Archive for category: Investing

Last Week

The were multiple and varied important economic data points released last week, but the general takeaway is this:  While the global economic recovery is clearly losing steam, data in the U.S. consistently show the recovery is not only solid but also gaining momentum. This dichotomy between the direction of the U.S. economy and other major global economies (Japan, Europe and China) is accelerating and will continue to have implications across asset classes (and it’s the main reason the greenback continues to surge).

Looking then to the specific data from last week, focus was on last Friday’s jobs report (which was almost perfectly “Goldilocks”), but the most important numbers last week were the global September PMIs.

By now you know they were universally disappointing, led by a surprise drop in the German reading to 49.9.  The broader EMU number wasn’t much better and is teetering above 50 (50.3, to be exact), while the official government number from China also barely stayed above 50.  Even the U.S. PMI missed at 56.6, but on an absolute basis that’s still pretty strong, so it isn’t really that much of a negative.

Bottom line with the September PMIs (ex-U.S.) was that they were weak. They imply the EU economy is further decelerating and that it’s inching closer to a triple-dip recession. Meanwhile both Japan and China are seeing the rate of growth slow—raising fears of a potential “hard landing,” although that’s a bit premature.  Regardless, though, the data last week demonstrated that global growth is diminishing, and that’s a risk for global stock prices if it continues.

Staying global for a moment, the second most important thing that happened last week was the ECB meeting, which was initially taken as “disappointing” mainly because ECB President Mario Draghi didn’t further (and more forcefully) allude to “QE.”  Also, Bloomberg reported over the weekend there were three dissents to the measures announced—so while they were passed, that’s not going to help alleviate concerns the ECB isn’t truly committed to doing what’s necessary in Europe (i.e., QE).

But, to focus for a moment on what the plans they actually implemented (which is more important than the soft analysis), the ECB did include “retained” covered bonds in its “private market” QE program, which begins later this month.

This means the “private market” QE program, which is the ECB buying Asset-Backed Securities and covered bonds, is going to be bigger than initially thought.  That’s important because size matters here — the bigger the  private-market QE program, the larger the expansion of  the ECB balance sheet.  And, the larger the balance sheet expansion, the more help should be provided to the economy … and the greater the upward pressure on Europe.  So, although the reaction was one of disappointment, the news from the ECB was bullish for European stocks beyond the very near term.

Finally, turning to the jobs report, it was almost perfectly “Goldilocks.”  The headline number was a strong beat (248K) and we also encouragingly saw positive revisions to August (from 142K to 180K).  So, clearly this number reflects that the jobs market continues to improve.  But, what made the number “Goldilocks” was the fact that year-over-year wages increased only 2.0%, which implies the pop in wage inflation we saw earlier this year hasn’t stuck. As such, the jobs number won’t result in more pressure on the Fed (because the jobs gains are resulting in wage inflation).  Also, the unemployment rate fell to 5.9% but that’s because of the participation rate—not substantial job gains.

So, bottom line is the jobs number was a good report and came at the right time (we needed a reminder that the U.S. recovery is doing fine). But there is enough weakness in the details that this report (wages and the participation rate) that it’s not going to cause the Fed to become incrementally more “hawkish.”

This Week

It’s a very quiet week, economically speaking.  The most important event this week will be the minutes release from the September FOMC meeting (Wednesday).  As usual, the market is going to be looking for any clues as to just how “hawkish” the discussion about policy was at the meeting.  In particular, any sort of commentary on the anticipated pace of interest rate increases will be especially important (remember the “dot” projection for ’15, ’16 and ’17 all increased at this meeting).  So, it’ll be important for stocks that the minutes reflect a “not too hawkish” Fed.

Outside of the FOMC minutes it’s very quiet domestically, as weekly claims is the only other notable number.  Internationally, composite Chinese PMIs are the highlight (Tuesday), while we also get a Bank of England meeting Thursday (there will be no change to policy) and some sporadic second-tier international economic data.  But, nothing released this week should materially alter the economic outlook for Europe, China or Japan, even if there are positive/negative surprises.

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The Key to Europe—the ECB Balance Sheet (What It Means for Stocks and Bonds)

What Happened:  Part of the reason we’ve seen a rally over the past two days in the Treasury market is because of Europe—specifically the “dud” of the first TLTROs late last week.

Not only was demand for the initial offering poor (86.4 billion vs. (E) 150 billion euros), but on Friday European banks actually repaid nearly 19 billion euros worth of the previous LTRO, making the total addition to the ECB balance sheet only about 67 billion (86.4B – 19B)—less than half of the 150 billion the market expected.

Why It’s Important:  The size of the ECB balance sheet is very critical to the economic recovery in Europe.  QE, TLTROs, ABS purchases and all the other acronyms are simply tools being deployed to accomplish the same goal—to get the ECB balance sheet to rise.

The logic goes that if the ECB can expand its balance sheet and pump money into the system, then they should create economic growth. That would in turn create inflation, which would then solve the deflation problem they are currently experiencing.  (That script has “worked” in the US, UK and lately, Japan).

So, to keep things simple, an expanding balance sheet is inflationary and positive for growth, while a contracting balance sheet is deflationary. And as you can see from the chart, the ECB is the only major central bank whose balance sheet has been contracting.

How We Make Money Off It: If the ECB fails to materially expand its balance sheet, then deflation will get a tighter grip on the economy. European bonds will rally like they did for most of this year, and that will put upward pressure on Treasuries—just like it did from March to September.

As the ECB implements these measures (TLTRO, ABS), you will see the market waver in the short term between thinking the measures are working (and the balance sheet expanding, which is Treasury-bearish) and the measures failing (as in the case of last week, which is Treasury-bullish).

Treasuries will be much more sensitive to the short-term data from Europe than stocks.  But importantly, as long as the ECB remains committed to expanding the balance sheet, any short-term rally is “noise” compared to the overall negative trend in bonds.

European stocks should be much less sensitive to short-term fluctuations than bonds.  That’s because, as was the case last week, the failure of the initial TLTRO was just seen as further increasing the odds of QE. The ECB simply cannot fail to increase its balance sheet and spur a recovery—because if they do, it’s very likely the EU would split apart. (Southern European countries are not going to stay in the EU if deflation takes hold—they will break away and devalue their own currencies.)

So, bottom line is this:

“Short bond positions” will see volatility depending on what’s happening with the ECB balance sheet, because it will directly affect Treasuries.  But, the trend should remain lower in bonds as long as the ECB remains committed to balance sheet expansion. So, don’t get spooked by counter-trend rallies.

For “long Europe” equity positions, the trend upward should be more smooth, as stocks are clearly viewing “bad as good” in Europe—as long as the expectation remains that the ECB will eventually do QE.  Point being, the trends (Treasuries down, European stocks up) remains in place despite the fact we’re likely to see some short term counter trend moves.

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Last Week

The calendar was busy, but the only numbers of any real importance last week were the flash global manufacturing PMIs. There were gives and takes, as always, but the bottom line was that they met current market expectations (and as such aren’t rocking the global macro boat).

Growth remained strong in the U.S. While it was a “technical miss” vs. expectations (57.9 vs. (E) 58.1), the September flash PMI was the second-highest ever. So on an absolute basis, it’s still strong.

In Europe, official EMU PMI stayed above 50 (so technically in expansion territory). But, the German number was a big miss (50.3 vs. (E) 51.2), and that number was definitely the biggest disappointment last week.

But, if Germany was the disappointment, then China was the positive surprise. Despite loud “whispers” that PMI would drop below 50, it actually rose slightly. It confirmed what we know about China: Growth isn’t particularly strong, but it’s not about to implode either.

The takeaway from last week was: The U.S. is still strong, China is “OK” and Europe remains in the economic ICU.

This Week

It’s a busy week of data with a large number of reports. While we get insight into virtually every corner of the domestic and global economy this week, the most important numbers to watch will be from Europe.

In order of importance: EMU flash HICP (their CPI) (Tuesday), U.S. jobs report (Friday), ECB decision and press conference (Thursday), global official PMIs (Tuesday night/Wednesday morning), global composite PMIs (Thursday night/Friday morning).

The EMU HICP is the most important number of the week because it’ll offer us the latest insight into whether we are seeing a continued slight moderation of deflation fears in the EU.  Because a “triple-dip” recession in the EU remains the #1 global macro risk to watch, it’s obvious why this inflation reading is so important.

The jobs report here in the U.S. is always important, although honestly it’s not quite as monumental as it has been in the past. Unless it’s another “dud” like August, or a very hot number (say north of 300K) it’s not going to shift expectations for the Fed.  But, it will be important to see a bounce-back and a revision higher to August’s disappointing 142K.  Also keep in mind it’s “jobs week,” so we get ADP Wednesday and claims Thursday.

The ECB meeting Wednesday won’t bring any new policies or interest rate cuts, but the market will be looking for more reassurance from Draghi & Co. about both their willingness to do QE if needed (and it almost certainly will be), and their reaction to the soft TLTRO demand. (If he can make a credible case why he thinks the December offering will be good, that will help market sentiment and be EU-stock-positive, bond-negative.)

The official PMIs are released Tuesday night/Wednesday night, and China’s official government manufacturing PMI will be the most important number to watch. It’s holding on above 50 and if it can confirm the surprise uptick we saw in the Markit flash PMI last week, it’ll help alleviate some nerves about the pace of China’s economic growth. The European and U.S. numbers will obviously be closely watched, but they shouldn’t differ too far from the “flash” readings we got last week. (If there’s a surprise negative revision to the European data, it may weigh on markets a bit, but there are too many other catalysts this week for it to do any major damage.)

Finally, we get the composite global PMIs (so, manufacturing and service sector) Thursday and Friday, and again the market will be looking for confirmation of current expectations:  Chinese economy losing some momentum but still seeing incremental growth, Europe “hanging on,” and the U.S. recovery progressing.  As long as the numbers generally confirm those expectations, don’t expect too much of a market reaction.

But, proving my point it’s a busy week, we also get several other numbers: Personal Income and Outlays will be watched this morning to see if there is a drop in the “core PCE price index” (the Fed’s preferred inflation gauge). Remember, CPI two weeks ago surprisingly dropped. If core PCE confirms this, it may give the Fed some room to stay “dovish” a bit longer than the market may expect. So, there is risk from a Fed expectation standpoint into the number.  We also get more housing data, via Pending Home Sales Tuesday, auto sales Wednesday, and non-manufacturing PMIs Friday.

Japan also has a slew of data out overnight tonight, but the biggest number this week will be the Tankan survey, released tomorrow night.  Worries about a slowing Japanese economy and eventual incremental stimulus have pushed the yen to multi-year lows and the DXJ to near-all-time highs. So, the data need to confirm that we are indeed seeing a slowdown; otherwise we could see a violent (albeit temporary) snapback move in both the yen and DXJ.

Bottom line is this week is busy, but really the key is Europe.  If investors can come away from this week more confident about Europe and the ECB, it’ll become a welcomed tailwind on risk assets (and likely a headwind on Treasuries).

 

The S&P 500 is now down 2.5% from last week’s fresh all time highs, trading well below support at both the recent 1980 level as well as the 50 day moving average (1976).