In Today's Markets Investors Need To Stop Swinging For The Fences And Focus On Fundamentals

Any Conversation these days needs to begin with the phenomenal run the KC Royals made to winning the World Series and becoming the 2015 Champions.  They kept at it.  Overcame sizable obstacles, long odds and yet persevered.  Similar to the US economy and markets.  The odds of a total financial collapse were high.  The resolve, flexibility and commoditization  of the US work force were questioned. Yet here we are six years later.  We too just refused to tap out. 

The US economy continues to run at below historical trend levels of 2 ¼%-2 ½%.  Perhaps this is just the new normal until the next technological breakthrough.   Perhaps we are now all benefiting from our last breakthrough and rounds of massive investments in software and technology.  Consider the average age of an automobile on the road these days is 11 ½ years old up from the historical norm of 8 1/2.  The refresh cycle for computers is now closer to four years up from two.   New drilling techniques (fracking and horizontal drilling) require far fewer workers and equipment to extract ever larger quantities of oil and gas.  There are many more examples such as these that are allowing companies and consumers to do more with less.   This year the US economy is adding in excess of two hundred thousand jobs per month.   Pretty solid but not enough to spark any real wage inflation.  Again, we must pose the question are we simply seeing the benefits from prior investment cycles?    First let’s see where we are currently.  

Jobs.  Non-Farm payrolls caught the street by surprise Friday when reported by exploding higher tallying +271,000 where most analysts had anticipated an add of +139,000.   There were revisions to the prior two months that tacked on an additional twelve thousand.  There was other good news backed in here as well as average hourly earnings ticked up +.4% which gives us a +2 ½% gains over the past year.   So, looking at the new three month average we are creating 187,000 jobs per month, good just not great but just maybe enough room to allow the Yellen Fed to hike interest rates that first ¼%. 

Leading Economic Indicators(LEI). LEI registered in at a -.2% for September after flat readings the prior two months.  This figure while slightly negative still suggests more of the same 2 ½% growth.  The big drains from the stock market sell off , manufacturing and housing permits were somewhat offset by gains financial indicators, drops in unemployment claims and consumer expectations.   We look for this figure to return to the plus side in the next monthly release.

Purchasing Managers Manufacturing Index(PMMI).  PMMI for October came in at +50.1% ( a reading above 50 reflects expansion) which just barely leaves us in expansionary territory but is still the 34^th consecutive month of expansion.  There were some highlights such as the New Orders Index increasing +2.8% to +52.9%.  The Production Index also added +1.1 to +52.9%.  The New Export Orders added +1% +47 ½%.   Some low lights also as the Import Index dropped 3 ½% to 47% which may not be a bad sign.  Slower imports allows US companies to run down that stockpiled inventory build witnessed earlier in the year which bodes well for future restocking.  Commentary from respondents were fairly positive:

*Paper Products and Chemicals “saw steady demand with sales impacted by the strength in the US dollar”

*Transportation “business is picking up”.

*Electrical Equipment, Appliances and Components “sales becoming more consistent”

*Machinery “some level of slowing but activity acceptable”.

Purchasing Managers Non-Manufacturing Index(PMNMI).  The services sector is booming as PMNMI popped +2.2% to +59.1% reflecting strong growth and the 69^th consecutive month of expansion.  Activity is accelerating.  Positives abound here.  The Business Activity Index registered +63% or +2.8%.  New Orders also had a strong showing +5.3% to +62% and lastly the employment Index inched up +.9% to +59.2%.  Since non-manufacturing accounts for nearly 90% of US output this was a very pleasant surprise. 

Housing.  Housing starts jumped 6 ½% in September to a 1.2 million annual run rate the best in nine years.  We are seeing definitive signs of a strengthening and sustainable pick-up in demand that has seemed so elusive during this recovery.  On permits we dipped a bit, -.3.  On a year over year basis starts are up over 17% and permits +4.7%. 

Industrial Production(IP).  IP inched down in September by -.2%.  No surprises here as mining was the big drag -2% and manufacturing output -.1%.   However, looking at the third quarter as a whole doesn’t paint such a bleak picture as IP rose at a +1.8% annual run rate lead by strong gains in motor vehicles and parts.   Capacity Utilization came off some (no surprise) down -.3% to 77 ½%.  That utilization rate is 2.6% below its long run average.  This can act as a buffer for any surges in future demand and potential inflationary pressures. 

Inflation (CPI,PPI).  Inflation remains the fly in the Feds Ointment when it weighs whether to hike rates or not.  The Federal Reserve stated target is a 2% rate.   The headline Consumer Prices Index or CPI figure is right at zero with the core (ex-food and energy) +1.9%.  Producer Prices Index or PPI dipped -.5% The biggest drops were in Final demand goods-1.2% with over 80% of the drop attributable to energy.  Ex-food and energy the core figure was unchanged. 

Where We Are Going

Central Banks.  Who will blink first?  The US economy is surely able to withstand a ¼% interest rate hike.  Since we live and operate in a globally linked economy that rate hike comes with risks and consequences.   We appear somewhat handcuffed by those links to Foreign Central Bank policies.   We've seen US corporate revenues and profits negatively impacted by the rise of the US dollar.  Should the US moved forward unilaterally raising rates while the European Central Bank, The Bank of Japan, Brazil, China, Russia and India continue easing rates or merely holding steady on policy this dollar strengthening will continue further negatively impacting the sales and  competitiveness of US exports.  This trickles down to lower exports, lower US corporate revenues, less demand for US workers and could potentially tip the scales in favor of the beginning of the next recession.  It’s this potential downward spiral that I believe keeps Fed Chief Yellen up at night.  I believe she’ll wait as long as possible without hiking rates but will feel pressured to move lest she lose the markets confidence.  That being said I believe she will not need to move alone.  I see the Bank of England in a concerted move along with the US Federal Reserve make that first ¼% point hike in December.   The markets are still grappling with what the implications of the first hike are.   The Federal Reserve communicating their strategy clearly will be pivotal.   Reinforcing their plan for a long, slow, drawn out time frame for “normalizing” rates will go a long way in easing investor fears of any dramatic policy shift which will benefit investors and the economy. 

Now is not the time to be overly aggressive, take big risks and swing for the fences.  No, it’s a time for lumber on leather.  Keep the line moving.  Take our singles and doubles knowing over the long haul we’ll all be winners.  For now we maintain our aggressive posture to the markets remaining open to the next catalyst to dictate market direction. 

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

From Wall Street Traders To Main Street Investors Fear Shouldn't Be The Great Generator Of Ideas There Are Better Times Just Right Ahead

With all the angst generated by elevated anxiety from a potential .25% basis point (1/4% of 1%) rate hike we at GSA have to wonder have investors been captured or corralled into the Federal Reserve’s Habitrail?  Have investors been abandoning all common sense and reason, trading kneejerk style at every and any Federal Reserve headline, statement or missives.  Unfortunately, we believe the recent trading activity suggests too many investors are getting caught doing just that.  We were all in one global easing mode module content to take on risk and invest across a broad spectrum of assets of varying quality.  Then, the Federal Reserve added on a tube and module, baits it with some tightening talk and many investors go stampeding through exiting their home base and core investment principals fearing they might miss out or there might be something better on the other side.   I’ve found out over the years those who stay true to their long term disciplines, in times like these tend to have a lot less competition picking through the scraps tossed aside during panic selling leading to successful outcomes.  

Where We Are.

Gross Domestic Product(GDP). The US economy clearly regained its footing in the second quarter as GDP was revised up to +3.7% coming off the first quarters +.6% showing.  The third quarter currently appears to be trending towards +3% rate of growth helped by strong demand for housing, auto’s, aerospace, retail sales along with a resilient level of consumer confidence.  Estimates for the fourth quarter stand close to +3.5-+4% which would see us exit 2015 at a +2.7-+2.8% level.  Good not great but a solid foundation heading into 2016 where GDP is targeted to expand at greater than 3% barring another polar blast or government shutdown. 

Leading Economic Indicators(LEI). LEI in July registered -.2% after a fairly robust June reading of +.6% and May’s +.6%.  This minor setback against the fallback of the prior two months strong readings would suggest we remain in a Goldilocks environment, not too hot not too cold and steady as she goes mode.

Purchasing Managers Manufacturing Index (PMMI).  PMMI came in down 1.6% to +51.1%.  Across the board respondents were positive.  Food and Beverage noted the positive impact from falling oil prices.   Transportation pointed to the strong demand but a bit of softening.  Computers and electronic pointed to the headwinds created by the stronger dollar which has since stabilized from the reporting period.  Machinery saw heavy demand from the automotive industry upgrades to equipment.   Lastly Furniture and related products pointed to strong business (see impacts from housing) while finding labor remains a challenge.  So, we may be seeing a bit of softness in the headline figure but the underlying businesses appear on solid footing and well above the 50% break even level. 

Purchasing Managers Non-Manufacturing Index(PMNMI).  PMNMI rang in at a very strong +59%.  Arguably since non-manufacturing or services accounts for 90% of the economy this should have a heavier weighting in our view.   We saw strength across the board here.  Business activity index +63.9%.  New Orders Index +63.4%.  Employment Index +56%.   By sector.  Healthcare noted “overall business is increasing”.  Construction seeing business as “good and no signs of any slowdown”.  Retail trade stated “ business and our market sector continue to be strong with continued growth and stability”.    Again a very solid showing. 

Industrial Production (IP).  IP popped to a +.6% the highest level since November.  Again here we see how the strength in autos contributed +.8% in manufacturing.  Capacity Utilization rang in at +78% up +.3%.  This improved level still leaves an ample 2.1% below its historic average of unutilized capacity to act as an inflationary buffer. 

Inflation.  No matter which indices or indicator utilized as a proxy all remain in favorable territory.  All remain below the Feds stated 2% target rate.  Many remain fairly stable, that is ex-energy.  Energy costs are down substantially.  So, we look to the core or figures ex-food and energy which tend to be the more volatile components.  Core PCE is up a very tame 1.2% year over year.  So, again I ask what is the rush by the Fed hawks to hike rates?

Housing.  Housing starts ticked up +.2% to a 1.206 million annual run rate in July.  On a year over year basis starts have increased +10.1% and permits are also up strongly +7.5% which bodes well for the upcoming quarters. 

Where We’re Going:

In order to assess where we’re going we need to understand how we got to where we currently are.  The recent market sell-off has many investors confused, was it due to a potential Fed rate hike?  Was it the well telegraphed slowing of the Chinese economy?  Is there an end to Global Central Bank QE?  I would say the following; 1 Overblown.  2. Well known. 3. A resounding NO.  I would also add to this great debate.  Could causation be, as opposed to the Amaranth Advisors collapse ($10 billion Hedge Funds bet large on an increase in natural gas prices) in which one firm bet big, bet wrong and lost/collapsed that currently far too many Hedge Funds with hundreds of billions  have entered into the same commodity related bets and are getting decimated?  This would help explain large unexplained selling as redemptions requests pour in along with margin calls being executed.   A few recent casualties.  A Carlyle Group(considered some of the more savvy investors by many) related fund saw assets fall from $2 billion to $50 million.  Another $650 million Hedge Fund Armajaro Holdings closed down after values fell precipitously in the first seven months of the year.   These are just two of the most recent that closed but the list of closures is long and the dollar amounts large, at least they were at one point. 

Taking a view from ten thousand feet above we see China’s economy is slowing to a targeted 7% rate of growth +/-.  This slowing also pressures the exports of their trading partners mainly its Asian neighbors and markets of Japan, Taiwan, Australia and Korea among others.  But, as we broaden our view we have to factor in the effects of the rebounding economies of India +7%+, a rebounding UK and Euro Zone that may finally break above a 2% growth rate in 2016.  Honing our focus over to the US, still the largest economy in the world, we see 2015 growth accelerating 3%+ into 2016 relying primarily on the domestic consumer which still accounts for 70% of demand.

I believe we experienced the recent sell off for the following reasons. 1. Seasonality.  Many professional trades/investors take vacations at this time of year before sending kids off to school.  2. The markets were fairly valued, not cheap not expensive at 18x earnings awaiting a catalyst to drive direction.  Energy’s volatility and collapse provided one catalyst.  3. China devalued the Yuan.  4. Crowded commodities related trades gone wrong experiencing forced liquidations. 

If correct we should see a continuation of the ongoing bottoming process the markets are attempting succeed.  This should be followed by investor refocusing on corporate and economic fundamentals.  The US is creating 200,000+ jobs a month or close to 2 ½ million annually.  Inflation is benign.   Global economic growth is slowing incrementally but is stable and could resume to faster growth as we look into 2016 an 2017.   Global Central banks even if the Fed hikes rates by the ¼% are incredibly stimulative and show no signs of abruptly ending QE or hiking rates.  This backdrop would pose US and European equities in a very attractive light.   The current market gyrations may be with us for a bit longer but when the time come to move we won’t be with the crowd wondering “who took my cheese”  and we won’t get caught on any tread wheels either.  We’re looking for our next opportunities now so we’ll capture the next leg higher when it comes.  For now we maintain our aggressive posture to the markets remaining open to the next catalyst to dictate market direction. 

Side note: Someone much brighter and more clever than myself once stated “the bear market enthusiasts have correctly predicted 30 of the last 11 bear markets”.  Always keep this handy as we never can tell when one of those experts may find a podium or platform so they can take a shot at their fifteen minutes of fame, again. 

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

Investors Must Remember Not To Be Symmetrical Thinkers

Many years back while living in New York an interesting situation took place in one of the tunnels connecting New Jersey to Manhattan that’s stuck with me these many years later and taught me invaluable lessons on life and investing.  A tractor trailer driver was attempting to cut out the traffic of the bridges and take the midtown tunnel which more or less was the more direct route to his destination.  Unfortunately for the driver he didn’t take into account the height clearance of the tunnel relative to his rig.  Needless to say he at first screeched and scraped the tiles from the tunnel ceiling before eventually grinding to a halt.   Now with traffic all backed up and the ever patient New York taxi drivers and civilians shouting helpful hints and leaning on their horns in order to help facilitate his escape the police and fire department turned up on the scene along with city engineers.   One after another they circled and surveyed the situation seeking a possible solution to unclog the tunnel.  One after another they’d toss out potential solutions and one after another they’d systematically be dismissed.  Finally as a passenger vehicle was inching by a child yelled out, “why don’t you let the air out of the tires”?  Their vehicle was waved by and suggestion dismissed.  Except by one engineer who had heard the child did exactly that freeing the truck.  Which inched its way through the tunnel freeing up passage once again.  There are many lessons to learn here.   I took with me the following: 1. Never be dismissive of anyone.  2. Experts are at times self-anointed or peer anointed which means they may share a similar thought or learning process. 3. Don’t be a symmetrical thinker. 4. Perhaps the most important of all, listen when people speak. 

These takeaways or skills seem most in need these days when parsing Federal Reserve Chair Janet Yellen’s Fed speak along with the attempting to anticipate the trajectory and future direction of the markets.   Investors both individuals and professionals alike are searching for clues in each and every headline from each and every country.  We have to ask ourselves are we missing the forest for the trees.   Are we looking too closely at Greece and whether they exit the Euro currency?  Are we watching China’s growth hitting stall speed of 7% growth?   Are we that frightened the Federal Reserve may hike short term interest rates from the near zero percent all the way up to a growth crippling .25%?  Can the costs of gasoline, heating oil, natural gas being cut in half be a bad thing for consumers?   You get the point.   Investors need to take a breath, step back and take a bigger and longer term view of where we are, which still appears to be more of the same, a good not great growth story with  very accommodative Global Central Banks offering very cheap and attractive financing.    But first, let’s see what our indicators are saying:

Gross Domestic Product (GDP).  The initial reading of second quarter GDP was released last week at +2.3%.   Along with this reading we received a new final revision to first quarter GDP which went from -.2% to +.6% due to new seasonality methodology calculations.   These seasonality adjustments perhaps made the first quarter figure appear a bit healthier while shaving off a few tenths from the second quarter figure.  Still, we saw a nice snap back from the dismal first quarter showing while reinforcing where we are currently.  Which is, a ham on rye recovery, in other words nothing exciting here.   We remain in a good not great mode which leave the Federal Reserve plenty of flexibility with interest rate policy. 

Leading Economic Indicators (LEI).  LEI scored another solid showing coming in at +.6% in June.  One big positive contributor came from Building Permits which bodes well for future growth.  The strong showing in LEI suggests continuing economic expansion into second half of 2015. 

Housing.  Housing has been the sleeping giant of the US recovery.  The recovery is showing signs of taking hold.   New home construction rose to a 1.17 annual run rate, the best sing 2007.  Multi-family dwellings popped +29.4%.  Permits for both single and multi-family housing climbed to an eight year high.  These figures are, no doubt supported by an improving employment environment and very low and attractive borrowing costs. 

Purchasing Managers Manufacturers Index (PMMI).  PMMI for July registered +52.7% down from the prior months +53.5%.  This report was mixed with strength witnessed in New Orders up at +56.5%, the Production Index at +56.5% offset by a softening in the Employment Index at +52.7%.  We saw big drops in prices, raw materials and inventories which was to be expected.   We keep in mind any reading above 50 suggests growth and expansion.   Comments from respondents pointed to optimism mixed in with concern over international markets and the sharp drop in oil.    All in all a good number, just not great. 

Purchasing Managers Non-Manufacturing Index (PMNMI).   PNMNI has not been released as of today.  Expectations are for a minor retracement from June’s +56% reading of .25%- 1% to +55% - +55.75%.  While a bit softer the same holds true, solidly above the 50% breakeven level.  We’ll have to wait for the actual reading. 

Inflation.  Where is it hiding?  The more commonly quoted PPI and CPI reflect a modest to low inflationary environment.  With the collapse in energy, minerals, agriculture products and basically all commodities, I’m fairly confident the Federal Reserve is relieved to not be fighting a 0% or deflationary scenario.   On the plus side, wage inflation tallied a +1.7% rise year over year reflected in the Feds preferred inflationary gauge the Personal Consumption Expenditure Index (PCE).  Cheap gas + cheap energy in general = MO’ MONEY!  And makes happy consumers.  To borrow a Martha Stewart-ism “That’s a good thing”.

Jobs.  The monthly jobs figure, Non-Farm Payrolls is out this Friday.  July’s figure is anticipated to show a gain of +215,000 jobs created after June’s +223,000 increase.   Boding well for this indicator is the real time weekly unemployment claims figures which remains under 270,000 for the last two readings.  The four week moving average registering in at 274,750.  Interestingly( I think so anyway but I get nerdy for numbers) unseasonally adjusted claims look even better totally 230,430 down -12.4% from the prior week.  So, we may be in for an upside surprise in jobs created in July.   More employed folks feeds into increased demand for goods, homes, autos, Nike’s, I-watches etc., which spurs companies to invest capital to capture that demand which now would complete our much sought after self-sustaining cycle.

Where we are going:

We’re in the heart of earnings season and so far a pretty good showing.  Seventy one percent of companies having reported have beat earnings estimates.  The rate of growth is coming out better than anticipated as well at +4 ½% vs. warnings of a decline by analysts entering this reporting period.  M&A activity has been ongoing at a healthy clip.  Weighing on S&P 500 earnings is no big surprise energy, mining companies and the supporting groups.  Leading the way has been biotech, financials, healthcare, technology and housing related industries.   What is restraining the markets march higher?  Much can be attributed to seasonality.  Many families take a quick vacation before sending the little ones off to school.   Federal Reserve policy meetings will have sandwiched around August with the next meeting not scheduled until September.  With a market that has a laser focus on commas missing from a Fed statement this time frame I’m sure seems like an eternity.  The route in energy and commodities.  While this huge tax break like effect for consumers, these lower prices are seeing major staff reductions in the tens of thousands from energy and mining companies alike as they cut expenses to, in some cases stay afloat.  The oil and energy markets need to stabilize for the overall market to advance.  Plain and simple.  Big gyrations have exaggerated effects in investor psyche and in turn ETF, I-shares and Mutual funds liquidations causing dislocations in the markets.  Market valuations.  The market currently, I believe neither rich nor cheap.  We need a catalyst to break us out of the range we’ve been trading in.   Expecting anything useful out of Washington is wishful thinking I’ve come to realize.   Thus whenever the market has a hiccup they point to the failings of the Federal Reserve policy.   Make no mistake, absent any semblance of fiscal leadership in DC these last seven years, without the Federal Reserve’s bold resolve we would not be within spitting distance of near record highs on all equity indexes.   I believe we will begin the witness the wealth effects on consumers of the collapse in energy prices.  Estimates put the annual savings from the drop just in gasoline of an additional $800 to $1,200.00 in consumers’ pockets.   It takes a while for this wealth effect to kick into gear.   Once consumers feel these lower prices are here to stay they will get back to their insatiable need to treat themselves after having to tighten collective belts for so long.  We also see strength and accelerating growth coming to the Euro-zone.  Now that Greece is off our radar we can shift our glance to the other players.  Players that took their austerity medicine that Greece seems to have no taste for, Ireland, Spain and Portugal to name just a few.  These countries implemented the tougher policies, liberalized their employment regulations (as much as a Euro country can) and have some of the strongest growth rates in the EU zone which may hit a 2% annual growth rate this year.   With growth comes demand which feeds domestic production along with exports which feeds into further growth and prosperity.  The Eurozone returning to moderate growth added to India finally beginning to hit high gear and China slowing to a 7% annual growth rate may just be the catalyst that breaks us out to the upside which is where I see us moving.  For now we maintain our aggressive posture to the markets butlisten intently to the experts calling for the markets imminent correction yet again, remaining open to any sane data source no matter the origin that argues for a continuation of the now six plus year old rally.

Of Note:

I’ve been asked why I follow various indexes.  I want to share my answer.  These indicators I follow give a broad based view of how the economy is doing at a snapshot (one month) in time.   One of the most reliable I follow is the ISM Purchasing Managers Manufacturing Index.   The PMMI has a solid track record.  Since the recession ended we’ve had a positive reading seventy of seventy two times.   Dating back to 1948 spanning eleven recessions the PMMI averaged 43.1% during the recessions and 54.7% outside a recession.   There have been times during this period when the index dipped into contraction mode but it was mainly due to an external shock such as the collapse of Long Term Capital Management, Korean and Vietnam wars and the Russian debt default. Overall the index has been in contraction nineteen percent of the time outside of recessions and eighty seven percent during recessions.   Since market sell-offs are associated with recessions this indexes recent positive reading continues to give us comfort we are on the right side.   

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

Are The Chicken Little's Scaring Wall Street Investors Or Is There More Room For This Bull To Run

Today’s Henny Penny’s continue to cry “the sky is falling, the sky is falling” or more rightly the Euro’s falling, The Shanghai Index is Falling, “let’s go tell the king” or in our case Janet Yellen.  So, should we perk up our ears and bolt our doors every time these modern day Chicken Little’s find a podium, soapbox or blog to bloviate from? Here’s an alternative thought let’s look to our economic indicators we follow at GSA to see if there really is any indication of an imminent economic contraction portending a recession. 

The discussion ongoing among analysts, economists and traders on Wall Street surrounds interest rate policy.  I must admit in the past I’ve fallen victim to group think, specifically around when must the Federal Reserve hike and begin to normalize rates.  This should introduce to the discussion why the Federal Reserve hikes interest rates.  Put very simply, interest rates are a reflection of money supply.  Better known as M1, M2 and M3.  The Federal Reserve eases or lowers rates by pushing more money into the system, lowering rates making it cheaper for consumers and corporations to borrow, expand and possibly stimulate employment.   The Federal Reserve will raise rates or extract funding from the system when the economy seems to be running hot or above trend and inflationary pressures appear to be coming to a boil.  This is the ultimate simplistic explanation of what drives Federal Reserve Monetary policy.  It does not enter into the discussion the exponential effects it can have on currencies strengthening or devaluations.  It does not take into account the Federal Reserve being the lender of last resort and periodically needing to break out “the bazooka” (a Treasury Secretary Paulson term) to stave off catastrophe when our fearless elected officials are incapable of legislating fiscal policy.  The bad news, we’ve been stuck in the latter for the last seven years.  Thank you President Obama, Congresspersons Boehner and Pelosi along with Senators Reid and McConnell and basically any incumbent that’s had their snout in the trough feasting on the public during this time frame.  Job undone.   

The reason this discussion arises now is the “experts” are all fretting about when the Fed will begin hiking rates and the ensuing demise of the US economy taking the markets with them.  The conventional discussions conclude the Fed must hike immediately so they have some flexibility to ease should the economy lose its footing and slip back closer to recession at some future point.   This is the growing thought majeure on the street.  My experience is succumbing to group think and pressure tends to lead to bad outcomes.  At GSA, contrary to the street view, we do not anticipate any aggressive shift in Federal Reserve policy for the remaining quarters of 2015.  Here’s why.  1. The US economy is in a good, not great growth trajectory.  2. The EU is in early recovery mode whose economy is anticipated to expand at a 1 ¾%-1.9% rate.  3. China’s economy is in transition from one being export driven to one more reliant on domestic consumption with estimates of growth at 6 ¾%-7%.  4. Japan is clawing its way back from near twenty years of stagnation and may finally have found it’s footing while also registering a good not great growth rate of 1 ½%-2%.   At a time of obviously modest but improving growth, cheap labor along with an explosion of cheap energy supplies, in GSA’s opinion, one needs to question conventional wisdom on the necessity to hike rates both soon or aggressively.   Before we get too deep though, let’s check those stats for the real story:

Jobs: The Non-Farm payroll figures released last Thursday tallied +223,000 new jobs in June with the unemployment rate falling to 5.3%.  There were negative revisions to the prior two months shaving off 62,000.  Also released Thursday was the real time labor indicator the weekly unemployment claims which came in at 281,000 an increase of 10,000 from the prior week but still solidly below 300,000.  The four week moving average was also camped comfortably below 300,000 at 274,750.  These levels seem to coordinate well to continued monthly job gains of 200,000+ and +2,400,000 annually. 

Leading Economic Indicators(LEI). LEI jumped +.7% last month.  This was the second monthly +.7% gain in a row.  The strength  was broad based with Building Permits a standout for future indications of growth. 

Purchasing Managers Manufacturing Index (PMMI). PMI for June expanded to +53.5% for the seventy third consecutive month.  This was an increase of +.7% over May’s +52.8%.  Strength was reflected in the New Orders Index, The Production Index and Inventories.  Front and center the Employment Index came in at +55.5% up +3.8% from the prior reading of +51.7%.  Solid reading.

Purchasing Managers Services Index (PMSI). PMSI registered in at +56% an increase of +.3%.  We saw firming in the Business Activity Index at 61.5% a full 2% rise and the New Orders Index at +58.3% up +.4%.  On the flip side the Employment Index slipped but stayed in expansion mode at +52.7% well above the 50% line. 

Housing.   Another bright spot on a slightly overcast market.  New Homes sales were up +20% to the best levels since 2008.   Pending Home Sales ticked up +.9% the best levels since 2006.  Lastly Existing Homes sales jumped as well +9.2% year over year.  Solid all around.

Gross Domestic Product(GDP).  We received the final first quarter GDP reading and while still negative was generally well received.  First quarter GDP was revised up to -.2% from the prior -.7% reading.  The first quarter was negatively impacted by another severe arctic blast coupled with a union sponsored shut in of the West Coast docs choking off any imports as well as exports.   Those clouds appear to have dissipated as the just closed second quarter appears to be tracking +2 ¾%-+3 1/4%.   Another nice bounce back but not great in the bigger picture. 

Where We Are Going:

Frankie Valli penned today's mood perfectly, “Greece is the time is the place is the motion and Greece is the way we are feeling”.  The markets behavior flip flops on the great unknown.  Namely, what happens if Greece throws in the towel  or is kicked out of the Euro-zone and Euro Currency.  The dotted line, I’m sure originated from Greece sources point to a Lehman-like catastrophe.  Hardly.  Lehman’s cataclysmic effects ruptured our financial system due to exposure to counter-party risk related to Lehman’s equity, bonds, options, repo lines, swap lines, credit default swaps etc.  The largest institutions with exposure to Greece aside from Germany ($95 billion) are the European Central Bank, Sovereign Central Banks, and the International Monetary Fund (who’s largest contributor happens to be the US).  So, while those socialist leaning talking heads congratulate the Greeks on being “bold” and “courageous”, know it is the US taxpayer paying for the Greek reckless overspending and social policies.  Interestingly, this comes at a time the US is finally acknowledging our own inability to afford our Social Security Insurance and Medicare programs.  Courageous is certainly not the work I’d have chosen.   

The global economy remains in an uneven recovery or stabilization mode.  The US, India, Japan and the EU are in recovery mode searching for firmer footing most likely to be found in thus far elusive fiscal policy.   While China, Russia and Brazil are finding that talking about growth policies and strategies are as useful as a bottle of Beam, a rock glass and one ice cube in Hades.   It’s just not enough.  In this environment of stagnant and below trend growth an argument to raise rates in 2015 is just a harder one to make.  There is little doubt the global rally in equities, real estate and fixed income is built upon the unprecedented stimuli or liquidity provided by global Central Banks.  The immediate risks lie with pulling away the punch bowl too early and choking off the economic and asset recovery.   Doing so may cause a backslide into a recession and a plunge in asset prices mirroring Japan’s 20 year slog.  Clearly when it comes to any adjustments to monetary policy, for now anyway, less is more and Chairwoman Yellen seems to agree.  So, the next time you hear those talking heads prognosticating about the end of this bull run, think like those Cows posted on the highway billboards and “Eat Mor Chiken”. 

We are cautiously optimistic as we enter earnings season.  Should earnings and guidance not meet our lowered expectations we’ll look to move to a more defensive posture and raise our cash allocations.

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

Yours in pursuit of the KWAN.

Wall Street Says Nyet To The Ouzo Just Yet But The Risks Too High To Just Sit This Market Out

Is it time to get ready for my great big fat Greek default?  The window to closing a compromise deal between Greece and the EU is closing fast.  The Syriza party has successfully boxed themselves into a corner.  The party took control with the promise of austerity abolition.  I mean who wouldn’t like having their debts forgiven?  Can you imagine opening up your Amex or Visa bill and seeing your amount due $0.00 when you know you’ve been feasting on caviar, Kobe steaks and lobster having just returned from the trip you took on a chartered jet?  Heck I’d vote for that too.  Unfortunately you and I can ask Visa and Amex for a redo all we want and we’ll get the same response Greece is getting from the EU.  Nyet!

China may be shaping up to be our next NASDAQ laden tech bubble about to burst.  Nearly seventy percent of mainland stocks are trading at near fifty times earnings, and that’s if we can rely on their unaudited financials.  Margin borrowing is exploding up to $258 billion vs roughly $52 billion a bit over a year ago.  All at a time China is orchestrating a soft landing for its economy with growth struggling to find its footing and achieve a 7% rate of growth.  At least it sounds a little bubble-icious to me.  Now to add a bit of balance and be fair there is some good news going on.  Even at China’s slower rate of growth it would create an economy the size of Spain every two years.  It would create an economy the size of Italy every three years.  Still pretty impressive.   Since we’re talking about growth let’s see where the US, still the Big Kahuna currently stands. 

Gross Domestic Product-GDP.  US GDP for the first quarter of 2015 came in with an anemic +.2% rate of expansion.   Most are willing to look through this quarter as being severely impacted by weather and importantly the West Coast ports being shut down by the dock workers union.  The effects of this shut down also was reflected in the just recently released trade deficit which ballooned 43% from the prior reading to $51.37 billion. These events combined effects make it very difficult to get a reading of where we really stand.  So, we at GSA do not write this off until we see evidence that the economy will be able to rebound from this terrible reading. 

Jobs.  The Monthly jobs figure is scheduled to be released this upcoming Friday morning and the analysts range is for +200,000-+245,000.  The real time employment indicator, the weekly unemployment claims figures support a rebound in the jobs figure from March’s dismal reading of +126,000. We believe the weekly claims figures suggest a strong rebound and an upward revision to March’s release.  We’ll be watching closely. 

Leading Economic Indicators-LEI.  LEI for March ticked up +.2%.  LEI has reached some pretty lofty levels of late.  The rate of expansion reflected in the most recent releases point to a more moderate expansion going forward. 

Factory Orders.  US Factory Orders rang in at +2.1% after seven monthly declines.  The figure was helped along by a  13 ½% jump in transportation equipment with tend to be volatile month to month.  Order for durable goods(items with a greater than three year lifespan, think washing machines, refrigerators, ovens) also rose +4.4%.   All in all a solid number.

Institute for Supply Management Manufacturing Index-ISMM.  ISMM for April came in a +51.5% which was unchanged from March.  We saw growth in New Orders, Production and Exports which should bode well for further domestic expansion.  The Employment and Order backlog indexes both came in a bit.  Lastly, on the positive side of the ledger Inventories were drawn down leaving plenty of room for future restocking as sale pick up.

Institute for Supply Management Services-ISMS.  ISMS registered in at +57.8% up +1.2% from March.  Here again the positive for future growth  were front and center.  The New Orders Index popped +1.4% to +59.2.  Production also showed a strong rebound up +4.1% to +61.6% from +57.5%.  Finally the Employment Index rested comfortably above the 50 neutral figure coming out at +56.7% up just a tick from the prior reading. 

Housing.  New homes sales rose +6.1% in March the best level in over four years.  Housing is benefiting from ultra-low interest rates along with a firming jobs market.  Another positive in the housing sector, housing starts in March rose a full 2% to an annualized rate of  926,000 new homes.  Building permit applications for new homes dropped to a 1.04 million annual run rate lead by a steep decline in permitting for multi-family units.  Single family permits rose +2.1%.  So, all in all pretty good not great which is about in line with our current assessment with the economy overall. 

Where we are going:

There is an old saying in the markets.  Technicals chart the course, fundamentals drive.  Technicals in the market are pointing to a market that is coiling.  On the charts we see higher lows and a triple top which gives the basis for a pie formation (more of a slice of pie).  AS of now the market is churning.  We believe there is a breakout coming.   The catalyst may be right around the corner with Friday’s Non-Farm Payroll figures or Chicago(insert Puerto Rico if you like) defaulting on its massive debt. It could be the decision by Greece’s ruling Syriza party to do what’s best for the country and strike a bailout deal and forget about protecting their cushy seats.  For now we’re not overly optimistic on the Greek situation so we’ll hold off ordering the snails and Ouzo. 

In closing we believe there is a big move coming.  We believe in this modest growth environment with incredibly stimulative monetary policy provided by nearly all major global central banks the biggest risks to the market is being on the sidelines.   Should Greece fail to come to their senses, or perhaps Russia resume its push to expand its buffer zone with the west we may alter our outlook and stance.  For now we maintain our aggressive posture to the markets but will be in touch immediately should we need to adjust to the changing political and economic environment.

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

Yours in pursuit of the KWAN. 

PT Barnum Was Made For This Market Animal Spirits And All

PT Barnum once said, “energy and patience in business are two indispensable elements of success”.  That couldn’t be more true with investing in today’s markets.  The volatility and prices of the Dow specifically have seen near swings of 200pts on eight trading days out of the last two weeks of the just closed quarter.  These swings have shaken the faith of some investors while other market timers continue their attempts to pick tops and bottoms getting chopped up in the process.  The markets and economy both appear to be in a digestion phase.   Meaning we’re feeling the effects of the 45%+ drop in oil pricing  while dealing with the accompanying slowdown in capital outlays and hiring in those related industries.  At the same time we’ve also had to absorb the shocks from the polar blast that blanketed the east coast along with the West Coast port shutdown.  Expectations for revenue, earnings and first quarter growth are all coming down at the same time.  Considering all these headwinds a nice market correction seems inevitable, yet here we are a few percentage points from all-time highs.  Let’s take a closer look at the numbers. 

Jobs- Well this one left a mark.  Friday’s jobs figure was highly disappointing to say the least.  The headline figure +126,000 new jobs was roughly 100,000 shy of expectations.  This figure clearly reflects the residual effects of below normal temperatures and heavy snow accumulation.  When viewing these monthly figures it’s always best to look at the three month moving average at a minimum, which currently stands at +197,000.  We’ll wait for the April figure to be released in May to conclude we’re recession bound just yet. 

Purchasing Managers Manufacturing Index(PMMI)-PMMI came in at +51.5% which reflects economic expansion for the twenty seventh consecutive month.   The New Orders Index, Production Index and Employment Index all showed a softening from the prior month while all remaining in positive growth territory. 

Purchasing Managers Services Index(PMSI)-PMSI registered in at +53.5% up a bit from February’s release of +52.7%.  This was the sixty second consecutive month of expansion.  The Business Activity Index, New Orders Index and Employment Index all were solidly in growth mode.  The commentary from respondents were overwhelmingly bullish or pro-growth.

Leading Economic Indicators(LEI)-LEI increased +.2%.  Conference board economist Ozyildirim noted, “ widespread gains among LEI continue to point to short term growth”.  He further commented that weakness in the Industrial sector and business investment were restraining economic growth overall. 

Producer Price Index & Consumer Price Index and (CPI,PPI)- PPI fell -.5% in February and was down -.6% for the trailing twelve months.  In February, no surprise nearly 30% of the decline can be traced to margins for fuels and lubricants which were off 13.4%.  Energy wasn’t the only culprit as we see weakness across minerals, vegetables and chicken.  CPI however ticked up to +.2% with the core (ex-food and energy) mirroring the top line figure of +.2%.  Over the prior twelve months the index remains unchanged overall.  Our takeaway here is inflation has not been a problem, will not be a problem for some time giving the Fed ample flexibility on future interest rate hikes.

Gross Domestic Product (GDP)-First quarter GDP report will be released later this month.  Nearly all analyst projections have been revised lower.   The new range looks to be from -.5%-+2% down from original calls for an average of +2 ½%.  This is a tough call. Clearly across the board the West Coast port shut down and the arctic blast had a devastating effect on consumer and product mobility, behavior and availability.  We’ll find out just how severe.  Last year’s freeze was responsible for a -2.2% contraction.  We don’t anticipate a hit of this magnitude as the economy and consumer are both on much firmer footing.

Where we’re going:

Coming into the year there were three huge Black Condors gliding above in threatening formation.  1.Iran 2.Ukraine 3.Greece.  The first two birds have been grounded or on trajectory to do so for now. The third resemble more of a pigeon than condor.  Should Greece exit the Euro, well, so what.  The benefits to being a member of the Euro-zone are clear.  An overleveraged, over-entitlement dependent Greece with a political policy not of diplomacy and negotiation but of nose snubbing and name calling in its place being asked to exit the Euro would not be as destabilizing as originally hypothesized.  There does not appear to be other Euro members lining up to take that same path which was once feared.  Should Greece’s virtual EU membership card get revoked, personally I’d feel worse having Costco revoke mine.  In the end Greece politico’s may or may not come to their senses.   Greece maintaining its EU membership would be a positive, but in the end would not be a devastating blow.

Speaking of the Euro-zone, we are beginning to see those ‘green shoots’ of spring growth.  After taking measures to firm up finances, liberalize work force rules (for some) and re-liquify the financial system (in progress)EU growth is now anticipated to move up +1.7% in 2015 and +2.1% in 2016.  Another bright spot for the global economy as China executes it’s long landing policies and growth eases closer to +7% annualized growth in 2015 we are seeing an acceleration in India’s economy which could pick up any residual slack in global demand.   India’s growth is targeted to expand (IMF and S&P estimates)+6 ¾%-+7.9% for 2015 and +6.52%-+8.2% in 2016.  Impressive. 

Domestically we are feeling the front end effects of cheap oil  That being slowed expansion and investment in new projects and manpower.  Visa has done some good work here suggesting a six month lag for the consumer wealth effect to flow through from sharp drops in energy translating to stronger retail sales and consumer behavior in general.   We should begin seeing a trickle of that new found consumer wealth in this current month and gaining steam as we get deeper into the year.   We appear to be stuck in a good not great economic growth scenario.  The low inflation environment we currently inhabit bodes well for the Janet Yellen lead Federal Reserve to put off any sharp hikes in interest rates to the latter half of this year and/or into 2016 which should maintain the favorable backdrop for equities.

We are cautiously optimistic as we enter earnings season.  Should earnings and guidance not meet our lowered expectations we’ll look to move to a more defensive posture and raise our cash allocations.  For now we remain patient as for those who rush in too quickly well, PT Barnum had another saying, something about “One being born every day”. 

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

Yours in pursuit of the KWAN.

Quit All The Barking. No Bear Market Coming. Just Follow Bear

While growing up back east in the Big Apple our family always had at least one quad-ped with a tail, better known as a dog.  The one that was my favorite and best friend was a Chow and German Shepherd mix.  He was brown and white and BIG whom we named Bear.   He was extremely protective and would spring to attack mode when anyone even looked cross.   Thing is, it wasn’t until I was much older that I realized he’d spring to attack mode with anyone, anytime friend or foe, just never against us.  I realized Bear was wise beyond even his dog years and adhered to the old saying, “you don’t bite the hand that feeds you”.   Some, and for me far too many, investors continue to gripe  and get downright ornery  about the current and very generous Federal Reserve monetary policy.  A policy  which arguably rescued the global economy, our capital markets and for many a lifetime of savings.  So, no need for tail wagging or face licking just looking for an end to the teeth gnashing. 

The US economy continues an improving trajectory at a speed of good not great.  We are a near $17 trillion economy expanding at a 2 ½% to 3 ¼% annual growth pace.  The US recovery is far more broad based and on firmer footing than our global partners.  So, that being said let’s just get right to it. 

Where we are.

Institute For Supply Management Manufacturing-ISM Manufacturing.  ISM Manufacturing for February came in at +52.9% down -.6% from January’s +53.5%.  There was a general easing off the accelerator across the board, but 67% of the reporting manufacturers reported growth, 17% reporting unchanged and 16% reporting contraction.   Respondents commented as follows:  “West Coast ports is an issue for exporting” Food and Beverage.  “The major concern for us is the ongoing situation with the West Coast ports” Transportation Equipment.  “The dock delay on the West Coast is seriously impacting the supply chain” Computer and Electronic Products.  “Business in general is staying its course. Concerns abound over strike possibilities by West Coast Longshoreman” Machinery.  You can see a clear trend here.  The takeaways here.  The +52.9% while lower is still solidly above the +50% mark which denotes growth.  As well the West Coast Longshoremen strike has by now been resolved and the backlogs are now being dealt with and cleared. 

Leading Economic Indicators-LEI.  LEI increased +.2% in January on top of the +.4% gain recorded in December.  The trailing six month average comes in at a reasonably healthy +2.3% showing with broad based gains and participation.   The most recent reading continues to suggest a slow growth environment with a lack of strong residential construction continuing to act as a drag on growth.

Industrial Production-IP.  IP rose +.2% in January.  While the US factories continue to chug along at a moderate level exports seem to have hit stall speed, potentially impacted by, yet again the downshift to snail speed at the West Coast ports.   Factory Capacity Utilization stood steady at +79.4%. 

New Homes Sales-NHS.  NHS dropped-.2% in January.   The supply or inventory of unsold homes stood steady at 5.4 months.    Existing homes sales also took a hit down 5%.  Both figures appear to have been impacted by the severe cold snap experienced across the US and the sharp rise in pricing.   Housing Permits edged down also to a 1.05 million annual run rate.  Should this slow growth mode take root it would be problematic to the US recovery as construction plays a sizable role in the domestic economy.  We do not anticipate this scenario as the generally favorable conditions are still present.  These include strong and growing employment, ultra-low interest rates along with a deleveraged consumer.  

Jobs- The real time gauge of the employment picture, weekly unemployment claims have entered into a seasonally choppy period allowing for seasonal workers being released now that the holidays have come and gone.   We’ve witnessed swings of +/- 30,000 over the course of the last month pushing the gauge above and below the 300,000 threshold leaving us  currently at 294,000.  Next the granddaddy of jobs figures the monthly Non-Farm Payrolls .  Non-Farm Payrolls rose 257,000 in January with private average hourly earnings increasing +.12.   Good news along with the recent announcements from major retailers hiking hourly rates nationally.   February’s Payroll figure will be released this upcoming Friday with the expectations for another gain in jobs right around +230,000. 

Where we are going.

The US economy is resilient in it recovery not withstanding we continually shoot ourselves in the foot.  Starting with a dysfunctional Capitol that for the past six years have shown us leadership at its worst.  Starting with a President that continues to circumvent both houses and back to a Congressional lack of leadership that almost resulted in initiating a bear market raid in response to a government shutdown.  Then most recently the Longshoremen’s union(which many of my uncles and both my grandfathers were members of) nearly shutting down the West Coast Ports at the most important time of the year, holiday season.  Despite all of these attempts to inflict pain on both business and consumers in order to trigger a negative backlash the US economy keeps chugging along. 

This contrasts with our global partners.  The Euro-zone is showing early signs of recovery.  However, due to a European Central Bank that had been shackled by the Euros structure, large budget deficits, Germany’s adherence to austerity as tonic for anything that ails EU members and a renewed fear of a Greexit, it’s no wonder Euro-zone GDP would be lucky to generate the forecast +1.3% for 2015 and +1.9% expansion in 2016.   

Now we shift to China.  China remains an interesting story.  China is attempting to shift the economy to one less reliant on exports.  They were/are a low cost provider of labor. Their goal is to diversify away from cheap labor and real estate to include the higher margin, higher paying services and technology sectors while spurring domestic consumption.   China’s approach to markets appears to shackle if not completely lock out US companies only to encourage domestics to build out mirrors of US success stories.  Think Google vs Baidu.  Look again at Amazon and EBay vs Alibaba and Tencent.   Chinese companies don’t necessarily innovate, they do however replicate and quite successfully.   We could continue to list companies in Banking and Insurance and many more.  We’ll see how well they fare when China finally opens the doors for US competitors.  China’s economy is anticipated to expand at a 7% annual rate though growth has been choppy. In response the Chinese Central bank recently eased monetary policy to help juice  the slowing domestic growth rate which had been feared to have dipped below that pace.  

Shifting our gaze just a bit we see Japan continuing its own Quantitative Easing program.   Prime Minister Abe has staked his legacy on finally jump starting the Japanese economy and stabilizing inflation.  We are seeing early signs of success.  India has also joined the program of the race to debase one’s currency.  The Central Bank of India recently cut rates to spur growth.  This coupled with recent steps taken by new Prime Minister Narenda Modi to encourage business investment and spur infrastructure spending are encouraging measures.  Much like Europe, India and Japan recognize the structural issues restraining growth each country face cannot be resolved by rate cuts alone.  Finally after a near lost decade all are beginning the arduous task of taking on structural reform and the powerful unions.  In order to unlock each countries growth potential, workforce liberalization must occur while attempting to simultaneously root out at least some corruption.  These steps being taken currently will in retrospect prove to be baby steps and take a few more years to implement but they are finally heading in the right direction. 

When we take our view from ten thousand feet above we see even better times ahead.  The Euro-zone should continue its early stage recovery aided by the European Central Bank’s Quantitative Easing program of $60 billion monthly asset purchases.  This should reinforce modest 1%+ 2015 growth accelerating albeit from a low base closer to 2% into 2016.   We look for Japan’s GDP to expand at a .6% annual growth rate for 2015 bumping up to +.8% in 2016.  India and China are targeting an impressive annual GDP growth rates of 7% +or – ¼%.  These tailwinds  for the US economy  should be aided in no small part by the generationally low current interest rate environment provided by Fed Chair Yellen.  So, when the Federal Reserve finally begins to normalize interest rates later this year or early next year, before investors  begin growling and gnashing their teeth they’d be much wiser and take a note from my old friend and “be the bear”. 

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.