Archive for category: Investing

Is This As Good As It Gets for the S&P 500?

The outlook for U.S. stocks remains positive, as the “Four Pillars” of the rally remain intact:  Global central bank accommodation (this was mildly solidified last week by the ECB and the soft jobs report), a clear macro-economic horizon (also further solidified by the Ukraine/Russia cease-fire), global economic recovery and reasonable valuations.

But, one characteristic of last week’s market that I didn’t like is there was no real desire for buyers to push stocks higher. The two failed rallies at 2,010 in the SPX are representative of the sentiment that this may be as good as it gets in the U.S:  Economic growth (according to most metrics) is accelerating, but any material improvements will be met with a “hawkish” Fed.  Washington is coming back into focus via the mid-term elections (the absence of any tomfoolery from Washington has been an underappreciated tailwind for the market).  And from a valuation standpoint, even if the economic data stay “Goldilocks,” you’re buying an SPX that is trading at 15.4X 2015 earnings—again not prohibitively expensive, but not cheap, either.

Now, to be clear, I’m not saying there’s anything wrong with the market and/or to de-risk. But unless we get some additional multiple expansion by an uptick in earnings, I’m not sure what else out there is going to carry stocks higher in the near term. So, I think a consolidation/chop sideways is in order.

Adding to this is the growing attractiveness of Europe (and to a lesser extent Asia).  European stocks, while mired in slow growth at the moment, are about to see the implementation of growth-stimulating programs. Meanwhile in Japan and China, both the respective governments and central banks are intent on helping their economies.  And, the above regions trade at a significant discount on a valuation basis compared to the U.S.

So, point being, while I wouldn’t materially decrease U.S. equity allocations, I would point any new or tactical capital toward some other regions (especially Europe) as there is just a lot more room for improvement over there than there is in the U.S. at this moment.

 

ECB Decision

The ECB shocked/surprised markets last week by announcing a targeted, private-market QE program that will begin in October. This decision, combined with the start of the TLTRO, represents a significant bullish tailwind on the euro zone that should not be ignored.

What Happened:

The important event you need to be aware of from the ECB today was the announcement that it would begin purchasing “Asset-Backed Securities” and “Covered Bonds” starting in October.  This amounts to a “private-market QE” program, which was not expected by the market (and is very dovish).

Why It Is Important:

The ECB can’t do the type of QE we have here in the U.S. because there is no European equivalent to Treasuries.  Instead, there are individual countries’ bonds.  So, if the ECB were to try and do traditional QE on the scale of the Fed or Bank of England, it could very well end up owning all of smaller European countries’ debt (like Portugal, Ireland, etc.). So, public QE isn’t an option.

Instead, the ECB needs to do a more-targeted, private QE program, and that was what today’s announcement was about.

By buying ABSes and covered bonds (which are basically higher-rate ABSes), the ECB is directly funneling money into the real EU economy, which should help spur economic growth and, eventually, inflation.

This is how it works:  A European bank will now be able to bundle and sell performing loans on its books to the ECB. It would get cash in return, which it can then turn around and lend to businesses, thereby creating inflation (eventually) and economic growth.

To learn How We Make Money Off it Simply sign up for a 2 week free trial on the right hand side of the page and gain access to the full “ECB Decision Portfolio.”

Tom Essaye discusses the outlook for interest rates and makes the case for regional banks despite the market sell off on CNBC’s Closing Bell.  Click the link below to view the video.

http://video.cnbc.com/gallery/?video=3000297300&play=1

The technicals of the gold market are beginning to favor the bulls as futures have held both the 50 day Moving Average and now the 100 day Moving Average over the past week. And, the underlying fundamentals continue to favor the bulls as well with the threat of inflation looming and growing concerns that the Fed is “behind the curve” with regards to current policy.

Equities

Market Recap

Stocks rallied yesterday on a combination of better than expected economic data and stagnant geopolitics. The S&P 500 added +0.5% on the day.

Stocks traded sharply higher out of the gate yesterday, hitting fresh all-time highs by midmorning before trading sideways for the remainder of the session and closing just off the highs.  Stocks rallied thanks to several encouraging economic reports: CPI was not too “hot” like many investors had feared, while housing data were better than expected.

Additionally, the lack of any material developments in either the Ukraine/Russia or Gaza/Israel situations reduced a bit of the recent geopolitical headwind that has been hindering equity markets (confirmed by the weakness in commodities yesterday, which have been supported by geopolitics in recent sessions).

There was a mini-dip in the market around 2:45 that coincided with a headline that the FAA was halting flights into Tel Aviv after reported rocket attacks near the airport, but the dip was temporary and stocks recovered shortly thereafter. Stocks hit fresh highs late morning, but investor conviction was absent, leaving the S&P to drift sideways into the close.

Trading Color

Encouragingly, cyclicals outperformed yesterday as the Russell 2000 traded +0.8% higher and the Nasdaq was +0.7% higher, both decently outperforming the S&P 500 (although while the SPX hit a new 52-week high yesterday, the Russell remains well off the highs).

The cyclical outperformance yesterday extended into sector trading as tech was the leader (up  +0.84% ahead of AAPL and MSFT earnings, which were mostly in-line).

Industrial miners and those sectors linked to the global recovery also continued to outperform, with PICK rallying +1.25% after hitting a new 52-week high yesterday.

Defensive sectors lagged again as consumer staples again traded poorly (mostly thanks to lackluster earnings). Meanwhile utilities, despite the fact that bond yields are basically at the lows of the year, continue to lag—which is not what you would expect in this environment.

Finally, regional banks continued to get beaten due to this rotation into the investment banks. But at this point, KRE is off more than 10% from the March highs and approaching multi-year support around $38 (this trendline dates back to Oct ‘11), and has to be worth a look on the long side if you’re a macro bull.

“Left Field”

Part of our  job is to make sure nothing comes out of “left field’ and blind sides us  – so we have a white board in the office called left field where we put potentially disruptive events that are low probability.

“Argentine default” has been up there for a while, and after yesterday’s non-decision by a New York court to allow Argentina to pay other bond holders before the hold outs from MNL Capital and others.

The likely outcome is there will be some sort of an agreement to extend the negotiations, but the official deadline for Argentina to pay other bond holders is a week from today July 30th, so we are getting down to crunch time.  Again, this will all probably work out, but we’re getting close, and this situation needs to be watched, because another Argentina default is currently not priced into risk assets.

Bottom Line

Yesterday was a nice rally but the S&P 500 failed to materially break through 1,985. This sort of reminds me of what we saw earlier in the year in the March-May period where 1,885 proved resistance and the market basically treaded water for two months.  I’m not saying that’s going to happen again this time, but it feels similar.

Earnings season rolls on, but I get the feeling it’s ready to be chalked up as “better than expected,” although it’ll be important to see continued revenue strength.  Today should be quiet as the next big data point is the flash PMIs out tomorrow.

Economics

CPI

• CPI rose 0.3% m/m in June vs. (E) 0.3%.
• Core CPI rose 0.01% vs. (E) 0.2%.

Takeaway

June CPI was in line, with both the monthly and year-over-year readings meeting expectations (importantly, core CPI maintained the 1.9% yoy increase seen in May, which will give the Fed some breathing room).

While clearly the pace of inflation remains elevated compared to a year ago, the recent acceleration from March-May seems to have moderated (as expected, because it was pretty unsustainable).  Nonetheless, this most recent CPI reading furthers the point that we are seeing inflation bottom, although we aren’t in a material acceleration phase.

But, there’s more to inflation than just price inflation. As I alluded to yesterday, there is evidence that wage inflation is starting to bottom along with price inflation – and that’s something for the Fed to watch closely.

More Signs of Growing Wage Pressures

While the world yesterday was focused on price inflation (which is what CPI measures), there have been some interesting developments lately with regard to wage inflation.  Stagnant wages remain one of the core reasons QE hasn’t resulted in higher general inflation. But there are some signs that wages may finally be rising, and along with them wage inflation.

In its quarterly survey, the National Association for Business Economics (NABE) reported that nearly 50% of companies reporting had increased wages during Q2 2014, which is up from 35% in Q1 and most importantly 19% in Q2 2013.

Taken in the context of the whole “Fed is behind the curve” opinion, if this trend continues and turns into legitimate wage inflation, then the outlook for inflation will take a material jump to the upside.  This matters because if that happens, then the Fed will be perceived as “way behind the curve” and they’ll have to react.

The Fed has been able to dismiss general price inflation (Yellen called it “noise”) because, so far, price inflation has been limited mostly to commodities—which is viewed as transitory.  But, wage inflation is another issue entirely, and it’s one that’s not so easily dismissed by the Fed.

Bottom line is despite the relentless rally in bonds, evidence is building that the Fed is going to have to adjust when it expects to begin to tighten. If these trends continue, that adjustment remains one of the biggest threats to this rally.  Again, we’re not there yet, but the case is slowly but surely building.

Commodities

Commodities traded mostly lower yesterday as the multiple geopolitical disturbances eased (or at least did not escalate) and economic data largely met or beat expectations. Natural gas was again the worst performer as prices remain in “free-fall,” while copper continued to trade well and was the sole outperformer on the day. DBC (the benchmark commodity index) fell -0.35%.

Beginning with the sole outperformer, copper was up well over +1% yesterday morning, but much of those gains were lost as short-term longs took profits and traders positioned ahead of Chinese economic data due out later tonight. Regardless, copper futures still encouragingly finished the day up +0.25%.

Going forward, we continue to like owning copper as one way to gain exposure to the ongoing global reflation trade. The charts, however, are relatively neutral on the low time frame as investors await the closely watched global flash PMI reports, namely the Chinese figure. But, an important support level to watch is the 200-day moving average at $3.18, as a close below it would shift the technicals in favor of the bears.

Elsewhere in metals, gold fell -0.55% yesterday thanks to the in-line CPI report as well as the better than expected housing data in Existing Home Sales. The CPI report was the real focus of the metals markets, though, as many investors continue to fear that the Fed may be “behind the curve” and a rate hike could come sooner than is currently priced into the market.

And, for that very reason, we remain cautiously bullish on gold as any mention of that possible “sooner than later” rate hike would likely cause a sharp rally as part of a greater “inflation trade” (which would include a sell-off in both the stock market and bonds, and a dollar rally).

Moving to the energy space, WTI crude oil futures fell -0.47% yesterday as energy traders positioned ahead of the weekly EIA inventory report due out this morning (10:30). Analysts are forecasting a draw of 2.5 million barrels in crude oil, a build of 900k in RBOB gasoline, and a build of 1.9 million in distillate supplies.

Looking at the technicals in WTI, yesterday sent mixed signals as futures failed to close above the $103 mark, which has proven to be stubborn resistance this week, but encouragingly held the 100-day moving average. Going forward, the story remains the same: As long as the economy continues to grow, specifically the labor market, so too will demand for crude oil and refined products. This means prices should remain comfortably above the $100 mark.

Natural gas continues to be under heavy selling pressure as the bears clearly maintain momentum for the time being. Futures fell another -2% yesterday and are down over -10% since this time last week. Sooner or later, natural gas is going to reverse, and likely sharply. But, until we get a disruption in production, or a spike in demand because of warmer weather, the path of least resistance remains lower.

Currencies & Bonds

The euro was the big mover in the currency markets yesterday as it fell to a new low for the year after violating major support at the 1.35 level.  There wasn’t any specific reason for the declines other than that technical break – and rather than having any specific catalyst, the euro has sold off this month on general realization that the paths of interest rate policy between the EU and the U.S. are diverging (EU easier, U.S. tighter).  Also pushing the euro lower yesterday was selling ahead of the flash manufacturing PMIs out tomorrow morning, as investors are assuming we’re going to get another soft number.

Despite other major currencies trading flat vs. the dollar (the pound, yen, Loonie and Aussie were all basically unchanged), the Dollar Index still managed to rally +0.28% almost entirely on euro weakness (the dollar largely ignored the in-line CPI and Existing Home Sales data).  Now, on the eve of the July flash PMIs, the Dollar Index sits at resistance at 81 while the euro is teetering on the lows.

At this point the euro is short-term oversold, and disappointing PMI is at least partially priced in. But even if there is a bounce, it appears that downward pressure on the euro is building, which would be a positive for the EU economy and EU stocks (remember, a weaker euro means the ECB policies are “working” and that will help stoke inflation and equity prices).  The weaker euro may be a potential signal to get back “in” to our euro longs, and this bears watching.

Turning to bonds, they went up again yesterday despite the in-line inflation data and stronger than expected Existing Home Sales report.  Initially, bonds declined on the CPI and EHS print, but there were buyers on the dip as clearly the trend remains higher.  Bonds now are sitting just off the highs ahead of the July flash PMIs tomorrow morning, and if recent past is prologue, then regardless of whether there’s a beat (which would be bond-bearish) or a miss (which would be bond-bullish), bonds will rally.

As I said yesterday, this market is totally detached from (apparent) economic reality at the moment, but clearly the trend remains higher for now, so more patience is required.

Have a good day,

Tom