Current Economic Overview and Three Key Questions Facing the Market
Last Week
Although last week was dominated by the temporary resolution in Washington, there were two important takeaways from the domestic and global economic data that was released.
First, last week was important with regard to Chinese data and their economy, and largely the results met expectations (which is a positive). Q3 GDP met expectations, rising 7.8%.
The Consumer Price Index was a touch higher, but mostly because of vegetable prices. Importantly, it’s not high enough to have the Chinese government start to remove economic stimulus.
Plus, industrial production and retail sales data for September met expectations. Finally, commodity imports were surprisingly strong, implying there is underlying strength in the Chinese economy.
From a market standpoint, this data was important because it further reassures the markets that the Chinese economy isn’t seeing a significant slowdown in the pace of growth. (Meaning ,there is little risk of a Chinese economic “hard landing.”) From an investment perspective, it implies the “global economic recovery” investment thesis remains valid, which is positive for cyclical stocks, multi-national industrials, global industrial miners and transportation stocks.
Second, here in the U.S., we got our first look at the state of the economy in October via the Empire State and Philly Fed reports. The takeaway is that the shenanigans in Washington did have a negative effect in the near term, but the manufacturers surveyed in the reports continued to see positive momentum building beyond the temporary government shutdown. We know that because, while both headline indices declined from September levels, the new orders index (a leading indicator) rose for both reports—again implying that the government shutdown hasn’t significantly altered expectations of activity in the future.
So, to word it simply: For the next several weeks, the market will be wondering: “How Much Damage Did Washington Do?”
And, although it’s still early, both the Empire State and Philly Fes surveys gave us an answer of “some, but not a lot.”
If that answer proves valid, then that’s bullish for risk assets into year-end.
This Week
This week will be very important in providing more insight into the three key questions before the market: 1. “How much damage did Washington do to the U.S. economy?” 2. “Is the global economic recovery continuing or losing some steam?” and 3. “Will the Fed taper in December?”
Right now the market “expects” the data to reflect these answers: 1. “Some but not much.” 2. “Yes it’s continuing but with a small loss of momentum” and 3. “No, unless the economic data comes in much, much better than expected.”
First, the September jobs report will be released tomorrow morning at 8:30 a.m. Right now the expectation is for around 180K jobs added, but make sure to watch the revisions.
The August number was very low (153K), almost borderline shockingly low, and there is some expectation that this number may be revised significantly higher. So, point being, look at the revisions to the August data as much as you do the headline number for clues as to how the market will trade.
Second, global “flash” Purchasing Managers’ Indexes for October hit Wednesday night (China) and Thursday morning (Europe & U.S.). Obviously this is the next key round of data for the “global economic recovery” thesis.
Additionally, the flash PMIs (which are collected by the private firm Markit and will reflect activity throughout the government shutdown) will give a lot more insight into the “how much damage has been done to the economy” question
Third, we get the latest look into the health of the housing market via Existing Home Sales (today) and New Home Sales (Thursday). Obviously a recovering housing market remains a key driver for the growing economy. And, as has been the case, investors will be looking for clues about the effects of higher interest rates on home purchases. Incidentally banks, in their earnings calls, have had generally “OK” commentary toward mortgages and housing, so most expect these numbers to reflect a bit more slowing, but with the recovery still intact.
The Economy: A Look Back and What’s Ahead
Last Week
The ongoing government shutdown delayed several pieces of data last week, so weekly jobless claims and the Federal Open Market Committee minutes were the only two reports released.
Starting with the Sept. 18 FOMC meeting minutes, they revealed, as expected, a divided Fed about when and how to taper QE. The decision not to taper QE was a “close call,” as multiple Fed governors had said in follow-up speeches since the meeting. The market initially took the minutes as a touch “hawkish” based on a sentence that stated most governors still expected tapering this year. But the “hawkish” response from the market was short-lived, as clearly a lot has happened since the September meeting, and virtually none of it has been good—with the exception of President Obama formally nominating Vice Chair Janet Yellen to replace Chairman Ben Bernanke, as was widely expected.
Jobless claims saw a huge jump last Thursday as governmental incompetence trickled down to the state level. California, apparently because of computer upgrades, had a backlog of unreported claims from the last several weeks. (This was despite the Department of Labor saying that, for two weeks, the data has been “clean.”)
Initial claims jumped by more than 60K due to the backlog, although the takeaway is the four-week moving average is basically where it was one month ago (in the mid-320K range). This means the multi-year dip we saw in claims over the past three weeks was a mirage, and the labor market remains basically unchanged since last month (meaning, we aren’t seeing any marginal improvement).
The bottom line of the data last week was that—taken in the context of the Washington fiscal drama and negative effect of the government shutdown on the economy—expectations for QE tapering are now rapidly shifting to early ‘14, in either January of March, and the prospects for a December taper are quickly falling to near-zero.
This Week
Thankfully the most-important economic release this week won’t be delayed because of the shutdown. Most important to the markets this week is data from China.
Over the weekend, we learned exports from China dropped much more than expected in September—falling 0.3% vs. (E) 5.8% increase. It was already an important week of data from China, but that “miss” will have people even more focused on the releases.
Third-quarter GDP, Industrial Production and Retail Sales are all released Thursday night. It goes without saying that Chinese economic growth stabilizing around the 7.5% GDP mark is essential to the “global recovery” investment thesis, so it’ll be important that Chinese data is close to estimates.
Domestically, the Empire State and Philly manufacturing surveys (Tuesday & Thursday, respectively) will give us the first look into economic activity in October, and clearly people will be watching to see if there has been any negative effect on the manufacturing recovery given the drama in Washington. It’ll only be an anecdotal look, but in particular keep an eye on the Philly Fed, as recently it’s been a good predictor of the national Institute for Supply Management’s manufacturing PMIs. So, expect a negative reaction from the market if that number is weak.
Elsewhere, the Fed Beige Book will be released Wednesday. Although, given the nature of the analysis and the government shutdown, this report—unless it’s shockingly negative (which is a very low probability)—shouldn’t be a market-mover. Finally, weekly jobless claims, given last week’s volatility, will again be watched, in particular to make sure they come back down after the big jump from the California backlog.
The shutdown will again delay several pieces of data this week. Industrial production, the Consumer Price Index and housing starts continue to be on hold until further notice.
An Update on Washington and the Economic Climate
Washington Update
The rhetoric escalated a bit over the weekend, and Boehner said there are not the votes to pass a “clean” CR or debt ceiling debate without first having a “serious conversation” about what’s driving the debt. That comment is responsible for the weakness in risk assets this morning. Democrats re-affirmed their stance that they will not negotiate on the CR or debt ceiling.
From a market standpoint, despite the escalation, the very widely held expectation is that a deal will get done, and the market views the fact that the CR and debt ceiling are now one negotiation as a positive. Most expect some sort of resolution later this week (CNN reported a six-week CR and debt-ceiling deal is gaining momentum), although if we go into another weekend with no progress, expect the anxiety level to creep higher. For now though, we can expect a continuous stream of headlines as both sides posture and continue with their respective PR campaigns.
This Week
Away from Washington, there are several other important things going on. First, earnings season kicks off this week with AA and YUM posting results Tuesday after the close, but the big releases of the week will be bank earnings on Friday. JPM, WFC and WBS all release results Friday morning. Sentiment toward the banks has turned very negative since the “no taper” surprise, and recent reports of depressed trading volumes and revenues have added to concerns. So, it’ll be very interesting to see if the reality of the results matches the low expectations.
Second, while economic data will be sparse, there are a number of Fed speakers this week (two on Tuesday and two on Thursday), in addition to the FOMC minutes being released on Wednesday. In addition to the Fed speakers, we will also hear from ECB head Mario Draghi, who makes comments in Massachusetts on Wednesday, and BOJ head Haruhiko Kuroda speaks Thursday in New York.
Economics
Last Week
The economic data last week implied the U.S. and global recoveries are still ongoing, but they’ve lost a little momentum from August. The most-watched numbers last week were the U.S. and international manufacturing and service sector PMIs. And across the board, they reflected continued expansion but a slight loss of momentum.
Chinese and European manufacturing PMIs remained above the 50 level (both at 51.1) but declined marginally from August readings, while service sector PMIs both beat expectations. It was the exact opposite in the U.S., as September manufacturing PMI hit another multi-month high at 56.2 vs. 55.0 (E), while non-manufacturing PMI declined to 54.4 from a high August reading (57.0).
The takeaway from the global PMIs is that, while they lost some momentum, they still imply the global economy is recovering. As such, the numbers don’t give any reason to think the “global economic recovery” thesis, that has in part led to international outperformance over the past several months, is ending.
Looking domestically, last week was “jobs week.” But because of the government shutdown we didn’t get the monthly Employment Situation report, making the week somewhat anti-climactic. Given that, the ADP report took on a bit more significance. So, the fact that it missed estimates and saw a decent downward revision to the August data weighed on markets and continues to imply we’re not seeing the incremental improvement in the national jobs market that we would like. And, the drop in jobless claims, which remained just above 300K last week, isn’t yet resulting in a pickup in hiring.
This Week
Even before the government shutdown, this week was going to be quiet from an economic standpoint. But because of the shutdown, the most-anticipated number of the week (retail sales on Friday) has been postponed. The Produce Price Index (PPI) and wholesale trade are also being delayed.
Turning to what will be released this week, the most-anticipated will be the Fed minutes on Wednesday. We have had an endless parade of Fed speakers since the surprise “No Taper” in September, and basically we’ve had two conflicting messages from them. Some Fed governors, such as Dudley and Williams, have been pretty dovish—implying the economy isn’t strong enough for the Fed to taper. Conversely, some Fed governors such as Bullard have repeatedly said not tapering QE in September was a “close call.” Given all the Fed confusion, the minutes will be poured over for clues as to just how close the Fed was and is to tapering. Going into the minutes this week, the overwhelming expectation is for tapering of QE at the December meeting at the earliest, and many are now expecting the first taper to occur in early ’14.
Other than the minutes, data is very light, assuming the shutdown stays in effect. The three releases this week are consumer credit (Monday), jobless claims (Thursday) and University of Michigan Consumer Confidence survey.
Bottom line on data this week is nothing released is going to materially change the current expectation that both the global and U.S. economies are recovering at a slow pace. And, really, markets will be gaming on any potential negative effects of a protracted U.S. government shutdown and debt-ceiling crisis more than they will be trading off any data released this week.
What Washington Dysfunction Means for the Market (It’s not all bad).
Washington Update
The House Saturday night passed a bill that funds the government through Dec. 15, but added a one-year delay on the individual mandate to the “Affordable Care Act” and removed a tax on medical devices. Like the earlier version, this bill is dead in the Senate, so at this point the chances of the federal government shutting down at midnight tonight have increased substantially.
But, although the media will portray it as such, even if the government shuts down for a short period, it’s not a bearish game-changer. The real risks here (that would require getting defensive, and fast) are for a protracted government shutdown (not just a few days) and/or a breach of the debt ceiling. Drama aside, both those “Armageddon” scenarios look very, very unlikely.
At this point, the Senate will come back into session around mid-day today, where they will vote down the CR sent from the House. And, at that point, we start the game all over again—will the House pass the “clean” CR or will it add another set of amendments? The answer will result in a shutdown or not (although at this point at least a temporary shutdown is likely, just based on the fact there’s not a lot of time to get everything done).
Bottom line is this, though: Unless a government shutdown becomes extended (say >20 days or so), it’s not a bearish game changer. Selling right now isn’t panicked – its just cautious and there are no bids in the market. But, keep in mind the high probability is that a deal does get worked out to fund the government sometime in the next few days (if not late tonight).
This Week
Besides Washington drama and a heavy calendar of economic data, there will be multiple Fed speakers (highlighted by Ben Bernanke on Wednesday, although there may not be much on monetary policy. The speech is called “Community Banking in the 21st Century”).
Internationally, all eyes are on Italy. PM Letta is scrambling to shore up support for his government amidst the with drawl of support by Berlusconi. All this is occurring as the Italian Senate is set to vote on Silvio Berlusconi’s expulsion on Friday, and more pressingly Letta will hold a vote of confidence Wednesday. Obviously if there is a collapse of the Italian government and new elections, that will be a significant negative event for Europe peripherally.
In Japan, Prime Minister Shinzo Abe is expected to announce tonight whether the planned sales tax increase will go through in the spring. (The wide expectation is “yes it will.”)
Micro-economically, the calendar is quiet but we’re now in “pre-announcement” season for Q3 earnings, which start with Alcoa (AA) on Tuesday, Oct. 8, so there are potential surprises lurking.
Larry Summers Was a Casualty of Syria
The big news over the weekend was Larry Summers withdrawing his name from consideration for Fed Chairman. Summers withdrew after Democratic Senator Jon Testor from Montana signaled Friday he would not vote for Summers, making it virtually impossible for Summers to make it out of the Senate banking committee vote needed before full Senate confirmation, which basically killed any chance for nomination.
This is a surprise, as Summers was largely “priced in” in the Treasury market, the dollar, and gold, especially after last Friday’s Nikkei article (bet that reporter didn’t have a good Monday).
Yellen will now be the overwhelming favorite to replace Bernanke, with Don Kohn a longshot. Very short term (and I mean basically just today) this is positive gold, equities and Treasuries and negative for the dollar. Longer term, Yellen over Summers isn’t a major game changer from a policy standpoint, but it is “dovish” on the margin and likely a boost for inflation linked assets.
The important positive from this news has more to do with continuity than it does policy. The Fed is more involved in markets than ever, and I think it is a positive there’s going to be continuity (assuming it’s Yellen) as the Fed unwinds its balance sheet, because the truth is they are making this up as they go along. As we know, markets hate uncertainty, and Summers, however qualified, was an unknown. With Yellen as Chairman, there will be continuity, and that is a positive for stocks. Bottom line is the market “knows” the Fed under Yellen, and happily one major decision from Washington appears to have resolved itself without major fighting or drama.
Is Larry Summers a Casualty of Syria?
One of the more interesting things I was reading yesterday had to do with the topic of Chairman Bernanke’s successor. Over the past two weeks, the market had largely become resigned to the fact that Larry Summers would become the next Fed chair, which was viewed as an incrementally “hawkish” event. Acceptance of that fact is something that I think helped push Treasury yields to their recent highs.
But, I’m hearing a lot of chatter that, because President Obama has spent so much political capital on getting this Syria resolution passed (which incidentally may not even be voted on now) he may not have enough left to get Summers into the Fed chair. (Summers remains Obama’s #1 pick, but there is a lot of opposition in Congress.)
At a minimum, the announcement of a new Fed chairman, which prior to Syria many were penciling in for early to mid-September, will inevitably be delayed due to the Syria resolution.
Bottom line is the market “thought” it was Summers all along, but if Janet Yellen gets the nod, that will be a “dovish” event compared to current expectations, and I’d expect to see Treasurys rally off that news.
The Economy: A Look Back and What’s Ahead
Last Week
In almost an exact repeat of the first week of August’s data, almost every economic report last week pointed to an economy gaining steam, except the monthly jobs report.
The Institute for Supply Management’s manufacturing and non-manufacturing PMIs surged higher, with the non-manufacturing rising to the highest levels since ‘05. Additionally, the details of both PMIs were as strong as the headline numbers. New orders (the leading indicator in both reports) rose sharply, and most sub-components pointed to increased activity. The PMIs last week strongly imply the domestic economy is continuing to grow, and that the pace of this growth may be accelerating.
Auto sales were also strong last week, both in aggregate (total motor vehicle sales) and on a company-specific level. As I said in the Report last week, despite the tech industry hogging most of the headlines, the U.S. is an autos- and housing-driven economy, and it’s pretty difficult for the economy to be slowing when sales of both are rising (as they are now).
But, once again a disappointing jobs report left a bad taste, economically speaking, in everyone’s mouth.
To spend a few seconds on the newest jobs data—it certainly was an underwhelming report, but as always, the monthly jobs report should be taken with a grain of salt.
First, even on its best day, this report is subject to massive revisions. Second, it’s also subject to crazy one-offs. For instance, the big downward revision to the July jobs report came almost entirely because of more temporary layoffs from car manufacturers than expected due to scheduled maintenance on plants. Those job “losses” were job “gains” in August. Second, and I’m not making this up, a work stoppage in the porn industry centered around an AIDS case could have skewed the data. (You can read the Washington Post story here.)
The internals of the report were actually “OK.” Average workweeks moved up 0.1 hour and hourly earnings moved up 0.05 (both are leading indicators of employment growth). The U-6 unemployment rate—which is the one we should all watch because it includes underemployed workers and is a better measure of the labor market than typical unemployment—declined to 13.7% from 14.0 in July.
Bottom line is the data from last week, when taken in aggregate, showed the domestic economy is definitely continuing the trend of slow growth, and potentially seeing some marginal growth acceleration. And, jobs report aside, the data further cemented the market’s expectation for a $10 billion-ish QE tapering announcement at the September Fed meeting.
This Week
Things should slow considerably from an economics standpoint this week. Retail sales on Friday is the highlight, as there are concerns the U.S. consumer is slowing down, given less-than-stellar June and July retail sales reports, and a slew of retail stocks missing earnings or issuing lower guidance (WMT, TGT, AEO and ANF, to name a few).
While the rebound in the manufacturing sector is good to see, the consumer still carries the U.S. economy. If data shows the consumer is materially pulling back (the data hasn’t shown that yet, but that’s the concern), then that will dampen the outlook for equities going forward.
Jobless claims Thursday is the second-most-important number, and after the disappointing August jobs report, markets will want to see claims continue to fall and make new lows for the recovery. If claims can continue to fall, that will help ease some of the anxiety the monthly jobs report caused.
Really everyone’s focus should be on the Chinese economic data this week, as we have already gotten the August trade balance (which was positive), the Consumer Price Index and the Producer Price Index.
Chinese industrial production and retail sales come very early tomorrow morning, and obviously if the data can confirm the manufacturing PMIs and continue to show a continued stabilization in the Chinese economy, that will help commodities and basic materials stocks continue their outperformance vs. domestic equities. (Expect European equities to peripherally benefit as well.)
China growing at minimum 7.5% this year is essential to the “return of global growth” investment thesis. If these numbers are good, we could see that trend accelerate.
Bottom line is, outside of China, this is a slow week. Expect further digestion of last week’s numbers and lots of conversation about when and how the Fed will taper QE, as well as whether Larry Summers will be Bernanke’s replacement. But, don’t expect any of the data this week to change the market’s expectations of a September taper. Unless the retail sales data are just awful (and I doubt even that would be enough to change Fed expectations, but people will speculate), a “small” taper looks like it’s on the very near horizon.
The Economy: A Look Back and What’s Ahead
Last Week
Economic data last week was sparse, and what we did get largely missed expectations. But, the data wasn’t important enough, nor were the misses big enough, to materially alter the expected course of Fed policy. So, the net effect was that last week’s data further solidified that the Fed will announce QE tapering this month, but the amount of the taper will be very, very small (say $10 billion, give or take $5 billion).
Looking at last week’s data, the durable goods number was probably the “worst” of the week, showing a pullback in capital expenditures from businesses in July. But, while a disappointing number, there has been undeniable improvement in capex over the past several months. For now, this one bad report isn’t materially changing the economic outlook, although some firms noted their projections for 3Q GDP may be revised down because of the weak durables number.
While durable goods was the biggest miss last week, pending home sales was probably the most-important number. Pending home sales declined from a six-year high in May but generally met expectations. More importantly, pending home sales—which reflect contract signings in June—didn’t fall off a cliff like new home sales did.
So, while there is now a lot of proof to show that higher mortgage rates are slowing the housing recovery, the recovery itself has not stalled. The economy can continue to grow even with the housing recovery moving at a slower pace—the important thing is that housing hasn’t reversed course. Remember, don’t confuse a slowing of the pace with a turn in direction—the former the economy can live with; the latter, it can’t.
Other notable reports last week included the revised look at 2Q GDP, which beat expectations at 2.5% vs. the 1.7% reading from the first look. But, a lot of the positive revisions came from exports and inventories, not from an increase in Personal Consumption Expenditures or Non-Residential Fixed Investment, which would signal that the “real” economy is accelerating.
Jobless claims were flat last week, and continue to imply small but incremental improvement in the labor market. Meanwhile personal income and consumer spending both increased in July but missed expectations.
Importantly, the core PCE price index (the Fed’s preferred inflation measure) contained in Friday’s income and outlays report showed that year-over-year price increases remain well-below the Fed’s 2% target at 1.2%. That’s important because it means concern about “dis-inflation” will remain, which is another reason the Fed will keep the September taper very, very small.
This Week
This is a busy and potentially decisive week with regard to what will happen at the Sept. 18 Fed meeting. That’s because it’s “jobs” week for August. So, we get ADP Wednesday, Challenger job openings and weekly claims Thursday, and then the government report Friday.
Right now expectations are for a number similar to what we’ve seen over the last several months (in the high-100K job adds), but here is the key to the number this week: Unless the report is awful, and by awful I mean fewer than 100K jobs added, then tapering in September is definitively “on.”
Away from employment, we get the latest official manufacturing and composite Purchasing Managers’ Indexes from around the globe.
One of the biggest themes we’ve been talking about during the past several weeks is the stabilization of global economic growth—which, if it continues, is a major foundational positive for risk assets. I’ve said it before, but it’s been years since we’ve had the four largest economies in the world (EU, China, Japan, U.S.) all growing at the same time, and I think a lot of strategists and analysts are underestimating the positives of that environment, if it truly materializes.
We got official Chinese and European manufacturing PMIs already, and they were universally better than expected, but China’s composite PMI comes tonight, and European numbers are released Wednesday morning. Domestically, the manufacturing PMI comes this morning, and the services PMI comes Thursday.
Finally, there are multiple central banks with announcements this week: the Reserve Bank of Australia on Tuesday; the Bank of Japan Wednesday; and the European Central Bank, Bank of England and Bank of Canada Thursday.
No one is expecting any movement on the interest rate or policy front from any of them, and I’ll cover ECB/BOE expectations as we get closer. But here’s the overarching theme to look for: The Fed, via its intention to taper, is exporting higher interest rates to the rest of the world. Other central banks need to more-effectively counter that rise in rates, either through rhetoric (“forward guidance”) or, ultimately, via more accommodation. (That means more QE from the BOE, and more Long-Term Refinancing Operations from the ECB).
So, look for all these central banks to reiterate their commitment to very accommodative policy, which is an underlying positive for those respective economies (especially Europe) as the global economy turns for the better amidst a backdrop of still-historic monetary accommodation.