Weekly Update: 'Hurricane season coming'
I spent much of the week in New Orleans, where the above banner was playing all over the TV. The likelihood of a correction has been a consistent theme—after seven strong months, the historical odds of a weak August were good. And seasonally, upcoming September is typically a nasty month. This year’s concerns include 1) tapering; 2) Bernanke’s replacement; 3) a new round of sequestration cuts; 4) the debt ceiling; 5) budget issues and politics coinciding with the launch of health-care exchanges and the individual mandate; 6) and the potential for disappointment in consensus GDP and S&P 500 earnings expectations. September also is the month of my birthday, and as the years pass, I look forward to it less and less. How apropos that it may hold a correction—if this low-volume sell-off can hold on that long. ISI says we have had a mini perfect storm of sorts (a Category 1 hurricane?) to the extent the one thing the Fed has pointed to as the marker on QE, employment, has gotten better (the latest claims data is near a six-year low) at the same time production, spending and other data has disappointed (more below). However, the market may be overreacting and is closing in on an oversold condition; 40% of the S&P traded Thursday at a 20-day low—historically, readings north of 50% tend to be very buyable (particularly in the context of an uptrend). Technical indicators suggest the downside risk to the current correction is likely to coordinate with the 100- and 200-day moving average lines, putting support for the S&P at 1,628 and 1,550, respectively.
While concerns arose about second-half U.S. growth, the news out of Europe was encouraging. The German economy returned to growth for the first time in three quarters, expanding at an annualized pace faster than achieved in even the world’s largest economy (2.9% vs. 1.7% in the U.S.). Perhaps the better news was France contributed strongly to the euro-zone’s advancing fortunes. French output surged by more than two times its expected pace, putting national output 0.3% above its year-ago level. Overall euro-zone growth rose 0.3% in Q2, ending a prolonged recession that began in Q4 2011. The third quarter has seen continued improvement so far. European manufacturing expanded in July for the first time in two years, a key U.K. housing gauge reached its highest level since November 2006, and both the current conditions and expectations components of Germany’s ZEW index rose considerably in August, indicating Europe’s largest economy is on a sustained growth path. There were also signs global growth is becoming more broad-based with the OECD composite leading indicator rising in June by the most in four months to its highest level since August 2011. Stronger global demand should be a positive for U.S. growth and capex in particular (more below).
As I was getting ready to speak to 400 CPAs at the Ritz, my New Orleans host asked if I was going to discuss gloom and doom. I said, “No, it’s actually quite good.” He said Louisiana doesn’t always know what it’s like out there—as long as oil is good, so are they. Market sentiment has turned pretty gloomy lately, which will likely wind up being a tailwind as the “Wall of Worry” gets climbed. Much of the investor focus has shifted to 2014, for which Goldman Sachs economists are forecasting above-trend growth for the first time in six years. They expect annualized GDP growth will range from 3% to 3.5% through 2016, with this year’s third-quarter S&P sales playing an important role in establishing the economic environment for 2014 (we are watching sales closely). S&P sales are highly correlated with economic growth. Every time I was introduced in New Orleans, it was “Linda Due-Sell”—as in French. Of course, my husband’s people are German but I wouldn’t correct them. The French sounds cool. Presenting in my stilettos (I wouldn’t recommend it, but I own the shoes so I have to use them), I learned about the Mardi Gras floats operated by krewes. In recent years, the female krewe Muses threw shoes to the crowd and my friend was hit with a stiletto! They love their unique city. They know that hurricane season is coming and are well experienced with how to deal with it. They understand nature has its ebbs and flows, just as the market does. As I have breakfast overlooking the Mississippi River, I would say the evidence indicates this is a welcome correction, and not a hurricane.
We love it when homebuilders are in a good mood July housing starts rose 5.9%, all in the multi-family area, and future construction permits rose nearly 3%. While the profile of housing starts and permits has been somewhat choppy over the past few months, the fact homebuilder sentiment continues to make new cyclical highs—the NAHB gauge rose a fourth straight month in August to its highest level since November 2005—supports the view that activity will continue to increase through year-end despite the recent backup in mortgage rates. Residential investment is expected to be an important component of accelerating economic growth over the next several quarters, with increasing employment more than offsetting the drag of rising rates (more below).
Keep an eye on capex While the Philly Fed PMI disappointed (more below), its capital expenditures component provided more signs of further acceleration in capex, an expected catalyst for stronger second-half growth. Several economic indicators support this outlook, including stronger manufacturing orders, rising business confidence, easier bank lending standards, and signs of firmer global growth. Moreover, the 50% bonus depreciation is set to expire at year-end, which should boost equipment investment. We saw a similar impact ahead of the presumed end of the same tax credit at the end of last year. Finally, the orders-to-shipments ratio of nondefense capital goods orders ex-aircraft hit its highest level in six years in Q2, a sign of firmer demand, and the CEO Confidence Index, which historically has correlated well with capex, also posted its first year-over-year gain in the quarter.
It’s too early to worry about inflation July PPI and core PPI both came in below consensus, with the 1.2% year-over-year core rate at its lowest since June 2010. July CPI and core CPI matched expectations for 0.2% increases, with the year-over-year core CPI at 1.7%, below the Fed’s 2% target. July import prices did rise for the first time in five months but far short of expectations and, stripped of fuel, they actually fell the most since June 2010. Renaissance Macro notes some inflation concerns brewing in the markets, which could weigh on multiples, but the five-year forward inflation expectations are no worse than they’ve been over the last several years.
July industrial production disappoints It was unchanged versus expectations for a 0.2% gain, and June also was revised down. Also, both the New York Empire and Philly Fed gauges of activity unexpectedly slipped in August (but remained in expansion territory), suggesting July’s lull may have carried over to this month. While industrial production is growing on par with its average at this stage of the expansion, it has yet to recover its pre-recession peak, highlighting once again the weakness of economic recovery.
Consumers cautious The University of Michigan’s early read on August consumer sentiment slipped sharply to its lowest level since April, with both the current conditions and expectations components falling. The report comes as July retail sales disappointed and as Wal-Mart and Macy’s lowered their outlooks. Still, consumers are spending more on and borrowing more for cars and housing—the second-quarter’s $20 billion increase in car loans represented the largest quarterly gain in seven years, the New York Fed said.
Rates matter Even though mortgage rates remain near 50-year lows, their recent rise is having a negative impact. This week, the Mortgage Bankers Association's gauge of refi activity fell to its lowest level since April 2011 while the NAHB/Wells Fargo housing opportunity index, which measures affordability, fell to its lowest level in nearly five years on rising home prices and mortgage rates.
Yet another reason to go to college One gauge of the quality of new workers is educational attainment. Employment growth for college graduates is accelerating, while it is weak and choppy for people without a high school degree. Indeed, in the past year, the growth in employment is highest for college educated (3.4%), next highest for those with some college (1.0%), second lowest for those with just high school (0.4%) and lowest for those without a high school education (-3.0%).
Do you remember where you were when you heard that Elvis died? I certainly do, and that was 36 years ago today. My greatest regret in life is when I refused to go on a date to see Elvis play in Pittsburgh on New Year’s Eve. I didn't want to mislead the young man who invited me. What a mistake! He would have certainly forgotten by now, but I will always regret never having seen the king in person. Oh yeah, I'm all shook up.
I’m left-handed. So was Einstein. That is where the comparison ends Tuesday marked the 21st anniversary of International Left-Handers Day. This annual event is for left-handers everywhere so they can celebrate their sinistrality and increase public awareness of the advantages and disadvantages of being left-handed. One out of every 10 people walking down the street is left-handed. Everywhere they go, left-handed people come across tools that were designed for right-handed persons. I figure this is why I can’t parallel park.