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.
