Archive for category: Investing

Last Week

Global economic data were again mildly disappointing last week, but they didn’t turn negative. Against the backdrop of global central banks becoming “more” accommodative, the data were good enough not to change the current outlook that the global recovery is (barely) continuing—but that outlook is enough to hold stocks up at current levels.

From a stock standpoint, global data are more important than U.S. data in the near term because everyone is comfortable the U.S. economy is getting better. How much better can be debated, but there’s ample evidence to show it’s gaining momentum.

The same can’t be said for the global economy. Last week’s manufacturing and composite PMIs from China and Europe were slightly disappointing in that they missed expectations. No global readings were above 52 (keep in mind 50 means no growth; even 52 represents slow growth), so none of the numbers were “good.”

But, they did stay above 50 and the important distinction is that the global economy is still recovering (albeit slowly). The sell-off in late September/early October was partially predicated on the idea the global recovery was failing. Last week’s numbers further refuted this concern; that’s the important takeaway (stocks can hold these levels as long as the global recovery isn’t failing).

Here in the U.S., manufacturing data and jobs were in focus. The October PMIs were generally fine, in that they showed the manufacturing and service sector continuing to expand at a good pace (both were above 57).

Turning to the jobs report, it was also generally in-line, with 212K job adds. This missed expectations of 240K but closely tracked the rolling 12-month average of 222K. So, it was in the middle of our “just right” range.

But, I do want to point out that the jobs report was a bit more “hawkish” than the market reaction. Importantly, the unemployment rate fell to 5.8%, which is not very close to the 5.5% “normal” unemployment rate. Also, U-6, which considers underemployment, dropped to 11.5% from 11.8%—the lowest levels in several years.

The “dovish” reaction came from the wage data, as wages rose 2.0% yoy (above 2.2% is “hawkish.”) But, keep in mind wages always lag an improving jobs market. While this report won’t cause expectations of the first rate hike to be pulled forward, it does solidify June as a target date for the first hike, and I’m not sure the bond market accurately reflected that on Friday.

Finally, the Fed and BOJ were quiet last week while the BOE made no changes to rates or policies (as expected). The ECB was the highlight of the week, and while it didn’t change any policies, Draghi did as good a job as possible of “talking” dovish. He refuted various accounts of infighting at the ECB, explicitly saying economic risks were to the downside. He added that ECB staff are now researching alternative ways to stimulate the economy (which means corporate bond purchases and QE).

Bottom line, the ECB continues to slouch toward QE and more stimulus. While “euro bulls” wish they would hurry, the important thing is they are headed in the right direction. The ECB this week reinforced my bullish Europe thesis.

This Week

This week will be very quiet. First, keep in mind bonds and banks are closed Tuesday for Veterans Day. Second, there is really only one economic report of note this week domestically, and that’s Retail Sales (Friday). There is now a month-plus of lower oil prices in the economy, so it’ll be important to see retail sales (ex gasoline) increase if the U.S. consumer is really starting to come out of his/her shell.

Internationally, the latest round of Chinese economic data Thursday night (retail sales/industrial production) is obviously important from a global growth standpoint (these numbers need to continue to show incremental progress).

In Europe, the Bank of England’s inflation report Wednesday is the highlight, but that really will only affect the pound. And, given the precipitous decline in the pound the last few weeks (it hit new 52-week lows vs. the dollar last week) there is the chance for a “hawkish” surprise. But that won’t be a reason to be enthusiastically long the pound unless it’s a real shocker.

Finally, the flash estimates for Q3 European GDP come Friday morning, and like the Chinese data earlier this week, it’s important from a “Is the global recovery ongoing?” standpoint.

Bottom line, while there are numbers to watch this week (again, the Chinese data is the uncontested highlight) nothing this week should make anyone’s outlook on the global economy materially worse or better, even with some big surprises.

This was a look at the economic section of today’s Sevens Report. To continue reading today’s sevens report, simply sign up for a Free Trial on the right hand side of this page.

Jobs Report Preview

The importance of these jobs reports from a Fed policy standpoint is on the rise, and the risk to stocks is for the numbers to run too “hot” and pull forward Fed interest rate increases.

The “Too Hot” Scenario: >300K job gains. A jobs number this strong would likely result in a pulling forward of rate increase expectations, and the markets would react hawkishly: Stocks, bonds and commodities would all decline, the U.S. dollar would continue to rally.

The “Just Right” Scenario: 180K – 290K job gains. This is the “sweet spot” for this report, as it implies a still-healing labor market but not one that’s so strong it would pull forward the date of the first rate hike. A number in this range shouldn’t elicit too much of a market reaction as it’s mostly priced in.

The “Too Cold” Scenario: <180k job gains. Given all the other employment metrics released in October, the chances of this number being a big miss are very remote.

If we get a number below 180K, expect a mildly “dovish” reaction—stocks and the dollar will decline, while bonds and commodities will rally. But, even if this is a big miss, don’t expect markets to move too much as it’ll probably be discounted as a statistical aberration.

Wage Increases and the Unemployment Rate: >2.2% and <5.9% will be taken as “hawkish.”

Given the risk is skewed to the “hawkish” side of things for this meeting, changes in the year-over-year wage gains and unemployment rate are equally as important as the headline jobs number.

An annual wage increase over 2.2% would be considered “hawkish” and elicit a “hawkish” reaction from markets, while a drop in the unemployment rate below 5.9% would also be “hawkish.”

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ISM Non-Manufacturing  PMI

• October ISM Non-Manufacturing PMI was 57.1 vs. (E) 58.0.

Takeaway

The non-manufacturing (or service sector) October PMI was a slight disappointment as it declined from a 58.6 reading in September, and the details were also a bit underwhelming. New orders (the leading indicator of the report) fell 1.9 points to 59.1, the lowest reading since April. And, this weakness was confirmed by the private firm Markit’s service sector PMI, which also fell to 57.1. The one bright spot was the employment component, which rose to 59.6 from 58.5 in September, a multi-month high (which bodes well for the jobs number Friday).

But, while a slight moderation, the bottom line here is the absolute level of activity of the service sector (which is by far the larger portion of the economy compared to manufacturing) remains strong and comfortably above 50. There is some slight evidence that, on the margin, the pace of activity in the U.S. economy is moderating slightly, but the recovery remains very much intact, and the economy remains generally supportive of stock prices.

 

Boring But Important: Employment Cost Index

Part of our job is to watch indicators that are important and often overlooked by financial media and other research sites.

To that end, an overlooked but important number came Friday via the Employment Cost Index (ECI), a quarterly reading of employment costs and wage trends. The ECI rose +0.7% in Q3 vs. (E) +0.5%, and is up +2.2% year-over-year. Specifically the wages and salary component rose +0.8% q/q, the largest quarterly gain since ‘08.

A similar jump in wages and employment costs caught the market off-guard in July and led to a temporary spike higher in yields. That didn’t happen Friday because, as we’ve noted here, Treasuries remain more focused on international markets than domestic economics in the short term. But, it is important to note that for the 2nd and 3rd quarters of 2014, the annualized increase of employment costs was +2.8%, the highest since 2008.

This is important from a Fed standpoint because it means the Fed is closer to achieving its goal of repairing the labor market. Stagnant wages, despite improvement in the unemployment rate, have been a thorn in the Fed’s side for years (it’s the “underutilization” the Fed keeps referencing).

If that trend is ending (and the ECI implies it is) then that is potentially “hawkish” down the road, because it means the Fed won’t have to keep rates this low to support the labor market that much longer.

Additionally, while all the world seems consumed by commodity-price-driven “dis-inflation,” wage inflation begets real inflation, and this number further refutes the “dis-inflation” argument. Point being, an uptick in wages is dis-inflation, regardless of what commodities are doing.

The “need to know” on this is that while it’s certainly not going to make the Fed more “hawkish” from a policy standpoint in the near term, wage inflation is bottoming. In the coming quarters (meaning into early ‘15), if wage inflation continues to increase, that may make the Fed get more hawkish than current expectations. This is an indicator we need to watch carefully in early ‘15, as the potential for a hawkish surprise from ECI is rising.

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Global Manufacturing PMIs

• Chinese Official PMI slid to 50.8 vs. (E) 51.2.
• German Manufacturing PMI was 51.4 vs. (E) 51.8.
• U.S. ISM Manufacturing PMI rose to 59.0 vs. (E) 56.0.

Takeaway

Although slightly disappointing, the final October manufacturing PMIs generally supported the fact that global economic growth wasn’t as bad as feared in October.

Importantly, while the Chinese, German and EMU PMIs declined slightly vs. expectations, they all stayed above 50—implying the global manufacturing recovery is still ongoing. That’s enough to keep the worries about global growth at bay for the next few weeks.

Here in the U.S., the manufacturing sector remains at the forefront of domestic economic growth. The headline was a beat and the details of the report were also strong, with New Orders rising 5.8 percentage points m/m to 65.8 in October while the Employment component also increased by 0.9% to 55.5%.

Oddly, though, there was a divergence between the ISM number and the private firm Markit manufacturing PMI (they both produce manufacturing PMIs). The Markit number declined to a 3-month low of 55.9, missing estimates of 56.1. But, both reports did indicate solid growth in the manufacturing sector, with indices remaining well above the expansion threshold level of 50. Bottom line is the divergence is a bit odd but doesn’t undermine the data, as the manufacturing sector is in good shape and will continue to support the market. If anything, the divergence just made the November report a bit more interesting.

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