Archive for category: Investing

IOER, or “Interest On Excess Reserves,” refers to the interest the Fed and other central banks pay banks on their excess money (reserves) they keep in those central banks.  So, if I’m a large bank, and I deposit more money than is required at any Fed bank, I get paid 25 basis points on that money.  As of the latest Fed release, in October there was more than $2 trillion in “excess reserves” on the Fed’s balance sheet, earning 0.25% annual interest.

One of the big problems the Fed, and other central banks, has is getting money off the banks’ balance sheets and into the “real economy” via lending.  Well, one of the theoretical ways to “force” banks to lend money would be for the Fed to push the IOER negative.  So, instead of the banks earning 0.25% annually on the $2 trillion at the Fed, they would have to start paying interest on those balances, which theoretically should compel them to lend the money out.

This is important because a negative IOER is one of the few remaining “bullets” the Fed has in its arsenal to help stimulate the economy.  And, while it becoming reality is likely still a long shot here in the U.S. or in Europe, a negative IOER would be, theoretically, an economically stimulating move by the Fed or ECB (so, dovish and likely equity-positive). I wanted to make sure everyone knew exactly what it was, because it’s a topic I think will come up a lot more in the coming weeks/months, and it will be a focus of markets at tomorrow’s ECB meeting and Fed meeting later this month.

Last Week

Last week was highlighted by lots of “Fed-speak” and important economic data, and the net effect of both was to firmly solidify expectations for a Q1 ‘14 tapering of QE, and to incrementally increase the chances for a January taper (as opposed to March).  Despite last week’s good data and “hawkish” Fed-speak, a December taper is still remote (and it’ll take a blowout jobs report next week to move those odds up significantly).

Starting with Fed-speak last week, there were multiple speakers (Chairman Ben Bernanke, Vice Chair William Dudley, James Bullard, etc.) and the result was a slightly “hawkish” tone.  Bernanke’s comments went largely as expected (he again stressed that “tapering is not tightening”), but it was Dudley and Bullard’s comments—along with the FOMC minutes from the October meeting—that provided the hawkish tone.  Dudley said he was “more hopeful” about the economy accelerating, while Bullard said a December taper isn’t “off the table.”  And, although the minutes didn’t reveal much, the market did focus on the FOMC saying tapering would likely occur “at one of the next few meetings.”

Turning to the actual economic data, it continued the recent trend of being better than feared.  Retail sales showed the consumer isn’t quite as weak as was feared, as “core” retail sales (which exclude gasoline, cars and building materials) rose 0.52% from September. This was the biggest one-month increase since July (although September was revised lower, so the number wasn’t quite as good as it seemed).  But, against a pretty depressed outlook for the consumer, it was a positive surprise.

Jobless claims also dropped to multi-week lows, and the four-week moving average hit its lowest level in a month.

Finally, the most-anticipated number of last week, the November Flash Manufacturing PMIs, beat expectations at 54.3 vs. (E) 53.0, and rose to an eight-week high.  Additionally, new orders, the leading indicator of the report, also rose.

Bottom line is the data again was better than feared, and it’s becoming apparent that the government shutdown did not hamper economic growth, and the economy might just be stronger than we all thought.  And, that good data is why the “hawkish” tone from the Fed didn’t result in a sell-off in stocks.  Keep this in mind over the coming week:  The market can rally into Fed tapering as long as the economic data continues to get better (i.e., good economic news is good for the market).

This Week

It’s a holiday week here in the States, so data-wise it’s pretty slow (the next major catalyst domestically comes next Friday with the November jobs report).  But, although we can expect a slower week, there are a few things to watch.

First, this week is heavy on housing data, and that’s important because the one bad number from last week was existing home sales, which clearly shows the housing market recovery is slowing.

I’ve been saying this for months, but the housing recovery continuing is integral to the economic recovery.  But, it’s integral in that the recovery continues (it can be at a slower pace — we just can’t have the housing market start to decline again.  That is a big, big problem if it happens).  So, given mortgage rates are rising again, housing data will be important to make sure the recovery is still ongoing (even at a slower pace).

Pending home sales (a leading indicator for existing home sales) are released this morning, and Tuesday we get both September and October Housing Starts (September’s report was delayed by the government shutdown), and also the Case-Shiller Home Price Index.  Those releases will be the most-watched of the week.  The only way they result in a sell-off, though, is if they imply the housing recovery is stalling, not just slowing (and so far the data is implying the latter).

Also this week, October Durable Goods and jobless claims will be released Wednesday, and claims in particular will be watched to see if the downtrend in claims from last week continues.

Outside of a big negative surprise from the housing numbers, though, this week shouldn’t really alter the current market narrative or Fed expectations.  Again the next big catalyst is the jobs report on Dec. 6.

Internationally, it’s a busy week in Japan.  Wednesday night brings Retail Sales, and Thanksgiving Day we get CPI, household spending, unemployment and industrial production.  I’m pointing this out because we’ve seen a big drop in the yen/rally in DXJ, and to a point I think any “good” economic data may already be priced in, in the short term.  So, we could see a “sell the news” effect in Japanese stocks/rally in the yen, but I’d use that to add more long exposure to DXJ/short exposure to the yen (via YCS).

Finally, Friday we get EMU Flash HICP for October (HICP is Europe’s version of CPI).  I’m pointing that out because it was the weak September HICP that prompted the European Central Bank to cut rates. So, from a “What Will the ECB Do Next?” standpoint, this number will be important. (If it’s still very low, like last month’s 0.7%, expect euro weakness as calls for the ECB to do “more” will get a lot louder.)

Chinese shares were the big outperformers yesterday, as the iShares China Large-Cap ETF (FXI) rose more than 4% on positive sentiment surrounding details announced from last week’s “Plenum” of the Communist Party.  Interestingly, the initial reaction to the conclusion of the “Plenum” was one of disappointment, but we’re seeing a reverse “devil in the details” effect. In other words, the more details we get, the more the market likes the reforms that are being enacted.

While there were several reforms announced, the two that were positive catalysts for Chinese shares were :  1.  The relaxing of the one-child policy to allow couples where one person was an only child to have a second child, and 2.  The loosening of regulations for private companies to offer IPOs in the Chinese stock market. (Currently it is very difficult for private Chinese companies to list on any Chinese exchanges, as the process takes a very, very long time and is extremely onerous.  Public listings in China are dominated by majority state-owned companies.)

Both of these reforms contributed to a broad rally in Chinese shares. Specifically, anything childcare-related (for obvious reasons) led markets higher, as did Chinese investment banks (again for obvious reasons).

In total, the reforms announced have led to some pretty bullish calls on China, and many have called the economic reforms the biggest since the mid-1990s.  But, the question remains “Is China a Buy Here?” and I’m not sure the answer is as clearly “yes,” as the market seemed to imply yesterday.

Keep in mind that we’ve seen a big whipsaw in Chinese shares. Recall that, in the middle of last week, they were hammered after reports surfaced that the Chinese government will reduce the 2014 GDP expected growth rate to 7.0% from 7.5% this year.  Additionally, let’s not forget that there is lots of concern about a property bubble in China. (Over the weekend, monthly stats showed housing prices up 9.6% over a year ago in October.) And, the People’s Bank of China is still actively trying to drain liquidity form the system. (Remember SHIBOR rates spiked again at the end of October before the PBOC added liquidity.)

These reforms are a positive for China long term, but it’s going to take a long time for these reforms to be implemented (meaning years). And, while ultimately more children and more IPOs are a positive for childcare product markets and investment banks, we’re still a long way from that translating to the bottom line.

Longer term, does this make “China” a better place for capital than it was before?  Yes, it does.  So, maybe there‘s an argument for an IRA allocation, but I don’t think the reforms from the “Plenum” are reason alone to get “bulled up” on China right now—not in the face of potentially slowing growth and a central bank trying to drain liquidity from the system.

As far as “what’s next” for China, the official 2014 GDP growth rates should be released in the next few weeks (again, 7.0% GDP growth is the expectation) and also the results of a “debt audit” the Chinese government is conducting on local and federal debt. The debt estimate is around 60% of GDP, but the quality of that debt will also be scrutinized because many China “bears” think bad debt (specifically that which is tied to real estate) will be a major negative on the Chinese economy and market (although they’ve been saying this for a couple years now, too).

The results of the GDP growth estimates and debt audit over the coming weeks will be a lot more important to the near-term direction of Chinese shares than the reforms just announced.  Bottom line is while there is a “value argument” to be made on China given FXI is down year-to-date and well off multi-year highs hit in late ’10, the doesn’t appear to be a clear, well-founded trend to capitalize on.

Last Week

Economic data last week were stronger than their relatively low expectations, as concerns about the negative effects of the government shutdown had resulted in pretty low expectations for most of October’s economic releases.

And, it would appear that those concerns have been misplaced, because we’re not seeing the drop in economic activity you would think we would have.  At the same time though, while the data is better than depressed expectations, it’s not clear we’re seeing an acceleration of activity, either.

Certainly the highlight last week was the jobs report Friday, which was a solid “beat” vs. pretty depressed expectations.  October payrolls grew by 204K, much more than the 120K expectation, and the revisions to September and August were a positive 60K. (The direction of revisions to prior months can often be a good signal of the overall trend in hiring.)

But, the jobs report was just the highlight of consistently “good” data last week. Third-quarter GDP was 2.8%, higher than the 2.0% expectation, although that number was a bit deceiving as inventories added 0.8% to the report. (So, in reality, real economic growth in Q3 met expectations.) October Non-Manufacturing (or service sector) PMI rose to 55.4, beating expectations, although the new orders component (the leading indicator of the report) declined.  Finally jobless claims declined marginally to the 330K level, which is pretty much where they were in August.

Internationally, last week was also busy.  The highlight overseas was the “surprise” 25-basis-point cut in interest rates by the European Central Bank, which led to a plunge in the euro and a rally in the Dollar Index.  The cut was in response to currently very low inflation across the European Union, which some are fearing might turn into “dis-inflation” if allowed to persist.

Somewhat lost in the ECB and jobs report hysteria was strong economic data from China.  October composite PMIs beat estimates early last week and exports rose more than forecast Friday morning. (Strong exports to Europe are an encouraging sign of a continued economic recovery, not only in Europe but also globally).

The economic data remains very important mainly because of WWFD (What Will the Fed Do?).  In an absolute sense, while last week’s data beat low expectations, it’s still a long way from achieving “escape velocity” for the economy, where we no longer need QE or very, very low interest rates.

But, from a WWFD standpoint, last week’s better-than-expected data furthered the shifting expectations for when the Fed will taper QE, which seems to be the dominant theme in markets these days and the single-biggest influence on the bond market.  Although I don’t think the Fed will taper QE in December, the strong jobs report from Friday did result in January now becoming a strong contender for the first tapering.  But, at this point we need to see follow-through on this stronger-than-expected economic data in November before the consensus shifts from the current March expectation of the first tapering.

This Week

This should be a relatively quiet week on the economic front, especially compared to last week.  The most important event of the week will be the confirmation hearings for presumptive Fed Chair Janet Yellen, which begin Thursday.  There will be plenty of grandstanding and some tough questions and obstacles (in particular from Rand Paul). Despite this, she is widely expected to be confirmed (it would be a shock to the market if she wasn’t).

Looking at the actual hard data coming this week, we get our first look at November data with the Empire State Manufacturing Index on Friday. (Although it’s just one region, markets will be looking for any signs of follow-through from October’s surprisingly strong data.)

Jobless claims and October industrial production will also be watched.  In particular, markets would like to see the weekly claims start to decline and confirm the surprisingly good October jobs report. (Right now it’s a bit of a contradiction, in that claims are at the same level as in August while the monthly jobs report has improved.)

It’s actually a busier week in Europe from a data perspective, and given the ECB’s rate cut last week and growing concerns about dis-inflation, data there will be watched closely to see if the fledgling economic recovery is still intact.  HICP (the EU equivalent to our CPI) will be released Friday, and markets will be looking to see if there is any uptick in this final reading from the “flash” reading of two weeks ago.  It was the very low “flash” HICP reading that was really the big catalyst behind the ECB cutting rates, as it’s starting to flash a “deflation” warning sign.

Last Week

The most important thing that happened last week economically was that expectations for Fed tapering of QE were pulled forward a bit—from the previous “consensus” of mid-2014 to the early part of 2014— thanks mainly to an FOMC statement that wasn’t as “dovish” as expected plus a Jon Hilsenrath sentence that stated a December taper remains “on the table.”  Interestingly, this change in expectation came despite decidedly mixed economic data.

Starting with the FOMC statement from last Wednesday, it seems most are calling it slightly “hawkish,” but that’s really only because it didn’t feature any material downgrade of the economy in the commentary (as was widely expected).

Looking at the actual statement, it was hardly changed from September, although the two important takeaways were that the FOMC noted the labor market had slid a bit and also somewhat celebrated that interest rates had declined.

Both changes are, on balance, slightly “dovish.” So even though the market didn’t trade that way, I think the meeting didn’t really change anything with regard to when the Fed will taper QE (and certainly didn’t materially pull it forward, as they remain data-dependent).

Outside of the FOMC, as I said, economic data was at best mixed. Early in the week, things looked somewhat grim:

• The manufacturing indicator of the September industrial production report was weak and August was revised down.
• Pending home sales dropped 5.6%, the biggest monthly drop since April 2011.
• The October ADP employment report missed expectations at just 130K jobs added, and the September figure was revised lower as well.

These reports were especially disconcerting because they implied the economy was seeing a slowing of growth before the government shutdown, as this data was from before October.

Later in the week, though, the data surprisingly turned better.  Chicago PMI, which isn’t usually a watched number, caught people’s attention. It exploded to a multi-year high, and the details of the report were equally strong.  And, on Friday, the national ISM manufacturing PMI increased 0.2 to 54.4, beating expectations of a small decline.  So, if anything, the beginning of the week was considered “dovish” but turned “hawkish” as the week went on.

I’m spending time talking about how the market interprets the data (hawkishly or dovishly) because right now it’s as important as the actual data itself.  As was the case prior to the government shutdown, the question of “When will the Fed taper QE?” remains the single biggest driving factor in the markets (for bonds, the dollar, commodities and equities).

The first three assets have traded (and will trade more immediately) to shifting “tapering” expectations, as we saw last week.  But, although stocks won’t trade off daily shifting of tapering expectations, it very much remains to be seen if stocks can rally in a “QE-less” world.

Ultimately, if the Fed has to taper QE and the economy isn’t very strong, that could usher in “stagflation” and be a rally-killer.  So when and how this whole thing works out remains the key to any medium-term outlook for equities.

This Week

There aren’t many economic releases this week, but the October jobs report is Friday and clearly that’s important from a WWFD (What Will the Fed Do?) standpoint, although this jobs report will be taken with a hefty grain of salt given the government shutdown.

Also on Friday is the “Personal Income and Outlays” report, which is particularly important because it gives us a look at the Fed’s preferred measure of inflation—the core Personal Consumption Expenditures deflator.  Stubbornly low inflation has been a growing concern of the Fed’s for some time, so a weak core PCE deflator will be “dovish.”

Also on the calendar this week is the first look at Q3 GDP on Thursday (expectations are for close to 2%), weekly jobless claims (this report will be overshadowed by the  October report Friday) and ISM Non-Manufacturing (or service sector) PMIs (Tuesday).  Really, though, those reports won’t move the needle much with regard to WWFD. (GDP is more a media favorite than anything anyone really trades off of.)

Outside of the jobs report, arguably the other “highlight” of the week will be the ECB meeting Thursday.  The euro plunged last week (and the Dollar Index spiked) on a very weak inflation reading, and speculation is high as to whether the ECB will cut rates to fend off a hint of deflation potentially hitting the “Continent.”  Given the falling euro’s effect on the Dollar Index, this meeting has implications for the commodity markets particularly.