Performance

Brexit fears hung over the market as the SPY fell 1.18% (dividends included) on the week. International markets did about the same, the VXUS was down 1.19%. Bonds were up 0.16%, the US dollar fell by 0.68%.

Bond yields in Europe continued to fall. The German 10-year went into negative territory for the first time. Polls at the beginning of the week leaned toward the “exit” camp but in the last day or so the have tilted back to the “stay” camp. Basically it is too close to call right now. Ultimately, an “exit” vote will have to be put into legislation. The vote is not binding although there would be enormous pressure to follow the will of the voters.

Oil was down 2.22% on the week. Rig counts have gone up for three weeks in a row.

Treasury rates fell on the week. The 5-year fell 4 basis points and the 30-year dropped 1 basis point.

Technical Analysis

As in the five previous attempts, a failure to crack through to a new high has led to a sell-off. Helped by Brexit fears, the market is off 2.76% from its recent high on June 8th.

The market has now retraced about 60% of its gain from the low on May 19 to the high on June 8th. If the market is going to make a new high in the short run, right about here (206.52 on the SPY) would be a good place to put in a higher low and then advance. The outcome of the Brexit vote might provide the fuel in one direction or another. A “stay” vote will likely push the markets higher and an “exit” vote will send equity markets lower. The impact overseas is likely to be greater.

Earnings

Earnings for Q2 are now expected to decline 5.1% per FactSet. At March 31, the estimated decline was 2.8%. However, earnings estimates are normally revised lower during a quarter. The trailing 5-year average is a decline of 4.4%, versus 2.30% currently. The information technology sector has been the biggest contributor to the lower estimates. Earnings estimates for the sector are now -7.3% versus -0.1% at the start of the quarter. The forward p/e for the entire SP500 is 16.4. This compares to the five-year average of 14.6.

Brexit impact on SP500

The Brexit vote takes place on Thursday. According to data compiled by FactSet, the aggregate revenue exposure of the SP500 to the UK is 2.9%. The UK represents the third highest country-level revenue exposure. The US is at 68.8% and China is at 4.9%. Thirty SP500 companies get more than 10% of their revenue from the UK.

Fed

The Fed released their latest version of the dots plot at their meeting this week. The “dots plot” is the Fed Governors estimate of the future path of interest rates. Eleven participants called for two rate hikes this year and six called for one rate hike. The estimate for this year is 0.875%. The 2017 estimate is now 1.625% versus 1.875% in March, implying three rate hikes. For 2018, the estimate is now 2.375% versus 3.00% in March, also implying three hikes. The long term median estimate fell by 25 basis points to 3.00%.  James Bullard of the St. Louis Fed thinks the FOMC should hike one time this year and then leave rates stable for two years.

Economy

The consumer price index (CPI) was up 0.2% in May and is up 1.0% year over year. Energy prices rose 1.2%. Food prices fell 0.2%.

Core CPI increased 0.2%. Shelter rose by the biggest amount since February of 2007, up 0.4%. Apparel prices jumped 0.8%. Medical services increased by 0.5%. Medical care commodities fell 0.2%. Year over year core CPI is up 2.2%.

Core service inflation hit the highest year over year rate since September of 2008, rising by 0.3% for the month and 3.2% year over year. Given the current tight labor market, higher wages will begin working their way through the pipeline and probably push service prices higher in the near to intermediate term. So while inflation might be slowing building in the system the Fed is reducing estimates for the future path of interest rates.

Housing starts fell slightly, by 0.3% in May. Starts have been stable at around the current 1.164 million annual rate for the last year. Building permits rose by 0.7%.

The Philly Fed General Business Activity Index increased to 4.7 in June, reflecting moderate expansion in factory activity. But the Empire Services Business Activity Index dropped 2.3 points to 3.2, indicating slightly slower activity.

Jobless claims rose to 277k, the first increase in five weeks.

Retails sales were up 0.5% for May. Over the last two months, retail sales are up 1.73%. That is the strongest two-month performance since April of 2014.

Demand for Debt

The yield on Germany’s 10-year bond dropped into negative territory. As of Tuesday it was yielding -0.008%. There is now about $10 trillion in global sovereign debt with negative yields. Corporate debt is also at ridiculously low yields. A Unilever 2020 bond now yields -0.02%. Toyota Finance issued $186 million (in yen) of three year notes yielding 0.001%.

GDP Estimates

The Atlanta Fed’s GDPNow increased their Q2 GDP estimate by 0.30% to 2.80% due to improved forecasts for real consumer spending growth and real residential investment growth. The NY Fed’s NowCast decreased by the same amount, falling to 2.10%.

Summary

This week should be all about the Brexit vote. Equities fell slightly last week. German 10-year bonds went negative. The outcome of the vote will likely determine the near term direction of the market. As has been the case for a long time, economic data was mixed as the economy continues in slow growth mode.

http://www.wsj.com/articles/aha-the-case-for-buy-and-hold-investing-1465833316

PERFORMANCE

The SPY (SP500 ETF) made a run at its all time high on Wednesday, but fell short. The SPY closed at 212.37, the all-time high was 213.50 set on May 21, 2015. The market sold off after that closing on Friday at 210.07, dropping a little more than 1% from Wednesday. The market has now made six attempts over the last year at cracking the high but has failed. However, it still is holding above the declining trend line dating back from last year.

According to this week’s Barron’s, 23 times since 1929 has it taken 300 days or more to make a new high. But when it has happened, the SP500 has advanced an average of 15.6% during the following year.

Of course, there is also the chance that the failed attempt will lead to a sell off, as did the previous five attempts. There is a negative divergence between the moving average convergence divergence (MACD) histogram on the bottom of the chart and the price action up top (see the yellow lines). The MACD, which measures the relationship between the 26-day and the 12-day moving average, is trending down while the SP500 has been trending up. That is called a negative divergence. Sometimes, certainly not always, such a divergence indicates a weakening of price momentum that will signal a near-term decline in the market.

For the week, the SPY was down just barely, -0.10%. International markets took the bigger hit, the VXUS (international x-US ETF) dropped 2.09% on the week. There is new concern that the UK may actually vote to leave the European Union. The markets have been pretty much forecasting a “no” result, but if sentiment begins to trend towards the “yes” camp we could be in for a wild ride in equity markets. Bonds and oil were up on the week, although oil fell 4.2% on Thursday and Friday.

MARKET VALUATION

There has been a tug-of-war between those in the overvalued versus the undervalued camp. We have stated before that based on traditional metrics the market is somewhat overvalued (you can argue about the degree), but when taking into account low interest rates, the market might be somewhat undervalued. Here is another notch in the undervalued camp, albeit a very slight undervaluation. Bloomberg Intelligence Economics has recreated Nobel Prize-winning economist James Tobin’s Q ratio. The Q ratio measures corporate net worth and compares the total value of corporate shares against the replacement cost. The ratio is currently 0.97 indicating that the stock market is valued just less than the replacement cost of its assets. An even reading of 1.00 would be fair value.

FED/INTEREST RATES

Janet Yellen gave a speech on Monday and was relatively upbeat. Yellen says positive economic forces still outnumber negative forces. Yellen did not give any guidance on a June or July rate increase.

Interest rates fell this week across the curve and got slightly flatter. The 2-year dropped 7 basis points, the 10-year was down 9 basis points and the 30-year was down 11 basis points. There is so much debt at negative yields around the world that investors continue to be drawn to higher yielding US securities. In the chart below, Japan, Germany, France and Italy are all yielding negative rates going out a few years.

JOBS

Jobless claims declined to 264k. It was the third drop in four weeks. The Job Openings and Labor Turnover Survey (JOLTS) report for April showed that total job openings are now at their highest level ever. The rate for all separations (people quitting, terminations and retirements) remained roughly flat. Together, these reports are at odds with the negative non-farm payroll hiring report from last week. There might be a mismatch between job openings and the applicants with the proper skills to fill those positions.

ECONOMIC INDICATORS

The OECD U.S. Composite Leading Indicator moved up 0.02 points to 98.9 in April. This was the first increase since July of 2014. Service revenues rose 3.6% year over year during Q1, that was the fastest pace in three quarters. The Freight Transportation Services Index was up 1.3% in April, its first increase in three months.

GDP

There was no change in the estimates for Q2 growth for either GDPNow or the NowCast. GDPNow is projecting 2.50% and the Nowcast forecasts 2.40% growth for Q2.

SUMMARY

The market came close, but could not break through to a new high. In the 5-previous attempts, the failure led to a sell-off. However, this was the first attempt above the declining trend line.The market is beginning to get nervous about a “yes” vote on the Brexit.  Economic data was decent for the week.

PERFORMANCE

The equity markets were flat to slightly up. The SP500 (SPY) was up 0.02%, the overall US market as measured by the VTI was up 0.28%, international markets advanced 0.86% and the aggregate bond index was up 0.61%. The US dollar declined by 1.96% and crude fell by 0.91%.

The SPY has held just above the declining trend line that it broke through last week. On Thursday the SPY closed at 210.91. That was the high for the year. The all-time closing high was 213.50 set on May 21, 2015. However, when adjusting for dividends, the Thursday close of 210.91 represents the all-time high. The May 21, 2015 adjusted close is 209.04 after dividends (per Yahoo Finance).

On each of the first three days of June, the market has started lower and worked its way up to close towards the high of the day. Some market-followers would consider that a bullish sign as supply could not overcome demand, even with the terrible payroll report (see further below).

PAYROLL

Non-farm payrolls rose only 38,000 in May. This was a huge miss. Estimates were for 100,000 plus. It was the lowest number in almost six years. Numbers were also revised downward for March and April.  The number probably would have been about 35,000 higher without the Verizon strike but that is still much lower than expectations. The disappointing payroll number significantly lowered the chance of a Fed rate increase in June, given that one of the conditions to increase rates was continued improvement in the labor markets.

The Vanguard economic model, which we talked about at our April webinar, forecast a high likelihood of a “growth scare.” Vanguard defined that as a fall in monthly nonfarm payrolls below 50,000, exactly what happened. Writing on May 5, Vanguard economist Joel Davis said, “At this stage in our long economic expansion…slowing job growth is not a sign of recession. It’s a symptom of a labor market near full employment…our analysis of financial and economic variables puts the odds of a near-term recession at about 10%. So brace for bad headlines. Prepare to put the data in a broader – and less alarming – economic context. And fight the fear with patience and perspective.”

But economists at JP Morgan are placing a much higher probability of a US recession in the next 12 months. Putting the probability at 36% this week. That is the highest level during this economic recovery.

“Goods-producing” payrolls dropped by 38,000 in May. It was the fourth consecutive month that payrolls have fallen in this sector. According to David Rosenberg, chief strategist and economist at Gluskin Sheff, “this is precisely the sort of rundown we saw in November 1969, May 1974, October 1989, November 2000 and May 2007” that foreshadowed a recession by an average of five months.

The unemployment rate fell to 4.7% but that was due to about 500,000 people leaving the work force.

But even with the fall in new jobs, average hourly earnings was up 2.5%, year over year, indicating a tightening labor market.

On a more positive note, the initial jobless claims report came in at 267k, down 1k from last week. 267k is a historically low number.

GLOBAL RISK

The probability of a global recession is also increasing and is much more likely than a US recession. We have been on recession watch outside the US for several months now. The global manufacturing PMI fell by about 0.1 to an even 50.04 in May, indicating flat manufacturing activity.

One bright spot, 71% of the reporting entities were in expansion mode, up from 60% last month.

OTHER ECONOMIC REPORTS

The ISM Non-Manufacturing Index fell to 52.9. Anything above 50 is considered as expansion, but 52.9 was the lowest number since September of 2013.

There were positive personal income and spending reports. Nominal incomes were up 4.91% year over year and spending rose 0.94% month over month. The savings rate is 5.3% indicating that US consumers are in decent shape.

Factory orders were also a positive. They rose 1.9% in April, the most in six months.

GDP ESTIMATES

Even in the face of the non-farm payrolls report, the GDP estimates held in there. The Atlanta Fed’s GDPNow estimates Q2 growth at 2.50% (down from 2.90% last week). The NY Fed’s Nowcast forecasts Q2 growth at 2.40% (up from 2.20% last week).

SUMMARY

Economic news tilted negative this week but there were some positive reports. The non-farm payrolls report was such a huge miss it is hard to ignore. The global economy did take a step back and appears closer to a global (not US) recession. The equity markets held strong.

The SP500 broke higher on Tuesday and then finished strong on Friday to close at its highest closing price since 11/4/2015. It is, however, a little bit shy of its intraday high from April 20th. Overall, the SPY (SP500 ETF) was up 2.31%, the US markets (VTI) were up 2.38% and international (VXUS) advanced 2.06%. The aggregate bond index was about flat (+.08%), the US dollar moved higher (+0.39%) and oil continued its advance (+2.43%).

Equities managed to rally even though Fed Chair Janet Yellen made it clear on Friday that there is a good chance of an increase in rates in the near future. Assuming that economic data continue to show some type of growth (even if it is just above zero) and if payroll numbers continue to be strong, an increase in June or July is on the table. The federal-funds futures market is pricing in a probability of 34% for a June increase and 58% for a July increase.

TECHNICALS

The SPY (SP500 ETF) broke through its declining trend line dating back to May of last year. For the long term trend to turn positive it will have to hold above this line and then push through last year’s high. On April 20th, the SPY did the same but could not hold the advance. In technical terms, this is called an “upthrust”. Market participants expect that when the price moves through a line of resistance, it will go on to higher prices from there as demand should now more easily overtake supply. When the expected demand does not show up, the price quickly falls.

The opposite happened on May 19th. On that day, the SPY fell below support. Market participants might think that the SPY was now going to head lower and the supply would swamp demand. But it turned out that the selling was declining going into that point and there was no more fuel to push the SPY lower. When that happens, that is called a “spring”. That set up the run we had last week.

ECONOMY

GDP

Q1 GDP was revised up to 0.8% from 0.5%. Q2 continues to track stronger than Q1. The Atlanta Fed’s Q2 estimate hit its high, coming in a 2.90%. The NY Fed’s Nowcast increased to 2.20%. Growth now shows some modest acceleration coming off of a weak Q1.

However, poor profit numbers over the last year, coupled with somewhat weak Regional Fed surveys (see the Richmond survey below) and company estimates of spending point to lower capital investment by business. There is a high correlation coefficient (0.84) between GDP growth and changes in capital investment. The slower investment will most likely hurt GDP growth going forward. The economy needs improved corporate profits to help increase capital spending.

Manufacturing

The Richmond Fed Manufacturing Activity Index fell in May by 15 points to -1. it was the biggest drop in a decade. However, the individual activity indexes looked good pointing to modest expansion down the road.

Housing

Mortgage applications have been improving. New single family home sales exploded higher, up 16.6% month over month and 18.1% year over year. It was the biggest increase since 1992 and sales hit the highest level since January of 2008. Pending home sales hit a post-crisis high.

Employment

Jobless claims fell again, the number came in at 268k. We had a couple of weeks recently where the claims shot higher but the numbers are now back in sync with the strong reports we saw earlier in the year.

MARKET SENTIMENT

The American Association of Individual Investors bullish sentiment dropped to the lowest level in more than 10-years, coming in at 17.75%. But bearish sentiment also fell, dropping to 29.39%. The majority is now in the neutral camp at 52.86%. In the past, very low bullish sentiment readings have often been associated with positive market performance over the following year.

Barron’s Cover Story – “Why the Market Won’t Crash – Yet”

Barron’s has a good article this week on the near-term threat of a recession and a bear market. We have covered all of these topics over the last few months but this is a good review. Barron’s writes that the market is headed for another crash, but it always is headed for another crash, and it probably won’t be for a while. Market crashes are usually caused by a recession, although the decline usually begins before the recession arrives. Right now there does not appear to be a recession around the corner. Barron’s defines a market crash as a decline of 20% or more that lasts longer than 12 months.

Key reasons why there likely won’t be a crash soon:

HOUSING – A crash in housing prices preceded the last recession, but prices are below the 2007 peak. The median price today is 12% lower than in July of 2007.

OIL – The price of oil usually jumps much higher before a recession. That is not the case today.

YIELD CURVE- when the curve is flat or inverted, is often signals a recession is on the way. That is also not applicable today.

Reasons that might signal a problem ahead:

VALUATIONS – the current market p/e is 20.3, which is greater than the July 2007 p/e of 16.3. The offset to that argument is that earnings in 2007 reflected inflated earnings from the financial sector that eventually disappeared and that earnings today are understated by the problems in the energy sector. Another difference is the 30-year treasury bond yield was 5.1% in 2007 with a 2.9% dividend yield (on equities that pay dividends). Today, the 30-year yields 2.6% and dividends are yielding 3.2% (on equities that pay dividends). It would make sense that equity prices would be much higher given the lower bond yields, thereby, resulting in a lower dividend yield. But that hasn’t happened. Equities that pay dividends have a higher yield today even though the bond yields have declined dramatically.

POSSIBLE GLOBAL SLOWDOWN – the international economy is barely above recession level.

TRUMP / TRADE WAR / DEFICIT- Trump raises the uncertainty level in key areas that can impact the markets including his position on trade and the deficit.

SUMMARY

The market appears to be setting up for another shot at its high. It failed the last time around April 20th. The economy has made some progress over the last few weeks. The Q2 GDP estimates are up the last couple of weeks and the employment numbers are solid.

Source: Callan

(from this week’s Barron’s)

Happy, or maybe, not so happy, anniversary. It was one year ago on May 21 that the SPY (ETF for the SP500) hit it’s high of $213.50. On Friday it closed at $205.49. That is a drop of 3.8%. Although adjusted for dividends, the drop is only 1.7%. So basically the market is in about in the same position as last year, with some pretty good volatility along the way to the down side.

The markets had lots of ups and downs this week but when it was all over equities did manage a gain of 0.45% on the VTI (overall US stock market) and 0.36% on the SPY.  International stocks (VXUS) were up 0.59%.

On Monday the market shot higher by almost 1% on news of Warren Buffet’s Berkshire Hathaway’s $1b investment in Apple. But that gain didn’t hold as the market reversed direction and fell 0.9% on Tuesday on fears that interest rates will rise faster than expected this year. Wednesday was an up and down day and the market finished at its midpoint, roughly in line with the previous day. Thursday the market dropped below the support line of $203.90 but managed to rally and closed above that number. And on Friday the market advanced to finish with a modest gain for the week.

The US dollar also increased, up by 0.66%. The USD is now up 2.92% for the month

FED / INTEREST RATES

Higher CPI numbers (see below) as well as upbeat housing and industrial production reports got the market anticipating that an interest rate rise might happen sooner (June or July) rather than later. That was confirmed on Wednesday when the Fed released their minutes from the April meeting. Inside the minutes was this quote, “Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen, and inflation making progress toward the Committee’s 2 percent objective, then it likely would be appropriate for the Committee to increase the target range for the federal funds rate in June.”

We think that the key words in this quote are that “[if] labor market conditions continue to strengthen,” that is something that has not happened since the April meeting. Labor markets have been flat at best.

Despite that, recent comments by other Fed officials have emphasized that the market was out of line with the Fed’s desire to increase rates two times this year. Markets were anticipating maybe one cut late in the year. But now the markets are finally getting the message. In the last week, the chance of a June rate hike has increased from less than 10% to over 30% now.

YIELD CURVE FLATTENING

There has been a lot of talk about the flattening of the yield curve and if that is telling us something about a possible recession down the road. The 2-year note has increased this month by 12 basis points while the 10-year is up by only 2 basis points, meaning the spread has fallen by 10 basis points to .96 as of Friday, down from 1.21 at the end of last year. The spread is now at its narrowest point since December of 2007. The 2-year has been rising due to the possible Fed increase and the higher CPI numbers (see below), while the 10-year is being held down by negative rates overseas.

As written about in this week’s Barron’s, the spread normally has to hit zero to indicate the onset of a recession.

APPLE

Warren Buffet’s Berkshire Hathaway announced on Monday that they had taken a $1b in stake in Apple. We wrote on April 29th that Apple shares looked cheap and it looks like at least one other person noticed! The shares jumped 3.7% on the news, or $18.4b in terms of market capitalization.

YUAN

After a frightening start to the year, the Chinese yuan picked up steam and rallied into late April. But since then, the yuan has been falling against the dollar to the tune of 0.6%. The People’s Bank of China’s (PBOC) mandate is to promote growth, often by pumping currency into the economy. That weakens the yuan. But if the currency weakens too much, Chinese business and citizens will look to get money out of the country and into safe-havens like the United States. That has been happening for a while now, but the recent yuan rally brought some relief. If the currency continues to fall that will accelerate the process. The PBOC might be forced to step into their falling reserves to defend the currency.

But there are other consequences to a lower yuan. The big market selloff at the beginning of the year was due in large part to slowing economic growth in China coupled with the weakening yuan. The selloff was a worldwide phenomenon. As the currency falls, Chinese exports should increase and imports decrease. That means lower growth across the globe. The fear of a domino effect that impacts economies worldwide might lead to another market sell off.

The number one goal of the Chinese government is social stability and that means a steady currency. We expected a gradual decline in the value on the yuan and we will have to be on watch to its future path.

ECONOMY

Industrial production increased by 0.7% in April. That was the biggest rise since November of 2014. Factory output improved by 0.3%. Housing started rose by 6.6% in April and building permits were up by 3.6%. Sales of homes are on the rise.

The Empire Manufacturing report which measures manufacturing activity in the New York region declined. The index has been up the two months prior. The Philadelphia region also reported lower readings.

LEI/CEI

A good measure of an on-coming recession is the ratio of the Conference Board’s Leading Economic indicators to the Coincident Indicators. A series of new lows might indicate that a recession is on the way. But we have not seen that yet.

Bespoke Invest

PAYROLL

Initial unemployment claims came in at 278k. That is an improvement over last week’s 294k. The two prior payroll reports moved in the wrong direction so it was good that we got positive payroll numbers this week.

INFLATION

The consumer price index put in its biggest monthly increase since February of 2013, rising by a seasonally adjusted 0.4% in April. Gas prices contributed to the increase, up by 8.1%. The increase, excluding food and energy, was up by 0.2%. Core prices were up 2.1% year over year.

GDP ESTIMATES

The Atlanta Fed’s GDPNow forecast for Q2 declined slightly from 2.8% to 2.5%. The drop was a result of (1) a lower forecast for real residential investment growth, (2) a drop in the forecast for real consumer spending growth and (2) a decline in inventory investment. However, the NY Fed number increase from 1.20% to 1.70%. If we split the difference we have a 2.1% estimate for Q2 growth.

SUMMARY

The markets have begun pricing in the possibility of an interest rate increase in June or July. That, coupled with higher inflation data, has pushed up short-term interest rates while longer-term rates have been stable, resulting in a flatter yield-curve. The Chinese yuan is declining again. Economic numbers were mixed and payroll numbers improved but overall Q2 growth is on path to be higher than Q1.

The market was down for the third week in a row. The US markets fell about 1/2% and the international markets were down almost 1%. The short-term momentum that has pushed the markets higher since February seems to be fading at this point. While the weekly trend has remained negative throughout this recent rally, the daily trend is now beginning to turn negative.

The SPY closed at 204.76, it has bounced off resistance of about 203.90 a couple of times already, so that line is likely to be tested again soon.

The US dollar increased for the second week in a row and that hurt the large caps. A higher US dollar makes our exports less competitive and hurts overseas earnings as they are translated back into dollars. Crude oil was up on the week 3.47%.

POLITICAL UNCERTAINTY

There has been a general consensus over the past week that the odds of a Trump Presidency have increased. Not to say that he is the odds on favorite, but sentiment has moved in his direction. Forgetting whether one believes that Trump will be great for the economy or terrible, there is no arguing that what policies he chooses to pursue and to what degree make his possible presidency much higher on the scale of uncertainty. And therein presents a problem for the markets and the economy. Uncertainty often means lower and/or volatile equity markets. Larry Summers went so far as to compare the US to an emerging market at the SALT Conference in Las Vegas, saying “political risk driving huge economic risk is something I always thought you talked about in connection with emerging markets. Now I think it is something you talk about in respect to the U.S.”

RETAIL

It was a tough week to be a retailer. Macy’s, JC Penny, Kohl’s and Nordstrom all had disappointing Q1 earnings and/or a disappointing outlook. Amazon is taking a bigger and bigger piece of the retail market and they seem to have really cut into the retailers over the past several months. According to the April retail sales report, online shopping was up 8.1% over the last four months.

In terms of the overall economy, the retail sales report did have good news, April retail sales were up 1.3% versus a 0.8% consensus. That was a big beat and was the main factor in pushing the GDPNow estimate for Q2 growth higher for the week.

GDP ESTIMATES

The retail sales report helped move the Atlanta Fed’s Q2 GDP estimate higher. GDPNow increased by 1.10% for the week to 2.80%. The NY Fed’s Nowcast also increased, but not by as much, to 1.20%. Both reports show improved growth over Q1.

EMPLOYMENT

However, disappointing employment numbers would make one think that growth was declining, not increasing. Initial jobless claims came in much higher for the second week in a row. The number came in at 294k, up 20k from the prior week. It was the biggest gain in two years. We are closing in on the 300k level. The economy has held below that since March of 2015. Jobless claims are now up 46k since the low of 248k three weeks ago. Bespoke Investments ran an analysis showing that there have been 77 such spikes of 45k or more in initial jobless claims since 1967, including 5 in this current expansion. There is about a 50/50 split if an increase like this is indicative of a recession or continued expansion.

bespokepremium.com

It might be that employment is going to start catching up with falling corporate profits. Profits have been down for more than a year now, but employment has held steady. At some point that divergence will most likely close. Either employment will fall or profits will improve.

On the other hand, the Job Openings and Labor Turnover Survey (JOLTS) report showed a 2.7% increase in the number of job openings in March to 5.757 million. Throughout this recovery, the job openings rate have been increasing faster than the hire rate, indicating mismatches between hiring needs and applicants able to fill those needs.

DIVIDEND CUTS

According to Standard and Poors, 213 companies have cut their dividends during the first four months of the year. That is the highest number since 2009 when 298 companies made cuts during the same time period. The energy sector was the main culprit.

SENTIMENT

The American Association of Individual Investors conducts a weekly survey of market sentiment. 20.4% of investors are bullish, that is the lowest reading since the week of February 11th when the market hit its low for the year. However, bearish sentiment is only 1% above the norm at 31%. In late January that number was above 40%. Most investors have now moved into the neutral camp.

EARNINGS

91% of SP500 companies have now reported. The blended earnings decline is 7.1% versus an expected decline of 8.8% on March 31 (per FactSet). The forward p/e is 16.60. The energy sector has reported a year-over-year earnings decline of 107.20%.  Excluding the energy sectors, earnings would be down 1.80% for the SP500. Companies are still reporting that the high US dollar has negatively impacted earnings.

There is a belief out there among some that we have hit a trough in earnings and that they should begin to stabilize for a quarter or two and then begin to increase. Improved earnings would give the market reason to move higher.

RISK IN BONDS

At some point interest rates will go up, and bonds will go down. Investor are clamoring for safety and whatever drop of yield they can find. That has pushed 30-year municipals down to an all-time low.

Along those same lines, governments, especially in Europe, have been borrowing long-term at ultra low interest rates. When interest rates begin to rise, even a little, holders of those bonds will face losses. Finance ministers may not view that as a problem, after all, it is the investors that will take the hit. But one of the problems is that the main investor in much of this debt are the same banks that these same governments have helped bail out. Higher interest rates in the future will hurt these same banks.

SUMMARY

Short-term market momentum and positive employment reports have been helping the equity markets and the economy since February, but both of those factors appear to be fading. It seems like the market is running out of fuel, turning down towards the end of the week after a promising start on Monday and Tuesday. The market is now down about 2.5% from its recent peak. Overall retail sales were a positive surprise, and that actually pushed GDP estimates for Q2 higher. Disappointing employment numbers are something to watch and are of concern. The economy cannot seem to get any serious positive traction. That coupled with the uninspiring choices for President have not helped.

Week Ending 5/6/2016

The market was down slightly for the week, the overall US market as measured by the VTI fell 0.50%, international markets as measured by the VXUS were down 2.38% and the aggregate bond index as measured by the AGG rose 0.26%. The US dollar also rallied by 1.29% and crude oil fell by 2.74%.

The market has now fallen two weeks in a row but the move has been small. The SP500 (SPY) is only off 2.1% from its recent high of 210.10 on April 20th. On Friday, the market opened almost at the low of the day, pushed against a resistance line (see the yellow line below) and bounced right off it and finished pennies off its high from the day. So even in the face of falling prices over the last couple of week, the equity market has shown pretty good strength.

REITs had a big week. The VNQ rallied 4.6% and broke out to a new high. In the face of a slow growth economy, low interest rates, and stable to increase real estate values, higher yielding REITs have become more attractive.

GDP Q2

Q2 GDP estimates remain in line with last week, GDPNow (Atlanta Fed) drop by 10 basis points. to 1.70%. The NowCast (NYFed) remained at 0.80%.

MANUFACTURING

The Institute for Supply Management’s (ISM) Index for manufacturing fell to 50.8 from 51.5 in April, but remained about the breakeven level of 50 indicating expansion for the second straight month. It was a disappointing number but at least it was still positive. The export index, helped by a lower dollar, rose to its highest level since November of 2014.

Global PMI fell to 50.1 from 50.5. This is just 0.1 point above the 39-month low from February of this year. Employment fell for the third month in a row. Inventories did decline at the fast pace since July of 2013. That means if sales picks up, it would translate into new manufacturing, as opposed to working down existing inventory.

Japan fell to 48.2, probably impacted by the higher yen. The UK PMI dropped to 49.2, dropping into contraction territory for the first time in three years. Uncertainty from the Brexit vote gets the blame there.  China fell to 49.4, but that is still up from the September low. Brazil was a disaster, coming in at 42.6. The Eurozone did increase by 0.1 to 51.7. Other positive countries were Australia, Mexico, Vietnam and emerging Europe.

Overall, 60% of individual countries are still in expansion territory, that is down from 69% last month. The global economy appears to be just keeping its head barely above water and we are still on a global recession watch.

SERVICES / COMPOSITE

The numbers were better on the services side. The ISM Non-Manufacturing Index rose to 55.7, up from 54.5. That is the highest level this year. So while manufacturing was a disappointment, the service number was better than expected.

Combined, the ISM Composite Index rose to 55.1. That also is the highest reading of the year.

EMPLOYMENT NUMBERS

Employment statistics have been the linchpin of the US economy in recent months. But this week the numbers were not as strong as we have become accustomed to. Jobless claims came in at 274k, which was the highest reading in five weeks. Relatively speaking 274k is a very good number, just not as good as the very low numbers we have been seeing. The unemployment rate remains at 5%. Only 160k new jobs were created. That number was a disappointment and lower than the 200k consensus. It is going to be hard for the economy to keep creating 200k+ jobs per month in a slow growth economy.

In our quarterly webinar we cited 5 factors that often are leading indicators for a recession, two of them are rising jobless claims and declining employment. While rising claims were up and the change in newly created jobs was down, these two numbers are are not yet indicative of a trend.

The weaker than expected employment numbers likely diminished the chances of a June rate increase by the Fed.