PERFORMANCE

Stocks moved up this week as a lower than expected payroll hiring number decreased the chance of a September rate hike. In the sometimes upside down world of stock market logic, that was considered good news. 150k jobs were added in August. The consensus was for 180k. Wages increased only by 0.1% and the average work week was slightly smaller.

GDP

The Atlanta Fed’s GDPNow Q3 forecast was up 0.1% for the week to 3.5% on a higher forecast from the contribution of net exports. The NY Fed’s Nowcast remained steady at 2.8%. Negative signals from a lower than expected ISM manufacturing report and lower than expected imports were offset by higher than expected consumer spending and exports. The ISM manufacturing index fell to 49.4. Below 50 is considered to be contractionary.

SALES TAX

Congress is working on a plan to fairly tax sales across state lines. Basically since the inception of the internet, most sales that have crossed state lines have effectively been tax exempt. This has had a devastating impact on local retailers, as they were put at a huge price disadvantage against internet retailers like Amazon. And this disadvantage has been going on for years at this point. While it has helped internet based businesses, it has unfairly hurt retailers that provide more local employment and that are a major source of small business formation. The proposal, while not ideal, is a step in the right direction and would tax according to the tax base of the retailer at a tax rate chosen by the consumer’s home state. So what does that mean in English? If a business in Ohio ships product X to Maryland, they would use Ohio’s rules for taxing item X and the tax rate that would apply would be from Maryland.  The main objective should be to make it so that local business is not put at a disadvantage to internet based businesses.

OIL FIRMS

Oil prices may be up but they are still way down from a couple years back and the big oil firms are trying to adjust. They have been avoiding dividend cuts but time may not be on their side. BP, Shell, Exxon and Chevron could not cover their dividends in the first half of 2016 to the tune of $40 billion. They companies have been adding debt to help make up for the shortfall.

“WHO DID THIS TO US?”

We are a little off topic here, but Bret Stephens penned the above titled commentary in the Tuesday WSJ. Professor Bernard Lewis once wrote that when a nation is faced with adversity, there are two ways to respond. One, you can ask, “Who did this to us?” That question essentially leads to blaming all of your problems on others, to dig up conspiracy theories, and to avoid the real issues. And all of that leads to avoiding the real issues and further decline in the society.

Or, a society can ask this question, “What did we do wrong?” That leads to taking personal responsibility, understanding the real question and figuring out possible answers. Those societies have flourished and that has been the path that the United States has normally taken. But today, both political parties have been taking the route of blaming someone else for our “problems”. We really need to ask the correct question and work on real solutions.

PERFORMANCE

Equity markets fell last week. US markets were down by about 0.55%, international by about 1%, bonds fell slightly (0.12%) and crude dropped 2.66%. The USD was up by 1.23% on the chance for higher interest rates earlier than expected. That has helped financials which have been a strong performer of late.

A prolonged period of low volatility, a negative divergence of price performance versus technical indicators (see pink graphics below), price action that is slowing rolling over, and a calendar period (August to October) that sometimes, historically, has been unkind to stocks, might be a hint that there is the possibility of a small to modest sell off here.

Interest rates rose 8 basis points on the 2-year note, 6 on the 5-year, 4 on the 10-year and 0 on the 30-year, as the curve flattened. Hawkish comments by Fed vice chair Stanley Fischer indicated that a rate hike is possible in September or December.

Economy

The GDP estimate for Q2 was revised lower to 1.1% from the 1.2% advance estimate. That works out to real GDP growth of 1% in 1H, the slowest pace in three years. However, the Q3 estimates are tracking much higher.

The Atlanta Fed’s GDPNow forecasts Q3 growth at 3.4%, down from 3.6% last week. A decline in the forecast for Q3 real residential growth pushed the estimate down. The NY Fed’s Nowcast also declined by 20 basis points. Positive news from higher than expected new single family home sales was offset by higher than expected manufacturers’ inventories of durable goods (indicating subdued demand).

Jobless claims remain low, coming in at 261k last week, down by 1k.

China’s manufacturing PMI moved back into negative territory, although just barely. China is a wildcard that moved the market down significantly at the beginning of the year.

A quick report as I was traveling all last week.

PERFORMANCE

With the exception of oil, it was a quiet week all around. All of the equity markets were up about 0.10%, the bond index was down by 0.13%. The US dollar declined by 0.95%. Crude had a big jump, +9.06%.

Treasury rates were slightly higher, up by between 5 to 7 basis points all along the curve.

ECONOMY

Jobless claims dropped by 4k to 262k. Claims have been consistent around the 265k area. These numbers are ridiculously low. This makes 76 straight weeks of sub 300k claims, the longest such streak since 1970 when the US population was 2/3’s the size of what it is now.

The Fed released their July minutes, leaving open September for a possible increase. The officials seem to have mixed opinions and the next increase will likely be in December. That would be after the election and still give the Fed the opportunity for at least one increase in 2016.

GDP estimates for Q3 improved. GDPNow is forecasting 3.60% growth (up by 0.10%) and the NowCast increased by 0.6% to a 3.0% estimate. Q3 is looking, at least so far, to be a much better quarter than Q1 and Q2.

TRADE

Last week we wrote about free trade and how the two Presidential candidates are politicizing trade to win an election, not to improve an economy. Barron’s has followed up with their cover story titled “Free Trade, Why it’s Good for America.”

The link to the article is here.

PERFORMANCE

It was another flat week as the US equity markets increased by about 0.13%. The story was better worldwide (x-US), gaining 1.79%. Bonds increased 0.41% as rates fell by about 9 basis points on treasuries that mature in 10 years or longer. The dollar fell by 0.55% and crude had a big rally, advancing 6.44%.

On Thursday, all three major indexes (Nasdaq, SP500 and Dow) hit new highs. That was the first time that has happened since the last day of the last century, December 31, 1999. Despite that, there has been no big spike higher in US equities, the market has broken out from its recent range and has moved only slightly higher.

What has been making a decent move higher are emerging markets. The chart below shows the VWO (Vanguard Emerging Markets ETF). The fund was up about 1.8% on the week and is up 16.7% on the year. Maybe emerging markets are up because on some valuation metrics, such as price to book, this is one area that is still reasonably priced on a historical basis compared to US equity markets. Or maybe, given US politics, Brexit, and other disconcerting geopolitical events, emerging markets don’t look so different from the more established developed markets!

The chart does show a negative divergence between the moving average convergence/divergence (MACD) indicator and the price action. The former is moving lower while the latter is moving higher. Sometimes that indicates a pullback is due.

ECONOMICS

Retail sales came in flat for July, after have a nice increase in the prior months. The consensus was for a 1/2% gain, so the report was a disappointment. The slowdown hurt GDP estimates, and Q3 estimates for both GDPNow and the NowCast fell on the report.

Jobless claims remained steady, falling by 1k to 266k.

THE BENEFITS OF FREE TRADE

Trump especially, but Clinton also, have been railing against free trade. The unfortunate part of all of this is that cutting back on free trade will hurt the majority of Americans. Free trade may not make good politics, but it does make good economics, and ultimately, free trade improves the economy, not hurt it. Specific, legitimate trade issues, such as theft of intellectual property or government subsidies, should be dealt with, but don’t take down the entire free trade infrastructure which has vastly improved economies around the world including here in the United States. Trade wars are dangerous, it has already been tried once, and it didn’t work out so well (read up on the Depression and Smoot-Hawley).

Read Dan Ikenson’s piece from the Cato Institute for more.

LIBOR ON THE RISE

While interest rates have been falling just about everywhere else, The London Interbank Offered Rate (LIBOR) has been on the rise. LIBOR is currently 0.82% up from 0.33% a year ago. LIBOR rates impact costs for banks, businesses and individuals.  LIBOR costs are up because of money-market reforms that have pushed funds into government debt instead of LIBOR based debt. This is another unintended consequence of government regulation. As demand for LIBOR based debt has dried up, rates have increased. Short-duration bond funds should be benefactors but anyone with debt tied to LIBOR is now paying more.

VENEZUELA CONTINUES TO UNRAVEL

Venezuela continues to violate every rule of economics as the Chavez/Maduro team further destroys the country. President Maduro now has turned to a Marxist professor from Spain for advice. Even most leftists now agree the country needs to open up the economy for any hope for positive change. But Maduro is going in the opposite direction, with the help of his new friend, Alfredeo Serrano. There will now be more state control, not less! Massive food shortages are the result of price controls and expropriations. Not according to Serrano, they are the results of “speculative capitalism” and companies hoarding products.

However, at the end of the week, Venezuela did make one good move, they announced they would open up their border with Colombia. That at least is one step in the right direction.

PERFORMANCE

The overall US market as measured by the VTI was up 0.42% for the week. International markets were flat. Bonds declined as interest rates increased. The USD and crude were both up.

Equity markets got a big lift with another strong jobs report (see below). The SPY (SP500 ETF), which had been trading in a tight range between 215.60 and 217.35 since mid-July, attempted to push lower between Tuesday and Thursday. On Tuesday, the SPY closed 5 cents below that range, but on Wednesday and Thursday the bears could not follow through, and the market closed within its recent range. On Friday, the strong jobs number helped the market break higher, closing at 218.18.

ECONOMICS

Nonfarm payroll increased by 255k, making it two straight months of solid gains. The 255k was above the consensus estimate of 179k. The average work week increased by 0.1 hours to 34.5 and average hourly earnings increased by 0.3%.  It was a strong report and the Fed may have a hard time ignoring it when deciding on whether to increase rates or not. The numbers are not consistent with recent GDP data which showed growth of only 1% growth during the first half of the year. The Fed will have to figure out which data point better reflects economic reality.

ISM Non-Manufacturing fell to 55.5 from 56.5 in July indicating growth is continuing albeit at a somewhat slower pace than last month. The Markit US Services PMI flash reading rose by 1/2 point to 51.4, showing slight growth. Light vehicle sales had their best month since March of 2014, up 6.4% in July.

The Bank of England dropped its lending rate to 0.25%. That marks an all-time low in the Bank’s 322-year history. The Bank will also start buying corporate debt, all in an effort to counter Brexit.

GDP

The Atlanta Fed’s GDPNow came out with their initial reading for Q3. The estimate came in at a whopping 3.80%. We have a long way to go until we get final Q3 numbers, but a growth rate of 3.80% would be way above trend and a huge positive for the economy. The NY Fed’s Nowcast estimate for Q3 was a more modest 2.60%.

EARNINGS

Earnings have been coming in better than forecast. On June 30th, the estimated earnings decline for Q2 was -5.50%. Currently, the blended earnings decline is coming in at -3.5% (according to FactSet). 86% of SP500 companies have now reported, 69% beat earnings estimates and 54% beat sales estimates.

At some point earnings (green below) will need to turn around and start moving up. The driver of most equity returns this year has been multiple expansion (purple below) with some help from dividends (blue below).

THE LACK OF ECONOMIC GROWTH

Increased Regulation

The WSJ reports that the Obama administration has just enacted their 600th major regulation rule, defined as a rule imposing costs of more than $100 million. The Bush administration wasn’t much better, they imposed 496 such rules. The American Action Forum calculates the total cost of these rules at $743 billion. If there has been one theme dating back decades it has been the growth of regulation in the US. If you are wondering why we have seen such lackluster growth since the 2008 recession, regulation might be a good place to start.

Demographics

Demographics might be another reason growth is in slow motion. Nicole Maestas of Harvard University and David Powell of the Rand Corp. have published a paper showing that employees leaving the workforce to retire has a negative impact on productivity which harms the entire economy. The authors analyzed the impact of aging on the different states in the US and concluded that for every rise of 10% in the share of a state’s population over the age of 60, growth in per-capita GDP was cut by 5.5%.  A smaller labor force and the loss of experienced employees (impacting productivity) were the main drivers in the cut in growth. A possible solution would be to encourage people to retire later, not earlier.

VALUATION

Here is another view on valuation. Geraldine Sundstrom of Pimco compares how “certainty” and “uncertainty” are priced. The blue line shows 10-year US treasuries, which now trade at about 65x earnings. Corporate credit, trades at about 35x, and the SP500 trades at 20x. Sundstrom writes that “[corporate] credit is likely to remain attractive, while the jury is still out on equities.” She thinks inflation expectations need to normalize and earnings need to recover to support equities, US treasuries remain an important diversifier, but that comes at an expensive price.

PERFORMANCE

The US equity markets were flat, but international markets advanced by 1.53% and the bond index managed a 0.44% gain. The US dollar dropped by 1.83% and crude took another hit and fell by 6.49%. July overall turned out to be a great month. The US markets were up almost 4%, international about 4.50% and bonds +0.55%.

The SPY (SP500) ETF has traded in a tight range between $215.31 on the downside and $217.54 on the upside. That spread represents just 1.02% of the closing price on Friday. The Volatility Index (VIX) closed at 11.87, a ridiculously low number based on history.

We are now start August, which has been the worst month of the year over the last 20 years. The Dow has averaged a decline of 1.30% during that time period.

Treasury rates fell by about 10 basis points from the 5-year bond on out in reaction to the lower GDP number (see below).

ECONOMICS

In a shocking report, GDP grew 1.22% in Q2. That was way off the GDPNow estimate which was 2.4% last week and the NY Fed’s Nowcast which had growth estimated at 2.2%. GDPNow was revised lower earlier in the week to 1.8% but it was a miss that was simply unexpected. The consensus was for a 2.6% advance.

Of course, GDP might end up being revised higher (or lower) as more data comes in, but growth of 1.22% is a big disappointment. The number was hurt by a significant fall in inventories. The good news is that when businesses rebuild their inventory levels, that will provide a boost to GDP down the line. On the positive side, consumption increased by 2.8% for the quarter, the highest growth rate since 2014.

The GDP report must have even surprised the Fed, which earlier in the week indicated that an interest rate hike is back on the table. The Fed stated that “near-term risks to the economic outlook have diminished.”

Of late, economic reports have been coming in better than expected as evidenced by the Citibank Surprise Index that we posted a couple weeks back (click here).  But with the lower GDP number, with the possible slowdown from Brexit, geopolitical problems and the US Presidential election, economic risk to the downside is increasing.

Jobless claims rose to 266k, up 14k from last week. But 266k is a very low number, the labor market continues to be tight.

For Q3, the NY Fed Nowcast dropped only 10 basis points, showing respectable growth of 2.50%.

PERFORMANCE

The US equity markets were up about 0.70%, international +0.28% and the bond index, +0.24%. The dollar continued to rise, +0.81% and crude oil continued to fall, -3.81%.

Treasury rates were down just slightly for 5-year maturities and up.

FED

Consensus is moving back towards a rate hike this year. The Fed Bias Index is based on a modified Taylor Rule, the US unemployment rate and the Bloomberg Financial Conditions Index. The Bias Index now favors tightening. In addition, with the strengthening of financial markets and improved economic reports the Fed is going to be in a good position to hike rates, likely after the election.

ECONOMIC REPORTS

The Empire Services Business Activity Index improved by 2.2 points, as service activity grew in the NY region. But optimism about the near-term outlook declines to its lowest level in 10 months.

The Markit Flash US Manufacturing PMI was up 1.6 points in July to 52.9, it was the biggest increase since August 2014.

Housing starts were up 4.8% in June. Architecture Billings Index was down slighty by 0.5 to 52.6, but still up from last year.

The Case Freight Shipments Index was up 1.7% in June, the fifth consecutive month, but was down 4.3% year over year.  Railcar loadings have also been heading up. Positive trending railcar loadings would indicate the economy is generating momentum.

GDP

GDP estimates remained the same this week.

QUARTERLY WEBINAR

Our report this week is shorter than normal as we had our quarterly webinar this weekend. We will send around the YouTube link next week.

SUMMARY

It was a fairly quiet week in the US equity markets. Trading was in a tight range. Economic reports continue on the favorable side.

PERFORMANCE

It took 425 days by the SPY (SP500 ETF) hit an all-time high on Tuesday and finished the week higher by 1.50%. The VTI (overall US market) added 1.57% and the VXUS (international x-USA) was up 3.05%. This continues to be a market that hardly anyone believes in, and that may be enough to keep momentum positive. Market breadth (number of companies advancing versus declining) is solid and strong performance by the small caps all are all good technical signs. But the Dow transports are not near their highs. Market analysts like to see transports confirming the action of the overall market. The US dollar was up another 0.74% and oil was up 1.19%.

Treasury rates went sharply into reverse. The general consensus going into last week was that rates were headed lower, thus providing fuel for equities to move higher. But that didn’t happen last week. Rates went higher across the curve.

TECHNICALS

Interest rates have been declining for 35 years. Maybe we saw the bottom last week. As we wrote above, the consensus was that interest rates were still headed lower. But the market had none of it and interest rates reversed higher this past week after setting an all-time record low. The monthly chart below graphs the 10-year Treasury yield (symbol is TNX). After setting an all-time low, the TNX couldn’t hold it, setting up a “spring” (see our May 27th column). There was also a positive divergence with the “volume zone oscillator” (VZO). Notice the white circle in the bottom right of the chart. That sub-graph shows the VZO. The VZO evaluates volume in relation to the direction of the price change. In this example, when the yield on the TNX is moving lower, the VZO was moving higher, resulting in what is called a “positive divergence”. Some technicians would consider that a bullish signal that interest rates would move higher and that is what happened last week.

Of course, there is no technical indicator that is perfect and works all the time. In fact, all college students learn in Corporate Finance that according to the efficient market hypotheses, markets are “weak form efficient.” That essentially means that securities follow a random walk, and that future prices are not influenced by past prices. In other words, looking at technical charts doesn’t help traders or investors. Many people disagree with that hypotheses.

ECONOMY

Retail sales advanced 0.6% in June, making it three months in a row. Year over year, retail sales are up 2.60%. Industrial production was up .06% in June, the most in nearly a year. But for the quarter, industrial production was down 1% annualized. Year over year industrial production is down 0.7%.

The Consumer Price Index rose 0.2% in June. Year over year, CPI is up 1.0%, but Core CPI (inflation x food and energy) was up 2.3%, the second fastest pace since 2012. Import prices declined 4.8%, year over year, led by drops in the price of fuel. The pace of decline has slowed over the last nine months. Overall, inflation remains under control.

Mortgage refinancing is up 80.3% year over year as borrowers take advantage of lower interest rates, the fastest pace since July 2012. The Freight Transportation Services Index was up 0.2% in May.

Economic reports have been surprising to the upside. The Citigroup US Economic Surprise Index measures how reports come in compared to consensus. After hitting a recent bottom on May 12, the index has been surging to the upside. Positive surprises in economic news will generally move markets higher and that has probably helped move the market to new highs.

GDP

The Atlanta Fed’s GDPNow estimated Q2 growth remained steady at 2.4%. The NY Fed’s Nowcast estimate increased by 0.1% to 2.20%. The Nowcast estimate for Q3 moved up by 0.4% to 2.60%. It is very early to nail down the Q3 numbers, but right now the trend over the first three quarters of 2016 is going in the right direction.

JOLTS:

Job openings dropped for the first time in six months, falling 4.9% in May. Hires were down by 1%, the third straight monthly decline. Both declines are consistent with late cycle labor market activity.

DOLLAR STRENGTH

The US Trade-Weighted Dollar Index is a measure of the value of the US dollar compared to other world currencies. The index was started in 1973 with a base value of 100. Today, the value is 90.62. The high this year was 95.80 in January. Between June 2014 and March of 2015, when the dollar was spiking, the index increased by 23%. Economists consider a 4% move in either direction as similar to a 25 basis point change in the interest rate. That would mean the 23% move would be equivalent to a 1.4375% increase interest rates. That move, coupled with the December rate increase, would have a net effect of higher rates of 1.69% since March of 2014, possibly help explaining the sluggishness of the economy and the hit to corporate profits. The worry now is that the dollar may strengthen further on Brexit fears.

DO LOW RATES REALLY HELP THE ECONOMY?

That was the question in Kopin Tan’s Streetwise column in Barron’s this week. Tan notes that U.S. households have $14 trillion in debt but 7x more in assets including $26 trillion in cash and fixed income assets. Deutsche Bank strategists write low rates can be “a sizeable net tax, not a subsidy.”

SUMMARY

The equity markets set a new high after 425 days. Ultralow interest rates helped that move, but rates have gone up over the last week. Economic news has been tilted slightly positive of late.

Apparently this is the ultra-hot new game, who would know?! A hint of what gaming will look like in the future.

http://www.bloomberg.com/news/articles/2016-07-11/pokemon-go-s-already-capturing-minds-and-money