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
