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 16th 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!
