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

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

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

Where we are.

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

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

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

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

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

Where we are going.

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

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

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

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

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

For now we maintain our aggressive exposure to the markets while monitoring the data for any signals to become more defensive. 

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

Yours in pursuit of the KWAN.

For Wall Street And The Markets Expect Much Of The Same

As the glow fades from holiday festivities and New Year’s celebrations the view forward in 2015 is now becoming clear, more of the same.  Sounds boring but when you consider what the returns from the prior four years were, I’ll take, “more of the same” any day, month and year. 

Where we are and our outlook.

GDP.  The US economy likely finished out the calendar year 2014 with a 2 5/8%-2 ¾% annual growth rate if fourth quarter growth comes in the expected 3%-3 ½% range rate of expansion.  After a surprise weather related contraction in the first quarter the economy bounced back strongly reflecting increasing underlying strength which topped out at 5% in the third quarter.  We anticipate the trend to continue into 2015 with growth for the year finally topping 3% annualized growth driven by strong consumer demand and an uptick in capital expenditures.

Leading Economic Indicators (LEI)-LEI increased to +.6% in November pointing to a continuation of the “much of the same”.   This should portend a continuation of an improving growth trend.  Novembers release followed Octobers +6% and +.8% in September.  Economist Ken Goldstein of the Conference Board noted the LEI signals moderate growth that is somewhat restrained by income growth.  Real income growth is up +.8% year over year.   

Industrial Production (IP)-IP jumped +1.3% in November year over year.  IP has grown +5.2%, the best showing since 2011.  The gains were led by automobile manufacturing which popped +5.1%.  Ex-auto’s IP still had a solid showing of +.9%.  Capacity Utilization tightened up with the increased manufacturing demand to 80.1% or +.8% the best since 2010.   The excess factory capacity present throughout this current recovery has been sopped up so any continued strength may finally spark the inflation rate closer to the Federal Reserve’s target range. 

Inflation- Still no problems on this front.  The Federal Reserve will just have to wait as the plunge in commodity prices in general and specifically oil and energy related products continue to put downward pressure on all inflation indices.   Great news for consumers and commercial users of these feedstock’s. 

Employment.  Job creation once again turned in a solid showing.  In 2014 Non-Farm payrolls averaged better than 240,000 on a monthly basis, ex-Decembers figures (due out this coming Friday).  The prior three month average for the September to November period clocked in an even better rate of 270,000 adds with November scoring  the strongest gains of 321,000. We look for Friday’s Non-Farm figure to come in right around trend growth of 240,000.00.  At the same time weekly unemployment claims have been anchored under 300,000 for some time signaling more workers finding new jobs.  Both very positive signals.  We’d still like to see the participation rate tick up along with a decline in the population now receiving disability checks. This program’s rolls ticked up strongly as many unemployed individuals applied for disability benefits once ultra-long term unemployment benefits expired.

Institute for Supply Management Manufacturing (ISMM)-ISMM closed out the year in December with a reading of +55.5% down -3.2% from November but solidly above the 50 breakeven line.  That overall trend was seen throughout the report with New Orders and Production solidly over 50 but down over 5% from the November figures.  The two brightest spots were the Employment Index rising +1.9% to +56.8% while the Price Index dropped 6% to 38 ½% indicating lower raw materials pricing.  Eleven of the eighteen reporting industries  reported growth.   We heard from the Food and Beverage sectors that “sales are much improved year over year”.   From transportation, “trucks and RV business very strong”.   While Fabricated Metals and Textiles noted “the ongoing drag from the West coast  port planned union slowdowns”. 

Monetary Policy- The Federal Reserve has telegraphed their plans to investors of their wanting to begin to normalize rates.  Current expectations are for the first ¼% point rate hike to occur mid to late second quarter.  This normalization plan is fluid, flexible and data dependent with an eye to both domestic and global growth data points.   Federal Reserve Chair Yellen’s plan may be pushed back even further should the Euro-zone and Japan slip back into recession as the effects may wash up on US shores. 

White Condors

1.      The Grid. The US electricity grid is hit by terrorists.  The US grid stretches over 160,000 miles and is easily accessible and lightly if not at all guarded.  Earlier on in 2014, April to be exact a coordinated group of attackers  cut telephone cables and snipers took out 17 large transformers that funneled power to Silicon Valley.  The country has 2000 of these type transformers and a limited supply of manufacturers that could replace them in a timely fashion should there be a large scale attack.  Strategically coordinated attacks on our grid could leave vast swaths of the US dark and without power for weeks and would be catastrophic. 

2.     Russia.  In a complete rebuke to western sanctions Russia mounts a full scale invasion of Ukraine in the first of an all-out effort to recreate a smaller more compact USSR while expanding its buffer zone to the West.   Russia over the last few years has taken a page from the Obama playbook and pivoted east towards China.   As the West tightens the economic noose on Russia with sanctions and oil prices for which the Russian economy relies on for over 50% of total revenues continue in a free fall Russia has turned to China.  They have cultivated a wary friendship with a very willing buyer of its natural gas and oil and diversified their customer base making them less reliant on Europe.  As Russia moves away from Europe and closer to China they may feel emboldened to do as they wish retaking what Putin believes is theirs from the beginning.

3.     Oil.  What is the correct price of oil? Energy “experts” rolled out the Peak Oil thesis for decades in order to justify exorbitant pricing.   Chevron’s CEO earlier this year stated “$100.00 per barrel of oil was the new $20.00”.  Another noted oil expert, Harold Hamm founder of Continental Resources was so positive of oils lofty pricing he sold off his hedges back in the October, November months when oil was still hovering around $80.00 a barrel confident oil pricing would rebound sharply.   Now with oil changing hands closer to $52.00 and the “experts” claims that US producers would turn off the spigots once we broke $75 clearly a miscalculation at a minimum why does this rate as a White Condor?  The last time speculators were chased from the markets was during the near financial collapse and ensuing recession.  The price of oil hit right around $36.00 a barrel.  We could be headed there or lower.  The Saudi’s claim they are profitable extracting oil at $10.00 Exxon says they can extract oil profitably at $14.00.   Ultimately oil pricing will be determined when demand catches up to supply.  On the supply side the US alone is expected produce an additional 1 million barrels this year.  We’ll also see new supplies come online from Mexico, Brazil, Australia and Canada.  As well, as the outside world lifts sanctions on Iran  we could see even more production from Iran and from the middle east.   These supplies could be soaked up easily. First the Euro-zone would need to resume a growth trajectory.  Second China’s economy could cease the planned downward trajectory it is currently on.  Third India could and should continue on its path of opening markets, engagement and encouraging foreign investment.  If oil plumbs the levels mentioned above the high yield market could take a major hit from Exploration and Production companies that overleveraged their balance sheets to acquire land and expand anticipating stable or higher energy pricing.  The defaults could spike rather significantly forcing liquidations and bankruptcies while spilling over into the equity markets as well.

Going Forward

Enough can’t be said about the stimulative effects on the consumer and economy from the falling energy prices.  If oil prices stabilized around current levels it is estimated to provide over $150 billion back in consumers’ pockets and that’s just talking gasoline.   Or in D.C speak $1.5 trillion since they seem to like extrapolating out 10 years.  Aside from the tax break effect consumers will feel, inflations flames driven by commodities should be extinguished giving the Federal Reserve a longer leash and allow slower implementation of their interest rate hike plans.  Further cheap energy feed stocks are attracting foreign manufacturing dollars to invest in and build new plants domestically. 

The US economy has clearly reached escape velocity from the negative gravitational pull of the bruising recession.   The US economy is anticipated to expand at a 3%-3 ¼% pace  of growth with a backdrop of low inflation and a still highly accommodative Federal Reserve along with Global Central banks.   With corporate balance sheets and consumers ledgers in excellent shape to support growth we look to future revenues, earnings, multiples and valuations for our projections. We also note the potential upside surprise should our fearless leadership in D.C finally decide to work together on tax reform.   We look for the S&P 500 companies to generate $133 in earnings this year.  Utilizing a still reasonable 16 ½% P/E we arrive at 2194 or +6 5/8% add in the dividend yield and we come to a +8.8% total return.   Due to the sharp drop in oil and commodities along with a potential rate hike, volatility should spike and remain at elevated levels making 2015 a challenging year.  But we believe and maintain that any correction can and should be bought.

For now we remain aggressively 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!

Job Growth Surges 321,000 For November Now It's Really Time To Prepare for the Newer New Normal

One of Pacific Investment Management Company’s (PIMCO) elite brain trust  Mohamad El-Erian coined the phrase, “the new normal” six years ago when characterizing the future returns for equity investors.  Basically after all his in-depth research, analysis, modeling and magic wand he stated equity investors would need to adjust to future returns of 5% or so.   Mr. El-Erian is undeniably a very intelligent fellow witch, up to this point in time  had a very solid record.  Mr. El-Erian fell victim to his conviction.   Meaning even as the markets raged forward he continued to dig in his heels stubbornly clinging to his “new normal” theory costing his investors and followers hundreds of billions of dollars and some years later his very own job.   The underlying theme here is the markets are always right so, as investors we need to be humble, flexible and when called for quick. 

The US economy is no longer a good house in a bad neighborhood.  We are the Bentley in a used car lot.   The US economy for the trailing two quarters is averaging better than a 4% expansion rate of growth with the current quarter estimated to be tracking at close to 3%. This would give us a three quarter average of better than 3 ½%.   Take that when comparing the US vs. the Eurozone’s blistering pace of +.2%, Japan at -1.6% contraction, the United Kingdom’s +.7% and Russia at +.7%.   The US economy, now after five years of repair from a bruising and painful recession, is now finally starting to fire on all gears.    So, where are we.  Let’s get to it.

Jobs- The Non-Farm Payroll figures were released this morning and they were stellar coming out at +321,000.  There was strength across the board.  Average hourly earnings registered a +.4%.  The average workweek pushed higher to 34.6 hours.  Importantly the jobs created were good paying solid jobs with Business and Services adding 81,000 to head count and Healthcare and Manufacturing added 28,000 and 29,000 respectively.  No two ways about it a very strong number.  We’ll wait for the January release to see if this was a one off number, if this November number is followed up with another very strong number we may need to rethink the timing of the first Fed rate hike.

Institute for Supply Management Manufacturing –The ISM Manufacturing figures released earlier this week came in a +58.7% which is solid but down slightly from the prior reading of +59.%.  Looking inside the headline figure we continued to strength across the board.  Aside from the positive Production and Employment components we saw an uptick in the New Orders an Exports indexes and a slowdown in inventory build outs which bodes well for future growth .

Institute for Supply Management Non-Manufacturing-The ISM Non-Manufacturing figures came out at +59.3 which was 2.2% higher from the prior month.   There were some softness noted in the employment index but still registered growth along with a pickup in the Business Activity Index which leapt 4.4% to +64.4%.  Also, importantly the New Orders posted a 2.3% increase to 61.4%.   Respondents noted the following: Finance-“uptick in demand and spending”, Technology, “Business is good with new products”, Professional Scientific, “Business is strong with many accounts wishing to be implemented before year end”.   Also very positive was from mining,’ we are experiencing downward pricing pressure on natural gas as a result of lower pricing from OPEC.    There should be a smiley face inserted her but I’m prohibited from doing so. 

Leading Economic Indicators-LEI.  LEI released in late November showed a very strong jump of +.9% following September’s +.7%.   This continued strength suggests a strong holiday season spilling over and into the first quarter of 2015.  There was strength registered across the board. 

Industrial Production-IP.  IP ticked down a -.1% in October after having surged ahead +.8% in September.  There was some strength seen in manufacturing  up +.2% which was far outweighed by the decline in mining activity of      -.9%.     This overall indicator is still showing a 4% gain for the comparable year ago period.   The Capacity Utilization rate declined -.3% to 78.9% which leaves ample cushion to absorb any future inflationary pressure when they arise. 

Housing- Housing Starts for October registered a 1,009,000 annual run rate which was a bit softer than September release of 1,038,000 but is up +7.8% from the year ago period.   Importantly Housing Permits came in at 1,080,000 this is a +4.8% improvement from the prior months reading.  

Now to where we are going.

There is no getting around what is driving the US economy now.  Front and center Jobs and energy.   I’m not sure which is the cart and which is the horse and for me that’s another discussion.    The jobs picture is finally starting to see acceleration with the three month average now at +263,000.  We’ll hold off on our opinion regarding the latest Non-Farm figure until we get confirmation this wasn’t a onetime anomaly from the January release.   The argument that there were no “quality” jobs being created should now be quieted.   Clearly good quality high paying jobs in Manufacturing, Business and Healthcare are being created.  I always had a problem with the term “good quality jobs” to begin with.  When I was out of work, any job was a good job, up until the time I could find a better one.   Looking to the other input part of the economy the correction going on in the energy sector is a boom for everyone, ex- Texas, North Dakota and most notable OPEC, Russia and Venezuela.   But those players have partied on our dime for long enough. Foreign investment to take advantage of our cheap natural gas and natural gas liquids is booming.   Over the course of the last 10 years we’ve debunked the “Peak Oil” theory as a paper funded by and for the oil industry.    The Shale formations in the US have unleashed a tidal wave of cheap oil and gas that will forever change the pricing and security of America.  No longer will we need to engage hostile forces to protect “US Interests “abroad.  No longer will we be held hostage to rival religious fanatical factions to heat our home and fill our tanks.   The Shale Revolution has changed all of that while producing  tens of thousands of high paying US jobs.   The argument now is where will oil find a bottom.  I can remember back to the depths of the financial crisis when Institutional Investors and Hedge Fund managers were scrambling to raise cash for clients redemption requests.  They were selling any and everything which meant the futures and options position being closed out in the energy pits as well.  The bottom price of oil at that time when speculators were chased out of the market was  right around the $36.00 barrel level.   The Saudi’s say they can extract oil at $10 barrel.   Some estimate the Bakken and Permian have similar extraction rates for break even.   We’ll see.  But to show just how powerful this move down in gasoline can be for consumers.  US consumers spent close to $374 billion on fuel last year.  If we simply hold the 30% correction at the pumps we’ve already experienced for the next year we’ll have put $110 billion back in to consumers’ pockets and pocketbooks.  That doesn’t take into account the additional savings from heating ones homes.  Potentially hugely stimulative to the consumer and better than any government program.  So, let’s hope the government  doesn’t try and figure a way to get ahold of those monies before it gets to the consumer.    Back on point.  The point here is the US is doing much better and about to take flight. This without much assistance from the Euro zone which is close to reentering a recession, Russia about to enter a recession, Japan which is fighting stagflation to a standstill at best along with China and India enduring a soft landing of +7.5% and +5.4% respectively.   This drag the US is encountering from the global economy may actually work to our benefit as it prevents our economy from overheating forcing the Yellen Federal Reserve to hike interest rates thus choking off a continuation of the domestic expansion and market surge.   Instead with more American’s being put back into “good jobs” with improving wages coupled with the drop in energy prices this scenario could provide us with years of this Goldilocks environment providing above average returns for investors.  So, if this is Mohamad’s New, New Normal, I’m all aboard. 

For now we remain aggressively 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!

Are Wall Street And Markets Doing The Two Step?

Paula Abdul and that foxy MC Skat Cat got everyone jumping 24 years ago when she serenaded us with “I take two steps forward and two steps back, we come together ‘cause opposites attract”.  A few Investors seemed to adhere to the same thought process when contemplating where the economy and Fed Chair Yellen are heading.   Two steps forward and two steps back going nowhere.   From GSA’s perch the economy is about to finally hit breakaway velocity from the grips of the bruising recession and trend growth reaching 3% or better going forward.  We’ll get right to it and share why we believe the pundits have been just plain wrong  and if they don’t alter their view they’ll continue to be so and miss the upcoming rally in equities. 

Where we are:

JOBS- Non-Farm Payrolls. Hot off the presses this morning Non-Farm Payrolls came out this morning at a surprising +248,000.  This compares favorably with the twelve month average of 213,000.  The quality of jobs was also supportive of an improving base with Professional and Business Services up +81.000 compared with the average +56,000 over the prior twelve months.  Healthcare added +23,000 while construction tacked on +16,000.  The unemployment rate ticked down to 5.9% The participation rate held steady at 62.7% The workweek ticked up +.1 to 34.6 hrs.  Hourly earnings were virtually unchanged at $24.53 hr. which reflects a 2% gain over the prior year.   There were also big revisions to the prior two months.  July’s figure was revised to +243,000 vs the originally reported +212,000.  The August figure which was hugely disappointing was revised up to +180,000 from the original report of +142,000.  Taken together the original releases were under-reported by +69,000 and a solid report overall.   

Leading Economic Indicators-LEI.  LEI increased +.2 in August.  This gain builds off July’s +1.1 and June’s +.7.    The LEI suggests an economy that is continuing to gain traction but not as aggressively as the earlier growth rates of the second quarter.   Released along with the LEI is the Coincident Economic Indicators-CEI.  CEI a measure of current economic conditions continued on its expansion in August as well inching up +.2% following a +1% in July.  Strength was reflected in personal income, employment and retail sales which were somewhat offset by weakness in Industrial Production.  LEI continues to suggest an economy expanding at a reasonable pace for the next few quarters. 

ISM Purchasing Managers Index-ISM PMI.  ISM PMI Manufacturing registered at +56.6% for September which was a decrease of -2.4% but still above the expansionary 50 level and the 16^th consecutive positive month.   There was growth reflected throughout the report, namely in New Orders, the Production Index and the Employment Index.  While still very healthy all were off from their August highs.   Commentary from respondents were all very positive as well.  From Construction, “Warehouse and multi-family construction continues to be strong”.  From Machinery “Our search continues  for good machinists and engineers”.  Lastly from Manufacturing, “ Overall, orders are at the strongest point this year”.   No signs of any weakness here either.      

ISM Non-Manufacturing Index-ISM NMI came in today at +58.6.  This is down from August but another very solid figure.  New order came in at +61 along with the employment index posting a +1.4% gain to +58.5%.   All areas covered experienced growth but slowed marginally from the August showing.   Respondents were generally upbeat about future prospects but noting some leveling off.  In Construction, “ We see a lot of smaller remodels and additions with many company’s putting off new builds due to concerns about large investments at this time”.   From Professional, Scientific and Technical Services, “Orders continue to be steady, and forecasts strong for the remainder of the year. There doesn’t appear to be significant growth but a steady strong business level”.  Wholesale trade comments “ Business remains steady but not robust”.   This report again suggests a good not great environment and improving. 

New Homes Sales- New home sales surged +18% in August the strongest since 2008.  This followed a home builder optimism survey that had reached levels not seen since 2005.  This is very good news as a recent release of existing home sales had slipped breaking the four months of prior gains. 

NAHB Housing Market Index-HMI.  The HMI is an index we’ve followed for some time which tracks the builders confidence for new single family homes which rose to a level of 59 the loftiest since 2005.   Similarly a reading above 50 suggests market conditions are favorable.  Notes included in the release from builders noting buyer traffic and interest had picked up.   All components came in positive territory.   Current sales conditions registered 63 along with expectations for future sales increasing to 67.  The gauge for foot traffic of prospective buyers came in at 47 which was a 5 point increase.  So, again suggesting an environment that is good and improving. 

Where we are going:

Clearly there is a change going on.  During the earlier years of the recovery of 2010 and 2012 the US was constantly referred to by investors (myself included) as the best house in a bad neighborhood.   Meaning the global economy was in such shambles and deteriorating that the safety of the US even in the face of massive monetary expansion (Quantitative Easing) and subpar growth was a good place to invest.   The rest of the world still appears to be shackled by the effects of the global financial crisis and an unwillingness to make structural reforms, take the asset write downs and fiscal belt tightening necessary to break free from its gravitational pull.  The overly generous social programs and employment protectionist policies are clearly hamstringing the EU along with budget deficits and sovereign debt levels that are still not being addressed aggressively enough.  European banks have been far too slow in writing down or off bad loans on their books and recapitalizing as the US banking system was forced to do.  Thus the financial system is still not functioning properly.  Then we have Russia now focused on expanding its sphere of influence coupled with an economy almost solely reliant on energy being penalized with sanctions that most likely will push it back into recession in 2015 if not sooner.   Now to China where the planned slowing and transitioning of their economy to one more focused on domestic consumption is proving tougher to manage than thought and now Hong Kong protestors have taken to the streets demanding their promised Democratic right to elect.  This should provide a little more unneeded drag to an economy struggling to maintain its footing.   The last two we’ll touch on is Japan and India.  Both have relatively new leaders that came into office promising reform, anti-corruption measures and moves to open their economies.  Japan’s Abe-nomics policies are still a work in progress.  Higher taxes must be forced through to pay down their massive debt levels while simultaneously attempting to stimulate and reinvigorate their economy.  So far so good but much remains to be done.  India’s new leader Narendra Modi also rode in on the reform cart.   India’s economy once thought to be a potential rival to the “China Miracle” is still bogged down by massive corruption which will take years to work through making reform much more difficult.   Their protectionist policies also make attracting the necessary foreign investments even more difficult.   We like what we’re hearing from Prime Minister Narendra Modi so we’ll be watching closely for investment opportunities.  

When it comes to allocating assets we think about 1. Low inflation. 2. An accommodative Federal Reserve.  3. Moderate and improving US growth.  4. Solid Corporate balance sheets along with increasing revenues and earnings. 5. Global Central banks fully committed to growth.  Because as Paula so appropriately put it, “ ‘cause when it comes together it just all works out”.    We’ll  maintain our aggressive exposure to the market but remain vigilant to any signs this minor correction morphs into something more and will be in contact should we need to take a more defensive posture. 

We thank you for your patience and confidence in these very challenging times. 

Yours in pursuit of the KWAN!

Investors Would Be Wise To Know When to Ante Up and When To Call

It was Bell X1 who muttered those famous words, “I’ll see your heart and raise you”.   I know former Federal Reserve Chairman Bernanke during the nadir of the financial crisis experienced a gut check and showed a lot of heart for investors, workers and his country when he took such extreme measures which up until then had only been theorized and written about in text books.   I have to admit he went further than I’d ever expected.  I recall many a conversation when discussing the tools and policy maneuvers available to the Federal Reserve stating, “ what are they going to do cut rates to zero?”  I was also know to utter, “well rates can’t below zero.”  I have to admit unashamedly I was wrong on both counts.  The Fed did indeed cut the Federal Funds rate to zero and the European Central Bank instituted a negative interest rate policy.   It wasn’t that I didn’t think they had the ability to do so, I simply laid my confidence on the ability of our elected officials coupled with a proactive Fed policy would be enough to stave off a near collapse of our financial system and economy.   The Fed Chair obviously was forced to shoulder the weight of turning things around due in no small part to the increasing dysfunction in DC that prevails today from our elected brain trust.  So, while the Fed has done most if not all of the heavy lifting up until now the game is not over but our hand is looking pretty good from where I sit.    Here at GSA we see a continuing and broadening out theme in the economy, strength. 

Where we are.

Institute of Supply Management Manufacturing-ISM Manufacturing.  The ISM released just Tuesday surged to a three year high of 59.0% the fifteenth month of expansion and highest since March 2011.   Digging into the report shows more reasons for optimism as the New Orders component ripped higher to 66.7% a ten year high.   Also, importantly the Employment Index came in at 58.1% the fourteenth month of expansion (a reading above 50 would reflect  growth)

Second Quarter GDP-GDP.  The first revision to second quarter GDP resulted in an uptick of +.2% to 4.2%.  In the report we saw corporate profits increased +9% and revenues popped over +4% very healthy for the quarter and ahead of analyst expectations.  This was of course on top of the first quarters negative reading of a -2.1% contraction which was impacted by severe cold weather.  

Leading Economic Indicators-LEI.  LEI rose +.9% for the month of July reaching its best level since 2007.  Positive contributors to July’s figures mentioned importantly for future prognosticators of growth, Building Permits and the continued fall in Jobless Claims.

Industrial Production-IP.  IP continued its rise in July up +.4% the sixth straight increase.  Automobiles lead the charge up +10.1% the best showing since 2009.  Year over year IP is reflecting a +5% growth rate the best since 2011.  We also saw Capacity Utilization ticking up to 79.2% leaving ample room below the 80.1% long term average utilization rate in order to absorb any future inflationary pressures. 

Housing.  Housing starts leapt +15.7% in July back above the 1,000,000  unit level to an annualized 1,093,000 run rate.   Broken down multi-family homes increased a whopping 28.9% while single family home starts came in with a very respectable +8.3%. 

Building Permits.  Permits, a great forecasting tool for future job growth and economic expansion sustainability  were up +8.1% the best since last April to a 1,052,000 annual run rate.  The level of demand continues to outstrip new supply by an estimated 600,000 just to keep pace with new household formations.  Perhaps more newcomers into the market are anticipated to be renters instead of owners leading to the strength in multi-family housing construction and permitting. 

Construction Spending-CS.  CS rose +18% in July nearly doubling street estimates and the largest jump in over two years.

Jobs- As of now we are awaiting the Weekly Unemployment Claims and monthly Non-Farm Payroll figures out Thursday and Friday respectively.  We are anticipating a drop of 8,000-10,000 in Claims and another good not great Payroll figure around +225,000-+230,000.

Where we are going.

As many of you know I cut my teeth in the industry working on the Fixed Income Institutional Arbitrage desks of Wall Street.  We studied among other things the yield curve, yield spreads, credit quality along with economic releases and Fed policy and their potential implications to maximize returns.   Way back then it was what I thought a bit more challenging with then Federal Reserve Chairman Greenspan who would purposefully obfuscate each Fed policy statement, which came to be known as Green-speak.  He once stated after a release in an interview, “if you think you understood what I was saying , you weren’t listening.” Flash forward to 2008 and I thought the new openness of the Fed would be a breath of fresh air and simpler.  Things however were changing so quickly on the ground back then though what was true yesterday had changed so dramatically the next as to render available information and policy statements virtually useless.  I bring this up as the Federal Reserve is two meetings away from exiting its Quantitative Easing program, the Grand Experiment as I refer to it as.   Many economists, analysts, Institutional managers and hedge funds believed QE would be a radical failure resulting in a cataclysmic collapse of our economy, financial institutions and markets.  We at GSA while wrong on how far monetary policy would be extended were correct in “never fighting the Fed” and believing in our core disciplines.   It is a mistake to believe the end of QE is a rate hike.  The Federal Funds rate will remain at near 0% for nearly a year after in our opinion, driven not solely by the US economy, but by external factors.  Remember, we are a global market participant and for now the largest.  In this global economy we must factor in the Euro-zone is barely keeping its head  and economic expansion above recessionary levels of growth.  Japan is still experimenting with Abe-nomics and experiencing uneven growth.  Russia’s economy will remain in recession for most of 2015 unless sanctions are repealed immediately.  China is in the midst of a “long landing” one of slowing overall growth while attempting to transition to an economy more driven by domestic consumption than exports as is currently the case.   In this environment the Yellen Fed will most likely not act  to hike rates with a hair trigger finger nor will Global Central Bankers cease to buck up as the stakes are just too high currently.  When the Yellen Chaired Fed does eventually get around to hiking rates it will be when we are on sounder footing which would support stronger consumption leading to higher Corporate revenues and earnings.   This will lead to the next leg of the rally one driven fundamentally without the training wheels the Fed has had to provide up until now.  So, when other investors are sitting idly by at the table “checking” as the Fed begins to shift monetary policy we may just have to ante up a bit before we show our hand.    

For now we maintain our aggressive exposure to the markets while monitoring the data for any signals to become more defensive. 

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

Yours in pursuit of the KWAN.

James