Weekly Update: 'We were welling up in Houston'
And I don't mean oil wells, though there were plenty in this boom town where I spent much of the week. On our drive from the airport, we passed the construction site for Exxon's new campus. Of course, it's huge—it’s in Texas. We also passed the Johnson Space Center, where the story goes that when native son LBJ became president after Kennedy's assassination, the country was building out the space program. Asking what had been built and what needed to be built, he was told the launch pad was completed but a site for mission control had yet to be chosen. "Take it to Texas," he said. As for the title of this week’s missive, it derives from a breakfast meeting in the wealthy "oil suburb" of The Woodlands, where an adviser said his clients are so risk-averse they still hold lots of cash. This is common among baby boomers. Many are preparing for retirement by searching for yield in a yield-starved environment, but worry reaching for yield is risky. So I spoke of the diversified yield strategy—U.S. and international dividend stocks; balanced funds of stocks and high quality corporate and international bonds; and balanced funds that hold stocks and municipal bonds. “This is the solution!,’’ I said, a tear forming in my eye. I quickly returned to earth in my next meeting, in the Galleria area, as there was an ovation—not for me, but for one adviser stating that, "Texas is the greatest state in the land." Texans stand apart in their state pride.
Despite another week of record highs, the average S&P 500 stock is 5.5% below its 52-week high, while the average Russell 2000 stock is 20% below its 52-week high—a very large discrepancy and a sign that the Russell 2000 is in a stealth bear market. Looking at the percentage of stocks above their 200-day moving average for both indices, FBN Technical Research notes the spread is at its widest point in the history of their database. The average gap between the two over the last 19 years was about 7.5; today at roughly 30, it’s four times as wide. While breadth is not a proper market timing tool, a heightened reading often has forewarned of troubles ahead, with the S&P more often pulling back to the Russell rather than the Russell playing catch up. Whatever path these two indices decide to take over the next few months, investors should appreciate just how different the stocks in each group are behaving. Something is abnormal and uncharacteristic of conventional markets. Breadth readings confirm that the S&P 500 and the Russell 2000 are two very different markets now. I finished the week in San Antonio, where the advisers were in an unbelievably (and infectious) good mood, even wearing our Federated logo polo shirts. One said if he had a worried client, no matter the reason, he says one word: "Fracking." Indeed, Texas has five times the oil as Saudi Arabia. Yes, Houston is booming because the corporate headquarters are there, but a lot of the drilling is going on in these parts and in West Texas. A Barclays analyst says in his 10+ years of doing trips, he’s never seen that may rigs in one place and that includes trips to Russian and China.
Fracking provides an excellent long-term positive outlook for our country (for more, see our new white paper), though there are concerns about a near-term shortage of workers, including welders, ironworkers, pipefitters, plant operators, design engineers, machinists, petroleum engineers, pipeline workers, etc. This is symptomatic of the emergence of new technologies leading growth and employment. The Institutional Strategist says the difficulty the U.S. is having in creating employment is reflective of an economy in transition, with old industries becoming obsolete and employment growth shifting geographically to the Midwest and by industry, to energy production/servicing. I came to Texas the day after celebrating my 30th wedding anniversary. My husband has barely changed over the years, but that is because he was bald when I married him (bald is obviously beautiful). Speaking of 30, how surprised was I when after a meeting filled with stoic faces, a gentleman said my claim to have been in this business for nearly 30 years must have meant I started as a teen; a woman said I was the best speaker she had ever heard; and the adviser with the most serious expression asked at length about our dividend funds. I love Texans for many reasons to include how they embrace dividends. My wholesaler spoke of how he simply defends utility stocks—“No one wants to take a cold shower in the dark." Tough one to argue.
Jobs, sales and ISMs suggest acceleration May payrolls expanded broadly, topping 200,000 a fourth straight month and putting job growth at its fastest pace since the late 1990s. Also last month, light vehicle sales surged to their highest annualized sales rate—16.8 million units—since early 2007; heavy truck sales, which consistently have led swings in capital spending on structures, remained on a pace to rise at a 56.8% quarter-over-quarter annual rate in Q2; chain store sales as measured by Redbook recorded their biggest increase since November 2013; and both ISM gauges—services and manufacturing gauges—were up significantly. April factory orders, shipments and inventories also increased more than expected.
Beige Book suggests acceleration All 12 Fed districts reported increased activity from mid-to-late May, with consumer spending expanding in “almost all” districts, service sector activity growing in most districts, lending up everywhere and manufacturing activity expanding “throughout the nation” and at an “increasingly strong pace” in several districts. Also, labor market conditions were “generally improved,’’ a view reflected in this morning’s jobs report, while wage pressures remained “subdued.”
ECB steps up While he didn’t initiate quantitative easing, European Central Bank President Mario Draghi on Thursday proposed a series of “significant” stimulus measures—including the first negative deposit rate by a central bank—to support the eurozone recovery, especially in the periphery markets. While critics would have been right to dismiss these measures as simply “pushing on a string” even earlier this year, London’s Redburn Partners says nascent signs of returning credit demand and the near-completion of banking sector repair in the eurozone mean they could not have come at a better time. Action in the European markets would appear to agree, as Italian and Spanish bond yields are plunging and major European equity indices have rallied.
Trade disappoints April’s trade deficit widened to $47.2 billion in April, significantly worse than forecasts, though much of the miss was due to revisions dating back to 1999 (March’s deficit, for example, was raised to $44.2 billion from an original $40.4 billion). The surprise came from imports, which rose 1.2%, while exports fell 0.2%—the fourth decline in the past five months.
Productivity disappoints It fell at a 3.2% annualized rate in Q1 2014, not all that unexpected given the hit rugged winter weather put on overall economic activity. But the year-over-year data, which tends to smooth out quarterly and seasonal volatility and disruptions, show productivity up only 1.0%, down from 1.4% in Q4 2013, as output rose 2.8% and hours worked rose 1.7%. Productivity growth continues to be weak in this expansion compared to those of the past, and unit labor costs are now roughly a neutral influence on core inflation.
Construction spending disappoints It rose only 0.2% in April, well below expectations, as private residential investment tailed off. The softness in private construction was confined to home improvement, however, as both single-family and multi-family increased. The overall trend was indicative of a sector that should contribute modestly to Q2 growth.
Math suggests acceleration GDP is calculated as economic activity quarter over quarter annualized (or basically multiplied by four). So from a mathematical perspective, the weakness in the first quarter is now a very low base upon which to build; it allows for an easy comparison. For example, if economic activity improves one percentage point from the Q1 2014 base, this translates roughly into a 4% annualized rate in Q2. In fact, it would not be surprising if second-quarter GDP increases by 3.5% to 4% annualized.
Go Spurs, Go My son says we’re Mavericks fans but since they are playing LeBron and the Heat, we can root for the Spurs, whose colors were everywhere I traveled throughout San Antonio. The NBA star pulled up with leg cramps in the fourth quarter in the Spurs sweltering home arena, where the AC had malfunctioned. LeBron’s tough night reminded us of a joke that was making the rounds a few years back over LeBron’s late-game struggles during a championship series. Asked if he had change for a dollar, LeBron says, “Sorry man, I ain’t got no fourth quarter.’’ Just kidding, LeBron—we wish you well.
David Tepper is staying on my wall of worry even as he recants The hedge fund kingpin is making headlines again, this time for reversing on comments he made a few short weeks ago. On May 15, markets buckled after Tepper warned "the market is dangerous right now" and it is "nervous time." Specifically, he said he was nervous about Europe, China, the U.S. and Ukraine, among other things. Now, he’s telling CNBC's Kate Kelly "all of those things alleviated, one by one … to a certain extent." (Either that, or the market is getting away from him.)