunged to a 14-year low, which helped sentiment.

Again, bottom line was the data were mixed and the negative market reaction to the early-week “misses” was more a reflection of overall nervousness—not that the data were that “bad.“

Looking at the Fed, there was a lot made about “dovish” comments by Bullard and Williams (especially the Bullard comments).

But, neither one reflects the “core” of the FOMC. Although Fed Funds futures continue to push out the expected date of the first rate hike (now December 2015), the Fed will almost certainly end QE at the meeting next week.

This Week

This week is all about the October global flash PMIs, plain and simple. Chinese numbers come Wednesday night, while European and U.S. numbers come Thursday morning. Given that worry about global growth is the main negative influence on markets right now, these numbers are the next major catalysts for markets.

In China, the main focus is whether the flash PMIs can hold 50 (if they can, it’ll be a mild positive). In Europe, it’s the same question (can they hold 50?). Sentiment is so negative toward Europe right now, it’ll take a pretty bad number to make the outlook there materially worse. Finally in the U.S., the market will be looking for further evidence that, despite global issues and a stronger dollar, the manufacturing sector is continuing to expand at a decent pace.

After the flash PMIs, the next most important number to watch is the September CPI, out Wednesday. As you know, growth and dis-inflation are the two concerns in the market right now. Obviously the PMIs give us a glimpse into growth, and the CPI will give us a glimpse into the dis-inflation. A bounce back toward that 2.0% yoy increase in core CPI will be very welcomed by the market, if it occurs.

Third in importance this week are the Chinese economic data coming tonight: GDP, IP and Retail Sales. China’s been put slightly to the back burner with all this Europe worry, but growth there needs to maintain pace. If concern grows that China may not be able to maintain 7.0% annual GDP growth, this will be an added negative on the market.

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Greek Bond Yields Surge

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Greek Bonds

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What Is Happening With Oil?

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What Is Happening With Oil?

Oil collapsed further yesterday, dropping all the way to the low-$81 level. We and others have been pointing to the decline in oil as a potentially worrisome sign about the state of global growth, but you don’t have to work on a physical oil desk to figure out that, with oil falling through the floor, something else is going on here.

Both supply and demand influences are pushing oil prices lower.

On the demand side, foreign oil demand is falling. Yesterday, the International Energy Administration (IEA) significantly reduced expected oil demand growth for 2014—down to 700K barrels per day, from the previous 900K b/d. Although they kept 2015 demand growth estimates unchanged, it’s still a large reduction.

The main reason behind that demand-growth reduction is a drop in economic activity in Asia (mostly China) and Europe. Both economies are losing positive momentum (one slowly, one quickly), but these aren’t exactly new facts, and this demand reduction by itself isn’t responsible for the sharp drop in WTI crude prices.

There is also a significant supply aspect to this drop, but likely not the one you think. Simply put, OPEC is starting to fracture, and it is sending Brent crude, which is what’s traded globally, falling sharply. Last month, despite falling prices, OPEC increased production to a 13-month high, led by Saudi Arabia. In addition, Saudi Arabia is now cutting prices to multi-year lows for Asian and European buyers to maintain market share. And, it’s sparked a bit of a price war. Over the last week, Saudi Arabia, Iraq and Iran have all cut prices to buyers to try and compete on market share, and that is driving the price of Brent crude sharply lower (from $113 to $84.50 over the last 3 ½ months, or a -25% drop).

So, this recent plunge in oil prices has largely been a Brent crude-led phenomenon.

That’s important, because our firm and others are trying to figure out if the plunge in WTI crude prices (which is produced here in the U.S.) is reflecting a slowing of our economy, and basically the answer is “no.” WTI has fallen in sympathy with Brent crude, not because U.S. demand for oil is falling. U.S. demand isn’t falling – it’s still sitting basically near all-time highs.

Now, the direction of oil prices is very important to the stock market on a sentiment basis, so I’m not saying we can discount this plunge. And, I do not believe stocks will bottom until oil can stabilize.

But – in addressing the important fundamental question of whether or not the plunge in oil is a warning sign on the U.S. economy, the answer is “no.” It’s more a sign of dysfunction at OPEC, which could be a virtuous thing down the road.

Finally, the logical question then is, “Are oil stocks a buy here?” No, I don’t think yet, as the chances of a further decline in oil prices are high. But, certain sectors of that market (low-cost, lower-leveraged domestic oil and natural gas producers, and select oil service stocks) will be fantastic buys. But we’ve got to be patient and let this OPEC spat settle itself out – because if they want to drive oil lower, they will continue to succeed.

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Your Weekly Economic Cheat Sheet

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Last Week

The focus of the global economy shifted entirely to Europe last week, and the continued lackluster economic numbers were among the main reasons we saw such massive volatility and selling in risk assets. At the moment, U.S. and Chinese data are firmly in the backseat (barring any major disappointments).

Specifically within Europe, focus was on Germany last week and the data simply weren’t good: Monday it was August manufacturers’ orders, which slumped —declining -5.7% vs. (E) -2.5%. Tuesday it was August industrial production, which fell -4% vs. (E) -1.1%). And then Thursday exports dropped -5.8% in August—completing a trifecta of negative data from Germany.

Now, to be fair, August is typically a bad data month in Europe, and especially the export numbers were hurt by the timing of a holiday. But at this point the No. 1 concern for the market is global growth and, specifically, whether Europe is backsliding into a recession. And as Germany goes, so goes Europe. So, the bad data elevated fears about global economy growth.

While the European data were the most important last week, the most followed/anticipated release was the FOMC minutes, which surprised markets by being exceptionally dovish. The main takeaway was the “core” of the Committee appears much more concerned about growth in Europe, global growth and the stronger dollar than most people thought. As a result, they seem to be putting a lot of weight behind these risks, implying they may be more dovish than the market thinks.

Oddly, these “dovish” minutes were somewhat contradicted by FOMC officials’ comments later in the week, as multiple Fed presidents—including former Vice Chair Dudley and current Vice Chair Fischer—implied “lift off” for interest rates remains mid-2015. That muddled message added to the volatility in stocks last week.

Muddled message aside, the market took the Fed is dovish last week, and Fed Fund futures are now pricing in a rate hike sometime in Q4 2015.

Turning to actual data in the U.S., it was sparse but what we got was good: the 4-week moving average for jobless claims fell to an 8-year low, while both the Kansas City Fed Labor Market Index and the new “Labor Market Conditions Index” both showed further improvement in the jobs market (some tried to spin the LMCI as dovish, but it wasn’t).

Finally, Chinese composite PMI slightly missed expectations but remained solidly above 50, and the market largely ignored the release.

Bottom line is the main concern of the market is the health of the global economy, and last week’s data were not reassuring.

This Week

It’s going to be a busy week, as there are multiple reports from all regions of the globe (U.S., Europe and Asia), although as mentioned, the European data will be the most important.

Starting with that, then, we get multiple readings on inflation and growth from Europe.

First, the growth numbers to watch (in order of importance): EMU industrial production comes Thursday (it’s going to be bad—just a question of how bad). The German ZEW Business Survey is released Tuesday night (look at the expectations component), while Italian GDP is released Wednesday (there are fears that Italy is already in a recession).

Turning to inflation, we get final inflation readings for September (we got the “flash” readings two weeks ago). There shouldn’t be any major surprises, but given the concern about deflation, if the flashes are revised down even by just -0.1%, look for that to pressure the market.

Italian CPI comes Tuesday, Germany CPI is released Wednesday, EMU HICP comes Thursday, and French CPI comes Friday.

Again, this is all about Europe at the moment, so any good news on the growth or inflation front will be welcomed by risk assets.

Turning to the U.S., it’s also a busy week. By all accounts, U.S. growth remains “fine,” but this market is unsettled and it needs a confidence boost. Good data this week, especially from Empire State manufacturing and the Philly Fed (Wed/Thurs), could help sentiment. That’s because they are the first look at October data and will remind everyone growth here is still good.

Also on the calendar are retail sales (Wednesday) and industrial production (Thursday), as well as weekly claims and housing starts (Friday). Again, while none of these numbers will change anyone’s outlook on growth for the U.S., they will affect confidence, so good numbers are needed.

Finally turning to China, its trade balance was better than expected, while CPI and PPI are tomorrow. Again, not to be repetitive, but the No. 1 concern is about global growth—if the trade numbers are a disappointment, that’s going to be a headwind.

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What Happened to JNK?

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What Happened to JNK?

Perhaps the most unnerving thing I saw yesterday was the big drop in JNK and rally in EUM. Given what the Fed did Wednesday, that is the exact opposite of what should have happened. And, this tells me yesterday’s sell-off was a lot more about escalating concerns about Europe and growth than dis-inflation.

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The FOMC Minutes Explained

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FOMC Minutes

The minutes were obviously dovish, given the stock market surge, dollar decline and bond rally. They were taken as dovish for three primary reasons:

  • First, the FOMC voiced considerable concern about the state of the global economy and the potential negative impact on our economy.
  • Second, the strengthening dollar was expressly cited as a potential headwind to growth and to the Fed meeting its inflation target of 2.0% (so the dis-inflation we’ve been talking about).
  • Finally, with regard to the FOMC statement, the removal of the “considerable time” phrase (and more broadly, any material alteration of the language of forward guidance) was seen as potentially being interpreted as “hawkish.”

Given the minutes, it was no surprise then that “Considerable Time” and “Significant Underutilization” stayed in the September statement – and it’s clear from the minutes that the FOMC is still much more concerned about the various risks to the recovery. And this is totally trumping any urgency to begin to normalize policy.

The bottom line here is that is would appear the majority of the FOMC is more dovish than we previously believed, and their confidence in the economy remains low. This was a dovish event, and while it doesn’t necessarily mean we’re going to see expectations for the first rate hike pushed out from June 2015, it’s certainly a step in that direction.

From an investment takeaway standpoint, although I don’t think we’re going to see stocks immediately move to new highs, I think we will see money move back into more risky/higher yielding instruments, so as a result if you own SJB I would take at least some profits, and I’m closing out our EUM hedge this morning, as the Fed’s dovish will send money back into lower quality, higher yielding assets in the near term.

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