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Commodities Update, August 22, 2017

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Commodities were mostly higher yesterday as gold continued to benefit from risk-off money flows and a weaker dollar, which also propped up copper futures. Meanwhile, crude oil bucked the trend and gave back most of Friday’s rally. The benchmark commodity index ETF, DBC, fell 1.21% thanks to he declines in energy futures.

Yesterday’s pullback in oil was a textbook retracement of Friday’s very “squeezy” rally. Shorts that were run out of the market late last week repositioned yesterday morning, which influenced the heavy trading that was largely dictated by technicals. WTI futures fell 2.22% on the day.

Friday’s big rally essentially created a “gap” in the market as the bulk of the move occurred in less than an hour, and on very light volume. That set things up for a reversal, and because newswires were very quiet yesterday, algos and technical traders took control of the market and largely “filled the gap” as we ended the day near where Friday’s rally began.

As far as the longer-term trend in oil goes, yesterday’s session was rather insignificant. The market remains in a broad, sideways range with the $50 mark continuing to act as a stubborn resistance level.

Fundamentally, the OPEC/NOPEC meeting in Vienna was anticlimactic. The previous extraordinary meeting was a non-event as well, and the market is beginning to shrug off OPEC-related headlines more and more as the cartel has been largely ineffective in recent months.

The oil market remain bearish for now, as US production continues to grind higher and OPEC has so far failed at trying to offer material support to the market through their policy decisions. Looking ahead, the $50 mark in WTI is a very important technical and psychological resistance level that will not likely be violated in the absence of a legitimate bullish catalyst.

Natural gas rallied 2.42% yesterday as the market continues to show signs of life in the late summer. There was no real catalyst for the move yesterday, but nat gas is continuing to show signs of putting a bottom in and forming support in
the $2.80-$2.90 area.

Looking ahead, the bulls have their sights set on reclaiming the $3.00 mark, and a close above would be a bullish development on the charts. That would match the supply side fundamentals showing a potential long-term shift of supply levels turning lower.

In the metals, the weaker dollar was the primary influence on the market yesterday, as gold rallied 0.39% and copper rallied 1.36%. Gold continued to catch a bid from the cautious feel in the market after last week’s sharp pullback in stocks, but futures failed to close at a new high and above the $1300 mark despite rallying through the important resistance level briefly in Friday trade.

For now, we remain cautious on gold as the technical outlook is rather cloudy. If, however, bond yields break- down further (more on that in the currencies and bonds section) then gold will surely have the support to break out through $1300 and begin a new uptrend.

Copper continued to grind higher yesterday with futures hitting the highest level since late 2014. With the price action in gold and the bond market both flashing a warning sign for risk assets, copper continues to flash a positive signal for the global economy.

Looking ahead, the path of least resistance is still higher for copper, which is a positive for the global economic outlook and risk assets. Yet, the biggest thing to watch with regard to the rally is the dollar, as a reversal back higher in the buck could significantly damage the uptrend in all metals.

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Weekly Market Cheat Sheet, August 21, 2017

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Last Week in Review

There were some puts and takes from the economic data last week, but in aggregate it didn’t change the outlook for the US economy (still slow but steady growth) or the Fed (balance sheet reduction in September, a rate hike in December dependent on inflation).

I say puts and takes, because there were some decent economic reports last week, starting with a strong Retail Sales report. July retail sales beat estimates on both the headline (up 0.6% vs. 0.3%) and in the more important “Control Group” (retail sales ex-autos, gas and building materials), which rose 0.6% vs. (E) 0.4%, and saw a positive revision to June data.

That was a legitimate uptick in activity and an economic positive, although it remains to be seen whether that strength in consumer spending can be sustained past back-to-school and summer-vacation season.

The other highlights from last week were the August manufacturing surveys. August Empire Manufacturing surged to 25.2 vs. (E) 9.8 while Philly Fed Manufacturing also beat estimates at 18.9 vs. (E) 17.0. To boot, New Orders were strong in both reports (20.6 for Empire and 20.4 in Philly).

According to that type of data, we should see a big uptick in manufacturing activity in August, although I’ll again caution that these are surveys. And, unfortunately, with the exception of retail sales, the other “hard” economic data didn’t match these very strong survey results.

Specifically, July Industrial Production missed estimates, rising 0.2% vs. (E) 0.3%. But, more disconcertingly, the manufacturing subcomponent dropped -0.1% vs. (E) 0.2%. A lot of that decline was auto related, so it’s not quite as bad as it appears.

But, the overarching takeaway from last week’s data is that a wide gap remains between still-strong survey results (the PMIs) and actual, hard data (industrial production). We need that hard data to get consistently better if we have any hope of a rising economic tide carrying stocks higher for the rest of the year.

Turning to the Fed, the July meeting minutes were released last week, and while the market traded as though the minutes were slightly “dovish,” the reality is that they were neither hawkish nor dovish. The minutes confirmed that the Fed will reduce the balance sheet in September, although a rate hike in December seems very much 50/50.

Bottom line, it wasn’t a bad week for economic data, but we need evidence of economic acceleration to help push stocks higher, and that continues to be elusive.

This Week’s Preview

In aggregate, this is a quiet week for economic data (next week is the important week, as we get final global PMIs and the August jobs report), but there are still some potentially market-moving events to watch.

First, the Jackson Hole Policy Conference (i.e. conference/summer vacation) starts Thursday and runsthrough the weekend. The big names will be there: Draghi, Yellen, Carney, Fischer… but don’t expect anything that will move markets. It’s been made clear that Draghi doesn’t want to drop any hints about tapering until the ECB meeting in September (basically three weeks away). With the Fed, we know what to expect…balance sheet reduction in September.

Looking past central bankers, the key economic report this week will be the global flash PMIs, out Thursday morning. Again, we’re looking for the national PMI to match the strength we saw in Empire and Philly last week. If it does, that will be taken as an anecdotal positive. Internationally, there shouldn’t be any big surprises in this number.

Beyond the flash PMIs, July Durable Goods (Friday) is an important report, because it will give us greater insight into the state of “hard” economic data. If Durable Goods shows an uptick in corporate spending/investment, that might put upward pressure on expected Q3 GDP, which would be equity positive.

Bottom line, this week’s economic events should give more insight into the pace of the economy, but barring any big surprises, it’s likely the calm before the “storm” of next week.

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Why Taxes Caused Yesterday’s Selloff, August 18, 2017

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If there was one “reason” for the sell-off yesterday, it was taxes—specifically, the dying dream of tax cuts and a profit repatriation holiday.

That’s why the Cohn headline spooked stocks. It’s not that markets particularly love Gary Cohn. Instead, he’s important because he’s viewed as a key figure in pushing tax cuts through in early 2018, an expectation that market has held on to (until, perhaps, yesterday).

If Cohn resigns, then the prospects for tax cuts (and almost more importantly, the foreign profit repatriation holiday) dim… significantly.

The declining expectations for tax cuts and profit repatriation hit tech especially hard yesterday and it combined with the underwhelming CSCO/NTAP earnings to push that sector sharply lower—and falling tech dragged the whole market down yesterday afternoon.

Now, going forward, clearly there’s been some damage done on the charts (the S&P 500 closed at a one-month low), and momentum indicators are showing warning signs.

And, those warning signs are appearing at a particularly dangerous time for markets (in the short term) as late August is particularly favorable for “air pockets” to form in the markets given that a lot of desks are minimally staffed due to summer vacation. Point being, I don’t think we’re done with the uptick in volatility yet—again due mostly to the calendar.

However, Nasdaq, SOXX and FDN all remain above last week’s lows. So, while Thursday’s trading was clearly painful, I’m not ready to get materially more defensive just yet (although clearly we’re watching those indicators very, very closely going forward).

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Weekly Market Cheat Sheet, August 14, 2017

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Last Week in Review

There was more underwhelming economic data last week, especially on the inflation front, as the prospects for an economic reflation in 2017 continued to dim.

From a Fed standpoint, the disappointing CPI and PPI reports further reduce the chances of a rate hike in December, although importantly the Fed is still expected to begin to reduce its balance sheet in September.

Starting with the headline numbers, CPI and PPI, they were both disappointing. The Producer Price Index declined to -0.1% vs. (E) 0.1% while the core figure was flat vs. (E) 0.2%. Meanwhile, the CPI report was slightly less underwhelming at 0.1% vs. 0.2% on the headline, and the same for the core.

While these aren’t horrible numbers, they aren’t good either, and the bottom line is that statistical inflation
remains stubbornly low, and it is appearing to continue to lose momentum. Again, for context, that’s a problem because in this environment, with (supposedly) strong economic growth and low unemployment, inflation should not be going down. Period. And the longer it goes on, the more it sparks worries that eventual deflation or disinflation will rise, and that’s not good for an economy with still-slow growth and extended asset markets.

Bottom line, even before the uptick in North Korea jitters this was a market in need of a positive catalyst to spur further gains. Unfortunately, the economic data (ex-jobs and sentiment surveys) has been consistently underwhelming, so the chances of a rising tide driven by an economic reflation continue to dim. And while a “dovish” number may be good for a mild pop in the S&P 500, soft data and a lower dollar/bond yields aren’t going to drive the market to material new highs.

This Week’s Preview

This week is busy, with mostly anecdotal data that will give us a better overall picture of the economy and inflation—and the main risk to stocks now is that the data comes in light, and along with low inflation that spurs fears of an economic loss of momentum. If that happens, stocks will take out last week’s lows.

The most important report this week will be tomorrow’s Retail Sales report. Consumer spending has been lackluster for most of 2017, but around now we see a typical seasonal uptick. That will be welcomed by markets if that appears again this year. If the number is soft, it’s going to spur worries about the pace of economic growth (remember, hard economic data hasn’t been great all year, it’s been the PMI surveys that have been strong).

Beyond retail sales, we also get a first look at August economic data via the Empire and Philly manufacturing indices. Both numbers haven’t been highly correlated to the national PMIs lately, but it’s still our most-recent economic data and it could move markets, especially if we see any weakening in the data. Empire comes tomorrow and Philly comes Thursday.

Turning to central banks, we get the Fed minutes from the July meeting on Wednesday, and the ECB minutes from the July meeting on Thursday. The Fed minutes are important because we will be looking for clues as to how eager or committed the Fed is to September balance sheet reduction. With the ECB, the key will be seeing how committed or eager the ECB is to announce tapering of QE in September. As is usually the case, there shouldn’t be any big surprises in these minutes, but they could slightly shift expectations for those two events (balance sheet reduction/announcement of tapering), and as such also move Treasury yields and Bund yields.

Finally, July Industrial Production and Housing Starts also come this week (Thursday and Wednesday,
respectively). Again, these are an opportunity for the hard data to rise and meet strong soft data surveys, and in doing so reassure investors that the economy’s accelerating.

Bottom line, none of the numbers this week are “major,” but in aggregate they will give us a lot more insight into the pace of economic growth and the outlook for the Fed and ECB. And, this market needs some economic reassurance to help bolster sentiment after last week. Better data and steady Fed/ECB are a needed boost markets this week.

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Why Yesterday’s Decline Wasn’t Just About North Korea, August 11, 2017

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Why yesterday's decline wasn't just about North Korea

Thursday was another risk-off day in the currency and bond markets thanks to North Korea, but there were some underwhelming economic reports that shouldn’t be missed, either. The Dollar Index fell 0.09% and never strayed too far from unchanged, in part due to the looming CPI report out this morning.

Starting with the obvious, North Korean angst again kept a lid on most currencies and pushed the yen higher, in classic risk-off trade (although importantly, the moves were mild and currencies and bonds did not confirm the angst in stocks).

However, beyond North Korea there was important economic data that did also impact currencies, and again I maintain that unless we get a big deterioration in the North Korea situation the data remains more important for the remainder than the geopolitical landscape.

First, US PPI was soft, declining for the first time in months and again reinforcing the idea of slowing inflation. Now, PPI isn’t as important to the Fed or markets as CPI, but the bottom line is that if we are in (or approaching) an economic reflation, we shouldn’t see these types of underwhelming inflation reports.

That soft PPI weighed slightly on the dollar and bond yields, although again it was largely overshadowed from a market standpoint by North Korea and today’s CPI.

Looking internationally, the euro was flat all day vs. the dollar amidst little news, while the pound dipped 0.26%. The reason for the pound weakness wasn’t just risk off in the markets. It also was due to an underwhelming Industrial Production report. While the headline number beat estimates (0.5% vs. (E) 0.2%), the manufacturing sub-component was flat vs. (E) 0.2%. That was why the pound dipped back below 1.30 vs. the dollar.

The big gainer vs. the dollar yesterday was, again, the yen, which rallied 0.55% on a standard risk-off move. Economic data in Japan yesterday was, at best, mixed, but the yen isn’t trading off data right now… it’s trading off sentiment. And, the North Korea news is causing a flight to safety, and that means higher yen, higher Treasuries and, for now, higher gold.

Turning to bonds, Treasuries rallied as the 10 year rose 0.11% and the 10-year yield fell below support at 2.22%, although that drop happened into the close.

Bottom line, this flare up in North Korea has put the 10-year yield at a critical technical crossroads. If CPI is light this morning, the 10-year yield will likely drop below 2.20%. At that point, a test of the 2017 lows certainly isn’t out of the question. And, we’d find that disconcerting for multiple reasons, chief of which because it would imply too low inflation and largely destroy the chances for a reflationary rally in stocks in 2017.

We maintain that an economic reflation (higher growth, higher inflation, higher rates) is the only path to a sustainable medium- and long-term rally. While it may cause more of a decline short term, the medium- and longer-term investor in us is hoping for a strong CPI report later today. Unfortunately, I have a sneaking suspicion I will be disappointed. I hope I’m wrong.

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North Korea Update, August 10, 2017

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Stocks are down again this morning on this topic, and the reason is because North Korea said it will shoot a missile within “30 or 40” miles of Guam in mid-August. That would be another escalation because it would extend the range of the North Korean missiles—and at that point the US might actually shoot one down. Undoubtedly some of you are getting calls from nervous clients about North Korea, and while I don’t view this as a major market issue, I do want to briefly cover the situation so you can handle any client calls.

Ignoring the rhetoric and bluster on both sides for a moment, two important things happened with regards to North Korea this week.

First, in what was a major positive, the UN passed very harsh sanctions on North Korea with a unanimous vote. That unanimous vote part is key, because both China and Russia supported the sanctions, implying the international community is finally on the same page regarding North Korea’s nuclear program.

Second, in what was a negative that resulted in the recent escalation of tensions, North Korea has apparently learned how to miniaturize a nuclear warhead and place it on an intercontinental ballistic missile. If true, that means they could theoretically strike Japan with a nuclear missile.

Those two events, one positive, one negative, are why this situation has escalated so quickly.

Going forward, despite the escalation in rhetoric, the net events of the past weeks need to be viewed as a positive. If China and Russia stay on board, then the chances of resolution (peaceful resolution) go up significantly. So while things seem bad now, in reality, the chances of a lasting solution have gone up since this time last week.

However, if you have clients who are worried about this and want to hedge up a bit, basically the “North Korea Defensive Playbook” would be as follows: 1) Buy Treasuries (belly and longer dated, so IEF or TLT), 2) Buy defense stocks (TRN, LLL, LMT, NOC ) and 3) Buy the yen via FXY and sell Japanese stocks (i.e. DXJ or EWJ). Now, to be clear, I don’t think you should do this now, but this is the playbook if any clients are asking what to do in case of a conflict.

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Is the Earnings Rally Losing Steam?

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Earnings have been an unsung hero of the 2017 rally, but there are some anecdotal signs that strong earnings may already be fully priced into stocks, leaving a lack of potential positive catalysts given the macro environment.

Now, to be clear, earnings season has been (on the surface) good. From a broad standpoint, the results have pushed expected 2018 S&P 500 EPS slightly higher (to $139) and that’s enough to justify current valuations, taken in the context of a calm macro horizon and still-low bond yields.

However, the market’s reaction to strong earnings is sending some caution signals throughout the investor
community. Specifically, according to a BAML report I read earlier this week, the vast majority of companies who reported a beat on the top line (revenues) and bottom line (earnings) saw virtually no post-earnings rally this quarter. Getting specific, by the published date of the report (earlier this week) 174 S&P 500 companies had beat on the top and bottom line, yet the average gain for those stocks 24 hours after the announcement was… 0%. They were flat. To boot, five days after the results, on average these 174 companies had underperformed the market!

That’s in stark contrast to the 1.6%, 24-hour gain that companies who beat on the revenues and earnings have enjoyed, on average, since 2000.

In fact, the last time we saw this type of post earnings/sales beat non-reaction was Q2 of 2000. It could be random, but that’s not exactly the best reference point.

So, if we’re facing a market that’s fully priced in strong earnings, the important question then becomes, what will spur even more earnings growth?

Potential answers are: 1) A rising tide of economic activity, although that’s not currently happening. Another is 2) A surge in productivity that increases the bottom line. But, productivity growth has been elusive for nearly a decade, and it’s unclear what would suddenly spark a revival. Finally, another candidate is 3) Rising inflation that would allow for price and margin increases. Yet as we know, that’s not exactly threatening right now, either.

Bottom line, earnings have been the unsung hero of this market throughout 2017, but this is a, “What Have You Don’t For Me Lately” market, especially at nearly 18X next year’s earnings. If earnings growth begins to slow and we don’t get any uptick in economic growth or pro-growth policies from Washington, then it’s hard to see what will push this market higher beyond just general momentum (and general momentum may be fading, at least according to the price action in tech). To be clear, the trend in stocks is still higher, but the environment isn’t as benign as sentiment, the VIX or the financial media would have you believe.

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Goldilocks Jobs Report Preview, August 3, 2017

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Goldilocks Jobs Report Preview: What Will Make the Report too Hot, too Cold, or Just Right?

What a difference a month makes. For June’s jobs report, we were equally worried about a “Too Hot” report sending bond yields materially higher, and a “Too Cold” report implying a loss of momentum in the jobs market. Now, almost all the risks to this July report are skewed towards “Too Cold” given the drop in inflation we’ve seen since early July.

More specifically, even if the jobs report is a blow-outnumber, unless it’s accompanied by a big surge in wages it’s not going to elicit a “hawkish” reaction from the Fed or a spike in Treasury yields. Point being, the risk of the report being “Too Hot” is a lot lower than usual, given the drop in inflation.

Looking at the potential impact of this jobs report on the rally, it’s important realize that the dip in inflation since July has been a bullish catalyst, because economic data has stayed firm. So, low inflation makes the Fed more dovish, but economic growth stays constant, and that’s good for stocks.

However, that equation changes if US economic data starts to follow inflation lower (i.e. a big miss on the jobs number). As a result, the “Too Cold” scenario is the biggest risk for stocks heading into tomorrow’s report.

“Too Hot” Scenario (A December Rate Hike Becomes More Certain)

  • >250k Job Adds, < 4.1% Unemployment, > 2.8% YOY wage increase. A number this hot will refute the lower inflation of July and reintroduce the potential for a “not dovish” Fed. Likely Market Reaction: We should see a powerful re-engagement of the “reflation trade” from June..(withheld for subscribers only—unlock specifics and ETFs by signing up for a free two-week trial).

“Just Right” Scenario (Confirms Expectations of September Balance Sheet Reduction & Likely December Hike)

  • 125k–250k Job Adds, > 4.1% Unemployment Rate, 2.5%-2.8% YOY wage increase. This is the best-case scenario for stocks, as it would reinforce the current expectation of balance sheet reduction in September, and (probably) one more 25-bps rate hike in December. Likely Market Reaction: A knee-jerk, mild stock rally, but how powerful the rally is will depend on…(withheld for subscribers only—unlock specifics and ETFs by signing up for a free two-week trial).

“Too Cold” Scenario (Economic Growth Potentially Stalling)

  • < 100k Job Adds, < 2.5% YOY Wage Gains. If we see a big disappointment in the jobs number and a further softening of wage inflation, that will send bond yields lower, and that would likely weigh on stocks as it will raise concerns about economic growth. Likely Market Reaction: Bonds and gold should surge and…(withheld for subscribers only—unlock specifics and ETFs by signing up for a free two-week trial).`

Bottom Line

From a short-term equity standpoint, the best outcome is for “Just Right” job adds (so between 100k-250k) and “Too Cold” wages (so less than 2.5% yoy). That will likely make the Fed incrementally more “dovish,” and take a December rate hike off the table, although it shouldn’t stay the Balance Sheet Reduction in September.

Beyond the short term, it’s important to remember that an economic reflation is the key to sustainably higher stock prices. For anyone with a medium- or long-term time horizon (so almost all of us), I’d gladly take better growth and higher inflation over falling inflation and stagnant growth, even if it meant some short term stock weakness.

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Are Banks About to Break Out?

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Banks were again the highlight, as BKX rose 0.83%, and that pulled the Financials SPDR (XLF) up 0.72%. The bank stock strength came despite the decline in yields, which we think is notable. In fact, over the past several trading days, bank stock performance has decoupled from the daily gyrations of Treasury yields, and we think that potentially signals two important events.

Regardless, this price action in banks is potentially important, because this market must be led higher by either tech or banks/financials. If the former is faltering (and I’m not saying it is), then the latter must assume a leadership role in order for this really to continue.First, it implies bank investors are starting to focus on the value in the sector and on the capital return plans from banks, which could boost total return. Second, it potentially implies that investors aren’t fearing a renewed plunge in Treasury yields (if right, that could be a positive for the markets).

Bottom Line

This remains a market broadly in search of a catalyst, but absent any news, the path of least resistance remains higher, buoyed by an incrementally dovish Fed, solid earnings growth, and ok (if unimpressive) economic data.

Nonetheless, complacency, represented via a low VIX, remains on the rise, and markets are still stretched by any valuation metric. Barring an uptick in economic growth or inflation, it remains unclear what will power stocks materially higher from here. For now, the trend remains higher.

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Weekly Market Cheat Sheet, July 31, 2017

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Last Week in Review

Data has been remarkably consistent the last few weeks, including last week: “OK” but not great economic growth, and consistent signs that inflation is losing momentum. As such, the economic data continues to point to a “Stagnation” set up for stocks and other assets.

Given that inflation trends are more important than growth trends right now, I’ll start with the Quarterly Employment Cost Index, which, like many other inflation indicators in Q2, slightly missed estimates. The Q2 ECI rose 0.5% vs. (E) 0.6, maintaining a 2.4% yoy increase from Q1, but slightly disappointing vs. expectations.

Additionally on Friday, the PCE Price Indices from the Q2 GDP report showed deceleration in the pace of inflation. The PCE Price Index rose just 1% in Q2 vs. (E) 1.2%. Now, none of these inflation statistics are particularly bad. Yet from a policy standpoint, these numbers won’t make the Fed eager to tighten policy ahead of the current schedule (balance sheet reduction in September, rate hike, probably, in December).

Turning to actual growth data, it was “ok” but not great. Q2 GDP met expectations with a 2.6% yoy gain, and that was a true number as Final Sales of Domestic Product (which is GDP less inventories) was also 2.6%. Consumer Spending, or PCE as it’s known in the GDP report, rose 2.8%, again a solid but unspectacular number.

Similarly, June Durable Goods, while a decent report, wasn’t that strong. The headline was a big beat at 6.5% vs. (E) 3.5%, but that was because of one-time airline orders. New Orders for Non-Defense Capital Goods ex-aircraft, the best proxy for corporate spending and investment, was revised higher in May but dipped 0.1% in June.

Point being, like most growth data recently, it wasn’t a bad report, but it’s not the kind of strength that will spur a reflationary rally.

Finally, the one economic data point that was strong last week was the July flash manufacturing PMI. It rose to 54.2 vs. (E) 53.2, but while that is a potential positive (it’s a July report so it’s the most current) the PMIs are surveys, and the gap between soft survey data and “hard” economic numbers remains wide.

Turning to the Fed meeting last week, the two takeaways were: 1) The Fed confirmed that they will reduce the balance sheet in September, barring any big economic or inflation surprises. 2) The Fed did slightly downgrade the inflation outlook, but importantly it kept open the option to hike rates at any meeting, and as such a December rate hike is still likely).

This Week’s Preview

As stated, inflation is more important than growth data right now, so that means two most important numbers this week will be tomorrow’s Core PCE Price Index (contained in the Personal Income and Outlays report) and Friday’s wage data in the jobs report.

Stocks have rallied since Yellen turned incrementally dovish at her Humphrey-Hawkins testimony, and soft inflation data will further that sentiment and underpin stocks.

Conversely, if we see inflation bounce back, that will push bond yields higher and help reflation assets (banks, small caps, inverse bond funds, cyclicals).

But, inflation stats aren’t the only important numbers this week as we get the latest final manufacturing and composite US and global PMIs. They remain important because they will provide anecdotal insight into the pace of the US and global economy. But again, it would be a pretty big surprise if the data suddenly showed slowing in the global economy.

On the flip side, at least for the US, a strong report would be welcome, because strong economic data won’t cause the Fed to get more “hawkish” unless inflation ticks higher.

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