Sevens Report Chart of the Day by Analyst Tyler Richey
Copper futures sold off hard in pre-market trading and are now below support at the 50 day moving average. If prices can recover the 50 day MA by the close however, it will be bullish for the near term.
Sevens Report 7.16.14
Equities
Market Recap
Markets declined Tuesday as cautious comments from Fed Chair Yellen offset strong economic data, although stocks managed to close well off the worst levels of the day. The S&P 500 fell -0.2%.
Tuesday initially started pretty well as futures were higher after several major companies beat earnings (GS, JNJ, CMA, JBHT, JPM) and economic data (June retail sales, July Empire State manufacturing) beat estimates. The Dow Industrials hit a new all-time high, and the S&P 500 inched closer to its recent high, but markets reversed on the Yellen appearance before Congress.
I’ll cover it more in depth below, but Yellen’s comments caused the small caps and “momentum” sectors (biotechs and Internet stocks) to come for sale hard (you’ll see why in a minute), and that dragged down the entire market.
But, as has generally been the case since last Thursday, there was no real conviction or follow-through to the selling Tuesday. The S&P 500 bottomed down -0.5% shortly after midday, and then began a slow rally back toward flat before selling off slightly into the close.
Bottom Line
The market has been consolidating since the highs of July 7, and that continued yesterday.
The price action in small caps and momentum names is disconcerting, but most of the selling that’s going on in those sectors is by fast-money funds and algos, not real money materially reducing exposure (like we saw in April). Europe has also been weak and likewise needs to be watched, but the fundamentals behind the market remain broadly positive.
All that said, I don’t think this period of consolidation is over just yet, and it wouldn’t shock me if we have another “scare” to the downside on some sort of negative news over the coming days.
Earnings are helping to support markets (although it’s still early), but I’d continue to like to see the SX7P (European banking index) bottom before buying back into Europe, and for the NBI and QNET (biotechs and Internet indices) hold the lows of last week before allocating anything further into SPHB and more-cyclical sectors.
Again, this looks like a normal consolidation to me (rather than a correction), but I don’t think it’s over just yet.
Yellen’s Testimony Wasn’t ‘Hawkish,’ But It Did Cause Stocks to Decline.
The general consensus of Fed Chair Yellen’s statement and Q&A in front of the Senate yesterday was that she was incrementally “hawkish.” But that wasn’t really the case.
The main sentence that was being spun as “hawkish” was her commentary that “if the labor market continues to improve more quickly than anticipated by the Committee … then increases in the Federal Funds rate target would occur sooner and be more rapid than currently envisioned.”
Translation: If the jobs market improves and inflation accelerates, we’ll pull forward when we raise rates and how quickly we raise them.
That’s not a hawkish statement – it’s common sense.
The reason the market traded down yesterday was thanks to a totally separate piece of information – the Fed’s semi-annual report to Congress. It contained the statement that “valuation metrics in some sectors do appear substantially stretched – particularly those for smaller firms in the social media and biotechnology industries. … Moreover, implied volatility for the overall S&P 500 index, as calculated from option prices, has declined in recent months to low levels last recorded in the mid-1990s and mid-2000s, reflecting improved market sentiment and, perhaps, the influence of ‘reach for yield’ behavior by some investors.”
So, the Fed singled out bio-tech and social media as overvalued, and that statement echoes recent comments Yellen has made about pockets of “froth” in the equity markets. Importantly, though, she described the valuation of the broader stock market as “not far above historical averages,” so this was more about addressing the overvaluation in “momentum” sectors more than it was declaring the stock market “irrationally exuberant.”
The Fed signaling out “momentum sectors” is a unexpected headwind (the fear is a repeat of April where a sharp decline in those sectors drags the entire market lower).
But, and that’s not exactly new messaging, and more importantly, the bottom line is that the outlook for the Fed did not change in yesterday’s testimony (and likely won’t change today, either).
Economics
Both economic releases yesterday beat estimates and painted an encouraging picture for consumer spending and economic activity in July. But, neither resulted in an equity-market rally, as comments by Fed Chair Yellen overshadowed the hard data.
Retail Sales
- June Retail Sales rose 0.2% vs. (E) 0.6%.
Takeaway
June retail sales disappointed on the headline yesterday morning, but that was a bit misleading. The details of the report were good and there were positive revisions to April (0.5% from 0.2%) and May (0.2% from 0.0%). The “control” number — which is retail sales ex-autos, building materials, and gasoline stations — rose +0.6% in June, the 4th month in a row.
Bottom line, the disappointing headline of yesterday’s retail sales report for June was misleading and the report was actually pretty good. And, while not reflecting robust consumer spending, the strong June “control” figure and positive revisions will help ease some of the general concern regarding consumer spending. This report was a positive for the economy.
Empire State Manufacturing Survey
- General Business Conditions Index rose to 25.60 vs. (E) 17.80 in July.
Takeaway
Manufacturing activity accelerated to a 4-year high in the greater New York area in July. Both the headline and details of the report were good, as new orders (the leading indicator within the report) were little-changed but remain strong at 18.77.
Empire State manufacturing hasn’t been a very good predictor of the broader national manufacturing PMIs in 2014. Regardless, it’s encouraging for the market to see growth in the manufacturing sector continuing in July, especially in the context of constant worries about the strength of the manufacturing recovery.
Focus will now turn to the Philly Fed manufacturing index Thursday. But the bottom line is this first data point from July implies the recovery in the manufacturing sector is accelerating further and that’s anecdotally encouraging for the economy as a whole.
Commodities
Commodities were almost universally lower yesterday, in part thanks to a stronger dollar (+0.3%). The sole exception was copper, which was only slightly higher on better than expected Chinese economic data. The benchmark commodity tracking index ETF, DBC, fell to a 5-month low before bouncing slightly into the close.
Precious metals got hit again yesterday. Gold fell -0.8% while silver gave up a more-modest -0.4%. Nearly all of the session losses in gold came in the first 15 minutes of Yellen’s testimony (when her statement was released and then feverishly dissected by the news-reading algorithms). Gold smashed through support in that $1300—$1310 range in heavy selling before finding support in the $1290 region.
Gold futures were able to hold the 50-day moving average at $1,292.40. But the reason it was defended was more a result of shorts taking profits rather than new longs initiating positions. Bottom line, it appears that the broken uptrend line was more important over the near term than initially expected. Despite the 3 other supporting factors in the market (the bullish cross in the moving averages, the rising number of net longs, and the underlying inflation bid), the bears still have the momentum and we could see a further dip or at the very least some further consolidation here below $1,300.
Elsewhere in metals, copper was the only commodity to finish higher yesterday, adding a very modest +0.05% thanks to some better than expected economic data. A Chinese report showed that lending increased at a higher than expected rate last month, which helped reverse losses ahead of the release.
Going forward, prices remain somewhat extended as the recent rally from $3.00 was a sharp one; therefore we’d like to see a further pullback to around $3.20 before the risk/reward would be favorable to initiate long positions in copper. But, looking ahead, the improvement in the global economy will continue to be a tailwind on copper prices as a result of higher demand.
Crude oil futures resumed their downtrend Tuesday after seeing a bounce on Monday. WTI fell -1.01% yesterday but importantly held support at the 200-day moving average ($99.81). But, WTI still has some significant downside momentum and until we see a break of the sharp downtrend that has been in place since the mid-June highs, we will remain sidelined. Such a break would require a close above $101.25.
Fundamentally, today is inventory day for crude oil and the products, and a bullish report may facilitate a short-covering rally and a close above the aforementioned technical level. Expectations are: -2.6M bbls in WTI Crude, 700k bbls increase in RBOB Gasoline, and + 2M in distillates.
Natural gas traders retested trend support at the $4.10 level yesterday as futures fell -1.3%. Like crude oil, natural gas also remains a “falling knife” here. Even though the risk/reward setup for initiating a long here is favorable, like in WTI crude there is significant downside momentum in the very short term, and we would like to see a close above the steep downtrend line (above $4.15 or so) before initiating a long position.
Currencies & Bonds
The dollar was nearly universally stronger yesterday courtesy of the good economic data (retail sales and Empire State manufacturing survey) and a “hawkish” take on Yellen’s testimony. The Dollar Index rose +0.27%.
The only major currency that ended the day higher vs. the dollar was the British pound, as it rose +0.39% to (just off a new 6 year high) after Great Britain June CPI rose to 1.9% year-over-year, much higher than the 1.6% consensus.
The headline jump in inflation year over year was a bit eye-popping, but it’ll probably prove temporary. That’s because the spike higher was caused by price increases for footwear and apparel. But, the increase will likely be temporary because of seasonal adjustments. Normally, retailers in Great Britain heavily discount summer clothing in June, so the seasonality anticipates this discount. This year, though, the retailers appear to have not as aggressively discounted in June, and will likely spread out discounts over the summer months. So, that should result in some seasonality “payback” in the form of price declines in July/August.
Regardless, clearly inflation is trending higher in the UK, as is economic growth. This is just reinforcing the point that the Bank of England will be the first major central bank to raise interest rates, perhaps as early as this year. The pound remains the single-most-attractive currency vs. the dollar right now.
Staying in Europe, the euro was almost the worst performer vs. the dollar yesterday, falling -0.38%, on a combination of factors: dollar strength, a German ZEW Business Expectations Index miss, and “dovish” comments by ECB President Mario Draghi (he said a strong euro is a threat to growth and that asset purchases (QE) are well within the scope of the ECB). None of the comments were new, but Draghi wanted to try to talk the euro down and appears to have been moderately successful (the euro is down again this morning and through support at 1.355).
Keep in mind, a weakening euro is what the “Europe bulls” want right now, so a declining euro is a needed tailwind for European shares, if it continues.
Looking at the commodity currencies, the Loonie was the worst performer vs. the dollar yesterday, falling -0.4% ahead of a manufacturing report earlier today. The Loonie is now sitting on key support at $0.9260, and if that’s broken, look for the declines to accelerate. The Aussie was also slightly lower vs. the dollar after the Reserve Bank of Australia’s June meeting minutes were taken as slightly “dovish” in tone. (Nothing shocking was said; just general mention of concern about the economy.) But, the Aussie remains in the middle of the trading range ($0.92-$0.94).
Turning to bonds, the 30-year traded in a big range yesterday. It initially traded down nearly -0.3% on the strong economic data and Yellen comments, but then rebounded and rallied nearly +0.3% later on in the testimony, before giving back those gains to finish basically unchanged. Meanwhile the yield on the 10-year was also unchanged.
Treasuries remain buoyant but seem a touch confused at the moment, as the market tries to “game” the Fed’s potential normalization strategy within the context of foreign demand for Treasuries, an accelerating economy and bottoming inflation. And, in the near term, money flows from the two aforementioned sources are trumping the fundamentals of the two latter sources. Bottom line is that Treasuries remain above the uptrend of 2014. Until they decisively break that downtrend, then the short-term benefit of the doubt remains with the bulls, despite growing fundamentals that suggest Treasuries should be declining.
Have a good day,
Tom
Sevens Report 7.14.14
Equities
Market Recap
Stocks declined last week as soft global economic data led to a round of profit-taking in small caps and higher-beta sectors. The S&P 500 fell -0.90% and is up +6.45% year-to-date.
Stocks traded lower last Monday mainly on European growth concerns after Erste Bank became the latest European bank to issue a profit warning. The selling continued Tuesday as European banks were again lower on news that BNP Paribas was hit with a $9 billion fine and Commerzbank may be next.
Also contributing to the selling early last week was news that a subsidiary of Banco Espirito Santo (Portugal’s largest bank by assets) would miss a debt payment and may be having funding troubles (which was extrapolated out to imply the larger company may also have funding troubles).
Stocks saw an oversold bounce Wednesday helped by better than expected AA earnings and positive margin guidance from AAR. But it was a weak bounce, and the selling pressure resumed Thursday as the S&P 500 was down over 20 points very early in trading, dragged down by Europe.
Stocks lifted off those early morning lows to finish down modestly Thursday as there wasn’t a lot of follow-through or conviction to the selling, and an earnings beat by WFC helped stocks bounce slightly Friday in quiet trading.
Trading Color
One of the bigger takeaways from last week’s selling was that it was much more about profit-taking than it was some broad “risk off” move by investors, although obviously defensive groups outperformed higher-beta names. Utilities, consumer staples and REITs finished positive last week, and more broadly SPLV (which was flat on the week) handily outperformed SPHB (down -2%).
The reason I say the selling last week was much more about profit-taking than anything else was because sectors that have outperformed handily since May (momentum sectors like bio-techs and internet stocks) got hit hard, as did small caps (the Russell 2000 fell -4% last week as it was weighed down by financials, which were sold ahead of earnings, and the aforementioned biotech and Internet names).
The reason this distinction is important is because profit-taking-driven selling implies this is more of a consolidation in the markets rather than some sort of a bearish game-changer. Sellers weren’t aggressive last week despite the declines.
Two other observations from last week: First, not all cyclical sectors got hit, as PICK hit a new 52-week high last Tuesday (helped by AA earnings), and metal & mining stocks bucked the broader market’s negative trend as gold traded higher (GDX was up over +3% last week). We could see those sectors dip this week as they are short term overbought, but valuations in the global mining sectors aren’t extreme, and there’s plenty of upside from here as long as metals prices hang in there and we don’t get any materially negative data from China.
Second, energy was a standout underperformer last week, weighed down by WTI crude prices. The XLE chart looks pretty bad at this point, as does FCG and XOP. And, while I remain an energy bull, it looks like this selling has a bit further to go.
Looking at market technicals, the Russell badly violated support last week and traded out a weekly negative “outside reversal,” which will have people nervous. The S&P 500 held support at the 1,964-ish level and that will be key again next week, while next support sits below at 1,950.
Bottom Line
Last week’s sell-off appears to be a normal correction in an upward-trending market more than it is the end of the rally. Stocks have enjoyed a strong and uninterrupted rally since mid-May, and at this point need to consolidate and correct to restore some health.
The soft European economic data and European bank weakness appear to have just provided the catalyst for that normal correction to start, and it likely will last a bit longer depending on earnings season, which kicks into high gear this week.
More broadly, the “4 Pillars” of the rally remain largely intact: globally accommodative central banks, an ongoing global economic recovery, a calm macro horizon, and still-reasonable valuations.
Risk remain to each of those pillars (Yellen speaks on monetary policy Tuesday, the global economic data have softened slightly lately, Israel is threatening to put ground troops in Gaza, and earnings need to confirm $130/share 2015 EPS). But, at this point those are just risks to monitor.
Focus this week turns to earnings, but Europe will also remain the key. I want to be a buyer of cyclicals and Europe on this dip, but I want to see the SX7P (European banking index) stabilize first—as I think that’s a leading indicator of when this correction will end.
Economics
Last Week
The biggest thing that happened last week, economically speaking, was that foreign data largely disappointed, and implied we’re seeing the global recovery lose a bit of momentum. That, much more than concern about Portuguese banks, was the real reason global shares traded heavily last week.
Chinese trade balance (both exports and imports); German, French and Italian May industrial production; and Japanese machine orders in May all missed expectations. Specifically in Europe, the soft data added to a string of indicators that implied the recovery, while still ongoing, is losing some momentum.
Keep in mind that one of the “four pillars” of the rally is a broad global economic recovery. And, while the data last week didn’t imply the recovery is stalling, numbers in Europe have been soft now for a few weeks. So, the global markets now need a bit of a confidence boost that the EU economy is indeed continuing to get incrementally better.
Domestically last week was very quiet, as FOMC minutes from the June meeting were in focus. Going into the release of those minutes, it was expected they may be more “hawkish” than the FOMC statement because it was assumed the FOMC would have been extensively discussing exactly how they were going to start to unwind all this historic stimulus.
But, as seems to be the case lately, the market overestimated the Fed’s concern about both inflation (which the broad committee doesn’t see as a problem right now) and the economic strength (the Fed remains committed to being very accommodative into the future).
Some details of just how the Fed plans to eventually raise rates were discussed, but the Fed seems in the very preliminary stages of figuring out how they will eventually raise rates.
The one big headline out of the minutes was that the Fed will likely end QE in October, but that wasn’t a surprise to anyone who’s been paying attention. Bottom line with the minutes last week was that they weren’t as hawkish as feared, and there were no changes to expected Fed policy.
This Week
The calendar gets busy again this week as we get several pieces of economic data and Fed Chair Yellen conducts her “Humphrey-Hawkins” testimony in front of the House Tuesday and Senate Wednesday.
Given the focus on the Fed and the expected transition in policy, the Yellen testimony Tuesday will be the highlight of the week. (Her prepared comments will be the same for the Senate testimony, so Wednesday all that matters is the Q&A session.)
The highlight of the week from a data standpoint will be retail sales. Consumer spending hasn’t been as strong lately as you would have expected, given the improvement in the labor market. Combined with recently dire commentary on the consumer from some companies (The Container Store last week was the latest to lament a poor retail environment), retail sales will be closely watched to see if the consumer is starting to increase spending.
Second in importance this week will be the first look at July data, via the Empire State Fed manufacturing survey (tomorrow) and Philly Fed manufacturing survey (Thursday). As I’ve said before, these regional manufacturing surveys have lost some importance since the national flash PMIs started being produced, but the market will want to see that the pace of the economic recovery is continuing in July.
We also get our first look at the June housing data, as housing starts come Thursday. Recent indicators implied the housing market is finally rebounding from the winter declines, and another good round of housing data will help further reduce concerns about the pace of the housing recovery. Finally this week we get May industrial production and the Fed Beige Book.
International data will also be in focus this week given recent concerns about the strength of the recovery, especially in Europe. There’s not a lot of data from the continent this week, but the German ZEW Survey will be in focus, especially given the recent weakness in German economic data.
In China we get the latest look at GDP, industrial production, fixed-asset investment and retail sales Tuesday night. Obviously the key here is that the pace of Chinese economic growth remains stable. As long as the numbers are mostly “in-line” with expectations, the market shouldn’t react too much.
Broadly this week, the market is looking for Yellen to not say anything surprising and to emphasize that any transition to policy “normalization” will be gradual. From a data standpoint, markets need a bit of a confidence boost, mainly from the EU, but also from China and the U.S.
Commodities
Commodities finished last week mostly lower, led down by continued weakness in the energy sector as WTI crude oil futures fell a staggering 3.16%. DBC, the benchmark commodity tracking index ETF, had its worst week of the year, falling 2.5%. However, one bright spot despite the fairly broad weakness in the space was the continued outperformance of precious metals.
Beginning with energy, crude oil futures crashed through several support levels over the course of the week, starting with the 50 day moving average at $103.60, then the 100 day MA at $102.39, and lastly trend support at $101.25.
As for a reason for the substantial selling pressure, several things were citied including easing tensions in Iraq and increasing exports from Libya. However, these were more excuses to explain the overwhelming momentum that the bears have at the moment rather than actual market driving headlines. All eyes are now on support at the 200 day moving average at $99.96 and the sharp downtrend line that futures have been riding since they topped out in mid-June.
Elsewhere in energy, natural gas futures also continued to sell off last week, falling 5.1%. But, unlike WTI, the selling in natural gas futures lightened up on Friday, and actually closed higher by .5% and importantly, 4 cents above support at $4.10. Cooler weather forecasts and growing inventories are the main reasons for the short term weakness, and despite inventory levels remaining historically low, the outlook for weather remains the driving factor in the near term. But, natural gas is nearing key medium/longer term support levels.
Moving to the outperformers, gold and silver both rallied 1.4% on the week. Both precious metals saw gains mid-week thanks to a “safe haven” during the Portuguese debt flare up. Both gold and silver are trading a bit lower this morning as equity markets bounce, but beyond the near term noise, gold and silver continue to benefit from general global unrest, rising inflation expectations and declining real interest rates.
Gold is now sitting on the uptrend in place since early June, so for those looking to trade it, buying this dip makes sense on the charts. Use a tight stop though ($1316ish).
Currencies & Bonds
The Dollar Index was flat last week, as the greenback initially declined in response to the “dovish” FOMC minutes, but then caught a bid late in the week on a “risk off” bid. The Dollar Index did manage to hold support above the 80 level, despite the choppy trading.
The euro also was surprisingly flat despite general risk reduction, disappointing data and Portuguese banking worries. Oddly, though, euro strength is now a reflection of things not “working” in the EU. The goal of the ECB (and the euro bulls) is to see the EU economy grow, bond yields rise gradually, and the euro fall. But, when the market doesn’t think the ECB policies are working or the economy is growing, they will buy euro out of deflation fears. So, trading in the euro is not all that dis-similar from the yen at this point—a weaker euro is a sign things are “working” in Europe. Clearly, things weren’t working last week.
Turning to the yen, things aren’t working there, either. The yen rallied to a 5-month closing high vs. the dollar despite weak economic data (again, the yen is pricing in potential low inflation/deflation concerns). 100.74 remains the key level to watch in the dollar/yen—if that is violated, then calls that “Abenomics” is failing will get louder, and we’ll have to significantly re-evaluate the “long Japan” thesis. I can’t believe, though, that the BOJ won’t try to put pressure on the yen as there’s a BOJ rate meeting early this week.
The bond market surged higher last week and completed one enormous head-fake, as the 30-year is now just a few ticks from the highs for the year. Lackluster economic data, a dovish Fed, and foreign buying helped push bonds higher. Astonishingly this uptrend isn’t over. 138’10 is the high for the year, and I’d be very surprised if that isn’t tested early this week. At some point this bond rally will end, but I’m now becoming convinced that it won’t be until ECB policies in the euro zone start “working” and this enormous Treasury carry trade starts to reverse. Until then, the short-term trend remains higher.
Have a good week,
Tom
Sevens Report 7.11.14
Equities
Market Recap
Stocks closed in the red again Thursday on more European bank concern, but stocks were able to cut the losses nearly in half by the close. The S&P 500 closed down -0.41%.
It was an ugly start to trading Thursday as more negative news from European banks combined with generally disappointing global economic data. (The Chinese trade balance missed, as did Japanese machine orders and Italian and French industrial production.)
But, a good weekly jobless claims report helped turn sentiment a bit. After hitting their lows almost immediately after the open in heavy selling, stocks began to gradually lift and the S&P 500 nearly got back to flat by 1:30, before giving some of those gains back during the final two hours of trading.
News-wise, the middle of the trading day was pretty quiet, as comments by Kansas City Fed President Esther George were the only real news event (and she did not say anything new). After giving some of the midday rally back, stocks managed to bounce into the close to cut the day’s losses in half.
After the close yesterday newly appointed Fed Vice Chairman Stanley Fischer spoke, but his comments focused on financial regulation and he didn’t reveal anything about monetary policy.
Trading Color
The Russell 2000 continued to trade poorly yesterday (down -1%) but outside of that, the internals weren’t that bad. The Nasdaq traded in line with the S&P 500 (down -0.5%) and while “momentum” sectors were negative, they had a nice bounce off the lows (NBI and QNET fell -0.35% and -0.7%, respectively).
Sector-wise, defensives outperformed (XLU was the only S&P 500 sub-sector in the green) but there wasn’t material underperformance by cyclical sectors (SPHB, banks, industrials and basic materials were down just -0.6%, in line with the S&P 500). So, we didn’t see the carnage in cyclical or high-beta sectors you would have expected given the way the market opened yesterday.
More broadly, while the open was ugly yesterday, similar to Wednesday we didn’t see any material follow-through from sellers. Stocks lifted more due to a drying up of that selling than buyers stepping in to aggressively buy the dip. Point being, much of these declines have been the result of fast-money funds and day traders pushing index futures and ETFs lower, not aggressive de-risking from real money. So, when the fast money stops selling, then the market naturally lifts.
That’s what happened shortly after the open yesterday. Now, does that mean the selling is done? No, but it does mean we’re not seeing real money selling yet (if that starts, it’ll be a new negative force on the market).
On the charts we’re still sitting on support in the 1,962-1,964 level (we closed above it yesterday) and below that, the 1,950-1,952 is the next level the bulls want to hold.
Is Portugal a Problem?
The yield on Portuguese 10-year bonds has risen to 3.99% as of yesterday, the highest level since March, on concerns that financial difficulties at Banco Espirito Santo will result in a flare-up of the sovereign-debt crisis.
I don’t know a ton about the subsidiary of BES that’s cash-strapped, or if there are major solvency/funding issues at the larger parent bank (as the bears portend). But, I do feel that extrapolating this out as some revival of the European sovereign-debt crisis is an exaggeration of the highest order.
After surviving bailouts of four separate countries and the Spanish banking sector, common sense tells us that—even if there are major problems at Banco Espirito Santo—Portuguese and European officials aren’t going to let it have a major negative influence on the European economy or funding markets, which after 4 years of malaise are just now starting to show signs of life.
If we want to talk about real risks to Europe, much more important than BES is the recent softening of economic data in Europe. Bottom line is the European economy remains the key beyond the very short term. Because of that, I don’t think this BES drama or the backup in Portuguese 10-year yields materially changes the outlook for the euro-zone markets.
So again, when we can get the SX7P to bottom, I’ll look to be a buyer of Europe (again) on that dip.
Bottom Line
Europe is something to watch but not a bearish game-changer at this point, and this still feels more like part of a consolidation/correction the market has needed since late June.
The S&P 500 is still just 20 points (so just over 1%) off the highs. And while the Russell’s weakness is something to watch, nothing here tells me that we’re heading toward some sort of a material correction, at this point.
European banks remain the “cause” of the weakness, so SX7P remains the indicator to watch. When it bottoms, so too will the broader averages (assuming nothing else bad happens between now and then). I continue to view this as a dip to buy.
Economics
Weekly Jobless Claims
- Weekly Claims dropped to 304K vs. (E) 315K
- The 4 Week Moving Average fell 3.5K to 311.25K
Takeaway
Weekly jobless claims fell 11K last week to 304K from an unrevised 315K the week prior. The smoother look at the data also showed a favorable move lower, down 3.5K to 311.25K, the lowest level in 5 weeks. Yet, the market showed little interest in the report as S&P futures were already down more than 15 points at the time of the release thanks to the negative European bank news.
Bottom line, we saw a bit of an encouraging drop in the headline jobless claims number (304K is the lowest since late May), but whether or not the downtrend in claims we saw over Q2 is set to resume remains to be seen.
Commodities
The commodity space finally caught a bounce yesterday as the benchmark commodity tracking index ETF, DBC, rallied for the first time in 10 sessions, finishing the day up +0.27%. The rally was fairly broad as both industrial and precious metals, along with oil and the refined products, posted solid rallies for the day. There were exceptions, however. Natural gas fell -1.2% as futures continue to feel for support, while the grains remain under pressure.
Beginning with the precious metals, gold and silver finished the day higher by +1.1% and +1.85% respectively. The continuation of the rally, in which futures traded to near 4-month highs early yesterday morning, was largely fueled by the negative headlines surrounding European banks, which brought a “safe haven” bid into the gold market as stocks sold off. However, the underlying “inflation bid” is also still present in gold and a strong uptrend remains intact on the charts, with the first level of resistance at yesterday’s highs in the mid-$1,340s, but the ultimate target remain $1,355-$1,360.
Copper also rallied yesterday, adding +0.8% on the day partially thanks to speculation of further economic stimulus measures by the Chinese government. But, copper was not able to break back above the trending support that was broken on Wednesday, and we continue to be in “wait and see” mode on copper. Until futures pull back toward the $3.20 level, we will remain sidelined.
Energy was mixed yesterday as natural gas continued lower in search of support, while a short-squeeze sent crude oil futures up +0.65%.
Nat gas futures fell -1.2% yesterday for the 5th straight daily drop. The lows of the day were hit shortly after the EIA released the weekly inventory report that showed stockpiles grew by 93 Bcf vs. (E) 92 Bcf. Yesterday’s EIA report was the first in nearly 2 months that was less than 100 Bcf, a report you would think would cause a bullish reaction. But, with the average weekly build for this time of year at just 72 Bcf, it is not a surprise that we saw the selling pressure continue.
Natural gas closed down near the lows of the day, which is bearish technically. However, futures are quickly approaching longstanding technical support at $4.10 which we have been watching since prices started to accelerate downward. And, we remain cautiously bullish from that level as long as we don’t see a close below it. But, most natural gas traders will tell you that you shouldn’t fight the direction of momentum in the market, and the sellers continue to have momentum on their side at the moment.
So, bottom line, we are essentially trying to catch a falling knife here, but the risk/reward remains favorable, risking about 10 cents for a potential return of 40 cents-plus. Proceed with caution.
In WTI crude oil, futures hit two-month lows in pre-market trading, but the sellers ran out of steam at the $101.55 mark and the short squeeze began. The rally started quietly, but accelerated as the day went on until futures closed the day within reach of the high ticks at $103. But, $103 is the technical level futures needed to close above in order to break the steep downtrend that has formed as a result of the heavy sell-off that began in late June. Today, closing resistance moved down to $102.50 while support is below at $101.25, and we recommend buying a dip toward support or a close above that $102.50 level.
Currencies & Bonds
It was an old-fashioned “risk off” day in the currency markets (and the first one in some time) Thursday, as the dollar was higher against every currency except the yen (the dollar and yen being the “risk off” currencies of choice).
The euro was the worst performer vs. the dollar yesterday, which isn’t surprising given all the negative European news and the move higher in Portuguese yields. The euro fell -0.3% yesterday and is once again sitting on support at the 1.36 level.
The Aussie was the next biggest decliner vs. the dollar, dropping -0.27% despite the fact that economic data from ‘Oz was better than estimates. The June Labour Force Survey (their jobs report) showed an increase in employment of 15,900 vs. (E) 12,000, but that was overshadowed by general risk aversion (the Aussie is still somewhat of a global proxy for risk sentiment, so when the Dow is down 200 points pre-market, the Aussie will usually be lower) and the disappointing Chinese import numbers.
There will be good money to be made shorting the Aussie at some point in the future, but for now it remains range-bound between $0.92 and $0.94, so I’d look to be a seller if the Aussie can rally further toward the upper end of that months-long trading range.
Looking at Treasuries, it surprisingly wasn’t the best day for bonds. The long bond did close positive (up +0.07%) and the yield on the 10-year crept closer to 2.50%. But bonds didn’t trade all that well yesterday, as they hit their highs of the day before the U.S. equity market open, and drifted lower throughout the day. Even when stocks were on their lows yesterday morning, the 30-year was up less than +0.5%, and given the quasi-hysteria in the market yesterday, I would have thought it would have been higher.
Helping Treasuries trade a touch heavy yesterday was a lackluster 30-year Treasury auction. The government auctioned $13 billion worth of 30-year Treasuries yesterday, and the results made it a trifecta of disappointing auctions this week (3-year Tuesday, 10-year Wednesday).
The bid to cover on the auction yesterday was 2.4, near the lower end of this year’s auctions, while bidding was less than aggressive as the actual yield was ½ basis point higher than the “when issued” yield at 3.369%.
Interestingly, though, there was a silver lining to this auction. Indirect bidders, which are often used as a proxy for foreign bidders, took down more than 53% of this auction, and that’s the largest percentage since 2008. I’m not an expert in the intricacies of bond auctions, but we know one of the reasons Treasuries remain buoyant is because of foreign (mainly European) demand. This high indirect bidder number implies that Treasuries are still attractive to foreign investors, which will help support the long bond.
Bottom line is the bond market appears to have thrown yet another enormous head fake with the drop of last week. The highs for the year at 138’10 remain resistance, but given the momentum in this market, I’d not be surprised if that’s challenged, despite strong economic data and bottoming inflation. Despite the surge in bond-negative fundamentals, this bond rally of 2014 isn’t going to end without a fight.
Have a good day – Tom
Is Portugal a Problem?
Is Portugal a Problem?
The yield on Portuguese 10-year bonds has risen to 3.99% as of yesterday, the highest level since March, on concerns that financial difficulties at Banco Espirito Santo will result in a flare-up of the sovereign-debt crisis.
I don’t know a ton about the subsidiary of BES that’s cash-strapped, or if there are major solvency/funding issues at the larger parent bank (as the bears portend). But, I do feel that extrapolating this out as some revival of the European sovereign-debt crisis is an exaggeration of the highest order.
After surviving bailouts of four separate countries and the Spanish banking sector, common sense tells us that—even if there are major problems at Banco Espirito Santo—Portuguese and European officials aren’t going to let it have a major negative influence on the European economy or funding markets, which after 4 years of malaise are just now starting to show signs of life.
If we want to talk about real risks to Europe, much more important than BES is the recent softening of economic data in Europe. Bottom line is the European economy remains the key beyond the very short term. Because of that, I don’t think this BES drama or the backup in Portuguese 10-year yields materially changes the outlook for the euro-zone markets.
So again, when we can get the SX7P to bottom, I’ll look to be a buyer of Europe (again) on that dip.
When a Normal Correction Becomes Something More
When a Normal Correction Becomes Something More
The market needs to pause/correct in the near future, but even if we get a decent correction (say > 5%), unless it invalidates one or more of the 4 core reasons stocks have rallied for 2+ years (what I call the 4 pillars of the rally), then it’s a dip we need to buy. Given we may be ready for a short term correction, I want to provide a reference sheet for sell-offs, because unless news accompanies a sell-off that invalidates one or more of these “pillars,” then the trend remains decidedly higher.
Pillar 1: Globally Accommodative Central Banks
For the first time in history (that I can remember), all the world’s major central banks are historically accommodative. The Fed, ECB, BOE and BOJ all have overnight lending rates below 1%, and all of them are still actively pursuing some form of quantitative easing (the ECB is shuffling toward QE “light” but they have bought PIIGS’ bonds and are providing virtually free money via their TLTRO programs).
Additionally, while the People’s Bank of China doesn’t have rates sub-1%, Chinese officials are actively conducting “mini” stimulus measures to help prop up the economy.
I’m not telling you anything new here, just emphasizing that basically the whole world is pumping easy money, which I believe is an under-appreciated support of global equities.
Pillar 2: A Growing Global Recovery Coupled with Macroeconomic calm
Over the past several years, markets have lurched from one global crisis to another, starting with the U.S.-based financial crisis of 2008-’09, and followed by the European sovereign-debt crisis of 2010-’12.
Along the way, the Japanese tsunami crippled one of the world’s largest economies in March 2011. Then there were the three separate U.S. government funding and shutdown dramas: the debt ceiling scare of July 2011, the “fiscal cliff” of December 2012, and the actual government shutdown of October 2013.
Throw in the Cyprus bailout of March 2013, and fears of a “hard landing” in the Chinese economy throughout ‘12/’13, and investors have had to deal with multiple (and, in some cases, overlapping) “once in a blue moon” issues.
But, for now at least, the macroeconomic horizon is as clear as it has been in six years. And, as a result, we are seeing the global economy finally start to recover. The U.S. economy is seeing growth accelerate … the EU has backed off the edge of the cliff and is seeing a tepid recovery (but is recovering) … Chinese growth has stabilized and the risk of a true “hard landing” has been diminished … the Japanese economy appears to be finally turning a corner … and even emerging markets are relatively stable.
Pillar 3: Reasonable Valuations
The U.S. stock rally of the past two years has mostly been the result of old-fashioned multiple expansion, which began in 2012 once the euro-zone crisis began to fade.
Summer is when most analysts begin to switch the basis year for the P/E calculations, so we’re going to see the S&P 500 shift from trading at a high 16.5X 2014 $120 EPS, to a more reasonable 15.2X 2015 $130 EPS.
Does that make stocks cheap? No, it doesn’t.
But, at the same time, given the larger backdrop room remains for stocks to rally further before they get prohibitively expensive. (For example, 16X 2015 EPS is 2,080 in the S&P 500, 17X is 2,210 and 18X is 2,340.) I’m not saying we’ll necessarily get there, but the point is the market isn’t prohibitively expensive at these levels.
Pillar 4: Sentiment toward stocks is more skeptical than enthusiastic.
Despite the gains of the past several years and an absurdly resilient rally, investors remain very distrustful of stocks, and most view this rally as simply a Fed-induced bubble that will inevitably go “pop” at some point and result in a steep, nasty correction. And, they will likely be right one day, but the fact remains this is the most-hated bull market I’ve ever seen. Instead of hearing a litany of reasons why stocks will make everyone rich, I continue to hear much more cautious comments about why the rally can’t last and how this will all end in tears.
There is no irrational exuberance in the market. My lawn guy isn’t giving me stock tips or saying how much he’s making in the market.
Again, I’m not saying the skeptics are wrong; rather, so far they’ve been wrong. Until we get some sort of bubbling-over enthusiasm for stocks as an investment, skepticism of this rally will continue to be a quiet tailwind on the markets.
Stocks won’t keep rallying in a straight line and there will corrections (and we are overdue for one now – yesterday’s drop notwithstanding). But, in the bigger picture, as long as these four realities remain, the trend remains higher and I’m a buyer of cyclicals on dips.
A Look at the Economy 7.7.14
Last Week
The most-important thing that happened last week was that the June jobs report and the June ISM manufacturing and non-manufacturing PMIs further implied the US economy is close to achieving “escape velocity” (meaning ending the era of around 2% GDP growth).
Other than the obvious (that an accelerating economy is good for stocks), the strong data and implication that we’re finally breaking out of this slow-growth economy is key for two reasons:
First, the strong data of the past few weeks are helping to remove any worry about the economy being able to recover from the Q1 hole. Second, the debate about whether the Fed is “behind the curve” (which is a term that just means the Fed may be too accommodative at this point, given what appears to be happening in the economy and with inflation) was reignited last Friday. If the market starts to believe the Fed is behind, look for inflation-linked assets/sectors to outperform going forward.
Turning to the data, ISM manufacturing and non-manufacturing PMIs actually slightly missed estimates last week. (Manufacturing: 55.3 vs. (E) 55.6, Non-Manufacturing: 56.0 vs. (E) 56.2.) Regardless, both were strong numbers and solidly above the 50 level that implies expansion.
And, the June jobs report was a blowout of 288K vs. (E) 213K. And, beyond the June report, for the first six months of 2014 we’ve seen average monthly job gains of 231K—which is the best 6-month stretch since the crisis of 2008. Additionally, the unemployment rate fell to 6.1% while the labor participation rate remained at 62.8% (meaning the unemployment rate likely declined because unemployed people found jobs, not because they dropped out of the labor force).
Bottom line is last week was an important week of data, and it implied that economic growth is accelerating. While last week’s data alone won’t result in a material change in Fed policy expectations, it does put some more pressure on the Fed to begin to explain their exit strategy. For now, we remain in a sweet spot of an easy Fed and accelerating growth. But if things continue at this pace, Fed outlook will have to change—but that’s a problem for another day.
Last week wasn’t all about the U.S., though, as there were also a lot of global data. The biggest positive surprise came from China, as both the private Markit and government June manufacturing PMI were above 50, while June service sector PMI in China surged to 53.1, up from 50.7 in May. Bottom line is the PMIs, along with other recent data, confirm that the pace of growth of the Chinese economy has stabilized above 7%, which is a general tailwind for global markets and the economy.
Finally, turning to Europe, there were a ton of data last week (flash June HICP, June manufacturing and composite PMIs, retail sales and an ECB meeting). Bottom line on all of it is that while there are some pockets of weakness (German data have been a bit soft the last few weeks, which is disconcerting), the consensus is that the slow recovery in Europe is continuing. The ECB, as expected, made no changes to policy and will wait to see the effectiveness of the June measures before moving again.
This Week
It is a very quiet week economically for both the U.S. and the rest of the world. Jobless claims (Thursday) is the only number to watch here in the U.S., while internationally the “highlight” will be Chinese CPI/PPI (tomorrow night) and trade balance (Thursday). Inflation is always a concern in China, because an uptick in inflation will cause the government to pull back stimulus (which puts economic growth at risk). But no one is expecting a major uptick in inflation this week.
In Europe it’s also quiet (the biggest number of the week was German industrial production, which we got this morning). The Bank of England meets Thursday, but there will be no change to policy. And, seeing as the BOE makes no statement at its rate meetings (unlike the Fed or ECB), this will be a non-event. After a very busy holiday-shortened week, last week, we generally get a break economically over the next several days.
Your Weekly Economic Cheat Sheet – 7.7.2014
Last Week
The most important thing that happened last week was that the June jobs report and the June ISM manufacturing and non-manufacturing PMIs further implied the US economy is close to achieving “escape velocity” (meaning ending the era of around 2% GDP growth).
Other than the obvious (that an accelerating economy is good for stocks), the strong data and implication that we’re finally breaking out of this slow-growth economy is key for two reasons:
First, the strong data of the past few weeks are helping to remove any worry about the economy being able to recover from the Q1 hole. Second, the debate about whether the Fed is “behind the curve” (which is a term that just means the Fed may be too accommodative at this point, given what appears to be happening in the economy and with inflation) was reignited last Friday. If the market starts to believe the Fed is behind, look for inflation-linked assets/sectors to outperform going forward.
Turning to the data, ISM manufacturing and non-manufacturing PMIs actually slightly missed estimates last week. (Manufacturing: 55.3 vs. (E) 55.6, Non-Manufacturing: 56.0 vs. (E) 56.2.) Regardless, both were strong numbers and solidly above the 50 level that implies expansion.
And, the June jobs report was a blowout of 288K vs. (E) 213K. And, beyond the June report, for the first six months of 2014 we’ve seen average monthly job gains of 231K—which is the best 6-month stretch since the crisis of 2008. Additionally, the unemployment rate fell to 6.1% while the labor participation rate remained at 62.8% (meaning the unemployment rate likely declined because unemployed people found jobs, not because they dropped out of the labor force).
Bottom line is last week was an important week of data, and it implied that economic growth is accelerating. While last week’s data alone won’t result in a material change in Fed policy expectations, it does put some more pressure on the Fed to begin to explain their exit strategy. For now, we remain in a sweet spot of an easy Fed and accelerating growth. But if things continue at this pace, Fed outlook will have to change—but that’s a problem for another day.
Last week wasn’t all about the U.S., though, as there were also a lot of global data. The biggest positive surprise came from China, as both the private Markit and government June manufacturing PMI were above 50, while June service sector PMI in China surged to 53.1, up from 50.7 in May. Bottom line is the PMIs, along with other recent data, confirm that the pace of growth of the Chinese economy has stabilized above 7%, which is a general tailwind for global markets and the economy.
Finally, turning to Europe, there were a ton of data last week (flash June HICP, June manufacturing and composite PMIs, retail sales and an ECB meeting). Bottom line on all of it is that while there are some pockets of weakness (German data have been a bit soft the last few weeks, which is disconcerting), the consensus is that the slow recovery in Europe is continuing. The ECB, as expected, made no changes to policy and will wait to see the effectiveness of the June measures before moving again.
This Week
It is a very quiet week economically for both the U.S. and the rest of the world. Jobless claims (Thursday) is the only number to watch here in the U.S., while internationally the “highlight” will be Chinese CPI/PPI (tomorrow night) and trade balance (Thursday). Inflation is always a concern in China, because an uptick in inflation will cause the government to pull back stimulus (which puts economic growth at risk). But no one is expecting a major uptick in inflation this week.
In Europe it’s also quiet (the biggest number of the week was German industrial production, which we got this morning). The Bank of England meets Thursday, but there will be no change to policy. And, seeing as the BOE makes no statement at its rate meetings (unlike the Fed or ECB), this will be a non-event. After a very busy holiday-shortened week, last week, we generally get a break economically over the next several days.