Posts

Economic Growth Slows: February 14, 2017

An excerpt from today’s Sevens Report.

Non-Political Risk #1: Economic Growth Slows.

Stronger economic data remains an unsung hero of this post-election rally, and while Trump gets the headlines, it’s really the economic data that’s enabling this rally as better economic growth is allowing the market to continue to give Trump and the Republicans the benefit of the doubt.

I can go through the litany of reports, but whether it’s PMIs, the Jobs Report, or Business Investment, the data has been accelerating since mid to late 2016, and that’s created the proverbial “rising tide” that’s helped under-write both policy optimism and the rally in stocks.

But, while hope may be growing that there will be less drama from the administration (the reason for Monday’s rally), at the same time there’s growing evidence that actual policy reality will not meet market expectations.

So, in the near term, it’s going to be up to economic data to continue to provide a reason for markets to give Washington the benefit of the doubt, otherwise the sober reality of a market that now trades well over 18X current-year earnings will begin to cause problems.

Bottom line, if economic growth slows in the near term, that will cause a pullback in stocks. So, in today’s Sevens Report for subscribers, I go into detail on: 1) How likely is an economic slow down? 2) What are the leading indicators to watch? and, 3) How do we position if it happens?

First, how likely is an economic slow down? > 50%.

A probability that high may surprise people, but I have several reasons for it: First, we’ve seen an acceleration in economic activity, but we still haven’t really achieved the “breakout” pace of consistent 3% GDP growth that tends to feed on itself and further stimulate the economy. For all the excitement, we’re still in a 2%ish GDP regime (GDP Now from the Atlanta Fed has Q1 GDP at 2.7% in Q1). Point being, things down have to slow very much before the economy is right back in neutral.

Second, the consumer has powered this economic acceleration, but the consumer is tired. Credit creation is slowing, and retail sales reports have been lackluster of late. To boot, the job market remains basically at full employment and while wages are rising, they aren’t rising fast enough to power incremental acceleration consumer spending. Unless we see proof consumers are accessing the equity in their homes, I don’t see what will cause consumer spending to grind higher.

The Citi Economic Surprise Index rose steadily through Q4 of 2016 as economic data consistently beat expectations. Going forward, this index is now an important leading indicator for the market, as any material move back down towards zero will create a headwind on stocks.

Third, business investment has accelerated lately and that is good, but the uncertainty over the tax code changes (and trade in general) has the potential to be-come a headwind on business investment. Here’s my point: The tax changes being discussed in Congress could eliminate interest deductibility and change a host of other tax issues. If I’m a business and I’m thinking of getting a big loan to finance expansion, I’m likely going to wait until there’s more clarity on these and trade issues be-fore taking on too much risk.

Finally, leading indicator of growth for the global economy, China, is actively trying to slow its economy. China’s credit-fueled expansion back in February 2016 marked an inflection point in the global economy and things have been better since. But with a year of stimulus be-hind it, currency issues, and once again overheating property and asset markets, Chinese authorities are trying to cool their economy. The effects aren’t immediate or direct on the US economy, but the fact is that a slow-ing Chinese economy will become a headwind on the US at some point (how much of a headwind depends on how well the cooling is managed).

“Leading Indicators” and, “How do we position if it happens?” sections are restricted to subscribers.

Take advantage of the limited time special offer—if you subscribe to the Sevens Report today, and after the first two weeks you are not completely satisfied, we will refund your first quarterly payment, in full, no questions asked.

Copyright 2017, Kinsale Trading LLC. All Rights Reserved. www.sevensreport.com

Economic Cheat Sheet: February 13, 2017

Last Week:

There was very little incremental economic data last week, and what reports did come met expectations and importantly did nothing to change the perception that economic activity is legitimately accelerating—a perception that continues to support stocks broadly.

From a domestic data viewpoint, there isn’t a lot to talk about. Jobless claims continued to fall and hit another multi-decade low (a 43-year low), and that’s even more impressive when you consider how much the population has grown since then. Internationally, there was mixed data from China as their foreign exchange reserves dropped below the psychologically important $3 trillion level. While that was ignored by markets this week, China continues to bubble as a potential macro surprise in Q1/early Q2. These foreign currency reserves are a story we need to continue to watch.

But, January Trade Balance was much stronger than expected (exports up 7.9% vs. (E) 3.1%), and that data point early Friday helped alleviate some concern. Still, China’s currency reserves are declining, and authorities are actively trying to pull leverage from their economy and cool growth. More often than not, that leads to some sort of macro-economic growth scare—so just a heads up for the coming months.

Bottom line, economic growth remains an important pillar of this rally, and nothing last week changed that set up, which again was why at worst stocks were flat before the political headlines caused the late-week rally.

This Week:

As we’ve said, two of the biggest risks to the rally outside of Washington remain 1) Lackluster data and 2) A more hawkish Fed. Given those risks, the growth and inflation data this week is important.

Janet Yellen (AP Photo/Jacquelyn Martin)

However, the most important event of the week will be Fed Chair Yellen’s semi-annual Humphrey-Hawkins testimony to Congress, on Tuesday (the Senate) and Wednesday (the House). While she isn’t going to telegraph when the Fed will raise rates, her comments are still important considering the market remains complacent with regards to a Fed rate hike. There is no expectation of a March or May hike, and we continue to think the market is a little too complacent with regards to the potential for a May hike (we admit March seems remote).

Staying on the theme of Fed expectations, the next most important number this week is the January CPI report out Tuesday. The Fed does not believe inflation is accelerating meaningfully (due to the data), but if inflation does pick up pace that will be hawkish and will send yields higher—and most likely stocks lower.

Looking at growth data, Wednesday and Thursday are the key days to watch as we get January Retail Sales (Wed), Empire Manufacturing (Wed), January Industrial Production (Wed) and Feb. Philly Fed (Thursday). Of those four reports, the retail sales number is the most important, because consumer spending has been the engine of growth for the US economy, and it needs to maintain a decent pace because while business investment has picked up, it won’t offset a continued moderation in consumer spending.

The Empire and Philly Fed Indices are the next most important numbers next week, as they will give us the first look at February activity. Since better growth is a key support to this rally, they need to show continued strength. Neither number needs to accelerate meaningfully, but we can’t see much of a retracement, either. Bottom line, strong economic data and benign inflation data (Goldilocks numbers) have been an important support for this market as Washington reverts to the mean (gets more dysfunctional), and that needs to continue if stocks can hold recent gains in the face of confusing political headlines.

Get full Sevens Report delivered to your inbox each morning before 7:00am: http://www.7sreport.com/

Chart of the Day: Natural Gas Continues to Climb

ng-12-28-16

Natural gas futures continued to climb yesterday as weather reports are forecasting colder than average temperatures well into 2017 which is raising prospects for more larger than average supply draws.

 

Chart of the Day: Nat Gas Surges Ahead of EIA Report

ng-12-21-16

Natural gas surged nearly 10% yesterday thanks to speculation that colder temperatures across the country will boost heating demand and in turn, draw down elevated inventories.

 

Chart of the Day: Copper Breaks Uptrend Support

hg-12-7-16

Copper futures finally violated the post-election uptrend yesterday suggesting that some profit-taking will likely occur in the coming sessions. $2.50 should be looked to for initial support in the US futures contract.

 

Chart of the Day: Oil Poised to Break Trading Range

cl-12-6-16

WTI crude oil futures surged last week, but have yet to materially break out of their multi-quarter trading range between $40 and $50/barrel. Today, focus will be on the weekly EIA inventory report to see if the data can help propel the energy market back to fresh highs.

 

Chart of the Day: “The Doctor” Extends Gains

hg-12-5-16

Since the unexpected Republican sweep in the US elections, the combination of strong growth expectations and more recently, upbeat Chinese manufacturing  data has spurred an impressive rally in copper futures.

 

Chart of the Day: Gold Holds On, Barely

gc-11-17-2016

Gold futures continue to hold on to critical support in the low $1200’s for now, but if the dollar rally continues, it will likely end the short-lived bull market we pointed out back in April.

 

Oil and Metals Jump React to Trump

mw-bm068_oil_pr_mg_20130927150959

Oil futures got caught up in “risk trading” during the election drama. Energy futures sold off hard with global stocks overnight Tuesday and then surged higher as money poured back into risk assets on Wednesday. That was about the extent of the effect that Trump had on the energy markets at least so far.

Tyler Richey, Co-Editor of the Sevens Report, said “Policy wise, it isn’t exactly clear yet how a Trump administration will affect energy markets, however it is fairly safe to assume that he will be pro-US oil and that could tighten or even reverse the arbitrage spread with the global benchmark Brent contract which trades at a premium to our domestic WTI contract.”

Market focus returned to the bearish fundamentals in the back half of the week once the election drama subsided. Most notably, doubts about OPEC reaching any sort of production deal later this month has become a notable headwind. OPEC members have been successful in jawboning the market higher in recent months but traders are beginning to get skeptical as they are saying one thing (“we are going to cut”) and doing another (pumping at or near record highs).

Additionally, the US fundamental backdrop is bearish as production has stabilized above 8M b/d in the lower 48 as rig counts continue to climb while stockpiles are near all-time highs.

Richey, “Bottom line, the trend in oil prices is currently lower and the fundamentals are decidedly bearish for the medium term, leaving the path of least resistance lower as we approach the end of the year.”

Volatility in the gold market has been extreme this week as the initial flight-to-safety reaction to the election results spurred a huge rally but money flows quickly turned risk-on and gold has since collapsed.

Heading into the election there were a lot of investors piling into gold as a hedge and while that position worked overnight on Tuesday, it has since become a losing bet and you are seeing longs get squeezed out as they cut losses.

Looking ahead, this price action in gold is rather discouraging for the bulls however we are not throwing in the towel on our long call just yet as we still see the risk reward of being long gold here as favorable. On the charts, support holding between $1200 and $1220 is now critical for the health of the relatively young uptrend in gold (technicals turned bullish in April).

Silver has a split personality in that it can trade in sympathy with both the industrials like copper or precious varieties like gold. Over the last few days, silver has outperformed gold as futures rallied in sympathy with the historic squeeze in copper futures in the wake of the election. But, the copper surge is showing signs of exhaustion this morning and the new lows in gold are starting to weigh on the dual-purpose silver contracts.

Chart of the Day: Copper Holds Longstanding Support

hg-10-17-16

Copper tested and held a multi-month uptrend support line yesterday, but if that level near $2.10 is materially violated it could be forecasting a further slowdown in an already very sluggish global growth rate.