The Dow Is Set to Drop Because Boeing Is Still a Problem
But for now, there’s nothing, and it just might stay that way. “Unless we get a surprise U.S./China trade headline (and chatter there seems to be…” Click here to read the article.
What’s in Today’s Report:
Futures are only slightly lower despite disappointing U.S./China trade headlines over the weekend and more underwhelming global economic data.
The South China Morning Post reported that a Trump/Xi trade summit (to end the trade war) might not happen until June, later than the current April expectation, as talks on key issues continue to drag out.
Global economic data remained underwhelming as Japanese exports missed expectations, falling –1.2% vs. (E) 0.7%.
Today there is only one economic report, Housing Market Index (E: 63.0), and no Fed speakers (they’re in the blackout period ahead of Wednesday’s meeting) so unless we get a surprise U.S./China trade headline (and chatter there seems to be rising following the weekend) I’d expect digestion of last week’s big rally.
What’s in Today’s Report:
Our regular editor is out today so my apologies for any uptick in typos.
Futures are modestly higher following more optimistic chatter on U.S./China trade and Chinese economic growth.
Chinese officials again reiterated support for their economy overnight and that, combined with renewed optimism for a U.S./China trade deal, sent futures higher. But, I do want to point out that nothing materially new happened overnight – it was jus more of the same commentary we’ve seen for the past month or so.
There were no notable economic reports overnight.
Today focus will be on economic data as we get our first look at March activity via the Empire State Manufacturing Survey (E: 10.0) along with Industrial Production (E: 0.4%), Consumer Sentiment E: 95.0) and January JOLTS (E: 7.155M). Again, the stronger the data, the better for stocks.
Finally, today is “Quadruple Witching” options expiration so don’t be surprised by some volatility, especially into the close.
What’s in Today’s Edition:
Stock futures are bouncing modestly this morning after the worst Christmas Eve selloff in history took place on Monday which saw all of the major indexes fall well over 2%.
News flows were mostly quiet over the last 48 hours however President Trump did make supportive comments regarding Secretary Mnuchin after he spooked markets Monday and continued to blame the Fed for the recent selloff.
There were no economic reports overnight.
There is not a lot on the calendar today as there are no Fed officials scheduled to speak and there is just one economic report to watch: S&P Corelogic Case-Shiller HPI (E: 0.4%).
As a result, investor focus will remain on U.S. politics and global growth as they have been the main reasons for the most recent stock declines.
What’s in Today’s Report:
Futures are slightly higher as markets bounce following Wednesday’s post Fed selloff.
It was a quiet night of news as there were no new headlines on trade, and most commentary focused on the takeaways of the Fed decision.
Economically, UK data was mixed as Nov. Retail Sales were strong (1.4% vs. (E) 0.3%) while Dec. Distributive Trades were weak (-13 vs. (E) 15).
Today focus will remain on the economic data, which becomes even more important in the face of the not dovish enough Fed. We get to notable reports today, Jobless Claims (E: 220K) and Philadelphia Fed Business Outlook Survey (E: 16.5) and if the later misses expectations, look for more selling.
Last Week in Review
The economic data remains remarkably consistent: Growth data remains good but not great while inflation data relentlessly disappoints. From a market standpoint, that means that the economy isn’t at imminent risk of a material loss of momentum, but at the same time there are no signs of the type of acceleration that would lead to a rising tide carrying stocks higher.
From a Fed standpoint, inflation remains lackluster, and that’s causing a reduction in expectations for a December rate hike. That’s not a medium/longer-term good thing for stocks, because it further throws into doubt the chances for reflation—and economic reflation remains the key to sustainably higher stock prices.
Looking at last week’s data, there weren’t many numbers, but the numbers we got reinforced the “slow growth/low-inflation” trend.
The ISM Non-Manufacturing PMI (or service sector PMI) rose to 55.3 from 53.9. So, there was acceleration in activity in August. But that acceleration missed estimates of 55.8, and while a number in the mid-50s is solid, it’s not the type of number that implies we’re seeing real acceleration.
The other notable number last week that was largely ignored by the media was August productivity and unit labor costs. An uptick in productivity, if it’s consistent and material, could lead to an economic acceleration.
The reason for that is simple: The economy is basically at full employment. But, if those workers get more productive, the total economic output increases, and we get a stronger economy.
August productivity rose to 1.5% vs. (E) 1.3%, so that is a good sign. It’s not nearly the acceleration we need, but it’s a step in the right direction.
However, that productivity number wasn’t the important one from this release. The important number was unit labor costs. Rising unit labor costs is a precursor to larger inflation, so it’s an important number. And, unfortunately, it once again missed expectations. Unit labor costs rose 0.2% vs. (E) 0.3%, providing even more fodder for the “doves” on the Fed to not hike rates in December.
Finally, turning to the ECB meeting last week, you know by now it was slightly hawkish. Draghi signaled the ECB will reveal the details of QE tapering at the October meeting, and he again chose not to try and “talk down” the euro, which led to the euro hitting new multi-year highs (and the dollar hitting multi-year lows).
From a market standpoint, that dollar weakness is a slight tailwind on US stocks, although not a material one. Until we get better inflation or growth data here in the US, the trend of euro strength/dollar weakness will continue.
This Week’s Preview
All the important economic reports this week come out Thursday and Friday, which is nice because that gives us a bit of time to get ourselves squared away following all the hurricane issues from last week.
The most important number this week is CPI, out Thursday. As you know, inflation remains the key issue with the economy and Fed expectations. Frankly, we need CPI to start firming because it’ll give us hope of a looming economic reflation. If, however, this number disappoints, as it has for a few months, we’ll see new lows in the dollar and new lows in Treasury yields, neither of which are a good thing for stocks beyond the very short term.
After CPI, there are three important growth numbers out this Friday: Retail Sales, Industrial Production and Empire Manufacturing Survey.
Starting with the first two, remember there remains a large gap between “hard” economic data and surveys. Put plainly, actual economic data is not rising to the level that’s being implied by the PMIs and/or consumer confidence. The longer that occurs, the more likely it is that the surveys are exaggerating economic growth.
So, the sooner hard economic data begins to accelerate, the better. If retail sales and industrial production can beat estimates, that will be an economic positive.
Turning to Empire Manufacturing, that’s the first data point from September, and that’s always anecdotally important because we don’t want to see any steep drop off that might imply a loss of momentum.
Bottom line, this week gives us more color into the state of growth and inflation in August. We need to see both begin to accelerate if we are to hold out hope that we can see an economic reflation create a “rising tide” for stocks in Q4 ’17 or Q1 ’18.
Time is money. Spend more time making money and less time researching markets every day. Subscribe to the 7sReport.com.
Join hundreds of advisors from huge brokerage firms like Morgan Stanley, Merrill Lynch, Wells Fargo Advisors, Raymond James and more… see if The Sevens Report is right for you with a free two-week trial.
The most likely “cause” of the midday reversal and selloff (which frankly looked ugly for an hour or so) was a cautious report from JPM quant analyst Kolanovic, and the reasons it caused a dip are twofold. First, Kolanovic is very respected on the Street, and he was one of the first analysts to correctly identify the role of “Risk Parity” funds in the violent market declines of August 2015.
Second, he outright suggested investors hedge equity exposure.
Now, to be clear, it wasn’t a bearish report, as he did note there are strong, positive fundamental factors supporting stocks including a rising economic tide and growing earnings.
However, he made the point that, in his opinion, market volatility is now at an all-time low. The specific accuracy of this claim can be debated, but let’s all agree market volatility is close to, if not at, all-time
lows.
The all-time lows in volatility have caused funds to use increasingly leveraged strategies to generate outsized returns. Selling volatility options is one of the simplest leveraged strategies, but the point is this: Quant funds and traders will ratchet-up leverage in low volatility environments to increase returns amidst perceived lower risk. And, since volatility is at or near all-time lows (and has been for some time) these leveraged strategies are both abundant and large.
And, this all-time low volatility and explosion of leveraged strategies is coming right at a time when global central banks are reducing monetary accommodation for the first time in, well, a decade.
So, while the analogy of fireworks sitting on top of a powder keg is a bit over the top, it does illustrate the general idea behind Kolanovic’s caution.
Bottom line, in my opinion, this report by itself isn’t a reason to materially de-risk, as the same argument could have been made about this market over the past few months (as it’s made new highs). But, Kolanovic is a smart guy, so his caution should be noted.
Finally, two anecdotal points. First, I believe what really spooked markets yesterday was that Kolanovic referenced this current set up as being similar to “Portfolio Insurance,” a strategy that failed miserably and contributed to the crash of 1987. Obviously, that’s not an uplifting analogy.
Second, for those of us watching the tape yesterday, the mini-freefall we saw in tech and specifically SOXX and FDN, was a bit unnerving. Things steadied, but the pace of the declines midday yesterday was a bit scary. That tells me these are very, very crowded trades, and I am going to have a “think” on potentially lightening up some exposure to that tech sector in favor of shifting it internationally (Europe, Japan, and perhaps emerging markets). Food for thought.
Getting back to the markets today, the Employment Cost Index is the key number to watch. If it’s hot, we could see yields rise, and that might pressure stocks mildly. Meanwhile, a soft reading will send yields lower and likely push stocks higher short term. Inflation remains a much more important influence on the markets right now than measures of economic growth.
Time is money. Spend more time making money and less time researching markets every day—start your free trial of the Sevens Report now.
What Does “Reflation” Actually Mean?
One of the reasons I started the Sevens Report more than five years ago was because I hated the overuse of jargon by analysts and commentators. Frankly, markets and economics are not particularly complicated topics. There are a lot of variables involved, so getting the future right is difficult. However, understanding market dynamics and economic conditions is actually mostly common sense, because markets and economies are just the sum of collective actions by people. And, since people generally act in their own best interests, it’s not too difficult to understand markets and economics once you get past the jargon.
To that point, I’ve found myself using the terms “reflation” and “cyclical” entirely too much lately. That’s jargon, and I want to make sure that everyone knows exactly what I mean when I say “reflation trade” or “cyclical outperformance.”
So, what is Reflation?
Reflation is simply the idea that economic growth is going to accelerate in the future. To understand why we use the term reflation, think of the economy as a soccer ball. The ball is full of air when we have consistent 3% GDP growth. But, fallout from the financial crisis has put GDP growth around 2% for nearly a decade. So, the soccer ball (i.e. the economy) is deflated.
However, if we see economic acceleration back to consistent 3% growth, the ball (i.e. the economy) has been “reflated.” So, any economic news that implies better growth is termed “reflation.”
And, since reflation is just the expectation of an accelerating economy, people (i.e. investors and the market) react to that expectation. That reaction, typically, is comprised of:
1) Selling bonds (so higher rates) because in an accelerating economy central banks hike rates and inflation rises, both of which are negative for bonds.
2) They allocate investment capital to sectors of the economy that are more reactive to better economic growth.
These sectors are called cyclicals, because their profitability rises and falls with economic growth (like a cycle). Banks (better economy=more demand for money), industrials (better economy=capital investment in projects), small caps (better economy=rising tide for products and more availability of capital), and consumer discretionary (better economy=more spending money) all are cyclical sectors.
Companies in those sectors usually make more money when the economy is getting better, and the anticipation of that attracts capital at the expense of bonds and “non-cyclical” sectors such as utilities, consumer staples, healthcare, and, increasingly, super-cap tech.
Up until June, the non-cyclicals outperformed because there was no evidence of higher rates or better growth. But in June central banks sent a shot of confidence into the markets, and since then, in anticipation of that economic acceleration, cyclical sectors have outperformed. And, if today’s jobs report is strong, beyond any short term “Taper Tantrum 2.0” that’s likely a trend that will continue, especially given the trend change in bonds.
Skip the jargon, arcane details and drab statistics from in-house research, and get the simple analysis that will improve your performance. Get the simple talking points you need to strengthen your client relationships with a free two-week trial of The Sevens Report. No credit card needed, no commitment—just tell us where to send it.
Get the simple talking points you need to strengthen your client relationships with the Sevens Report. Sign up today for your no obligation 2-week free trial.
Historically low volatility is becoming a bigger topic in the markets these days, and while earlier in the year low volatility was referenced with more of an observational tone, recently I’ve been hearing the bears touting low volatility as something that simply must revert soon, and as such we should be cautious on markets.
I don’t have a crystal ball, so I don’t know when normal volatility will return. However, I do want to spend a few moments pushing back on the idea that low volatility by itself means a correction is coming (obviously volatility will return, but as usual the key question is “when,” and ultra-low volatility doesn’t always mean it’ll return to normal levels soon).
First, you’re not seeing things. Volatility is at multi-decade lows, and that can be seen in multiple ways. First, the VIX hit a 23-year low yesterday, falling to the lowest level since 1993.
Second, so far in 2017 the S&P 500 has moved more than 1% on just three separate days, all of which were in March. By this time of year we’ve normally had 19 days where the S&P 500 has moved more than 1%.
Third, with a close at 9.98 yesterday, the VIX now is lower than nearly 99.5% of all the closes since Jan. 1, 1990. Put another way, it’s only closed this low about 0.05% of the time during the last 27-plus years. So, the VIX is extraordinarily low.
But, that doesn’t mean it’s going to bounce back soon.
First, According to a note from ConvergeEx, the all-time low for the VIX 50-day moving average is 10.8, which it hit in Feb. 2007. Right now, the 50-day moving average for the VIX is 12.17.
Takeaway: It’s very unlikely that the VIX will stay at these ultra-low levels for very long, but that doesn’t mean a big rally is looming. It would take several more weeks of VIX at these levels to drag the 50-day MA down towards the all-time lows.
Second, looking at the VIX to measure volatility can cre-ate a bit of an odd picture, because again the VIX is based on options prices and not the actual price move-ments of the S&P 500. Looking at actual stock price movement, it confirms what our eyes tell us.
Going back to the 1950s, the current volatility of stock prices is 48% of its longer-term average. That’s really low. And, this period of historically low volatility has been going on for 78 days (including yesterday). But, that doesn’t mean it necessarily will bounce back.
First, there have been two specific periods of similarly low volatility in the last 20 years. First in mid-2014 (75 days) and second from Nov. ’06 to March ’07 (79 days).
Second, we’re not even close to the record for low volatility. In 1992/1993 and 1995/1996 we saw respective periods of ultra-low volatility last for 179 and 254 days, respectively. That’s double and triple what we’ve seen so far in 2017.
The Sevens Report helps you cut through the noise and understand what’s truly driving markets, as this new political and economic reality evolves.
The Sevens Report is everything you need to know about the market in your inbox by 7am, in 7 minutes or less. Claim your free 2-week trial.
The S&P 500 has been largely “stuck” in the 2300-2400 trading range for nearly 10 weeks, despite a big non-confirmation from 10-year yields, modestly slowing economic data and political disappointment. Given that less-than-ideal context, the market has been downright resilient as the S&P 500 only fell to around 2320ish. The main reason for that resilience is earnings and valuation.
While it’s true that stocks are at a valuation “ceiling” right now, and need a new macro catalyst to materially breakout, it’s also true that given the current macro environment the downside risk on a valuation basis for the market is somewhat limited. That’s why we’re seeing such aggressive buying on dips.
Here’s the reason I say that. The Q1 earnings season was better than expected, and it’s resulted in 2018 S&P 500 EPS bumping up $1 from $135-$137 to $136-$138. At the higher end of that range, the S&P 500 is trading at 17.4X next year’s earnings. That’s high historically to be sure, but it’s not crazy given Treasury yield levels and expected macro-economic fundamentals.
However, if the S&P 500 were to drop to 2300 on a macro surprise, then the market would be trading at 16.67X 2018 earnings. In this environment (low yields, stable macro environment), that could easily be considered fairly valued.
Additionally, most analysts pencil in any help from Washington (including even a small corporate tax cut and/or a foreign profit repatriation holiday) adding a minimum of $5 to 2018 S&P 500 EPS. So, if they pass the bare minimum of expectations, it’s likely worth about $5 in earnings, and that puts 2018 earnings at $143.
At 2400, and with $143 expected earnings, the S&P 500 is trading at 16.8X 2018 earnings. Again, that is high historically, but for this market anything sub 17X will elicit buying in equities (whether it should is an open question, but that is the reality).
Join hundreds of advisors from huge brokerage firms like Morgan Stanley, Merrill Lynch, Wells Fargo Advisors, Raymond James and more… see if The Sevens Report can help you make more money in less time.