Inflation Peaking?

What’s in Today’s Report:

  • Is Inflation Peaking Already?

Futures are flat while overseas markets were mostly lower o/n after yesterday’s huge drop in oil weighed on risk sentiment, global data was mixed, and EU political tensions continued.

Chinese FAI and Industrial Production figures for October were slightly ahead of expectations but Retail Sales notably missed which pressured Asian shares overnight.

In Europe, the German GDP flash missed which only added to ongoing angst over Brexit and the Italian budget drama in broader European markets.

Today is the busiest day of the week as far as catalysts go. First we will get the latest inflation release in the U.S. ahead of the open: CPI (E: 0.3%), then Quarles speaks shortly thereafter (9:00 a.m. ET).

There is nothing major scheduled during market hours today but focus this evening will be on CSCO earnings ($0.72) after the close and then Powell and Kaplan are speaking in Texas at 5:00 p.m. ET (with Q&A) where Powell is expected to take a more dovish tone.

Why the October Sell Off Was Different

What’s in Today’s Report:

  • Why The October Sell Off Was Different
  • Valuation Update (the market is fairly valued here)

Futures are moderately lower following more disappointing Chinese economic data.

Chinese auto sales plunged 12% yoy in November and annual car sales growth turned negative for the first time since the early 1990’s, further fanning fears of a Chinese economic slowdown.

Earnings results were mixed as DIS posted solid numbers while EU corporate earnings were disappointing.

Today focus will be on inflation via PPI (E: 0.2%) and it needs to remain “Goldilocks” so as to not put more downward pressure on stocks.  We also have several Fed speakers (Williams (8:30 a.m. ET), Harker (8:50 a.m. ET), Quarles (9:00 a.m. ET)) although the next big Fed event will be Fed Chair Powell speaking on Tuesday.

Another Breaker Tripped

What’s in Today’s Report:

  • Sevens Report Economic Breaker Panel – October Update: A Macro Breaker Flipped

US stock futures are slightly lower this morning as EU shares are declining on renewed concerns about Italy’s budget despite mostly good economic data overnight.

The Italian Parliamentary Budget Office raised doubts about the government’s growth forecast of 1.5% in 2019 which would ultimately mean a larger budget deficit than previously expected, and that has triggered risk-off money flows this morning.

Economically speaking however, Industrial Production data across Europe was generally better than expected and revisions were mostly positive. While that is currently being overshadowed by the Italian budget drama, it is a positive for the medium term outlook for EU markets.

Today, we get our first of two notable inflation figures this week: PPI (E: 0.2%) as well as Wholesale Trade (E: 0.8%) and there are two Fed speakers to watch: Evans over the lunch hour (12:15 p.m. ET) and Bostic after the close (6:00 p.m. ET).

Otherwise, focus will remain on bond yields and tech shares. For stocks to continue to stabilize or turn higher this week, we will need to see the former hold steady or even pullback slightly and the latter once again outperform.

Inflation Update

What’s in Today’s Report: Inflation Update


Futures are slightly lower as strong Chinese economic data was offset by U.S./China trade worries.

Chinese August Manufacturing PMI increased and beat estimates at 51.3 vs. (E) 51.0, which will ease some concern about the Chinese economy.

Regarding inflation. EU Core HICP slightly missed estimates (1.0% vs. (E) 1.1%) as inflation remains stubbornly low.  This is important because it’s going to be hard for the dollar to really breakdown without a good euro rally – and we need higher EU inflation to fuel that EU rally, and it’s just not happening.

There was no new trade news overnight but prospects of 200 bln in new tariffs next week is a headwind on markets.  Both Bloomberg and Reuters had separate reports saying the administration intends to go forward with the tariffs shortly after the comment period ends early next week.

Today there is only one economic report, Consumer Sentiment (E: 95.5), so focus will remain on trade headlines – but assuming the news wires are quiet on that topic, it should be a typically slow, pre-long weekend Friday in the markets.

To read the full analysis Go Here

Reflation Pause- Part 2, October 11, 2017

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Reflation Update Part 2—Why This Reflation Is Different

In Wednesday’s Report, we covered why the reflation trade that started again in early September has taken a pause, and the reasons are twofold.

First, the market is unclear about who the next Fed chair will be. If it’s Kevin Warsh, that will be a “hawkish” surprise and rates could rise too quickly to keep this reflation “virtuous.”

Second, it’s unclear if upcoming central bank meetings, which means primarily the ECB but secondarily the Bank of England, will be Goldilocks. If either bank is more hawkish than the market expects it could send global rates sharply higher, causing a
pullback in the broad market.

Conversely, if either bank expresses doubts about growth or inflation, it could undercut the whole reflation idea that’s propelled stocks higher.

Point being, there are some key events that need to be resolved before the reflation trade can move higher. And, frankly, that makes this 2017 version of the reflation trade unique compared to previous economic reflations, most recently from ‘03-’06.

For simplicity, the easiest analogy to describe a normal reflation trade is a beach ball. When a recession occurs, the beach ball (the economy) deflates. But, low interest rates and government stimulus act as an air pump, and eventually the beach ball (economy) reflates.

Accelerating economic growth and rising inflation (due to easy money) are the “air” that inflates our economic beach ball. From a market standpoint, economic reflations are usually wonderful things. Markets go up in concert, and the way to outperform is to add beta and be exposed to cyclical, growth-oriented sectors. During a normal reflation (the last one was in ’03-’06) everything goes up regardless of what else is going on in the world.

However, this reflation is different.

Eight years after the end of the financial crisis, our economic beach ball is only half full. That’s because we’ve pumped in the “air” of accelerating economic growth (GDP going from negative to 2.5%ish) but we haven’t pumped any “air” of inflation in, yet.

Despite that, stocks are at all-time highs. Valuations are as stretched as any of us have seen them in decades. And, now we’re very late in the typical economic cycle.

Given that, barring some big surprise on tax cuts or infrastructure spending, it’s unlikely that we’re going to see a material acceleration of economic growth. In reality, 3.5% – 4% GDP growth is quasi impossible given demographics in this country—specifically the large demographic of baby boomers entering retirement, and them being replaced by a smaller workforce.

Getting back to our beach ball analogy, if inflation finally accelerates there will be a shorter time of euphoria—as the other half of our beach ball inflates. We got a hint of that in September.

But given valuations, stock prices and economic growth all are at or nearing reasonable ceilings, the risk is that after a short bit, the “air” from rising inflation over inflates our economic beach ball, and a bubble (or multiple bubbles) develop and we burst the ball. Practically, what I’m talking about is the Fed hiking rates and inverting the yield curve, which would be our signal that the beginning of the end of this eight-year expansion is now upon us.

From an advisor or investor standpoint, this creates a difficult set up. For now, we must continue to be invested and, potentially, allocate to the reflation sectors. Yet we also must do so knowing that unlike most revelations, we’re not going to enjoy an easy rally that lasts years.

So, the now years-long game of market musical chairs continues, albeit with a potentially reflation accelerating the pace of the music. For shorter or more tactical investors, holding “Reflation Basket” allocations makes sense as we approach and navigate these upcoming events.

For longer-term investors, we continue to await confirmation from the 10-year yield that this reflation truly is upon us. A few closes above the 2.40% level will be the signal, in our opinion, to rotate out of defensive names and into part or all of our Reflation Basket—Banks (KRE/KBE/EUFN), industrials (XLI), small caps (IWM) and inverse bond funds (TBT/TBF).

Bottom line, at this point in the economic cycle, for stocks to move materially higher we need inflation to accelerate and cause that reflation trade, but weneed to realize that brings us one step closer to the ultimate “bursting” of the recovery. This market remains more dangerous over the medium/longer term than the low VIX would imply.

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Reflation Pause, October 20, 2017

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Why Is the Reflation Rebound Pausing? Because It Should. Here’s Why…

After surging basically from Sept. 11 through Friday’s jobs report, the reflation rebound has taken a pause for the last few days, and I wanted to provide a comprehensive update of:

1) Where we are in the reflation process and specifically the key catalysts that are looming in the near future and that are causing this pause, and

2) Explain why this reflation trade is different from others, and requires A) A more tactical allocation to get the outperformance we all want, and B) Greater patience on the part of longer-term investors before abandoning what’s worked so well in 2017 and allocating to more reflation-oriented sectors.

Due to space constraints, I’m going to break this up into two parts covered today and tomorrow.

Reflation Update Part 1: Where Are We, and What Will Decide Whether It’s Going to Continue?

We’ve been saying since the July Fed meeting that inflation was now the most important economic statistic, and that markets needed inflation to start to rise to help fuel a “reflation rebound.”

Well, during the week between Sept. 11 and Sept. 15, Chinese, British and US CPIs beat expectations, and combined with an uptick in global economic activity, caused tactical investors to rotate into tactical sectors (banks, energy, industrials, small caps, inverse bond funds).

And, we were early on identifying that switch, and our “Reflation Basket” has outperformed the markets since we re-iterated it for short- and medium-term investors in the Sept. 21 Report.

However, also in that Report we cautioned longer-term and less-agile investors to wait for clear confirmation that the reflation rebound had started, and we identified two keys. The first was the KBW Bank Index closing above 100. This occurred both Monday and Tuesday. The second was the 10-year yield breaking above 2.40%.This has yet to happened.

So, while much of the mainstream financial press is now pumping the reflation trade (a month after it started) we’re acknowledging that it’s paused. Practically, that means we’re holding (not adding to) our “Reflation Basket” of KRE/KBE/IWM/EUFN/XLI/TBT/TBF, and think shorter-term/tactical investors should too.

I say that because I believe the first stage of this reflation trade is now complete, and in the next three weeks we will see two key events that will decide whether this reflation extends into November, pauses longer or potentially back tracks.

Near-Term Reflation Catalyst #1: ECB Meeting. Thursday, Oct. 26. Why it’s Important: As we’ve covered, markets have enjoyed a “virtuous” reflation recently because 1) Economic data has been good, but 2) Not so good that it’s causing global central banks to hike rates faster than expected.

Markets have a general expectation of what ECB tapering of QE will look like (somewhere around 20B per month) but we’ll get the details at this October ECB meeting.

If the ECB is more hawkish than expected, that could potentially send yields too high, too fast, and kill the
“virtuous” reflation. If that happened, banks and inverse bond ETFs would rally, but everything else would fall.

Conversely, if the ECB is too dovish, then markets might lose confidence in the reflation itself, and that would become a headwind.

Bottom line, the ECB needs to release a taper schedule that implies confidence in the economy and inflation, but that also isn’t so aggressive it kills the “virtuous” reflation rally.

Near-Term Reflation Catalyst #2: Fed Chair Decision.
The fact that President Trump will name a potentially new Fed chair in the next two weeks has been somewhat lost amidst the never-ending (and seemingly everescalating) Washington drama.

Right now, it’s widely believed there are three front runners: Kevin Warsh, Jerome Powell and Janet Yellen.

If Yellen is reappointed (and that’s seeming increasingly unlikely) then clearly that won’t cause any ripples in the reflation trade, and we can go back to watching inflation and yields. However, if one of the other two are appointed, things get interesting.

Warsh is considered the biggest “hawk” of the group,and if he becomes Fed chair we may see yields rise sharply, potentially endangering the “virtuous” reflation.

Powell is viewed as in the middle of the other two—not as dovish as Yellen, but not as hawkish as Warsh. But, it’s reasonable to assume that a Powell appointment would put at least some mild upward pressure on Treasury yields. It likely wouldn’t be enough to spur a killing of the “virtuous” reflation, but it would be cause for a pause in the move.

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Weekly Market Preview, September 18, 2017

Last Week in Review

Up until Friday, last week’s data looked like it was going to show “green shoots” of an economic reflation. But disappointing economic growth numbers on Friday off-set better inflation readings from earlier in the week, and while Hurricane Harvey likely impacted the growth data, the bottom line is the data just isn’t good enough to spur a rising tide for stocks.

From a Fed standpoint, the higher inflation data did increase the likelihood that we will get a December rate hike, although the market expectation of that remains below 50%. As such, increased expectations of a rate hike in the coming weeks could be a headwind on stocks, especially if economic data doesn’t improve.

Looking at last week’s data, the most important takeaway was that inflation appears to be bottoming. Chinese, (1.8% yoy vs. (E) 1.7% yoy), British (2.7% vs. (E) 2.5%), and US CPI (0.4% m/m vs. (E) 0.3%) all firmed up and beat expectations, and while it’s just one month’s data, it’s still a break of a pretty consistent downtrend.

That turn in inflation potentially matters, a lot, because it’s making central banks become more hawkish. The ECB is going to taper QE, the Bank of England is going to raise rates sooner rather than later (more on that in Currencies), the Fed may hike again in December and the Bank of Canada was the first major central bank to give us a surprise rate hike in nearly a decade. I’m going to be covering the implications of this a lot more this week, but the times, so it seems, they are a changin’.

That makes an acceleration in economic growth now even more important. Unfortunately, the growth data from last week was disappointing. July retail sales missed on the headline (-0.2% vs. (E) 0.1%) as did the
more important “Control” group (retail sales minus autos, gas and building materials). The “control” group fell to -0.2% vs. (E) 0.3%.

Additionally, Industrial Production also was a miss. Headline IP fell to -0.9% vs. (E) 0.1% while the manufacturing subcomponent declined to -0.3% vs. (E) 0.1%. Now, to be fair, Hurricane Harvey, which hit Southeast Texas, likely skewed the numbers negatively. But, the impact of that is unclear, and we can’t just dismiss these numbers because of the hurricane.

Bottom line, the unknown impact of Hurricane Harvey keeps this week’s data from eliciting a “stagflation” scare, given firm inflation and soft growth. But if this is the start of a trend, and it can’t be blamed on Harvey or Irma, then that’s a problem for stocks down the road. We need both inflation and growth to accelerate (and at the same time) to lift stocks to material new highs.

This Week’s Preview

The two key events for markets this week will be the Fed meeting on Wednesday, and the global flash PMIs on Friday.

Starting with the Fed, normally I’d assume this meeting will be anti-climactic, but it’s one of the meetings with the “dots” and economic projections, so there is the chance we get either a hawkish or dovish surprise. I’ll do my full FOMC Preview in tomorrow’s report, but the point here is don’t be fooled into a false sense of security if people you read say this meeting is going to be a non-event. It very well could be, but there’s a betterthan-expected chance for a surprise, too (and if I had to guess which way, I’d say it’d be a hawkish surprise… and that could hit stocks).

Turning then to the upcoming data, given the new-found incremental hawkishness of global central banks, strong growth data is more important than ever to avoid stagflation. We’ll want to see firm global manufacturing PMIs to keep stagflation concerns at bay. Looking more specifically at the US, Philly Fed comes Thursday and that will give us anecdotal insight into manufacturing activity, although the national flash PMI out the next day will effectively steal the thunder from the Philly report.

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Green Shoots of A Global Reflation, September 13, 2017

Are We Seeing “Green Shoots” of A Global Reflation?
• Chinese August CPI rose 1.8% yoy vs. (E) 1.7% yoy.
• British Core CPI rose 2.7% vs. (E) 2.5% yoy.


Are there “green shoots” of inflation? I reference the Bernanke comments regarding economic growth here, because very quietly we’ve seen two better-than-expected inflation numbers in two big economies (technically three if you count the uptick in Indian CPI, although that’s not widely followed).

August Chinese CPI beat (it came out Friday but couldn’t be priced in until markets opened on Monday) but it was the big uptick in core British CPI that saw the market extend the rally on Tuesday.

So, the logical question, given these two surprise beats is, “Will US CPI also surprise markets?”

The inclination is to believe in the trend, but to be clear, higher Chinese and British CPIs have no real bearing on US CPI—so strong numbers in those two reports don’t increase the likelihood of a strong CPI number.

But, if it comes, expect some potentially big market moves across Treasury yields, the dollar, and in stock
sector trading (banks and cyclicals will scream higher while defensives, including parts of tech, will likely badly lag). But again, that will depend on tomorrow’s number.

From a market standpoint, looking at the effects of the strong Chinese and British CPI, the clear ETF winner is…(withheld for subscribers only—unlock specifics and ETFs by signing up for a free two-week trial).

I continue to believe that an economic reflation (better growth, higher inflation) remains the key to a sustained US and global stock rally. And while two numbers don’t make a trend, they were the first positive surprises we’ve had on inflation in months, and we think that’s potentially very important (if it continues).

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Harvey’s Market Impact, August 29, 2017

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We got a couple of questions from advisors yesterday about the market impact of Hurricane Harvey, so I imagined you might be getting similar calls from your clients.

So, I wanted to clearly and briefly outline the market impact of the storm.

Macro Impact: Not Much. From a macro standpoint (Fed policy, GDP growth, inflation) Hurricane Harvey won’t have much of an effect. While clearly a significant human tragedy for Houston and Southeast Texas, storms simply don’t have a lasting effect on markets. Katrina and Sandy had impacts on the local economies, but again, the broader macro influence wasn’t big. Harvey does not change our “cautiously positive” stance on markets.

Micro Impact: The more palpable impact of Hurricane Harvey will be on specific market sectors, although I will not provide a list of “winners” given the damage wrought upon Houston and other parts of Texas.

That said, companies that likely will see increased demand due to the storm are: Refiners (HFC, DK), trucking companies (KNX), and equipment rental companies (URI). Unfortunately, there’s not a clean ETF for these sectors, and the only tradeable infrastructure ETF is a global ETF, so I don’t think it’s applicable here.

Companies that are likely to see business decline because of Harvey are: Natural gas and oil E&P companies due to a lower production and lower prices (ETF is XOP), and insurers.

Looking at insurers, the focus there is on property and casualty insurers as they will be the most affected by the storm. The big insurance ETF is KIE which traded down 1% on the news yesterday. But, while the first instinct would be to run from the insurance space, in some ways I view this as a potential opportunity to buy insurers on a dip (if this continues).

First, property and casualty insurers are just 40% of KIE. Yes, there will be more exposure through reinsurance (10.8% of assets), but that still leaves about half the assets of the ETF somewhat insulated from the storm. Additionally, 24% of the exposure of the fund is to the UK, and those should have little exposure to Harvey.

Point being, I’m not saying buy KIE today but I also want to look through the initial impulse to just shy away from the sector entirely. But, over the longer term, being long insurance companies are like betting with the house in a casino—they always win given enough time.

If Harvey creates an unreasonable downdraft in KIE, we will likely allocate capital to it for longer-term accounts. We’ll be watching this one going forward.

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Weekly Market Cheat Sheet, August 28, 2017

Last Week in Review

There were only two notable economic reports last week, and neither were particularly controversial… and neither did anything to change the current market expectation of 1) High 2% to low 3% GDP growth in Q3, or 2) Fed reduction of the balance sheet in September.

Neither data point gave us any incremental color on whether the Fed will hike rates in December, although
we’ll get a lot more color on that issue this week. Looking at the data, the most important number last week was the August flash composite PMIs. The headline number beat at 56 vs. (E) 54.3, but that strong aggregate number hid some pretty significant discrepancies in the details.

The reason the PMIs beat was because of a surge in service companies. Flash service sector PMI rose to 56.9 vs. 54.8. But, the more important manufacturing PMI dropped to 52.5 vs. 53.2 (the manufacturing PMI is just a better reading of activity, so it’s more heavily weighted in the minds of economists).

So, despite the headline beat, this number was actually a disappointment, although I want to be clear that it was not an outright negative (PMIs need to drop below 50 before they imply economic activity is slowing). Bottom line, this is not the type of August reading that would make us think we’re seeing an economic acceleration.

Turning to Durable Goods, they were in line. Yes, the headline reading missed expectations as orders for Durable Goods fell -6.8% vs. (E) -5.8%. But, longer-time readers of this Report know you should ignore the headline as it’s massively skewed by airplane orders. The more important number is New Orders for Non-Defense Capital Goods ex Aircraft (NDCGXA) and it rose 0.4% vs. (E) 0.5%, although June data was revised 0.1% higher, so it was an in-line reading.

Again, we watch NDCGXA because it’s the best proxy for business spending and investment. And, similar to the flash PMI, while the number isn’t an outright negative, it’s not the kind of number that makes us think a broad economic acceleration is coming.

Bottom line, both numbers last week implied continued steady, but unspectacular, economic growth, and that’s simply not enough to cause a rising.

This Week’s Preview

This will be one of the busiest weeks of the year from an economic data standpoint, and it will come during one of the lowest liquidity weeks of the year… so the potential for data-based volatility this week is high.

The key reports this week (in order of importance) are: Jobs Report (Friday), Personal Income and Outlays (Thursday) and Global Manufacturing PMIs (Thursday night/Friday morning).

The reason those reports are ranked like that is because of inflation. Remember, barring a shockingly week Jobs Report on Friday, nothing is going to stop the Fed from reducing the balance sheet in September.

But, whether they hike rates in December remains uncertain, and the key variable that will decide that is inflation. So, that means that the wage number in Friday’s Jobs Report, and the Core PCE Price Index (the Fed’s preferred measure of inflation, which is contained in the Personal Income and Outlays report) will be the two key numbers this week.

If they run hotter than expected, you will see markets begin to price in the chance of a December rate hike, which would likely be a near-term headwind on stocks as a rate hike is not priced in to bond yields, the dollar or equities.

Turning to measures of economic growth, the August manufacturing PMIs are always important, but again there really shouldn’t be any major surprises here. A firm number in the US that refuted the soft flash PMI from last week would be welcomed as we need better growth to push stocks higher, but really the focus will be on inflation this week.

Looking at the dovish possibilities, we could easily see the data this week push the 10-year Treasury yield to new lows if the inflation data is underwhelming, and we would view that as a negative for stocks broadly.

Bottom line, I know this is a heavy vacation week, but it’s important one for Fed and ECB expectations, and that has the potential to move markets, especially given the precarious technical situation the S&P 500 is sitting in.

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