Archive for category: Media

Last Week

With the exception of the ECB, it was more of the same last week as economic data from the U.S., the EU and China confirmed what the market currently assumes and has priced in.  Those assumptions are that:   U.S. growth is recovering from the temporary winter drop, and 3% annual GDP growth is consensus. The EU economy is seeing the recovery accelerate slowly (but overall economic growth remains weak). Economic growth in China is showing signs of stabilizing (so 7.0%-7.5% GDP growth is still to be expected).

Looking at last week’s data, reports were light in the U.S., but as mentioned, the reports we did get were good.

ISM non-manufacturing PMI was 55.2, the best reading since August, and that strong data helped reverse a big decline (over 100 points) last Monday in the Dow.

Additionally, weekly jobless claims declined to 319K, and appear to have resumed the downtrend we were seeing prior to the Easter/Spring Break “noise” in the number.  And, if that trend of lower claims continues, it’ll continue to imply we’re seeing incremental improvement in the labor market (obviously a positive for the economy).

The Yellen testimony in front of Congress was in focus last week. But while some in the media were trying to spin her comments as a slight downgrade on the outlook for the economy, they really weren’t. Her comments didn’t give anyone any reason to change their outlook for Fed policy (tapering ending October/December, with the first interest rate hike coming in mid-2015).

In China, composite PMIs were in-line (importantly the service sector PMI stayed above 50 at 51.4). Meanwhile, the April trade balance was the positive surprise of the week, as both exports and imports increased small vs. expectations of a 3% monthly drop for both.

We get more Chinese data this week, but if it can confirm what we saw last week, it would make a very good case that the Chinese economic growth pace is stabilizing. (This is important because we may be able to get long “China” and also because it’ll remove the macro risk of a Chinese “hard landing.”)

The “biggest” event of the week was the ECB meeting last Thursday.  As expected, there was no change to policy, but ECB President Mario Draghi’s comments during the Q-and-A (he stated that the Committee was “comfortable acting next time”) commanded the market’s attention.

We knew Draghi would again try to rhetorically ease policy, but no one expected this amount of specificity.  And, it worked. The euro collapsed late last week, and everyone is penciling in either a rate cut in June, or the introduction of negative deposit rates. (QE, however, remains well off in the future.)

This Week

This is a busy week of data on the calendar, but I don’t expect any of it to materially change the market’s economic assumptions about the U.S., EU or China, unless the numbers are simply horrid.

In the U.S., retail sales tomorrow are the highlight, followed by industrial production Thursday. Although economic data have been strong, the inexplicable strength in the bond market and U.S. dollar weakness are keeping concerns alive about growth going forward.  So, to a point, the market has a confidence problem, and each number that comes in better than expected (especially in April) helps to re-affirm that the economy is indeed seeing the recovery accelerate.  So, retail sales and IP are important from a confidence standpoint.

We also get the first look at economic activity in May, via the Empire State and Philly Fed reports (both Thursday).  These two first looks have lost some significance now that flash PMIs are released for the U.S. (they come next Thursday), but still they are watched because it’s the first data for the current month.  Philly has been the better predictor of national manufacturing activity lately, so pay more attention to that one.

Internationally, China releases April retail sales and industrial production tonight, and again the market is looking for further signs of stabilization.  In Europe there are several pieces of data, but again unless the news is horrid, it won’t really change anything as the entire focus of Europe is on what the ECB will do at the June meeting.

As we approach the jobs report later in the week, we need to be mindful that the greatest risk from an economic data standpoint isn’t of weakness, but instead inordinate strength, which could then sow the seeds of the market doubting “ZIRP.”  It wouldn’t mean that stocks would sell off immediately, but as we look out over the coming weeks and months, the risk of the market losing confidence in ZIRP is the biggest threat to the stock market, and the better the economy gets, the higher the chances.

Luckily, though, we have a bit of a leading indicator for what might happen if and when the market does begin to lose confidence in the Fed’s ZIRP.  The UK is somewhat of a “blueprint” for what we can expect here in the US, now that the Fed has started tapering QE and is relying more on “Forward Guidance” as a policy tool.  The UK shifted its policies away from QE to “Forward Guidance” over the past year, and that has resulted in higher stock prices as the economy improves, higher bond yields and a stronger Pound (sound familiar?).
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As I start to think about the outlook for 2014, my mind almost always wanders first to “what could go wrong in the financial markets this year?” Having been raised in this business as a trader, I learned early that avoiding disaster is the first step to making money.  So, I’ve spent some time thinking about what could go “wrong” in 2014.

Maybe I’m just a product of my environment, but I entered this business in the dot-com bubble burst of the summer of 2000, started on the floor one year after 9/11, and after a few good years then ran smack into the financial crisis.  So, despite my relative youth, I’ve seen a lot of mess over a relatively short time.

Now, in fairness, the macro-horizon is as “clear” as it has been for some time.  Europe is no longer teetering on the brink of a breakup or massive sovereign default.  The financial system and banks are well-capitalized and as healthy as at any time since the crisis.  Even the U.S. government appears to be trying to behave, as we’ve got a budget for the next two years (and the debt ceiling won’t be a drama in an election year—I don’t care what the Republicans say now).  So, all things considered, the horizon looks pretty clear.

But, as I look for places where something could go “wrong,” I keep coming back to the bond market.  I don’t think there are many people who would argue that the bond market, in general, reached “bubble” territory (or at least a blow-off top of a 30+ year bull market) over the past few years.

There are multiple measures to imply this is the case, whether it’s the amount of assets that have poured into the bond market, the amount of corporate issuance, or risk spreads compressing to historic lows, etc.

But, importantly, a declining bond market, by itself, doesn’t mean a crisis.  Bonds can go down like any other asset and not cause a crisis that infects other asset classes.  But, what makes me nervous about a crisis emanating from the bond market is the fact that we have a market in a blow-off top that was largely manufactured by government policy (the Fed), combined with government-mandated structural changes to the industry that has drained liquidity and will likely have multiple unintended consequences. (I’m referring to Dodd-Frank.)

And, this sort of dangerous cocktail should sound familiar to people.  The potential negative consequence of this, of course, is a stampede to the exit by investors, but no one to buy the dip—causing a liquidity crisis in the bond market, and specifically the corporate bond market (with ground zero potentially being the high-yield market).  And, the potential set-up is for a liquidity crisis in the corporate bond market that infects all other asset classes (like subprime did to everything else).

Throw in the explosion of bond-related ETFs and the retail money that’s flooded into them, and I can imagine a scenario where there is lots of selling of these ETFs and mutual funds. This in turn results in the bonds themselves having to be sold, but there simply being “no bid” for the specific corporate bonds, which then breeds a liquidity crisis that begins to feed on itself.

This report isn’t the venue for an in-depth analysis of the risks, but a client sent me an excellent report by McKinsey on this subject (I’m lucky to have a lot of smart people as subscribers), and the link is here.  We got a warning shot on this in May/June of last year, and this is a concern that is starting to make the rounds among smart people.

I’m not a Pollyanna, but as I think of risks coming out of left field that could result in an end to this rally, this is the one that keeps popping up in my head.  Again, this is a very, very low probability scenario, and one that likely won’t ever come to fruition. But if we’re looking for something that could go wrong next year, the pieces are in place.

Last Week

If economic data had been “Goldilocks” (meaning good, but not so good that the Fed would “taper” QE early) domestically during the past two months, then last week’s data was decidedly “anti-Goldilocks.” (It wasn’t bad enough to remove the prospects of tapering, but it wasn’t good enough to give people confidence the economy can keep growing if the Fed pulls back.)

Retail sales were basically flat last week, meeting low estimates.  The first look at August manufacturing data via the Empire State and Philly Fed reports showed continued expansion but at a slower pace than July.  Jobless claims fell to the lowest levels since October ’07, implying we’re seeing incremental improvement in the labor market, and the Consumer Price Index rose slightly. But it has been increasing for three consecutive months, which is helping to ease some fears about dis-inflation.

So, the latter two reports helped solidify the expectation of “tapering” being announced at the September Fed meeting. Meanwhile retail sales, Empire State manufacturing, Philly Fed, Industrial Production and Friday’s new home sales (which met expectations) basically showed an economy that’s still expanding, but at a slower pace than the previous few months.

Bottom line: The data rekindled the market’s primary fear that the Fed has to taper QE because of the potential negative side effects they risk by keeping it going, but that the economy isn’t strong enough to handle the rise in interest rates that will accompany the tapering of QE.  The economic data last week didn’t directly imply that’s what’s happening, but it certainly made people think about it. With the S&P 500 up 18% year-to-date, that’s a reason to de-risk a bit, which is what happened.

The opposite was true in Europe, as the data there almost universally showed the EU economy is indeed starting to turn, although many investors remain skeptical.  EU GDP turned positive thanks to strength in Germany and France, while the ZEW index, German industrial production, UK retail sales and labor market report were all better-than-expected.

So, from a rate-of-change perspective, last week implied that the EU economy is actually outperforming the U.S. economy. The data there implies an acceleration while the data here implies continued recovery, but at a stagnant pace—meaning, we may see continued outperformance from EU markets over the near term.

This Week

There isn’t a lot of data this week but what’s reported is important, and this is by far the most important week of the month from an economic and a WWFD (What Will the Fed Do) perspective.

The headline this week is the global flash PMIs from China (Wed night) and the EU and U.S. (Thursday morning).  International markets and basic materials have outperformed thanks to better economic data internationally, and this trend needs to continue for those markets to rally further.

The next most-watched event this week will be the FOMC minutes, as investors will parse the release for insight into whether tapering will be announced in September, October or December.  Right now the consensus remains on a September announcement, but that’s no sure thing.  Anything beyond September will probably be taken as peripherally “dovish” by the market. The important thing to keep in perspective here is that the Fed is tapering, whether it’s in September, October or December.

We get more housing data also this week in the form of existing and new home sales (Wednesday and Friday respectively).  The new home sales figure was “OK” and the market will welcome more signs that the housing recovery isn’t losing too much positive momentum in the face of higher mortgage rates.  It is very important for the market that housing doesn’t show signs of backtracking.

Finally, weekly jobless claims will be watched to see if the six-year low set last week sticks, or if there are some big revisions.  Regardless, the anecdotal evidence implies the job market is incrementally improving, and that supports the September taper argument.

Internationally, it’s quiet outside of the flash PMIs, as most of Europe will be on “holiday.”

This could be an important week with regard to resolving what’s expected of the Fed and specifically answering the question of whether or not we will see tapering announced in September.

One important thing to remember, though, as the week unfolds:  Good economic news is still good for the market, regardless of the very short-term reaction.  Better economic data is the only way this rally has legs over the medium and longer term—if the market sells off on good data, then that’s probably a place to nibble on the long side.