April 30, 2015

Stocks opened lower this morning (Dow -111pts; SPX -.63%). Pretty much all ten sectors are in the red, led by utilities and tech. By the way, a market technician might point out that the SPX just failed at a double-top of 2117. So the index is moving lower to test its 50-day moving average at 2090. WTI crude oil is actually moving higher toward $59/barrel, so it’s a bit strange energy stocks are down. Bonds are sharply lower following the Fed meeting yesterday. The 5-year Treasury yield spiked to 1.50% today and the 10-year moved up to 2.10%. If the 10-year closes above 2.12%, we’re probably going to 2.24% in the near term. This upward move in rates doesn’t really make much sense to us, given the results of the meeting and the inflation report this morning (see below).

The Federal Reserve’s key policy committee wrapped up its meeting yesterday and issued a statement. Importantly, all calendar references were removed from it, meaning short term interest rate hikes could be imposed at any time if the economy cooperates. It is not, by the way, cooperating at the moment. The Fed will raise when 1) it sees further improvement in the labor market, and 2) it is reasonably confident inflation is moving back to its target of 2%. That’s the party line, but we know they look at a lot more than just jobs and inflation.

Committee members thought current weakness in economic data is temporary and headwinds should now subside and the recovery should resume. The statement acknowledged household real incomes are strengthening but consumer spending has not accelerated much. This, too, is temporary in the Fed’s view. Economists reacted afterward, noting the mild market reaction. In addition, many felt the Fed did not set itself up for a June rate hike. So on balance, this is probably neutral for stocks. Rate hikes are clearly imminent, but not warranted over the few couple of months.

We’ll see. The Citigroup Economic Surprise Index has done nothing but decline this year, plunging from +40 (meaning data is better than expected) to -60 (meaning most data is disappointing). It has spent much of the last 6 weeks in negative territory. In our view, the Fed will not tighten monetary policy until this chart is very much on the mend. The labor market, by the way, is not the problem because very strong improvement over the last 8-12 months has brought all the numbers in line with what you would expect for a rate hike. No, the problem is inflation, which is non-existent. A complete lack of inflation makes rate hikes unnecessary. While our Fed contemplates tightening monetary policy, central banks around the world (Europe, Japan, China) are loosening policy, resulting in a strong dollar relative to other major currencies. A strong dollar, in turn, keeps a lid on inflation. This policy mismatch also encourages continued strong global demand for US Treasury bonds, and that is helping keep interest rates very low in the US.

The Fed likes to use the “PCE Core Deflator” as its inflation gauge, and coincidentally we got March data this morning. Core year-over-year inflation came in at 1.3% vs. economists’ consensus forecast for 1.4%. So we’re nowhere near the Fed’s 2% target. And as an aside, if you add back in food & energy (which the core figure excludes) year-over-year inflation is basically flat at .3%. So in our view, the Fed can’t raise rates any time soon.

October 10, 2014

Stocks opened lower again this morning following yesterday’s selloff. The Dow and SPX are currently up 7 pts & down .35%, respectively. Energy, industrials, tech and materials are leading to the downside. Consumer staples and utilities, however, are up over 1%. Volatility is clearly spiking—the VIX Index jumped to 20. Looking back at the previous 7 trading sessions, the Dow has swung around by over 200 points in each one. For the S&P 500 Index, we’ve had three consecutive days of 2-standard deviation moves, and that clearly illustrates volatility. Asia closed 1-2% lower overnight and Europe is about to close down 1%. The EuroStoxx 600 Index is now down 11.2% this year in Dollar terms.

We’ve seen massive demand for Treasuries in the last several days. The 5-year Treasury yield plunged to 1.55% yesterday from 1.80% a month ago. The 10-year is trading at 2.31%, down from 2.54% a month ago. Demand for Treasuries has strengthened the dollar, causing pain in commodities. Copper is down 12% year-to-date. Gold’s rally early in the year has completely fizzled.

Energy was the worst performing sector yesterday. The US is now producing oil at a rate of 8.8 million barrels per day. We consume about 18.9 million barrels per day. The top five countries in Europe are consuming 5% less oil than a year ago. Brent crude oil is now over 20% lower than it was at the peak earlier this year. WTI crude is now trading under $85/barrel. So supply is probably outpacing demand around the world. That said, it’s pretty clear energy stocks are deeply oversold. The iShares Energy Select Sector SPDR (XLE) is down 18% from its peak in June.

So the Dow is now about 4% from its all-time high (SPX down 4.7%). The Dow this morning briefly dipped down to touch its 200-day moving average, and quickly reversed course. That is a very good sign, at least for the near term. As long as that level serves as support we can expect it may closer higher today to end the week. The same technical level for the SPX is about .6% lower at 1905. That level will need to be tested. So this could be the reason for the Dow/SPX divergence today. By the way, one of the big questions in the market is when (not whether) the buyers step in? We could see this pullback go a total of 8-10% on the SPX, but most equity strategists agree there is no evidence we’re looking at a 15-20% pullback.

Fed minutes from their last meeting reveal an increasing concern for falling economic growth outside the US. They point out that a stronger Dollar could tamp down economic growth via less competitive exports. At the same time, Dollar strength precludes a pick-up in inflation and makes it less likely the Fed will have to raise interest rates. The Fed staff reduced its inflation outlook, saying inflation could remain sub-2% over the next few years. The PCE deflator is running at about 1.5%, whereas the Fed’s target is 2%. So the minutes were a surprise, suggesting the Fed is on balance a bit more dovish than it was a month ago.

March 28, 2014

Stocks surged at the open after two down days. The Dow an SPX are currently up 123 pts & .8%, respectively. The major averages are close to unchanged year-to-date, so the quarter could go either way (up or down) based on what happens in the next few trading sessions. This morning, several sectors are up more than 1%: discretion, healthcare, tech and materials. Commodities are broadly higher after China’s Premier Li Keqiang posted a statement on the government website that seemed (obliquely) to support monetary stimulus in case economic growth slows further.  So copper is up about 1.6% on the day; WTI crude is up about $1 to $101/barrel. Rates aren’t moving around very much; the 5- and 10-year Treasury yields are up modestly to 1.72% and 2.70%, respectively.  

According to Bloomberg, “the air is coming out of the balloon” of some high-flying tech stocks. Over the last year, names such as Facebook, TripAdvisor, Netflix, Tesla, and Amazon screamed higher regardless of fundamentals like sales & earnings growth, cashflow, etc. Consequently, the P/E ratios on these stocks don’t make sense. Tesla is trading at 135 times expected 2014 earnings, and Amazon is trading at 175 times. Even with the recent pullback, Twitter is trading at over 2000 times expected earnings. Valuation levels are “approaching the Internet bubble,” and it looks like traders are beginning to sell. Over the last month, the Global X Social Media ETF is down nearly 12%, Tesla is off 12%, and Netflix is off 18%. Over the last week, I’ve highlighted the fact that short term interest rates are beginning to move up. If that trend continues, it will certainly put a dent in demand for these trading stocks, which are often purchased on margin.   

Personal Incomes rose .3% in February, as expected, matching the prior month gain. Personal Spending also rose .3% in the month after a downwardly revised .2% gain in January. This is a pretty healthy report, leading me to believe the consumer is recovering from some winter weakness. About 70% of the US economy is driven by consumer spending. The PCE Deflator, a gauge of inflation on consumer goods, rose .9% y/y in February, and that’s considered very low. The Fed will start paying more attention once inflation accelerates to around 2%/yr.

University of Michigan Consumer Confidence edged down to 80.0 vs. 81.6 in the prior month. Economists anticipated a reading of 80.5, but nobody’s really disappointed. The bottom didn’t drop out over the winter months, and we’re roughly even with year-ago levels.   By the way, 80 is considered a “moderate level” by Barron’s.