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.

 

 

 

June ADP Employment Report

APD Employment Report

  • Non-Farm Payrolls surged 281K in June vs. (E) 213K

Takeaway

Yesterday’s ADP employment was far better than analyst expectations of just 213K. While the May data were left unrevised at 179K. Stock futures spiked up to session highs upon release of the report but quickly pared those gains as again buyers seemed a bit exhausted yesterday.

With regard to the government number today, the first print of the ADP report has overshot the actual government number every month since January of this year by an average of 28.5K.  So, if we keep things simple, that implies a print of 256K-ish this morning.

 

Australian Dollar Continues Lower

Most currencies were driven by economic data yesterday. The Dollar Index drifted slightly higher off the decent June ISM manufacturing PMI (up +0.06%) while the euro was slightly weaker (down -0.12%) after mixed manufacturing PMIs (they generally met expectations but the euro has seen a big rally lately).

The Aussie was the best performer vs. the dollar, rising +0.8%, breaking decisively through resistance at $0.94 and hitting a new high for the year.  The strength in the Aussie was due to short-covering as the currency rallied through $0.94 (which had been the high for the year) thanks to the improvement in Chinese PMIs and the lack of any dovish comments from the RBA during their rate meeting yesterday.

Markets were looking for the RBA to make some mention of the recent strength in the Aussie and attempt to “talk it down” as they did last year, but that didn’t happen.  It’s especially surprising given the fact that some bulk commodity prices (specifically iron ore) have collapsed 30% since April while the Aussie has rallied, causing a “double whammy” on the mining sector that continues to threaten the economy.  But, the RBA refrained from any Aussie-related commentary and instead said they continue to expect a “period of stability” in interest rates (meaning no more cuts).

Given the divergence in the Aussie vs. key commodity prices (high vs. low), a stabilizing but not accelerating Chinese economy, and the RBA’s reluctance to ease further, the picture isn’t very optimistic for the Aussie economy. Fundamentally, things are still bearish for the Aussie.  But, clearly the trend is higher for now, and next resistance is $0.9518.  And, until the RBA says something about the elevated Aussie, then this counter-trend rally will continue.

The pound continued its grind higher, hitting another multi-year high after the Great Britain June PMI beat estimates (57.5) Tuesday, and the trend remains clearly higher. (As long as the Fed is dovish and the UK economy continues to surge, the pound will continue to rally vs. the dollar.  We’ve not seen the highs yet in this trade, I believe.)

The yen weakened a bit vs. the dollar yesterday (down -0.25%), but it bounced off the intraday lows and dollar/yen remains below the 200-day moving average – and it needs to get back above that support level today or tomorrow; otherwise the outlook for the yen will continue to get stronger.

Economic data lately out of Japan has been a bit tepid, and given the lack of specifics from Shinzo Abe’s “3rd Arrow,” it appears the market is starting to lose some confidence in the PM (that’s why the yen is rallying – it’s not because of economics per se).  The Bank of Japan remains in the corner of the yen bears, and I believe they will act if the economy begins to falter – but that could be at a much lower level for dollar/yen.

Again this has been a trade that has worked for over 18 months, so I’m hesitant to abandon it now, but the dollar/yen needs to get back above the 200-day sooner than later.

Bonds were sharply weaker yesterday as the 30-year fell -0.65%, trading lower off of the global PMIs. This largely implied the global economic recovery is progressing (there was also a cautious article on junk bonds and credit spreads in the WSJ, although that didn’t really tell us anything new).

Bonds were weaker all day yesterday (the selling began overnight Tuesday once the Chinese PMIs hit), and the declines accelerated after the strong auto sales and ISM manufacturing PMI.  The yield curve steepened yesterday as the “belly” of the curve declined only modestly (down -0.27%), helped by the Fed purchasing $2.9 billion worth of 7-year bonds.

Bonds gave back a lot of last week’s rally yesterday, but still remain firmly in a solid uptrend until the 30-year breaks 135’18-ish, the uptrend will continue.

 

Update on the Conflict in Iraq

Iraq Update

Iraq has deteriorated a bit this week and the inability of the Iraqi Parliament to choose a new PM weighed a bit on stocks late yesterday.  Before reading the particulars, keep in mind there are two negative scenarios in Iraq for the markets.  The first is that ISIS gets south of Baghdad and gains control of major oil export terminals in Basra in southern Iraq.  That would send oil materially higher.  The second is this Iraq conflict sparks a Sunni/Shiite civil was that spreads across the Middle East and pulls in Iran, Saudi Arabia, etc.  Obviously, that would send oil  higher.  Given the events of the last few days, the worry is for the later and the moment more so than the former, as ISIS remains well north of Baghdad.

Now, the reason things have deteriorated a bit this week are two fold.  First, ISIS (which is comprised of Sunni Muslims) attached a Shite shrine in Samarra earlier this week.  The last time that happened was ’06, and it sparked a nasty mini-civil war in Iraq.

Second (and more importantly) it was expected that the Iraqi parliament would pick a new Shiite Prime Minister to replace current PM Nouri al-Maliki, who is accused of largely ignoring Sunnis.  It was hoped that a new PM would be viewed as more inclusive, and ISIS would lose support among regular Iraqi Sunnis.

But, as Baghdad dithers, Iraq burns.  And, while militarily it seems a bit of a stalemate at the moment, any real solution will only come from a more inclusive government that saps ISIS’s ability to rally regular Sunnis.  Then the government can beat them back militarily.  But, the longer that doesn’t happen, the more support ISIS can gather among regular Sunnis, increasing the probability of a broader civil war.

Oil is down this morning so clearly the market isn’t worried about this yet.  But, the situation has gotten a bit and I wanted to make you aware.  A major positive in this scenario remains the appointment of a new Iraqi PM, while oil (specifically Brent Crude) remains the indicator to watch as to whether things are materially getting worse.

 

Your Weekly Economic Cheat Sheet – 6.30.2014

Last Week

There were three important economic takeaways last week:  First, housing appears to be finally bouncing from its winter dip.  Second, capital spending (businesses buying a new machine or some other high-cost investment) continues to not rebound like the rest of the economy has since the winter.  Third, inflation has clearly accelerated over the past three months, but economic growth doesn’t appear to be keeping pace with the recent acceleration in inflation.

Of the three, the final point is by far the most important. While it’s very early yet, if the economy can’t keep pace with accelerating inflation, then we risk stagflation, which is bad for most assets (bonds and stocks).  We aren’t anywhere close to stagflation, but after the data last week, it’s something we need to keep an eye on.

Looking at the actual data, the Personal Income and Outlays report was the most important release last week, and the main cause of the “stagflation” worries.  Core PCE, the Fed’s preferred measure of inflation, rose +0.2% in May and is now up +1.5% year-over-year (yoy), and that met expectations.  More importantly, though, Core PCE has gone from rising +1.1% yoy in February to +1.5% in May. If we annualize the last three months’ gains, we get an annual core PCE increase of +2.1%, basically at the Fed’s target.  This recent acceleration confirms what we’re seen recently in CPI.

At the same time, though, while the economy is continuing to recover, it’s not matching the gains in inflation over the past three months.  Case in point: May consumer spending slightly missed expectations, increasing +0.2% vs. (E) +0.4%, and real consumer spending (consumer spending less inflation) was actually negative in April and May.  So, the key here isn’t that the economic recovery has stalled—it has not.  But, over the last few months, the economy hasn’t grown as quickly as inflation has.

Capital spending, however, still isn’t seeing the rebound in activity that other sectors of the economy have enjoyed since April.  The May Durable Goods report headline declined, but the real number to watch (Non-Defense Capital Goods Excluding Aircraft) rose +0.7% and the three-month rolling average showed a +1.5% gain.  But, while it’s a positive number, it’s not strong growth.

With housing now showing clear signs of a rebound, capital spending (again, think investment by businesses in machines, etc.) is the one sector of the economy that still hasn’t gotten a bounce. This probably reflects continued caution by businesses on the future of the economy (i.e., things are getting better, but not enough to make large investments because people aren’t confident in revenue visibility).

Bottom line with last week: Nothing resulted in a material change in the outlook for the economy or Fed policy. But the recent acceleration in inflation/less than impressive consumer spending report (and extrapolating it out to potential stagflation) bears watching.

This Week

It is going to be a busy holiday-shortened week (the market closes at 1 p.m. EST Thursday and Friday is off).

Probably the most important number of the week has already been released, and it was the European flash HICP for June (their CPI).  The annual inflation rate ticked slightly higher to 0.8% vs. 0.7% in May (meeting expectations) so that’s slightly encouraging, but overall the deflation threat in Europe remains and this will keep the ECB fully “engaged” in the deflation fight.

Turning back to the future data, it’s “jobs week” this week, although be aware the May jobs report will be released Thursday at 8:30, at the same time as weekly claims.  Prior to that we get ADP on Wednesday.  The jobs report isn’t as critical as it has been in recent months, but it still is important.  In the context of our “stagflation” point earlier, markets will be watching for jobs growth in line with recent reports (so around 200K). If there is an increase in wages and hours worked, this will imply tightening in the labor market (which is both inflationary and positive for consumer spending).

Tomorrow we get global official June manufacturing PMIs, which should continue to confirm the consensus that: The pace of economic growth in China has stabilized, Europe’s economy continues to slowly recover, and the manufacturing sector of the U.S. economy is seeing the recovery accelerate.

The biggest risk of disappointment in this report is in Europe, as France’s flash PMI was pretty bad (47.8) while the overall EMU was stagnant.

Finally, as if all that wasn’t enough, Fed Chair Janet Yellen speaks Wednesday (we can expect similarly “Dovish” remarks like the last FOMC meeting) and there is an ECB meeting.  But, after their attempt to “shock and awe” the market last month, this meeting should be a non-event.

 

 

 

Sevens Report Analyst Tyler Richey Featured on the WSJ’s MarketWatch.com Discussing Crude Oil Prices

Oil holds above $106 on demand prospects