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!

Spiking Volatility And Crimean Secession Have Markets On Edge, But Investors Should Keep Their Eye On The Ball

In with The Bear out like a Lion.   The first two months of the year have been as frustrating for investors as a Phil Niekro knuckleball is on a fast ball hitter.  Then March greets us with the awakening of the Russian Bear invading neighbor Ukraine sending equity markets reeling and oil spiking.   The equity and for that matter the US Treasury markets in the face of such turmoil and uncertainty have remained exceptionally resilient. 

First Equities.   The US market exited 2013 on a strong bullish note buoyed by a strengthening economy , strong cash flows and expectations for the economy to finally accelerate towards historical trend growth rates of 3-3 ½%.  We were immediately greeted with a polar vortex slap in the face of weak economic data and an ensuing selling that sent the indices down 6 ½%.   Just when many investors began to question their commitment to equities and sales began to mount the buyers showed up.  Upon inspecting the economic data it suggested even more strongly the current weakness was due to exceptionally cold weather.   Then buyers began bottom fishing and took the indices back to record highs. 

Now US Treasury Bonds.  In August of 2013 10 years Treasury yields popped from 1 5/8% up to 3% as the Federal Reserve merely hinted at tapering their monthly $85 billion monthly purchases of US Treasuries and Mortgage Backed securities.  Flash forward to December when the Federal Reserve actually did announce their plans to cut their monthly bond purchases by $10 billion followed by another such announcement in January 2014.   With a cut of $20 billion in purchases one would naturally expect to see prices fall and rates to rise.   What actually happened is just the opposite as prices rose and yields fell nearly 38 basis points.    Another swing and a miss. 

Let’s look through both markets for a clearer understanding.  Equities fell and recovered in January and February due to the acknowledgement that there was a bout of economic weakness but that the weakness was inspired by severe weather which was impacting consumption and manufacturing data to the downside.  Taking a closer look at the internals of many economic data points exposed the positive forward looking points of new orders indexes, capital expenditures, inventory draw down and expectations for hiring.   Then the Ukrainians spoke and Russia responded.  The Ukrainian people ousted their President and moved to elect a new government more representative of their goals, ambitions and a move towards a free market and free speech society.   Russia moved quickly to protect their interests and military bases in Crimea.  Fear and volatility spiked at the thought Putin would attempt to reclaim Ukraine.  It appears not.  From a simplistic view, either Putin is attempting to rebuild the Russian empire by embracing Georgia and bear hugging the Ukraine or he is protecting a strategically important military base and personnel forcing the Ukrainians to include both the West and Russia in further determining how this plays out.   His next steps will be telling.    With an outright war and invasion averted for the time being, the markets responded with a huge reversal rally that continued into Friday.  

Now Treasuries.  The Federal Reserved has clarified its plan to cut its monthly asset purchase plan $10 billion every meeting unless data suggests the need to halt or reverse their course and ultimately ending their purchases by late 2014.  Why haven’t rates spiked higher?  First geopolitics which brings the Russia, Ukraine conflict front and center. When there is such uncertainty of relative safety in various parts of the globe, investors typically flock to US Treasuries for their relative safe harbor.  Second the precipitous drop in the budget deficit also helps.  The US budget deficit is projected to come in at $514 billion.   So, with the Federal Reserve now agreeing to purchase $35 billion a month if that figure stayed constant they would buy 81% of all new issuance.   Combined both these points could account for the lid on yields so far this year.  

Going forward. On Interest rates and bonds. The Ukraine situation should be resolved through diplomatic channels and not on the battlefield.   The question currently appears to be of a free and democratically run Ukraine with or without Crimea.  Once resolved, for bonds the focus will be on the decreasing demand coming from Feds QE purchases and expectations for inflation.  Combined the march towards 3% and higher for 10 Treasuries should begin in earnest.    Onto Equities.  Equities will need the support of strong and improving fundamentals to propel us higher, which we anticipate.  The cold weather should have the effect of creating pent up demand.  As the weather warms up we should see strong snap back gains in home purchases, automobile sales and construction related employment.   Failure for these three cornerstone legs of our economy to materialize would surely send us reeling again. 

For now we maintain our strong commitment to the market, protecting the plate and looking for dead red, but wary of any potential curve balls to adjust our stance. 

Thank you for your confidence and patience in this trying environment. 

Yours in pursuit of the KWAN!

Are Equities Experiencing A Healthy Round Of Profit Taking Or Should We Prepare For A Major Correction

The winter Olympics is set to begin Friday and attention will shift to an odd sport, curling.  For those not enlightened, curling is a game played by teams of three on a sheet of ice.   One member of the three man team will ever so gingerly slid forward a large polished granite stone towards a scoring zone.  The path of the stone will be aided by the two other team members either scraping or sweeping the ice in front of the stone in order to assist or impede its path in order to get closest to a mark.   Odd as it sounds, it’s a fairly exciting game.

2014 saw its first major casualty when PIMCO’s Co-Chief was sacked, I mean retired.  Mohamed El-Erian grew to fame during the financial crisis prognosticating economic gloom along with market return projections of 5-6% for decades forward as the new normal.  He has since proven spectacularly wrong as the market bottomed in 2009 and doubled from there.  The economy seems to have entered a path towards normalcy after years of prodding by Federal Reserve stimuli.   The US GDP came in at a 4.1% pace in the fourth quarter after having clocked in at 3.2% in the third quarter.  This gave the Federal Reserve confidence to cut their monthly asset purchases from $85 billion to $65 billion and announced plans to continue cutting at a pace of $10 billion a month going forward as data allowed.   So, by year end the Federal Reserve’s QE program will have ended, the training wheels will have been removed for the US economy and we’ll be able to see if we can stay the course on our own.

Where We Are:
Institute for Supply Management Manufacturing (ISMM).  ISMM for January came in at 51.3 the 8th straight month of expansion.  Any number above 50 points toward growth and expansion.  So, while 51.3 is solidly above 50 it is down from Decembers 56.5.  The major components registered growth such as new orders and production although off their highs. There was noted weakness in inventories .   Many respondents pointed to adverse weather for the drop-off and optimism and increasing volumes in the early stages of 2014.

 Institute for Supply Management Non-Manufacturing (ISMNM) ISMNM for January posted a respectable 54 again above the 50 neutral level.  January’s figure of 54 is up from December’s 53.  The new orders and employment components both showed expansion pointing to positives for both going forward.   Eleven of the twelve reporting non-manufacturing  industries reported growth.  So the expansion was broad based.

Industrial Production (IP).  IP rose .3% in December the 5th  consecutive rise.  Year over year IP registered a rise of 3.7%.  Capacity Utilization moved up to 79.2 the highest rate since mid-2008 as companies ramped up production.   Cap U still is 1% lower than its long term average leaving slack capacity acting as a buffer from inflationary pressures.

Leading Economic Indicators (LEI). LEI increased .1% in December following a 1% rise in November.  This figure also suggests a gradually strengthening economy through the first half of the year.

Housing Starts: Starts fell 9.8% in December while the November release was revised up to a six year high.  For all of ’13 housing starts climbed 18%+ to 923,400 the best since 2007.

Building Permits: Permits fell to an annualized run rate of 986,000 lead by a drop of 4.8% in single family permits.  For the year 2013 permits rose 17.5% to 974,000 again at multi-year highs.

Going Forward:
The market is clearly experiencing a bout of profit taking as recent data being digested appears to show a slowdown in growth.  We will be watchful of this profit taking,5-10% morphing into more of a correction.  We don't sense this happening yet.  Domestic data was most likely impacted by multiple cold weather snaps that sent both workers and consumers scurrying for cover and staying home.  Global growth is stabilizing in major market such as China.  China’s January PMI stayed positive at 50.5 vs. 51 in December. The Eurozone PMI posted its best figures in 2 ½ years at 52.9 vs. 52.1 in December.  Hotspots remain in Emerging market economies amid cooling commodity prices in Brazil and overly generous social program spending in Brazil, Argentina and Venezuela.   Bottom line.  The market propelled nearly 30% higher in 2013, so a bit of give back of 5-10% while uncomfortable is longer term health restoring.  One potential catalyst adding to the selling pressure?  The normal year end profit taking and loss harvesting that typically takes place got pushed forward.  Back in 2012 with the planned expiration of the Bush tax cuts, we saw many investors book profits to take advantage of the 15% capital gains rates before they jumped to 20%-23.8 in 2013.  At that point those same investors must wait the mandatory 30 days under the “wash rule” to repurchase many positions.  Flash forward, those January purchases cannot be sold until 1 year later shifting that selling from December to January at the earliest.   For now we look at the 40 week moving average at 1700 on the S&P 500 as major support and will maintain our bias to the long side as long as that level holds.  The main focus for our positive stance being 1.An improving domestic economy. 2. An improving Eurozone economy. 3 Stabilizing major Asian economies. 4.Aggressive Central Bank monetary policies.  So, while we’re going through a patch of rough ice currently, we most likely simply require a bit more of a clearing broom (Continued Central Bank support) rather than a scraper to get us through.

Thank you for your continued confidence in these very challenging times.
Yours in pursuit of the KWAN
James Byrne  Chief Investment Officer

Main Street To Finally Engage Wall Street in 2014

                                                                                                                    

Grand Street Advisors

Market Outlook

2014

“Lions and Tigers and Bears oh My”.   Dorothy traipsed a path towards OZ fearful as an ant at the wrong end of an aardvark.   Similarly, many investors and prospective investors eyed the equity markets all through 2013.   Ultimately their fears of Legal and regulatory reform Tapering of the Federal Reserve Monetary stimuli and Budget shortfalls were all overcome by an improving job front, resilient consumer and impotent office holders in DC.    The US economy is clearly gaining momentum after having risen 4.1% GDP in the third quarter and economists on average looking for continued economic expansion of 2.6% in the just concluded fourth quarter. 

To The Stats:

Jobs: Non-Farm payrolls continued to surprise Wall Street economists and investors all year.  Payroll figures have entered a level often referred to as being in the Goldilocks Sweet Spot.  Not too hot, to force the Federal Reserve to alter policy and raise interest rates.  Not too cold as to force the Federal Reserve to take even more drastic and possibly inflationary measures to spark growth.  We seemed to have entered the Just Right point which will allow the Federal Reserve to neither raise not cut interest rates but allow them to initiate the downsizing of their monthly asset purchase program beginning in January.   November Non-Farm payrolls came in at a strong 203,000 with many forecasters looking for a more tame 165,000.   This put the 12 month average just shy of 200,000 at 195,000.  While still not great, much improved.

Chicago Purchasing Managers Index (CPMI): CPMI which has a good predictive history for the National figures slipped to 59.1 from 63 which stood at a 2yr high.  While there was some weakness some can be attributable to year end and a big drop in  inventories.  This may sound really bad but taken in the appropriate context it was really quite positive.  The big spike in the 3^rd quarter GDP figure was driven by huge inventory builds.  There were fears among some that the consumer would not show this holiday season leaving retail shelves overstocked leading to a drag on growth in 1^st quarter productivity.  This large drawdown clearly suggest this did not occur and we instead should look forward to a restocking cycle that must commence. 

Housing: The housing recovery is in full gear.  New home sales for November came in at a seasonally annual adjusted 464,000 which was a solid 16.6% over last November.  The average sales prices was $340,000.00.  The amount of homes available for sale stands at 4.3 month supply at current pace.   Total existing home sales came in at a seasonally adjusted annual rate of 4.90 million which was down 1.2% from November 2012.   The figures were impacted by the spike off generationally low interest rates, tight supplies of homes for sale and continued tight underwriting standards.  Said NAR Chief Economist Larry Yun,  “There remain pent up demand for both rental and owner occupied housing as housing formation will burst out but the bottleneck lie in supply.  As such rents are rising at the fastest pace in 5 years”.   Aside from housing being reflective of consumer sentiment and confidence housing is very supportive of the overall economy.   Specifically through construction jobs.  Also people who purchase homes tend to purchase new appliances, paint, furniture etc.  which creates even more jobs and consumers completing a cycle leading to a self-sustaining recovery.

Consumer Price Index (CPI).  CPI was unchanged in November which would translate to a +1.2% increase year over year.  Inflationary pressures should remain muted due to the slack in Capacity Utilization and an underutilized work force and below historical inflationary wage growth.  The trailing twelve month core figure (ex food and energy) came out at 1.7% still below the Federal Reserve inflation target of 2%.

Federal Reserve Policy: The Federal Reserve and specifically Chairman Bernanke has been a most prescient Market Maestro plucking our strings in such rhythm as to sooth our fears of The Great Taper.   Chairman Bernanke  assured investors frequently and persuasively enough to the point where instead of a market route the market actually rallied almost three hundred points upon announcement of a $10 billion cut in stimuli beginning in January.  The Great B-Oz I asserted the $10 billion cut in Quantitative Easing  was not a change in policy and their -0- interest rate policy would proceed into 2015 if not 2016.   I don’t where he gets his pixie dust but I want some. 

Going Forward:

The global economy is in much better shape entering 2014  from twelve months ago.  The Euro-zone has stabilized and is anticipated to expand +1% as measured by GDP vs. the -.4 contraction in 2013.   China, while having slowed from the double digit economic expansion rates of years gone by, appears to be targeting and executing growth in the range of 7 ¼%-7 ¾%.  The spillover effects for their Asian neighbors should reflect positively for Japan, South Korea, Indonesia, Philippines and Vietnam among others.   

The fears that restrained investor enthusiasm in 2013 have not disappeared.  The dysfunction in DC allowed our elected brain trust to merely kick the can down the road when it came to budget negotiations.  Importantly for them past the midterm elections.   At a minimum we’ve obtained a  degree of certainty surrounding policy and taxes which should unleash some much needed capital outlays for equipment, IT upgrades and headcount expansion.  This should add ammunition to the argument that we’ve finally reached breakaway velocity from the recessionary pressures of ‘08’-09. leading to growth accelerating closer to 3% in 2014.   There remain much that can go wrong which leads to a healthy amount of pessimism keeping investor enthusiasm in check.   Which leads us to our Black Condors for 2014:

Interest Rates.  The improvement in the economy and the markets is due in no small fact to generationally low level of interest rates.  As the economy improves, borrowing should pick up and interest rates will rise.  The Federal Reserve will alter their monthly asset purchases by $10 billion beginning in January.    There should be no fears of rising rates any rise in rates is a reflection of growth and demand.   Interest rates and borrowing costs can be managed and hedged.  It really is the velocity with which rates rise as seen in August when the Fed first mentioned Tapering.  Rates spiked and the market hiccupped.  If rates spike quickly to the 3 1/2%-3 ¾% range expect to see the bears reengage the markets and a correction of 8%-10% may follow. 

Fiscal Policy.   Or lack of one.  House Speaker Boehner finally found his backbone and lambasted the extreme right of his party for their scorched earth policy or “just say No!” policy.   The time for negotiation is upon us for a balanced budget, reforming safety net programs Social Security and Medicare along with Immigration policies.   Should Boehner be overrun by the far right expect the level of fiscal uncertainty to spike and the market to possibly correct 10%.

Iran’s No Nukes.  Goes up in smoke.  President Obama is gambling on a grand compromise with Iran to compliment his retreat from two grueling wars and the hotbed of unrest in Libya, Syria, Egypt and a simmering Turkey.   Should Iran be just biding time and ultimately pull back from Western negotiations and demands expect to see a spike in tensions along with energy prices amid threats of renewed military consequences. 

Japan default- Shinzo Abe’s bold moves to stimulate Japan’s economy have spurred the market and economy to decades highs.   Recent reported data show a slight slowdown in economic activity.   Should this weakness persist and investors lose confidence and pull out the fallout could be catastrophic.  The global economy shuddered with the potential collapse of postage sized Cyprus, a country with a bit less the $20 billion in debt.  The effect of a Japanese debt default  on $6 trillion in debt would make the Lehman bankruptcy look like a neighbor bouncing a check at the local grocer. 

We project S&P 500 earnings of $128 per share which is at the upper band of Wall Street analysts range of $118-$133.   Using a reasonable historic price earnings multiple of 16-16.5 brings us to our year-end target range of 2048-2112 or 11%-14% gains.  The primary risks we see to our opinion are 1. The handover of power to Janet Yellen at the Federal Reserve. 2.Political dysfunction reemerging in DC and 3. The strength of the economy.   We may just be underestimating the upside potential to earnings and the markets should one and two not pan out which should finally see investors reengaging in the five year old bull market.

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

Yours in pursuit of the KWAN!

James