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Last Week and This Week in Economics, April 3, 2017

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“Last Week and This Week in Economics”—an excerpt from today’s Sevens Report: everything you need to know about the markets in your inbox by 7am, in 7 minutes or less.

Last Week

Sevens Report - April 3, 2017 - This Week and Last WeekEconomic data was sparse again last week, but what data did come beat expectations (although it didn’t do a lot to bridge the gap between survey-based indicators and hard economic data). Still, the numbers did continue to be enough to offset growing Washington noise.

Consumer confidence was the highlight of the week, and it blew away expectations. The number rose to the highest level since summer 2001, coming in at 125.6 vs. (E) 113.8. While a strong number, that is another sentiment survey, and these soaring sentiment surveys need to start reflecting in the hard data starting in Q2 (remember, Q1 GDP is still expected to be around 1%).

The other notable number last week was Pending Home Sales, which also beat estimates, rising 5.5% vs. (E) 2.5%. The biggest takeaway from the March housing data is that it appears higher mortgage rates are not hurting the residential housing market, and that’s an important but underappreciated tailwind on the economy, generally speaking. Going forward, a stable housing market remains critical if there’s any hope to seeing a material economic acceleration.

Bottom line, the last two weeks have been light on economic data, but what numbers we’ve got have generally been good, and as a broad statement the economic data has continued to offset lack of progress in Washington… but that trend will be put to the test this week.

This Week

After two quiet weeks of economic releases, we more than make up for it this week, as the three most-important economic releases of the month all come over the next five days. From a broader context standpoint, with Washington stuck in neutral and hopes of big tax reform fading, economic data needs to stay firm to support stocks. If the data disappoints this week, don’t be surprised if we test last week’s lows.

The most important release this week is Friday’s jobs report. We will do our typical “Jobs Report Preview” later this week, but again it’s important this number is Goldilocks, in that it’s strong enough to support the market, but not so strong that it makes a May rate hike more likely.

The next most-important release this week is the global manufacturing PMIs (out today). The European and Asian numbers have already been released, and focus now turns to the March ISM Manufacturing PMI at 10 a.m. today. This number is taking on a bit more significance due to the disappointment of the flash manufacturing PMI of two weeks ago. It hit a surprise six-month low, so markets will want to see the ISM Manufacturing PMI refute that reading.

The manufacturing PMI is followed by the global manufacturing PMIs out Tuesday night/Wednesday morning. Those reports will again potentially confirm the uptick in global growth, and especially in Europe, where numbers have been strong lately. Domestically, it’s the same story. Economic data needs to support this market in the face of disappointment from Washington. Failure to do that puts this rally at risk.

The only other notable event this week will be the ECB minutes. If the minutes read hawkish, that could put a temporary headwind on HEDJ and long Europe positions. But a dip will likely be a buying opportunity in HEDJ.

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Time to Buy Emerging Markets? March 29, 2017

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The Case for Emerging Markets, an excerpt from today’s Sevens Report. Everything you need to know about the market in your inbox by 7am, in 7 minutes or less.

Time to invest in emerging markets, tom essayeAs expectations for a pro-growth policy based reflation trade (i.e. the Trump trade) fade here in the US, one potential beneficiary is emerging markets. The sector has underperformed since the election due to a combination of

1) Dollar strength,

2) Rising US bond yields, and

3) Fear of trade wars.

But, if we see an extended pause in the dollar and bond yield rally, and continued poor execution on pro-growth policies, then emerging markets offer value in an otherwise expensive market.

Now, I’m not saying I’m a long-term bull on emerging markets, nor does this analysis mean I’m not a long-term bull on the dollar or bond yields… I think both go higher long term.

However, the fact is this market has already priced in a an acceleration of growth in the US. If that doesn’t materialize, we could see a sideways chop in the dollar and bond yields, and emerging markets will likely outperform near term (i.e. the next few months).

The investment thesis behind EM is comprised of three pillars: Valuation, inverse correlation to the US-based reflation trade, and positive exposure to global growth.

Pillar 1: Attractive Relative Valuation. Emerging markets are much cheaper than most developed markets, as several research pieces we’ve read have emerging markets trading 12X forward P/E, compared to 17X and 15X for the US and Europe, respectively. So, there is value there, especially after the under-performance following the election.

Pillar 2: Hedge Against a Reflation Trade Unwind. If we see the reflation trade continue to unwind (which started in earnest last Tuesday) then emerging markets will benefit. Case in point, since the election, our preferred emerging market ETF (withheld for subscribers) has returned 5.9%. But, almost all of those gains have come over the past few weeks thanks to the Fed’s dovish hike, and the healthcare failure.

If reflation trade enthusiasm wanes in the US, emerging markets will continue to benefit thanks to the weaker dollar and lower yields. To put it simply, emerging market returns are highly inversely correlated to the dollar. If we see the dollar continue to grind sideways or continue to fall, emerging markets should outperform.

Pillar 3: Positive Exposure to Global Growth. Finally, emerging markets should benefit from a rising global economic tide. US rate hikes aside, the rest of the world’s central banks remain very “easy,” and generally speaking global growth is on an upswing… and that should continue to benefit emerging markets. There are, however, risks to the trade. First, if we get border adjustments in a corporate tax cut package, that’s negative EM because it effectively puts a tax on all emerging market exports (i.e. raw materials), which will reduce demand. Second, if the Fed becomes more hawkish near term, then the dollar and bond yields will rise, and EM will lag. Third, if China sees another growth scare that will hurt EM. Finally, if the Trump administration begins to levy import taxes or engages in aggressive trade policies, that will obviously be EM negative. Of these risks, we view the most probable as the Fed getting more hawkish. But, near term that just isn’t very likely. So, the risks to this strategy are real, but we don’t view them as imminent.

Finally, I’m not saying emerging markets are a long-term strategy, but I do think EM is something that can outperform over the coming months, especially if we see a lack of progress on tax cuts. As such, EM offers reasonable upside in a market where not much is cheap, and we think the potential reward is worth the risk.

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A Potential Warning Sign from Dow Theory, March 22, 2017

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An excerpt from today’s Sevens Report (the Sevens Report is everything you need to know about the markets, in your inbox by 7AM in 7 minutes or less).

The price action this week has made us more cautious on this market from a technical standpoint (we’ve been cautiously positive fundamentally for some time). And the reason for the caution has to due with Dow Theory.

The Dow Transports are poised to print a bearish “lower low” on the weekly chart (depending on how things play out through Friday’s close). In a nutshell, the Transports plunged through their most-recent weekly closing low at 9043.90 yesterday. The “lower low” would be the first signal of the four needed to turn our interpretation of Dow Theory bearish.

As a reminder, the last time we published that Dow Theory had turned bearish was in July 2015, just weeks be-fore the Dow Industrials and S&P 500 fell 1000 points and 100 points, respectively, in the opening minutes of trade due to Chinese currency turmoil. While Dow Theory was bearish, stocks fell nearly 15% before recovering after the election and turning back bullish. Our signals did miss out on a modest 3% upside gain (most of which took place in the back half of election week, before the signal was offered).

Bottom line, Dow Theory remains positive for now; however, the Transports did just flash a warn-ing sign. And while we still believe the path of least resistance, based on technicals, is higher for now, we are monitoring the technical situation carefully to keep you informed of another potential period of volatility.

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