The Economy: A Look Back and What’s Ahead

Last Week

It was a relatively quiet week economically speaking, and the “highlight” was the Yellen testimony before the Senate Banking Committee.  She was more “dovish” on the margin than generally was expected, although it’s safe to say nothing really new came from the testimony.

Perhaps most importantly, if you only read the transcript or her prepared remarks and the Q-and-A, you might have thought it was Bernanke giving the testimony.

That’s important (and an underappreciated positive) because, from a policy-continuity standpoint, we know what we’re getting with Yellen (Bernanke part two).  We’re in uncharted waters with how the Fed is going to unwind all this stimulus, and it was comforting to the markets last week that Yellen sounded so “Bernanke-like.”

Turing to actual data, we didn’t get much, and what we got was mixed.  The Empire State Manufacturing Survey was a big miss Friday and caused a bit of a “dovish” response in the markets (bonds up, dollar down), although I think that was more trading noise than anything. The Empire State survey did turn negative for the first time since May, and new orders also fell into negative territory.  But, while that is a bit disconcerting, we need to keep in mind that Empire State has been one of the softer regional surveys and hasn’t been very correlated to national manufacturing activity.  So, it really isn’t going to shift any “tapering” expectations.

Also softening the blow of the big Empire State miss was the October industrial production report, which missed on the headline number because of a reduction in utility output, but the more-important manufacturing component met expectations, rising 0.3%.  So, it confirms the good manufacturing PMIs from October, and implies the economy really didn’t take much of a hit from the government shutdown.

Finally, jobless claims missed expectations, and continue to send a “non-confirmation” signal with regard to the labor market.  (Claims aren’t falling the way they should be, given the improvement in the monthly jobs report.)

Bottom line is the economic data last week didn’t change the outlook for Fed tapering (January-March) or alter people’s perception of the economy (still slow growth).  But, importantly, it didn’t give any reason to think the recovery is stalling, either.  So, bottom line is the data and Yellen were a tailwind for stocks last week.

This Week

This week will be much-busier than the past few weeks from an economic-data standpoint.  The date that the Fed starts to taper QE remains the dominant question for the markets, and we should get some further insight this week.

First, Bernanke speaks Tuesday night. He will comment on the economy, so there’s the potential for him to be “dovish” or “hawkish.”  Additionally, we get the Fed minutes from the October meeting.  Remember, this was the meeting that first caused the tapering expectations to shift back from June to the January-March ‘14 time frame—and that was mostly due to the fact that the FOMC didn’t really downgrade its assessment of the economy (which was taken as “hawkish”).  Obviously, the Fed’s outlook for the economy is critical to when they taper QE, so the minutes will be important to getting more insight into the committee’s opinion of the economy.

There’s a lot of important hard data, too.  The global “flash” manufacturing PMIs for November come Wednesday night (China) and Thursday morning (EU and U.S.).  There’s been some concern the global recovery has been stalling lately, so these PMIs will offer more insight into the state of the world economy.

Domestically, we also get retail sales (Wednesday), and they’ll be watched to gauge the state of the consumer heading into the holiday shopping season. (Keep in mind the retailers are at all-time highs, and M earnings last week resulted in an uptick of expectations for holiday spending.)

It’s fair to say that over the past few weeks domestic data has implied the economy may be a bit better than we think, and international data has implied the global economy may not be as healthy as first thought.  Data this week will go a long way toward confirming or rejecting that sentiment.

The Economy: A Look Back and What’s Ahead

Last Week

Economic data last week were stronger than their relatively low expectations, as concerns about the negative effects of the government shutdown had resulted in pretty low expectations for most of October’s economic releases.

And, it would appear that those concerns have been misplaced, because we’re not seeing the drop in economic activity you would think we would have.  At the same time though, while the data is better than depressed expectations, it’s not clear we’re seeing an acceleration of activity, either.

Certainly the highlight last week was the jobs report Friday, which was a solid “beat” vs. pretty depressed expectations.  October payrolls grew by 204K, much more than the 120K expectation, and the revisions to September and August were a positive 60K. (The direction of revisions to prior months can often be a good signal of the overall trend in hiring.)

But, the jobs report was just the highlight of consistently “good” data last week. Third-quarter GDP was 2.8%, higher than the 2.0% expectation, although that number was a bit deceiving as inventories added 0.8% to the report. (So, in reality, real economic growth in Q3 met expectations.) October Non-Manufacturing (or service sector) PMI rose to 55.4, beating expectations, although the new orders component (the leading indicator of the report) declined.  Finally jobless claims declined marginally to the 330K level, which is pretty much where they were in August.

Internationally, last week was also busy.  The highlight overseas was the “surprise” 25-basis-point cut in interest rates by the European Central Bank, which led to a plunge in the euro and a rally in the Dollar Index.  The cut was in response to currently very low inflation across the European Union, which some are fearing might turn into “dis-inflation” if allowed to persist.

Somewhat lost in the ECB and jobs report hysteria was strong economic data from China.  October composite PMIs beat estimates early last week and exports rose more than forecast Friday morning. (Strong exports to Europe are an encouraging sign of a continued economic recovery, not only in Europe but also globally).

The economic data remains very important mainly because of WWFD (What Will the Fed Do?).  In an absolute sense, while last week’s data beat low expectations, it’s still a long way from achieving “escape velocity” for the economy, where we no longer need QE or very, very low interest rates.

But, from a WWFD standpoint, last week’s better-than-expected data furthered the shifting expectations for when the Fed will taper QE, which seems to be the dominant theme in markets these days and the single-biggest influence on the bond market.  Although I don’t think the Fed will taper QE in December, the strong jobs report from Friday did result in January now becoming a strong contender for the first tapering.  But, at this point we need to see follow-through on this stronger-than-expected economic data in November before the consensus shifts from the current March expectation of the first tapering.

This Week

This should be a relatively quiet week on the economic front, especially compared to last week.  The most important event of the week will be the confirmation hearings for presumptive Fed Chair Janet Yellen, which begin Thursday.  There will be plenty of grandstanding and some tough questions and obstacles (in particular from Rand Paul). Despite this, she is widely expected to be confirmed (it would be a shock to the market if she wasn’t).

Looking at the actual hard data coming this week, we get our first look at November data with the Empire State Manufacturing Index on Friday. (Although it’s just one region, markets will be looking for any signs of follow-through from October’s surprisingly strong data.)

Jobless claims and October industrial production will also be watched.  In particular, markets would like to see the weekly claims start to decline and confirm the surprisingly good October jobs report. (Right now it’s a bit of a contradiction, in that claims are at the same level as in August while the monthly jobs report has improved.)

It’s actually a busier week in Europe from a data perspective, and given the ECB’s rate cut last week and growing concerns about dis-inflation, data there will be watched closely to see if the fledgling economic recovery is still intact.  HICP (the EU equivalent to our CPI) will be released Friday, and markets will be looking to see if there is any uptick in this final reading from the “flash” reading of two weeks ago.  It was the very low “flash” HICP reading that was really the big catalyst behind the ECB cutting rates, as it’s starting to flash a “deflation” warning sign.

 

Three Reasons the Fed Won’t Taper QE in December (Despite Today’s Jobs Report)

This morning’s jobs report was certainly a positive surprise, but despite the fact that the bond market is getting hit hard, I’m not entirely sure that this report pulls forward any Fed tapering from the current March expectations.

First, despite the strong October print, the rolling six month average of the jobs report (which gives a better picture of the labor market) is still just 176k, which is below where the average was in June and well below the 200k+ that most think is necessary for the Fed to start tapering QE.

Second, although it was largely ignored with all the jobs report hysteria this morning, there was another important economic report released at 8:30 AM – Personal Income and Spending.  Contained in that report is something called the Core Price Index, which is the Fed’s preferred measure of inflation.  And, it didn’t change much – the September Core PCE Price Index rose just 0.1% in September, and year over year is up just 1.2%,which is the same level as August, well below the Fed 2.0% target.  Earlier this week Fed President Bullard said they were in no rush to taper QE because inflation is low – and clearly that trend hasn’t changed.

Finally, one of the reasons that the Fed chose not to taper QE in September was because of the rise in interest rates ahead of that meeting..  The Fed saw those increases in interest rates as a threat to the economic recovery.  Well, since the FOMC meeting last week, in just over 7 days the yield on the 10 year Treasury has risen from 2.47% to 2.74%, a one month high.  If rates keep rising into December, that will deter the Fed from tapering QE once again.

Instead of playing the guessing game of “taper vs. no taper,” I think one best ways to play the current environment is to revisit a trade I’ve been on top of since last December – long Japanese stocks/Short the Yen.  To me, the clear takeaway from today’s Report is we won’t see a material decline in the dollar any time soon, and I believe one of the best ways to play that is by getting long Japanese stocks via DXJ or short the yen via YCS.

Regardless of whether the Fed tapers or not, we likely won’t see any material US Dollar weakness over the coming months, and that should mean a resumption of the downtrend in the yen, and a rise in Japanese stocks.

SevensReport10.8

As I’ve been saying in recent editions of The 7:00’s Report, the yen has been held up by various “one offs” over the past few months:  The government shutdown, the spike in SHIBOR rates, and the plunge in the dollar after the “no taper” surprise.  But, with those events removed, I believe the yen decline will resume, as a yen below 100/dollar simply won’t result in the kind of economic growth PM Abe and the BOJ are striving for.  They want the yen lower, and generally speaking you always want to be on the same side of the trade as a countries central bank.

The Economy: A Look Back and What’s Ahead

Last Week

The most important thing that happened last week economically was that expectations for Fed tapering of QE were pulled forward a bit—from the previous “consensus” of mid-2014 to the early part of 2014— thanks mainly to an FOMC statement that wasn’t as “dovish” as expected plus a Jon Hilsenrath sentence that stated a December taper remains “on the table.”  Interestingly, this change in expectation came despite decidedly mixed economic data.

Starting with the FOMC statement from last Wednesday, it seems most are calling it slightly “hawkish,” but that’s really only because it didn’t feature any material downgrade of the economy in the commentary (as was widely expected).

Looking at the actual statement, it was hardly changed from September, although the two important takeaways were that the FOMC noted the labor market had slid a bit and also somewhat celebrated that interest rates had declined.

Both changes are, on balance, slightly “dovish.” So even though the market didn’t trade that way, I think the meeting didn’t really change anything with regard to when the Fed will taper QE (and certainly didn’t materially pull it forward, as they remain data-dependent).

Outside of the FOMC, as I said, economic data was at best mixed. Early in the week, things looked somewhat grim:

  • The manufacturing indicator of the September industrial production report was weak and August was revised down.
  • Pending home sales dropped 5.6%, the biggest monthly drop since April 2011.
  • The October ADP employment report missed expectations at just 130K jobs added, and the September figure was revised lower as well.

These reports were especially disconcerting because they implied the economy was seeing a slowing of growth before the government shutdown, as this data was from before October.

Later in the week, though, the data surprisingly turned better.  Chicago PMI, which isn’t usually a watched number, caught people’s attention. It exploded to a multi-year high, and the details of the report were equally strong.  And, on Friday, the national ISM manufacturing PMI increased 0.2 to 54.4, beating expectations of a small decline.  So, if anything, the beginning of the week was considered “dovish” but turned “hawkish” as the week went on.

I’m spending time talking about how the market interprets the data (hawkishly or dovishly) because right now it’s as important as the actual data itself.  As was the case prior to the government shutdown, the question of “When will the Fed taper QE?” remains the single biggest driving factor in the markets (for bonds, the dollar, commodities and equities).

The first three assets have traded (and will trade more immediately) to shifting “tapering” expectations, as we saw last week.  But, although stocks won’t trade off daily shifting of tapering expectations, it very much remains to be seen if stocks can rally in a “QE-less” world.

Ultimately, if the Fed has to taper QE and the economy isn’t very strong, that could usher in “stagflation” and be a rally-killer.  So when and how this whole thing works out remains the key to any medium-term outlook for equities.

This Week

There aren’t many economic releases this week, but the October jobs report is Friday and clearly that’s important from a WWFD (What Will the Fed Do?) standpoint, although this jobs report will be taken with a hefty grain of salt given the government shutdown.

Also on Friday is the “Personal Income and Outlays” report, which is particularly important because it gives us a look at the Fed’s preferred measure of inflation—the core Personal Consumption Expenditures deflator.  Stubbornly low inflation has been a growing concern of the Fed’s for some time, so a weak core PCE deflator will be “dovish.”

Also on the calendar this week is the first look at Q3 GDP on Thursday (expectations are for close to 2%), weekly jobless claims (this report will be overshadowed by the  October report Friday) and ISM Non-Manufacturing (or service sector) PMIs (Tuesday).  Really, though, those reports won’t move the needle much with regard to WWFD. (GDP is more a media favorite than anything anyone really trades off of.)

Outside of the jobs report, arguably the other “highlight” of the week will be the ECB meeting Thursday.  The euro plunged last week (and the Dollar Index spiked) on a very weak inflation reading, and speculation is high as to whether the ECB will cut rates to fend off a hint of deflation potentially hitting the “Continent.”  Given the falling euro’s effect on the Dollar Index, this meeting has implications for the commodity markets particularly.

The Economy: A Look Back and What’s Ahead

Last Week

With the drama in Washington successfully postponed, focus last week turned to the question of “How much damage has the shutdown and drama done to the economy?”

While it’s still early, based on last week’s data, the answer so far is “definitely some” because economic data almost universally missed expectations last week. Perhaps more disconcerting than that, though, were the weak jobs and durable goods reports. These are from September (and pre-shutdown), and they imply that the economy may have been losing momentum before the last round of drama in Washington.

With regard to WWFD (what will the Fed do), the soft data last week further solidified March 2014 as the “consensus” date for the first tapering of QE. However, many analysts think it could come as soon as January, depending on the data.  But, from a Fed standpoint, last week was marginally “dovish.”

The September jobs report showed 148K jobs added, with a net 9K positive revision for July and August, which was well-below expectations of 180K.  As mentioned,  this data was compiled before the shutdown, and the bottom line is that the jobs market remains largely stuck in neutral—adding between 150K and 200K jobs/month, as it has been doing over the past quarter.  Progress in the labor market has clearly stalled.

Manufacturing data was also disappointing. October flash manufacturing PMI, which is inclusive of the shutdown, missed expectations. New orders, the leading indicator in the report, fell to a multi-month low.  Although, importantly, the PMI did stay above 50—signaling continued expansion in the manufacturing sector—the pace of that expansion is slowing.

On Friday, the September durable goods report was also weak.  The headline number was a beat, but as always with durable goods, you can ignore the headline and instead look at the “New Orders for Non-Defense Capital Goods Excluding Aircraft.”  NDCGXA fell 1.1% in September (so, before the shutdown). This will raise some concerns that businesses are now starting to reduce spending and investment amidst all this uncertainty, which puts our 2% growth rate at risk.

Bottom line is the economy remains a major concern, and also the single-most-important catalyst for higher stock prices. (More QE won’t make the market go substantially higher; we need real economic growth.)

Interestingly, the stock market didn’t sell off in reaction to last week’s data, and that’s because it’s impossible to try and figure out how much of the weakness in the economic data was just temporary (because of the shutdown) and what was more structural.

And, we can expect the market to continue to largely “ignore” weak data for the next few weeks, given the noise from the shutdown.

The economy returning to above-trend growth (meaning 3%-plus) remains the key to substantially higher equity prices. If the data stays soft into December, the dynamic in the market will change, and not for the better.

This Week

This week’s highlight is undoubtedly the FOMC meeting Tuesday/Wednesday.  I’ll give a more in-depth preview of what’s expected, but at this point no one expects any tapering of QE, and in all likelihood this should be a relative non-event.

I would expect the Fed’s commentary on the economy will be downgraded given the government shutdown, and on balance the risk is that the meeting is perceived as “dovish.” But really, the only thing that people are trying to figure out is when will the Fed first taper. Given the data, it looks like the answer is “not in 2013.”

Away from the Fed, we get several key economic reports. These will be watched, but don’t expect the market to necessarily trade off them like we’d normally see, given the “noise” in the data and all that’s happened in the economy since September.

We get more insight into the state of the manufacturing industry with industrial production this morning and the final Institute for Supply Management’s manufacturing PMIs Friday.  In light of the soft durable goods report (and flash PMI), these pieces of data will be watched to see if they confirm the slowing growth we’ve seen in other recent manufacturing and business investment reports.

On the consumer side, September retail sales will be released tomorrow morning.  Recent data have implied consumer spending is slowing a bit, but consumer confidence readings in the wake of the shutdown have plunged lately.

This will keep concerns high that the consumer might materially slow down as we approach the holiday season.  It hasn’t happened yet, but that’s a legitimate concern for the market, because as the American consumer goes, so goes the U.S. economy.

Finally, this week would normally be “jobs week” but because of the shutdown, the October jobs report has been delayed till next week.  But, we do get the ADP jobs report Wednesday, so look for that number to potentially move markets more so than normal. That release will include the period of the October shutdown, and will offer a preview of how much damage was done to the labor market by the shutdown.

 

 

Sevens Report Chart of the Day: Chinese Markets Gap Lower

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Is Crude Oil Forecasting an Economic Slowdown?

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Current Economic Overview and Three Key Questions Facing the Market

Last Week

Although last week was dominated by the temporary resolution in Washington, there were two important takeaways from the domestic and global economic data that was released.

First, last week was important with regard to Chinese data and their economy, and largely the results met expectations (which is a positive).  Q3 GDP met expectations, rising 7.8%.

The Consumer Price Index was a touch higher, but mostly because of vegetable prices. Importantly, it’s not high enough to have the Chinese government start to remove economic stimulus.

Plus, industrial production and retail sales data for September met expectations. Finally, commodity imports were surprisingly strong, implying there is underlying strength in the Chinese economy.

From a market standpoint, this data was important because it further reassures the markets that the Chinese economy isn’t seeing a significant slowdown in the pace of growth. (Meaning ,there is little risk of a Chinese economic “hard landing.”) From an investment perspective, it implies the “global economic recovery” investment thesis remains valid, which is positive for cyclical stocks, multi-national industrials, global industrial miners and transportation stocks.

Second, here in the U.S., we got our first look at the state of the economy in October via the Empire State and Philly Fed reports. The takeaway is that the shenanigans in Washington did have a negative effect in the near term, but the manufacturers surveyed in the reports continued to see positive momentum building beyond the temporary government shutdown.  We know that because, while both headline indices declined from September levels, the new orders index (a leading indicator) rose for both reports—again implying that the government shutdown hasn’t significantly altered expectations of activity in the future.

So, to word it simply: For the next several weeks, the market will be wondering: “How Much Damage Did Washington Do?”

And, although it’s still early, both the Empire State and Philly Fes surveys gave us an answer of “some, but not a lot.”

If that answer proves valid, then that’s bullish for risk assets into year-end.

This Week

This week will be very important in providing more insight into the three key questions before the market:  1.  “How much damage did Washington do to the U.S. economy?”  2.  “Is the global economic recovery continuing or losing some steam?” and 3.  “Will the Fed taper in December?”

Right now the market “expects” the data to reflect these answers:  1.  “Some but not much.”  2.  “Yes it’s continuing but with a small loss of momentum” and 3.  “No, unless the economic data comes in much, much better than expected.”

First, the September jobs report will be released tomorrow morning at 8:30 a.m.  Right now the expectation is for around 180K jobs added, but make sure to watch the revisions.

The August number was very low (153K), almost borderline shockingly low, and there is some expectation that this number may be revised significantly higher.  So, point being, look at the revisions to the August data as much as you do the headline number for clues as to how the market will trade.

Second, global “flash” Purchasing Managers’ Indexes for October hit Wednesday night (China) and Thursday morning (Europe & U.S.).  Obviously this is the next key round of data for the “global economic recovery” thesis.

Additionally, the flash PMIs (which are collected by the private firm Markit and will reflect activity throughout the government shutdown) will give a lot more insight into the “how much damage has been done to the economy” question

Third, we get the latest look into the health of the housing market via Existing Home Sales (today) and New Home Sales (Thursday).  Obviously a recovering housing market remains a key driver for the growing economy. And, as has been the case, investors will be looking for clues about the effects of higher interest rates on home purchases.  Incidentally banks, in their earnings calls, have had generally “OK” commentary toward mortgages and housing, so most expect these numbers to reflect a bit more slowing, but with the recovery still intact.

The Economy: A Look Back and What’s Ahead

Last Week

The ongoing government shutdown delayed several pieces of data last week, so weekly jobless claims and the Federal Open Market Committee minutes were the only two reports released.

Starting with the Sept. 18 FOMC meeting minutes, they revealed, as expected, a divided Fed about when and how to taper QE.  The decision not to taper QE was a “close call,” as multiple Fed governors had said in follow-up speeches since the meeting.  The market initially took the minutes as a touch “hawkish” based on a sentence that stated most governors still expected tapering this year. But the “hawkish” response from the market was short-lived, as clearly a lot has happened since the September meeting, and virtually none of it has been good—with the exception of President Obama formally nominating Vice Chair Janet Yellen to replace Chairman Ben Bernanke, as was widely expected.

Jobless claims saw a huge jump last Thursday as governmental incompetence trickled down to the state level.  California, apparently because of computer upgrades, had a backlog of unreported claims from the last several weeks. (This was despite the Department of Labor saying that, for two weeks, the data has been “clean.”)

Initial claims jumped by more than 60K due to the backlog, although the takeaway is the four-week moving average is basically where it was one month ago (in the mid-320K range).  This means the multi-year dip we saw in claims over the past three weeks was a mirage, and the labor market remains basically unchanged since last month (meaning, we aren’t seeing any marginal improvement).

The bottom line of the data last week was that—taken in the context of the Washington fiscal drama and negative effect of the government shutdown on the economy—expectations for QE tapering are now rapidly shifting to early ‘14, in either January of March, and the prospects for a December taper are quickly falling to near-zero.

This Week

Thankfully the most-important economic release this week won’t be delayed because of the shutdown.  Most important to the markets this week is data from China.

Over the weekend, we learned exports from China dropped much more than expected in September—falling 0.3% vs. (E) 5.8% increase.  It was already an important week of data from China, but that “miss” will have people even more focused on the releases.

Third-quarter GDP, Industrial Production and Retail Sales are all released Thursday night.  It goes without saying that Chinese economic growth stabilizing around the 7.5% GDP mark is essential to the “global recovery” investment thesis, so it’ll be important that Chinese data is close to estimates.

Domestically, the Empire State and Philly manufacturing surveys (Tuesday & Thursday, respectively) will give us the first look into economic activity in October, and clearly people will be watching to see if there has been any negative effect on the manufacturing recovery given the drama in Washington.  It’ll only be an anecdotal look, but in particular keep an eye on the Philly Fed, as recently it’s been a good predictor of the national Institute for Supply Management’s manufacturing PMIs.  So, expect a negative reaction from the market if that number is weak.

Elsewhere, the Fed Beige Book will be released Wednesday. Although, given the nature of the analysis and the government shutdown, this report—unless it’s shockingly negative (which is a very low probability)—shouldn’t be a market-mover.  Finally, weekly jobless claims, given last week’s volatility, will again be watched, in particular to make sure they come back down after the big jump from the California backlog.

The shutdown will again delay several pieces of data this week. Industrial production, the Consumer Price Index and housing starts continue to be on hold until further notice.