Tired Stock Markets and Fed Fatigue

I'm tiredTired of playing the game Ain’t it a crying shame

-Lili Von Shtupp (Madeline Kahn) in “Blazing Saddles

One thing we can all agree on this political season is that everyone seems tired -- tired of the shouting, the rhetoric and the divisiveness. In some ways, the stock market also feels a bit tired right now, as investors continue to suffer from Fed fatigue. After enduring a correction early in the year, then charging to all-time highs over the summer, the rally seems to have lost some steam lately. Perhaps the slowdown is for good reason, at least from the consumer’s point of view: with the labor market tightening, US companies are paying higher wages, which eats into their profit margins and hurts stock performance. Most Americans would likely happily endure so-so mid-single digit returns from stocks in their retirement plans, in exchange for fatter paychecks.

Conversations about the Federal Reserve also seem a little wearing these days. The Fed’s impact on risk assets, like stocks, seems to wax and wane from week to week, with most now believing that the central bank will raise rates by a quarter of a percent at the mid-December meeting. By that time, investors will know the outcome of the election and will also have a bit more data to confirm that economic growth can withstand a Fed move. This week, the government will release one of the last few important reports before that meeting: third quarter Gross Domestic Product (GDP).

After a dreadful first half of the year, when the economy expanded by just about one percent, growth has accelerated in the second half of this year, as the effects of a stronger dollar and lower oil prices have started to fade. Economists expect that the first estimate of third quarter growth will rebound to an annualized rate of 2.5 percent, due in large part to a surge in exports and specifically soybean exports. Depending on how the Bureau of Economic Analysis handles the spike and then likely reversal in the subsequent quarter could impact the headline. When it’s all smoothed out, we should expect that growth for all of 2016 will be the same, tired 2 percent or so that we have seen over the past few years.

In addition to GDP, which will be revised in a month, the Fed will also chew on the following before the December FOMC: two employment reports (11/6 and 12/4), two Personal Income and Spending reports, which contain the Fed’s favorite measure of inflation, PCE Index (10/31 and 11/30) and one more Consumer Price Index report (11/17). Presuming that these reports are mostly in line with trends, the Fed should hike in December. After that, I'm afraid to tell you that we're likely to endure another round of exhaustive speculation about the pace of rate hikes…in other words, be prepared for the 2017 version of Fed fatigue.

• DJIA: 18,145, up 0.04% on week, up 4.1% YTD
• S&P 500: 2141, up 0.4% on week, up 4.8% YTD
• NASDAQ: 5257, up 0.8% on week, up 5% YTD
• Russell 2000: 1218, up 0.5% on week, up 7.2% YTD
• 10-Year Treasury yield: 1.74% (from 1.80% week ago)
• British Pound/USD: 1.2227 (from 1.2188 week ago)
• November Crude: $50.85, up 1% on week
• December Gold: $1,267.70, up 1% on week
• AAA Nat'l avg. for gallon of reg. gas: $2.23 (from $2.25 wk ago, $2.22 a year ago) Prices have climbed above their year-ago levels for the first time in over two years (7/13/14)

THE WEEK AHEAD:

Mon 10/24:

Visa

8:30 Chicago Fed National Activity Index

Tues 10/25:

Apple, AT&T, General Motors, Pandora

9:00 FHFA House Price Index

9:00 S&P Case-Shiller HPI

10:00 Consumer Confidence

Weds 10/26:

Coca-Cola, Groupon, Texas Instruments

10:00 New Home Housing Sales

Thursday 10/27:

Amgen, Deutsche Bank, Ford, Sirius XM

8:30 Durable Goods

10:00 Pending Home Sales

Friday 10/28:

Exxon Mobil, Hershey, MasterCard

8:30 Q3 GDP – 1^st Estimate

8:30 Employment Cost Index

10:00 Consumer Sentiment

Why are Stock Markets at New Highs?

"Why are stock markets at new highs?" The easy answer is that there are more buyers than sellers. The more complicated answer is that the Dow and the S&P 500 reached new all time highs last week, as investors shrugged off post-Brexit concerns and refocused on global central banks. In the case of the Bank of England, the Bank of Japan and the European Central Bank, the bet is that each will do something in the coming months to fight economic malaise. And in the US, the recent resurgent stock market is a result of investors’ belief that that the Federal Reserve will likely sit on its hands for the remainder of the year. Even if those assumptions are correct, the climate for investors is still riddled with danger. To earn anything approaching an acceptable return, many are turning back to risk assets, despite the bump in volatility seen over the past 18 months. In fact, since May 2015, when stocks previously saw new peaks, investors have endured two corrections (drops of 10 percent from recent peak) amid worries about slowing growth in China, plunging oil prices and fears over an emerging market debt crisis.

Those who gritted it out and stayed on course with their asset allocation, have done just fine. After dropping to 52-week lows in February of this year, the Dow is up a stellar 17 percent (and up 180 percent since the March 2009 nadir). But pity the market timers who sold at the various bottom points and then chased assets higher—they are likely licking their wounds and perhaps even sitting out this most recent leg higher.

There are also many investors who are on the sidelines because they see the world as a scary place. These folks likely stumbled upon the Economist Intelligence Unit’s updated list of Top Threats as a rationale for not feeling comfortable with any risk right now. Those top ten threats are:

1. China experiences a hard landing
2. Currency volatility and persistent commodity prices weakness culminates in an emerging markets corporate debt crisis
3. Donald Trump wins the US presidential election
4. Beset by external and internal pressures, the EU begins to fracture
5. "Grexit" is followed by a euro zone break-up
6. The rising threat of jihadi terrorism destabilizes the global economy
7. Global growth surges in 2017 as emerging markets rally
8. The UK votes to leave the EU
9. Chinese expansionism prompts a clash of arms in the South China Sea
10. A collapse in investment in the oil sector prompts a future oil price shock

My vote for number 11 on the list is “Corporate Share Buybacks halt”. As noted in the Wall Street Journal, “Among the most prominent drivers of the 2016 stock rally has been companies’ willingness to buy back shares. The strategy…drives up share prices and improves per-share earnings by reducing the number of shares outstanding. Some investors decry buybacks as financial engineering.”

The concept of companies buying back shares to drive prices higher is what Time business and economics columnist and author Rana Foroohar calls “financialization.” In her book “Makers and Takers: The Rise of Finance and the Fall of American Business,” Faroohar says that buybacks are a type of financial engineering that can juice short-term profits, thereby enriching shareholders. Unfortunately, waving a financial magic wand over a company’s balance sheet does nothing to serve the real economy, something that would occur by a company using its capital to invest in long-term growth.

Financial shenanigans may push the stock market higher for the foreseeable future, but they are unlikely to create a sustainable economic model that will produce results over the next several years.

MARKETS:

• DJIA: 18,516, up 2% on week, up 6.3% YTD
• S&P 500: 2161, up 1.5% on week, up 5.7% YTD
• NASDAQ: 5029, up 1.5% on week, up 0.5% YTD
• Russell 2000: 1205, up 2.4% on week, up 6.1% YTD
• 10-Year Treasury yield: 1.547%, (from 1.366% a week ago)
• British Pound/USD: $1.3214 (from $1.295)
• August Crude: $46.02, up 1.4% on week
• August Gold:  at $1,327.40, down 2.3% on week
• AAA Nat'l avg. for gallon of reg. gas: $2.22 (from $2.24 wk ago, $2.77 a year ago)

THE WEEK AHEAD:

Mon 7/18:

Bank of America, Hasbro, IBM, Netflix, Yahoo!

10:00 Housing Market Index

Tues 7/19:

Discover, Goldman Sachs, Johnson & Johnson,, Microsoft, Philip Morris, UnitedHealth

8:30 Housing Starts

Weds 7/20:

Abbott Labs, American Express, eBay, Halliburton, Intel, Mattel, Morgan Stanley

Thursday 7/21:

ATT, Chipotle Mexican Grill, GM, Starbucks, Visa 

8:30 Philadelphia Fed Business Outlook Survey

8:30 Chicago Fed National Activity Index

9:00 FHFA House Price Index

10:00 Existing Home Sales

10:00 Leading Indicators

Friday 7/22:

American Airlines, General Electric, Honeywell, Schlumberger

Saturday 7/23:

China hosts the G-20 meeting of finance ministers and central bankers.

Do Rotten Stock Markets Indicate Economic Trouble Ahead?

January was a rotten month for stock markets, but what is the action is telling us? Is the economy about to careen into a recession or did stocks get ahead of the broader economy and are now resetting lower, to a more reasonable level? My guess is that it's the later, but the answer will only be evident in hindsight. Here’s what we know: the economy slowed to a measly 0.7 percent annualized pace in the fourth quarter, dragged down by business investment (-1.8 percent) and net exports (-0.5 percent). Plunging energy prices was the culprit for the weak reading on business investment. Within the category, there was a 5.3 percent drop in structures investment, which was mainly due to the collapse in drilling activity. According to Capital Economics, “mining structures investment fell by 51 percent in 2015, subtracting 0.4 percentage points from overall GDP.”

Exports and inventories were down primarily due to a strong dollar. Although growth was only 2.4 percent for all of last year, essentially matching the slower than normal pace of the previous three years, U.S. GDP is better than other developed nations, like Europe and Japan. That’s why the dollar Index is up by more than 20 percent over the past two years. A strengthening greenback is great for consumers who are purchasing French cheese or Italian olive oil, but it also makes U.S. goods costlier overseas, which has put the manufacturing sector into a deep funk.

One bright spot in the GDP was consumer spending. Although consumption slowed to 2.2 percent in the fourth quarter, from 3 percent in the third, for all of 2015, consumption grew at the fastest pace in a decade, according to Joel Naroff of Naroff Economic Advisors. He notes, “given that the warm December meant a lot lower heating bills and very little reason to buy winter-related products such as sweaters or shovels, it [the 2.2 percent reading] was actually quite good.”

Americans may be spending, but they are not going crazy. Overall after-tax income increased by 3.2 percent at an annualized inflation-adjusted basis, but instead of blowing it, more people chose to bank those extra shekels. The personal savings rate jumped to 5.4 percent, the highest level since 2012 and a far cry from the negative rate seen in mid 2005.

Fed/Jobs Watch: The drop off in US growth kept the Fed on hold in January and investors think that the current economic uncertainty will clear up by the time of the next FOMC meeting in March. Futures markets anticipate only one additional quarter-point rate hike by the end of this year. It is important to underscore the US monetary policy remains accommodative—after all, the inflation-adjusted fed funds rate is still well below zero.

To determine whether or not to raise in March, the Fed will keep a close eye on economic data and the labor market. The January employment report, which is due on Friday, is expected to show that 200,000 jobs were created and the unemployment rate will remain at 5 percent. There may even be an upside surprise, as companies have recently been reporting that they are finding those job vacancies harder to fill and households say that jobs are plentiful.

Oil, Oil Everywhere: And finally, a word about oil…an old commodities trader once told me: “Honey (it was 1987), there are only two things to analyze with commodities: supply and demand.” The 2015/early 2016 oil selloff has been attributed to weak demand, reflecting fears of a slowdown in China’s economic growth and, consequently, its demand for oil.

But Capital Economics points out that the Energy Information Administration’ short- term outlook “shows that Chinese petroleum consumption has continued to rise at roughly the same pace as before. Instead, the slump in global oil prices appears to be predominantly due to the surge in supply that began in 2014 (a lot of it due to higher US shale output) rather than weaker world demand.”

MARKETS: Negative is a Positive for markets. Persistently weak growth in Japan and the rest of the world prompted the Japanese central bank to join other central banks (ECB, Sweden, Denmark, Switzerland) to push deposit interest rates for new reserves into negative territory. That means that a Japanese commercial bank will have to pay for the privilege of sitting on cash. The government hopes that the move will encourage banks to lend more, which would in turn create more spending. Investors saw the action as evidence that both Japan and Europe would like have to resort to more stimuluative measures in the future, which pushed stocks higher on Friday. It was not enough to save the dreadful month, but it coulda’ been worse!

• DJIA: 16,466 up 2.3% on week, down 5.5% MTD/YTD
• S&P 500: 1940 up 1.8% on week, down 5.1% YTD
• NASDAQ: 4613 up 0.5% on week, down 7.9% YTD
• Russell 2000: 1035, up 1.3% on week, down 8.8% YTD
• Shanghai Composite: down 23% in Jan, the largest monthly drop since 2008. The index has fallen by nearly 50% since its peak in June 2015, but remains 33% above its level in mid-2014, before the bubble began
• 10-Year Treasury yield: 1.93% (from 2.06% a week ago)
• Mar Crude: $33.62, up 4.4% on week, down 9.2% MTD/YTD and up 27% from Jan 20 low)
• Apr Gold: $1,116.40, up 1.8% on week, +5.3% MTD/YTD
• AAA Nat'l avg. for gallon of reg. gas: $1.80 (from $1.84 wk ago, $2.05 a year ago)

THE WEEK AHEAD:

Mon 2/1:

Aetna, Alphabet (formerly known as Google)

8:30 Personal Income and Spending

9:45 PMI Manufacturing Index

10:00 ISM Manufacturing Index

10:00 Construction Spending

Tues 2/2:

Exxon Mobil, Dow Chemical, UPS, Yahoo

Motor Vehicle Sales

Weds 2/3:

GM, Merck, MetLife, Yum! Brands

8:15 ADP Private Employment Report

9:45 PMI Service Index

Thursday 2/4:

8:30 Productivity Costs

10:00 Factory Orders

Friday 2/5:

8:30 Jan Employment Report

3:00 Consumer Credit

Janet Yellen Spurs Santa Claus Rally

Leave it to a nice Jewish girl from Brooklyn to give Santa Claus a nudge. In its last policy meeting of the year, Janet Yellen (who hails from Bay Ridge, Brooklyn) and her cohorts at the Fed split the difference on the language used to describe when we would see an increase short-term interest rates. The central bank “judges that it can be patient (emphasis mine) in beginning to normalize the stance of monetary policy,” but also added the new description of their stance was “consistent” with past assurances that rates would stay low for a “considerable time.” Investors loved the punt, believing that the Fed is not likely to raise rates any time soon. All of the sudden, the Santa Claus Rally was ON! In fact, after a dismal start to the week, stocks powered higher Wednesday through Friday (the best three-day percentage gain for the Dow and the S&P 500 in three years) and finished within striking distance of all-time highs. Fears melted away about the oil plunge signifying a global growth slowdown and a possible financial contagion from the Russian currency crisis, allowing ol’ Saint Nick (via Saint Janet) to take control.

Meanwhile, consumers and retailers are preparing for the last gasp of holiday shopping before Christmas. Early results have been mixed, but that might have more to do with the season stretching out over a longer period, than the fact that people are spending less overall. Separate data from IBM’s real-time tracking index of digital shopping and Adobe confirm that consumers have already spent record amounts online and companies like Wal-Mart and Target reported strong holiday numbers.

These results fly in the face of the National Retail Federation’s finding that total projected sales tumbled 11 percent during the Thanksgiving holiday weekend, but it’s important to note that NRF data is based on a totally non-scientific survey, which asks random shoppers whether they plan to spend more or less than last holiday season. Considering that most consumers can hardly recall what they spent last week - let alone last year, most analysts have dismissed NRF findings.

To determine whether or not Santa delivered retailers a jolly holiday season, we’ll have to wait until the Commerce Department releases its monthly retail sales report in January and retailers report their earnings reports for the fourth quarter. Until then, it’s probably best to concentrate on the holidays themselves and not get wrapped up in guesswork.

MARKETS: Last week was a great lesson in volatility…and if you can’t take it, then you might want to consider reviewing your portfolio allocation. For the five days, Santa stuffed investors’ stockings with gifts, not lumps of coal, as indexes climbed within spitting distance of milestones (Dow 18K) and records (S&P 500 2075).

• DJIA: 17,804, up 3% on week, up 7.4% YTD
• S&P 500: 2070, up 3.4% on week, up 12% YTD
• NASDAQ: 4765, up 2.4% on week, up 14.1% YTD
• Russell 2000: 1196, up 3.8% on week, up 2.8% YTD
• 10-Year Treasury yield: 2.18% (from 2.08% a week ago)
• January Crude Oil: $56.52, down 2.2% on week
• February Gold: $1,196, down 2.1% on week
• AAA Nat'l average price for gallon of regular Gas: $2.43 (from $3.22 a year ago)

THE WEEK AHEAD: By Tuesday at 10:15ET, you can call it quits for the week!

Mon 12/22:

8:30 Chicago Fed Nat’l Activity

10:00 Existing Home Sales

Tues 12/23:

8:30 Durable Goods Orders

8:30 Q3 GDP (final reading, previous=3.9%)

8:30 Personal Income and Spending

10:00 New Home Sales

Weds 12/24:

1:00 US Markets close early for Christmas

Thurs 12/25: CHRISTMAS DAY – MOST GLOBAL MARKETS CLOSED

Fri 12/26:

Are Stock Markets a Little Too Quiet?

Within days of starting the third quarter of the year, U.S. stock market indexes were breaking records again and this time, they were also marking new milestones. The Dow Jones Industrial crossed over the 17,000 mark, nearly eight months after breaching 16,000 (the seventh-fastest 1000-point gain in the index's history); the Standard & Poor’s 500 was knocking on the door of the 2000-level; and 14 years after hitting the 5,000 level the first time around, the NASDAQ Composite seemed ready to recapture its old glory, just 12.5 percent below its record set in March 2000. You might think that the Wall Street cheerleaders would be out there celebrating with a noisy show, but something strange is going on…despite records, milestones and smart year-to-date gains, it’s eerily quiet right now, perhaps too quiet.

Investors are feeling mellow, according to the St. Louis Federal Reserve, which announced that its Financial Stress Index fell to its lowest level since the regional bank started tracking the data in 1993. Through the July 3^rd close, the S&P 500 has gone 54 sessions in a row without closing up or down more than one percent, the longest such stretch since 1995. And the CBOE Volatility Index (VIX) -- often referred to as the “fear index” – closed at 10.32 just before the Independence Day weekend. To put that in perspective, the VIX soared above 80 during the financial crisis.

The VIX is down nearly 25 percent from the beginning of the year; is nearing its lowest level since 2007, when it fell below 10; and appears to be on path to challenge its all-time low of 9.31, reached on Dec. 22, 1993. Just because the environment seems calm, doesn’t mean that something bad is brewing. In fact there have been various periods when markets have been downright boring. But it would be unwise to let down your guard against the risks that are ever-present for investors, the biggest one of them all allowing your emotions to guide your decision-making.

A recent New York Times article called attention to something you probably already know: humans have physical reactions to extreme risk that can help protect us (touch that hot stove and your brain tells you pull it back in a hurry), but also can lead us astray. Author John Coates, explained that “under conditions of extreme volatility, such as a crisis, traders, investors and indeed whole companies can freeze up in risk aversion.” You may have experienced just such feelings in 2008 and 2009 and perhaps even sold everything in your portfolio to make those feelings go away.

The flip side of freezing up is getting lulled into a false sense of security. The current placid market conditions may allow you to gloss over the gyrations experienced during the financial crisis and subsequent bear market. Even more dangerous is the fact that a calm period can lead to a new round of risk taking. “When opportunities abound, a potent cocktail of dopamine — a neurotransmitter operating along the pleasure pathways of the brain — and testosterone encourages us to expand our risk taking.”

Because human risk preferences can change as market conditions shift, you may be wondering, “How can I protect myself from myself?” The answer is clear: to adopt a diversified investment strategy that incorporates your risk tolerance, time horizon and financial goals. Let me state unequivocally: the strategy does not work perfectly in the short-term. When markets crashed in 2008 and 2009, almost every asset class plummeted in unison, and in the first half of this year, everything from stocks to bonds to commodities increased in value.

That said, asset classes might gain or lose value simultaneously for a period of time, but typically not by the same magnitude and not over a longer time horizon. During times of crisis or times of extreme calm, you may question the benefits of diversification. When you do, remember that when markets are either very noisy or quiet, the subsequent period may be far less so. Stick to your game plan – you will be happy that you did!