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FOMC Preview and Projections plus the Wildcard to Watch, June 13, 2017

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The Fed meeting is more important than any other this year, for the simple reason that it could either exacerbate the glaring discrepancy between stocks and bond yields (which would be negative for risk assets medium term), or it could help close the gap (which would be positive for risk assets).

Specifically, the bond market has quietly been pricing in the expectation of a “dovish hike” for this meeting via the decline in yields. That “Dovish Hike” means the Fed does hike rates 25 basis points, but makes the statement dovish enough that it doesn’t cause longer-dated yields (i.e. 10- and 30-year Treasuries) to rise. If the Fed executes on that expectation, then we will see the 10-year yield dip and likely test the 2017 lows of 2.14%, and again that is a problem for stocks over the medium/ longer term.

Looking at the actual meeting itself, whether it meets expectations, is dovish, or is hawkish, will depend not only on the rate hike, but also the inflation commentary and any guidance regarding “normalization” of the balance sheet.

What’s Expected: A Dovish Hike. Probability (this is just my best guess) About 70%. Rates: It would be a pretty big shock if the Fed didn’t hike rates tomorrow, so a 25-basis-point hike to 1.25% is universally expected. Statement: In paragraph one, the Fed should include some additional soft language regarding inflation, noting that it’s been soft for a few months. However (and this is important), the Fed should still attribute sluggish inflation to “transitory factors,” implying Fed members are still confident they will hit their 2% inflation goal. Dots: No change to the 2017 dots (so, still showing three hikes as the median expectation). Likely Market Reaction: Withheld for Sevens Report subscribers. Unlock by starting your free trial today.

Dovish If: No Hike or a Very Dovish Hike. Probability (again, my best guess) About 10%. Rates: It’s widely expected that Fed will hike rates, but there’s always a possibility of a surprise. More likely, the Fed will hike 25 bps and accompany it with a very dovish statement. Statement: The Fed changes the characterization of risks from “balanced” to “tilted to the downside,” or some similar commentary, thereby signaling rate hikes are off the table again. This is a very unlikely, but possible change. More likely is the Fed adding considerable language regarding concerns about lower inflation. Dots: A reduction of the dots to reflect just two rate hikes in 2017. Likely Market Reaction: Withheld for Sevens Report subscribers. Unlock by starting your free trial today.

Hawkish If: We get a regular hike, not a “Dovish” Hike. Probability About 20%. Rates: The Fed Hikes Rates 25 basis points. Statement: The Fed does not add softer language regarding growth or inflation in the first paragraph, and instead just largely reprints the May statement, which was dismissive of the recent dip in inflation and growth. Dots: The dots remain the same or even increase one rate hike in 2017 (this is unlikely, but possible). Likely Market Reaction: Withheld for Sevens Report subscribers. Unlock by starting your free trial today.

Wild Card to Watch: The Fed Balance Sheet

The market fully expects the Fed to elaborate on when and how it intends to reduce its balance sheet (i.e. the holdings of Treasuries it has purchased over the years through the QE program).

I covered why the balance sheet is important back in April (a link to that report is here) but the bottom line is that when and how the Fed begins to reduce its balance sheet (the term “normalize” is just Fed speak for “reduce Treasury holdings”) could be a substantially hawkish influence on the bond market, regardless of rate hikes.

Specifically for tomorrow, the key detail the market will be looking for is at what level of interest rates does the Fed begin to reduce its Treasury holdings. The number to watch here is 1.5%. It’s widely expected that at 1.5% Fed funds, the Fed will begin to reduce its balance sheet. If we get one more rate hike this year, then that puts balance sheet reduction starting in early 2018 (likely March).

For a simple reference, if the Fed statement or Yellen at her press conference reveals the Fed will reduce holdings before 1.5%, that will be hawkish. If it’s revealed that the Fed will reduce holdings after rates hike 1.5% that will be dovish.

Bottom Line

This Fed meeting is likely the most important of the year (so far), not just because we will get updated guidance on expected rate hikes and the balance sheet, but also because it comes at a time when we are at a tipping point for bond yields (if they go much lower and the yield curve flattens, more people will start talking recession risk). We also are potentially seeing a shift in stock sector leadership (from defensives/income to cyclicals/ banks), so understanding what the Fed decision means for rates will be critically important going forward. You’ll have our full analysis, along with practical takeaways, first thing Thursday morning.

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Tom Essaye on “The Bell” Podcast with Charles Nenner of Goldman Sachs and Adam Johnson

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Bullseye Brief with Charles Nenner, Tom Essaye, Adam Johnson

Thanks to Adam Johnson for having me on his podcast “The Bell” again last week. We talked with Goldman Sachs Strategist Charles Nenner on Cycles, Shorts, and Sunspots. We also talk about the data deluge, incredibly high credit scores, and the very busy week in economic data. Plus, find out who’s shorting Costco… and why? What’s the secret to retail?


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Weekly Market Cheat Sheet, May 22, 2017

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Economic and Investing Cheat Sheet - May 22

Last Week in Review:

There weren’t many economic reports last week, and the data we did get was mixed. In sum the data did nothing to remove the growing feeling that the US economy is losing momentum.

First, the initial look at May data in the form of the Empire State Manufacturing Index badly missed at -1.0 vs. (E) 8.0, but the Philly Fed Business Outlook Survey on Thursday contrarily blew away expectations (38.8 vs. E: 19.6). The net effect is that it put more focus on this week’s flash manufacturing PMI to give us a true look at the pace of manufacturing activity in May.

In the US housing market, the Housing Market Index beat expectations on Monday (70 vs. E: 68), but Housing Starts data on Tuesday whiffed (1.172M vs. E: 1.256M).

The most encouraging report last week was Industrial Production, which beat estimates of 0.4% with a headline print of 1.0%. But, a lot of that “beat” came from auto manufacturing, and activity in that sector has almost certainly peaked (remember Ford is cutting employees amidst more challenging sales environments). Point being, the Industrial Production beat is likely a one off, not the start of a trend.

Rounding things out with the labor market, weekly jobless claims fell 4K to 232K, as the general trend lower remains very well defined. Continuing claims fell to a 29-year low while its four-week moving average fell to a 43-year low. This encouraging report was especially notable because the data was collected from the week corresponding with the survey week for the May jobs report, and the strong print suggests that May could be another very strong month for the labor market. Bottom line, economic data last week did not materially change our outlook for the markets.

This Week’s Preview:

This will actually be a relatively busy week of economic data, as we get the flash manufacturing PMIs, Fed minutes from the May meeting, and other important economic reports.

The most important report this week will be Wednesday’s May flash manufacturing PMI. This will be the first major data point for May and it needs to show stabilization and, better yet, acceleration for stocks to rally.

Second in importance this week will be the FOMC minutes. Markets have priced in a slightly more dovish Fed given the soft inflation data recently, but markets have overestimated the Fed’s dovishness throughout 2017. If the minutes are hawkish, that could push yields and the dollar higher (which would be stock positive).

Meanwhile, there are two reports on housing data, New Home Sales and Existing Home Sales due out on Tuesday and Wednesday, respectively. Investors would welcome a rebound after last week’s soft Housing Starts report.

Finally, both the second look at Q1 GDP and Durable Goods Orders will be released Friday morning. The latter will be closely watched as the gap between soft and hard data remains a concern, and a strong revision to GDP and a good Durable Goods number will help close that gap. Bottom line, economic data remains the key to reigniting the reflation trade (remember, it’s #1 in my list of four events needed to restart the rally). So, the market needs good data and a confident/hawkish Fed for stocks to again test recent highs.

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Two Markets Down, Three to Go?, May 18, 2017

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The most important trading across markets Wednesday was not in the stock market, it was in the bond market… and the signals sent there were not good. Both the absolute level of bond yields, and the shape of the yield curve, deteriorated materially… and this is a concern that should not be ignored.

First, the 10-year Treasury yield imploded, falling 11 basis points to close at 2.22%, the lowest in three weeks and now just above the 2017 low of 2.17%.

Second, and potentially more importantly, the 10’s—2’s Treasury yield curve also flattened materially, as the spread fell from 1.04% to 0.92%.

sevens report - trumponomics

This is especially important, because the 10’s—2’s yield spread has now retraced the entire post-election steepening, and the curve is more flat than it was pre-Trump presidency. That is a very bad sign for banks, and since banks must lead a market higher in a reflation expansion, that is a bad sign for the entire stock market.

The 10’s—2’s spread has more than retraced the entire post-election move, as has the US Dollar Index (two down).

The 10-year yield is threatening to fall to fresh lows for the year. Yet, the BKX (Bank Index) remains nearly 20% above the pre-election close, and the S&P 500 still trades almost 10% above its pre-election close.

So, are we now looking at a situation where we are two down, three to go?

This situation cannot exist in perpetuity, and the collapse in yields yesterday is a warning sign that should not be ignored.

It’s not definitive yet, and one bad day doesn’t break a trend, but the price action in the bond market is becoming outright worrisome. And, I must continue to stress (as I’ve been doing since mid-March) that the bond market is the leading indicator for stocks. If the 10-year yield breaks below 2.17%, that will add to that warning. At that point, I will consider becoming more defensive in our portfolios.

Again, for context, the entire 2017 stock market rally is based on a expectation of an economic reflationary expansion. But, that expansion likely can’t occur unless the pro-growth policies from Washington actually materialize, and that probability is decreasing daily.

So while stocks have held up, reflationary-sensitive as-sets have negatively reacted (banks, bonds and cyclicals). These sectors must lead a reflationary bull market, yet all of them are breaking down or are in danger of breaking down. If they go, then the broad market isn’t far behind.

Again, I’m not saying get materially defensive yet, as one bad day doesn’t invalidate the market’s resilience. But caution signs are growing on this market, and I do not want anyone blindsided.

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Trumponomics Update, May 17, 2017

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Politics remains a deafening influence on the markets in 2017, but amidst the ongoing circus (which again got bigger overnight) I wanted to step back and take a look at the current state of the Trumpenomics agenda, revise current markets expectations, and re-examine what will create positive or negative political surprises for stocks over the coming months and quarters.

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Finally, I want to provide some independent context to the recent political headlines. First, they are net negative because they are causing some Republicans to start to distance themselves from Trump, and that reduces the chances of tax cuts. Second, if there was some crime committed (obstruction of justice, etc.) that is clearly a bearish gamechanger—but we are not there yet. Third, impeachment claims are currently overblown. It’s a Republican Congress and Congress must decide impeachment. Every Republican, at this point, has a better chance of getting re-elected if they pass tax cuts rather than dump Trump, and we can always count on politicians to focus on their re-employment. Bottom line, these never ending headlines are a headwind on stocks, but they are not a bearish gamechanger, yet.

Trumponomics Pillar 1: Tax Cuts

What Was Expected By Markets: An agreement in principle by the August Congressional recess to cut corporate taxes to the low-20% range, and include a one time, 10% repatriation tax holiday for foreign profits.

Reality: Nothing. There has been little-to-no progress on the tax issue, and major sticking points remain between Republicans, including border adjustments and removing interest deductibility for corporations.

Market Impact: So far, stocks have generally weathered the ineptitude here because there is still the broad expectation that there will be corporate tax reform before the mid-terms in 2018 (people are now pointing to Q1 2018).

Current Expectation: A small corporate tax cut into the high-20% range in place by Q1 2018, and some foreign profit tax repatriation holiday (around 10% tax rate).

Bullish If: Withheld for subscribers. Sign up for your free trial today.

Bearish If: Withheld for subscribers. Sign up for your free trial today.

Trumponomics Pillar 2: Deregulation (Especially Obamacare)

What Was Expected: Repeal and replacement of Obamacare in the first 100 days; massive deregulation via executive order, especially regarding environmental regulations.

Reality: Virtually nothing. While the House passed an Obamacare repeal/replace, there is no credible path for the legislation to make it out of the Senate. Meanwhile, there has been progress on reducing one-off regulations, but it’s not the type of large-scale deregulation that will ignite economic growth.

Market Impact: Healthcare has outperformed on the reduction of political risk (XLV, IHF, IBB). Overall, however, no macro impact.

Current Expectation: Not much. The healthcare bill is in limbo, and there’s no expectation of a Obamacare repeal/replace anytime soon. Meanwhile, Dodd-Frank banking regulations remain largely in place and it’s unlikely we’ll see a large overhaul of that legislation, either (that’s anecdotally negative for regional banks as they bear an outsized compliance burden compared to money center banks).

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Bearish If: Withheld for subscribers. Sign up for your free trial today.

Trumponomics Pillar 3: Infrastructure Spending

What Was Expected: $1 trillion over a 10-year period (this was always an exaggeration, but a lot was potentially expected).

Reality: Virtually nothing. Infrastructure spending has been soundly buried between the healthcare drama, tax cut bickering, and the constant media battles emanating from the White House.

Market Impact: Infrastructure stocks that rallied hard following the election have lagged so far in 2017, but this hasn’t had any macro impact on markets.

Current Expectation: Nothing. Some hope that we will see a bipartisan infrastructure bill by Q2 2018, but it’s so buried by everything else right now that’s not very likely.

Bullish If: Withheld for subscribers. Sign up for your free trial today.

Bearish If: Withheld for subscribers. Sign up for your free trial today.

Bottom Line

Earnings and economics have helped to offset any Trumponomics disappointment as Q1 earnings were strong, and $138 2018 S&P 500 EPS is supporting stocks in the face of repeated Washington failures. Meanwhile, economic data has been “fine” on an absolute basis despite the slight loss of momentum recently.

Point being, markets have been lucky that earnings and economics have provided a shock absorber for the policy disappointment; but considerable risks remain should no further policy progress occur in the coming months and quarters, and given the seemingly unending scandalous headlines emanating from the White House, the probability of nothing happening is rising.

If we do not see real political progress by the end of ’17 or ’18, then its unlikely that economic growth will be able to hold up as the uncertainty surrounding these policies will begin to act as a headwind.

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Weekly Market Cheat Sheet, May 15, 2017

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Last Week in Review:

Economic data last week was mixed in total, but from a market standpoint the takeaway was that it was neither strong enough to support a push through 2400 in the S&P 500, nor weak enough to generate any real selling. So, the net effect is that the market is left wondering whether the economic acceleration can continue, or whether we are losing momentum.

Retail Sales was the most important report last week, and while on the headline it appeared disappointing, a closer look revealed it was basically in line with expectations.

I say that, because while the headline missed estimates (0.4% vs. 0.6%) the revisions to the March data were positive, from -0.2% to 0.1%. Taken in aggregate, the two-month retail sales performance was slightly better than expected.

Looking at the more important “control” group, which is the best measure of discretionary consumer spending, it also appeared to be a disappointment, up just 0.2% vs. (E) 0.4%. But once again, the revisions were positive (from 0.5% to 0.7%), so if you take the two months together it was in line with estimates.

Bigger picture, consumer spending remains decently healthy, but activity isn’t on pace with Q3/Q4 of last year, when consumer spending powered economic growth. Without an acceleration in consumer spending, it’s hard to see the US economy accelerating materially from here.

The other notable domestic numbers last week were the April CPI and PPI. The former was much-hotter-than-expected, as the core rose 0.7% vs. 0.2% on surging service inflation (financial services costs, especially). However, core CPI was slightly underwhelming, rising just 0.1% in April, and up 1.9% year over year, below the 2.0% estimate.

Bottom line, it’s a given that inflation pressures continue to build, but all the statistical data implies they are building very slowly. And given the Fed watches the statistical data, nothing in the inflation numbers will make the Fed think about hiking more aggressively or delaying the June rate hike.

The other notable data last week came from China, and it was on balance negative. April exports, imports, M2 money supply and PPI all missed estimates, although not by wide margins. Not all the data was bad, as new yuan loans were slightly better than expected. Then, this weekend, Fixed Asset Investment, Retail Sales and Industrial Production all slightly missed expectations.

Bottom line, legitimate doubts are creeping in about the state of the Chinese economy, but it’s simply too early for anyone other than Kyle Bass to declare a problem (he’s been warning about the implosion of China for years, and I’m sure one day he will be right. In the meantime, he has plenty of capital to wait it out). Yet for us, slowing Chinese growth remains a risk, but one that just needs to be monitored for now, which we are doing.

This Week’s Preview:

The calendar is once again relatively quiet this week, although we will get the first look at May data, which will help us decide whether the March/April lull in economic growth is ending.

To that point, the two most important numbers this week are the Empire Manufacturing Survey (today) and the Philly Fed survey (Thursday). Both give us our first look at May economic activity, and while both are just regional surveys, they still matter given the seemingly precarious trend in economic data (is it the pause that refreshes, or are we losing momentum?).

Outside of those two manufacturing surveys, April Industrial Production comes Tuesday, and that will give us another hard-data look at manufacturing activity. Remember, while manufacturing PMIs soared in early 2017, actual hard data hasn’t really moved (hence the gap between soft sentiment indicators and hard data). So, it’ll be an economic positive if Industrial Production can show an acceleration in manufacturing activity.

Outside of those reports, the only other notable numbers are housing related, as we get the first look at April home sales numbers. The Housing Market Index comes today, Housing Starts come tomorrow. Sentiment towards housing is pretty buoyant right now, so it’d be unlikely (and a big surprise) if we saw a housing roll over.

Bottom line, this week will shed some incremental light on the current state of economic growth, and given the markets are starving for a catalyst (positive or negative) usually inconsequential numbers may indeed move stocks.

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Weekly Market Cheat Sheet: May 8, 2017

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Weekly Market Cheat Sheet

Last Week in Review:

Economic data last week, highlighted by the strong jobs report, helped to somewhat narrow the gap between soft sentiment surveys and hard economic data… although it’s fair to say that gap remains open and is still a headwind on stocks, just a slightly less strong one. It was not all positive last week, though, as we got several signs of potential loss of momentum in China, which was an underreported but potentially important development last week. Finally, the Fed meeting proved to be a non-event, except in that it reaffirmed a June rate hike is likely (but that’s already mostly expected from the markets).

Starting with the jobs report, it met our “just right” scenario. The overall job adds were strong at 211k vs. (E) 185k, but revisions to the March report were negative 19k, so the net number was more in line. The unemployment rate dropped to 4.4%, but that was in part due to a decline in the participation rate. Meanwhile, year-over-year wage increases declined to 2.5% from 2.7%. Bottom line, this number was “fine,” but it wasn’t massively reflationary (in part due to the wage number) and that’s why we didn’t see the strong headline jobs report ignite an immediate reflation rally in stocks (again, the wage number undermined the strong job adds).

Looking at other economic data last week, there were more positives than negatives, highlighted by the ISM Non-Manufacturing PMI, which hit 57.5 vs. (E) 55.8. That strong Non-Manufacturing PMI helped to offset the soft April Manufacturing PMI, which dipped to 54.8 vs. (E) 56.5 while the New Order component dropped below 60 for the first time in five months. While disappointing vs. expectations, it’s important to remember that the absolute level activity remains strong.

Turning to the Fed, the key takeaway from last week’s Fed meeting was that the Fed viewed the loss of economic momentum in Q1 as “transitory,” and still said risks to growth were “roughly balanced.” Both terms are Fed speak for, “We’re going to hike in June despite the soft Q1 GDP.” The market largely expects that (Fed Fund futures have a hike priced at 83% (which is close to a universal conclusion).

Finally, I want to take a moment and focus on Chinese economic data from last week, as the numbers were universally disappointing. Official April Manufacturing PMI dropped to 51.2 vs. (E) 51.7 while composite PMI declined to 51.2 vs. previous 52.1. Additionally, iron ore went into quasi freefall this week, as iron ore futures ended limit down on the Dalian Commodities Exchange on Wednesday night. The drop came after the Chinese steel industry PMI dropped below 50, signaling contraction. Oversupply has something to do with the price drop as well (exports are surging out of Australia) but the bottom line is that base metal prices are a coincident indicator of economic activity. The declines in iron ore, steel and copper last week, combined with the under-whelming Chinese data, definitely caught our attention. We now are officially watching this closely for everyone, and will keep you updated.

This Week’s Cheat Sheet:

This week, April CPI and April Retail Sales (both Friday) are the important reports to watch. The latter is more important for markets at this point than the former, as we need to see a rebound from Q1’s paltry consumer spending. If retail sales fail to show progress and beat expectations, it’ll widen the gap between soft data and hard economic numbers. With CPI, we should see some mild cooling of the recent uptick in inflation, but overall inflation pressures continue to slowly build.

Outside of those two numbers, focus will be on the Chinese CPI and PPI, as again data there suddenly turned lower last week. Bottom line, it should be a quiet week, but retail sales and CPI are important as the “gap” between soft sentiment surveys and hard economic data remains… and it needs to close further if we are going to see a breakout in stocks.

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Tom Essaye on “The Bell” Podcast with Paul Sweeney and Adam Johnson

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Bullseye Brief with Adam Johnson, Paul Sweeney and Tom Essaye

I was a guest on Adam Johnson’s podcast “The Bell” last week. We talk with Paul Sweeney of Bloomberg Intelligence, “the man who’s turning Wall Street research upside down”. There are big changes in the research industry and Sweeney is on the leading edge of those changes. We also talk about “Animal Spirits” vs Hard Economic Data, Earnings and Employment, Mortgages being back under 4% here in Fed Week.

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Another Oil Plunge, Futures Down, May 3, 2017

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Oil futures sank 2.74% yesterday, with a large portion of the losses coming in the final hour. The catalyst for the decline was a collection of analysts’ estimates for this morning’s EIA report that started to come in showing more substantial builds in product inventories even though oil stocks are supposed to fall.

RBOB gasoline futures have been leading the way lower since they topped out on April 12. In fact, since that day, futures have only notched one single gain (that is three weeks with just one positive trading day). Gasoline futures now are within 3% of their 2017 lows, and if the downtrend continues that will be a headwind on the rest of the energy space.

Oil futures came within 1% of their 2017 lows yesterday and the momentum is clearly with the bears. Yesterday’s move was amplified by a “stop run” as futures broke through the March lows in the June contract. But in an encouraging sign of weakness, futures were unable to rebound.

On the charts, futures broke through a longstanding technical uptrend line that dated back to early August. That is another sign of technical weakness in the market.

In doing some cross-asset analysis yesterday, there was evidence that the inverse correlation between oil prices and long bond prices is resurfacing. As a reminder, for a period of time back in early 2016, long bond futures were trading almost exclusively off of the price of oil (specifically when WTI had a $20 handle). The reasons were twofold.

First, low oil prices are a drag on inflation readings, which would have dovish implications for Fed policy (long bond positive). Second, long bonds benefited from a safe-haven/fear bid as lower oil prices increased the risk of small producers defaulting on loans, many of which were issued by southern and central regional banks. Ultimately, contagion fears weighed on regional banks and the broader financial sector collectively. Now, it is not clear whether this is happening again as it was only one day of trading so far, but it is something to keep in mind going forward. If oil declines cause a sharp break lower in longer-term interest rates, that will weigh on stocks.

Bottom line, the fundamentals (rising US production and still-overflowing global stockpiles), technicals (new five-week lows), and market internals (bearish term structure) all continue to favor the oil bears right now, and the idea that we are in a “lower for longer” price environment still stands.

Oil and the rest of the energy complex is, however, near-term oversold, and we could see a volatile short covering rally given the right catalyst. Such a move would likely be short-lived, and if we were to see a continued move into the low $40s or even high $30s that would have serious implications for all asset classes (as in early 2016).

Skip the jargon, arcane details and drab statistics from in-house research, and get the simple analysis that will improve your performance. The Sevens Report is the daily market cheat sheet our subscribers use to keep up on markets, seize opportunities, avoid risks and get more assets. Start your free two-week trial today.

Tom Essaye on “The Bell” Podcast with Kenneth Polcari and Adam Johnson

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I was a guest on Adam Johnson’s podcast “The Bell” last week. We talk about the reality of tax reform, tax trade, geopolitics, and the bond market, straight from the NYSE Floor. We were also joined by Kenneth Polcari, Director, O’Neil Securities, director of NYSE Floor.

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