Weekly Market Cheat Sheet, July 24, 2017

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Last Week in Review

The economic calendar picks up this week beginning with the flash PMI today (9:45 a.m. ET), as we continue to get an initial look at the July data. So far, the data has been a bit underwhelming as both the Empire and Philly Fed surveys came in light last week.

As far as hard data goes, Durable Goods comes out Thursday, and the preliminary second-quarter GDP number comes out Friday.

Housing data also picks up this week, and after last week’s mixed results (remember the Housing Market Index missed but Housing Starts was solid) economists will be looking for a better read on the current status of the real estate market. The two big reports this week are Existing Home Sales on Monday, and New Home Sales on Wednesday. However, the S&P CoreLogic Case-Shiller HPI also will be worth watching (due out Tuesday). If the housing data is more in line with the strong Housing Starts data we saw last week, that will be an underlying positive for the economy and supportive for risk assets near term.

Turning to the central banks, the FOMC meets Tuesday and Wednesday, and the meeting will be concluded with an announcement on Wednesday at 2:00 p.m. There are no material changes expected to come from the meeting, and it would be a shock if rates were not left unchanged. There is no press conference or forecasts released with this meeting, but language in the statement will be closely watched for any further clues on the Fed’s plans to reduce the balance sheet, or on when rates will be raised. Right now, expectations are for a December hike, but based on the trend in other central bank rhetoric the risk is for a dovish development due to the complete lack of inflation acceleration.

This Week’s Preview

Economic data was thin last week, but we did get our first look at July data in the form of regional Fed outlook surveys as well as a few reports on the housing markets.

Beginning with the Fed surveys, the Empire State Manufacturing Survey was released on Monday, and despite the bad headline it was not a terrible report. The headline missed estimates (9.8 vs. E: 15.0), but the forward looking New Orders component remained solidly above 13. The reason the report was not that bad was the fact that it had started to run hot at unsustainable level recently, and was due for a dip. And the correction we saw in the June data wasn’t too deep, and the details remained encouraging.

The Philly Fed Survey out on Thursday was not as bad a miss as the Empire data on the headline (19.5 vs. E: 22.0), but the details definitely dimmed the outlook for the Mid-Atlantic manufacturing sector. The forward-looking component of the report, New Orders, fell more than 20 points to just 2.1. The survey Philly data last week finally started to show a decline in enthusiasm from the extremely strong survey reports we’ve seen since the election. If these reports are foreshadowing a pullback in the broader US economy, that would be very bad for stocks, as solid growth is still priced into the market at current levels.

Housing data was mixed last week as the Housing Market Index missed expectations, but Housing Starts and Permits were very solid. Data on the real estate market has been all over the place recently, and it will take more data to try to decipher where the trends actually are in the sector. But if the strong Starts and Permits data from last week are any indication (this is a more material data point than the Housing Market Index) that will be a sign of confidence in the US economy.

Lastly, jobless claims were very solid last week as new claims fell back towards a four-decade low. The very positive weekly report was significant, because the data collected corresponds with the survey week for the July BLS Employment report. So, based on jobless claims alone we can expect another very strong official employment report early next month.

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ECB Announcement Takeaways—July 21, 2017

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ECB Announcement Takeaways

• The ECB left key interest rates unchanged.
• The monthly QE program remains 60B euros
• Forward guidance was left unchanged from the June statement.

Takeaway

As expected, the ECB left all major policy decisions as they were at the July meeting, including interest rates, QE and a lack of any material new forward guidance. The initial reaction to the statement was dovish, as policymakers appeared to simple “kick the can” toward the September meeting.

But, Draghi’s press conference following the statement offered more mixed signals. First, the ECB President reiterated his upbeat view of the European economy, which is slightly hawkish, but did mention that he and other policymakers remain cautious about the lack of inflation. To that point, Draghi repeated his pledge to increase QE in both size and duration should the economy falter or financial conditions worsen. This was largely expected, but it offered a dovish reminder. At this point in the press conference, the release was still a wash.

The catalyst for the surge in the euro, which gained well over 1% in intraday trade, was actually due to the lack of attention Draghi gave to the recent strength in the currency. He had several opportunities to address the recent gains in the euro, which hit multi-year highs earlier this week.

Yet the failure to do so was enough for currency traders to chase the shared currency up to new highs.

Bottom line, the ECB effectively “kicked the taper can” to the September meeting, which means unless Draghi verbally suggests otherwise between now and then, any changes will likely be very subtle (i.e. modest taper to QE but extended duration). That was underscored by the fact that the 10-year bund was essentially unchanged yesterday. Looking ahead, the ECB still is a long way off from actually tightening policy (as they are technically still actively easing with their QE program) and as such, the rally in the euro is getting a bit extended. Nonetheless, the trend remains bullish for the euro, and until there is a catalyst such as blunt, less-dovish commentary from Draghi or a spike in EU inflation, then the path of least resistance will remain higher for the euro.

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Oil Update & What It Means for the Market – July 20, 2017

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Yesterday’s weekly inventory report from the EIA was universally bullish on the headline level as there were sizeable draws in crude oil stockpiles as well as in the refined products. The market responded favorably to the supply drops and WTI futures finished the day up 1.61%.

Beginning with those aforementioned headlines, commercial crude oil stocks fell –4.7M bbls last week, larger than analysts expectations of –3.1M and opposite from the API report that showed a build of +1.628M bbls.

Gasoline supply fell –4.4M bbls yesterday, and while that was less than the draw reported by the API (-5.4M) it was much larger than the average analyst estimate of –600K bbls.

Distillate inventories also fell –2.1M vs. (E) -700K rounding out a broadly bullish set of headlines in the report.

The details of the report however, once again showed a continuation in the bearish trend of rising US production. Lower 48 production (which filters out the seasonally volatile Alaskan data) rose another +30K b/d last week, above the 2017 average pace of +26K b/d to

8.97M b/d. Lower 48 production is now up +729K b/d so far in 2017, the highest level since late July 2015.

Bottom line, a string of supply draws over the last three weeks in crude oil and gasoline stocks totaling –18.6M bbls and –9.8M bbls, respectively, has offered the market some support, and helped curb a decline that pushed oil prices down to new 2017 lows. And with sentiment being very bearish coming into the month of July, the market was due for an upside correction. But, the underlying fundamentals remain bearish and as of now, we believe this is a counter-trend rally in an otherwise still broadly downward trending energy market. We won’t fight the rising tide, and a run at $50/barrel in WTI is very plausible, but we will be looking for signs of the trend to break in the weeks ahead and for the market to turn back lower based on fundamentals, market internals (term structure), and longer term technicals.

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Gold and Real Interest Rate Update—What It Means for the Economy, July 19, 2017

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Gold rallied 0.67% Tuesday, as political angst spurred a fear bid while strength in the Treasury market continued to help the “real-rate” argument for gold. British inflation data missed expectations, and that was the third release since Friday that showed below-expected price pressures.

That trend helped fuel dovish money flows, which ultimately bolstered the case for gold, because a lower pace of inflation changes the narrative of the world’s central banks. It’s also cause for recalculation of the real interest rate equation (which is simply interest rates minus inflation rates equals real rates).

If real interest rates are actually poised to move lower (as nominal rates fall and inflation remains flat/does not accelerate) that will be bullish for gold and the rest of the precious metals, as they are safe-haven assets that do not offer yield.

For now, we remain neutral on gold due to the technical support violation in early July. Looking ahead, it’s all about the fundamentals, which come back to real rates.

If real rates continue to fall, even because of soft inflation causing a slightly dovish shift in central bank expectations, that will be bullish for gold long term.

From a broader standpoint, if real rates fall further, that will mean that the economy is struggling, or at the very least not meeting expectations. That will be a concern for stock investors, and ultimately holding gold allocations would be a sound hedge against volatility.

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Chinese Data Recap and What it Means for Global Markets, July 18, 2017

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Chinese Economic Data

• GDP held steady at 6.9% vs. (E) 6.8% in Q2
• Fixed Asset Investment was 8.6% vs. (E) 8.4% in June
• Industrial Production rose to 7.6% vs (E) 6.5% in June
• Retail Sales rose to 11.0% vs. (E) 10.6% in June

Takeaway

The headlines tell the story of yesterday’s data dump in China. The reports were universally better than expected, but GDP was the report that warranted the most attention as the headline growth rate held steady at 6.9% rather than pulling back as expected.

Quarter-on-quarter growth jumped to 1.7% from 1.3%, which suggests that the Chinese economy is starting to stabilize towards the top end of the government’s target range of 6.5%-7%.

Looking ahead, the solid growth level seems to be sustainable, and not just a short-lived spike in economic activity. Without getting deep into the details, the growth is consumption driven, and new government policy and reforms are poised to help continue fueling solid growth into H2’17.

Bottom line, yesterday’s strong set of Chinese economic reports were welcomed by economists, as they underscored the positive outlook for the global economy going forward. But the reason the data did not ignite a more pronounced rally in global equities is the fact that growth in China has become more of an expectation, and global growth as a whole is no longer a great concern (as it was back in the summer of 2015).

Instead, very low inflation rates in the US and Europe are the most notable concern, and until those statistics begin to firm, weak inflationary pressures will be a drag on risk assets like stocks in the months ahead.

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Weekly Market Cheat Sheet, July 17, 2017

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Last Week in Review

Hard economic data continued to disappoint last week, as both inflation and economic growth statistics were a letdown. And while in the short term the markets embraced it, as it potentially makes the Fed less hawkish, longer term this is a potential problem as we need economic acceleration and higher inflation to power stocks materially higher.

Friday’s CPI report was the focus last week, as inflation has consistently been losing momentum since early 2017, and unfortunately that trend continued in June. Core CPI, which is the important metric in the report, rose 0.1% vs. (E) 0.2%, and 1.7% yoy. That continued a now four-month slowing of inflation, and unless this changes in the next month or two, it could alter expected Fed policy.

Specifically, while Friday’s disappointing data prompted calls from analysts to say the Fed won’t hike rates or reduce the balance sheet in September, we think that is premature. I believe it would take a material slowing of economic growth to cause the Fed not to start shrinking the balance sheet, and that is not what happened last week. With regards to rate hikes, if the inflation data doesn’t get better between now and October, then yes, the Fed will probably be on hold for a while. But, there’s a lot of time between now and October (think about how much changed during this period last year, when economic growth accelerated).

Looking at the other data last week, June Retail Sales was easily the most disappointing report. The “control” group (which is the key metric in the report, and reflects Retail Sales minus gas, autos and building materials) dropped to -0.1% vs. (E) 0.4%, and that is a potentially cautious signal for consumer spending.

Finally, Industrial Production looked like the one decent number last week, as the headline beat estimates at 0.4% vs. (E) 0.1%. However, it was a bump in mining activity that caused the headline to surge, and the more important manufacturing sub component just met expectations at 0.2%. Bottom line, last week’s data was a disappointment, and further confirmed the unsustainably wide gap between “hard” economic numbers and “soft” economic surveys (like the manufacturing PMIs), and that gap must be filled one way or the other.

From a market standpoint, in the short term the data will have a dovish effect. Longer term, this middling data is a threat. With global central banks becoming less dovish, economic growth must accelerate, and in the US that isn’t happening. Long term, that’s a problem for stocks.

This Week’s Preview

There are several notable economic reports out this week, including first looks at July economic activity, as well as the ECB meeting. But unless there are major surprises, the data shouldn’t really move the debate about reflation vs. stagnation.

The headline event this week is the ECB meeting, which comes Thursday. Other than parsing Draghi’s comments for hawkish or dovish hints, there shouldn’t be any surprises at this meeting. For the ECB, the outlook is they will announce tapering of the QE program at the September meeting, and that by mid-2018, ECB QE will be over. Nothing Thursday should change that expectation.

Looking at US data, we get our first look at July activity via the Empire Manufacturing Survey (today) and the Philly Fed Survey (Thursday). While anecdotally notable, both surveys haven’t been well correlated to the national manufacturing PMIs lately, and as such they aren’t likely to elicit much of a market reaction barring a big surprise.

Bottom line, this week’s economic events will give us more anecdotal insight into the current state of the economy, but really, it’s next week’s data (flash manufacturing PMIs) that’s the next potential market mover.

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Earnings Season Preview, July 13, 2017

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Earnings remain an unsung, but very important tailwind on the markets, in part because both 2017 and 2018 earnings keep getting revised upward. And since stock prices are just a total of future expected earnings, those higher earnings are resulting in higher stock prices.

Given Q2 earnings season begins today, I want to take a moment and cover 1) What’s expected, and 2) How earnings can be a catalyst for a pullback, or 3) Spark a new rally.

First, to give some perspective, what’s important here is to look at the aggregate S&P 500 calendar-year earnings. Think of it as if you got the full-year earnings estimates for all 500 companies, and then added them up.

For 2017, that number (and this is an average between FactSet and Bloomberg consensus) is $131.00/share. So, on a current-year basis, the S&P 500 is trading at about 18.7X earnings (2450/131.00). That is a very historically high multiple, but not, by itself, prohibitively expensive.

For 2018, the consensus headline earnings (again an average of FactSet and Bloomberg) is $146.46. However, you have to take next year’s earnings estimates with a grain of salt, as they almost always come down throughout the year by around 5%-10%. There are multiple and varied reasons for this, but just trust me that is what happens.

So, if we reduce the $146.46 by 5%, we get $139.13. (I’m reducing it by just 5%, because corporate performance has been strong and my general caution aside, there aren’t any specific events looming out there, at this point, that should really hit corporate earnings).

At $139.13, the S&P 500 is trading at 17.6X next year’s earnings (2018). Most analysts (including me) consider 18X the “ceiling” for a next year P/E multiple. So, the markets is trading close to what most would consider a valuation “ceiling,” but it’s not there quite yet. And, given this set up, I think there are a few notable conclusions that need to be drawn from this analysis.

First, in order for this market to move higher, we must not see that $139ish 2018 S&P 500 number go down following this earning’s season. If it does, this market instantly becomes too expensive (for instance, if the expected 2018 EPS drops to $135, then the market is trading 18.15X earnings, which in my view would be too expensive).

Second, if that 2018 number moves higher following Q2 earnings season, then stocks can rally further and potentially materially so. And, we’ve seen that throughout 2017. Expected earnings for 2018 in January were in the mid $130s; however, corporate results have been stronger than expected, so that number has moved steadily higher, and that’s helped underpin the rally in stocks. If Q2 earnings season is stronger than expected and 2018 EPS get revised higher, this market can rally further and still not break above that 18X valuation ceiling.

Bottom line, for all the focus on politics, the Fed and macro factors, the real push behind the 2017 rally has been earnings growth. In 2017, the S&P 500 is expected to earn $131/share. In 2018, it’s expected to earn $139/ share. That’s at least 6% earnings growth with upside risks. So, until something in the macro economy puts that earnings growth at risk (like materially higher yields, geopolitical scare, turn in US & global economic data) the fact remains that while the stock market is historically expensive, it’s not prohibitively so.

Getting this earnings season “right” from a valuation standpoint will be an important signal on whether we need to reduce exposure, or allocate more to equities. We will be watching, and as soon as we get enough numbers to get some confidence on 2018 earnings, we will let you know.

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