Weekly Update: This is it
I traveled in Houston this week. I can report that many things are bigger in Texas. We had meetings in the Williams Tower, the tallest skyscraper just outside of a major city in the U.S. Beautiful. In one of our meetings, an advisor thanked me for describing what is happening in the rest of the country. She said that things are so good in the Houston economy that they need to be reminded that things are not as good everywhere. There is for sure a sense of wealth—I visited in just a few days some of the most beautifully decorated offices that I have ever seen. In my spare time, I walked through the Galleria, one of the largest malls in the country. I had to visit but forced myself to look down instead of wandering into the designer shops (the Mister wouldn’t approve) and raced past the shoe stores. A local joke—“How can you tell that a person is a visitor, and not a Houston resident? He is outside walking.” (Blazing hot there). Speaking of walking, the market took a walk backwards, which we expected and welcomed. It had been a one-way market for too long. ISI says the combination of liquidation fears in emerging markets, the yen’s strength and volatility measures that are near highs in every asset class should continue to drive risk assets lower. The biggest asset beneficiaries from an ETF point of view since QE3 was announced have been emerging-market (EM) bonds, followed by U.S. high-yield bonds, followed by EM equities. All have been under pressure in recent weeks.
Deutsche Bank believes the recent bout of EM weakness will force Fed policymakers, who meet next week, to be very careful about tapering and in the end will force them to prolong QE beyond the point they’d ideally like and beyond market expectations. The Fed has assumed responsibilities beyond the U.S. economy over recent years and will surely have to consider the impact its actions will have on the global economy and asset prices. The Institutional Strategist notes longer U.S. Treasury rates are approaching resistance levels, suggesting an easing of interest rates over the next few weeks. The June-July period has a history of turning the bond market, so the current spike in rates may have run its course. A reduction in bond volatility already has occurred in Japan. A similar decline in America may provide the backdrop for the S&P 500 to make another run through the old highs. But first, possible a retracement to the 100-day moving average (now at 1,568 with more support at 1,550) would be a standard pullback for any uptrend. Over time, one should also expect a test of the 200-day moving average (now at 1,497 and rising). The correction can be seen in the advance/decline line, which made its last high on May 21, and the 10-day average of daily new highs, which is at 67. This is now below the 100 level used to confirm an advance but is typical for a correction phase.
Skepticism has surged quickly during this correction and is a favorable long-term sign, as are growth, earnings and policy fundamentals. Federated this week raised its growth outlook for the year’s second half and for 2014. Cornerstone Macro reports May’s earnings estimate revisions were net positive for the first time in 11 months and notes the single best leading indicator of earnings is the behavior of the P/E, which troughed in November of 2012 during the so-called “sequester correction” and has shot up since. Finally, the Fed appears set to discourage tapering talk. The only question is whether this sell-off is done. Oppenheimer notes the S&P declined 5.27% over 11 sessions from its high of 1,687 on May 22 to the low of 1,598 on June 6. Of the 206 corrections of 5% or more since 1927, the median decline was 8.31% while the mean was an even bigger decline of 12.21%. Once the market is down more than 5%, it ends up going down further more often than not. And then there’s the matter of duration. The 5.27% sell-off was a mere two weeks in the making. By comparison, the median 5%+ correction since ’27 is 23 days while the mean is 42 days. So this pullback probably has further to go. That would present an opportunity for longer-term investors to average in at more attractive prices. If history is a guide, this is it!
The consumer is on fire Other than the few historic spikes, such as the “let’s roll” event following 9/11 and the 2009 cash-for-clunkers, never before have Americans spent as much on cars as they did in May. Equally, sales of building materials and garden supplies was the largest in almost six years and overall, retail sales rose an above consensus 0.6%. Despite below-trend job growth, household finances are supportive of spending, with household net worth reaching a new high of $70.3 trillion at the end of Q1, 5% above the previous peak at the end of 2007. Rising home prices, rising stock prices and continued declines in household debt have driven the improvement. This morning’s initial take on June consumer sentiment dipped, but the expectations component rose to near a recovery high, and the 12-month outlook also jumped.
The housing recovery is for real 30-year fixed mortgage rates jumped a sixth straight week to nearly 4%, up more than half a point in a month. This is leading to worries that rising rates may crash housing’s party, but Bank of America dismisses such talk. It notes bidding wars for houses have returned in neighborhoods throughout the country, and that low inventory and rising demand have set the stage for greater construction. Applied Macro also observes the current level of residential investment relative to the housing stock is its lowest since the Great Depression, the level of existing homes for sale as a percent of the housing stock is its lowest on record and real home prices remain further below the long-run trend than in any other housing cycle in the post-war period.
Small businesses starting to feel it The NFIB’s monthly optimism gauge rose for the fifth time in six months in June to its highest level in a year and just below its pre-recession level of 94.6. The outlook for the economy has gained 23 points over the past two months, the biggest back-to-back increase since May 2009. Expected credit conditions improved to its best level since the summer of 2007 and, the percentage of firms planning to expand increased. The only blah was hiring plans, though the percentage of firms raising worker compensation rose to a near five-year high. Separately, the quarterly Duke survey of CFOs found CFO optimism about the economy at its highest level in two years. What would really get this economy going is this optimism translating into more hiring.
Disinflation may be the bigger worry This morning’s report on PPI surprised, with the headline jumping 0.5% in May, more than double consensus. But the core rate was up only an in-line 0.1%, putting the year-over-year increase at 1.6%. Other inflation monitors showed import prices falling 0.6% in May (vs. consensus flat) and 1.9% year-over-year. Consumer goods prices, which hold some predictive power for core CPI inflation, fell 0.3%, the largest month-on-month decline since October 2010. Moreover, the core CPI inflation rate is only 1.7% year-over-year, and the core PCE Index, the Fed’s preferred measure of inflation, is the lowest on record at 1.0%. This downward pressure on consumer inflation argues for continued monetary accommodation by the Fed.
Inventories, manufacturing signal sluggish status quo The inventory restocking some expected has yet to fully emerge. Total business inventories—including manufacturing, wholesale, and retail inventories—rose a modest and in-line 0.3% in April, though retail inventories did bounce back after plunging in March. The wholesale inventory-to-sales ratio was roughly unchanged at 1.21, within recent ranges. Industrial production in May also was unchanged on declining utility output because of chilly, wet weather; the manufacturing component only rose a below-census 0.1%. On a three-month basis, manufacturing declined by an annualized 0.4%, consistent with slowing economic growth during second-quarter (though retail sales and spending suggest a resilient consumer may be an offset).
The world’s greatest challenge: Creating jobs April’s JOLTS report showed the job market moving sideways, while surveys by accountants and small businesses found a reluctance to hire much. RDQ Economics says this continuing subtrend improvement in the labor market is particularly troublesome for young adults, for whom the jobless rates are twice as high as that of the overall population both in the U.S. (16.2% currently) and Europe (a staggering 23.9%). Since the Global Financial Crisis, youth have suffered disproportionately as weak labor markets are not producing the quantity or quality of jobs needed. Further, over a trillion dollars in U.S. student debt is aggravating youth unemployment here in the U.S. while in Europe, little to no GDP growth is portending higher future levels of social unrest. The future well-being of these economies rests largely on its youth and, for now, that’s a big worry.
Who would have thought the road for can kicking could be this long A key reason why the risk of fiscal policy restraining economic growth in the U.S. is ebbing is that debt-to-GDP is stabilizing in the U.S., and could remain relatively stable over the next decade. Recent CBO projections have debt/GDP stable until 2023! Yes, there are some aggressive growth assumptions in the next few years, but CBO trend growth returns to roughly 2% after that, which is likely reasonable. To be sure, we have not fixed our longer-run entitlement problems, but the most severe of these issues appear beyond 2023. For most investment horizons, the U.S. budget deficit and debt is fading as a concern, and this should continue.
Automakers set for hiring spree USA Today reports that factories are operating at about 95% of capacity, and many are already running three shifts. As a result, some auto and parts companies are doing something they’ve been reluctant to consider since the recession: Adding floor space and spending millions of dollars on new equipment.
Can’t you please use another word? Fed officials hate the word “tapering.’’ Tapering implies a steady and predictable wind down and that isn’t what the Fed wants markets to assume. The Fed is “data dependent” and doesn’t want investors to begin making any assumptions about the asset purchase exit strategy.