Job Growth Surges 321,000 For November Now It's Really Time To Prepare for the Newer New Normal

One of Pacific Investment Management Company’s (PIMCO) elite brain trust  Mohamad El-Erian coined the phrase, “the new normal” six years ago when characterizing the future returns for equity investors.  Basically after all his in-depth research, analysis, modeling and magic wand he stated equity investors would need to adjust to future returns of 5% or so.   Mr. El-Erian is undeniably a very intelligent fellow witch, up to this point in time  had a very solid record.  Mr. El-Erian fell victim to his conviction.   Meaning even as the markets raged forward he continued to dig in his heels stubbornly clinging to his “new normal” theory costing his investors and followers hundreds of billions of dollars and some years later his very own job.   The underlying theme here is the markets are always right so, as investors we need to be humble, flexible and when called for quick. 

The US economy is no longer a good house in a bad neighborhood.  We are the Bentley in a used car lot.   The US economy for the trailing two quarters is averaging better than a 4% expansion rate of growth with the current quarter estimated to be tracking at close to 3%. This would give us a three quarter average of better than 3 ½%.   Take that when comparing the US vs. the Eurozone’s blistering pace of +.2%, Japan at -1.6% contraction, the United Kingdom’s +.7% and Russia at +.7%.   The US economy, now after five years of repair from a bruising and painful recession, is now finally starting to fire on all gears.    So, where are we.  Let’s get to it.

Jobs- The Non-Farm Payroll figures were released this morning and they were stellar coming out at +321,000.  There was strength across the board.  Average hourly earnings registered a +.4%.  The average workweek pushed higher to 34.6 hours.  Importantly the jobs created were good paying solid jobs with Business and Services adding 81,000 to head count and Healthcare and Manufacturing added 28,000 and 29,000 respectively.  No two ways about it a very strong number.  We’ll wait for the January release to see if this was a one off number, if this November number is followed up with another very strong number we may need to rethink the timing of the first Fed rate hike.

Institute for Supply Management Manufacturing –The ISM Manufacturing figures released earlier this week came in a +58.7% which is solid but down slightly from the prior reading of +59.%.  Looking inside the headline figure we continued to strength across the board.  Aside from the positive Production and Employment components we saw an uptick in the New Orders an Exports indexes and a slowdown in inventory build outs which bodes well for future growth .

Institute for Supply Management Non-Manufacturing-The ISM Non-Manufacturing figures came out at +59.3 which was 2.2% higher from the prior month.   There were some softness noted in the employment index but still registered growth along with a pickup in the Business Activity Index which leapt 4.4% to +64.4%.  Also, importantly the New Orders posted a 2.3% increase to 61.4%.   Respondents noted the following: Finance-“uptick in demand and spending”, Technology, “Business is good with new products”, Professional Scientific, “Business is strong with many accounts wishing to be implemented before year end”.   Also very positive was from mining,’ we are experiencing downward pricing pressure on natural gas as a result of lower pricing from OPEC.    There should be a smiley face inserted her but I’m prohibited from doing so. 

Leading Economic Indicators-LEI.  LEI released in late November showed a very strong jump of +.9% following September’s +.7%.   This continued strength suggests a strong holiday season spilling over and into the first quarter of 2015.  There was strength registered across the board. 

Industrial Production-IP.  IP ticked down a -.1% in October after having surged ahead +.8% in September.  There was some strength seen in manufacturing  up +.2% which was far outweighed by the decline in mining activity of      -.9%.     This overall indicator is still showing a 4% gain for the comparable year ago period.   The Capacity Utilization rate declined -.3% to 78.9% which leaves ample cushion to absorb any future inflationary pressure when they arise. 

Housing- Housing Starts for October registered a 1,009,000 annual run rate which was a bit softer than September release of 1,038,000 but is up +7.8% from the year ago period.   Importantly Housing Permits came in at 1,080,000 this is a +4.8% improvement from the prior months reading.  

Now to where we are going.

There is no getting around what is driving the US economy now.  Front and center Jobs and energy.   I’m not sure which is the cart and which is the horse and for me that’s another discussion.    The jobs picture is finally starting to see acceleration with the three month average now at +263,000.  We’ll hold off on our opinion regarding the latest Non-Farm figure until we get confirmation this wasn’t a onetime anomaly from the January release.   The argument that there were no “quality” jobs being created should now be quieted.   Clearly good quality high paying jobs in Manufacturing, Business and Healthcare are being created.  I always had a problem with the term “good quality jobs” to begin with.  When I was out of work, any job was a good job, up until the time I could find a better one.   Looking to the other input part of the economy the correction going on in the energy sector is a boom for everyone, ex- Texas, North Dakota and most notable OPEC, Russia and Venezuela.   But those players have partied on our dime for long enough. Foreign investment to take advantage of our cheap natural gas and natural gas liquids is booming.   Over the course of the last 10 years we’ve debunked the “Peak Oil” theory as a paper funded by and for the oil industry.    The Shale formations in the US have unleashed a tidal wave of cheap oil and gas that will forever change the pricing and security of America.  No longer will we need to engage hostile forces to protect “US Interests “abroad.  No longer will we be held hostage to rival religious fanatical factions to heat our home and fill our tanks.   The Shale Revolution has changed all of that while producing  tens of thousands of high paying US jobs.   The argument now is where will oil find a bottom.  I can remember back to the depths of the financial crisis when Institutional Investors and Hedge Fund managers were scrambling to raise cash for clients redemption requests.  They were selling any and everything which meant the futures and options position being closed out in the energy pits as well.  The bottom price of oil at that time when speculators were chased out of the market was  right around the $36.00 barrel level.   The Saudi’s say they can extract oil at $10 barrel.   Some estimate the Bakken and Permian have similar extraction rates for break even.   We’ll see.  But to show just how powerful this move down in gasoline can be for consumers.  US consumers spent close to $374 billion on fuel last year.  If we simply hold the 30% correction at the pumps we’ve already experienced for the next year we’ll have put $110 billion back in to consumers’ pockets and pocketbooks.  That doesn’t take into account the additional savings from heating ones homes.  Potentially hugely stimulative to the consumer and better than any government program.  So, let’s hope the government  doesn’t try and figure a way to get ahold of those monies before it gets to the consumer.    Back on point.  The point here is the US is doing much better and about to take flight. This without much assistance from the Euro zone which is close to reentering a recession, Russia about to enter a recession, Japan which is fighting stagflation to a standstill at best along with China and India enduring a soft landing of +7.5% and +5.4% respectively.   This drag the US is encountering from the global economy may actually work to our benefit as it prevents our economy from overheating forcing the Yellen Federal Reserve to hike interest rates thus choking off a continuation of the domestic expansion and market surge.   Instead with more American’s being put back into “good jobs” with improving wages coupled with the drop in energy prices this scenario could provide us with years of this Goldilocks environment providing above average returns for investors.  So, if this is Mohamad’s New, New Normal, I’m all aboard. 

For now we remain aggressively committed to the market closely monitoring data along with any signs to change course in which case we’ll be in contact immediately. 

Thank you again for your patience and confidence in this very challenging investing environment.

Yours in pursuit of the KWAN!

Are Wall Street And Markets Doing The Two Step?

Paula Abdul and that foxy MC Skat Cat got everyone jumping 24 years ago when she serenaded us with “I take two steps forward and two steps back, we come together ‘cause opposites attract”.  A few Investors seemed to adhere to the same thought process when contemplating where the economy and Fed Chair Yellen are heading.   Two steps forward and two steps back going nowhere.   From GSA’s perch the economy is about to finally hit breakaway velocity from the grips of the bruising recession and trend growth reaching 3% or better going forward.  We’ll get right to it and share why we believe the pundits have been just plain wrong  and if they don’t alter their view they’ll continue to be so and miss the upcoming rally in equities. 

Where we are:

JOBS- Non-Farm Payrolls. Hot off the presses this morning Non-Farm Payrolls came out this morning at a surprising +248,000.  This compares favorably with the twelve month average of 213,000.  The quality of jobs was also supportive of an improving base with Professional and Business Services up +81.000 compared with the average +56,000 over the prior twelve months.  Healthcare added +23,000 while construction tacked on +16,000.  The unemployment rate ticked down to 5.9% The participation rate held steady at 62.7% The workweek ticked up +.1 to 34.6 hrs.  Hourly earnings were virtually unchanged at $24.53 hr. which reflects a 2% gain over the prior year.   There were also big revisions to the prior two months.  July’s figure was revised to +243,000 vs the originally reported +212,000.  The August figure which was hugely disappointing was revised up to +180,000 from the original report of +142,000.  Taken together the original releases were under-reported by +69,000 and a solid report overall.   

Leading Economic Indicators-LEI.  LEI increased +.2 in August.  This gain builds off July’s +1.1 and June’s +.7.    The LEI suggests an economy that is continuing to gain traction but not as aggressively as the earlier growth rates of the second quarter.   Released along with the LEI is the Coincident Economic Indicators-CEI.  CEI a measure of current economic conditions continued on its expansion in August as well inching up +.2% following a +1% in July.  Strength was reflected in personal income, employment and retail sales which were somewhat offset by weakness in Industrial Production.  LEI continues to suggest an economy expanding at a reasonable pace for the next few quarters. 

ISM Purchasing Managers Index-ISM PMI.  ISM PMI Manufacturing registered at +56.6% for September which was a decrease of -2.4% but still above the expansionary 50 level and the 16^th consecutive positive month.   There was growth reflected throughout the report, namely in New Orders, the Production Index and the Employment Index.  While still very healthy all were off from their August highs.   Commentary from respondents were all very positive as well.  From Construction, “Warehouse and multi-family construction continues to be strong”.  From Machinery “Our search continues  for good machinists and engineers”.  Lastly from Manufacturing, “ Overall, orders are at the strongest point this year”.   No signs of any weakness here either.      

ISM Non-Manufacturing Index-ISM NMI came in today at +58.6.  This is down from August but another very solid figure.  New order came in at +61 along with the employment index posting a +1.4% gain to +58.5%.   All areas covered experienced growth but slowed marginally from the August showing.   Respondents were generally upbeat about future prospects but noting some leveling off.  In Construction, “ We see a lot of smaller remodels and additions with many company’s putting off new builds due to concerns about large investments at this time”.   From Professional, Scientific and Technical Services, “Orders continue to be steady, and forecasts strong for the remainder of the year. There doesn’t appear to be significant growth but a steady strong business level”.  Wholesale trade comments “ Business remains steady but not robust”.   This report again suggests a good not great environment and improving. 

New Homes Sales- New home sales surged +18% in August the strongest since 2008.  This followed a home builder optimism survey that had reached levels not seen since 2005.  This is very good news as a recent release of existing home sales had slipped breaking the four months of prior gains. 

NAHB Housing Market Index-HMI.  The HMI is an index we’ve followed for some time which tracks the builders confidence for new single family homes which rose to a level of 59 the loftiest since 2005.   Similarly a reading above 50 suggests market conditions are favorable.  Notes included in the release from builders noting buyer traffic and interest had picked up.   All components came in positive territory.   Current sales conditions registered 63 along with expectations for future sales increasing to 67.  The gauge for foot traffic of prospective buyers came in at 47 which was a 5 point increase.  So, again suggesting an environment that is good and improving. 

Where we are going:

Clearly there is a change going on.  During the earlier years of the recovery of 2010 and 2012 the US was constantly referred to by investors (myself included) as the best house in a bad neighborhood.   Meaning the global economy was in such shambles and deteriorating that the safety of the US even in the face of massive monetary expansion (Quantitative Easing) and subpar growth was a good place to invest.   The rest of the world still appears to be shackled by the effects of the global financial crisis and an unwillingness to make structural reforms, take the asset write downs and fiscal belt tightening necessary to break free from its gravitational pull.  The overly generous social programs and employment protectionist policies are clearly hamstringing the EU along with budget deficits and sovereign debt levels that are still not being addressed aggressively enough.  European banks have been far too slow in writing down or off bad loans on their books and recapitalizing as the US banking system was forced to do.  Thus the financial system is still not functioning properly.  Then we have Russia now focused on expanding its sphere of influence coupled with an economy almost solely reliant on energy being penalized with sanctions that most likely will push it back into recession in 2015 if not sooner.   Now to China where the planned slowing and transitioning of their economy to one more focused on domestic consumption is proving tougher to manage than thought and now Hong Kong protestors have taken to the streets demanding their promised Democratic right to elect.  This should provide a little more unneeded drag to an economy struggling to maintain its footing.   The last two we’ll touch on is Japan and India.  Both have relatively new leaders that came into office promising reform, anti-corruption measures and moves to open their economies.  Japan’s Abe-nomics policies are still a work in progress.  Higher taxes must be forced through to pay down their massive debt levels while simultaneously attempting to stimulate and reinvigorate their economy.  So far so good but much remains to be done.  India’s new leader Narendra Modi also rode in on the reform cart.   India’s economy once thought to be a potential rival to the “China Miracle” is still bogged down by massive corruption which will take years to work through making reform much more difficult.   Their protectionist policies also make attracting the necessary foreign investments even more difficult.   We like what we’re hearing from Prime Minister Narendra Modi so we’ll be watching closely for investment opportunities.  

When it comes to allocating assets we think about 1. Low inflation. 2. An accommodative Federal Reserve.  3. Moderate and improving US growth.  4. Solid Corporate balance sheets along with increasing revenues and earnings. 5. Global Central banks fully committed to growth.  Because as Paula so appropriately put it, “ ‘cause when it comes together it just all works out”.    We’ll  maintain our aggressive exposure to the market but remain vigilant to any signs this minor correction morphs into something more and will be in contact should we need to take a more defensive posture. 

We thank you for your patience and confidence in these very challenging times. 

Yours in pursuit of the KWAN!

Investors Would Be Wise To Know When to Ante Up and When To Call

It was Bell X1 who muttered those famous words, “I’ll see your heart and raise you”.   I know former Federal Reserve Chairman Bernanke during the nadir of the financial crisis experienced a gut check and showed a lot of heart for investors, workers and his country when he took such extreme measures which up until then had only been theorized and written about in text books.   I have to admit he went further than I’d ever expected.  I recall many a conversation when discussing the tools and policy maneuvers available to the Federal Reserve stating, “ what are they going to do cut rates to zero?”  I was also know to utter, “well rates can’t below zero.”  I have to admit unashamedly I was wrong on both counts.  The Fed did indeed cut the Federal Funds rate to zero and the European Central Bank instituted a negative interest rate policy.   It wasn’t that I didn’t think they had the ability to do so, I simply laid my confidence on the ability of our elected officials coupled with a proactive Fed policy would be enough to stave off a near collapse of our financial system and economy.   The Fed Chair obviously was forced to shoulder the weight of turning things around due in no small part to the increasing dysfunction in DC that prevails today from our elected brain trust.  So, while the Fed has done most if not all of the heavy lifting up until now the game is not over but our hand is looking pretty good from where I sit.    Here at GSA we see a continuing and broadening out theme in the economy, strength. 

Where we are.

Institute of Supply Management Manufacturing-ISM Manufacturing.  The ISM released just Tuesday surged to a three year high of 59.0% the fifteenth month of expansion and highest since March 2011.   Digging into the report shows more reasons for optimism as the New Orders component ripped higher to 66.7% a ten year high.   Also, importantly the Employment Index came in at 58.1% the fourteenth month of expansion (a reading above 50 would reflect  growth)

Second Quarter GDP-GDP.  The first revision to second quarter GDP resulted in an uptick of +.2% to 4.2%.  In the report we saw corporate profits increased +9% and revenues popped over +4% very healthy for the quarter and ahead of analyst expectations.  This was of course on top of the first quarters negative reading of a -2.1% contraction which was impacted by severe cold weather.  

Leading Economic Indicators-LEI.  LEI rose +.9% for the month of July reaching its best level since 2007.  Positive contributors to July’s figures mentioned importantly for future prognosticators of growth, Building Permits and the continued fall in Jobless Claims.

Industrial Production-IP.  IP continued its rise in July up +.4% the sixth straight increase.  Automobiles lead the charge up +10.1% the best showing since 2009.  Year over year IP is reflecting a +5% growth rate the best since 2011.  We also saw Capacity Utilization ticking up to 79.2% leaving ample room below the 80.1% long term average utilization rate in order to absorb any future inflationary pressures. 

Housing.  Housing starts leapt +15.7% in July back above the 1,000,000  unit level to an annualized 1,093,000 run rate.   Broken down multi-family homes increased a whopping 28.9% while single family home starts came in with a very respectable +8.3%. 

Building Permits.  Permits, a great forecasting tool for future job growth and economic expansion sustainability  were up +8.1% the best since last April to a 1,052,000 annual run rate.  The level of demand continues to outstrip new supply by an estimated 600,000 just to keep pace with new household formations.  Perhaps more newcomers into the market are anticipated to be renters instead of owners leading to the strength in multi-family housing construction and permitting. 

Construction Spending-CS.  CS rose +18% in July nearly doubling street estimates and the largest jump in over two years.

Jobs- As of now we are awaiting the Weekly Unemployment Claims and monthly Non-Farm Payroll figures out Thursday and Friday respectively.  We are anticipating a drop of 8,000-10,000 in Claims and another good not great Payroll figure around +225,000-+230,000.

Where we are going.

As many of you know I cut my teeth in the industry working on the Fixed Income Institutional Arbitrage desks of Wall Street.  We studied among other things the yield curve, yield spreads, credit quality along with economic releases and Fed policy and their potential implications to maximize returns.   Way back then it was what I thought a bit more challenging with then Federal Reserve Chairman Greenspan who would purposefully obfuscate each Fed policy statement, which came to be known as Green-speak.  He once stated after a release in an interview, “if you think you understood what I was saying , you weren’t listening.” Flash forward to 2008 and I thought the new openness of the Fed would be a breath of fresh air and simpler.  Things however were changing so quickly on the ground back then though what was true yesterday had changed so dramatically the next as to render available information and policy statements virtually useless.  I bring this up as the Federal Reserve is two meetings away from exiting its Quantitative Easing program, the Grand Experiment as I refer to it as.   Many economists, analysts, Institutional managers and hedge funds believed QE would be a radical failure resulting in a cataclysmic collapse of our economy, financial institutions and markets.  We at GSA while wrong on how far monetary policy would be extended were correct in “never fighting the Fed” and believing in our core disciplines.   It is a mistake to believe the end of QE is a rate hike.  The Federal Funds rate will remain at near 0% for nearly a year after in our opinion, driven not solely by the US economy, but by external factors.  Remember, we are a global market participant and for now the largest.  In this global economy we must factor in the Euro-zone is barely keeping its head  and economic expansion above recessionary levels of growth.  Japan is still experimenting with Abe-nomics and experiencing uneven growth.  Russia’s economy will remain in recession for most of 2015 unless sanctions are repealed immediately.  China is in the midst of a “long landing” one of slowing overall growth while attempting to transition to an economy more driven by domestic consumption than exports as is currently the case.   In this environment the Yellen Fed will most likely not act  to hike rates with a hair trigger finger nor will Global Central Bankers cease to buck up as the stakes are just too high currently.  When the Yellen Chaired Fed does eventually get around to hiking rates it will be when we are on sounder footing which would support stronger consumption leading to higher Corporate revenues and earnings.   This will lead to the next leg of the rally one driven fundamentally without the training wheels the Fed has had to provide up until now.  So, when other investors are sitting idly by at the table “checking” as the Fed begins to shift monetary policy we may just have to ante up a bit before we show our hand.    

For now we maintain our aggressive exposure to the markets while monitoring the data for any signals to become more defensive. 

Thank you again for your patience and confidence in these very challenging times. 

Yours in pursuit of the KWAN.

James

 

Wall Street Tells Main Street It May Be Game Over For The Markets, We Say It's Game On

First and Ten.   The market rally is by some measures getting a bit late in the game.  Or so we’re told.  But when analysts look in the rear view mirror utilizing historical data for their projections there remains the great game changer and historical neutralizer, Quantitative Easing (QE).   Never has there been as much cumulative monetary stimuli thrown at an economic catastrophe as currently unleashed.   If only that were accompanied by any reasonable fiscal response the recovery would most definitely be much further along. 

First where we’re at:

The economic recovery is on soundly sturdier ground with momentum building for a continuation.   First quarter GDP was revised up from a -2.9 to -2.1% contraction while second quarter GDP clocked in at a +4% expansion.   Strength was witnessed nearly across the board.  As far as I’ve read no economist or analyst can explain the -2.1% contraction for the first quarter when taking into account all the supportive positive data point readings going into quarter end.   That first quarter reading may ultimately be adjusted yet again when final revision are made.  The second quarter snapback saw continued strength in all major data points we follow including both ISM Purchasing Managers Indexes, Industrial Production, Leading Economic Indicators, Consumer Confidence and of course Jobs.   On the last note July’s recently released Non-Farm Payroll figures came in at +209,000 down from June’s revised up figure of +298,000 but still notching the sixth  straight monthly gains above 200,000 jobs created.   Also within the report we see the workforce participation rate ticked up a notch to 62.9% which would suggest more people re-engaging the workforce as they become more confident in their prospects. 

If all is so good what’s the problem?   To borrow a Clara Peller-ism, “here’s the beef”:

1.The Eurozone.  The European economy is arguably almost a solid two years behind the US recovery.  The lag is partly due to former ECB President Trichet being asleep at the wheel on inflation watch as their economy was on the brink of seizure and in dire need of monetary easing.   The EU zone is under renewed pressure  from economic sanctions being imposed upon trading partner Russia.  As the EU is just barely emerging from contraction to expansion mode the Russian anvil is proving to be a heavy weight to bear.   Russia is not that much of an issue with regard to US trade however, it is a major exporter of energy and important trade partner in many areas of the EU economy.  The ripple effect those sanctions may have on the EU economy showing up on US shores is important.  The EU is an important trade partner for the US and any slowing in demand for our good directly affects US trade and growth.

2. The Middle East. The Middle East is en-fuego.   The US’ end to engagement in Iraq, Afghanistan and an unwillingness to directly engage in Libya and Syria resulted in a vacuum of power.  Right or wrong, knowingly or unknowingly the US left open the gate for natives and /or extremists to fill that void.   The geographical and political lines in the Middle East are literally being redrawn daily with each battlefield victory and defeat.   Any disruptions to trade and specifically oil could result in a super spike in oil pricing pressuring all assumption for global growth.  As for now, prices remain stable and have defied the turmoil and actually declined 4% over the last two weeks. 

Where we’re going:

US economic growth is gathering steam.  Consumers are more confident.  Corporate expenditures are finally ratcheting up after being near absent the prior three years.   Pent up demand for automobiles and housing is finally being released.  Unemployment is dropping while new entrants are taking high paying quality jobs.  Corporate revenues and earnings growth are both robust and steady. Energy prices are declining creating a wealth effect as an effective tax break for consumers.  All this while global monetary policy remains incredibly accommodative  One key for investors to take away from this last point, typically bull markets end with restrictive monetary policy, an extreme exogenous shock to the system or stretched valuations.   We can say confidently two of these three factors currently do not exist nor do we see either in the coming quarters.   So, ex the external shock to the economy or markets, the view here at GSA, which is not aligned with the street consensus, is it’s time to grab a beverage and a dog, find your seats and get ready for the third quarter kick-off because we’ve got plenty of game left here.   

Thank you again for your confidence and patience in these very challenging times. 

 Yours In Pursuit of The KWAN

James

This Market Rally Is Past The Bulls or The Bears, Now It All About the Monkeys

If only investors shared the wisdom of Mizaru, Kikazaru and Iwazaru they’d be much better off and wealthier.  From the Buddhists the translation basically comes down to refusing to allow one’s self to dwell on negative or evil thoughts.   We realize this is asking a lot from retail and even professional investors as with any market move higher yet another expert is predicting the impending doom and bear market looming.  In the current environment the ability to block out the noise and focus on the fundamentals clearly would lend towards a bullish tactical allocation and free ride to prosperity.

First to the Fundi’s:

Jobs: The Non-Farm Payroll figures released Thursday caught everyone off guard surging +288,000 where street economists were looking for a figure in the range of 205,000-215,000.  The three month average is no slacker at +272,000 also reflecting a continuing trend of strengthening job creation.  Hourly earnings also ticked up slightly to +.06. The “noise” in the number?  There remains in some circles questions about the quality of jobs being created.  Some say they are low paying and low quality.   It would appear to me anyone out of work for an extended period seeking work and finally able to find a job wouldn’t argue the quality.  As we know once employed and engaged the employed appear more attractive to suitors as well.   Also, looking through the report would argue this point of quality as well.  Professional and business services added 67,000 vs the prior 12 mo. Average of 53,000.  Healthcare added 21,000 to headcount.  Financials and Manufacturing added 17,000 and 16,000 respectively.   All showing stability and/or improvement as the economic recovery continues to broaden and become more inclusive. 

Leading Economic Indicators (LEI):  LEI increased +.5% in May after having posted a +.3% gain in April.  Nine of the 10 components were either neutral or showed gains while building permits were the one main culprit easing off a bit.  This figure again suggests continued economic expansion over the coming months. 

Housing: New homes sales spiked sharply in May +18.6% to 504,000 units the best in nearly six years.   Also continuing on the housing recovery theme, Existing Homes sales rose 4.9% to a seasonally adjusted annual run rate of 4.89 million in May up from April’s 4.66 million annual run rate.  The 4.9% gain was the best showing since August 2011.  Existing homes sales were benefitted by increased inventory and a slowing of price increases. 

Housing Starts came off a bit in May retreating to the 1 million unit annualized run rate.  Again some of the best numbers in almost six years.  Permits eased off also reflecting a soft patch in the multi-family sector but was somewhat offset by a rebound in single family housing permits. 

Industrial Production (IP): IP popped +.6% in May the third increase over the past four months and puts the twelve month average close to a +.4% rate of growth which would reflect a steady as she goes environment.   Capacity Utilization rose .2% to 79.1% still leaving a potential 1.9% of slack capacity in order to absorb any future inflationary pressures. 

Institute Supply Management Manufacturing (ISM):  ISM Manufacturing for June came out at 55.3% for June the 13 consecutive month of expansion for manufacturing and 61st month of expansion for the overall economy.  There was a bit of noise buried here in the report.  New order grew +2%, employment was flat as were inventories.  There was a bit of a slowdown in production and order backlog.  So, all in all a solid number and there could be some seasonality issues to explain the easing off the faster pace of growth. 

Institute for Supply Management Non-Manufacturing (ISM).  ISM Non-Manufacturing for June came out at 56% a slight slowing from May of .3%.  For the most part respondents were very positive.  With construction commenting on “the very strong environment”  Science and IT “Business outlook is good and steady” and from Retail “sales in many categories are improving partially due to pent up demand” which they anticipate carrying deep into the second quarter.   The negative draw came from Healthcare and Social Assistance citing reduced reimbursements. 

On the global scene we witnessed more signs of stabilization as well.   China’s official PMI registered in at 51% for June vs. 50.8 in May which was a six month high.   As well the HSBC Composite China PMI index (which is comprised of both manufacturing and services)came out at 52.4% for June vs. 50.2% in May.  Both figures suggesting continuing economic expansion in the world’s second largest economy.  Two camps have taken opposing ground as to China’s hard landing or soft landing (with regard to overall economic growth).   I tend to come down on the side of Peking Finance Professor Mike Pettis when he terms it China’s Long Landing.   The long landing appears to be playing out.  In the long landing China slows down lending or credit creation.  Economic growth contracts one percent a year for five or six years.  This scenario is bad but not disastrous  as growth would still be good not great and unemployment remains manageable.  The professor warns that banks and financial institutions constantly rolling over or extending loans to prevent default (going on currently) absorbs capital to spur growth and puts at risk support for future expansion. So, in his scenario the Chinese economy slows over time to a still healthy rate but doesn’t crash.  In the Eurozone the pace of expansion slowed a bit here posting a 52.9% rate of expansion in June vs. May’s 53.5%.  In the Eurozone PMI you need only dig into the details to see reasons for optimism as the New Orders Index jumped up to 53.1% vs 52.6 the fastest pace in three years.   One last look abroad to see the effects of Abe-nomics sees the Japanese economic expansion as reflected in the PMI at +51.5% for June vs. 49.9% in May.    This return to expansion mode is somewhat more positive than it appears after the large hike in sales taxes from 5% to 8%. 

Clearly the global economy is showing signs of stabilizing and in most cases expansion.   Fueled and aided in no small part  by global central bank stimulative policies and market activities.   This Central Bank support will have to end at some point.  The Federal Reserve continues to exit from its Quantitative Easing program, but remains nearly one year away from any interest rate hike.   The European Central Bank has just begun their earnest attempts to jump start their respective economies.   They have recently gone to negative rates (never thought I’d hear that one in my career) and may soon begin direct open market asset purchases.   Japan’s Central Bank remains full throttle open committed to growth policies and easy money.  China continues its targeted stimuli to stabilize growth while attempting to take some froth out of their domestic real estate market and prices.   Market tops and bear markets typically are a result of Federal Reserve monetary policy becoming more restrictive and/or conservative, clearly there is no signs of that shift taking place.

While it’s not time for the monkey and the dart board we do take our cue from Kikazaru and prefer to “hear no evil”.  Basically block out the noise, focus on the improving global economic fundamentals and maintain our aggressive exposure to the markets.  External shocks could shake us.  One we are keenly watching is the potential for a super spike in energy prices precipitated by a complete and outright civil war in the Middle East and a further deterioration of the fighting in Ukraine supported by Russia’s President Putin.  

 Earning season is upon us which we see filled with the potential for positive upside surprises as corporate guidance has been very conservative leading up to quarter end.   As we said for now we monitor these and other situations that may disrupt business and energy flows and maintain our posture to the markets wary for early signs to adjust positions and raise cash. 

Thank you again for your patience and confidence in these very trying times. 

Yours in pursuit of the KWAN!

It's A Yogi Berra Style Recovery & Market

Grand Street Advisors

Market Snapshot

June 2014

“A nickel ain’t worth a dime anymore”.  Huh?  Yogi Berra was a very good baseball player.  He was an excellent wordsmith.   Far too many hedge funds and ordinary investors in general have adhered to this Yogi-ism with regard to the US dollar and specifically equities.   Many have missed the market bottoming all the way up to recent near daily record highs being posted by the Dow Jones Industrial Index and the S&P 500.  Clearly this daily push to even loftier levels cannot go on uninterrupted.   When does it end and why?  Attempting to catch an absolute market top or bottom is a fools game and a recipe for failure.   When there appears to be signs of froth in valuations, smart investors begin taking profits and build a reserve to take advantage of any selloffs.  When fear and selling volume spike in a bear market or a correcting market, again smart investors begin dollar cost averaging into the market.   Going all in or all out doesn’t make for a solid investment strategy unless you’re playing Texas Hold-‘em.  

So, with the market continuing to plow ahead to all time record highs let’s take a look at where we are:

The US economy continues on a moderate growth trajectory with ISM manufacturing coming in at an expansionary +55.4, while Leading Indicators increasing +.4% in April suggesting  more of the same going forward.   Industrial Production dropped -.6% after rising +.9% and year over year is up 3 ½% which is consistent with our view of the expansion.   Factory Capacity Utilization dropped to 78.6% leaving 2.4% in excess capacity when measured against the long term average of 81%.   The vitally important Housing sector appears to be suffering from a few contributors.  1.Lack of supply.  2.Availability of credit.  3. Weather.  4. Affordability.   Some good news in the sector, home price increases have moderated along with the frigid temperatures and bank underwriting standards have eased.   While the recent housing data points are yet again, good not great, the tree in the forest we should focus on is building permits which augur future growth.   Permits rose 8% in April to a 1.08 million annual run rate the best since 2008.   We’re waiting for non-farm payrolls out this Friday but the real time employment index, weekly unemployment claims last week ticked down to 300,000 the lowest level since August 2007.  The trend lower in claims is solid and suggests stronger job creation in the months ahead.  We look for Friday’s non-farm figure to come in around 215,000-225,000 which again would continue the improving growth trend. 

Overseas we see the Chinese managed economy, with Central bank support in a bottoming pattern with growth around 7 ½-7.6% rate of expansion.   India is in a similar patter but a few percentage points lower at 4.5-4.7% targeted growth.   Japan is experiencing the desired effects of Abe-nomics with sales holding steady even after a substantial sales tax hike and growth stabilized.  Investors  wait for the promised structural reform to the Japanese economy that may finally break the grips of two decades of deflation and stagnation.    If the Asian economies are in fact bottoming this would provide a solid backdrop for US exporters and the global economy in general. 

To Europe, Thursday should provide interesting theater.   The Mario Draghi lead European Central Bank will unveil plans to jump start lending and the economy while fending off a Japan like era of stagflation.   They may hold off on a US Federal Reserve like asset purchase program, aka QE but they may be the first to go to negative interest rates in order to prod banks to improve lending.   Another arrow in the quiver is to provide long term low interest rate loans to Euro area banks to again provide the mother’s milk to any expansion, cheap funding. 

Back home the US experienced a disappointing first quarter contraction of 1% in the economy as expressed in the GDP figure.  The market was largely given a pass on the weak first quarter economic performance due to the effects of the frigid temperatures effects on consumer behavior.  At this point the second quarter is tracking at a +3.6%-+4.2% GDP rate of growth.  So, if we average out the two, we’re back close to a near 2% expansion with stronger growth anticipated going into the third and fourth quarters leaving us close to a 3% growth rate for all of 2014.   Tuesday’s release of Domestic auto sales showed strong demand across all brands pointing to an annual run rate of 16 ¼-17 million.  No matter how you look at these figures, robust, suggesting earlier weakness was indeed weather related.  We anticipate the Federal Reserve to hold the course on tapering their bond purchasing and make the cut from $45 billion to a combined $35 billion monthly purchases of US Treasuries and Mortgage Backed Securities.   The verbiage accompanying the Federal Reserve announcement to cut QE should also stay the course of “very low interest rates for an extended period of time” which we believe keeps current zero interest rate policy in tact into mid-2015. 

Against this backdrop of China, India and Japan economy bottoming, a newly aggressive ECB along with a still very accommodative Federal Reserve policy we maintain our aggressive posture to the market.  With regard to those prognosticating a resumption of the Bear market while watching the markets march to near daily and weekly new highs, well as Yogi put oh so well, “It’s like déjà vu all over again”. 

Thank you again for your confidence and patience in this very challenging environment. 

Yours in Pursuit of the KWAN

Putin Has Walll Street Investors Nervous But Patient Investors Should Look At Any Weakness As Opportunities To Add Quality Stocks

The Federal Reserve has not veered from tapering their bond purchases as they see continued gradual improving underlying fundamentals driving growth.  As for the robust recovery we’re all on the watch for, well it’s like Justice Steward said regarding porn vs. art “I’ll know it when I see it.”  The numbers can deceive sometimes but they never lie, so let’s get right to the digits. 

ISM Manufacturing PMI (PMI)- The recently released April ISM Manufacturing Index rose to 54.9% up +1.2% vs. the March release of 53.7%.   This was the eleventh consecutive month of expansion.  The report reflected a 55.1% showing for the new orders index. The employment component registered in at  54.7% a +3.6% increase.  Of the 18 industries  included in the survey 17 reported growth.  Respondents pointed to weather driven pent up demand being released in the US along with strong demand from Asia. 

ISM Non-Manufacturing PMI (Service Sector PMI)-The new Services Sector PMI came in at 55.2% a +2.1% improvement over March.  The business activity index climbed +7 ½% to 60.9% along with the new orders index rising from 48 to 58.2%.  The important employment component while still in expansion mode eased off from 53.4% to 51.3%. 

Leading Economic Indicators (LEI)- LEI for March jumped up to +.8% which is improved from February’s +.5%.  On a longer term view year over year the index is up 6.1% sharply up above the 2.3% annual average gain. 

Industrial Production (IP)-IP showed an increase of +.7% in March after February’s +1.2% gain.  For the first quarter as a whole IP moved up at a 4.4% annual clip.  Importantly Capacity Utilization (Cap-U) increased to 79.2%.  While improved the figure still leaves some slack  in the line to absorb any future inflationary pressures when they arise. 

Retail Sales- Retail Sales were up +1.1% from February and +3.7% year over year.   Strength was notable in autos and other motor vehicle dealers up +9 ½%.  Clearly we can see how strongly weather restrained sales earlier in the year and only now are being recouped.   We look for continued improvement along these lines as we get deeper into the warmer spring temperatures. 

New Homes Sales- An improving homes sales environment is a critical piece of this becoming a sustainable economic recovery.  Right now we’re getting mixed signals.  March’s new homes sales figures were a seasonally adjusted annual run rate of 384,000 below February’s 449,000 figure. Building Permits came in at a seasonally adjusted annual rate of 990,000 or 2.4% below February’s rate of 1,014,000 but up +11.2% year over year.   Weather and a choppy interest rate environment may have impacted the sales figures.   We’ll be watching closely.

Consumer Price Index & Producer Price Index (CPI & PPI)- Both CPI and PPI remain well below the Federal Reserve’s target of 2%.  March’s PPI came in at +.5% following a -.1% decline in February and +.2% for January.  Meanwhile CPI increased +.2% after rising +.1% in February.  Ex. Food and energy (cause who eats or heats their homes) the index rose +.2% also.  

Non-Farm Payrolls(Jobs)-Non-Farm Payrolls registered in at 288,000 for April.   Many, upon hearing this release thought this much better than anticipated figure would have sent the market rocketing higher.   As always the devil’s in the details.  The unemployment figure dropped to 6.3%.  Sounds good right?  Would have been if not for the 806,000 folks that dropped out of the labor force or referred to as the labor participation rate.   This followed an increase of the labor pool of 503,000 in March.   Clearly an uneven figure that make this monthly number extremely difficult to model.   Two issues may be driving the drop in the participation rate, baby boomers retiring and long term unemployed deciding not to attempt to reenter the workforce once long term extended unemployment benefits were not renewed.   Yet another reason for Congress and our President to strongly consider reforming current  Immigration policies.  Also, the average hourly workweek remained unchanged and the same was reflected in the wage component, unchanged. 

Going Forward.

The first four months have been frustrating to say the least.  First we contended with a little froth in the market as a hangover from the December rally.  After we regained our footing we received a polar smack down that sent consumers running for the comfort of their couches, toting popcorn and a good moving.  Again, we recovered as weather warmed, consumers thawed and corporate cap-ex kicked into gear.   THEN, just as we’re ready for the next leg of this rally to kick in, Private Equity firms  began the onslaught of garbage class IPO’s knocking the stuffing out of even good quality growth stocks as sellers overwhelmed buyers in a rush to raise cash for these “hot” IPO’s.  (After seeing many of these issues lose half their values it’s no wonder retail investors don’t trust Wall Street bankers and brokers). Still yet we recovered and pushed the indices to new record highs.  In the face of an all-out potential civil war in Ukraine instigated by Herr Putin’s land grab, we continue to hold near those market highs in equities.   Investor conviction is surely being put to the test. 

The Federal Reserve lead by Chairwoman Yellen continues the exodus from its monthly bond purchasing program or QE.   Most recently the Fed moved the monthly purchases down $10 billion to $45 billion and plans to be completely QE’d out by October 2014.  That is if there are no shocks to the economy either internally or exogenous.  External shocks could come  from 1.a hard landing in China as they try and manage their economy to a slower growth path while promoting domestic consumption simultaneously.  2. Japan’s Abe-nomics proves unsuccessful potentially leading to another massive stimulus jolt of QE and/or  a catastrophic sovereign debt default.  3. The budding Eurozone economic renaissance stumbles from its recent positive trajectory.  4. Russia cuts down on the flow of gas and oil to the Eurozone sending prices spiking creating a drag on growth.  5. Venezuela’s economy continues spiraling downward, inflations rise higher into the stratosphere accelerates and the country slides into a full out civil war rebellion.     

For now we remain fully invested as the market appears fairly valued with weakness seen as opportunities to purchase solid core holdings at times of market stress.   The EU financial system is writing off bad loans and investments.  After some prodding by regulators banks are recapitalizing leading to a healthier lending environment which should lend support for further progress in expanding the economy.   China’s economy while slowing some is in the process of trying to pop the real estate bubble  before it becomes to bubblicious.   Worker incomes are rising leading to increased domestic consumption while at the same time damaging export competitiveness.   A double edged sword they can live with since they sport a population in excess of 1 billion.  Japan’s Abe-nomics seems to be having the desired effects as consumption has held steady even after they raised sales taxes a full 300 basis points from 5% to 8%.   Most importantly the US cold snap has ended and the warm weather is beckoning consumers back outside.  There were very real fears that the consumer may have been tapped out and the first quarter slowdown was something more lasting and troubling.  Thus far this doesn’t appear to be the case with sales strength seemingly across the board and cap-ex picking up along with job creation.  As for the acceleration and sustainability of this economic recovery some investors can’t see the forest for the trees.  At GSA, well, we’ll just know it when we see it. 

Thank you again for your confidence  and patience in this very challenging environment. 

Yours in pursuit of the KWAN!