Archive for category: Investing

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.

 

Last Week

Economic data last week was largely supportive of the current market trends (improvement in global economic growth & tapering of QE in the U.S. to begin this fall). But the one glaring exception was Friday’s new home sales report, which implies higher mortgage rates are indeed acting as a headwind on the housing recovery.

FOMC minutes from the August meeting was the most-watched item last week, although they failed to provide any insight into when the Fed might taper QE or how they might do it (size of the taper and split between Treasuries or mortgage-backed securities).  The minutes showed a divided Fed that lacks consensus on every aspect of tapering QE … other than the fact that they all agree QE does need to be tapered starting this fall.

The bottom line from the Fed minutes (and the outlook for Fed policy) is that the market “consensus” (and I use that term lightly because it’s not a big majority that see tapering in September) is that the Fed will announce a small tapering ($10 billion-$15 billion) to start in October and it will occur entirely in Treasury purchases. That represents a slightly more “dovish” outlook than we had going into the meeting (the expectation for a September taper was a bit higher, and the amount of tapering was expected to be around $20 billion).  But, the key is that tapering is still on schedule for later this year.

The second big release last week was the flash global PMIs, and they were universally better than expected.  Importantly, China’s flash manufacturing PMI got back above 50 for the first time since April, and Germany and the EU’s flash PMIs beat estimates.  This data further implies we’re seeing a stabilization of global economic growth, which should continue to benefit European and Chinese markets.

Finally, housing was in focus last week, and here’s where an otherwise good week of data hit a speed bump.

Existing home sales for July largely met expectations, but the new home sales data released Friday was a big miss. Not only did the headline badly miss, but we also saw a revision of negative 64K to the prior three months’ sales data.

While this report doesn’t show the housing recovery has stalled, this report has to make investors and the Fed nervous that higher mortgage rates are indeed acting as a headwind on the recovery. And if the housing data continues to appear to be getting soft, we could see an even smaller “taper” in September than currently expected.

This Week

Although there are numerous releases this week, the data is largely “second-tier” and unless it’s horrid, it shouldn’t really change current Fed expectations.

Revised 2Q GDP is released Wednesday, and there aren’t expected to be any major positive or negative revisions from the 1.7% annual rate that was announced at the preliminary look back in July.

Personal income and outlays is the second most important report this week, but not because of the headline data.  Instead, the core Personal Consumption Expenditure price index, which is the Fed’s favorite measure of inflation, is contained in the report. Markets will be looking to see if we get any uptick in that price index, which would imply we are seeing the seeds of inflation.

Given last Friday’s report, housing also remains in focus this week as we wrap up the July housing data.  Pending home sales is released Wednesday, and this will be a more closely watched report than usual given last Friday’s New Home Sales miss.

In May and June, when markets initially declined on the prospects of Fed tapering, I pointed out to my clients two very important things we all needed to keep in mind as the market started to adjust to the reality of higher interest rates in the future.

First, it’s the pace of the rise in interest rates that’s important, not the absolute level.  So, the stock market can rally along with interest rates, as long as the pace of the rise in interest rates isn’t too fast.

Second, emerging-market debt is now the “leading edge” of any potential market turmoil, as that sector has replaced Europe as the “weakest link” in the global financial system.  Stable emerging debt markets are a pre-requisite for any sustainable rally in stocks.

With that in mind, after we saw an initial shock in May/early June, the pace of the increase in interest rates leveled off, and emerging-market debt stabilized—which allowed the stock market rally to new all-time highs.

But, over the last week, emerging debt markets have quietly begun to break down again as the pace of the rise in interest rates here in the U.S. has quickened substantially. (The 10-year yield went from a low of 2.55% last Monday to a high of 2.899% yesterday.)

In reaction to that acceleration, emerging-market bonds—as measured by the PowerShares Emerging Markets Sovereign Debt ETF (PCY) and the iShares JPMorgan USD Emerging Bond Fund (EMB)—have declined sharply, and are now dangerously close to breaking down.

As a refresher, I’ve included an excerpt from the June 12 Report that explains why emerging-market debt poses a potentially significant risk to the market (below):

Why The Plunge In the South African Rand Matters to You (June 12^th 7:00’s Report).

“Away from the yen, the other focus in the currency markets was on the implosion we’re seeing in emerging-market currencies.  The Indian rupee hit another all-time low vs. the dollar. The Brazilian real and South African rand hit four-year lows vs. the dollar, and even strong currencies like the Mexican peso got hit yesterday. 

“The reason for the weakness is this:  Since the Fed went to 0% interest rates and round after round of QE, investors have moved into higher-yielding emerging-market currencies over the past few years. 

“Now with the Fed potentially ‘tapering’ and interest rates in the U.S. rising, investors are reversing the trade. They no longer need to take the risk of being in emerging markets, as rates are rising here at home. 

“That’s causing the currencies of those emerging-market countries to drop as investors sell their bonds and reconvert those investments back into dollars.  Basically, ‘doomsayers’ are saying the world’s major central banks, led by the Fed, have created a bubble in emerging-market credit, and now it’s popping.

“The question I’m sure you’re asking right now is ‘Why the hell do I care about emerging-market credit?’  Well, you care because, as these currencies and bonds plunge, it’s causing losses in the leveraged hedge funds that have put the trade on. That’s causing them to liquidate other holdings to cover the losses (like stocks and gold, for instance). 

“Point being, you should care for the same reason everyone should have cared when the mortgage-backed security markets started blowing up in ‘07, ‘08 and eventually led to the takedown of Bear, Lehman, etc.  I’m not saying it’s the same thing here at all—but it’s the leverage and the huge declines that are making people nervous. 

“So, while it’s not a disaster yet, this unwind out of emerging-market debt and currencies is having an effect on all asset classes.  It’s not anywhere near 1998-style proportions yet (the emerging-market debt crisis), but it is unnerving investors, and weighing on other risk assets.  Bottom line is watch PCY and EMB, the two emerging-market bond ETFs. Emerging-market bonds need to stabilize in order for equity markets to calm down a bit.”

Bottom Line

The market dynamic may have changed a bit Monday, and for the worse.  The acceleration in the rise in interest rates is causing another round of turmoil in the emerging markets. And, as stated, a stable EM debt market is a requirement for any rally in the global equity markets.  If emerging-market bonds can’t stabilize at these levels and they take another leg lower, then stocks are going to follow them down, regardless of the positive economic momentum in Europe China, etc.

My optimism on equities has been consistently hedged with the statement “if the macro environment stays relatively clear.”  Well, an emerging-market currency/debt crisis doesn’t constitute a “relatively clear” macro horizon, so emerging markets need to stabilize before equities can resume their rally.

Keep an eye on PCY and EMB—if they break down to new lows, that’s a sign to get defensive with regard to domestic and international equity exposure.

I wouldn’t sell yet as EM bonds haven’t made new lows, and keep in mind the EM inspired dip in June turned out to be a buying opportunity.  But, this is a potential game changer if we get a sustained move lower in the emerging markets, so I’d certainly get a plan together about just how I want to de-risk if EM bonds break down further.

Is “Forward Guidance” Overvalued?

Whether the paper from the San Francisco Fed has any effect on Fed policy remains to be seen. But I think the conclusion that “forward guidance” is a more-effective policy tool than QE is incorrect, and I’m starting to get the impression that the academics at the Fed, and other central banks, are overvaluing “forward guidance.”

Last week, the Bank of England released “forward guidance” that said they would keep rates at or near 0% for the next several years.  The British pound reacted by doing exactly the opposite of what should happen—it rallied more than 1%.  The reason it rallied was because most investors think the BOE is too pessimistic on their economic projections, and that the economy will be doing much better over the coming years. At that point, the BOE would then have to abandon its “0% until 2016” policy stance or risk big inflation.

I think it’s the same thing with the Fed.  All of us have watched the Fed for a long time—and I can tell you their long-term forecasting abilities leave a lot to be desired.  So, beyond about 6 months or a year, I’m not sure how many people actually believe the Fed’s forecasts.  Does anyone think that, if the economy starts to accelerate and the 10-year yield moves through 3% and GDP growth accelerates, the Fed reiterating its promise to keep rates low until 2016 will have any legitimacy behind it?

I bring this up because if the Fed “tapers” QE and expects “forward guidance” to keep rates anchored, I think they risk letting the rise in interest rates accelerate, potentially significantly.  So, if this shift in policy focus does occur, I think it only strengthens the case for the inverse bond plays: the ProShares Short 20+ Year Treasury ETF (TBF), ProShares UltraShort 20+ Year Treasury ETF (TBT), iPath U.S. Treasury Steepener ETN (STPP) and ProShares Short High Yield ETF (SJB).

Economics

Last Week

The economic data and central bank announcements last week were expected to help provide greater clarity on the three major questions in the market right now:  When will the Fed taper?  Is the European economy stabilizing? Is the slowing of China’s growth getting worse?

Despite almost universally better-than-expected economic data (the jobs report being the notable exception), what we got was more clarity on the latter two questions, but surprisingly more confusion on the outlook for Fed “tapering,” which is by far the most important topic in the markets right now.

In Europe, manufacturing PMIs rose back above 50 and largely the economic data signaled the EU economy is finally stabilizing.  In China, the data wasn’t any worse than expected, and Chinese officials were again saying they will defend economic growth as needed. So, bottom line was last week was good for both Europe and China and, with regard to Europe, the numbers point to continued potential outperformance.

Looking at the economic data domestically, last week was a good week and further implies that the economy is continuing to recover.  ISM Manufacturing PMI was a very strong number not only on the headline (which hit a multi-year high), but the details of the report were also strong. They further confirmed what we’ve been pointing out here for over a month: that the manufacturing sector of the economy is finally recovering, and this recovery is starting to accelerate.

Lost in the jobs report hysteria Friday was a strong personal income and outlays report, which showed consumer spending beat expectations for June. (The weak retail sales report of two weeks ago raised some concerns about the health of the consumer, so Friday’s report is helping alleviate those concerns, somewhat.)  Additionally, the “Core PCE Deflator,” which is the Fed’s preferred measure of inflation, ticked a bit higher. It shows year-over-year inflation at 1.3%, up from 1.0% in May, and core inflation up 1.2%, up from 1.1% in May.  This is important because if inflation ticking up, as it appears to be doing, then that is a good thing for the economy.

The one disappointment last week was, of course, the jobs report.  The report itself wasn’t particularly good in that, not only did the headline miss, but “leading indicators” of the jobs market were also surprisingly weak. Average hourly earnings and average workweeks were flat to down from the May report (both move higher ahead of jobs gains as employers increase current employees’ pay and hours before adding new employees).

For all the gnashing of teeth Friday morning, though, the miss itself wasn’t really all that bad (162K jobs added vs. (E) 185K) and I’d characterize it as a “ho-hum” report, not a “weak” report.

Finally, the biggest “event” of last week was the Fed meeting, and this is where things got confusing.

The Fed statement was “dovish” in that they lowered their commentary on economic growth, and also cautioned on low inflation and an uptick in mortgage rates, and the dovish message surprised markets.

Last week the economic data continued to show the economy is recovering, which would imply “tapering” is on schedule for September.  But, the Fed has thrown that into doubt with the newest statement. Bottom line is this: Despite the whiplash caused at the end of last week by a dovish Fed, strong data and then a ho-hum jobs report, the expectation remains for tapering of QE to start in September, although that’s not as concrete as it was this time last week.

This Week

Domestically it is very quiet this week.  The three things to watch are: non-manufacturing (service sector) PMIs this morning, the Mortgage Bankers Association’s purchase application data Wednesday morning, and jobless claims Thursday.  The MBA purchase applications will take on added importance because the Fed singled out higher mortgage rates last week as a potential headwind on the economy.  So, a weak purchase application number, one that further implies the housing recovery is losing steam, will be “dovish” … and not positive for stocks.  Finally, jobless claims hit a new, multi-year low last week, and if that trend can continue, it will help alleviate some of the concerns about the labor market raised by last week’s jobs report.

Internationally, it’s a much-busier week. Most importantly, we get the latest round of Chinese inflation and economic data Thursday night/Friday morning. Clearly, given concerns over Chinese economic growth and whispers of potential stimulus from Chinese officials, these numbers are important.  If Chinese growth can level off, that’s a big positive for risk assets.

In Europe, there will be a lot more insight into whether the EU economy is indeed stabilizing.  Composite PMIs and retail sales this morning—and UK and German industrial production tomorrow  and Wednesday—will be watched closely to see if economic data further improves.  The big event is the Bank of England’s “Inflation Report,” which will be issued Wednesday. This is important because the BOE will elaborate more on their use of “forward guidance” as a monetary policy tool to help keep interest rates low.  No one knows exactly what they will say, but the expectation is they will use forward guidance and, on balance, be dovish. This should be good for UK stocks.

Bottom line is it’s an important week for China and Europe, but domestically, with regard to the Fed, none of the data will change current shaky expectations of “tapering” in September—we will have to wait for the FOMC minutes for more color there.

Finally, keep this in mind:  The market is “OK” with tapering in September as long as the data stays good (which it is).  If “tapering” is delayed, it will be because of a weak economy or threat of deflation, and neither are good for stocks.  So, if tapering of QE is delayed, it  will not be bullish for equities.