For Investors Wary Of Sovereign Wealth Fund Selling and Commodities Weakness This Markets A Slippery Slope To Navigate

Forget about oil and water not mixing, these days for investors oil and stocks don’t mix.  The near direct correlation between equity markets and the price of oil has far too many confused, perplexed or just pulling an ostrich and sticking their heads in the dirt.   Let’s help explain and simplify this new phenomenon.  Lower energy prices are a boom for consumers plain and simple.  For most businesses these same lower energy costs are a savings dropping right down to the bottom line as well.  Hugely positive.  Now the elephant in the ointment.  All oil and gas producing companies and countries are getting absolutely pole axed by the collapse in energy.  Exploration and production companies can cut capital expenditures and head count to help ease the pain.  Many of these companies during the explosion of US production due to hydraulic fracking and improved technology took on massive debt loads to purchase attractive drilling properties.  With oil at $100 a barrel, no problem.  At $30 a barrel, ouch.   We’re not done.   Major energy exporting countries  such as Saudi Arabia, Russia etc., already owned the land so that’s not the issue.   Oil revenues were the primary sources of these countries funding for their annual outlays and budgets.   They are running into similar problems.  Many of these exporting nations budgets were set based upon oil pricing $100 a barrel, no problem as long as oil is around that $100 level.  With oil at $30, ouch.  These same exporting countries ran sizable surpluses over the years and utilized these $100’s of billions of profits to invest in foreign assets through their sovereign wealth funds.  Again, now with oil around $30 those surpluses become deficits.  In order to plug government deficits those natural buyers of assets have become net sellers.  We’re talking about again 100’s of billions of dollars of assets (stocks, bonds, real estate, hedge fund shares, private equity funds) up for sale putting continuous pressure on near all asset classes.   This is a major issue that will continue until oil finds a bottom and or there is a response from Federal Reserve Chairwoman Yellen.  If recent history serves us we certainly should not expect our elected officials to think of the country first and build consensus for a policy response instead of worrying more about caucuses and elections.    No, speeches about  building walls to keep people out or stealing the money of successful savers and/or business-persons through higher taxes is much more effective economic policy response or at least what we can anticipate.

Where we’re at:

Gross Domestic Product-GDP.  4^th quarter GDP came in at an anemic +.7% as of the first reading which is subject to two more revisions over the coming weeks.  A very large drag on the top line figure was inventory draw downs.  Conversely the second and third quarter figures sported reasonable +3.9% and 2% rates of expansion driven by consumption helped by lower energy prices and employment gains.  While the fourth quarter figure is weak by any measure, the inventory draw down leaves open the prospects for better news in the coming quarters as firms look to restock inventories.  There are two items that bear watching closely.  First the newly agreed to budget was a sequester buster.  So, government spending should no longer be a drag on growth and actually may add +.5%-+.75% to growth this year.  Second, any stumble in converting the energy savings into stronger and continued consumer consumption could be the canary in the coal mine and bring to fruition the talks of a looming recession.  We’re not even close to there yet.  But, we’re on watch.

Institute for Supply Management Manufacturing Index-ISMMI.  ISMMI registered in at 48.2% that was +.2% from December.  While still reflecting a contracting manufacturing sector there were bright spots.  New Orders and Production both gained +2.7% and +.3% respectively.  No shocker, due to the free falling commodities prices the Employment component dropped -2.1% and the Prices Index  stayed flat at 33.5%.  Surprisingly survey respondents remained fairly upbeat.  We’ll see if that optimism plays out and translates into a resumption to manufacturing expansion. 

Institute For Supply Management Non-Manufacturing-ISMNM.  ISMNM came in at +53.5% comfortably above the 50 level of expansion.  New Orders and Employment were softer at +56.5 and +52.1% again a nice cushion above 50.   Here again respondents remained relatively positive about current and future business activity.  One soft spot was in pricing due to low energy pricing and stronger dollar squeezing margins.

Housing.  Housing continues to benefit from ultra-low borrowing costs and higher employment levels.  Existing home sales surged +14.7% to an annualized 5.46 million rate in 2015 the highest since 2006.  Consumers willing to make such large scale purchases flies in the face of so called recession fears. 

Autos.  Another strong sector for the US.  January domestic auto sales reached an annualized run rate of 17.58 million from Decembers reading of 17.34 million.  Very positive for both of these important economic pillars and drivers of good paying jobs.  The question remains are these levels sustainable and is the consumer’s confidence in making these big ticket purchases  warranted or are they too myopic to realize the light at the end of the tunnel is the recession train steaming down the tracks head on.   We see no reason why these levels cannot be sustained as the average age of auto’s on the road is still at an historically high eleven years old.

Inflation.  The Federal Reserve’s boogey man is largely absent or in hibernation.  While the Fed continues on their perennial game of where’s Waldo consumers continue to benefit from these low to slow growth price gauges.  The one area being impacted from stronger demand lies in shelter or rents which posted a strong +3.2% which helped support the CPI rising +2.1%.  Ex-housing the figure drops to +1.3%.

Leading Economic Indicators-LEI ticked down -.2% in December following the prior two readings of +.5%.  Year over year the index registered +2.7% which would continue to suggest a moderate rate of expansion.

Going Forward:

This current market volatility is in our opinion not, contrary to a few popular perma-bears, due to an oncoming recession but very simply (though no less painful) due to the flows of capital.  Look no further than the Middle East countries and OPEC members.  The overly generous subsidies these governments provided its citizenry (In Valenzuela gasoline costs $0.04 per gallon) in order to keep them happy and politicians/monarchies  in power, at $30 a barrel are no longer feasible.   During the prior prosperous decades the enormous sovereign wealth funds, instead of using these surpluses  to invest domestically and diversify their economies, purchased foreign assets that now must be liquidated in order to maintain these programs as long as possible.  The US’s day of reckoning  will be upon us soon enough if we do not tackle Social Security benefits and Healthcare spending we simply cannot afford as the plans currently operate and are funded today.  But the US can borrow our way right up to the gates of Armageddon.  At least that’s what our elected brain trust is betting voters will believe.  Until oil producing nations have adjusted budgets to the new reality of oil prices being lower for longer the selling pressures will remain a headwind and overhang.   Investing in  companies with strong balance sheets, experienced management, excellent products and solid dividends remains a prudent approach.  This sell off is and will provide opportunities  to invest in companies at attractive valuations.  In this market patience is an investors best friend and virtue. Trying to call a bottom in this environment would be more tricky than catching a greased pig at a country fair.   Oil rules for now.  But Chairwoman Yellen is up next and she might just save the day starting tomorrow on Capital Hill.  We’ll be tuned in for her speech.   

For now we remained committed to the market holding our cash, biding our time to deploy.  The surprise may be that time may come sooner rather than later. 

Thank you again for your patience in these very challenging markets. 

Yours in pursuit of the KWAN!

Wall Street Crosswinds Are A Blowin'. Investors Should Get Ready To Trim The Sails & Search For Value

This year has gotten off to an onerous beginning with the US market being dragged down almost 6 percent to begin 2016.   It brings me back to some misspent days of my youth at the racetrack.   We had the opportunity to see this behemoth of a horse Secretariat strutting around the track.   He was a big beautiful muscular beast.    We just knew he was our horse and we all ran for the window to place our bets, to show of course (which is 3rd place or better).  We didn’t have much money so we had to play it safe.   Lucky for us we played it closed to the vest.  For on that day he got trapped on the rail and even though he thundered down the final stretch he couldn’t make up the lost time and came in second beaten by a horse named Onion.   While disappointed we all came out winners which meant a delicious bowl of clam chowder for us all once we cashed in.   That’s where we are currently in this market.  The market broke out of the gates poorly.  There’s some congestion impeding our path starting with the sell-off in China’s markets coupled with light volume.   But, as you all are aware investing is not a sprint and we haven’t even reached the first turn.    The economy remains in good not great mode.   Job creation is still solid.  Consumer spending and confidence are both gaining while low energy prices will provide trail winds that will remain supportive.  So, let’s look at where we are.  GDP.  Fourth quarter GDP will be released later on this month.  Estimates are for a one and a half to two percent gain.   If this pans out we’ll have booked another not so great year for the expansion.  The primary drags on growth were front and center.  Energy, mining,inventories and cuts to government spending (the last doesn’t appear to be a bad thing).   The new budget just inked in D.C. has put to rest and further fears (by some) of austerity and responsible spending of our tax dollars.   That should allay fears of and continued drag from cuts to government spending and possibly add ½% to 5/8% to GDP growth going forward.  As well the draw down on inventories bodes well as companies will need to restock those shelves in the coming quarters.  We’d anticipate a continuation of this good not great environment and look for 2016 GDP to fall within a range of 2 1/2% -3%.  JOBS.  Job creation remains on solid footing adding 252,000 jobs in November followed by Decembers whopper of +292,000.   The participation rate ticked up +.1 and the unemployment rate stayed steady at 5%.   Hourly earnings along with the workweek remained largely unchanged.    The big gains were seen in good paying jobs such as professional and business services adding 73,000.  Construction add 45,000 and healthcare tallied a 39,000 gain.   The argument that the jobs created are all of low quality, is slowly being put to rest.  This is good news going forward as well.  Leading Economic Indicators-LEI.  LEI for November was up +.4% following October’s +.6%.  Strength was noted in building permits and interest spreads.   The rate of growth has moderated some though this data point suggests a positive outlook for this just completed fourth quarter and into the new year.   This would also lead investors to dismiss rumors or arguments for an imminent recession for the US.  ISM Manufacturing Index-ISMM.  ISMM dropped -.4% to 48.2 in December from November’s 48.6%.  A reading below 50 reflects a contraction in the sector.  The hit to the ISMM index came from the obvious sectors, energy and commodities.  The new orders index was a rare bright spot rising slightly to 49.2% while the employment index dropped -3.2% to 48.1%.  The only saving grace domestically lies in the fact the US economy is not overly reliant on the manufacturing sector to drive growth along with the drag on the sector from lower energy and mining.  ISM Non-Manufacturing Index-ISMNM.  ISMNM December shaved off -.6% from November’s +55.9% to +55.3%.  This continues to reflect an expanding services sector in the US but at a slightly slower pace.  There were many areas of strength.  The New Orders Index added +.7% to +58.2%.  The Employment Index also posted a +.7% to +55.7% with prices dropping -.6%.   Respondents were generally rather positive.   Management Companies and Support Services stated “Business continues to be strong for consulting services”.    Construction “Professional and skilled labor remains hard to find”. Professional, Scientific and Technical Services “ We see continue spend demand higher than any months of this year.  However productivity reaches its peak and projects need to be carried over to 2016”.  Educational Services “ Construction continues at a record pace”.     The headline figure along with the commentary continue to paint a very positive picture for demand and growth heading into 2016.  Housing.  Housing remains mired in a conundrum.  Even with the recovery in home prices many would be sellers remain underwater thus limiting the supply of existing homes for sale.  This lack of supply is allowing sellers to demand higher pricing.  Coupling this dynamic with many “newbie” or first time home buyers strapped with onerous student debt they are being either priced out of the market or unable to gain access to credit.  This would partially explain  the good not robust recovery in housing.  Another hindrance to adding to new supply is builders are having difficulty finding skilled workers (see above ISMNM).  During the housing bust many craftsmen left the industry and simply haven’t returned.  Inflation.  With commodities in near free fall for the prior eighteen months and little signs of stabilization currently, the ability for the Central Bankers to stimulate inflation has turned into a herculean task.  The wildcard here is actually quite obvious.  If commodities prices simply are able to stabilize the US and EU Central Banks 2% target rate would seem easily attainable.    We’re seeing upward pricing pressures from rents, home prices, auto pricing, medical care, education and to a lesser extent wages.  If pricing for energy, food stocks and metals simply stopped falling through the floor we would be more concerned about inflation, but current pricing action   isn’t supportive of this just yet.  Chair Yellen alluded to this in her testimony to Congress in 2015.  Where are we going; As we begin 2016 there are considerable risks, both known and unknown.  Black Condors: 1.     China aggressively devalues the Yuan.  China’s transition from one driven primarily by manufacturing and export to one similar to the US reliant  on services and domestic consumption is happening just not quickly enough to the latter to offset the slowdown in manufacturing and exports.   The manufacturing and construction build out over the last few decades  have led to vast overcapacity and enormous debt loads.  In order to prop up manufacturing the Peoples Bank of China may aggressively devalue the Yuan triggering a race to debase of trading partners respective currencies in order to remain competitive.   A cheaper currency would in effect make goods manufactured for export cheaper for China giving them a decisive edge.  This could set off a catastrophic set of events from massive emerging market currency devaluations stifling the somewhat fragile global recovery.  2.     Russia retaliates against Turkey’s downing of one of their jet fighters.  As the US retreats from being the sheriff of the Middle East choosing to lead from behind Russia looks to expand their sphere of influence, further strengthen their ties with Iran and Syria while forcing NATO to defend an ally against an aggressor setting off a firestorm and direct confrontation between the US and NATO v Russia.    3.     Brazil ousts Rousseff setting off a set of events that further paralyzes growth potentially forcing Brazil’s oil giant Petrobras into default.  That’s over $120 billion in debt and $90 billion in dollar denominated debt.  That would be a tough pill to swallow.  Petrobras is caught in a corruption, graft and kickback scandal who’s web has snared prominent business leaders and politicians alike.   The investigation is ongoing and still playing out.  Petrobras plays a huge part in Brazil’s economy and the global energy markets overall.  As it stands Petrobras debt has been downgraded, projects have been put on hold and investor confidence is non-existent.  This is one to watch as revenues from Petrobras fund social programs, subsidize and allow for cheap below market energy prices that keep the populace content.  Take that away and watch out.  The markets are currently caught between major crosswinds.  China’s economy is slowing more rapidly than planned for causing capital flight and a policy response to devalue the local currency the Yuan.  One of the many explanations for the strengthening of the US dollar.  The strength in the US dollar in turn is helping push down the prices for oil and commodities in general since most are priced in dollars.  The near collapse in those commodities will push many over leveraged producers to file for bankruptcy and force the survivors to significantly curtail budgets.   We’ve already witnessed outsized layoffs in excess of 150,000 in the sector with more to come.  This is just direct layoffs in the energy and mining sectors not that me be directly or indirectly affected such as equipment providers Deere, Caterpillar, GE etc.  In the indirectly geographically affected areas like Texas, Pennsylvania Oklahoma etc. we’ve seen a slowdown in construction projects ,layoffs in restaurant staff, drycleaners, bar staff etc.  Aside from the drags on the economy from cheaper energy and food stocks there is a definitive and very visible benefit to both business and consumers alike.  Conventional estimates point to a $193 billion annual savings to the consumer from the decline in gasoline alone.   For every $.01 drop in the cost of gasoline this would point to an equal $1 billion in savings to consumers.    From the 2011 average of $3.53 (high was $4.12)  to today’s current price of $1.60 leaves consumers with $1.93 or $193 billion in extra discretionary spending.  While not exact the figures are pretty impressive.   As consumers gain confidence that lower prices are here for longer those dollars should find their way out of savings and back into boosting consumer spending.   This massive figure doesn’t even take into account the savings on heating oil and natural gas.  Further, companies use natural gas and liquid gas as a feedstock to make plastics, tires, aerosol, refrigerants, power barbeques, detergents and foam among others items/products you may use.  You can see this touches consumers everyday lives and benefits us all in one or more products and savings.   As for the overall domestic economy growth remains constrained below its long term average growth rate of +3.25% with 2015estimated to come in at +2.2% with a slight improvement expected in 2016.   Headwinds remain, a strong US dollar, weak emerging economies and fears of rising interest rates.  Tailwinds include a robust domestic service sector, aerospace and auto sectors are firing on all cylinders, strength in housing, rising consumer confidence, increasing wages and fairly robust job creation along with a still very accommodative Federal Reserve policy.   Add in India’s economy has overtaken China as the fastest growing major economy and expected to outpace by a full 1% to 7 ½% in 2016.  Lastly you have to take into account the slow steady recovery taking place in the Eurozone.  The Eurozone should exit 2015 at +1.6% growth and we look to 2016 for modest improvement to +1.8%.   These major crosswinds are the catalysts driving the turmoil in the markets along with generating angst among investors and CEO’s alike.  During highly volatile market swings investors sometimes cave into fear and move to liquidate positions seeking the safety of cash. Similarly, CEO’s during times of uncertainty and low visibility for their business prospects cut back on capital expenditures and hiring.  These can exacerbate the emotions and selling to say the least.  The market volatility is here to stay and gains in 2016 will be hard fought for.   Now is not the time to wager on so called Unicorns as many gamblers did after watching Onion stride to victory over Secretariat only to watch him huff turf a few weeks later at the Marlboro Stakes.   Now is the time to go with the best of breed. Investing in companies with a proven business model, management with a vision and plan backed by solid revenue growth and earnings coupled with a an attractive dividend to help cushion the ride around this track we’re all too familiar with, even if it feels different this time around.    For now we remain committed to the market closely monitoring data along with any signs to change course in which case we’ll be in contact immediately.  Thank you again for your patience and confidence in this very challenging investing environment. Yours in pursuit of the KWAN! Investor Alert!  The Equity markets are taking their direction from energy.  Plain and simple.  Oil broke through $30  on Friday.  Should that selling pressure and price decline continue on Monday we advise adding to cash positions as $22-$25 would be the most logical next stop.  The market remains oversold but can remain so for some time.  So, adding to cash positions until oil finds a base would be a cautious but prudent step.  When the oil market bottoms there will be plenty of time to reengage.   So, researching and building out your watchlists would also be a prudent use of time.    We urge against attempting to pick through beaten down energy and mining companies.   The supply demand equation is incredibly difficult to predict with more Iranian and Libyan oil coming back to the markets while demand remains consistent while not strong enough to absorb all that is still sloshing around or being pulled out of mines.

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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.