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SGK Blog--Update May 13, 2016: U.S. Dollar Climbs Sending Stocks Lower and Bonds Higher on Strong Retail Sales & Consumer Sentiment Data 

The dollar rose to a six-week high and U.S. stocks declined in Friday trading after the biggest gain in American retail sales in a year reignited speculation the Federal Reserve may lift rates as early as June.  Oil retreated from a six-month high and iron ore fell to a two-month low. Commodities for the most part are priced in U.S. dollars, so a strong dollar move in either direction can make prices volatile. The U.S. currency gained versus all but two major peers, as the gap between two- and 10-year Treasury yields fell to the narrowest since 2007, after sales at retailers climbed more than forecast, renewing confidence in the consumer after forecast cuts by Macy’s Inc. and Nordstrom’s raised concerns about spending. Stocks fell earlier Friday amid signs of lackluster growth in Europe and Asia and a pull-back in industrial metals.  A rally in global equities that added $8.5 trillion in market value through April has lost momentum this month amid mixed earnings and speculation over the trajectory of borrowing costs in the U.S. Fed chiefs for Boston and Kansas City said Thursday that the central bank risks stoking an asset bubble by delaying raising interest rates for too long. They seemed to be preparing the markets for a pending rate increase, so their comments managed to effectively add to the pressure on equity prices this week. 

Sales at retailers jumped in April by the most in a year, indicating consumer spending will help the U.S. economy recover from an early-year slowdown. Purchases climbed 1.3 percent last month, the biggest gain since March 2015, after a 0.3 percent March drop that was smaller than previously reported, Commerce Department figures showed Friday in Washington.  The median forecast of economists surveyed by Bloomberg called for a 0.8 percent gain. Healthier household finances, reflecting reduced borrowing and increased savings, mean consumers have the wherewithal to boost spending even as gasoline prices rise and job growth moderates.  That can help shore up profits at retailers such as our core holding DICK’s Sporting Goods after this week’s volatility thanks to terrible earnings reports from retailers such as Macy’s, The Gap and Nordstrom’s. DICK’s releases earnings on the 19th of May. The stronger retail sales figures for April seems to be more consistent with the strong income numbers we have recently witnessed. Sales estimates in the Bloomberg survey ranged from gains of 0.2 percent to 1.5 percent.  March’s reading was revised from a previously reported 0.4 percent decrease. 

Eleven of 13 major retail categories showed increases last month, indicating the advance was broad-based.  Demand at auto dealers climbed by the most in a year and sales at grocery stores and online merchants were the strongest in almost two years. Core sales, the figures that are used to calculate gross domestic product and which exclude such categories as autos, gasoline stations and building materials, advanced 0.9 percent last month, the most since March 2014, after a revised 0.2 percent increase in March that was larger than previously reported. The report will probably prompt economists to boost forecasts for second-quarter consumer spending and economic growth after a disappointing start to the year. The household spending that makes up about 70 percent of the economy is projected to advance at a 2.6 percent annualized pace in the three months ended in June after a 1.9 percent gain in the first quarter, according to median forecast of economists surveyed by Bloomberg before the retail sales data. 

Consumer confidence in the U.S. climbed to an almost one-year high in May as Americans grew the most upbeat about incomes after inflation than at any time in a decade, the University of Michigan’s report showed on Friday. The University of Michigan’s preliminary May index rose to 95.8, the highest since June, from 89 in April. The median projection in a Bloomberg survey of economists called for 89.5. The current conditions index, which takes stock of Americans’ view of their personal finances, rose to 108.6 from 106.7. The measure of expectations six months from now climbed to 87.5 from 77.6. Earlier in the week the data was decidedly mixed. For example, weekly initial jobless claims for the week ending 5/7/2016 came in at a seasonally adjusted level of 294,000 which was well above the forecast for 270,000 and the prior week’s figure of 274,000. Producer prices for April (PPI) rose 0.2% which was just shy of the 0.3% expected while the core PPI figure came out right in line with expectations at +0.1%.  

 Strong U.S. figures give the Fed ammunition for a rate increase and that simply does not sit well with traders at this time.

SGK Blog--Update May 6, 2016: Payrolls Disappoint


The thud you heard was the sound of payroll data coming off Wall Street printers this morning.  Instead of the expected 200,000 gain in nonfarm payrolls in April, the Labor Department reported a rise of only 160,000 and revised the previous two months 19,000 jobs lower.  The difference in the unemployment rate was mere decimals—4.984% in April vs. 5.001% in March.  The biggest slowdown centered in the retail and construction categories which saw strong gains over the latter half of the winter thanks in part due to mild weather conditions.  One bright spot was average hourly earnings rose 0.3% from the prior month which meant worker pay rose 2.5% over the past 12 months, up from a 2.3% gain a month earlier.  The average work week for private workers rose by six minutes to 34.5 hours.  These are positive signs that Fed Chairwoman Yellen has been looking for—people working longer and getting paid more for doing it.  Another positive was that the underemployment rate—which includes part-time workers who would rather have a full-time position—fell to 9.7% from 9.8%.  However, the participation rate, which tracks working-age people in the work force, fell to 62.8% from 63%. 


The $64,000 question in 1955 has morphed into the $415 million Powerball quandary today: Was the slowdown due to weaker economic performance spilling over from the first quarter to the second or was it the natural deceleration in payrolls that happens as labor markets approach full employment?  If it was the former, the Fed’s decision next month about interest rates becomes very clear: do not raise rates.  They would likely vote to keep things as they are.  In fact, the probability of a rate rise in June is now only 4%.  On March 1, that number was 38%.  According to the futures market, traders are not expecting the first above even chance of a hike until February 2017.  If the answer to the question is the latter, it opens up a whole can of worms.  It would mean that the Fed should seriously consider raising rates because full employment means that inflation is right around the corner.  The 2.5% yearly pace of hourly earnings supports this view and suggests that the economy is close to “running hot” unless the Fed begins to pump the brakes.  Clearly, the market would not take a positive view of that decision.  It is at the June meeting where we will also get an update on the Fed’s dot plot where the members enter their projections on stats ranging from inflation to employment to GDP growth.  This update will go a long way towards seeing where the Fed is headed.  We are still over a month away from the meeting, but the global economic conditions which took center stage at previous meetings have seemingly exited the spotlight for the time being.  Therefore, the updated projections and Fed statement will be the clearest pure take on the domestic outlook investors have had for a while.  Stay tuned.
SGK Blog--Update April 29, 2016: Fed Sends Mixed Signals On U.S. Economy   

Federal Reserve policy makers signaled they’re open to raising interest rates in June, nodding to improvement in global financial markets and downplaying recent weakness in the U.S. economy. The Federal Open Market Committee omitted previous language that “global economic and financial developments continue to pose risks,” instead saying officials will “closely monitor” such developments, according to a statement released Wednesday following a two-day meeting in Washington.  The Fed left its benchmark interest rate unchanged. “Labor market conditions have improved further even as growth in economic activity appears to have slowed,” the FOMC said.  “Growth in household spending has moderated, although households’ real income has risen at a solid rate and consumer sentiment remains high.”  The committee reiterated that it will probably raise rates at a “gradual” pace.  The central bank’s next meeting is June 14-15. Extending a hold since raising interest rates in December from close to zero, the committee said that inflation has continued to run below the Fed’s 2 percent target, and market-based measures of inflation compensation remain low. 

Officials omitted an assessment of whether the risks to the outlook were balanced or not for the third straight meeting.  After saying in December that risks were “balanced,” policy makers removed the so-called “balance of risks” in January amid financial-market turmoil. Minutes from the March meeting showed that “many” officials saw the global situation posing downside risks to the U.S. economy. Esther George, president of the Kansas City Fed, dissented for the second meeting in a row, repeating her preference for a quarter-point increase instead of voting to leave the federal funds rate’s target range at 0.25 percent to 0.5 percent. Despite continued strength in the labor market, the committee balked at another move in January and again in March amid worries that weak global growth and turbulence in financial markets might harm the U.S. economy. Markets have since calmed and inflation has showed signs of rising closer to the central bank’s 2 percent target, but growth in the U.S. has slowed. “Since the beginning of the year, the housing sector has improved further but business fixed investment and net exports have been soft,” the FOMC said.  The committee reiterated that “a range of recent indicators, including strong job gains, points to additional strengthening of the labor market.”  

On a related note, Jobless claims last week hovered around four-decade lows, showing the labor market remains the strongest part of the U.S. economy. Initial applications for unemployment benefits climbed by 9,000 to 257,000 in the week ended April 23, a report from the Labor Department showed Thursday in Washington.  The prior week’s revised 248,000 claims were the fewest since 1973. The low level of firings indicates companies are optimistic about prospects for demand after a soft first quarter.  Continued progress in the labor market that’s accompanied by accelerating wage growth will be needed to help prop up consumer spending, which accounts for 70 percent of the economy. For the third year in a row, the U.S. economy started the year with a dose of the blues as gross domestic product eked out a 0.5 percent annual gain, according to Commerce Department figures released Thursday. Yet unlike in 2014 and 2015, the blahs can’t be attributed to harsh weather.  Indeed, a milder-than-normal winter may have helped, rather than hurt GDP, as builders were able to do more work outdoors than otherwise. That’s one reason why the economy may have difficulty springing back anything like it did in 2014 and 2015. It would not be unrealistic to see second quarter growth come in at 1.5 percent.  That’s a far cry from a second-quarter surge of 4.6 percent in 2014 and 3.9 percent in 2015 as construction and other spending snapped back after being depressed by the weather earlier in those years. Another reason for caution: a slowdown at the core of the economy.  After stripping out unsold goods and trade, the two most volatile components of GDP, as well as government expenditures, so-called final sales to private domestic purchasers increased at a 1.2 percent rate, the weakest advance since the third quarter of 2012. Looks like the Fed got it right in holding off on a rate increase at this month’s meeting. 

Consumer confidence rebounded last week as Americans felt more comfortable about their finances and considered it the best time to buy goods and services in two months. The weekly Bloomberg Consumer Comfort Index advanced to 43.4 in the period ended April 24 from 42.9.  The improvement left the gauge close to the 2016 average of 43.8.  The comfort measure has held in a 2-point range since the start of this year, the longest such streak since 2003. Also Friday the University of Michigan’s Consumer Sentiment Index was released for April and it came in at 89.0 versus the expectation for 90.0 and the prior month’s level of 89.7. 

The dollar dropped this week against all of its G-10 peers after weaker-than-expected U.S. economic growth dimmed prospects for a Federal Reserve interest-rate hike. This pressured stocks while commodities were set for their biggest monthly gain since 2010. The Bloomberg Dollar Spot Index sank to an 11-month low, while the yen was headed for its biggest weekly jump since 2008 after the Bank of Japan (BOJ) unexpectedly refrained from adding to record stimulus on Thursday.  The greenback’s decline is proving a boon for raw materials, helping lift gold and silver to 15-month highs.  Crude oil has jumped 20 percent this month to more than $45 a barrel. The BOJ’s surprise decision capped a week of fence-sitting for central banks, with the Fed keeping interest rates steady for a third straight meeting and policy makers from New Zealand to Brazil also holding the line.  The European Central Bank maintained stimulus last week and economists have reined in forecasts for monetary easing in China.   

In other global news, Germany’s retail sales fell in March from the previous month, while France’s economy expanded more than analysts forecast in the first quarter, data showed Friday.  The French and Spanish economies grew faster than expected in the first quarter, suggesting some momentum in the euro area’s expansion. Growth in France accelerated to 0.5 percent from 0.3 percent, beating the 0.4 percent projection in a Bloomberg survey, statistics office Insee said on Friday.  In Spain, GDP increased 0.8 percent, maintaining its pace of growth from the previous quarter and also exceeding the median forecast of analysts. The euro-region economy probably grew 0.4 percent in the period, according to analysts, though the better-than-predicted national numbers mean there’s a chance it may now come in higher. China’s central bank responded to an overnight tumble in the dollar by strengthening its currency fixing the most since a peg was dismantled in July 2005. The reference rate was raised by 0.6 percent to 6.4589 per dollar.  While the change in the fixing is extreme relative to the small moves of recent years, analysts said it reflects increased volatility in the dollar against other major exchange rates rather than a policy shift by the People’s Bank of China.  The yuan weakened against a basket of peers even as it climbed versus the greenback on Friday. 

It seemed to be the lack of central bank action and mixed earnings reports that pressure equity markets this week.   We report on a long list of our core holdings that released earnings this week below. As always, stay tuned! 

SGK Blog--Update April 22, 2016: Earnings Season Heats Up 

This week earnings took center stage as companies began to report first quarter results.  With nearly a dozen of our companies reporting, it was a busy week and we will discuss results below, but there was some economic data released on Monday related to the housing market.  Residential starts declined 8.8% to a 1.09 annualized rate which was the lowest since October.  Estimates of 78 economists polled by Bloomberg ranged from 1.12 million to 1.22 million so the final number was weaker than any forecast.  Permits, a proxy for future construction, also fell.  Work on multifamily homes fell 7.9% to an annual rate of 325,000, the lowest figure since February 2015.  Housing starts and permit data can be very volatile because weather plays such a strong role even though the data is seasonally adjusted.

Meanwhile, existing home sales rose more than projected in March.  According to the National Association of Realtors, contract closings rose 5.1% to a 5.3 million annualized rate last month.  That was above February’s 5.1 million rate and above the median forecast of 75 economists surveyed by Bloomberg.  The report also showed that supply continues to be a key driver.  There were 1.98 million homes on the market at the end of March, down 1.5% from the same month last year.  That translates into 4.5 months to sell all those houses if sales continued at the current pace.  Less than five months’ supply is considered a sellers’ market according to the Realtors group.  First time purchases remain historically low around 30% which suggests that affordability may be becoming a bigger factor.  We will not get new home sales data until next week.  Those figures are tabulated at the time a contract is signed versus existing home sales which are totaled only at closing.   

The National Association of Home Builders (NAHB)/Wells Fargo builder sentiment held at 58 during April.  It has held this level since February.  Readings above 50 indicate good market conditions.  The median forecast called for a 59 reading with the range from 57 to 60.  The index reached a 10-year high of 65 last October.  According to NAHB Chief Economist Robert Dietz, “Builders remain cautiously optimistic about construction growth in 2016.  Solid job creation and low mortgage interest rates will sustain continued gains in the single-family housing market in the months ahead.”  Speaking of hiring, on Thursday the weekly initial unemployment claims decreased to their lowest level since 1973 according to the Labor Department.  In the week ended April 16, new applications for unemployment benefits fell by 6,000 to 247,000.  The number of people already on benefits declined to a more than 15-year low.  The recent performance of weekly claims suggests that job gains over 200,000 per month are likely to continue when April’s payroll numbers are released in early May.

SGK Blog--Update April 15, 2016: Earnings Season Begins

Before earnings season reaches its peak, the economic calendar grabbed the attention of investors this week.  Retail sales unexpectedly fell in March by 0.3% following little change in the prior month according to the Commerce Department.  The median forecast in a survey conducted by Bloomberg of 81 economists called for a 0.1% gain.  Though nine of the 13 major categories did show gains last month, it was not enough to overcome the large declines in auto, clothing and restaurant sales.  Automobile dealers’ sales fell 2.1%, the most since February 2015.  According to Ward’s Automotive Group, purchases of cars and light trucks grew at a 16.5 million annualized rate in March, the slowest in more than a year.  Excluding autos, purchases rose 0.2% thanks to sales at service stations.  The numbers brought to a close a disappointing first quarter that even featured an early Easter this year (March 27) which usually spurs holiday sales and early spring buying.  The lackluster results do raise a bit of concern that consumers are not in the mood to buoy growth so far this year.  Unless we see a much stronger pickup in sales data, it will be challenging for the Fed to do anything with rates in April.  But nothing was expected at this month’s meeting on April 26-27 anyways.  However, if the malaise continues deeper into the second quarter, a hike at the June 14-15 meeting may also be non-existent.   

Price data did little to support a boost in the federal funds rate either.  Wholesale prices fell in March for a second month.  The 0.1% drop in March followed a 0.2% decline in February according to the Labor Department.  Over the past year, producer prices have fallen 0.1%.  Excluding the more volatile food and energy groups, producer costs were little changed and up only 1.0% over the past 12 months, still very comfortably below the 2% benchmark the Fed is looking for.  Consumer prices, both headline and core, were each expected to rise by 0.2% last month.  However, they each rose only 0.1%.  As a result, the core CPI figure on a yearly basis moderated back to up 2.2% from a 2.3% rise in the month prior.  Though this figure is above the benchmark, pronounced weakness in apparel, airfares and lodging away from home showed that trend is toward cooler figures not hotter.  The single largest component of CPI is owners’ equivalent rent and that metric was up only 0.2% last month, down from an increase of 0.3% in February.  What’s most interesting is looking at the price of goods versus services in the index.  Goods prices fell 0.3% in March while services were up 3.0%, slightly below their post-recession peak of 3.1%.  Some of the goods price deflation can be traced to a stronger dollar.  Though the dollar has fallen from its heights for the year, it will take time for currency-related factors to work their way through the supply chain.  The bulk of the economy is related to services but manufacturing of goods still plays a key role in how the entire economy operates.  The bottom line is that the Fed will be hard pressed to find any inflation in the wholesale or consumer channel anytime soon.   

Meanwhile, the labor market continues to show positive signs.  In the week ended April 9, the Labor Department stated that jobless claims fell by 13,000 to 253,000.  That equals the lowest number since December 1973.  The median forecast in the Bloomberg survey called for a figure of 270,000 claims.  The less volatile four-week moving average fell to 265,000.  The number of people continuing to receive jobless benefits also fell by 18,000 to 2.17 million in the week ended April 2.  This marks the 58th consecutive week that claims have been below the 300,000 level.  That is the longest stretch since 1973.  The recent Jobs Labor Turnover Survey showed that there is an increasing number of people who are voluntarily leaving their positions suggesting that confidence is growing.  That makes sense given that the national unemployment rate went higher in March (from 4.9% to 5.0%) as more participants entered the labor market looking for work.  Eventually, this tide of workers will lift prices, but we have yet to see any signs of it.  The Fed has gone on record to say that they are willing to let the economy “run hot.” They may just get their wish if wage demands begin to sprout in various sectors.  Hopefully, the Fed will then have the tools to keep the economy from getting overheated. 

SGK Blog--Update April 8, 2016: Fed Reunion

Against a backdrop where jobless claims dropped by 9,000 in the week ended April 2, Federal Reserve Chair Janet Yellen made some interesting comments this week during a panel at the International House in New York.  She stated, “We are coming close to our assigned congressional goal of maximum employment.”  Though it appears a bold statement, it is not a surprising one.  Measures of employment from monthly payroll figures to average hourly earnings have showed steady improvement over the past year and point to an environment where jobs are far from hard to get.  Nevertheless, she added that broader measures of underemployment are “higher than one would expect” and suggest that some slack remains in the labor force.  Specifically, many part-time workers would prefer full-time positions but cannot acquire them.  The panel marked the first time four previous Fed chiefs made a joint appearance as Yellen was joined by Ben Bernanke (Fed Chief: 2006-2014), Alan Greenspan—appearing via video link from Washington--(1987-2006) and Paul Volcker (1979-1987).  Though there was definitely some serious discussion about what it is like to hold what is considered the most powerful financial position in the world, panel moderator Fareed Zakaria of CNN did allow a little levity.  For instance, Greenspan, did not deny that he used “big words” to try to dodge tough questions at congressional hearings.  Bernanke revealed that he did not appreciate being called a traitor in 2011 by then governor Rick Perry of Texas.  Bernanke commented, “I didn’t take the job for adulation.”  When asked how he would unwind the $4 trillion plus on the Fed’s balance sheet, he responded, “Fortunately, I don’t have to.” and pointed toward Yellen.  Paul Volcker, who stands at an impressive six feet, eight inches often had to lean over the podium when speaking into a microphone and can be initially intimidating.  Size did not eliminate anxiety, however.  He paced so much in his office worrying about the Fed’s decisions that he thought he would wear a hole in his rug. 

All four played key roles at crucial times in recent U.S. financial history.  Volcker was responsible for “breaking” inflation created by high oil prices in the 1970’s by raising the federal funds rate to 20% in June 1981.  Though the economy suffered a double-dip recession on his watch, inflation never spiraled out of control and laid the groundwork for making the U.S. dollar the world’s reserve currency that it is today.  Greenspan was only three months into the position when Black Monday pushed Wall Street down 23% in late October of 1987.  Closer to the end of his term, the real estate bubble reached a peak.  That mess was the first challenge his successor, Bernanke, had to deal with.  The so-called Great Recession had global ramifications which brought the financial industry to the precipice by early 2009.  Yellen inherited a much more stable financial environment in early 2014, but that does not mean that her job is any easier. 

She and her Fed governor colleagues met last month to discuss the current situation and decided that the federal fund rate, now nearly 20% below Volcker’s level, should stay unchanged.  According to the minutes, “Several expressed the view that a cautious approach to raising rates would be prudent or noted their concern that raising the target rate as soon as April would signal a sense of urgency they did not think appropriate.”  A big factor contributing to this decision is the global picture.  “Many participants expressed a view that the global economic and financial situation still posed appreciable downside risks to the domestic economic outlook.”  This viewpoint was repeated by Yellen during the panel stating that the U.S. is “suffering from a drag from the global economy.”  Undoubtedly, rates are on hold because outside the U.S., the economic picture is soft.  Though the Federal Open Market Committee has room to raise rates, it does not have much leeway on the downside.  It does have policy tools—quantitative easing—to react if the slowdown begins to drag on the domestic picture.  However, with employment near “maximum,” the path of least resistance for rates is higher.  Yellen stated yesterday that raising rates in December was not a mistake.  Actually, it gave them some much needed breathing room, but definitely not enough ammo to fight the next recession whenever that might occur with purely rate cuts.   

The Fed’s next meeting is April 26-27.  With each meeting that passes where rates are not increased, it heightens the tension about a hike at the next get together.  Could the Fed hike later this month?  We are doubtful.  According to Bloomberg, the odds of that happening based on overnight index swaps is 0.0%.  In fact, the odds of the next hike do not rise above 50% until December.  That, of course, can change with the next data point.  What we focus on is the trend, and the market has been voting with their dollars for many months now that the Fed will not even come close to the four hikes they envisioned back in January.  Even two seems like a stretch given the issues that lie ahead.  Brexit worries. More Greek debt drama in July.  A U.S. election in November.  This says nothing of the geopolitical fallout which may ensue if one of the petro-sovereigns like Venezuela collapse if oil prices remain subdued.  Saudi Arabia and Russia have plenty of currency reserves but they are also feeling the pain of sub-$40 oil.  Stay tuned because there are plenty more challenges ahead before we can properly place Yellen’s term in historical context.
SGK Blog--Update April 1, 2016: Another Solid Employment Report 
The Labor Department reported that nonfarm payrolls rose 215,000 in March following a revised 245,000 advance in February.  Unemployment ticked higher to 5.0% from 4.9%, but that increase can be attributed to more job seekers entering the labor pool which bodes well for future employment trends.  A key focus of the Fed, average hourly earnings, rose 0.3% or 2.3% year-over-year suggesting that inflationary pressures are not quite omnipresent but signs of higher paycheck demands are definitely bubbling below the surface.  This month’s report was clearly a strong vote of confidence in the U.S. economy against an anemic global backdrop.  The labor force participation rate, which measures working-age people who are employed or looking for work, rose to 63%, the highest since March 2014.  A lot of reasons have been given to why it has fallen from the mid-60% level, but what is not up for debate is that a rise in that metric is for the good.  

To the market, the positive employment report is not new news.  The 3-month and 6-month trend in payrolls have suggested a consistently good picture, and this week’s initial unemployment claims report—a more timely measure than the monthly reports—posted a 4-week average of 263,000 which is 15,000 below 2015’s similar average of 278,000.  In a speech to the Economic Club of New York earlier this week, Federal Reserve Chair Janet Yellen said it was appropriate for the U.S. central bank to “proceed cautiously” in raising interest rates thanks to heightened risks in the global economy.  She added: “This caution is especially warranted because, with the federal funds rate so low, the FOMC’s (Federal Open Market Committee) ability to use conventional monetary policy to respond to economic disturbances is asymmetric.”  If rates, currently pegged at a range of 0.25%-0.50%, were to have to be reduced, Ms. Yellen said the FOMC “would still have considerable scope” to deal with the situation.  Before the employment report was released this morning, the chances of a Fed rate hike in June were only 22% and 0.0% for April’s meeting.  After the announcement it ticked up to only 26% for June so traders are still considering the global economic picture as a key input into the decision.  Euro-area inflation was negative for a second consecutive month in March and, when food and energy are stripped out, rose only 1.0% from February to March.  Germany, Europe’s engine, remained at a record-low 6.2% unemployment but is still grappling from the entrance of 1 million migrants in 2015.  That country may best be equipped to handle this flow of displaced souls but recent border crossing changes have trapped many of them in Greece and Italy which are far less able to absorb them into their already weak economies.  The Atlanta Fed’s GDPNow estimate for the U.S. first quarter is only 0.6% so evidence is mounting that domestic growth may be slowing, but if job growth continues at this pace or becomes even more robust, those estimates will have to rise if not for the first quarter then at least over the balance of 2016. 

Data released earlier this week by the Commerce Department showed that spending on goods and services rose 0.1% for a third month in February.  January spending was revised down to a gain of 0.1% from a previously reported gain of 0.5%.  Disposable income, which is money to spend after taxes, rose 0.3% in February.  Personal income rose 0.2% in February, 0.1 percentage point better than expectations.  That meant year-over-year incomes grew at 4.0%.  The Fed closely watches the personal consumption expenditure (PCE) deflator for a read on inflation.  Excluding food and energy, the core PCE deflator, rose just 0.1% in February following a 0.3% rise the prior month.  A 0.2% increase was projected in a survey of economists by Bloomberg.  Thus, the year-on-year change in core inflation held steady at 1.7%.  This remains below the 2% target set by the Fed but it is the highest level since July 2014.  During her speech this week, Ms. Yellen was confident that inflation would gradually return to that goal over time and this week’s average hourly earnings metric points in that direction.   

Home prices, according to the S&P/case-Shiller index, rose 5.7% in January versus the year-ago period.  This follows a 5.6% gain in the year ended in December.  All 20 cities in the index showed a year-over-year gain led by increases in Portland, Seattle and San Francisco.  Chicago saw the smallest increase at 2.1%.  A limited supply of available properties is being cited as the main reason for the gains.  Nevertheless, the spring selling season is well under way and assuming homes do not get priced too highly, the positive momentum in that market is likely to continue.
SGK Blog--Update March 24, 2016: U.S. Economic Data Mixed In This Holiday Shortened Trading Week 

Our hearts and prayers go out to the victims and their families of the terror attacks that occurred in Belgium this week. It is a senseless tragedy.

The euro-area economy showed signs of strengthening in March and confidence rose as the region tried to put a turbulent start to the year behind it. A gauge of factory and services activity in the 19-nation currency bloc unexpectedly rose this month, with a similar indicator for France indicating a return to expansion after a contraction in February. In Germany, business and investor confidence gauges also improved, reversing the recent downward trend in Europe’s largest economy. Economic resilience may be on the mend after an equity rout at the beginning of the year cast doubt over the bloc’s fragile recovery. Nevertheless, weak links remain, with German manufacturing barely growing and prices in the euro area falling. Tuesday’s terrorist attacks at the airport and metro system in Brussels may also challenge the outlook by further undermining consumer and business sentiment. “Today’s economic news flow in the euro area was encouraging after the dent seen in the first two months of this year,” said Johannes Gareis, an economist at Natixis SA in Frankfurt. “The Brussels attacks could have an impact on the economy due to fearful consumers but, drawing on the Paris attacks, that could be transitory.” At least 30 people were reported dead and many more injured after explosions ripped through the Belgian capital’s airport departure hall and a downtown subway station. While the terrorist attacks that killed 130 people in Paris last November hurt spending and tourism, the latest data show shoppers are returning.

For a shortened trading week, there was a decent amount of U.S. economic news to digest. U.S. home prices rose in January as shoppers competed for a limited inventory of listings. Prices increased 0.5% on a seasonally adjusted basis from December, the Federal Housing Finance Agency said Tuesday in a report from Washington. The gain matched the median estimate of 19 economists, according to data compiled by Bloomberg. Prices climbed 6% from a year earlier. The low number of homes on the market is holding back home sales and driving up prices. Closings on purchases of existing homes decreased 7.1% to a 5.08 million annual rate in February, a three-month low, after a 5.47 million pace in January, the National Association of Realtors reported on Monday. The median price of an existing single-family home in the U.S. was $215,000 in January, up 8.3% from a year earlier, according to the Realtors group. 

The number of new homes sold rebounded by 2.0% in February to 512,000, which was basically in-line with the Bloomberg consensus estimate of 510,000, and January sales were revised higher to 502,000 or -7.0% compared with a month earlier (previously estimated at 494k and -9.2%). New home sales are currently running above the 12-month moving average of 499,000 and the 2015 average of 503,000. In the details, the rebound was entirely driven by a rebound in sales in the West. The region saw an increase to 151,000 in February after sales fell to 109,000 in January from 162,000 in December. Other regions saw moderate declines in the pace of sales. The median price of a new home was $301,000 in January, a 2.6% increase from a year ago. A modest increase in sales offset a small pick-up in inventory, resulting in no change in the months of supply measure, which held steady at 5.6. This was below the recent peak reached in September (5.9) and slightly above the average for all of 2015 (5.2). An insufficient amount of affordable inventory will continue to restrain a more significant pickup in home sales and push home prices higher in the near- to medium-term. A broader view of the economic landscape continues to show a moderately improving market for homes, illustrating why it is important for analysts to take care when interpreting housing data’s signals during winter months. The moderate upward trend in housing activity remains intact. Favorable conditions in the form of rising incomes, stronger employment and low borrowing costs should continue to support moderate growth in the sector.  

Orders for durable goods fell in February for the third time in four months, reflecting a broad-based slowdown that underscores lingering softness in U.S. capital investment. Bookings for goods and materials meant to last at least three years declined 2.8% after a 4.2% gain that was less the previously reported, Commerce Department data showed Thursday. Bookings for non-military capital goods excluding aircraft dropped 1.8%, more than estimated. Limited progress by companies in bringing inventories more in line with sales has led to thinner order books at the nation’s factories. Tepid global markets, the dollar’s advance and a slump in commodity prices also have led overseas customers to pare bookings as manufacturing remains a weak spot of the economy. The median forecast of 74 economists surveyed by Bloomberg called for a 3% decrease in overall bookings, with estimates ranging from a 7% plunge to a 0.5 gain. Filings for U.S. unemployment benefits last week rose less than economists forecast as the number of dismissals stayed consistent with a firm labor market. Initial jobless claims increased by 6,000 to 265,000 in the period ended March 19, a Labor Department report showed Thursday. The median forecast of 42 economists surveyed by Bloomberg called for 269,000. Hiring managers are demonstrating a preference to maintain and build staff as domestic demand continues to hold up. Tighter employment conditions are helping to buoy the economic outlook in the face of sluggish overseas growth. Initial filings have been below 300,000 for 55 weeks, the longest stretch since 1973 and a level economists say is consistent with a healthy labor market. The four-week average of claims, a less-volatile measure than the weekly figure, was little changed at 259,750 compared with 259,500 in the prior week. 

Federal Reserve Bank of Chicago President Charles Evans said policy makers rightly refrained from raising interest rates this month after a rocky start to the year clouded the economic outlook. “The rationale for no rate change in March is that economic and financial risks seem somewhat higher for 2016 than we had hoped back last December when we first began raising rates,” Evans said Tuesday in a speech in Chicago. “Most of the Federal Open Market Committee’s cautionary pause in the rate normalization path is about assessing risks and just being careful.” The FOMC kept the target range for the benchmark federal funds rate unchanged at 0.25% to 0.5% last week and halved projections for how many times it would hike rates this year from four times in December. Evans, one of the Fed’s most dovish officials who will vote on policy next year, said those estimates, also referred to as the dot plot, are “really a pretty good setting” for him and “a good reflection of what most people are thinking.” Nine policy makers predicted two rate hikes in 2016. Seven officials foresaw three or more increases this year, while one projected just one move. Evans said the identity of which policy maker picked which individual dot is confidential and isn’t even revealed inside FOMC meetings. The U.S. economy is projected to grow between 2% and 2.5% this year, with fundamentals “really quite good,” and unemployment should edge down further to around 4.75%, Evans said. At the same time, policy makers are looking for signs that inflation will rise in a “sustainable” way, he said. “The continuation of a wait-and-see monetary response is appropriate to ensure economic growth continues, labor markets strengthen further, wages begin to increase more, and all of this supports an eventual increase in currently low inflation, right back up to our 2% objective,” Evans indicated. Of course Fed governor Bullard came out on Wednesday indicating that his view was the Fed could raise rates at their April meeting. He gave several reasons for that. The bottom line is Fed governors should think about speaking less between meetings and staying focused on their statement delivered when they do all meet together at their regularly scheduled intervals.   When they speak between meetings it often leads to mixed messages and confusion, as we witnessed this week. Traders have a pretty good idea of who carries the most weight at the Fed, but the confusion created by Fed governors virtually every time they open their mouths between meetings once again reigned supreme this week. That is why we here at SGK focus on the fundamentals of the economy, in addition to the fundamentals of the companies we own for our clients. As always, stay tuned!

SGK Blog--Update March 18, 2016: No Moves By the Fed

Though the Federal Reserve left interest rates unchanged, they made market-moving news with their projections.  The Federal Open Market Committee voted, with one dissention, to keep the benchmark federal funds rate at a range of 0.25%-0.50%.  According to their official statement, “The committee currently expects that, with gradual adjustments in the stance of monetary policy, economic activity will expand at a moderate pace and labor market indicators will continue to strengthen.  However, global economic and financial developments continue to pose risks.”  Kansas City Fed President Esther George preferred a quarter-point rate boost but was outvoted by the other members. 

The tone of the statement was dovish and the market liked the accompanying economic projections which are updated once a quarter.  The median of Fed officials’ projections, known as the “dot plot,” saw the federal funds rate at 0.875% at the end of 2016.  That is down from the 1.4% median based on their December projections.  Similarly, the end of 2017 figure fell from 2.4% to 1.9% and 2018’s level was reduced to 3.0% from 3.3%.  Thus, instead of an expected four hikes in the funds rate, the Fed, on average, is expecting only two.  That is much closer to where overnight index swaps have settled.  These instruments are where traders can bet on future rate moves.  For 2016, the OIS curve has settled on 0.65% and 0.875% for 2017.  It was this discrepancy between the Fed and the markets which had introduced additional volatility in trading since January.  According to Bloomberg, the probability of a rate move does not rise above 50% until the September 21 Fed meeting which has a probability of a hike at 55.1%.  On Tuesday, before the Fed meeting, that September figure was 68.1% which suggests that even Wall Street is becoming more skeptical of a rate hike this year.  Nevertheless, markets were relieved that the Fed was at least coming around to their point of view.

The Fed reiterated that the course of rate hikes is not set, it plans to move gradually and changes will depend on “realized and expected economic conditions.”  This data dependency would actually favor a rate move like Ms. George suggested.  Payroll gains have averaged 235,000 over the past six months.  The more timely weekly initial unemployment figure remain close to a four decade low and have been below 300,000 for 54 consecutive weeks.  The latest unemployment rate is only 0.2% away from where the Fed expects it to be by year-end 2016.  Builders broke ground on more homes last month as new starts increased 5.2% which was higher than estimated in a Bloomberg poll, with January’s numbers also revised higher.  February consumer price index data was released this week which showed, excluding food and energy costs, prices climbed 2.3% in the 12 months, which is the largest yearly gain since May 2012.  Inflation has been the missing ingredient for the Fed to take a more hawkish view.  January’s personal consumption expenditure report showed signs of life, rising 1.3% from year earlier, after 13 consecutive months with rises below 1%.  As that number creeps closer to the Fed’s 2% target the chorus gets louder for a rate hike.

However, the Fed realizes that it is indeed the world’s central bank.  When they said “global economic and financial developments continue to pose risks” they were essentially saying that they are keeping one eye on what the rest of the world is doing.  The European Central Bank unleased unprecedented stimulus last week and further cut their key interest rate below zero.  The Bank of Japan laid the groundwork for additional easing after cutting its deposit rate to -0.1% in January.  The world’s second largest economy, China, has its central bank focused on stimulative measures in order to avoid a slowdown.   For the Fed to move in the opposite direction of these other institutions would play havoc with currency markets and may lead to tariff concerns.  Dollar strength since mid-2014 has been a headwind to U.S. companies with operations overseas.  A higher dollar also makes crude oil more expensive since it trades on a global basis only in greenbacks.  Recently, crude has crept back over $40 per barrel, and the Fed on hold will help sustain that move.         

SGK Blog--Update March 11, 2016: ECB's Mario Draghi Sends Markets on a Wild Ride      

All eyes were on the European Central Bank Thursday in anticipation of potential further stimulus measures to be announced. European Central Bank president Mario Draghi did not disappoint. He unleashed his most audacious stimulus package yet, unexpectedly testing the lower bounds of all the European Central Bank’s interest rates and expanding its monthly bond purchases by a third. The euro immediately sank and stocks rose. The 25-member Governing Council, meeting in Frankfurt on Thursday, cut the rate on cash parked overnight by banks by 10 basis points to minus 0.4% and lowered its benchmark rate to zero. Bond purchases were increased to 80 billion euros ($87 billion) a month from 60 billion euros, and corporate bonds will now be eligible. A new series of long-term loans to banks will begin in June. The package exceeded market expectations for more stimulus and may signal increasing concern about persistent weakness in consumer prices and a Chinese slowdown. Draghi -- who will present new economic forecasts -- has repeatedly said policy makers are willing to do what’s necessary to revive inflation and underpin the region’s upturn. The euro sank 1.3% to $1.0856 at 2:13 p.m. Frankfurt time immediately after the announcement while the Stoxx Europe 600 Index jumped more than 2%. All seem well with the world, until he made the comment – we may be done with further interest rate cuts. The euro quickly recovered lost ground and stocks retreated on that one remark alone. 

As traders digested the news overnight, Friday’s markets greeted his package of stimulus measures with more enthusiasm. The focus now shifts to Draghi’s explanation of the package and its potential impact on banks. Negative rates have been criticized for squeezing bank profitability to the point they curb lending. Investment-grade euro-denominated bonds issued by non-bank corporations established in the euro area will be included in the list of assets that are eligible for regular purchases under QE. The ECB said its new round of targeted refinancing operations will start in June. The central bank said the interest rate “can be as low as the interest rate on the deposit facility.” The word bazooka comes to mind, but we are looking for more details now on the targeted long-term refinancing operations also known as TLTRO will work and how that and other measures will mitigate the impact of negative rates on banks. As we mentioned, the rally in European stocks and our futures quickly faded when Draghi during his press conference indicated he did not see a need for future interest rate cuts after the measures taken Thursday. Then when analysts and traders had an opportunity to further digest the measures we had a global rally is equity trading in the early going Friday. This is why we do not depend on central bankers to make stock and bond decisions! We prefer the approach utilizing good, solid fundamental analysis.  

 Filings for U.S. unemployment benefits fell last week to the lowest level in five months as the number of firings remained consistent with a solid labor market. Jobless claims dropped by 18,000 to 259,000 in the week ended March 5, the fewest since mid-October, from a revised 277,000 in the prior period, a Labor Department report showed Thursday in Washington. The median forecast of 48 economists surveyed by Bloomberg called for 275,000. Employers are demonstrating an appetite to further add to staff and hold off on firings based on a brighter U.S. outlook, even as overseas growth sputters. A tighter job market is slated to slow the pace of hiring this year as workers await a bigger pickup in wages. There does appear to be enough domestic momentum to offset most of the drag from the global slowdown. Estimates in the Bloomberg survey for jobless claims ranged from 259,000 to 285,000. This combination of information presents a quagmire for the Fed, do they raise interest rates based on the general health of the U.S. economy while foreign central banks are doing the opposite by adding stimulus? It brings U.S. dollar strength back into play just when that appeared to have stabilized and commodity prices seemed to have recovered some ground.   As always, stay tuned!
SGK Blog--Update March 4, 2016: Employment Surges    

The monthly report from the Labor Department showed that employers were busy adding to their ranks. Nonfarm payrolls rose 242,000 in the month of February following a 172,000 rise in January that was larger than previously estimated. The jobless rate held at 4.9% which was significant from the viewpoint that more people entered the labor force, as measured by the labor participation ratio, and found work which kept that rate steady. The median forecast in a Bloomberg survey called for a 195,000 increase with a range of 70,000 to 245,000 so the final figure was almost higher than the peak estimate. Private payrolls, which exclude government hiring figures, also exceeded expectations at 230,000 versus the 190,000 survey figure. The labor market is coming off its best two years for job growth since 1998-1999. Though the headline figure was impressive, there is justified caution when further analysis is done. 

Average hourly earnings fell by 0.1% from January to February. That is the first decline since 2014. Worker pay still increased 2.2% over the 12 months ended in February but that was below the 2.5% Bloomberg estimate and less than the 2.7% pace we saw in January. Additionally, the average work week declined by 12 minutes. That’s not a huge move obviously but again it is a data point that is moving in the opposite direction of the trend we saw in previous months. These figures get revised sometimes two or three times once more data is compiled and tabulated so an initial reading cannot be stressed too much. A more timely indicator, namely the weekly initial unemployment benefits report, showed a four-week average that fell to the lowest level since the end of November even though the current week’s report ended February 27 reported a climb in claims. With another week below 300,000 claims, this continues a trend for over a year that suggests employers are retaining workers to cater to rising demand. 

Nevertheless, for a Fed that is supposedly data dependent the trends on the whole can be viewed as a mixed bag with a slightly positive tilt. Plus, it is logical to conclude steady job gains if they continue will eventually put pressure on future wage increases. There have been plenty of other signs that point towards a continuation of the interest rate tightening path they embarked upon last December. The ISM manufacturing and non-manufacturing surveys showed a slight uptick in February. Manufacturing’s 49.5 reading inched closer to the 50.0 level which divides an expansionary trend (above 50.0) from a contractionary trend and lent support to the resurgence in durable goods orders. The service component remained in the growth area where it has been since 2010 and, since the majority of the U.S. economy is services based, is a good indicator of the overall health of a variety of industries. The U.S. 10-year breakeven rate which measures the market’s guess of what inflation will be 10-years from now has risen to 1.564% from 1.356% during the time of the Fed’s last meeting in January. This has translated into more bets on when the Fed will actually hike. The probability of a move in June is now 40.2%, up from 11.6% in mid-February. Obviously, that number can swing widely each day but is a good indicator of where federal funds futures are headed. We also keep a close watch on the spread between 2-year and 10-year U.S. Treasury notes, the so-called slope of the yield curve. Recently, it has hovered around 100 basis points (1.0%), down from the 125 basis points at the start of the year. This flattening of the curve’s spread is a graphical interpretation of the market’s prediction of slower growth. If we see that number move back higher in the coming weeks, it will suggest the market is betting more heavily on a reacceleration of growth. The market will have mixed feelings about that because it would mean the economy is healthier but it would also point towards a higher likelihood of a rate hike. We are also keeping an eye on the spread between U.S. securities and overseas instruments. With the European Central Bank focused on quantitative easing, yields in Europe have fallen sharply. The Fed, which often finds itself as not on the U.S. monetary brain trust but also de facto the world’s central bank, must be wary of these moves. The spread between the 10-year U.S. Treasury note and the 10-year German bund has risen to 165 basis points from the 140 range last fall. The higher that spread, the stronger the U.S. dollar, which can have a deleterious effect on the financial results of U.S. multinational corporations. With overnight index swaps continuing to price in only one more hike in 2016, the upcoming Fed meeting in two weeks will be in even more focus given today’s payroll figures. Fed members will be releasing their quarterly updates for year-end projections of GDP, inflation, unemployment and interest rates. With the economy already hitting the targets they established in January, inquiring minds want to know: What’s next? Stay tuned.
SGK Blog--Update February 26, 2016: Earnings Season Wrapping Up as Economic Data Flows  

The Fed says that it will be data dependent as it sets future interest rate policy.  This was a week when the data came in a deluge.  We received information on both existing and new home sales.  Existing homes make up the bulk of housing transactions (about 90%) and in January it rose to the second-highest pace since February 2007 according to the National Association of Realtors.  The median forecast of economists surveyed by Bloomberg called for a 5.32 million annualized rate, but the actual result was surprise to the upside at 5.47 million annual rate.  The data was volatile in the last two months of 2015 because of a change in regulations which included the introduction of new forms used by lenders and title companies that led to delays in November signings.  January is not the main month for housing transactions (the data is seasonally adjusted) but it is good to see a nice spike in the numbers given the fear of a slowdown in the economy.  At the current sales pace, it would take four months to sell all the housing inventory—currently at 1.82 million previously owned homes on the market.  Less than five months’ supply is considered a tight market, and it was little changed from the 3.9 months at the end of December.  Another positive was the fact that first time buyers accounted for 32% of all purchases, up from 28% in January 2015, and distressed sales, which includes foreclosures and short sales, fell to 9% this year from 11% in January of last year.

New home sales, which are tabulated when the deal is signed not when the transaction is closed, fell 9.2% to an 494,000 annualized pace in January according to Commerce Department info released on Wednesday.  While the drop is noteworthy, it is far too soon to predict any material shift in the trend towards a healthy housing market.  In particular, the data seems to have been dragged down by sales in the West which fell 32.1%.  Conversely, sales in the Northeast advanced 3.4% and 1.8% in the South.  The rate of contract signings in the southern U.S. reached a five-month high.  According to Freddie Mac, the average rate on a 30-year, fixed mortgage was 3.65% in the week ended February 18, the cheapest since April and not far from the 3.31% record-low reached in 2012.  Thus, we believe it is safe to assume that healthy gains in employment, budding wage growth and still low borrowing costs are benefiting the residential real estate market and will continue to do so in the important spring selling season. 

The confidence in that market is a reflection of a better consumer environment.  According to the Commerce Department, the 0.5% rise in consumer purchases in January exceeded the 0.3% median forecast.  Personal incomes also rose 0.5%, more than projected.  With consumer expenditures making up 70% of the economy, an environment of steady hiring, cheap gas and rising home values are providing a solid backdrop.  Disposable income, which are funds left over after taxes, rose 0.4% for a second consecutive month.  The core personal consumption expenditure measure, which is a key Fed statistic, rose 0.3% for the month and climbed 1.7% from January 2015.  This was the biggest jump since November 2012 and is much closer to the “around 2%” level that the Fed is aiming for.  It could definitely cause a few more sleepless nights for bond traders as they try to determine the Fed’s next move with interest rates.  We also saw a rebound in January for spending on durable goods.  This could be a sign that we are close to a bottom in manufacturing’s downturn.  Orders for non-military equipment excluding commercial aircraft rose 3.9%, more than forecast, and was a big reversal from the 3.7% decline in December.  Durable goods are meant to last three years and if businesses are willing to spend on these items—cars, computers, metals and machines—it could mean that the consumer will not have to shoulder the entire load of the U.S. economy going forward.

On Friday, we got the latest update on the value of all goods and services produced in the country.  Gross domestic product grew at a 1% annualized rate in the fourth quarter according to the Commerce Department after an initial estimate of 0.7% annualized growth.  The median forecast called for a 0.4% gain.  The GDP estimate is the second of three for the quarter, with the final number to be released next month when more information is gathered.  After today’s revision, GDP expanded at 2.4% for 2015 matching the pace of 2014.  Most of the upward revision was due to even faster inventory accumulation.  That meant the contribution to growth was not -0.45% as first reported, but only -0.14%.  The downside to this is that higher inventories mean less demand for near-term production, all else being equal.  The other components of GDP: personal consumption (+2.0% vs. +2.2% as initially reported), business investment (-1.9% vs. -1.8%), net exports (-2.7% vs. -2.5%) and government spending (-0.1% vs. 0.7%) all weakened.  That could mean that the economy was even weaker than expected at the end of last year.  One positive is that final sales, which excludes inventory swings, remained unchanged at 1.2%.  The most recent Bloomberg survey still calls for 2.2% GDP growth in 2016.  As long as the malaise that was present during the fourth quarter gets replaced by a more buoyant consumer, more confident business spending trend and a slowdown in the dollar’s strength to help net exports, the current expansion is likely to continue slow and steady but still far from robust.      

SGK Blog--Update February 19, 2016: Markets Show Evidence of Stabilization This Week 

Tuesday morning when trading opened after the President’s Day Holiday Monday, we were greeted with the news that Saudi Arabia and Russia agreed to freeze oil output at near-record levels, the first coordinated move by the world’s two largest producers to counter a slump that has pummeled their economies, markets and companies. While the deal announced Tuesday was preliminary and at that point did not include Iran, it was the first significant cooperation between OPEC and non-OPEC producers in 15 years and Saudi Arabia said it’s open to further action. Oil pared gains after the accord was announced, as there was some hope that an actual production cut would be signaled, but overall it was a positive development for the oil markets. The deal to fix production at January levels, which initially included Qatar and Venezuela, is the “beginning of a process” that could require “other steps to stabilize and improve the market,” Saudi Oil Minister Ali Al-Naimi said in Doha Tuesday after the talks with Russian Energy Minister Alexander Novak. Qatar and Venezuela also agreed to participate, he said. Later that day, Kuwait agreed to do the same. Saudi Arabia has resisted making any cuts in output to boost prices from a 12-year low, arguing that it would simply be losing market share unless its rivals also agreed to reduce supplies.  

Naimi’s comments may continue to feed speculation that the world’s biggest oil producers will take action to revive prices. “The reason we agreed to a potential freeze of production is simply the beginning of a process” over next few months,” Naimi told reporters. “We don’t want significant gyrations in prices. We don’t want a reduction in supply. We want to meet demand. We want a stable oil price.” The freeze is conditional on other nations agreeing to participate, Russia’s Energy Ministry said in a statement. So it remains to be seen how effective it is, but at last they are talking! After initially trading down early Wednesday, oil prices moved higher in mid-day trading on the comment from Al Mazrouie, the United Arab Emirates (UAE) energy minister that they support the accord and the freeze will have a “positive impact in balancing future demand with current oversupply.” Additionally, every trader in the world was very skeptical as to whether Iran would have any interest whatsoever in even commenting on the accord. So when Iran’s oil minister Bijan Namdar Zanganeh met with counterparts from Iraq, the second biggest OPEC producer, Qatar and Venezuela following the output agreement in Doha Tuesday and he stated that Iran supports the Doha proposal, it caught traders completely off-guard. So oil rose higher particularly on that news. We can, of course, read a lot into his comments. He did not specify if Iran would join in restraining production given they are just now back on line, but the news was all the same received positively after Tuesday’s announcement and the other countries subsequently coming on board. 

Attention this week moved from the volatility we witnessed during the most recent earnings season and data from the Chinese economy to data that came out on the U.S. economy this week, which was altogether pretty good. U.S. manufacturing output rose in January by the most since July 2015, a sign the industry was starting to stabilize at the beginning of the year. The 0.5% advance at factories, which make up 75% of all production, followed a 0.2% decrease the prior month, a Federal Reserve report showed Wednesday. Total output, which also includes mines and utilities, jumped a larger-than-projected 0.9%. Factory production was boosted by the biggest gain in the output of consumer goods since July on increases in both durables and nondurables. These figures were both better than expected. The improvement indicates the worst of the drag from a stronger dollar, malaise in overseas markets and less spending in the energy sector may be starting to diminish. The January increase was the biggest since November 2014. Subsequent to the report on U.S. manufacturing, The American Petroleum Institute (API) reported a surprising drawdown in U.S. inventories for the week ending February 12. The API reports inventory levels of US crude oil, gasoline and distillates stocks. The figure shows how much oil and product is available in storage. The indicator gives an overview of US petroleum demand. Oil prices got a further boost after markets closed on Wednesday on the report that there was a drawdown of 3.3 million barrels for the week versus an expectation for a build of 3 million barrels.   We tied this stat to the manufacturing data as it may be an indicator that demand remains relatively healthy here in the U.S. and that the selling pressure on futures contracts for oil was overdone. 

Federal Reserve policy makers debating their outlook for interest rates last month expressed concern that the fall in commodity prices and the rout in financial markets increasingly posed risks to the U.S. economy. “Participants judged that the overall implications of these developments for the outlook for domestic economic activity was unclear but they agreed that uncertainty had increased,” according to minutes of the Federal Open Market Committee’s Jan. 26-27 meeting released Wednesday in Washington. “Many saw these developments as increasing the downside risks to the outlook.” Policy makers, who projected in December that they’d raise interest rates four times this year, are grappling with the fallout of market turbulence that has cast doubt over the economic outlook globally. Fed Chair Janet Yellen suggested in congressional testimony last week that the central bank could delay its plans for tighter policy to assess how the economy reacts to current headwinds. The minutes go into more detail than the FOMC’s statement on policy makers’ concerns about the risks to the U.S. economy. While voting members “generally agreed” they couldn’t assess the balance of risks to the outlook in the statement, officials “observed that if the recent tightening of global financial conditions was sustained, it could be a factor amplifying downside risks,” according to the report. Another part of the minutes indicated that a minority of policy makers judged that recent developments had “increased the level of downside risks or that the risks were no longer balanced.”  

The reason we go into this level of detail on their discussion is that when their January statement came out after their meeting, it was not well received. The stock market had been trading higher prior to their statement and when it was released in January stocks reversed course and ended the day sharply lower.   With respect to the release of these minutes Wednesday, stocks were trading higher prior to the release and they ended the day at about the same level – even slightly higher. The bottom line is, the minutes provide more insight into the issues they were debating, their thought process and the range of views of the committee members.   It was clear they were concerned about the spillover effects of the sharp declines in global markets and issues going on in China at the start of the year. They went on to note, while participants continued to expect that gradual adjustments in the stance of monetary policy would be appropriate, they emphasized that the timing and pace of adjustments will depend on future economic and financial-market developments and their implications for the medium-term economic outlook,” the minutes said. Officials agreed that incoming labor-market indicators had been “encouraging,” while data on spending and production were “disappointing.” “A number of participants were concerned about the potential drag on the U.S. economy from the broader effects of a greater-than-expected slowdown in China” and other emerging- market economies, the minutes said. Policy makers noted that the further decline in energy prices and an additional appreciation of the dollar “likely implied that inflation would take somewhat longer than previously anticipated to rise” to 2%. The Fed’s preferred gauge of prices has languished below that target for more than three years. The rate rose 0.6% in the 12 months through December, the fastest pace in a year. “A few participants noted that direct evidence that inflation was rising toward 2% would be an important element of their assessment of the outlook and of the appropriate path for policy,” according to the minutes. Enough said!  

Given all the concerns and talk over deflation here in the U.S. over declining oil prices at the start of the year, it was actually refreshing to see wholesale prices in the U.S. unexpectedly increased in January as higher food costs more than made up for the fall in energy prices. The 0.1% gain in the producer price index in January followed a 0.2% decline in December, according to the Labor Department. Wholesale prices were down 0.2% from January 2015. Another report Wednesday showed new home construction in the U.S. unexpectedly cooled in January, indicating there is a limit to how much gains in residential real estate will boost growth at the start of 2016. Housing starts dropped 3.8% to a 1.1 million annualized rate, the weakest in 3 months, from a 1.14 million pace the prior month, according to the Commerce Department data. Hopefully some of the housing data was negatively impacted by bad weather in January and that activity will pick back up in the near term. 

Interestingly, stock gains were hampered in Thursday and Friday trading on better than expected news on the U.S. economy. Initial weekly jobless claims for the week ending 2/13/2016 came in at 262,000 compared to the expectation of 274,000. The consumer price index for January was 0.0% compared to the expectation for a decline of -0.1% but the key was the core rate, which excludes good and energy, rose a relatively robust +0.3% compared to the expectation for a +0.1% figure. So the U.S. dollar rose, commodity prices declined and once again it fueled speculation that perhaps the Fed is correct that over time the core inflation rate will move closer to its target of 2%. The two data points – positive news on the job front and hints of inflation – created enough uncertainty with respect to the Fed’s next move that it pushed stocks lower in initial trading on Friday while the yield curve flattened. The flattening of the yield curve is interesting because it could be interpreted as the market saying to the Fed, if you do raise rates it is going to dampen future economic growth. In our view, we have plenty of data points between now and the next meeting of the FOMC in March and we have not seen enough evidence that they would be justified in raising rates at that meeting. Stay tuned!

SGK Blog--Update February 12, 2016: Yellen Speaks as Markets Listen 

Fed Chairwoman Janet Yellen spoke before Congress this week giving an assessment of the economic landscape and answering questions from elected officials.  Given the state of the global markets and also sluggish economic growth, she was due for a tough audience.  She commented: “Financial conditions in the United States have recently become less supportive of growth, with declines in broad measures of equity prices, higher borrowing rates for riskier borrowers, and a further appreciation of the dollar.  These developments, if they prove persistent, could weigh on the outlook for economic activity and the labor market, although declines in longer-term interest rates and oil prices provide some offset.”  The biggest challenge she and the rest of the Fed face is global weakness.  They have no control over the monetary or fiscal policies of Europe or China and thus can only do so much.  In response to these issues, she commented that downside risks of weak commodity prices and uncertainty about China’s exchange-rate policy could affect domestic shores.  Specifically, she added, “foreign activity and demand for U.S. exports could weaken and financial market conditions could tighten further.”  The markets traded slightly lower on Wednesday when she appeared before the House but had an awful day on Thursday during her Senate testimony.  

The uncertainty created when the entire Federal Open Market Committee met last month still persists but there are growing doubts if they will be able to raise rates at all in 2016.  According to Bloomberg, the chance of a rate hike is 29%...for February 2017!  Clearly, the market believes that global events and the sluggish U.S. manufacturing sector warrant a pause in the program.  This week was a great time to lay the groundwork for convincing the market that 2016 would not see anywhere near the four hikes laid out in January’s projections.  Yet, Chairwoman Yellen held the interest-rate card close to her vest.  Obviously, she did not want to paint the Fed into a corner and, even though it was her testifying, she has to speak for the group which has not met again since last month.  Next month is clearly the key time.  When the Fed meets on March 16, it must either boost rates and continue on its “gradual” path to reach the four hikes it outlined or it must change its outlook and not make any changes thereby admitting that the hike plan is on indefinite hold.  We would bet on the latter.  Maybe by June’s meeting, there will be calmer financial markets and a pickup in the economy after the slowdown that characterized the second half of 2015.  Domestic trends are encouraging.  Initial unemployment claims were 11,000 below consensus this week.  The U.S. JOLTS report (Job Openings and Labor Turnover Survey) showed that the willingness of workers to leave a job rose to the highest level since April 2008.  Job openings totaled 5.6 million in December meaning that if these positions were all filled with the unemployed, the national unemployment rate would fall from 4.9% to 1.4%.  Retail sales released today showed that consumer spending rebounded in January after a so-so December.  Low gas prices and surging auto sales affected the headline number.  Yet, even ex-gas and ex-auto sales, consumer demand is up 3.8% year-over-year which is solid number.  The late January East Coast blizzard affected restaurants, home improvement and sporting goods sales but electronics, clothing and general merchandise showed broad-based gains.  These categories make it clear, when people could not get out of their door, they still shopped via the internet. 

The Fed and investors will be concentrating on more data points between now and mid-March.  We will get info on consumer prices, existing and new home sales and all-important payroll data all in the next three weeks.  With earnings season winding down, these headline figures will gain more importance and fill the information vacuum for traders.  The task for Yellen & Co. does not get any easier.  The market is clearly “speaking” and calling for the Fed to sit tight.  Stay tuned.       

SGK Blog--Update February5, 2016: Markets Fluctuate on Earnings, Oil and Fed Speculation

We have focused recently on China a great deal, as they head into their lunar new year next week with their markets closed the entire time, we turn our attention to our economy here in the U.S. We had a key data point released Wednesday that caught the attention of traders globally and we are pretty sure Federal Reserve bankers as well. Service industries in the U.S. expanded in January at the slowest pace in nearly two years, raising the risk that persistent weakness in manufacturing is starting to creep into the rest of the U.S. economy. The Institute for Supply Management’s non-manufacturing index fell last month to 53.5, the lowest since February 2014, from 55.8, the Tempe, Arizona-based group’s report showed on Wednesday. Readings above 50 signal expansion. The result was less than the 55.1 median forecast in a Bloomberg survey. The industries that account for about 90% of the economy may be adjusting expectations after consumers tempered spending and businesses cut back on investment in the fourth quarter. While service providers can be more insulated than their factory counterparts from sluggishness overseas and a stronger dollar, the January retreat reflected a sudden shift lower in sentiment about business activity.    

The ISM non-manufacturing survey covers an array of industries including utilities, retailing, and health care, in addition to construction and agriculture. The group’s factory survey released on Feb. 1 showed manufacturing shrank for a fourth straight month. The 48.2 reading for the index in January was little changed from 48 a month earlier, which was the weakest since June 2009. Ten non-manufacturing industries reported growth in January, led by finance and insurance, real estate and leasing. Eight sectors, including mining, education and transportation, reported contraction. While the majority of respondents had positive comments about conditions, the report showed there is concern about financial markets, global weakness and the effect on sentiment. This is where it is clear to us that survey participants are in fact being impacted by events overseas and the potential for slowing growth in China, along with stock market volatility. Details of the services survey showed the business activity index dropped to 53.9 from 59.5 in the prior month, marking the biggest decrease since November 2008. The measure parallels the ISM’s factory production gauge. The services employment index fell to 52.1 in January, matching the lowest since April 2014, from 56.3 the prior month. The new orders measure decreased to 56.5 from 58.9 as the share of respondents indicating fewer bookings climbed to a two- year high of 23%. The index of prices paid dropped to 46.4, the first contraction in three months, from 51. The economy grew at a 0.7% annualized rate in the fourth quarter, Commerce Department data showed last week. Consumer spending, which accounts for about 70% of the economy, moderated to a 2.2% pace, while business investment fell at a 1.8% rate, the first drop since the third quarter of 2012. Sustained job creation and lower fuel bills have the potential to spur demand. At the same time, wage growth has been sluggish and Americans have been intent on boosting savings rather than ramping up purchases. Housing, which is included in the ISM services report, is also benefiting from strong hiring and low mortgage rates that are boosting purchases, though bigger advances in income would help accelerate sales this year. 

As a result of this latest data, bond traders are sending the clearest signal yet that they doubt the Federal Reserve will be able to raise interest rates this year. The fixed-income market’s balance leaned toward zero rate hikes this year after the U.S. services industry report. Treasuries drew support from the data as well, briefly pushing the benchmark 10-year yield to a one-year low as it dropped below 1.9%. The bond world’s skepticism about the Fed’s projected pace of four rate increases this year grew in January as sliding energy prices and stocks raised concern about policy makers’ ability to stoke economic growth. Futures traders expect the Fed’s effective rate to be 0.51% by year-end. The metric fell as low as 0.47% Wednesday after the ISM services industry data was released. That’s closer to the current effective overnight rate of 0.375% percent than it is to 0.625%, where it may stand if the central bank raises its target range by a quarter-point again, following liftoff from near zero in December. Traders see a 45% chance the Fed will raise rates at or before its Dec. 14 meeting, down from a 93% probability assigned at the end of last year. Our view is the fall in the value of asset markets is a tightening of financial conditions and it should affect central bank policy, along with the signs the strength of the U.S. dollar is having a very real negative impact on our domestic economy. New York Fed President Bill Dudley said as much when he indicated that financial conditions have tightened since they raised rates in December and that the strong U.S. dollar could have “significant consequences” for the U.S. economy. 

Helping markets recover lost ground in Wednesday trading, particularly energy and materials related companies, was the fact that oil settled up 8.03% at $32.28 per barrel. It was a classic case of bad news leading to a positive move for commodities based on the fact that the U.S. dollar spot index retreated approximately 1.7% that day. This was all prompted by the weaker than expected report on our services sector here in the U.S. as we discussed in the preceding paragraphs. Contributing to concerns over the domestic economy, the number of Americans filing applications for unemployment benefits rose last week as employers continued to adjust staffing levels following the holidays. Jobless claims climbed by 8,000 to 285,000 in the week ended Jan. 30, from a revised 277,000 in the prior period, a report from the Labor Department showed on Thursday. The median forecast of 47 economists surveyed by Bloomberg called for 278,000. The four-week average exceeded 280,000 for a third consecutive week, indicating the pace of firings has sped up a bit from historically low levels. While the uptick in claims bears watching, it also represents the week-to-week volatility common to claims data around holidays, economists said. Additionally, worker productivity slumped in the fourth quarter by the most in almost two years, leading to a pickup in U.S. labor costs that threaten corporate profits. The measure of employee output per hour of work decreased at a 3% annualized rate in the final three months of last year, the most since the first quarter 2014. The median estimate of economists surveyed by Bloomberg called for a 2% decline. Rising labor costs that are unaccompanied by increased efficiency represent a downside risk for corporate profits, although we have seen that managed very well in the companies we own for our clients. 

On Friday we had the employment report for January released and the results showed that job growth settled into a more sustainable pace in January and the unemployment rate dropped to an almost eight-year low of 4.9%, signs of a resilient labor market that’s causing wage growth to stir. The 151,000 advance in payrolls, while less than forecast, largely reflected payback for a seasonal hiring pickup in the final two months of 2015, Labor Department figures showed Friday.  The jobless rate fell to the lowest level since February 2008.  Hourly earnings rose more than estimated after climbing in the year to December by the most since July 2009. The moderation in hiring still leaves the job market on solid footing and shows companies are confident about the outlook for domestic sales.  A further tightening of labor conditions that sparks wage gains would help assure Federal Reserve policy makers that inflation will reach its goal. While employment at temporary-help agencies and couriers declined in January following a ramp-up ahead of the year-end holidays, the labor market showed strength elsewhere. Retailers added almost 58,000 jobs last month, the most since November 2014, and the health care industry took on another 44,000 workers.  Perhaps most surprising was a 29,000 gain in hiring at manufacturers, the biggest increase since August 2013. The median forecast in a Bloomberg survey called for a 190,000 gain in overall payrolls last month, with estimates ranging from gains of 142,000 to 260,000. 

The report also showed that the pendulum is starting to swing in favor of the American worker. At 4.9%, the U.S. jobless rate in January was the lowest in eight years, prompting employers to increase pay to attract the talent needed to stay in business.  Earnings per hour for all employees rose 0.5% on average from the prior month, the biggest gain in a year, the Labor Department reported Friday. Of course while this is a positive for the American worker, it does pose a challenge to the American corporation whose profit margins may be squeezed as a result. Stocks reflected this in Friday trading as they declined along with the price of oil as the U.S. dollar spot index ticked up slightly higher. It added confusion to what the Fed will do in March as the report runs counter to some of the weaker data we had been receiving more recently on the U.S. economy. Of course, the employment report is something of a lagging indicator while the ISM figures tend to be more forward looking.   We have a lot of data points as well between now and the next Fed meeting in March so it is simply too early to make that call. The pool of still-available workers is shrinking enough to begin to give those with jobs added leverage in asking for a raise after years of wage stagnation.  The risk is that, in an environment where consumers resist price increases, corporate earnings take a hit and companies decide they can’t afford to keep hiring. Over the past 12 months, hourly earnings climbed 2.5%, more than forecast, according to the Labor Department. What’s more, previous data were revised up to show a 2.7% advance in the year through December, the biggest advance since July 2009. Some of the jump in pay last month was probably attributable to legislation as the minimum wage climbed in 14 states at the start of the year.  Of those, 12 increased the floor by law, while automatic cost-of-living adjustments accounted for the boost in the other two. 

SGK Blog--Update January 29, 2016: Earnings Season Continues 
The Federal Open Market Committee met this week just six weeks after they decided to lift the target for their federal funds rate from a range of 0% to 0.25% to the current 0.25% to 0.50%.  There was no change in that rate range target, but, as usual, the market tried to decipher what the Fed was actually trying to say through its usual press release.  The message was unclear and therein lies the problem.  Policy makers were “closely monitoring global economic and financial developments” which is code for: we know what’s happening in China and with commodity markets and taking it into account.  They also stated, “Labor market conditions improved further even as economic growth slowed late last year” which we can interpret as: December’s payroll growth was impressive but we continue to see poor manufacturing data.  What the market wanted to hear loud and clear: there is no way we are going to hike interest rates four times this year.  Instead, officials were noncommittal on whether the outlook had fundamentally shifted.  It took out a statement in its December notes which said risks were “balanced”.  How does one interpret a statement that is no longer there? Are we no longer in balance? Is balance to be assumed going forward? So does that mean there will or will not be a hike in March?  Futures markets, where traders put their money to work, think there is a 14% probability of a hike at the March 16 meeting.  In fact, the probability matrix does not exceed 50% until the September 21 meeting, and then it is only 51.3%.  We also noticed that the world interest rate probability matrix for the U.S. on Bloomberg now includes a column that was not there previously: Probability of a Cut. For the record, that still shows 0% through early 2017.

The big issue is that a rate hike coupled with slowing or falling earnings is a toxic mix.  That is what the market does not like and that is why when the Fed’s statement was released, the market began to fall.  Though only about one quarter of the S&P 500 have reported so far, the decline in the fourth quarter of 2015 from the fourth quarter of 2014 is 4.9%.  This follows a 0.8% decline in the third quarter year-over-year results.  That quarter marked the first year-over-year decline since 2009.  Granted, energy sector losses are playing a large role in the current downdraft, but the same can be argued for financials during the global crisis in 2008 and technology in the early 2000s.  There’s always a scapegoat.  The pertinent question is has the direction of the economy changed from growth to contraction?  Since 2008, we have never come close to “escape velocity” with U.S. real GDP growth peaking at 2.4% in 2014 with a similar number in 2015.  The Commerce Department reported the latest fourth quarter figures today which showed that real GDP rose at a 0.7% annualized rate in the three months ended December.  This follows a 2.0% gain in the third quarter, so the 2.4% yearly number is comprised of growth that started strong at the beginning of the year but has since limped to a crawl.  Even when trade and inventories are excluded, so-called final sales to domestic purchasers rose only at an inflation-adjusted 1.6% annualized rate in the fourth quarter compared to the 2.9% pace during the third quarter.  On a global basis, real GDP rose 5.4% in 2010 but has declined to a more meager 3.1% in 2015.  This is the “new normal” you may have heard or read about.  Growth which is ok but not great, employment which is steady but not robust, prices which are somewhat inflationary but just barely.  This is the environment the Fed must navigate.  We will get a clearer picture of the Chairwoman Yellen’s thoughts when she appears before Congress next month during her usual bi-annual testimony on financial policy.  The stock market, in the interim, must continue to trade on what it perceives as imperfect information until a clearer picture emerges.     

Meanwhile the data which we are getting shows that many sectors of the U.S. market are doing well and that includes housing.  Purchases of new homes rose in December to the highest level in 10 months for the best year for housing since 2007.  The Commerce Department reported that sales jumped 10.8% to a 544,000 annualized pace and for all of 2015, purchases climbed 14.6% to 501,000.  The median sales price fell 4.3% from December 2014 making a new home more affordable for first time buyers.  The supply of homes at the current sales rate dropped to 5.2 months from 5.6 months in the prior month.  Anything around 5 months is indicative of solid housing demand.  New home sales are tabulated when contracts get signed so even though they comprise only about 10% of housing transactions, they are considered a timelier barometer of the residential market than existing home sales.  Housing is important because it has spillover effects into other industries—lawn care, home security, home improvement, furniture, insurance, etc.  The biggest headwind to growth recently has been foreign trade thanks to the strength of the dollar coupled with weakness in global growth which is hurting exporters.  Trade deducted 0.47 percentage point from GDP growth last quarter and has been a negative in four of the last five quarters.

Looking forward, next week’s employment data will get a lot of scrutiny.  Investors will want to know if the strong momentum from 2015 continues.  That number also will only be slightly affected by the effects of the East Coast Blizzard since it did not hit until late this month and will only be marginally included in January’s data.  A good job market leads to solid housing and auto markets—two core industries for the country.  Consumer confidence levels have held thanks to gains in the job market and low inflation but there’s no guarantee that will continue if employment trends start to turn south in the coming months.  Solid initial unemployment claims this week are a timely indicator that businesses are still hesitant to lay off large amounts of workers just in case demand picks up as we approach the spring and summer months.  Stay tuned. 

SGK Blog--Update January 22, 2016:  Earnings Season Gathers Steam    

A volatile holiday-shortened week in the markets was the focus of conversation this week.  Tuesday’s trading session had the Dow down over 500 points intraday before rallying into the close.  For some it felt like a return to the crisis-fueled markets of 2008.  In our view, today’s environment is nothing like those dark days.  Equity markets, sooner or later, reflect what is going on in the economy.  Oftentimes it will serve as a preview because participants discount future expectations into today’s prices.  Sometimes they serve as concurrent indicators reflecting the mood of consumers and the monetary environment in place at the time.  But eventually, the fundamentals shine through.  For example, when the U.S. government debt was downgraded by Standard & Poor’s rating service in August of 2011, fears of a recession swamped the markets in short order.  In hindsight, it became one of the best windows for purchasing shares since the bull market began in 2009 because the recession never came.  As economist Paul Samuelson once said, “Wall Street indexes predicted nine out of the last five recessions.”  Markets can be a wonderful tool for looking into the future, but they can also be subject to wild fluctuations.  In the words of value investor Benjamin Graham, “In the short run, the market is a voting machine but in the long run, it is a weighing machine.”  Fickle opinions come and go just like dance crazes (remember the Macarena?) but underlying business fundamentals will follow the trend of overall growth which generally trends higher based on historical GDP growth.  The key is having faith in the investment process because it is engineered with some long term growth in mind. 

Corrections are a normal part of the market cycle.  Prior to August of last year, it was that normalcy that was stretched.  According to Deutsche Bank analysis, corrections happen every 357 trading days on average since 1950.  In August of 2015, we were over 1,000 trading days since the previous one.  Now, we have had two corrections in six months.  It may not be pleasant, but, statistically, it is not unusual.  Markets have put together seven consecutive years of positive gains in the S&P 500 return (including dividends).  Such a run is unusual but not unprecedented: the S&P 500 generated nine straight years from 1991 through 1999 with the second longest 1982 to 1989.  Will 2016 keep the streak alive?  Nobody knows.  The main point is that the markets have done well but to expect uninterrupted gains is not prudent.  Analysts often talk about bear cycles within bull markets and vice versa.  We may be in the middle of one of those right now. 

The real question is will this correction turn into a bear market?  Again, the answer is nobody knows.  But we can turn to those economic fundamentals which over time will be reflected in the markets themselves.  China has been a worry.  It contributes up to 30% of global GDP growth.  Though recent economic reports have not been as dire as some expected, there is no doubt the world’s second biggest economy is in a slowing cycle.  Plus, the amount of debt accumulated since the financial crisis in 2008 will prove a strong headwind just as it was here.  Total debt has ballooned to nearly 260% of GDP with some companies using new debt to pay off old.  That is a problem.  What helped the U.S. recover was the transfer of its debt from households and businesses to the government (hence the $4.4 trillion Fed balance sheet) which could handle it better and print money to offset its growth.  Most importantly, was the innovation and environment which created and nurtured growth of companies like Uber, Square and Palantir and gave jobs to those who were laid off due to the real estate bust.  China will need such growth to dig out of its own problems and that will take time.  With Chinese companies comprising about 3% of S&P 500 sales, it is not a huge part of the equation.  China is also not our leading trading partner, and the U.S. only generates about 14% of GDP through exports anyway.  There has been too much focus on China.  Its contribution to growth is unquestioned because of its size and its effect on the entire emerging market region.  But it is a stretch to say that China is the main determinant of the future of the U.S. or for companies in the S&P 500.  Clearly, it remains something to keep an eye on.  

If China is not as big an issue as the headline say, then what is the temperature of the U.S. economy?  According to Bloomberg’s survey of economists, 2016 GDP will be about 2.4% which is line with the 2.4% estimate for 2015.  Industrial production looks weak but the majority of income accrues to the service industries.  It is one economy so they cannot be totally separated but with the trend in employment we have seen last year, jobs being lost in oil fields are being outweighed by payroll growth in retail and health services.  Weekly initial unemployment claims have held below 300,000 since last March.  That is a level that is typically consistent with an improving job market.  With winter weather on our doorstep, payroll figures are likely to be skewed for a few weeks at a minimum so hopefully the market doesn’t fixate on one negative figure should it emerge.  New housing starts fell 2.5% in December but home data is often volatile in winter months.  Existing home sales released today rose more than forecast.  Contract closings for December jumped 14.7%, the most on record, to a 5.46 million annualized rate.  Some of the boost came from adjustments to new mortgage regulations that delayed closings a month earlier and some of it came from those trying to finish deals before the Fed began raising rates.  The conclusion to take from the data is that things look good for housing especially if mortgage rates remain low and employment continues to grow. 

These are positive signs and should help the stock market in the long run.  In the short run, we have to deal with earnings in 2015 that were below 2014 levels for the S&P 500.  Sales growth, because of the lack of global pricing power, also is weaker than we would like to see.  We track the option volatility indicator VIX.  Even with the turmoil of the first two weeks, it remained relatively benign.  It was not until this week that it hit a level of 30.  To put that in perspective, after Lehman collapsed in 2008, it hit 80!  But 30 seems to be the key level recently where buyers start to enter the market and sniff around for bargains.  By week’s end, the VIX was back below 25.  Weak sales and earnings are a reason why 12% pullback in the S&P from its all-time closing high in May could get worse.  A too aggressive Fed pushing rates higher when there is not really a need for it is another reason.  Economic fundamentals are a reason why it could find a trough and work higher.  It is this data that the Fed is looking at, so we, and the market, are betting that they will use their financial acumen and experience to steer the economy toward steady growth.  In the long run, if history is a guide, stocks should follow.  
SGK Blog--Update January 15, 2016:  Markets Continue to be Swayed by China as Earnings Season Commences  

The volatility in China’s currency and equity markets continued unabated this week as their stock market gyrated wildly despite government efforts to try to stabilize the situation. We wrote extensively about the issues with respect to their currency last week and that situation seems to have stabilized, but the movements in their mainland stock exchange have also unsettled global traders. The reality is at the beginning of the year stocks trading on the mainland exchange were wildly over-valued at 65 times earnings and a 30%-40% premium over the same companies trading on the Hong Kong exchange. So a correction in their mainland stock market was inevitable. It has contributed to concerns over the further impact it may have on a slowing of the world’s second largest economy. Their manufacturing and export sector have been slowing for a while – we actually had figures this week out of China indicating that the pace of this may actually be slowing, which would be a positive development. The majority of participants in their mainland stock exchange are small retail investors so the concern is that the market gyrations may impact their proclivity to spend to bring their standard of living closer to ours here in the U.S. The figures for their services segment have shown growth in the 8%-9% range recently which is pretty good. With over 1 billion consumers China still represents a great opportunity for many companies long term and it is not surprising their government and their economy faces some hurdles as they continue to develop. 

Here in the U.S., we have had earnings released from a number of prominent companies but it is still early in the earnings season period.   Year-over-year earnings for the 4th quarter 2015 are projected to fall between 6%-7%.   Although our market is no longer over-valued in our opinion in light of the equity market declines here so far in 2016, the fully year 2016 earnings projections may still need to come down, as they have for the 4th quarter 2015. So far earnings releases have been limited but the results from some prominent companies such as JP Morgan have been pretty good. Of course, the outlook for a large global bank such as JP Morgan does become a little more clouded given the rocky start to stock markets so for in 2016. The recent downward move in the price of oil does help the average consumer in giving them more money in their pockets and the futures market is now forecasting that the next Fed increase in interest rates will not take place until July. 

On the domestic economic front, the data was tilted to the weaker than expected side. Retail sales for December disappointed coming in at -0.1% which matched Bloomberg forecasts but was down from November’s +0.4% gain, according to the Commerce Department. For all of 2015 purchases climbed 2.1%, which unfortunately was the smallest advance post great recession. It appears Americans are socking away more of the funds they are saving at the gas pump. Faster wage gains, something the Fed has been looking for, have proven to be elusive as well. This follows the 3.9% advance in 2014. Warmer than usual weather last month probably curtailed purchases of winter gear including clothing. This was the warmest December on record for the contiguous U.S., according to the National Oceanic and Atmospheric Administration. Some economists may lower estimates for fourth-quarter gross domestic product and consumer spending following the retail sales results. The median forecast in a Bloomberg survey shows household purchases rose at a 2.2% annualized rate from October through December, after a 3% pace in the prior three months. 

In other news, factory production declined in December for a second month as a stronger dollar and softer U.S. and global growth pinch manufacturers. Output at factories dropped 0.1%, matching the previous month’s decline, figures from the Federal Reserve showed Friday. Total industrial production, which also includes mines and utilities, fell a larger-than-forecast 0.4%. Factories have struggled in recent months as a stronger dollar makes American-made goods more expensive for overseas customers, and recent data show domestic demand is having trouble picking up the slack. Heightened concerns that global growth is weakening, including a slowdown in China, also are contributing to concerns. Capacity utilization, which measures the amount of a plant that is in use, declined to 76.5% last month from 76.9%. The decrease was largely due to less utility demand. Capacity at power plants dropped to 73.2% in December, the lowest since records began in 1972. Mining production, including oil drilling, decreased 0.8% last month after a 2.1% slump in November. Drilling and servicing at wells dropped 7.4% and was down almost 62% from the same time a year earlier. The production of motor vehicles and parts declined 1.7% in December as demand started to simmer. Cars and light trucks sold at a 17.2 million annualized rate last month, the slowest pace since July, according to data from Ward’s Automotive Group. Still, 2015 was a banner year for the industry, with a record 17.5 million cars and light trucks sold. 

Wholesale prices in the U.S. declined in December from the prior month, showing inflation is still well- contained as Federal Reserve officials weigh further increases in the benchmark interest rate. The 0.2% decrease in the producer-price index followed a 0.3% gain in November, a Labor Department report showed Friday in Washington. Over the past 12 months, wholesale prices fell 1%. The PPI excluding volatile food and fuel prices climbed 0.1% from the prior month. Businesses have gotten used to subdued wholesale costs as the plunge in fuel prices and appreciation of the dollar limit cost pressures. The New York Empire Fed Index, a measure of business activity in that region, for January came in at -19.37 versus the expectation of -4. Based on the weakness in the overall data this week in the U.S., the market’s five-year estimate for inflation beginning five years from now, a model the Federal Reserve uses in setting rates, is approaching a record low as commodity prices have fallen. The five-year forward break-even rate projects that consumer prices will increase at a 1.6% annual rate starting in 2020. The gauge bottomed at 1.56% in January 1999. Federal Reserve Bank of St. Louis President James Bullard, a traditional inflation hawk, called the decline in market-based inflation expectations “worrisome.”  

On a positive note, as we hate to end the week on the gloomy side particularly with stocks ending the week where they did, the University of Michigan’s preliminary sentiment index for January climbed to 93.3, the highest since June, from 92.6 in December. The median projection in a Bloomberg survey called for 92.9. The gauge averaged 92.9 last year, the best annual performance since 2004. Last month’s advance was paced by those making more than $75,000 a year. Americans’ projected inflation rate over the next year dropped to the lowest level since 2010, helping to give consumers added buying power. “Consumer optimism is now dependent on the continuation of an extraordinary low inflation rate,” Richard Curtin, director of the University of Michigan consumer survey, said in a statement. As we have mentioned, the lower price at the pump and the fact that employment levels are at the highest since the great recession are contributing to a higher level of consumer confidence. 

SGK Blog--Update January 8, 2016:  Solid Jobs Data Counter China Market Turmoil    

Turmoil in the Chinese stock market reverberated around the globe during the first week of trading in 2016.  Volatility was so sharp that China’s equity exchanges closed just 29 minutes after they opened on Thursday.  China’s markets are usually open from 9:30 a.m. to 3 p.m., with a 90 minute break in the middle, but new circuit breakers curbed activity at 9:59 a.m. local time when the CSI 300 Index reached the 7% decline needed to stop trading for the day. By week’s end, that index in local currency was down 9.9% kicking off the worst start for Chinese markets in two decades.  We will investigate the meaning behind the carnage in more detail in our performance sector below, but clearly the year has not started off on the right foot for equity investors.  The good news is that there are still more than 50 weeks to turn things around.

On the domestic front, the latest job data painted a very good picture for the U.S. economy.  According to the Labor Department, nonfarm payrolls surged by 292,000 in December which crushed the median forecast in a Bloomberg survey that called for a 200,000 gain.  The unemployment rate held firm at 5%.  Importantly, revisions to prior reports added a total of 50,000 jobs to payrolls in the previous two months.  Thus, for all of 2015, payrolls rose by 2.65 million which follows a 3.1 million gain in 2014 for the best consecutive years for hiring since 1998-1999.  Optimism is somewhat tempered by the fact that average hourly earnings were unchanged from the prior month.  They increased 2.5% year-over-year versus the median forecast of a 2.7% gain.  Thus, that figure did not meet consensus but it has topped the Fed’s target of 2% annual growth for every month last year except February when it was rose at a 1.9% rate.  The industries showing the strongest growth were temporary-help services, health care, transportation and construction.   Weekly unemployment claims, a more timely measure of the job market, is also showing strength.  On Thursday, the Labor Department said first time claims for unemployment benefits insurance fell by 10,000 to 277,000 in the week ended January 2.   For all of 2015, weekly claims averaged 278,000 which is an indicator of solid job growth which we have seen in the monthly data.  Continuing claims rose to 2.23 million during the week ended December 26 which is about 8% lower than the 2.43 million a year ago.  For all of 2015, the average weekly level of continuing claims was 2.26 million. 

This strength in the job market was the primary reason why the Fed raised its benchmark federal funds rate at its December meeting.  This month we got the minutes from the gathering which gave more color to the reasons behind their decision.  The 10 voting members of the Federal Open Market Committee decided unanimously to raise the benchmark rate to a range of 0.25%-0.50%.  Yet, the decision itself was a “close call” for some members who worried about too-low inflation.  The minutes stated that “the risks attending their inflation forecasts remained considerable.”  It was also noted, “the committee was now reasonably confident in its expectation that inflation would rise, over the medium term, to its 2 percent objective.”  According to the latest personal consumption expenditure data excluding food and energy, the Fed’s preferred measure of core inflation, prices rose just 1.3% in the 12 months ending November 2015.  Thus, as we stated in previous newsletters, the Fed was not merely reacting to what it saw in the markets, it was actually making a pre-emptive move by boosting rates and assuming that inflation would raise in the future.  The minutes did state: “Many concluded that longer-run inflation expectations remained reasonably stable.  However, some expressed concerns that inflation expectations may have already moved lower.”  In fact, we saw weak business activity in the final quarter of the year as evidenced by data released this week on durable goods.  Also the headline ISM Manufacturing Survey index for December was 48.2, worse than the 49 consensus estimate and below the 50.0 line between expansion and contraction.    

The main area of concern for investors remains the Fed’s path of policy going forward.  Though the emphasis has been on a “gradual” rise in rates, the median forecast predicts four interest rate increases in 2016 assuming a 0.25% hike each time.  This week, Fed Vice Chairman Stanley Fisher said four hikes were “in the ballpark,” though China’s uncertainty make it difficult to predict with total confidence.  According to Fisher, “We make our own analysis and our analysis says that the market is under-estimating where we’re going to be.”  The market via federal funds futures is only anticipating two or at most three such bumps this year.  The next personal income and personal spending data will not be released until February 1 which is after the Fed’s January 27 meeting.  Expectations show a 47% chance that rates will move higher at the Fed’s April meeting and a 62% chance at the June meeting.  There are only eight regularly scheduled Fed meetings in 2016.  If the Fed is honest about its “gradual” path, and if a 0.25% hike would be the most the Fed wants to push, then, if there is no move until June after half the year is over, the market will have its answer:  we won’t get four hikes this year.  By that time, to hit the 1.375% average expected by year-end 2016, the Fed would need to start boosting at every meeting or start make 0.50% jumps—moves that would not fall under the definition of “gradual.”  Stay tuned.

SGK Blog--Update December 31, 2015:  Markets End the Week and the Year on a Down Note  

The Holiday shortened week was pretty quiet in trading and economic releases.   Here in the U.S. we did get a couple of key data points on the health of the U.S. economy. Home values in 20 U.S. cities rose at a faster pace in the year ended October as lean inventories of available properties combined with steadily improving demand. The S&P/Case-Shiller index of property values climbed 5.5% from October 2014 after rising 5.4% in the year ended September, the group said Tuesday in New York. The median projection of 21 economists surveyed by Bloomberg called for a 5.6% advance. A limited supply of properties for sale has helped prop up home values, boosting the household wealth levels of U.S. homeowners in the process. Faster wage growth and continued low borrowing costs will be needed to keep low-income and first-time buyers in the market and provide the next leg of growth in the housing recovery. All 20 cities in the index showed a year-over-year increase, led by gains of 10.9% in San Francisco, Denver and Portland, Oregon. Twelve cities saw year-to-year prices climb at a faster rate than in September. Chicago showed the smallest increase, at 1.3%. The year-over-year gauge provides better indications of trends in prices, according to the S&P/Case-Shiller group. The panel includes Karl Case and Robert Shiller, the economists who created the index. “Generally good economic conditions continue to support gains in home prices,” David Blitzer, chairman of the S&P index committee, said in a statement. “Among the positive factors are consumers’ expectations of low inflation and further economic growth as well as recent increases in residential construction.” 

Consumer confidence rebounded more than forecast in December as Americans grew more optimistic about the current state of the economy and job market. The Conference Board’s sentiment index climbed to 96.5 from a revised November reading of 92.6 that was higher than previously estimated, the New York-based private research group said Tuesday. The median forecast in a Bloomberg survey of economists called for 93.5. The combination of a strong labor market and cheap fuel costs have buoyed households’ finances, giving them the wherewithal to purchase everything from cars to clothing and holiday gifts. Faster growth in wages would usher in bigger gains in confidence and probably provide another boost to consumer spending, the biggest part of the economy. The share of Americans who see greater job availability in the next six months increased, and fewer expected their incomes to decline, the report showed. The group’s report is in sync with the University of Michigan’s final reading for December. That gauge climbed to 92.6, the highest since July. Additionally, America’s merchandise trade deficit shrank to $60.5 billion in November from $61.3 billion the prior month, advanced data issued by the Commerce Department showed on Tuesday. The 1.3% narrowing from October will help shape economists’ tracking estimates of fourth-quarter gross domestic product. The November deficit was close to in-line with the median forecast of $60.7 billion based on estimates from 30 economists in a Bloomberg survey. Advance reports on monthly international goods-only trade allow the Commerce’s Bureau of Economic Analysis to incorporate three months of official trade data into its first estimates of quarterly GDP. Previously, the BEA had two complete months of trade figures for goods and services to calculate its first estimate of GDP, prompting it to project the data for the final month of a quarter. This should help make the figures more accurate going forward. 

In light trading Wednesday, we had a report on U.S. Crude inventories for the period ending 12/26/15 and they unexpectedly rose 2.629 million barrels. Not surprisingly this put downward pressure on crude prices and the broader stock market. Contracts to purchase previously owned U.S. homes unexpectedly fell in November, confirming earlier figures that showed the industry lost momentum toward the end of the year. The index of pending home sales dropped 0.9%, after a revised 0.4% gain the prior month, figures from the National Association of Realtors showed Wednesday in Washington. The median forecast of 28 economists surveyed by Bloomberg called for an increase of 0.7%. The pullback underscores concern raised by the slump in sales of existing homes last month, weakening the real-estate agents’ group argument that new mortgage-lending rules caused the slowdown. Rising prices and a limited supply of properties on the market have restrained buyers, making for a slowing recovery in housing. “Home prices rising too sharply in several markets, mixed signs of an economy losing momentum and waning supply levels have acted as headwinds in recent months,” NAR chief economist Lawrence Yun said in a statement. “Available listings that are move-in ready and in affordable price ranges remain hard to come by.”  

The week ended on a sour note as two data points sent the major averages sharply lower in early trading Thursday, the last trading day of 2015.   Initial weekly jobless claims for the week ending December 26, 2015 spiked higher to 287,000 versus the expected 270,000 and the prior week’s 267,000.   This was the highest level since the week ended July 4th. Additionally, the Chicago purchasing managers index or PMI came in at 42.9 for December, well below the expectation for 50.1 and November’s figure of 48.7. This is a measure of business activity in this important region and is a forward looking activity measure. So this was a disappointment as well.   So much for the Santa Claus rally to cap 2015! If we look forward to 2016, the gloomy economic data on the last trading day of the year was not encouraging, especially in light of the potential for the Federal Reserve to implement further interest rate increases in 2016. They have indicated they will remain data dependent and, as we have written repeatedly in this forum, if they move too quickly they will slow the economy too much. We are confident they will be paying close attention to the early economic data points here for the U.S. economy in 2016. 

From all of us here at Steigerwald, Gordon & Koch Wealth Advisors, we would like to wish you a happy and prosperous 2016!

SGK Blog--Update December 23, 2015: Markets Digest Data 

With the Federal Reserve fireworks now in the rear-view mirror, the markets began to focus on year-end releases.  In a holiday-shortened week, there were a number of economic data points that deserved the attention of traders.  Sales of both new and existing homes were below expectations.  Existing homes, which comprise the bulk of housing transactions, fell in November to the lowest level since April of last year.  Closings fell 10.5% to a 4.8 million annual rate after a revised 5.3 million pace in October according to the National Association of Realtors.  The main cause of the decline was a change in industry rules from the federal government which lengthened the amount of time it took buyers to close on a deal.  The length of time to close a purchase was 41 days in November, up from 36 days a year earlier.  Existing home sales are tabulated once a deal is closed so a longer time to completion meant, technically, fewer sales.  Also contributing to the decline was the fact that the number of existing properties on the market fell 3.3% to 2.0 million in November, the fewest since March.  Plus, the median price rose 6.3% to $220,300 from November 2014 which priced out some first-time buyers who accounted for 30% of all purchases, down from the usual 40%.  Nevertheless, the median time a home was on the market actually decreased to 54 days in November from 57 days in October which shows that demand is still present.  New home sales, which are tabulated once a contract is signed, are viewed as a more timely indicator of housing health.  However, November’s data from the Commerce Department was not holiday spirit bright.  Though sales rose 4.3% to an annualized 490,000 pace, it was below the 505,000 pace expected by economists surveyed by Bloomberg and purchases in the prior three months were revised lower.  The supply of homes at the current sales rate fell to 5.7 months from 5.8 months as there were 232,000 new houses on the market at the end of last month, up from 227,000 in October.  Builders remain optimistic as data from the National Association of Home Builders/Wells Fargo index remain close to decade-high levels.  But even this group is getting more concerned about the rising costs of land and labor and now they have to face a rising rate environment from the Fed in 2016.  It will likely take some time for the Fed’s minimal 0.25% bump to filter through to longer-term loans such as mortgages, but the trend is not headed in direction of lower costs for builders or buyers.

The U.S. economy expanded at a revised 2.0% annualized rate in the third quarter, compared with a previously reported 2.1% pace, according to the Commerce Department.  Last quarter’s gain followed a 3.9% advance in the second quarter but was within the 1.5%-2.1% range expected by economists.  This latest figure is the third and supposedly “final” update, but it is subject to change once annual revisions are issued in July of 2016.  After expanding at a 2.4% pace in 2014, the first half of 2015 saw a 2.3% rise and it looks like the second half will be even below that.  These declining GDP numbers are a big reason why the Fed waited so long to make its change last week.  Given the sluggish Eurozone and China figures which are likely to fall below expectations, the U.S. economy remains one of the lone, decent beacons of growth around the globe.  Net exports subtracted 0.3 percentage points from overall growth after adding 0.2 percentage points in the second quarter.  The buildup in inventories during the first six months of the year are being drawn down but slow overseas demand is not helping. 

If the backs of consumers are hurting this holiday season, it is because they are carrying the weight of keeping the U.S. economy aloft.  Household purchases rose at a 3% annual pace in the GDP data which added two percentage points to growth—that is, it provided 100% of the growth in the third quarter after the contributions from government spending, investment and net exports cancelled each other out.  In a separate report, household incomes rose 0.3% in November after a 0.4% advance in October.  Consumer outlays are being powered by cheap gasoline, rising home equity and steady but not spectacular hiring.  Disposable income, or the money left over after taxes, rose 0.2% after adjusting for inflation, up 3.5% from November 2014.  The savings rate inched down to 5.5% from a three-year high of 5.6% in October.  The personal consumption expenditure index rose 0.4% from a year earlier.  This is the Fed’s preferred measure of inflation and, excluding food and fuel, rose 1.3% from November 2014 still falling far short of the Fed’s 2% goal which it has not reached since April 2012.  So with little inflation on the horizon, household outlays on services were little changed.  The higher savings rate suggests that consumers are being somewhat frugal but not downright miserly.  The good news for the economy is that they continue to open their wallets and purses or there would be no forward momentum for the economy as a whole.

SGK Blog--Update December 18, 2015: Federal; Reserve Raises Interest Rates; First Time Since 2006

The last time the Federal Reserve raised interest rates was June 2006. That was one year before the launch of the original iPhone by Apple! Whew – that is going back in time… Federal Reserve Chair Janet Yellen delivered a two-pronged message that stock market investors initially cheered: The U.S. economy is performing well and the central bank is in no rush to raise interest rates again. She told a news conference that the central bank had put itself in a position to nurture the 6 1/2-year-old expansion by raising rates a bit now to avoid having to increase them a lot later. That will enable the Fed to tighten policy gradually, moving rates up in fits and starts to keep the economy on track. While U.S. exports had been hurt by weaker overseas growth and a stronger dollar, Yellen said these headwinds were being offset by a solid expansion in domestic spending. "Americans should realize that the Fed’s decision today reflects our confidence in the U.S. economy," Yellen said. "While things may be uneven across regions of the country and different industrial sectors, we see an economy that is on a path of sustainable improvement." 

Yellen repeatedly stressed her confidence in the health of the U.S. economy and played down concerns that it would be knocked off course by weakness overseas or by the recent tumult in the high-yield bond market. It’s a myth that expansions die of old age," Yellen said. "I don’t see anything in the underlying strength of the economy that would lead me to be concerned" about a recession. She acknowledged in response to a question that central banks in the past have killed off expansions by tightening policy. But she argued that was because policy makers felt compelled to raise rates sharply and abruptly because they had waited too long to move. "It is because we don’t want to cause a recession through that type of dynamic at some future date that it is prudent to begin early and gradually," she said. Yellen used the word "gradually" or "gradual" about a dozen times in her hour-long press conference to describe the pace of future rate increases. Policy makers forecast that the short-term policy rate will rise to 1.375 percent at the end of 2016, implying four quarter-point increases in the target range next year, based on the median number from 17 officials. Yellen repeatedly argued that inflation was largely being held down by transitory forces -- weaker oil prices and a stronger dollar -- and that it would begin to rise as those influences waned and the jobs market continued to strengthen. 

She did though suggest that policy makers would want to see signs of that happening as the central bank proceeds along a path of higher interest rates. "We really need to monitor over time actual inflation performance to make sure that it is conforming, it is evolving in the manner that we expect," she said. That would help buttress inflation expectations, which have recently shown signs of softening. Yellen has stressed the importance of keeping such expectations anchored in order to ensure the Fed is able to hit its inflation target. The decision by the FOMC to raise rates for the first time since 2006 was unanimous. The move drew to a close an unprecedented period of record-low rates that were part of extraordinary and controversial Fed policies designed to stimulate the U.S. economy in the wake of the most devastating financial crisis since the Great Depression. "The economic recovery has clearly come a long way, although it is not yet complete," Yellen said. The Fed rate increase "reflects the committee’s confidence that the economy will continue to strengthen." We will see – the rally in equity markets on exuberance on the Fed move and her comments was relatively short-lived as the major averages Thursday gave up the gains they had garnered in Wednesday trading. 

What concerned investors and traders Thursday was the continued move higher in relative value of the U.S. dollar and the Fed action and also some weaker than expected U.S. economic data.   The higher dollar pushed commodity prices down again, raising global deflationary concerns. The Philadelphia Fed figure (a measure of manufacturing strength in that key area) for December came in at -5.9, which was much weaker than the expected +2.0 after the prior month’s +1.9. This followed reports on industrial production and capacity utilization for the month of November which came out at -0.6% and 77.0% respectively compared to expectations for -0.,4% and 77.5% respectively. These figures combined point to continued weakness in our manufacturing and export sectors here in the U.S. Housing data earlier in the week was a redeeming factor as both housing starts at 1.173 million and building permits at 1.289 million for November were well above expectations. As mentioned, the sell-off Thursday was primarily precipitated by the continuing trend of the price of oil falling and the dollar strengthening which the weak manufacturing data reinforced. A rising dollar does not bode well for corporate earnings releases which are right around the corner beginning in January. 

Part of what precipitated declines in the stock market late last week and into the early part of this week were concerns over the “high-yield” fixed income portion of the market.   We have scrupulously avoided this segment of risky securities for our clients. These were formerly known as “junk bonds.” We have known of the risks for a long time in these area, but the sell-off over the past two weeks was triggered by a major mutual fund company, Third Avenue, making an announcement last week that they were suspending redemptions on one of their funds to allow for an orderly selling of securities. As we mentioned, the risks have been rising and in the past eight months, $183 billion of value evaporated from the U.S. high-yield bond market. At first, the losses crept up slowly on investors in this area. Then the declines accelerated, with a nearly 5% plunge in the third quarter alone, forcing investors to face their first annual loss since the 2008 financial crisis. Why such carnage? Initially the declines were concentrated in the debt of commodities companies, which were struggling in the face of falling gas, iron ore and coal prices. But as the year went on, other industries also began to falter. Sprint, which has more than $30 billion of debt, was downgraded. Debt of retailers such as Claire's Stores and Bed Bath & Beyond also ran into trouble. Investors broadly stopped allocating money to the junk-debt market, and average prices on the notes dropped to the lowest since 2009. Some funds have weathered the turmoil better than others. The worst performers had higher exposure to bonds with the lowest credit ratings. The Third Avenue Focused Credit fund, which was forced to liquidate and opted to gate in remaining investors to avoid a fire sale, had 82% of its assets in debt rated CCC or lower or that had no ratings at all. It's clear the credit cycle has turned and these types of securities are now viewed unfavorably. Especially in light of the Fed’s actions this week. 

In overseas economic news, German investor confidence improved for a second consecutive month, with a robust recovery in Europe’s largest economy set to gain added impetus from more stimulus by the European Central Bank. The ZEW Center for European Economic Research in Mannheim said its index of investor and analyst expectations, which aims to predict economic developments six months ahead, rose to 16.1 in December from 10.4 in November. That compares with an estimated increase to 15 in a Bloomberg survey of economists. While the ECB’s Dec. 3 stimulus package fell short of investors’ expectations, it’ll still help bolster the recovery in the 19-nation currency bloc, Germany’s biggest trading partner. A further reason for optimism is the Fed’s first rate increase in almost a decade, which signals strength in the world’s biggest economy. ZEW’s gauge for current conditions in Germany rose to 55 in December from 54.4 the prior month. A measure for business expectations in the 19-nation euro region increased to 33.9 from 28.3. The Bundesbank this month kept its 2016 growth forecast for the country unchanged at 1.8% and projected an expansion of 1.7% in 2017. “With export markets outside the euro area expected to rebound and economic growth within the euro area gaining a little more traction, the healthy underlying state of the German economy should stand out even more clearly over the next two years,” it said on Dec. 4. “Downside risks to economic growth would arise if the current sluggish dynamics in a number of emerging-market economies were to worsen,” according to the statement from the German central bank.

SGK Blog--Update December 11, 2015: Active Week for Stocks as Fed Decision Looms   
The Federal Reserve will unveil its conclusion about future monetary policy after its next Federal Open Market Committee (FOMC) meeting ends on Wednesday, December 16.  The decision will be disseminated at 2:00PM ET and will be followed by a Q&A session with Chairwoman Janet Yellen at 2:30PM.  The markets will be focused on two items.  First, will the Fed raise their guidance for the federal funds rate for the first time since June 2006?  On December 16, 2008, the FOMC reduced its funds target from 1.00% to a range of 0%-0.25% in response to the global financial crisis which was enveloping the country.  It has stayed there ever since.  All signs point to a “yes” to raising next week.  According to the futures markets, there is an 80% chance of an increase to the 0.25% to 0.50% range.  Moreover, according to the minutes from their last meeting in October, ““While no decision had been made, it may well become appropriate to initiate the normalization process at the next meeting.”  Ms. Yellen has also been dropping several hints since the middle of the year that a policy change by year-end would be more likely than not.  Second, what is the outlook for the future path of interest rate hikes?  According to the latest projections from Fed governors which were released following their September meeting, on average, they are looking for a 3.375% fed funds rate by 2018.  Conversely, the markets are anticipating barely above 1.5% by then.  Unless that huge gap is somehow lessened, the reaction from the markets is likely to be very volatile.  Though Yellen & Co. have stressed that any future rate hikes would be gradual and, as usual, data dependent, the market wants to see that the Fed governors actually put that in their projections.  If we see the projected curve of rate increases, the so-called “dot plot”, become somewhat flatter, the market will be pleased and we might see a solid rally next week.  However, if there is little change from these earlier projections, the market will not be pleased.  That would show that either the Fed is out of touch with the reality of slower economic growth which we have seen overseas and in many domestic manufacturing data or that they intend to push rates higher and faster than what they have been telling the public.  Not good.  The stakes are high and the world will be watching.

In order so that we may devote more space this week to some of our holdings which have been in the news, we will curtail our usual discussion of economic releases.  To quickly summarize, retail sales were above expectations as holiday shopping began in earnest while producer prices unexpectedly fell for the second consecutive month.  Next week, we will definitely have plenty of thoughts on the Fed’s move and how we believe it will affect the economy, rates and markets going forward. 
SGK Blog--Update December 4, 2015: Janet Yellen Speaks; Market Participants Listen 

Prior to Janet Yellen speaking we had a key economic release on the U.S. manufacturing sector. The U.S. manufacturing sector contracted in November, falling to its worst levels since June 2009, when the economy was still in the midst of a recession, according to an industry report released on Tuesday. The Institute for Supply Management (ISM) said its index of national factory activity fell to 48.6, the first time the index has been below 50 since November 2012, after reading 50.1 in October. The reading was for expectations of 50.5, according to a Bloomberg survey of 77 economists. A reading below 50 indicates contraction in the manufacturing sector; the ISM data is often viewed as a precursor to movement in the overall economy, though its contribution to U.S. economic activity has been in decline for decades. The ISM index fell below 50 in 2012 briefly, but the economy did not go into recession.  

So why the strong stock rally Tuesday and the sharp drop in interest rates sending bond prices also higher? Market participants, us included, fully expect the Fed to raise rates after their December 15-16 meeting. We also anticipate the Fed will move very slowly on future interest rate cuts once they do get started. Weak manufacturing data supports this thesis. The manufacturing and export segments of our economy have been negatively impacted by the continued strength of the U.S. dollar. The dollar has been strong because globally currency traders see the U.S. central bank on a path to raise interest rates while other key economies, Europe and China in particular, are heading down a path of cutting interest rates and adding stimulus to support their economies. This policy divergence has led to our dollar gaining ground on virtually every other currency over the past six months. So this is yet another prime example where weak U.S. economic data actually weakened our dollar relative to other currencies and led to greater buying of U.S. assets such as treasuries, stocks and bonds. 

U.S. construction spending rose more than expected in October as outlays rose across the board, suggesting the economy remains on firmer ground despite some slowing in consumer spending and persistent weakness in manufacturing. Construction spending increased 1.0% to a seasonally adjusted $1.11 trillion rate, the highest level since December 2007, after an unrevised 0.6% gain in September, the Commerce Department also said on Tuesday. Construction spending has risen every month this year and is likely to support the economy in the final three months of the year as it deals with the headwinds of a strong dollar and spending cuts by energy firms, which have undermined manufacturing. Frugal consumers are also holding back growth. Construction outlays were up 13% compared to October of last year. Construction spending in October was buoyed by a 0.8% rise in private spending, which touched its highest level since January 2008. Outlays on private residential construction gained 1.0% and hit their highest level since December 2007, reflecting increases in home building and renovations.  

When Janet Yellen, Federal Reserve Chair, finally spoke on Wednesday her comments were not really surprising. "Between today and the next FOMC meeting, we will receive additional data that bear on the economic outlook," Yellen told the Economic Club of Washington. "When my colleagues and I meet, we will assess all of the available data and their implications for the economic outlook in making our policy decision." The job market, she added, is close to the Fed's maximum goal, but she can't yet declare full employment. Yellen said there has been "less progress," on the Fed's goal to boost inflation to 2%, but she forecast that drags will diminish next year. Turning to the Fed's future rate decisions, Yellen said it will be appropriate to be more cautious on raising rates from near zero, and the Fed must take into account the lagging effects of its policy. On the other hand, she said, if the Fed delays hikes too long, then it might have to tighten abruptly. The U.S. central bank, she explained, could inadvertently create a recession by waiting too long. Even after the initial rate hike, the funds rate will be accommodative, Yellen said, adding that expectations for the path of the rate hikes will be key to the economic outlook. During a question-answer session after the speech, Yellen said the Fed has no "predetermined" plan for rate moves after initial liftoff, and that policy will continue to depend on incoming data. "There is no plan to proceed over time in some mechanical or calendar-based way," she said. "When the committee begins to normalize the stance of policy, doing so will be a testament, also, to how far our economy has come in recovering from the effects of the financial crisis and the Great Recession," Yellen said at the conclusion of her speech. "In that sense, it is a day that I expect we all are looking forward to." 

Oil prices fell 4.6% on Wednesday after U.S. government data showed a 10th straight week in crude builds and after the release of the Fed’s Beige Book. The dollar's surge to 12½-year highs after pro-rate hike comments by U.S. Federal Reserve Chairperson Janet Yellen also weighed on oil and other dollar-denominated commodities Wednesday, as it makes them less affordable to those holding the euro and other currencies. U.S. crude oil inventories rose 1.2 million barrels last week, for a tenth straight week on higher imports and in spite of a jump in refining rates that also boosted stocks of gasoline and distillates, data from the Energy Information Administration (EIA) showed. Both WTI and Brent crude benchmarks had raced into positive territory earlier on Wednesday, reacting to a headline from Tehran's oil ministry news agency Shana that a majority of OPEC members agree on output cuts. But prices fell back rapidly as the report also said Saudi Arabia, the kingpin in the Organization of the Petroleum Exporting Countries, and other Persian Gulf Arab member countries of OPEC were not agreeable to the reductions. In spite a global supply glut, most traders expected OPEC at its Friday meeting in Vienna to endorse its decision from last year to pump oil vigorously to protect its market share from non-members like United States and Russia. Only a few OPEC members, such as Venezuela and Iran, are hoping for output cuts to stabilize crude prices which have tumbled from highs above $100 a barrel in June 2014.  

European Central Bank (ECB) President Mario Draghi disappointed investors with their policy announcement and his press conference Thursday. He indicated asset purchases are set to go at least until March 2017, though that will not provide a meaningful stimulus because the ECB has already signaled its willingness for the program to run beyond September. Monthly asset purchases were not expanded, which was a disappointment because that would have been a way to deliver a material boost to the outlook at this week’s meeting. The composition of their asset purchases did not changed significantly. They added the fact that they will be buying the bonds of regional governments but that is unlikely to dramatically affect the economy in a different way compared to what has been bought so far. Broadening the range of assets to include corporates, for example, might have delivered a more direct stimulus. The deposit rate was cut a further 10 basis points but that is also unlikely to deliver any meaningful lift to demand prospects because the reduction is very small. Overall the package of measures announced is unlikely to significantly change the outlook for the euro-area economy significantly. So the euro area basically remains mired in a gradual recovery and weak core inflation can be expected to persist through 2016. The dollar fell sharply relative to the euro as traders were quickly covering short positions on their dollar euro bets on the announcement.   This sets up our own federal reserve nicely to raise rates at their December meeting with few impediments. 

By week’s end, the combination of weak economic data and comments from Janet Yellen clearly designed to prep market participants for a rate increase in December finally took its toll on stock and bond markets. Service industries in the U.S. expanded in November at the slowest pace in six months, indicating malaise in manufacturing is impeding progress in other parts of the economy. The Institute for Supply Management’s non-manufacturing index declined to 55.9 from October’s 59.1, the biggest monthly decrease in seven years, the Tempe, Arizona-based group said Thursday. A gauge above 50 denotes expansion, and the median estimate in a Bloomberg survey of economists called for a reading of 58. The setback in the industries that make up almost 90% of the economy coincides with the weakest reading in manufacturing since June 2009 as mentioned above. While factories bear the brunt of a stronger dollar and sluggish sales overseas, service producers probably will be more insulated by steady household demand and improving real-estate and labor markets. Applications for unemployment benefits in the U.S. rose last week, maintaining a see-saw pattern around four-decade lows that shows persistent strength in the labor market. Jobless claims climbed by 9,000 to 269,000 in the period ended Nov. 28, matching the median estimate in a Bloomberg survey, a Labor Department report showed Thursday. Filings are hovering just above the 255,000 level reached in July, the lowest since the 1970s. Companies are reluctant to dismiss workers as the labor market tightens, a development Federal Reserve policy makers are monitoring as they consider raising their benchmark interest rate. A greater sense of job security may help Americans feel more comfortable spending during the holidays, which would provide a much-needed boost to growth.  

When the employment report numbers came out Friday there was some welcome relief the report was not too strong.  The economy created 211,000 new jobs in the month of November relative to the expectation for 200,000 new jobs and the unemployment rate, as expected, remained steady at 5.0%. So the report ended up being close to expectations. After two days of tough stock and bond markets, traders were resigned to the fact a Fed rate increase is in the cards here in December.   The fact that the jobs report was good but not too good helped reinforce the notion that the Fed will likely move at an easy pace after the initial increase.   The bond market stabilized Friday with bonds rallying slightly and this helped support the broader equity market. Oil prices dampened some of the enthusiasm while oil stocks continued to suffer as OPEC made no cuts to production.   To a certain degree that was expected by Friday’s meeting. WTI crude actually dipped below $40 per barrel in Friday trading before stabilizing. There is no question it has been a very rough period for energy stocks. We need to maintain a longer term outlook on this sector. If oil prices firm and recover ground over the next two years as production continues to come off-line, then energy stocks are setting up to potentially be a very strong area of the stock market looking ahead.   Stock market traders are always forward looking. This will take a while to play out and we could be looking as far out as the second half of 2016 and into 2017 when earnings comparables for these companies are much more favorable on a year-over-year basis. A continued very weak environment is priced into these securities currently so it would not take much of a catalyst to push the securities we own in this segment higher. 

SGK Blog--Update November 25, 2015: Markets Begin Sprint for Year End 

During a holiday-shortened week, various government entities tried to squeeze in five days’ worth of data releases in three days.  For those traders and investors that were still around come Wednesday afternoon, they got a deluge of information that will play a role in what moves the Federal Reserve will make next month during their Federal Open Market Committee meeting.  Gross domestic product (GDP) for the third quarter rose at a 2.1% annualized rate according to the Commerce Department.  That figure was up from the initial estimate of 1.5% and will be revised once more before a “final” figure is determined.  Inventories grew at a $90.2 billion annualized rate from July through September, almost twice as much as previously estimated which puts pressure on the fourth quarter to liquidate these growing stockpiles.  Higher inventories boost the headline growth figure while trimming those goods results in a drag on GDP.  Household consumption, which makes up nearly 70% of the economy, grew at a 3% annualized rate, smaller than the previously estimated 3.2%.   

The better GDP figure is a result of more consumers having jobs which is resulting in more spending.  Existing home sales, which comprise over 90% of all housing transactions, surprisingly retreated in October according to the National Association of Realtors.  Closing dropped 3.4% to a 5.4 million annual rate which was in-line with the median forecast of 71 economists surveyed by Bloomberg.  The median price of an existing home rose 5.8% from October 2014 to $219,600.  This price rise was echoed in the S&P/Case-Shiller index of property values which showed a 5.5% year-over-year increase in prices from last September.  Prices are being boosted by a limited supply of homes as inventory dropped 2.3% in October from a month earlier, the fewest since March.  With the holidays upon us, more homeowners are likely to remove their listings because buyers become distracted by plump, juicy turkey dinners, gift-giving next month and winter weather lasting until March or April of next year.  New home sales, which are a more timely indicator of housing market health, rebounded in October from a 14-month low and order backlogs reached an eight-year high.  Sales, which are calculated when a contract is signed versus when a transaction is actually closed weeks or months later, rose 10.7% to a 495,000 annualized pace according to Commerce Department data released today.  The supply of new homes, which account for about 8% of the residential market, fell to 5.5 months from 6 months in September.     

The labor market remains on solid footing which will provide further fuel to the economy.  First time jobless claims fell by 12,000 in the week ended November 21 according to Labor Department data.  The total of 260,000 is close to the 255,000 reached in mid-July, the lowest since December 1973.  The less volatile four-week moving average held at 271,000.  The last payroll report released in 2015 will be next Friday.  Expectations are for an increase of 200,000 versus October’s 271,000 reading.  The unemployment rate is forecast to hold steady at 5.0%.  Maybe most importantly, the year-over-year average hourly earnings figure is supposed to be 2.3% according to the Bloomberg survey of economists.  That is a little below the 2.5% in October, but still firmly above the 2.0% level Fed Chairwoman Yellen is looking for in order to raise interest rates.  The Fed has been looking for any signs of inflation, some might say desperately.  If the average worker is getting a little more each paycheck, that, theoretically, will turn into a higher level of spending.  The Commerce Department, however, reported this week that consumer purchasing was up by only 0.1% in October, below the 0.3% median Wall Street estimate.  Therefore, consumers pocketed most of the savings from lower gasoline prices and lower or non-existent heating bills so far this fall even though wages, according to this report, rose a healthy 0.6%, the biggest gain in five months.  The gain in pay in October was twice as big as the advance seen in September.  Disposable incomes, or the money left after taxes, rose 3.9% over the past twelve months.  Federal Reserve Governor Daniel Tarullo commented on Bloomberg Television this week, “We’ve certainly seen some continued improvement in the labor market, but the environment for inflation is still one where there is still a lot of uncertainty.” 

The odds of a fed funds rate target increase at the December Fed meeting is 74%.  Our analysis has concluded that both the equity and fixed income markets by now have priced in an increase.  The focus becomes the trend.  This is where the greatest source of volatility can arise next month.  Based on the Federal Open Market Committee participants’ assessments of appropriate monetary policy, this is how they see fed funds over the next few years:  2015: 0.375%/2016: 1.375%/2017: 2.625%/2018: 3.375%.  The market, where people put their money where their mouths are, is showing this: 2015: 0.375%/2016: 0.78%/2017: 1.30%/2018: 1.64%.  Outside of the next month, the trend cannot be any clearer—the economy is not going to grow very fast over the next three years so much higher interest rates are unnecessary.  We are seeing it in the yield curve where the steepness of shorter maturities compared to longer maturities has flattened.  The spread between two year Treasury securities and 10 year Treasuries has fallen from 178 basis points (1.78%) in July to 129 basis points (1.29%) now.  By way of perspective, since the start of 2008, little trading has occurred in any spread narrower than 120 basis points.  If we had to sum it up, we believe the market is saying, “Let’s get this rate increase over with, but, afterwards, let’s not do a thing.”  We would agree.
SGK Blog--Update November 20, 2015: U.S. Economic Data Supports Fed December Rate Increase 

We had some key U.S. economic indicators this week, with signs pointing to the likelihood of a Federal Reserve rate increase at their December meeting. Both the headline and core (excluding food and energy) figures for the Consumer Price Index rose 0.2%, in line with median estimates.   This puts the year-over-year figures at +0.2% for the headline number (due to the drop in energy prices) while the core rate rose 1.9% over the previous 12 months. This is very close to the Fed’s target rate of 2.0%. Inside these figures, the price of goods excluding food dropped 0.7% from a year earlier while the cost of services minus energy jumped 2.8% from the prior year. This latter point was the strongest advance since November 2008. Weak global growth and a strong dollar are helping depress commodity prices, while an improving U.S. economy and reduced joblessness are allowing service providers to charge more. The increase in services inflation is spreading beyond rents to include health care, auto insurance and movie tickets. As mentioned, this will probably boost confidence among Federal Reserve policy makers that inflation will head toward their 2% target after missing that goal since May 2012. 

Industrial production fell 0.2% for second month, weaker than 0.1% gain forecast, as output declined at utilities and mines. Factory production climbed 0.4%, which was twice the median forecast. Warm weather led to a 2.5% drop in utility output, while declines in crude oil extraction and well drilling pushed mining production down 1.5%. The rebound in factory activity may suggest the drag on the industry from a stronger dollar and weak global growth is easing. Americans’ lingering appetite for new cars, amid easy standards for loans, remains a pillar of support for the industry. Cars and light trucks sold at an 18.1 million annualized rate last month, the most since July 2005, according to data from Ward’s Automotive Group. Output of motor vehicles and parts climbed 0.7% in October after rising 0.5% a month earlier. While auto production has been a pillar of support for manufacturing, and October proved no exception, the Federal Reserve’s data also showed broad improvement in other areas. Particularly encouraging was a pickup in the output of construction materials, which climbed by the most since December 2011. Production of durable goods such as appliances and primary metals also rose.  Still, plenty of slack remains in the factory sector, with plant capacity at 76.4% last month. That compares with 78.7 when the last recovery ended in December 2007. Weekly jobless claims ending November 14, 2015 were 271,000 and this was down from the prior period’s figure of 276,000. 

The National Association of Homebuilders (NAHB) Index, a gauge of builders optimism, for November unexpectedly fell to 62 from an October reading of 65, which was highest in a decade. Measures of current sales and purchase expectations both dropped as well as builders continue to complain about the limited availability of lots and skilled labor. While sales and expectations cooled during the month, a measure of foot traffic of prospective buyers increased to the highest level in 10 years. The survey of builders is consistent with further strength in home sales and construction. That may help explain why the Fed’s industrial production report showed stronger output of construction materials. In other housing news, new-home building declined more than projected in October, led by a slump in apartment construction and showing fitful progress in residential real estate. Residential starts dropped 11% to a 1.06 million annualized rate, the slowest since March, from a revised 1.19 million pace the prior month, a Commerce Department report showed Wednesday. The median forecast in a Bloomberg survey called for 1.16 million. The most construction permits for single-family homes since 2007 indicates ground-breaking will rebound in coming months. The figures suggest the real-estate market is settling into a more sustainable pace, fueled by persistent job growth and cheap borrowing costs. A labor market that begins to drive faster wage growth would help provide additional impetus for home sales, contributing more to the economy. 

Of course, it would not be a weekly email without mentioning the latest in Fed news!! Traders eyes were glued to their computer screens Wednesday afternoon as the Fed minutes were released from their October meeting. Federal Reserve policy makers inserted language into their October statement to stress that “it may well become appropriate” to raise the benchmark lending rate in December and largely agreed that the pace of increases would be gradual, minutes of the meeting showed. “Members emphasized that this change was intended to convey the sense that, while no decision had been made, it may well become appropriate to initiate the normalization process at the next meeting,” said minutes of the FOMC’s Oct. 27-28 meeting, released Wednesday in Washington. A majority of Fed officials have signaled they expect to raise interest rates this year for the first time since 2006. That message was underscored when policy makers inserted a reference to the “next meeting” on Dec. 15-16 in their October statement, in connection with their assessment on when to act. A “couple” of voting policy makers had qualms that the wording change “could be misinterpreted as signaling too strongly the expectation” for December liftoff, according to the report. Participants in the meeting “generally agreed,” the minutes said, “that it would probably be appropriate to remove policy accommodation gradually.” Then the key statement came out that reassured equity traders, “It was noted that the beginning of the normalization process relatively soon would make it more likely that the policy trajectory after liftoff could be shallow,” the minutes said. Stocks rallied and bonds sold off primarily based on that latter statement. 

The minutes broke policy makers into three camps, with some saying economic conditions necessary for tightening policy “had already been met,” while “most participants” estimated that their criteria “could well be met” in December. “Some others, however, judged it unlikely that the information available by the December meeting would warrant” a rate increase, the minutes said. U.S. economic data since the meeting have been encouraging. Employers added 271,000 people to payrolls in October, the biggest gain this year, and unemployment fell to 5%. Job openings in September climbed to the second highest on record, while the consumer price index, minus food and energy, as mentioned rose 1.9% last month from a year earlier. Earlier Wednesday, several Fed officials talked up recent data on the U.S. economy and said it reinforced the case for raising interest rates, though they stopped short of committing to liftoff at their next meeting. “I’m comfortable with moving off zero soon, conditioned on no marked deterioration in economic conditions,” Atlanta Fed President Dennis Lockhart told a conference in New York. Looks like it is a go – heavens then what are we to write about?! The pace of increases we suppose.    

Our hearts and prayers go out to the victims and the families of the victims of the terrorist attacks in Paris.

SGK Blog--Update November 13, 2015: Eyes Still on Fed  

After last week’s solid employment report, the economic calendar was not as robust this week.  Applications for unemployment benefits were unchanged in the first week of November.  In the week ended November 7, jobless claims held at 276,000 according to the Labor Department.  At this point, demand for labor is pretty strong as evidenced by the rise in October payrolls by the most in 10 months and the unemployment rate falling to a seven-year low.  The four-week average of weekly claims rose to 267,750 which still remains relatively low and is a sign that employers are not eager to lay off staff especially with holiday sales about to heat up.  The monthly average amount of jobs created is 206,000 which is strong but remains below the 260,000 monthly average from last year.  According to the latest Jobs Openings Labor Turnover Survey released this week, there were just 1.4 people per job opening counting themselves as unemployed.  That is the lowest level since May 2001.  Chairwoman Yellen and the rest of the Federal Open Market Committee will have to weigh this latest data plus one more monthly nonfarm payroll report in early December before their regularly scheduled two-day meeting December 15 and 16 in Washington. 

Making the decision a bit more complicated is a retail sales figure for October which was little changed from September.  The median forecast of 84 economists surveyed by Bloomberg called for a 0.3% median rise, but the Commerce Department reported only a 0.1% gain.  On a positive note, core prices which exclude autos, gasoline stations and building materials, rose 0.2% but even that was below the 0.4% median estimate.  Also, wholesale prices unexpectedly fell 0.4% in October according to a separate report from the Labor Department.  Last month’s drop followed a 0.5% decline in September that was the biggest in eight months and was in stark contrast to the 0.2% gain expected by economists.  Food prices dropped 0.8% for a second consecutive month, led by the biggest decline in egg prices since early 2000.  On a year-over-year basis once food and fuel costs are excluded, prices rose 0.1%.  The soft manufacturing and wholesale price data are becoming a recurring theme we have seen since the end of the summer.  This will certainly play into the Fed’s thinking next month.  Meanwhile, the nation’s services component continues to grow at a moderate pace.  Thus, we are seeing GDP figures that are modest but not robust even nearly six years after the recession officially ended.    

In Europe, European Central Bank president Mario Draghi signaled that the central bank was ready to boost its stimulus programs next month because “Signs of a sustained turnaround in core inflation have somewhat weakened.”  He added: “Downside risks stemming from global growth and trade are clearly visible.”  Data on Thursday showed industrial production in the euro area fell 0.3% in September after a 0.4% drop in August.  Inflation was 0% in October so far below the “about 2%” level central bankers are looking for in the short-to-medium term.  On Friday, third quarter GDP data for the 19-member bloc rose 0.3%, down from 0.4% in the second quarter.   The current quantitative easing program, which calls for monthly purchases of 60 billion euros in debt, could be ramped up in size, duration or type of assets.  The euro has fallen as a result of these measures and outlook for more easing.  The exchange rate dropped to the 1.07 dollars per euro range.  In the middle of November last year, that rate was closer to 1.25.  Theoretically, a lower exchange rate should make goods imported more expensive thereby stoking inflation.  That has not happened and Draghi has developed a more pessimistic view of the balance of risks to the euro zone.  The slowing Chinese economy has had a negative effect on export-dominant and EU engine Germany which is already struggling itself with an aging society and rising immigration issues which could further weigh on productivity.  Odds have risen close to 100% that the ECB will reduce its deposit rate next month from -0.2% to -0.3% according to the forward securities market.
SGK Blog--Update November 6, 2015: Odds of December Fed Lift-Off Rise  

Federal Reserve Chair Janet Yellen and New York Fed President William Dudley both said the central bank could boost interest rates as soon as next month, while Fed Vice Chairman Stanley Fischer voiced confidence that inflation isn’t too far below the central bank’s goal. “At this point, I see the U.S. economy as performing well,” Yellen said on Wednesday in testimony before the House Financial Services Committee in Washington. If economic data continue to point to growth and firmer prices, a December rate hike would be a “live possibility,” she said. Speaking in New York hours later, Dudley said he agreed with the chair, but “let’s see what the data shows.” Fischer didn’t comment on the timing of liftoff during a speech Wednesday evening in Washington, but said that price pressures will move toward the Fed’s target. The Federal Open Market Committee said in its October statement that it will consider raising rates at its “next meeting,” citing “solid” rates of household spending and business investment. The comments from Yellen, Dudley and Fischer, who are considered the three most influential members of the committee, reinforced the idea that next month is in the crosshairs for an increase if economic progress holds up. No decision has yet been made on the timing of a rate increase, Yellen cautioned. The Fed chair appeared before the committee to testify primarily on the Fed’s supervision and regulation of financial institutions. “What the committee has been expecting is that the economy will continue to grow at a pace that’s sufficient to generate further improvements to the labor market and to return inflation to our 2% target over the medium term,” she said. Markets interpreted Yellen’s remarks as a sign that a rate hike in December is more likely. Traders have raised to almost 60% the probability of a rate increase by policy makers’ December meeting, according to pricing in the federal funds futures market. That compares to 33% a month ago, assuming the effective funds rate average is 0.375% after liftoff. U.S. central bankers have held the policy rate near zero since 2008 as they have waited for labor markets to move closer to their goal of full employment.

Across the Atlantic, the European Commission cut its euro-area growth and inflation outlook for next year, citing more challenging global conditions and fading impetus from lower oil prices and a weaker euro. Gross domestic product in the 19-nation bloc is set to grow 1.8% in 2016, down from a previous projection of 1.9% in May, the Commission said in its autumn forecast published Thursday. Inflation is seen accelerating to 1.6% in 2017 from 0.1% this year. The economic recovery in the 19-nation region is resting on unprecedented stimulus by the European Central Bank. With a slowdown in emerging markets weighing on global trade, risks have increased that growth won’t be strong enough to sustain the decline in unemployment and bring inflation back in line with the ECB’s goal of just below 2%. “Today’s economic forecast shows the euro-area economy continuing its moderate recovery,” Valdis Dombrovskis, vice president of the European Commission, said in a statement. “Sustaining and strengthening the recovery requires taking advantage of” temporary tailwinds including “low oil prices, a weaker euro exchange rate and the ECB’s accommodative monetary policy,” he said. While noting that the recovery has proved to be resilient to external shocks so far, uncertainty surrounding the economic outlook shows few signs of abating. Risks include a larger-than-anticipated slowdown in China and financial-market volatility triggered by a normalization of U.S. monetary policy, according to the report. The latest Commission forecast may provide some insight into what’s in store from the ECB, which releases fresh projections on Dec. 3. That outlook is set to guide policy makers in deciding whether more stimulus is warranted. ECB President Mario Draghi has said that the central bank will examine its monetary-policy stance next month. A new round of easing may include more asset purchases and another cut in the deposit rate. In September, the central bank forecast inflation to accelerate to 1.7% in 2017, barely in line with its goal. Draghi as well has repeatedly called for national governments to do their part, noting that monetary policy can’t be the only actor. Reforms aimed at tackling structural imbalances such as high unemployment are “essential” to reap the full benefits of monetary policy, according to the central bank. We will have to wait and see! 

On the U.S. economic front, early in the week we had anemic data on the U.S. manufacturing sector. The Institute of Supply Management’s (ISM) Index of manufacturing for October came in at 50.1 versus the expectation of 50.0 and the prior month’s 50.2. With the strong U.S. dollar, everything but the auto manufacturing sector it seems has been under pressure. Construction spending and factory orders for September came in at 0.6% and -1.0% respectively. Just to emphasize what a services driven economy we have here in the U.S., the ISM Services Index came in at a robust 59.1 for October, well above the expectation for 56.6 and the prior month’s 56.9. Initial weekly jobless claims for the week ending 10/31/2015 were 276,000, above the estimate for 262,000 and the prior week’s figure of 260,000. Third quarter productivity came in at +1.6% while Unit Labor Costs in the third quarter rose 1.4%. As long as productivity is rising above the level of unit labor costs, then technically there should be no labor inflation. Economists were way off on the estimates for productivity as the forecast was for a 0.2% decline (say yes to the American worker!) and the forecast for unit labor costs was for a 2.2% increase. So economists failed in their estimates on both of these counts. 

All eyes were of course riveted to the computer or television screens in anticipation of Friday’s October jobs report.   The forecast was for the unemployment rate to remain steady at 5.1% and for 181,000 new jobs to be created. Thus forecasters were predicting a pick-up in activity from the relatively low reading of 142,000 new jobs created in September, which was a disappointing figure. The October and November jobs figures will go a long way to influencing the Fed on their decision on the timing of their first increase to the Fed Funds rate. The ADP report earlier in the week showed that 182,000 new private sector jobs were created in October compared to the estimate of 180,000. When the figures came out, the market reacted swiftly as both stock and bond prices retreated. The October jobs report left little doubt the U.S. labor market is back with a vengeance after a two-month lull. 271,000 new jobs were created and this was the largest monthly increase in two years, the Labor Department report showed Friday.  The jobless rate fell to a seven-year low of 5% and average hourly earnings over the past 12 months climbed by the most since 2009. Treasuries tumbled and the dollar strengthened as the report allayed concerns of a hiring slowdown after weaker payrolls advances cooled in August and September.  Such improvement will probably mean a green light for Fed officials, who last month held out the possibility of a December rate increase. The futures market as of Friday projects a 70% chance the Fed will increase rates at their December meeting so we will take that as in the category of practically a sure thing at this point.

SGK Blog--Update October 30, 2015: Fed: December Hike Still in Play  
Janet Yellen and the rest of the Federal Open Market Committee decided to leave interest rates unchanged at their regularly scheduled meeting this week.  Instead of taking the opportunity to put to bed the ongoing debate about whether they will or whether they won’t raise rates in 2015, they decided to keep the door open to a shift at their next meeting scheduled for nine days before Christmas.  Happy holidays indeed!!  In its statement accompanying the decision, the Fed added the following: “In determining whether it will be appropriate to raise the target range at its next meeting, the Committee will assess progress—both realized and expected—toward its objectives of maximum employment and 2 percent inflation.”  The Fed has been “data dependent” for some time, but the explicit mention of raising the target at its next meeting has previously not been so plainly stated.  The overall tone of the statement could marginally be construed as hawkish or leaning towards a hike.  For example, it was mentioned that “Household spending and business fixed investment have been increasing at solid rates in recent months” versus the September statement which mentioned those two areas have been improving “modestly.”  Instead of mentioning that global conditions “are likely to put further downward pressure on inflation in the near term,” they stated “economic activity will expand at a moderate pace” with appropriate policy in place.   

Unfortunately, we, like so many others on Wall Street, have delved into the minutiae of comparing statements sentence by sentence.  We continue to see little hurdles to beginning the rate hike cycle assuming it will be slow and stretched over an extended period.  Thus, there is some disconnect between what the Fed is saying as we highlighted above and their actual actions—which have been nil.  There are plenty of signs continuing to point to a strong economy.  Initial applications for unemployment benefits continued to hover near four-decade lows for the period ending October 24 in data released by the Labor Department.  The number of people continuing to receive jobless benefits fell by 37,000 in the week ended October 17 to the lowest level since November 2000.  The S&P/Case-Shiller index of property values climbed 5.1% from August 2014 to August 2015 after rising 4.9% in the year ended in July.  All 20 cities in the index showed a year-over-year increase.  Homebuilder confidence has risen in recent months even with purchases of new homes unexpectedly below expectations on Monday.  Inflation remains subdued which continues to be the key point experts refer to as the main reason for waiting.  The Fed wants to be “reasonably confident that inflation will move back to its 2 percent objective over the medium term” according to its statement.  The futures market now seems totally confused.  On Tuesday, the chance of a rate hike at the December meeting was 4%.  On Wednesday after this week’s meeting, that chance had risen to 50%!  As we have written about previously, credibility is very important because once it’s gone, it is not coming back anytime soon.  It is one thing to be wrong, it is quite another to stubbornly espouse a viewpoint consistently and repeatedly only to change it when heretofore facts become too large to ignore.   More transparency is something the Fed has worked on for years dating back to the early days of previous Fed chair Ben Bernanke so to lose that trust is not something the Fed will take lightly.  The clock is ticking and the market is listening. 

The first look at headline GDP does show a slowing and reason for the Fed’s non-action.  The “advance” reading (which will be revised two more times) on the third quarter from the Commerce Department showed real gross domestic product grew at a 1.5% annual pace compared to the 3.9% surge in the second quarter.  That was even below the first half average of 2.3% growth which included weather-hampered first quarter growth.  Going “inside the numbers” reveals a more solid growth story.  Household purchases, which account for nearly 70% of GDP, rose at a 3.2% annual pace, down from the second quarter’s 3.6% but not by a huge margin.  After-tax incomes adjusted for inflation grew at 3.5% annual rate, almost three times the 1.2% gain in the prior three months.  Inventory adjustments played a big role in this week’s figure, subtracting 1.4 percentage points from growth.  Ironically, a liquidation of inventory is seen as a drag on growth because those goods are already made and, thus, already counted in previous GDP data.  Take that data out, as the GDP final sales figure does, and growth for the third quarter was 3%, down again from the 3.9% in the second quarter but much better than the headline figure would indicate.   

A further boost to the economy and potentially more inflation may come from fiscal policy.  In somewhat of a surprise, President Obama and Congressional Republican leaders reached a deal on debt extension with the Senate voting in favor of the deal by a margin of 64-35.  This would avert a U.S. debt default and lower chances of a government shutdown before it reached the usual crisis mode.  With borrowing authority extended until March 2017, an ugly pre-election year standoff is avoided and will be thrown on the plate of the next President three months in office.  Obama gets additional spending on domestic programs while avoiding cuts to Social Security and Medicare while conservatives get to lift caps on defense spending.  Having people working and then spending their paychecks, especially as the holiday season approaches, will be a much better scenario than seeing government workers once again idled.  Given that this is Congress, there is no “all clear” sign yet as lawmakers need to allocate an additional $80 billion in spending among thousands of budget-line items before a December 11 deadline.  Whether this accord is enough to boost economic data in the next two months before the December meeting is unlikely.  A better indicator will be next week’s monthly employment report which will be a crucial input in the Fed’s decision-making process.
SGK Blog--Update October 23, 2015: Earnings Capture the Attention of Market Participants 

While earnings were the story again this week, we will begin with a brief summary of some key economic releases on the U.S. economy before we get into our summaries of how our holdings did in the third quarter. We had 13 companies release earnings this week and we have provided summaries of those results below. Housing continues to be a key story here supporting the U.S. recovery. New-home construction in the U.S. climbed in September, a sign residential real estate will continue to bolster the world’s largest economy. Housing starts increased 6.5% to a 1.21 million annualized rate, more than forecast and the second-highest level in eight years, figures from the Commerce Department showed Tuesday in Washington. A drop in building permits indicates the rebound may be slow to materialize however. American consumers, powered by an improving job market, are keeping the U.S. afloat as they continue to spend on big-ticket items such as homes and cars. A pickup in wage gains would give even more households the ability to save for a down payment, helping to sustain momentum in the housing industry. Estimates for housing starts in the Bloomberg survey of 78 economists ranged from 1.09 million to 1.2 million. The August figure was 1.13 million, little changed from the prior estimate. The increase in starts was mainly propelled by gains in work on multifamily homes, such as apartment buildings, which rose 18.3% to a 466,000 pace. The advance highlights increasing demand for rentals. Construction of single-family houses climbed 0.3% to a 740,000 rate, the report showed. Building permits declined 5% to a 1.1 million pace, the fewest since March. The decrease was also concentrated in multifamily, showing that these data can be volatile. Applications for single-family projects fell 0.3% to a 697,000 pace, suggesting this part of the market will plateau in coming months. Those for multifamily developments dropped 12.1% to a 406,000 rate. The starts data are consistent with a report Monday that showed builders are increasingly confident in the outlook for their industry. The National Association of Home Builders/Wells Fargo said its sentiment gauge rose in October to the highest level in a decade, lifted by stronger confidence about the six- month sales outlook. The continued expectation of low interest rates may be part of those prospects. The average 30-year, fixed-rate mortgage was 3.82% in the week ended Oct. 15, compared to an average of 6.15% in the previous expansion.  

In other economic news this week, continuing on the housing theme, sales of previously owned U.S. homes rebounded in September to the second-highest level since February 2007, the latest sign that the recovery in residential real estate will support growth in the world’s largest economy. Closings on existing homes, which usually occur a month or two after a contract is signed, climbed 4.7% to a 5.55 million annualized rate, the National Association of Realtors said Thursday. The increase was entirely due to a jump in purchases of single-family dwellings. Higher property values and improved job security are helping persuade more Americans to trade up and relocate, providing a source of support for the economy amid a global slowdown. Faster new-home construction that brings additional housing supply to the market is needed to lure first-time buyers and provide a further boost to the industry. The median forecast of a Bloomberg survey of economists called for 5.39 million. Estimates in the Bloomberg survey of 75 economists ranged from 5.25 million to 5.55 million. August’s rate was revised to 5.3 million from a previously reported 5.31 million. Compared with a year earlier, purchases increased 8% in September on an unadjusted basis. The median price of an existing home increased 6.1% to $221,900 from $209,100 in September 2014. In other news, the index of leading indicators dropped 0.2% in September compared to the expectation for a 0.1% dip. Initial weekly jobless claims once again fell below 260,000 to come in at 259,000 compared to the expectation for a 265,000 figure and the prior week’s 256,000. 

The big news Thursday stemmed from the meeting of the European Central Bank which elected to hold interest rates steady. But what sent the European equity bourses higher and in turn ours in Thursday trading were his comments in his post-meeting news conference, which traders were eagerly awaiting. Mario Draghi said the European Central Bank will investigate fresh stimulus measures to boost the economy and that options include a further reduction in the deposit rate. The euro slid as the ECB president said the Governing Council has tasked the central bank’s committees with examining the pros and cons of different monetary-policy action. He told reporters at a press conference after the meeting in Malta on Thursday that there was a “rich discussion” about the instruments that might be used, while hinting fresh stimulus may be added before the end of the year. “The degree of monetary-policy accommodation will need to be reviewed at our December meeting when new macroeconomic projections will be available,” Draghi said. “We want to be vigilant, as people used to say in the old times.” Draghi’s predecessor Jean-Claude Trichet used the phrase “vigilant” to warn of upcoming changes in policy. The 19-nation region’s woes include a global economic slowdown that is weighing on overseas sales, and a currency appreciation that’s putting downward pressure on inflation. Consumer prices fell in September and while that is largely due to a drop in energy costs, there’s concern that the declines may become entrenched. The euro slid as much as 1.6% against the dollar and was down 1.4% at $1.1177 at 4:21 p.m. Frankfurt time on Thursday. Policy makers seem to have drawn a $1.14 line in the sand for the single currency, there seems to be verbal interventions whenever the common currency closes higher than that level. The communication at the press conference was as dovish as it could have possibly been without announcing more policy easing at this meeting. They next meet on December 3rd so we will see if their words are backed by actual action. As we mentioned, officials left their key interest rates unchanged.  The benchmark rate was kept at 0.05% and the deposit rate at minus 0.2%, both record lows. Draghi said officials discussed a potential future cut in the deposit rate at Thursday’s meeting. More than a year ago he said that rate had reached its lower bound. “Today, things have changed,” Draghi said on Thursday. “That doesn’t necessarily imply that we are going to use this instrument. The discussion was wide open.” As always, stay tuned! 

Also helping equities in Friday trading, China’s central bank cut its benchmark lending rate and reserve requirements for banks, stepping up efforts to cushion a deepening economic slowdown. The one-year lending rate will drop to 4.35% from 4.6% effective Saturday the People’s Bank of China said on its website on Friday, while the one-year deposit rate will fall to 1.5% from 1.75%.  Reserve requirements for all banks were cut by 50 basis points, with an extra 50 basis point reduction for some institutions.  The PBOC also scrapped a deposit-rate ceiling, a further step in the liberalization of interest rates. The expanded monetary easing underscores the government’s determination to meet its 2015 growth target of about 7% in the face of deflationary pressures, overcapacity and tepid global demand.  China’s sixth rate cut since November comes as the European Central Bank President signals more policy easing as we discussed above and amid expectations for additional stimulus from the Bank of Japan. Oil gave up some ground in Friday trading as the U.S. dollar strengthened on the news out of China.

SGK Blog--Update October 16, 2015: Earnings Season Begins   
This week investors were focused on earnings reports from companies, but there were also many economic releases to take note of.  Retail sales rose less than forecast according to data from the Commerce Department.  Sales rose just 0.1% in September making for a weak finish to the third quarter.  The median forecast from Bloomberg called for a 0.2% advance and ranged from a drop of 0.2% to a gain of 0.6%.  Seven of 13 major categories showed declines led by a 3.2% fall at service stations which suffered from having to charge less thanks to lower fuel prices.  Warmer-than-usual weather also curtailed purchases of fall clothing, and building-materials dealers and grocery stores also saw lower sales.  Auto dealers remain a bright spot in the data, with sales rising 1.7%.  Excluding vehicles, the data looked even softer as the index fell 0.3%, the weakest since January.

The consumer price index and producer price index for last month also were released this week.  Wholesale prices fell in September by the most since the start of the year.  The Labor Department reported producer prices fell by 0.5% in September following no change in August thanks primarily to lower costs in gasoline, food and brokerage services.  This figure, too, was below consensus which called for a 0.2% drop.  Over the past 12 months, producer prices are down 1.1%.  Excluding food and energy items, wholesale prices slumped 0.3% versus the 0.1% gain expected in a Bloomberg survey.  Consumer price data was not much better in terms of growth.  Prices, excluding often-volatile food and fuel, climbed 0.2% last month according to the Labor Department.  The total consumer price index fell 0.2% after falling 0.1% in August.  Rising rents is the most likely support of inflation according to analysts.  Rents on primary residences rose 0.4% in September or 3.7% on a yearly basis, the most since June, while owners’ equivalent rent used a proxy of costs for homeowners rose 0.3% last month which brings its increase to 3.1% over the past 12 months.  Over the previous year, CPI overall was basically unchanged while the core index rose 1.9%.  We continue to see a divergence between goods-sector and services-sector prices.  There is a clear deflationary trend in goods-sector areas like energy but services-sector areas like rent and medical care continue to push higher.  With the U.S. economy services-heavy, that is leading to overall upward prices but the divergence cannot last forever.

A key remains the health of the job market.  Initial jobless claims this week fell to 255,000 from 262,000 in the week ending October 10, matching the lowest level in four decades (since November 1973!) according to the Labor Department.  The less volatile four-week average fell to 265,000 (the lowest since December 1973) and the number of people continuing to receive jobless benefits fell by 50,000 to 2.16 million in the week ended October 3.   That was the lowest level since November 2000.  Thus, we are seeing that businesses have been reluctant to lay off workers, with initial claims holding below 300,000 per week since March.  However, they have also been hesitant to hire new employees as can be seen in the tepid 142,000 non-farm payroll growth in September which also included revisions that subtracted 59,000 jobs from the prior two months.  This state is not leading to higher wages which, in turn, is why we have only seen the slightest whiff of inflation in the monthly pricing data.  That is likely not going to change until we see a little more robust global growth.  Even though roughly 14% of U.S. GDP is export oriented, it was about 11% five years ago and 9% 25 years ago.  Clearly, this figure is rising.  Foreign sales accounted for 33% of aggregate revenue for the S&P 500 in 2014 according to Goldman Sachs research.  The median stock reported 29% of sales outside the U.S.  This suggests that when the Fed mentioned overseas turmoil as a reason for not increasing the federal funds rate last month, the percentage of international sales most likely played a part.  Consensus real GDP growth is 3.0% for 2015 and 3.4% for 2016 which is not bad but below the 5.4% figure for 2010 and 4.2% for 2011.  China, the world’s second biggest economy, is going to play a key role and forecasts call for 6.3% growth in 2017 which is solid but pales in comparison to the 10%+ growth we saw in the latter half of the previous decade.  Thus, the diversification, entrepreneurial environment and stable legal environment in the U.S. economy will likely keep us out of a recession in the next few years, it cannot guarantee the type of growth—absent a tailwind from overseas markets—that can justify higher interest rates at this point.  How that realization will translate into the stock markets is the key question as the holiday season quickly approaches.   

SGK Blog--Update October 9, 2015: Odds of Fed Rate Hike in 2015 Decline on Mixed U.S. and European Economic Data  

Monday’s markets opened with a bang following Asia’s overnight lead as weakness in U.S. economic data triggered speculation the Federal Reserve may hold off on an initial interest rate increase until next year. The bond market shows traders see only a 10% chance the Federal Reserve will raise interest rates at its Oct. 27-28 meeting after reports last Friday showed the pace of hiring slowed in September and wage growth stalled, spurring speculation policy makers will take longer to remove stimulus that has helped repair the global economy. Data released Monday showed growth in U.S. services slowed in September, as the Institute for Supply Management’s non-manufacturing index fell to 56.9 from 59 in August, below the 57.5 forecast in a survey of Bloomberg economists. As we highlighted last week, last Friday’s employment release showed the U.S. added 142,000 jobs in September, versus the 201,000 that analysts had predicted, according to the Labor Department. This combined news caused the U.S. dollar to weaken relative to other currencies at Monday’s open. The weaker dollar bolsters the earnings prospects of American companies that do business overseas and fuels demand for emerging-market assets and higher-yielding currencies. 

As we mentioned, the pace of growth in U.S. services industries cooled last month from the best readings in a decade, a sign consumers may be taking demand down to a more sustainable level in the face of global weakness. While the figure of 56.9 still denotes expansion, the previous month’s figures were much higher and not likely sustainable given the heightened uncertainty surrounding the outlook for global growth. Demand for services, which make up the lion’s share of the economy, has held up to this point in the face of financial-market volatility and a slowdown in international markets as the consumer has remained willing to spend. However, with payroll growth slowing and wages still stagnant, households may become more cautious. Thirteen industries reported expansion in September, led by educational services, construction, finance and health care. Mining, which includes oil and gas well drilling, and retail were among the four that contracted. The last time retailers reported shrinking business activity was February 2014, in the aftermath of a slump in sales owed to harsh winter weather. The weakness may in retail may be attributed to the softening of the stock market and consumer confidence. The new orders gauge dropped to 56.7 in September, the lowest in seven months, from 63.4 the prior month. The 6.7 point plunge was the largest since November 2008.  The business activity index, which parallels the ISM’s factory production gauge, declined to 60.2 last month from 63.9 in August, while a measure of services employment picked up to 58.3 from 56. So overall the report was mixed.      

On the footsteps of the September employment report, the ISM services release Monday shifted the odds of a Fed rate increase down to about 37% for the December meeting, 45% at or before the January session and 59% at or before the March meeting, according to futures data compiled by Bloomberg. The odds for a boost by the October meeting had been at 18% on October 1st. The calculations are based on the assumption that the effective fed funds rate will average 0.375% after liftoff, versus the current target range of zero to 0.25%. Clearly this runs contrary to what Janet Yellen had indicated in her last speech – that the Fed was confident they would be able to boost rates sometime in calendar 2015.   We will just have to wait and see – as we have written, they may have missed their ideal window of opportunity. Who wants an increase in interest rates at Christmas? Would journalists “boo” Janet Yellen at her press conference?! One thing is for sure, it would not be a popular move at that time of year. 

A combination of news releases – the weekly jobless claims figures and a report on German exports - sent stock indices lower in Thursday trading. Weekly jobless claims for the week ending 10/2/2015 fell to 263,000 from the prior week’s 276,000 and it was below the expectation for 274,000. This is one of those situations where good news was actually bad news for stocks as it indicated that while hiring slowed in September, the pace of layoffs has not picked up.   This in turn could be interpreted as giving credence to the Fed’s goal of a rate increase this year just as traders were getting comfortable with the notion that it may not happen, hence the decline in stocks Thursday. In European news, German exports slumped the most since the height of the 2009 recession in a sign that Europe’s largest economy is feeling the pain of weakening global trade. Foreign sales declined 5.2% in August from the previous month, the Federal Statistics Office in Wiesbaden said on Thursday. That’s the steepest drop since January 2009 and compares with a median estimate in a Bloomberg survey for a fall of 0.9%. Imports slid 3.1%. In a further sign of euro-area strain, French business confidence unexpectedly worsened. Germany is grappling with a slowdown in China, its third-biggest trade partner, and other emerging markets that have been key destinations for its exports. With factory orders from countries outside the 19-nation euro region plunging more than 13% in July and August combined, the focus is shifting to stronger domestic spending fueled by pent-up investment demand and consumption. From that perspective, their import figure was disappointing. 

The Fed minutes from their September meeting were eagerly anticipated by market participants as the feeling was the release may help enlighten traders confused by their inaction and dovish statement from their last meeting – and the follow-up comments from Committee members and Janet Yellen herself that a rate increase was in fact imminent this calendar year. While it is easy to interpret their actions and statements as in fact confusing, the reality is even if they begin the process of a rate increase this year, the pace of future increases will be slow. There is simply too much uncertainty coming out of China and Europe to sustain an aggressive interest rate policy on the part of the Fed, and little justification at this point in the absence of greater signs of inflation.  

As far as the minutes themselves, when they finally came out they indicated that Federal Reserve officials put off an interest-rate increase in September because of growing risks to their outlook for economic growth and inflation, mainly from China, even as they continued to say they were on track to raise the target later this year. Policy makers “agreed that developments over the inter-meeting period had not materially altered the committee’s economic outlook,” according to minutes of the Sept. 16-17 session of the Federal Open Market Committee, released Thursday in Washington.  Nonetheless, ’’the committee decided that it was prudent to wait for additional information confirming that the economic outlook had not deteriorated.’’ The FOMC noted that domestic economic conditions, including data on consumer spending and housing, had continued to improve, and the labor market had reached or was close to the committee’s long-run estimates for unemployment. Still, concerns over China and its potential spillover to other economies “were likely to depress U.S. net exports” and cause further strengthening of the dollar, which could damp inflation in the U.S. “Participants anticipated that the recent global developments would likely put further downward pressure on inflation in the near term,” the minutes said.  “Compared with their previous forecasts, more now saw the risks to inflation as tilted to the downside.” All-in-all traders were relieved to learn there was no more dissention amongst committee members and this provided a bit of a tailwind to the equity markets when the information from the minutes was digested.

SGK Blog--Update October 2, 2015: Jobs Data Disappoints 
The Labor Department reported that nonfarm payrolls rose 142,000 in September.  The median forecast in a Bloomberg survey of 96 economists expected a gain of 201,000.  The market’s initial reaction was negative.  Additionally, the figure for August was revised lower which put a further damper on an already dreary East Coast day.  The year-to-date monthly average gain is 198,000, lower than the 12-month average of 229,000 and the 2014 average of 260,000 so there is a definite deceleration taking place.  Jobs in private services rose 131,000 which was below the average of 196,000 in the first half of the year.  What makes this significant is that services drive the U.S. economy more than manufacturing which had begun to slow.  Now, services seem to be showing signs of retrenchment as well. 

Even though the unemployment rate itself was steady at 5.1%, the key hourly earnings figure was not impressive.  Over the past twelve months, that metric has risen 2.2% which is identical to the 12-month pace registered in July and August.  Though we are technically above the 2% key level that the Fed looks for, the lack of movement higher suggests there is a distinct lack of wage pressure.  The average workweek also fell slightly which is another indicator of slack in the labor force.  Previous disappointing jobs reports could be attributed to one-off factors like weather-related weakness.  There are no such excuses this time as this month’s report fell materially short of expectations.

In the Fed’s press release on September 17 following their Federal Open Market Committee gathering, it was noted: “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.”  That served as the key to why the Fed did not raise rates last month.  The instability of international markets was given as a factor for not making a move by Fed Chair Yellen.    In subsequent public appearances, she and other Fed members spoke of raising rates “in 2015” which points to a late-October or mid-December bump higher which would correspond to regular Fed meeting dates.  Given this latest data, October is likely off the table.  According to the Bloomberg world interest rate probability function, the chances of an increase in October are only 8%.  December’s chance is higher at 31.9% but that figure is lower than even odds.  The first date above 50% is the March 16, 2016 meeting.

Now comes some serious tightrope walking.  Clearly, the non-move in September by the Fed has been justified by the recent weakening data.  The Institute of Supply Management’s (ISM) factor index fell to 50.2 in September from 51.1 the prior month.  A figure above 50.0 indicates growth so last month barely met this criteria.  The ISM measure of new orders fell to the slowest pace since November 2012, and order backlogs fell to 41.5 from 46.5 last month.  Headwinds from a strong dollar and weak commodity prices are legitimate excuses for why the manufacturing sector has largely stalled since late summer.  The non-manufacturing ISM figure is to be reported on Monday, and it could be market making news if it, too, shows more weakness than expected.  Weekly initial unemployment data this week rose 10,000 to 277,000 which was above the consensus figure of 271,000.  Given this backdrop, can the Fed rationalize an increase even in December?  We have argued that the 0% target is appropriate in emergency circumstances.  Today’s payroll data was not pretty, but it was not Depression-era either.   The Fed has more room now to let the economy “run hot” should wages spike higher.  That flexibility should be emphasized rather than continue to let the market’s believe that rates will rise “in 2015.”  The clock is ticking and Father Time remains undefeated.  Granted, guidance cannot be changed from week to week depending upon the most current economic data point but clearly, as has been the case for some time, the financial futures markets are saying that a rate rise is not going to happen anytime soon.  Shouldn’t the Fed echo those thoughts or at least acknowledge them?  Transparency is paramount to functioning markets because traders do not like uncertainty and fuzzy interpretations.  With earnings season right around the corner, the last thing the markets need is to start guessing.

SGK Blog--Update September 25, 2015: Fed Inaction and Mixed Messages Confuse Market Participants; Yellen Soothes Frayed Nerves with Speech  

We wrote in this forum two weeks ago that we saw no reason for the Federal Open Markets Committee (FOMC) not to increase rates incrementally, our forecast was a baby step to 0.375% from the current 0-0.25% range, based on the strength of the data we have been receiving on the U.S. economy.  In a nutshell, the Fed chose not to act and to release what was construed as a dovish statement citing global uncertainty and the resulting risks to the U.S. economy and the achievement of their inflation mandate.  Talk about a recipe to deflate confidence!  After bonds shot up in price and stocks moved in the other direction in Friday trading, the Fed move was quickly followed over the succeeding weekend and on Monday by statements from four Fed committee members stating that the FOMC still fully intends to raise rates prior to year-end with one member actually stating in not exactly these words that the committee made a mistake by not acting at the last meeting – given the recent data on the U.S. economy.  What is a trader supposed to do with that?  Is it like we are going to get some newfound clarity on what is really going on inside China in terms of the extent of their economic slowdown between now and when the Fed meets again in October and December?  It’s fine to mention the risks to meeting their inflation target near term based on international factors, but in our view that should not override their responsibility to act based on the information they are receiving on the U.S. economy.  Their inaction also adds uncertainty and we keep hearing the question from the television pundits – does the Fed know something everyone else does not?  As we pointed out last week, the Fed has never in its history raised interest rates within a month of a correction in the stock market.  So perhaps they were just plain scared.  Whatever the reasoning, the statements after the fact and their inability to act and find consensus caused traders to sell securities globally in Tuesday trading and does not inspire confidence.  Yellen speech on Thursday evening in which she sounded a more positive note with respect to the U.S. economy while indicating the Fed’s intention to raise rates prior to year-end helped calm global fears to a certain degree. 

The Fed’s move also creates uncertainty on the next steps the European Central Bank will take to stimulate growth.  They are pursuing their own quantitative easing through bond purchases to stimulate growth.  The view that the Fed was poised to raise interest rates here in the U.S. was helping their currency as it was depreciating relative to our dollar.  This had resulted in better growth on the continent in recent quarters.  Additional uncertainty has been created as to how the ECB will react to the Fed’s surprise inaction.  At the ECB’s meeting in early September, the central bank’s policy expectations for growth and inflation over the next three years for Europe were revised lower, reflecting one of the concerns the Fed laid out last week when it held its key rate steady: falling energy prices and their impact on inflation expectations.  In fact, after the Fed’s policy hold, ECB Executive Board member Benoit Couere said that the Fed’s decision to keep rates on hold confirms the ECB’s own assessment for global growth.  ECB Chief Economist and Executive Board member Peter Praet said last week that the ECB wouldn’t hesitate to act again if it deemed “shocks” to be longer lasting than currently anticipated.  Hence the sell-off on Tuesday on the European equity bourses which precipitated our own drop in the U.S. equity futures prior to the market open. 

In U.S. economic news, existing home sales for August came in slightly short of expectations at 5.31 million versus the estimate of 5.50 million and the prior month’s figure of 5.58 million.  But on the positive side, U.S. home prices increased more than estimated in July as the job market improved and buyers competed for a tight supply of properties.  Prices climbed 0.6% on a seasonally adjusted basis from June, the Federal Housing Finance Agency said in a report from Washington Tuesday.  The average estimate of 23 economists was for a 0.4% increase, according to data compiled by Bloomberg.  The gain was 5.8% from a year earlier.  The declining unemployment rate has helped create a bigger pool of buyers, who’ve been finding few homes on the market to pick from.  Listings nationwide fell 4.7% in July from a year earlier, according to the National Association of Realtors.  Price increases will encourage more homeowners to sell as they gain enough equity to trade up. 

Weekly U.S. jobless claims for the week ending September 19, 2015 were 267,000 which was below the forecast for 272,000 and this dropped the four week moving average to the lowest level in more than a month.  Why again did the Fed not increase rates?!  Consumer confidence rose last week by the most in three months as Americans grew more upbeat about the economy, their finances and the buying climate.  The Bloomberg Consumer Comfort Index rose to 41.9, the first advance in four weeks, from 40.2 the week prior.  The 1.7 point gain was the biggest since the period ending June 21 and brings the gauge to its highest reading in a month.  While the stock market remains volatile, sentiment is being bolstered by fewer job cuts, more hiring and falling gasoline prices.  This coincided with the release overseas of figures for German business confidence which unexpectedly increased in September as companies benefitted from strengthening domestic demand in Europe’s largest economy, shrugging off risks from slowing growth in emerging markets.  The Ifo institute’s business climate index climbed to 108.5 from a revised 108.4 in August.   The median estimate was for a decline to 107.9 according to a Bloomberg survey of economists.  This of course was prior to the news breaking of Volkswagen’s major breach of consumers trust and confidence.   

Back to the domestic economy, purchases of new homes jumped in August to a seven-year high as Americans continue to take advantage of historically low interest rates.  Sales climbed 5.7% to a 552,000 annualized pace, exceeding all forecasts of economists surveyed by Bloomberg and the highest since February 2008.  Steady job growth and cheaper borrowing costs are bolstering demand for new homes, particularly as the supply of previously owned properties is still scant.  Further healing in residential real estate should help underpin the U.S. economy amid weakness from the stronger dollar and slower overseas growth.  On that note, the momentum in orders for business equipment stalled in August following gains the prior two months as U.S. investment took a breather amid volatility in financial markets and concerns that global growth is slowing.  Bookings for non-military capital goods excluding aircraft fell 0.2% last month after rising 2.1% in July, according to the Commerce Department.  Orders for all durable goods – items meant to last at least 3 years – dropped 0.2% also, reflecting declines in defense and aircraft.  The bottom line is the relatively steady reading in capital goods bookings following the best back-to-back gains in more than a year signals companies waiting to assess prospects for U.S. demand as global growth slows and financial markets turn volatile.  A strong American consumer, powered by more jobs, growing incomes and low inflation, will be needed to help support the outlook for growth in the second half of the year.  In fact Friday’s third revision to second quarter gross domestic product (GDP) was revised upwards to 3.9% from the previous 3.7% estimate thanks to the mighty U.S. consumer.  As always, stay tuned!

SGK Blog--Update September 18, 2015:  The Fed Holds Steady  

The Federal Open Market Committee met this week to decide the future direction of interest rates, and the world was watching.  At the end of the two day meeting, the rate target settled upon was the same as last week, last month and nearly the last seven years.  The key phrase in the post-meeting statement: “Recent global economic and financial developments may restrain economic activity somewhat and are likely to put further downward pressure on inflation in the near term.”  Since the 1940’s the Federal Reserve has never raised rates within a month of a correction in the stock market.  Obviously, voting Fed members were spooked with what happened in China which spilled into domestic markets starting in the beginning of August.  The Fed is still planning on raising rates this year with 13 of the 17 members of the committee predicting at least a 0.25 percentage point rise before 2016.  Projections also reveal three more expected hikes in 2016 and one in 2017.  But, after telling investors that a rate hike is coming this year, it is now September 18 and time is running out on 2015. 

Are there clear signs that the Fed had to act this week?  National unemployment is at 5.1% and this week’s initial unemployment claims declined to the lowest level in two months.  In the week ended September 12, the Labor Department said jobless claims fell by 11,000 to 264,000 versus a median forecast of economists who expected 275,000.  We have been below 300,000 for a considerable time.  The number of people continuing to receive jobless benefits fell by 26,000 to 2.24 million.  The latest monthly payroll data showed that wages on a yearly basis are definitely at the 2% threshold Fed members have been calling for to demonstrate that we are near “full employment”.  Another supporting area, housing, also seems to be growing nicely.  The National Association of Home Builders index of homebuilder sentiment reached yet another post-recession high this month.  A level of 62 in September is at the highest level since it reached 68 in October 2005 during the midst of the ill-fated housing boom.  The three-month moving average reached 61, the first time it has been above 60 since December 2005.  New home starts fell in August but that was offset by a solid increase in applications for permits which signifies strong future growth.  Retail sales were in-line with expectations which is a positive sign for the economy given that back-to-school season is the second most important time of the year for many retailers.   

Thus, a lot of checkmarks were satisfied for a rate increase, yet none came.  One reason for this could be found in the Fed’s dual mandate.  In addition to “full employment”, the Fed is charged with stable prices which involves moderate long-term interest rates.  Long-term interest rates are heavily influenced by today’s inflation and inflationary expectations for the future.  Think about it this way—when you as an individual lends money you expect a real return because you do not get to use that money while it is being loaned.  But there’s also the chance that the level of prices—i.e., inflation—will adjust during that period.  So, you might get paid back in dollars which have less purchasing power than when they were originally loaned out.  It is this factor—future inflation—which the Fed is seeing no signs of.  With a 10-year breakeven inflation rate of about 1.59%, investors are barely expecting much of it over the next decade.  That number could change tomorrow, of course.  It was over 2% in October of last year.  The Fed believes it has time on its side.  It does not have to make a move because inflationary pressures are not present and the employment market, though the strongest it has been since 2008, is not overheating.  At present, the Fed is in no danger of not meeting its mandate.  By the end of 2015, the Federal Reserve Board members and district presidents believe core personal consumption expenditures, excluding food and energy inputs, will be 0.4%, down from the 0.7% increase in its June projection.  Real GDP, according to the group, is expected to peak in 2016 at 2.3%, which is down from 2.5% in June, then decline to 2.2% in 2017 and 2.0% in 2018.  Again, those figures mean there is no pressure to make any move. 

Historically, the Fed has often been guilty of making a move too late.  Interest rates were pushed higher only after inflation had gained momentum.  Over the past many months, Fed members have spoken of rate increases as if they were almost around the corner.  Is the Fed’s credibility harmed?  Technically, this year is not over and there are two more meetings to make a rate move.  Realistically, traders are likely getting a little tired of the sky-is-falling routine.  Granted, the Fed has been pressured in the past to be more transparent about its thinking so talking about rate moves months or up to a year in advance would satisfy that need.  Chairwoman Yellen and her predecessors have struggled for years to come up with benchmarks that the investing public can track as a hint for the next move.  They have largely abandoned such road signs given that single data points are too simplistic to use for a $17 trillion economy.  Therefore, the market where trades are executed in milliseconds is always going to have a conflict with the Fed’s attempt at transparency where decisions are based on data collected over many months.  The Fed is concerned with its mandate—if that doesn’t translate into a sound bite or headline for the nightly news—too bad.   

So what next?  The Fed will meet on October 27-28 and December 15-16.  Both are considered “live” meetings meaning that a change in monetary policy can occur at either meeting even though there is only a press conference after the December meeting.  According to Bloomberg, the probability of an increase at the December meeting is 46%, down from 65% on Wednesday.  The probability for a move at the January meeting is 54%.  What the markets do not like is the fact that the Fed has opened the door to having its decisions be affected by global developments—especially China and the emerging markets.  Chinese transparency is fictional so tracking developments in that country is going to invite lots of risk.  Is a 10% decline in the Hong Kong markets too much?  15%? 5%?  The focus on the mandate is important because that is what the Federal Reserve Act which created the Federal Reserve dictated.  The U.S. cannot act in a vacuum and neither can the Fed but as Yellen stated in the press conference “when there are significant financial developments it is incumbent on us to ask what is causing them.”  The ultimate question then is can the markets trust the Fed to decipher correctly what these causes are and how they will specifically affect the U.S. markets and when?  That’s a big “if” with trillions at stake.  The market does not like uncertainty and by avoiding lift-off it has created more of it.  By waiting until the doubts in global cross-currents have lessened or at least dissipated, the Fed may be waiting too long.

SGK Blog--Update September 11, 2015: All Eyes Are On Next Week's Fed Meeting

As we have been writing about China making headlines over the past few weeks in this venue, we thought it appropriate to continue that theme as we did see a higher level of stability in their markets this week. It is interesting to get the perspective from the economists of prominent global investment banks on the world’s second largest economy. The general view is the slowdown in China that took financial markets on a wild ride the past month won’t be enough to hobble the world’s biggest developed economies. That’s the consensus from economists at Goldman Sachs Group Inc., Deutsche Bank AG and JPMorgan Chase & Co., with forecasts that could help quell investor concerns over a deceleration in the world’s No. 2 economy. Number-crunching by JPMorgan Chase economists Joseph Lupton and David Hensley suggests that if China’s expansion slows by 1%, the spillover to industrial nations is just 0.2% of gross domestic product. “It doesn’t mean there isn’t a negative effect, it just means that some of the positive supports are there,” said Lupton in a webcast. The supports include lower commodity prices thanks to weaker Chinese demand, and increased capital flows to other destinations. That gives a boost to purchasing power, and puts a cap on borrowing costs in financial markets outside China. Also, just 2.5% of global GDP is exported to China, and much of that is composed of goods still in the production process, which are then shipped back out. There will still be some victims from China’s weakening, namely the emerging markets including Brazil and Russia that churn out raw materials, or rely on exports for economic strength. JPMorgan Chase estimates that a slowdown in China has a one-for-one hit on such economies, meaning the biggest global threat may be an emerging-market slump. At Deutsche Bank, economists led by Peter Hooper suggest that such concerns are overblown. They reckon China’s stock market, which has tumbled since June, is divorced from the overall economy and that the yuan’s slide will be contained. As for Europe, Deutsche Bank is sticking by its forecast for the euro-area economy to grow 1.4% this year. Also relaxed are Goldman Sachs economists Sven Jari Stehn and Jan Hatzius, who concluded that the drag on the U.S. will be minimal. With only about 7% of exports headed to China, they estimate the total spillover from the recent Chinese downdraft and devaluation on the U.S. to be around 0.2% with respect to the impact on U.S. GDP growth. “But the uncertainty is significant in light of the difficulty of disentangling financial spillovers and the continued downside risks to the Chinese economy,” the Goldman Sachs economists said. This makes sense to us and is consistent with our point of view. 

The second major theme we have been consistently writing about in this venue is when the Fed will begin to move on rates and what impact that will have on markets. In our view, Janet Yellen has the fixed-income market just where she wants it: ripe for the first increase in U.S. interest rates since 2006. Just about every indicator is telling the Federal Reserve Chair a move at next week’s policy meeting would cause government bonds little disruption. Her guidance has money markets pricing an extraordinarily slow pace of tightening, volatility metrics show no signs of panic, and forwards indicate benchmark rates will remain contained. Differences between shorter- and longer-term yields are flashing a positive signal for the economy. A green light from Treasuries is vital to avoid derailing the recovery that Yellen has nurtured because they help determine borrowing costs for businesses and consumers. In our view, acting decisively now may even lend investors greater confidence in the outlook for growth. To keep it in perspective, at the time of writing this draft the benchmark Treasury 10-year note yield was at 2.23%, versus an average of 3.17% over the past decade. Forward contracts foresee a gradual increase to 2.38% in one year, with yields only reaching 3% around a decade from now. That’s a boon for any money manager fretting about an end to the 25-year bull market in bonds. Once we get through the first increase, and see the economy can do fine, it will remove the looming worry. 

Bond investors have had plenty of time to get comfortable with the idea that interest rates are going to rise from near zero.  As long ago as March, the Fed introduced the possibility of a move in 2015. Policy makers said more recently they intended to act before year-end, assuming continued improvement in the labor market, as they were confident inflation would move back toward their 2% goal. With the unemployment rate at a seven-year low, futures trades are pricing in a 28% likelihood of an increase this month and 57% odds of a tightening before Dec. 31. The Fed will announce its next policy decision on Sept. 17. Even when the Fed does move, communication tools such as officials’ estimates for the future evolution of interest rates and Yellen’s own press conference may help assuage market nerves. Money-market derivatives indicate investors see an exceptionally slow pace of tightening. They show the fed funds rate will average just 0.60% one year from now. Assuming it trades close to the middle of the official band, that doesn’t even price in two quarter-point increases. For now, Treasuries at least are showing few signs of alarm.   A widening gap since mid-August between yields on five-year Treasuries and those with 30 years to maturity indicates the Fed can move without killing off the potential for inflation to eventually reach the central bank’s 2% target.  

Before we touch on the domestic economic data this week, let us look at how progress is being made in the euro area now that their central bank has embarked on its own path of quantitative easing. The euro-area economy grew more than initially reported in the second quarter, driven by a surge in exports and consumer spending. Gross domestic product rose 0.4% in the three months through June after expanding a revised 0.5% in the first quarter, the European Union’s statistics office in Luxembourg said Tuesday. Household consumption increased 0.4%. Eurostat had reported second-quarter growth of 0.3% on August 14. The European Central Bank predicted last week that the region’s recovery will continue, albeit at a weaker pace as an economic slowdown in emerging markets including China weighs on global trade. Policy makers revised down their growth and inflation forecasts for the 19-nation bloc through 2017, and President Mario Draghi committed to expand stimulus if needed. Government spending increased 0.3% in the three months through June, while investment fell 0.5% after a 1.4% surge at the start of the year, according to the report. Household consumption contributed 0.2% to GDP, and net trade added 0.3%. A gauge of factory and services activity rose to a four-year high in August in a sign that the euro area’s recovery is proceeding at pace. Unemployment in the region declined to 10.9% in July, the lowest since early 2012. Progress appears to be slow but it is moving in the right direction. 

On the domestic front, markets were rattled in Wednesday trading by the release of the Job Openings and Labor Turnover Survey (JOLTS) which came in at a record 5.753 million for the month of July compared to the prior month’s figure of 5.323 million. The issue here is with the tightening of the labor market and the healthy employment figures for August, this lends support to the notion that wage growth and potentially inflation is around the corner. Once again, this supports our view that there is really no justification for the Fed not to raise rates at their meeting next week. Hence, interest rates rose and stocks sold off on Wednesday – turns out good news is actually bad news for stocks! Weekly initial unemployment claims for the week ending 9/5/2015 came in exactly as expected at 275,000. Wrapping the week up on Friday, the figures for the producer price index for August came in flat and up just 0.3% excluding the volatile food and energy sector. Lending to the somber mood in Friday trading, the University of Michigan consumer sentiment survey for September came in at 85.7 versus the expectation of 91.5 and the prior month’s figure of 91.9. This is not exactly surprising to us – volatility in markets does tend to shake consumer confidence as we have written in previous emails. As our headline suggests, next week all eyes will be on the Federal Open Markets Committee (FOMC) decision when it comes out on the 17th

SGK Blog--Update September 4, 2015: Payroll Data Gives Fed Direction 
The financial world has been waiting for these numbers for many, many weeks. Probability that the U.S. Federal Reserve would raise interest rates at the their mid-September meeting has wavered from around 60% to below 30% with each new data point swinging odds in one direction over another. Given how Fed Chairwoman Yellen and her colleagues have placed so much emphasis on being “data driven,” it is no surprise that today’s employment numbers carried so much weight. The Labor Department reported that for the month of August, the economy created 173,000 non-farm workers new to payrolls. The gain was less than forecast of a gain of 217,000 by economists surveyed by Bloomberg, but it followed upward revisions to the July and June data. The year-to-date monthly average gain in non-farm workers stands at 212,000. Private payrolls, which exclude federal, state and local government hiring, rose 140,000 for August. The unemployment rate dropped to 5.1% as the participation rate, which indicates the share of working-age population in the labor force, held steady at 62.6%.

The biggest item in the report is the wage figure. Having more people working is good but, with 90% of the population depending upon wage increases to improve their standard of living and quality of life, are they any better off? Yellen has continuously stressed this point since become Chairwoman. Average hourly earnings increased 0.3% which translates into a 2.2% year-over-year gain. The yearly figure has not been below the desired 2% level since December of last year and excluding that one month, that string stretches back to April 2014. In other words, it is hardly robust but there is definite traction is this very key statistic. It was also accompanied in August with an uptick in the average work week from 34.5 hours to 34.6 hours. The one-tenth increase in average work week lifted total worker-hours which when combined with the three-tenths increase in average hourly earnings  means aggregate income rose by 0.7% last month compared to 0.4% in July. The math boils down to the fact that the near-term outlook for consumer spending (comprising nearly 70% of GDP) is quite solid and can propel the economy through the end of the year. 

Is the case for a September increase strengthened by this report? Marginally. The jobs headline figure fell too far short of expectations though voting Richmond Fed president Jeffrey Lacker gave a speech this morning, before the jobs report was released,  titled “The Case Against Further Delay.” The speech emphasized two points: household spending in the second half of 2015 and the resilience of the domestic economy to international developments. This month’s report proved the first point. The gyrations of the stock markets over the past two weeks does not prove the latter. Thus, the die may or may not be cast. If the Fed does not make a move in September, there is an October meeting. Many believe the Fed will not adjust policy without a post-meeting press conference and there is not one scheduled…yet. No move at either point means the Fed, in our opinion, must do something in December. Why? After saying and repeating and emphasizing that a move in 2015 is highly likely, for the Fed to do nothing will lose all credibility with the markets. In a twisted fashion, it is more important for them to save face then to be right. A Republican-controlled Congress has not taken further oversight of the Fed off the table and having the independent central bank essentially mislead the American public would result in a tremendous blow to that independence going forward.

As we have written previously, the first rate hike is really much ado about nothing. A 0.25% increase means little in the grand scheme of interest rates especially if a subsequent increase is six months or more down the road. Emergency monetary policy is clearly no longer necessary so neither is having a 0% rate. But what about Lacker’s second condition about international affairs influence on the U.S.? European Central Bank President Mario Draghi indicated on Thursday that the bank is ready to expand its stimulus program if needed. Stressing the bank’s “willingness and ability to act if warranted,” Draghi wanted to send a message that turbulence in financial markets will not hinder its ability to push for higher inflation or its conviction to do so. Along the lines of his now famous “whatever it takes comments” back in July 2012, the details were not filled in. Given that the U.S. employment report was not yet released and finance and ministers and central bank chiefs from the Group of 20 largest economies were set to meet today, he stated in a press conference that the ECB will have “much more visibility in the coming days than we do now.”   Can the Fed stomach a 5% drop in the market? 10%? We would argue yes given the fundamental strength of the balance sheet of many firms, the lack of stress in global liquidity markets and the strength of the domestic labor market. The Fed will not raise rates until the market can withstand a raise in rates, and it seems as though it can do that at this point. Also, the Fed mandate says nothing about how happy people are about their 401k values. According to Bloomberg, the probability of a move at the September meeting is 34% versus 61% at the December meeting. Today’s employment report was important yet there remains a few more juicy details between now and the Fed meeting such as the latest consumer and producer price data, retail sales data, housing market sentiment, housing starts and building permits and two more weeks of timely weekly initial and continuing unemployment claims. The market will be watching carefully as the calendar moves forward.

SGK Blog--Update August 21, 2015: Markets Volatile on Global Basis 

Global markets endured a volatile week as investors questioned future worldwide growth.  Following China’s decision last week to allow the value of the yuan to decline, uncertainty rippled through many trading desks.  At the heart of the concern is the worry that China, the world’s second largest economy following the U.S., will see further demand decline.  That pullback has affected the prices of oil and other raw materials.  Since the end of June, the price of Brent crude, the global benchmark, has fallen approximately 28%.  Corn is down about 11% with wheat and soybeans down around 19% and 13%, respectively, over the same period.  These declines have hit developing countries the hardest.  Brazil and Russia are major exporters of commodities and their economies have reflected the fear.  Emerging nations are also struggling as investors sell shares and move funds out of those deteriorating currencies.  The euro zone, which has recently shown signs of life, now has to deal with the resignation of Greek Prime Minister Tsipras and the uncertainty surrounding elections next month.  That all washes back to U.S. shores where the Federal Reserve faces a crucial decision next month on whether to raise their benchmark fed fund rate for the first time since 2006.

In the face of these worries is the fact that domestic data, especially on the housing front, is decidedly positive.  The National Association of Home Builders/Wells Fargo builder sentiment gauge rose in August to 61, the highest since November 2005.  Readings above 50 suggest more respondents report good market conditions.  Not surprisingly, new home construction climbed in July to the highest level in almost eight years.  Residential starts rose to an annualized rate of 1.2 million, the most since October 2007.  A drop in permits, a proxy for future construction, suggests additional gains will be pushed back a bit.  However, that does not diminish the positive momentum in the industry.  This was confirmed by yesterday’s data from the National Association of Realtors showing existing home sales, which provide about 90% of residential housing transactions, rose in July to the highest level since February 2007.  The median price rose 5.6% from July 2014 to $234,000 thanks to still low mortgage rates and a tight supply of homes on the market.  At the current sales pace, it would take 4.8 months to clear out the existing inventory.  Anything below 5.0 months is considered a sellers’ market according to the Realtor’s group. 

With first time claims for jobless benefits below 300,000 again this week, the labor market continues to support a healthy economy.  The solid housing data is a direct reflection of the better labor market.  The housing market affects so many other industries from financial services to home improvement to moving companies to demand for school books.  According to the minutes of the latest Fed meeting released on Wednesday, policy makers took note of the improvement in housing.  However, there remains no clear sign that the Fed will indeed move to raise rates.  The minutes stated: “Most [officials] judged that the conditions for policy firming had not yet been achieved, but they noted that conditions were approaching that point.”  Some also worried about moving prematurely.  Others argued that an increase would convey confidence that the economy had moved toward “normalcy.”  Before the minutes were released, the probability of a move according to Bloomberg’s world interest rate probability function was 50%.  Today, that number stands at 34%.   

The real question is how much of the recent events since the yuan devaluation are temporary market adjustments versus a secular shift?  The Fed has repeatedly mentioned commodity weakness as temporary.  In fact, lower oil prices boost the economy.  According to road club AAA, the price of a gallon of gasoline in the U.S. has fallen to $2.65 from $3.44 a year ago with some states selling it for less than $2.  Global fears also boost demand for safe instruments.  The yield of the benchmark 10-year Treasury bond broke through its recent trading range to the downside the past few weeks.  It is now hovering slightly above 2%.  It has not traded below that level since late April.  Low rates filter through to low mortgage levels which provide further fuel to housing construction and home sales.  All of these signs point to an increase in September.  Moreover, the current 0%-0.25% range the Fed has targeted for the past nine years was meant for extraordinary circumstances.  We are not longer looking at double-digit unemployment levels, falling home prices or major blue chip companies facing bankruptcy.  Each and every day it becomes harder for the Fed to argue that emergency measures are needed for an non-emergency environment.  And, the biggest challenge is…if not now, when?  Fed chairwoman Janet Yellen has testified that the first rate hike is not the key to focus upon but rather the entire trajectory and speed of the rate increase cycle.  The next recession is not around the corner because the U.S. economy has too much positive momentum right now.  But the Fed would rather have some ammunition for when the next recession does take place.  That is much easier to do if the fed funds rate is 2% or 3% or higher which means a slow steady rate hike to reach those levels must start sooner rather than later.  The September 4 employment report, in our opinion, is going to be the last major data point before the next meeting and the deciding factor in whether the Fed will raise.  More important than the job number itself will be the wage component and whether it reaches the “magic” 2% year-over-year figure.  The world will be watching.    

SGK Blog--Update August 14, 2015: China Roils Markets With Currency Devaluation 

After the week started on a positive note for equities, China rattled traders by initiating a devaluation of their currency. The spillover effect was dramatic as emerging market stocks and currencies declined, as did commodity prices. The move was interpreted as signs that the Chinese economy may be slowing more than anticipated. It was also a move that many viewed as an attempt by their central bank to stimulate the export part of their economy as that segment has been a key driver of growth historically and maintains strong political influence. Of course U.S. politicians from both parties jumped on the bandwagon and were quick to criticize China for initiating this action. In the immortal words of Donald Trump, it would “suck the blood out of the U.S.” Enough said! In our view this was important, but the significance of the move was way overblown. First, China has been working with the International Monetary Fund (IMF) for the past year to include their currency, the yuan or renminbi, as part of the basket of currencies known as reserve currencies. Unlike our politicians here, the view of the IMF after the appreciation of the yuan over the past 12 months is that it is in fact overvalued considering the slowing growth trend in their economy. They also indicated that the People’s Bank of China (PBOC) should allow the currency to float within a prescribed range. In fact Tuesday this is exactly what the Chinese did. So in our view the move was meant to appease the IMF as much as anything else. The impact on markets though was dramatic as the currency dropped 1.6% relative to the dollar on Tuesday alone and at one point was down close to 3% during the week before the PBOC indicated they would intervene in markets to stabilize the currency. Bond traders seemed to recognize this as fixed income markets stabilized relatively quickly while equity traders can tend to be a little nuts anyway so it took a while for stocks to settle into a trading range. Our big issue is the lousy communication skills from the PBOC in general. There was no telegraphing the move – they just did it – so it took market participants by total surprise. Our Federal Reserve does a far better job of communicating both their forecasts and the basis for making moves in advance of the actions taking place. 

The impact of the move by the Chinese authorities is not insignificant. The strengthening of the dollar relative to the yuan will have a negative impact on our export market, as it makes our goods more expensive to the Chinese consumer. It is the world’s second largest economy after all. Additionally, the move by the PBOC prompted other Asian and emerging economies to look to devalue their currency as well. In some cases they had no choice as there has been an outflow of funds from some of these emerging markets as a result of the Chinese action. The other impact will potentially be felt in corporate earnings. China is an important market for many companies, and when money earned in the renminbi is translated back into U.S. dollars it can mean less U.S. dollars flowing through to the bottom line. That is why we witnessed a stock like Apple drop on Tuesday based on the uncertainty at that point that was created by not knowing to what extent they would let their currency decline on a relative basis. By week’s end, the intervention by the PBOC helped settle markets and the stocks of companies that do business over there. 

In other global news this week, Euro-area economic growth unexpectedly slowed last quarter as expansion in its three largest economies fell short of estimates, highlighting the fragility of the recovery amid uncertainty surrounding the global outlook. Gross domestic product in the 19-nation region rose 0.3%, data on Friday showed. Economists had forecast that the 0.4% pace of the first quarter would be maintained. Germany’s economy grew 0.4%, Italy’s 0.2%, while France stagnated. With China jolting global markets by devaluing its currency and Greece on the verge of a new bailout program, the euro area’s nascent revival may yet struggle. European Central Bank policy makers meeting in July called the recovery “disappointing” and said they’re ready to adjust stimulus if needed, a summary of the discussions showed on Thursday. German GDP had been forecast to rise 0.5% in a Bloomberg survey. France and Italy were projected to increase 0.2% and 0.3%, respectively. German growth was driven by net exports and private consumption, the statistics office said, while investment, especially in construction, was a drag. France’s stagnation marks the first time in a year that the economy has failed to grow. Consumer spending rose just 0.1% in the second quarter after climbing 0.9% in the previous three months. Surprisingly, Spain and Greece provided the high points of the period’s GDP. Spain’s economy expanded 1%, the fastest pace in more than eight years, data showed last month. Greece, which imposed capital controls and came close to leaving the currency bloc during a standoff with creditors this year, said on Thursday that its GDP rose 0.8%. The surprise surge, led by consumer spending and tourism, is seen by analysts as a blip amid a crumbling economy. The International Monetary Fund last month cut its forecast for global growth, singling out financial-market turbulence in China and Greece.  

On the domestic front, there were no major surprises in the economic data out this week. U.S. productivity in the second quarter was +1.3% while unit labor costs were +0.5%. Combined with the figures for the producer price index which was +0.2% with the core rate coming in at +0.3% for July, this shows that inflation remains in check. Industrial production and capacity utilization for July, measures of the health of the manufacturing sector, came in as expected at +0.6% and 78% respectively. Earlier in the week we had retail sales for July which came in pretty good at +0.6% and when autos were excluded it was a still healthy +0.4%. Initial weekly jobless claims for the week ending 8/8/2015 were in-line with expectations at 274,000. Again, no major surprises on the week which is usually a good thing! The U.S. economy continues to chug along at a moderate pace. There was nothing in this week’s data to influence the Fed in either direction and despite the turmoil from China this week we feel they will still raise rates this year.

SGK Blog--Update August 7, 2015: US Economy Create 215,000 Jobs in July  

The U.S. job market is chugging ahead, making the type of progress Federal Reserve policy makers want to see in order to raise interest rates as soon as September. Employers added 215,000 jobs in July and the unemployment rate held at a seven-year low of 5.3%, a Labor Department report showed Friday in Washington.  The gain in payrolls last month followed a 231,000 advance in June that was bigger than previously estimated. The persistent pace of hiring this year indicates companies are sanguine about prospects for demand in the face of a tempered global growth outlook.  Better job security that leads to bigger wage gains could encourage consumers to spend more freely and provide more momentum for the economy. While the data also showed a pickup in hours worked, average hourly earnings climbed a less-than-forecast 2.1% from a year earlier, indicating little momentum in wage growth. Retail and professional business services led the industries adding to headcounts in July, followed by health care and leisure and hospitality.  Manufacturing payrolls rose by the most in six months on gains among non-durable goods producers.  More jobs were also added in construction. The report also showed a jump in full-time employment, while the number of part-time workers declined. The median forecast in a Bloomberg survey called for a 225,000 advance. Interestingly, the yield curve flattened on the release as the general view amongst market participants is that this report is strong enough to warrant a Fed rate increase at their September meeting but that could put pressure on future economic growth.

America’s service providers from restaurants to real estate agencies expanded in July at the strongest pace in a decade, putting the U.S. economy on track for faster growth. The Institute for Supply Management’s non-manufacturing index jumped by 4.3 points to 60.3, the best reading since August 2005 and well above the most optimistic projection in a Bloomberg survey of economists, the group’s report showed Wednesday.  All major components of the gauge, including orders and employment, advanced. Steady hiring, a recovering housing market, reduced fuel expenses and cheap borrowing costs are benefiting service producers while the nation’s factories battle tepid global sales and slower capital spending.  Resilient domestic demand helps explain why Federal Reserve policy makers will probably raise interest rates this year for the first time since 2006. Entertainment and recreation, real estate, and retail led the list of 15 industries that reported expansion in July.  Mining, which includes oil and gas well drilling, was among the two that contracted. Readings above 50 for the Tempe, Arizona-based ISM’s index signal expansion.  The median forecast in the Bloomberg survey was 56.2 after 56 in June, with estimates ranging from 54 to 58.  It marked the biggest positive surprise in the gauge since February 2012.  While it is “a bit unusual” to see such elevated readings at this time of the year, “all indications are that we should see growth continue,” Anthony Nieves, chairman of the survey, said on a conference call with reporters after the release. The service sector “is having a nice uptick.” The survey covers industries that make up almost 90% of the economy, including utilities, retailing, and health care.  It also factors in construction and agriculture. In contrast, American manufacturers were off to an uninspiring start to the second half of 2015, according to the group’s survey released on Monday.  The factory index dropped in July to a three-month low of 52.7. We would attribute this to the continued strength of the U.S. dollar which can dampen enthusiasm for American goods abroad. The 7.6 point difference between the ISM’s non-manufacturing gauge and the factory index was the biggest since January 2009, six months before the last recession ended. Again, the strength in this gauge lends support to the notion the Fed will move in September and this dampened enthusiasm for equities this week globally. 

There were no surprises in other data that came out this week on the U.S. economy. U.S. personal income and spending for August came in at +0.4% and +0.2% respectively, continuing the positive trend in these categories. Factory orders for June were right in line with expectations at +1.8% while weekly unemployment claims for the week ending 8/1/2015 came in on target at 270,000. The core personal consumption expenditures index, one that the Fed does closely monitor for hints of inflation, came in slightly below expectations for June at +0.1%. This lends support to our view that with an absence of significant inflation, while the Fed may launch their rate cycle increases as soon as their September meeting, they are unlikely to move at a robust pace thereafter lest they put the brakes on the U.S. economy, which is the last thing they want to do.

SGK Blog--Update July 31, 2015: Earnings Season Continues   

The Federal Open Market Committee meet this week and decided to leave its benchmark federal funds interest rate near zero.  The central bank has three more scheduled policy meetings left in 2015 with start dates of September 17, October 28 and December 16.  They are usually 2 day meetings but sometimes they can be shortened to one or extended to three if necessary.  There will be a Q&A with reporters after the September and December meetings so that would be the most likely time for a significant change in policy.  It is also the dates when the Fed updates its economic projections.  In this week’s policy statement, Fed officials cited “solid job gains and declining unemployment” which investors could interpret as a sign that the Fed was moving towards pushing the target rate higher.  In side-by-side comparisons between its July 29 and June 17 statements, the verbiage concerning inflation is identical.  Specifically:  “the Committee expects inflation to rise gradually toward 2 percent over the medium term as the labor market improves further and the transitory effects of earlier declines in energy and import prices dissipate. 

The market continues to believe that the Fed will move but not until later this year.  Shortly after the Fed statement was released, the probability of a rate increase at the September meeting is 38.6% according to the current implied probabilities function in Bloomberg.  For December, it is over 50% at 69.7%.  The September figure has risen from 34.2% at the beginning of the month but is down from 41.7% at the beginning of June.  According to a recent study by Schwab’s  Chief Investment Strategist Liz Ann Sonders, rising rates do not always lead to bear markets or recessions.  She differentiates a “fast” rate cycle versus a “slow” rate cycle by the speed at which the Fed hikes rates—e.g., “fast” meaning a hike at every meeting.  Given that we will see a “slow” cycle based upon comments by various Fed members, the likelihood of a negative equity reaction is low.  And regardless of speed, when the entire rate cycle hike from start to finish was analyzed versus economic growth, job expansion and S&P returns, the result was a median market return of 9.2%.  The Fed is not going to hike rates until the economy can stand a hike in rates.  Once the $17 trillion U.S. economy gets moving in one direction, it tends to gain momentum.  Thus, job gains are unlikely to come to a complete halt just because overnight interest rates went from 0% to 0.25%.  Fed chairwoman Janet Yellen has emphasized many times that it is not the initial hike which is the worry but the path the rate hike cycle takes afterwards which is key.  The Fed is clearly setting the stage for an increase.  The recent turmoil in Chinese markets might be serious enough to cause them to delay until December but with two more employment reports between now and September 17, if we see more solid job gains and, in particular, increases in wage growth greater than 2%, then the probability of an early fall pop will rise. 

In housing news, the S&P/Case-Shiller index of property values was released on Tuesday.  The usefulness of this particular index is that it tracks a consistent basket of 20 U.S. cities for price changes.  It declined 0.2% in May versus the month before but rose 4.9% for the previous 12 months.  That was a bit below the median projection of a 5.6% rise in a survey of 28 economists conducted by Bloomberg.  Importantly, the single-family home price increase has moderated around the 4%-5% range for about the year.  That is below the double-digit gains of 2013 but the current pace is more sustainable and, thus, more affordable for those looking to get into the market for the first time or for those looking to trade up.  The largest monthly increases occurred in Las Vegas and Miami while the largest monthly declines happened in San Francisco, Chicago and Detroit.  Year-over-year, all 20 cities in the index remained in positive territory.  Many economists are hopeful the trends will continue in the positive direction given the relatively low mortgage interest rate and improving job picture. 

GDP figures were revised this week for the second quarter to show a 2.3% annualized rate of growth according to the Commerce Department.  The first quarter was also revised to show a 0.6% advance which wiped out a previously reported contraction of 0.2% in the world’s largest economy.  Consumer spending grew at a 2.9% annualized rate in the second quarter following a 1.8% advance at the start of the year.    Business spending and government outlays were two sources of weakness with a 2% gain in state and local agencies almost wiped out by a 1.1% drop in federal spending.  Stronger GDP growth is another item to check off for the Fed before they begin to raise interest rates so slowly but surely we are moving in that direction. 

SGK Blog--Update July 24, 2015: Earnings Season in Full Force  

The turmoil that surrounded Greece the past few weeks settled over the weekend.  After various parliaments ratified the new requirements for Greece, the European Union (EU) provided a 7.2 billion-euro bridge loan that helped Greece repay the European Central Bank (ECB) on Monday.  Missing the payment could have prompted the central bank to pull the emergency funding keeping Greek banks solvent.  The banks themselves opened their doors for the first time in over a week to desperate citizens who had been on a strict withdrawal schedule and that was assuming the ATMs they found even had money in them in the first place.  Instead of the 60 euro daily limit, depositors were able to take out 420 euro for the entire week at once.  The extra money will come in handy as a sharp increase in value-added taxes for everything from taxis to many food purchases went into effect immediately when the bailout package was ratified.  The Athens Stock Exchange, which has been closed since June 29, remained shut and it was unclear when it would resume trading.  The agreement reached last week, less one forget, was necessary to open the door for yet another negotiation on the actual three-year 86 billion euro bailout Greece seeks.  The so-called troika including the ECB, EU and the International Monetary Fund returned this week to hammer out more details.  And many investors already suffering from bailout fatigue surely cannot wait until this fall when new Greek elections are likely to be called.  Stay tuned!

On the domestic front, housing data was front and center this week.  Existing home sales climbed to an eight-year high in June to a 5.49 million annualized rate according to the National Association of Realtors.  A better employment environment combined with tighter supply of homes were the key factors in the strong figures.  Compared to the year earlier, closings on existing homes, which usually occur a month or two after a contract is signed, were up 9.6%.  The median price rose 6.5% from June 2014 to $236,400, the highest on record before adjusting for inflation.  At the current pace, it would take five months to sell those house in inventory compared with 5.1 months at the end of May.  A six month cushion is considered healthy so the current level officially characterizes the market as “hot”.  The strength was broad based as sales rose in all four regions, led by a 4.7% gain in the Midwest.   With only 30% of first-time buyers in the market, the transactions are being driven primarily by existing homeowners looking to relocate.  That makes sense in the context of a healthier job market.  Previously, potential buyers were held back by poor employment prospects and the fear of not qualifying for a mortgage.  Now, the higher prices are giving current homeowners the source of cash to relocate.  With the average rate on a 30-year fixed mortgage at 4.09% according to lender Freddie Mac, rates remain historically low and, assuming a healthy credit profile, provide further fuel for the market.

Unexpectedly, purchases of new home sales fell in June according to the Commerce Department.  Sales fell 6.8% to a 482,000 annualized pace, the weakest since November and below any forecast of economists.  Such a drop can be attributed to a one month anomaly but it cannot be ignored given the strength in existing home sales and the belief that the housing market in all phases—new starts, sales of new homes and purchases of existing homes—was finally on track.  May’s new home sales had been a seven-year high but were revised downward as were the figures for April and March.  Industry experts did admit that of all the housing numbers, new home sales figures are the most subject to revision.   Housing starts climbed in June to the second-highest level since November 2007 so these revisions do stick out like a sore thumb.  Nevertheless, builders remain confident even though some caution is likely warranted until another month or two of data comes out to be fully convinced that the housing market has found its legs.

SGK Blog--Update July 17, 2015: Tsipras Capitulates; Global Stock Markets Rally 

Greek Prime Minister Alexis Tsipras, who came to office six months ago pledging to end austerity and restore “dignity” to the Greek people, now plans to sell an onerous bailout deal at home by arguing it could have been much worse. That was the message Tsipras delivered Monday morning in Brussels after all-night talks with European leaders. They resulted in plans for large-scale asset sales, tax hikes and spending cuts, many of which must be approved by parliament right away. The agreement, he said, would avert “a collapse of the financial system” and, most importantly, keep Greece in the euro, which the premier calls his No. 1 goal. Tsipras is seeking to implement measures even harsher than those rejected by Greek voters in the July 5 referendum on austerity -- which he himself called after the previous round of discussions. In exchange for aid, Syriza’s leader is now endorsing pension reductions, sales tax increases and “quasi-automatic spending cuts” in the event that Greece’s government budget fails to hit surplus targets. “We took the responsibility of the decision to avert the most extreme plans of the most extreme conservative forces in the European Union,” Tsipras said after 17 hours of meetings. “We averted the plan to cause a credit crunch and the collapse of the financial system, a plan which had been prepared in great detail.” He of course is referring to the plans creditors had put together to facilitate a Greek exit from the euro. Monday’s deal also envisions as much as 50 billion euros in sales or other monetization of state assets, to be used partly to pay off debt and partly to pay back funds for the recapitalization of banks. Greek lenders have been shut for more than two weeks to stem withdrawals.  

We are at a loss to explain Tsipras’s thought process over the past five months in terms of his negotiating tactics with Greek’s creditors. Suffice it to say when push came to shove the other European countries, led by Germany, were prepared to allow a so-called Grexit and had plans drawn up to make that happen. Tsipras pushed his hand too far, the situation rapidly deteriorated in economic and humanitarian terms in Greece, and he was forced to capitulate. Whether it was the reality of the Greek people running out of food, medicine and the ability to conduct basic commerce; or a recognition that even the banks in Greece had finally run out of resources; or just the fact that he and former finance minister Yanis Varoufakis’s negotiating tactics had led to a complete lack of trust, and even incredulity at times from their European counterparts, clearly he misjudged the patience and resolve of the people he was dealing with. Again, we feel for the Greek people as they are the ones who have suffered through this entire process, and been subject to misleading and false promises from the current ruling party and their so-called leaders. A populist message is easy to deliver, but clearly in this case, not so easy to actually make happen. It is clear to us the Greek people will never be able to repay the sheer volume of debt they continue to accumulate without some significant restructuring in the future, but this circus we have witnessed over the past five months has just compounded the nation’s difficulties. The markets approved of the result because it is a case of public funds (through the borrowings of countries such as Germany) that are being used to basically save a nation’s banking system and facilitate the flow of capital through the country’s economy again. And it desperately needs a jump-start! The good news is by week’s end the Greek parliament had voted in favor of the bailout and the EU agreed to a 7.16 billion euro bridge loan to help the debt-ravaged nation with a stop-gap until its full three year bailout deal is settled. 

In U.S. economic news, sales at U.S. retailers unexpectedly dropped in June, curbing optimism about the strength of the rebound in consumer spending during the second quarter.  Purchases decreased 0.3% after a 1% advance in May that was smaller than previously reported, Commerce Department figures showed Tuesday in Washington. The median forecast of 82 economists surveyed by Bloomberg called for a 0.3% gain. Eight of 13 major retail categories showed declines in demand. An early Memorial Day holiday that may have boosted sales in May at the expense of last month, and a longer school year caused by the harsh winter probably contributed to the more subdued sales performance for the quarter. Stronger gains in incomes will probably be needed to give consumer spending, which accounts for almost 70% of the economy, a bigger lift heading into the second half of the year. The Commerce Department’s report on sales showed auto dealers, restaurants, furniture and clothing stores were among the retailers that showed declines last month. While the drop in autos in June was in line with industry data released earlier this month, the industry remains a bright spot.  

In other news, industrial production and capacity utilization for the month of June exceeded expectations. This was somewhat surprising given the continued strength of the U.S. dollar, but was welcome news as they are indicators of the strength in manufacturing here in the U.S. Industrial production rose 0.3% whole capacity utilization was 78.4%, up slightly from May. Weekly initial jobless claims finally declined week-over-week to 281,000 for the week ending 7/11/2015, an improvement from the prior week’s 296,000 level. U.S. consumer sentiment declined in July on concerns global risks will dim the prospects for the U.S. economy. The University of Michigan’s preliminary index of sentiment dropped to 93.3 during the month from 96.1 in June. The median forecast in a Bloomberg survey of economists called for a reading of 96. Housing data was strong as both housing starts and building permits in June exceeded economists’ forecasts. Housing starts rose to 1,174,000 from the prior month’s 1,069,000 and building permits, a sign of activity to come, rose to 1,343,000 from the prior month’s 1,250,000. 

Wholesale prices climbed more in the month of June than forecast as the cost of fuel picked up. The 0.4% increase in the producer-price index followed a 0.5% gain in May, Labor Department figures showed Wednesday in Washington. The median forecast of 70 economists surveyed by Bloomberg called for a 0.2% advance. A broad pickup in prices would help strengthen the case for Federal Reserve policy makers to start raising interest rates this year, as Chair Janet Yellen has indicated could be appropriate. The plunge in oil costs last year may wring itself out of the data in the coming months, helping to boost the inflation figures further. Energy expenses rose 2.4% last month, paced by higher gasoline costs. Food prices increased 0.6% in June, reflecting a record 85% surge in the cost of chicken eggs as the bird flu epidemic crimped supply. Wholesale prices excluding food and energy increased 0.3%, compared with the 0.1% gain seen by the median forecast of economists surveyed. It followed a 0.1% increase in May. Those costs were up 0.8% from June 2014. The produce price gauge is one of three monthly inflation reports released by the Labor Department, which also publishes the import cost measure and the consumer price index. A report Tuesday showed the cost of goods bought abroad dropped in June, restrained by cheaper automobiles. The import-price index declined 0.1% last month after advancing 1.2% in May, according to Labor Department figures. Import prices were down 10% from the year before. The consumer price index climbed 0.3% after rising 0.4% in May driven by increases in rents that are helping nudge inflation towards the Federal Reserve’s goal. 

As part of their dual mandate, Fed policy makers are keeping a close watch on inflation trends. The personal consumption expenditures index, the Fed’s preferred inflation gauge, rose 0.2% in May from a year earlier and has been below the Fed’s 2% goal since May 2012. Yellen expects “that it will be appropriate at some later this year to take the first step to raise the federal funds rate and thus begin normalizing monetary policy,” she said in a speech last week in Cleveland. She also added a note of caution, saying that “the course of the economy and inflation remains highly uncertain, and unanticipated developments could delay or accelerate this first step.” She reinforced this notion in testimony before Congress this week. A pick-up in inflation figures as we saw this week would lend support to their efforts to begin the process of raising rates here in 2015.

SGK Blog--Update July 10, 2015: Greece and China and Bear Markets! Oh My!  
It was a busy week in the markets here and abroad with both Greece and China dominating the financial front pages.  European leaders threw down the gauntlet (again) and demanded that Greece come up with a new restructuring plan or else risk being kicked out of the eurozone.  On Thursday, Greece submitted a 13-page plan outlining economic overhauls and budget cuts.  The troika—the European Commission, the European Central Bank and the International Monetary Fund—will send their assessment to eurozone finance ministries ahead of a Eurogroup meetings on Saturday.  Sunday was the deadline given to Greek Prime Minister Tsipras and his government to come up with a credible plan in order to gain more cash from creditors.  Sunday is the date European Union leaders meet for a crisis summit.  If an agreement is reached at Saturday’s meeting, the Sunday summit will not be required according to an EU official and all will breathe a sigh of relief. 

The plan itself is not that much different from the package offered by creditors on June 26.  That was rejected by Greek voters in a July 5 referendum.  So, why might this one pass muster?  First and foremost, the Greek banks are rapidly running out of cash.  Without some sort of lifeline the chance for social unrest rises dramatically.  Second, cooler heads have surfaced.  Former Greek Finance Minister Yanis Varoufakis resigned after the referendum and other finance ministers were not sad to see him go.  His replacement, Euclid Tsakalotos, is described as a more refined negotiator.  Mr. Varoufakis’ extreme anti-austerity stance made him very popular in Greece but his relative confrontational style and colorful rhetoric (for example, “Whatever Germany does or says, it pays anyways.” and “Karl Marx was responsible for framing my perspective of the world we live in.”) rubbed many the wrong way and impeded any progress.  A third reason is that the latest proposal is for three years versus the original five-month extension.  That extra cushion might give Greece a chance to put in place their proposals without facing deadline after deadline and actually give the leaders in charge a chance to put in place a plan and see it through.   

What are some of the proposals?  Greece will raise the sales, or value-added, tax on restaurants to the maximum rate of 23%.  A supplementary payment to the poorest retirees will be eliminated.  An overhaul to the pension system is also included.  Mr. Tsipras urged lawmakers from his Syriza party to back the proposals.  Many European leaders gave an initial positive response to Greece’s latest effort led by French President Hollande.  Even Slovakia’s finance minister, who has been one of the harshest critics, gave his blessing in a Twitter message: “It seems we have progress on Greece.”  But Germany, as expected, remained more cautious than the others and said it was too early to evaluate the proposals.  The markets overall responded favorably to the actions, pushing both European and U.S. equity markets higher on the day. 

Meanwhile, while most of the headlines were hogged by Greece early in the week, the situation in China—the world’s second biggest economy—was worsening day by day.  The combined market capitalization of the Shanghai, Shenzhen and Hong Kong stock markets ($14.2 trillion) are second only to the New York Stock Exchange ($19.7 trillion).  The Shanghai market had skyrocketed with a nearly 60% increase between January and early June.  Trading volume on the Chinese market is four times bigger than on the NYSE with 3% of the market turning over every day compared to 0.3% at the NYSE.  Unlike U.S. markets where institutions drive trading, the Chinese market is dominated by retail investors some of whom day trade or based on rumors.  So as the leveraged-fueled rally was reaching new heights, the populace became more and more fascinated with its rise.  Then the bottom fell out.  Doubts rose about further interest rate easing by the Chinese central bank and brokerage firms were banned from providing unregulated margin funding.  Between June 12 and this past Wednesday, shares plunged 32%.  It was still less than the 70% plunge markets took during the 2008 credit crisis, but with so many individual investors affected, the government decided it had to step in. 

What makes the situation so unique is that the government instituted measures to stop the bear market that go above and beyond what other regulators would do in other countries.  It cancelled IPOs, eased margin credit conditions, stopped trading in half of the listed shares, banned insider selling and forced brokerages to buy shares until the index reached a certain level.  Clearly this level of manipulation is why many institutions have avoided the Chinese markets and these actions are likely to solidify that aversion.  MSCI Inc. creates various indices to track markets around the world.  They decided in early June not to include the Chinese markets in their emerging market indices because the stability and predictability shown by other markets was absent.  Had they been included, the trillions of dollars that track such indices may have been sucked down in the collapse. 

The New York Stock Exchange did not suffer from such oversight this week, but they did get a big black eye when a software glitch shut down trading for hours on Wednesday.  From about 11:30am ET until shortly after 3pm ET, the exchange took no buy or sell orders.  It was the biggest interruption for U.S. stock trading in two years since the Nasdaq system halted trading in August 2013.  This event did not stop overall trading, however.  Though the NYSE went dark, the shares kept trading on 10 other exchanges.  No single venue handles more than 16% of overall market volume.  The most significant thing operationally to happen was merely the NYSE losing market share to its competitors.  The effect on public confidence is another matter.  When the headlines reads “NYSE Shuts Down” many will think of a terrorist event, which was quickly dispelled by authorities.  The public incorrectly still believes that all trades are executed at the NYSE which is why it garnered front page news.  In reality, it was just business as usual for those with knowledge of how markets work.         

In economic news, the Fed released the minutes from the June 16-17 gathering of the Federal Reserve Open Market Committee.  The Fed noted that they were worried about Greece and “the likely pace of economic growth abroad, particularly China and other emerging market economies.”  Since that meeting, Greece has defaulted on a loan from the IMF and China’s market decline only steepened.  This might push a potential interest rate hike further back, but in recent speeches, Fed officials have showed caution but not alarm.  They noted that domestic economic growth had rebounded since the weather-affected first quarter but wage growth still had not firmed as much as they would like.  At this point, a September or December interest rate move is too close to call.  Stay tuned.

SGK Blog--Update July 2, 2015: Greek Saga Continues While U.S. Economic Data Remains Solid 

It was hard to avoid the headline news on Greece this week across virtually all international newspapers. On a typical day there were at least a dozen articles related to the ongoing saga on our Bloomberg Professional software. So we will not bore you with news on the latest developments as most of you are probably familiar with them. It seems when imminent deadlines are set, a development occurs to extend the day when a final determination on whether they stay or go with the common euro currency region will happen. We are all waiting, not so much with bated breath anymore, for the results of their referendum on Sunday. There is a high level of uncertainty as to what will happen after that – irrespective of whether the Greek people vote Yes or No to the set of questions. Given the offer from their European creditors is actually no longer on the table, there is a serious question as to whether what they will be voting on is even accurate or pertinent anymore. Tsipras’s statement that a No vote, his recommendation, will give them a stronger bargaining position is so far out in left field it is not even funny! The reality is – he does not have the support in Parliament to pass anything close to what creditors are offering – he recognizes that and is not a total idiot. A Yes vote by the Greek people will mean he will have a very short and disastrous tenure as a politician. We can only hope at this point. Our hearts and prayers are with the Greek people who are really suffering. Greece imports fuel, food, medicine and on down the list and they are rapidly running out of euros to pay for these items. The next escalation will be significant social unrest and we can only hope and pray some type of resolution will happen soon. 

Initially the impact on markets in Monday trading after a weekend when negotiations were halted due to Tsipras’s surprise referendum announcement was to cause stock prices to drop and bond prices to rise in dramatic fashion. The fear was of contagion and traders and holders of mutual funds elected to sell first and ask questions later. By the time Tuesday rolled around, it was clear that whatever contagion was going to occur was very muted – we read that Greek banks were significant holders of Bulgarian bank securities so that became a risky area of the market. Really?! Like Bulgarian bank securities were not risky to begin with? Anyway, we don’t mean to exaggerate the insignificance and the full ramifications of a Greek exit or “Grexit” from the euro have yet to be felt, but market professionals started to look around Tuesday/Wednesday and ask themselves – who actually still owns Greek or Bulgarian bank securities at this point and is that risk not relatively isolated? The answer is yes – it is isolated. Banks across Europe and the United States have all but eliminated their exposure to these securities so the contagion was actually well contained. So if Tsipras is trying to put pressure on Germany, the European Central Bank or the International Monetary Fund, it is clearly a strategy that has backfired and is simply not working. The Germans at this point are pretty much understandably fed up and the political will to continue to participate in the drama is about over. Merkel pulled the plug on further discussions and in our view she is pretty much done with Tsipras who continues to be embarrassingly amateurish in his handling of the situation. The firewalls are in place and working well. Portugal is on track to see significant growth in their economy over the next several years – they have plenty of cash on hand and they exited the European assistance programs two years ago with significant monetary reserves built up and a dramatically restructured economy. Italy had a large issuance of government bonds this week and their interest rates remained stable. That is not to say that more turbulence is not expected – it is just that the attention of traders turned to other important news this week, like the economic releases in the mighty US of A (how about our women’s soccer team – go USA!) 

On that note, we had several data points released this week. The big one was the employment report for the month of June. An increase in June payrolls followed smaller gains in the prior two months and wages were little changed as U.S. job market reflected a more moderate pace of economic growth. The addition of 223,000 jobs followed a 254,000 increase in the prior month that was less than previously estimated, a Labor Department report showed Thursday in Washington. The jobless rate fell to a seven-year low of 5.3% as more people left the labor force. The figures indicate corporate managers are confident they can temper hiring and meet demand against a backdrop of stronger consumer spending and feeble overseas markets. At the same time, more moderate job gains may still be enough to reduce the unemployment rate, consistent with the Federal Reserve’s perceived timetable to raise borrowing costs by year-end. The median forecast in a Bloomberg survey called for a 233,000 advance. Estimates of 97 ranged from gains of 160,000 to 350,000 after a previously reported 280,000 advance for May. Revisions to prior reports subtracted a total of 60,000 jobs from payrolls in the previous two months. The economy has just completed its sixth year of expansion since the recession ended in June 2009.  

While the job market has rebounded, faster wage growth has been slow to follow suit. Average hourly earnings at private employers held at $24.95. They increased just 2% over the 12 months ended in June, following a 2.3% gain the prior month. They’ve posted a 2% gain on average since the current expansion began. Seasonal adjustments, or a calendar bias, probably explain the downward pressure on the wage figures in June after artificially boosting them in May. The unemployment rate, which is derived from a separate Labor Department survey of households, fell from 5.5% and is the lowest since April 2008. The decrease reflected fewer Americans in the labor force. The participation rate, which indicates the share of the working-age people in the labor force, decreased to 62.6%, the lowest since October 1977, from 62.9%. Government payrolls were little changed in June after a 4,000 increase in May. Employment at state and local agencies is often influenced this time of year by swings in the timing of school closings for summer recess. Retailers increased payrolls by 32,900. Employment in leisure and hospitality rose 22,000. Factories increased payrolls by 4,000 after a 7,000 gain a month earlier. Manufacturing and mining have been hurt by cutbacks in drilling and exploration following the plunge in oil prices. 

The improving outlook for the labor market is among the reasons Fed policy makers have said they may begin to raise the benchmark interest rate this year from near zero. Fed Chair Janet Yellen has said she expects the central bank to raise borrowing costs this year, and that subsequent increases will be gradual without following a predictable path. “Although progress clearly has been achieved, room for further improvement remains,” Yellen said at a June 17 press conference. She described wage growth as “relatively subdued.” Recent data underscore why employers are adding staff. Consumer purchases, which account for about 70% percent of the economy, rose 0.9 percent in May, the biggest gain since August 2009, Commerce Department figures showed last week. Households are feeling upbeat about employment prospects as more respondents than at any time since early 2008 said jobs were plentiful, a Conference Board report showed on Tuesday. A separate report Friday from the Labor Department showed applications for unemployment benefits held below 300,000 for a 17th straight week. Jobless claims rose by 10,000 to 281,000 in the week ended June 27. The median forecast called for 270,000 applications. Once the June employment report was digested by market participants, stocks futures rose and interest rates dipped. Traders feared that a much stronger than expected report, in terms of both job gains and wage growth, would have caused the Fed to act sooner than expected in raising rates. The market hates surprises. So the fact this report came in actually weaker than expected on many fronts turned out to be good news for markets. 

Data on the U.S. economy earlier in the week was mixed. Pending home sales in the month of May at +0.9% were below expectations as was the Case-Shiller 20-city Index of housing prices for the month of April which showed a 4.9% increase vs. the 5.6% expectation. Consumer confidence in June was a relatively robust 101.4 versus the expectation for 97.5 and the prior month’s 95.4 figure. The Institute of Supply Management’s Index for manufacturing the month of June rose to 53.5, above the forecast for 53.2 and construction spending in May rose 0.8% versus the consensus estimate for a 0.3% increase. As we mentioned, most market participants were fixated on developments overseas this week and the June employment report.
SGK Blog--Update June 26, 2015: Market Focuses on the Headlines  
News headlines dominated the attention of traders and investors this week.  The Greek drama continues to play on and on like a broken record.  Another week brought another series of meetings with Greek representatives and the three creditor institutions—the International Monetary Fund, the European Union (EU) and the European Central Bank (ECB).  Greek Prime Minister Alexis Tsipras used Twitter to express his frustration on Wednesday that the creditors refused to accept his earlier proposals which the market initially saw as a breakthrough in the negotiations early in the week.  His government later that day rejected a counter proposal tabled by creditors.  The chasm centers on the creditors desire to have Greece meet its obligations via expense cuts in areas like pensions while Tsipras and his government would rather focus on raising revenues via higher taxes on the rich, for example.  Credit markets are pricing in a Greek exit with higher interest rates on sovereign securities.  Our view is that this brinksmanship will continue into the weekend…and beyond.  The bottom line is that the sky is not falling.  Other European bond markets saw their bonds trade lower (and yield higher) but nothing to the same extent like two years ago when fear of a Greek exit pushed many government bonds close to double-digit yield levels.   Since then, ECB President Draghi has uttered his “whatever it takes” pledge, the ECB has begun quantitative easing and various signs in the EU have pointed to a better economic outlook.  The institutions most exposed to Greek issues are the creditor institutions negotiating right now.  This means that a contagion is quite unlikely though unintended consequences cannot be ruled out.  Regardless, we continue to merely shake our head when these issues garner headlines.  A Bloomberg team of writers has put together a comprehensive time line of events in the Greek situation which we highlight below:

"June 30: The extension expires for the “Master Financial Assistance Facility Agreement,” as Greece’s bailout is known.This will probably be a medium- to high-risk event. If, after this date, Greece were no longer officially in a bailout program, the ECB could decide to re-assess its collateral rules linked to Emergency Liquidity Assistance, though the most likely outcome of this soft -- and arbitrary -- deadline is an extension if an agreement remains elusive. In addition, Greece must make a payment of 1.2 billion SDRs to the IMF on this date after having opted to bundle its payments for June into one.That equals about 1.5 billion euros. IMF Managing Director Christine Lagarde has said there will be no grace period for Greece beyond June 30, though the immediate consequences of missing a payment to the IMF would be limited –- after all, the next step is a strongly worded letter. 

July 1: The ECB’s Governing Council will hold a non-monetary policy meeting in Frankfurt. This is a high-risk event. The policy makers are likely to discuss how to react to the events of June 30, which could include the expiration of Greece’s bailout package and the country having missed a payment to the IMF. In an extreme scenario, the ECB could decide as a result to cut off access to ELA, though that seems unlikely. On May 28, ECB Vice-President Vitor Constancio showed some flexibility saying that “there is no automatic -- and I underline the word-- connection between a default of the Greek government and the insolvency of Greek banks.”

July 13: Greece will have to make a payment of about 360 million SDRs to the IMF. That equals about 448 million euros. This is a low-risk event. If Greece has made it this far and is already in arrears, missing another payment shouldn’t be a big event. If it isn’t in arrears, it could once again ask for its payments to be bundled into one, due at the end of the month. 

July 19 and 20: Greece must make the largest coupon payments of the month -- about 199 million euros and 104 million euros, respectively -- on government bonds. The total for the month is 810 million euros. In addition -- and more importantly -- Greece’s 3.5 billion-euro bond held by the ECB matures on July 20. This is a high-risk event. A default could cause the ECB to cut off Greek banks’ access to ELA. That would probably be the first step to an exit of the beleaguered country from the monetary union."

We have left out a lot of dates in the article but tried to highlight the main ones.  The bottom line is this is likely to drag out for more weeks and the only thing we know for sure is…they will have more meetings.

On the domestic front, U.S. GDP shrank less in the first quarter than previously estimated.  According to the Commerce Department, it fell at a 0.2% annualized rate, revised from a previously reported 0.7% decline.  This data validates the Federal Reserve theory that first quarter weakness was temporary.  Fed Chair Janet Yellen said as much in the post-Fed meeting press conference: “Part of this weakness was likely the result of transitory factors.  Despite the soft first quarter, the fundamentals underlying household spending appear favorable, and consumer sentiment remains solid.”  On July 30 the Bureau of Economic Analysis will address the issue of why the first quarter data seems to be persistently weak.  That day, the first estimate of second quarter GDP will be released.  A Bloomberg survey of economists shows that many believe the economy will expand at a 2.5% annual rate from April through June and average 3% growth in the second half of 2015.  Helping the revised first quarter data was an increase of 2.1% in consumption versus the initial estimate of 1.8%.  The rise reflected larger outlays on food and transportation.   

The Commerce Department also stated this week that household spending in May rose by the most in almost six years.  Personal incomes rose 0.5% for a second month.  These figures coupled with the 16th consecutive week that initial jobless claims have held below 300,000 suggests that consumers are clearly pushing the economy forward after holding back and increasing savings during the first few months of the year.  Disposable income, or money left over after taxes, rose 0.2% in May from the prior month.  Excluding food and energy, the price measure closely watched by the Fed rose a scant 1.2% in the 12 months ended May.  That is far below the preferred 2% figure repeated by Fed officials.  In fact, this price measure has not met that target since April 2012. 

This was also a week of housing data releases.  On Monday, the National Association of Realtors showed that previously-owned homes sold in May at the fastest pace since November 2009.  Closings on existing properties rose 5.1% to a 5.35 million annualized rate versus the median 5.26 million pace called for in a Bloomberg survey.  The share of first-time buyers, at 32%, matched the highest level since September 2012.  The median price rose 7.9% from May 2014 to $228,700 thanks to tight inventories.  Purchases climbed in all four regions led by a 11.3% gain in the Northeast.  On Tuesday, new home sales data rose 2.2% in May based on Commerce Department information.  That was the highest level in seven years.  New home sales are tabulated when deals are signed versus existing home purchases which are totaled when the transaction closes usually a month or two after the contract is signed.  The median sales price of a new home fell 1% from May 2014 to $282,800 but the average price was up 4.2%.  This suggests that new construction is spreading to  lower-margin properties that are more affordable for would-be first-time homebuyers.  As with existing home sales, new home sales are getting a boost from lean inventory.  A better job picture is leading to more sales and more confidence.  Homebuilder sentiment advanced in June to the highest level since September according to the National Association of Home Builders/Wells Fargo gauge.
SGK Blog--Update June 19, 2015: Greece Steals Headlines While Fed Meets  

European shares were sent on a rough ride in early morning trading Monday as talks with Greece on Sunday lasted only 45 minutes as the two sides remained far apart on the basic tenets of a robust agreement. Europe needs a “strong and comprehensive agreement, and we need this very soon,” European Central Bank President Mario Draghi told lawmakers at the European Parliament in Brussels on Monday. “While all actors will now need to go the extra mile, the ball lies squarely in the camp of the Greek government to take the necessary steps.” With signs that negotiating fatigue was stoking intransigence on all sides, some euro-area officials publicly raised the prospect of Greece’s exit from the currency region as the Greek government suggested it had reached the limits of its ability to make concessions. Finance Ministry officials from the 19-nation euro zone held a conference call on Greece Tuesday ahead of a meeting of ministers which took place on the 18th. “We’re reaching a potential period of turbulence if no accord is found,” French President Francois Hollande told reporters in Paris on Monday. “This is a message for Greece, because Greece mustn’t wait, it must renew talks with the institutions,” he said, referring to the International Monetary Fund, the ECB and the European Commission. By week’s end, no resolution was in sight and time is quickly running out for Greece to strike a deal with its creditors.  

Confidence among U.S. homebuilders rebounded in June to a nine-month high as warmer weather and a brighter economic outlook drew prospective buyers back to the market. The National Association of Home Builders/Wells Fargo builder sentiment gauge rose to 59 this month, the strongest since September and exceeding all projections in a Bloomberg survey, from 54 in May, figures from the Washington-based group showed Monday. The median survey forecast called for 56. Activity in the residential real estate market has shown a slow rebound as the busier selling season takes hold, which could help the economy overcome weakness in manufacturing. Employment gains and rising wages are giving would-be home buyers reason to take the plunge. The data show “a growing optimism among builders that housing will continue to strengthen in the months ahead,” David Crowe, NAHB chief economist, said in a statement. “At the same time, builders remain sensitive to consumers’ ability to buy a new home.”  

Another report Monday showed factory production unexpectedly declined in May as the slump in energy output deepened. The 0.2% decrease at manufacturers followed a 0.1% increase in April, according to figures from the Federal Reserve in Washington. Total industrial production, which adds mines and utilities, also dropped 0.2%. This data was below the expectation for a 0.3% increase in May. The sluggish data signal that a stronger dollar and decrease in fuel prices are still holding back American factories. An earlier report showed manufacturing activity in the New York region unexpectedly contracted this month amid a drop in new orders. The strong U.S. dollar also impacted capacity utilization at the nation’s factories as this was 78.1% in May, a slight drop from the previous month and below the expectation of 78.3%. Housing starts in May were a disappointing 1.036 million versus the 1.1 million expected but building permits, a sign of future growth, came in at a very robust 1.275 million versus the expectation for 1.1 million, so that news was well received. Of course if interest rates continue to rise, this could dampen enthusiasm for the housing sector, and housing has been such a key driver in the U.S. recovery. The Consumer Price Index or CPI for May came in below expectations as did the core rate at +0.4% and +0.1% respectively showing inflation remains in check. Initial weekly jobless claims for the week ending June 13 also fell below expectations at 267,000 versus the 276,000 claims expected. Both of these latter data points were good news for stock and bond markets. 

Federal Reserve officials raised their assessment of the labor market and the economy, keeping the central bank on track to increase interest rates this year for the first time in almost a decade. “Since the committee last met in April, the pace of job gains has picked up and labor-market gains have improved further,” Fed Chair Janet Yellen said at a press conference in Washington Wednesday after a meeting of the Federal Open Market Committee. Fed officials also issued new economic forecasts that implied two quarter-point rate rises this year but a shallower pace of increases in 2016. They maintained their projection that the benchmark rate would rise to 0.625% in 2015, while dropping it to 1.625% next year -- lower than their March median forecast of 1.875%. There were no surprises in the Fed’s statement so this, combined with their lower forecast for rates next year, resulted in stocks rising and bonds rallying off their lows on the day of the announcement. A rebound in job growth is giving Fed officials reason to look beyond a first-quarter economic slowdown as they consider when to tighten policy. At the same time, inflation remains below their target, and central bankers say the timing of a rate increase depends on how economic data unfold. 

Fed officials expect inflation “to rise gradually toward 2% over the medium term as the labor market improves further and the transitory effects of earlier declines in energy and import prices dissipate,” according to a statement from the FOMC. “The committee continues to judge that the first increase in the federal funds rate will be appropriate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2% objective over the medium-term,” Yellen said. She said those conditions haven’t yet been met, and that officials expect a “moderate” pace of growth. The Fed repeated it will raise rates when it sees further labor-market improvement and is “reasonably confident” inflation will move back to its 2% goal over the medium term. Officials held the benchmark overnight fed funds rate in a zero to 0.25% range, where it has been since December 2008, during the worst recession since the Great Depression. The decision was unanimous. Again, there were no surprises in their statement or in Janet Yellen’s comments so generally the news was well received by market participants.
SGK Blog--Update June 12, 2015: Global Markets Getting Ready for Fed Meeting

The Federal Open Market Committee is expected to meet next Tuesday and Wednesday to decide whether to change their guidance for interest rates.  The market, as measured by futures markets, is betting that they will not change course, but recent market data is challenging the general consensus.  Last week monthly payroll figures showed a strong rebound from the tame first quarter employment reports.  More importantly, there were positive signs of wage growth with average hourly earnings rising 2.3% year-over-year.  Fed Chair Janet Yellen has pointed to wages as a key signal that would trigger a Fed move.  This week the Labor Department released its Job Openings and Labor Turnover Survey, or JOLTS, which showed even stronger signs of labor market growth.  Job openings in the U.S. rose to the highest level in more than 14 years.  Though the rate of hiring decreased, the firing rate and number of persons quitting their jobs were little changed.  The JOLTS report gives the monthly payroll figures more context by adding dynamics such as help-wanted ads, the pace of hiring and resignations.  For example, the number of workers saying they are so discouraged by job prospects that they’ve given up looking dropped by 193,000 to 563,000, the fewest since October 2008.  About 1.6 people are vying for every opening, compared with about 1.8 when the last recession began in December 2007 with a lower number suggesting a stronger environment for job seekers.  Such detail means it takes time to gather such data so this week’s report covers information from April making it less timely than the monthly payroll report or weekly initial unemployment claims.  Nevertheless, it paints a picture of a labor market solidifying gains after another year of first quarter malaise in the economy. 

Yesterday, May retail sales rose 1.2% according to the Commerce Department, matching the median forecast of economists surveyed by Bloomberg.  This follows a disappointing 0.2% figure in April which had many questioning the confidence of the consumer.  They returned in force last month as sales at auto dealers and clothing stores registered some of the biggest gains.  General Motors and Fiat Chrysler reported bigger sales increases than analysts had expected.  Excluding autos, retail sales rose 1% which was above the 0.8% median rise in the Bloomberg survey.  That, too, followed a smallish 0.1% gain in April.  Cheaper gasoline likely helped as the average cost of a gallon of regular was $2.75 on June 9 compared to $3.64 a year ago.  The question is whether this momentum can keep going into the summer months.  If the employment figures continue to impress, that is quite likely.  Thus, the Fed, which has advertised that its future decisions will be “data dependent” now have a large cache of information to analyze.  Will it be enough to change Wall Street’s belief that a rate rise is not going to happen?  Economists surveyed by Bloomberg June 5-9 put the probability of a September increase at 50% according to the median estimate.  The odds were 9% for an October increase, 20% for December and 10% for some time in 2016.  At June’s meeting next week, we will also get to see the Fed governors’ latest forecasts for growth, inflation and unemployment.  The market’s cheered the March projections when they matched consensus estimates pushing the indices to more record levels in March and April.  Will the same happen this time? 

SGK Blog--Update June 5, 2015: Draghi Indicates QE is Proving Its Worth as European Economy is "On Track" 

European Central Bank (ECB) President Mario Draghi said record monetary stimulus is filtering through to the economy on schedule and insisted the ECB needs to see its bond-buying plan to the finish. At a press conference in Frankfurt Wednesday he said, “The asset-purchase programs are proceeding well.” Central bank officials voted to keep interest on hold at record lows and they unveiled new forecasts projecting a pickup in growth and inflation in the next three years. He followed by saying, “Reaching our objectives is conditional on the full implementation of our monetary policy stance.” The good news for Draghi and his compatriots is that the deflation scare that helped usher in their quantitative easing (QE) program may be on the wane. We received data this week that the inflation rate in the euro area was positive for the first time in six months in May, rising a relatively robust 0.3% compared to the previous month’s level of 0%. Core inflation, which strips out the more volatile food and energy segments, rose 0.9% which was the fastest rate in more than 9 months. 

This announcement coincided with news that German Chancellor Angela Merkel was stepping in to unblock the stalemate at the finance ministers level to help try to pave the way for a deal for Greece to remain in the European Union. It has basically been a 4 month antagonistic circus with barbs being traded back and forth. New Greek Prime Minister Alexis Tsipras’s administration has seemed to be willing to put the fragile but recovering Greek economy at risk by hoping for their creditors to cave at the last minute. The situation is growing dire as Greece is badly in need of funds to meet their obligations to the International Monetary Fund (IMF), along with other creditors, and their own pensioners. As head of the biggest country contributor to Greece’s 240 billion euro ($268 billion) rescue, Merkel said at a press conference in Berlin, “Everyone is working – whether in the bilateral or trilateral telephone talks that the French president and I are leading – to help reach a conclusion within the agreed timeframe for the completion of the program. We are working on that with high intensity.” She has been true to her word in the past and time is of the essence as the program she is referring to is the existing bailout platform that ends here in June, coinciding with four payments Greek is scheduled to make to the IMF this month. All we can do is wait and see at this point, but June appears to be the month where something is either going to happen, or Greece is potentially headed for self-destruction. 

Here in the U.S., our Federal Reserve released a report known as their “Beige Book” showing the economy expanded in the past two months, even as manufacturers in some regions took a hit from a stronger dollar and a slowdown in energy related investment. Four of the 12 Fed districts reported “moderate” growth, and three others described the expansion as “modest,” according to the Beige Book, which is based on reports gathered from early April to late May by regional Fed banks. Elsewhere, the pace of growth varied from “mixed” to “slight” with growth actually slowing in the Dallas Fed district. Despite tepid reports on the U.S. economy, Treasuries were volatile this week as were German bunds on Draghi’s comments that markets must get used to periods of higher volatility. The U.S. Ten-year Treasury hit 2.36% on Wednesday following his comments, which is the highest level since November 7, while Germany’s 10-year borrowing costs also jumped to a 7 month high. The bad news is that this pushed U.S. mortgage-backed security yields to their highest levels in 7 months, just as we are in the peak selling season here in the U.S. U.S. 30 year mortgage rates rose to 3.84% from the previous week’s average of 3.74%, according to Zillow Group Inc. 

We received a lot of information on the U.S. economy this week and, as we indicated, it was decidedly mixed. Personal income for April rose 0.4%, above expectations, while personal spending was flat for the same month, below the forecast. This adds to the notion we have previously mentioned, U.S. consumers are saving more and paying down debt. The Institute of Supply Management’s (ISM) index for manufacturing for May was 52.8 signaling expansion and above the 51.9 expectation, while the ISM’s services index was 55.7 below the forecast of 57.1. Construction spending in April rose 2.2% above the expectation for a 0.8% increase, while factory orders for the same month actually fell 0.4% versus the forecast for it to be flat for the month. 

On the employment front, payrolls climbed in May by the most in five months and worker pay accelerated, showing companies were upbeat about the U.S. economy’s prospects after an early-year slump. The 280,000 advance in payrolls exceeded the median forecast in a Bloomberg survey and followed a revised 221,000 April increase, figures from the Labor Department showed Friday in Washington.  The median forecast called for a 226,000 May gain.  The unemployment rate crept up to 5.5% as more people entered the labor force, while hourly earnings rose from a year ago by the most since August 2013. Such job gains show corporate managers are convinced the economy is regaining its footing following a first quarter that was beset by temporary headwinds including a labor dispute at western U.S. ports.  A dwindling in the ranks of the unemployed would be consistent with forecasts the Federal Reserve will raise its benchmark interest rate later this year. Employment accelerated in May at automakers, local government agencies, retailers and temporary-help agencies.  Restaurants, hotels and builders also boosted headcounts in May, the Labor Department report showed. Average hourly earnings increased 0.3% from the prior month.  They were up 2.3% from May 2014, exceeding the average gain since the current expansion began six years ago. Payrolls estimates in the Bloomberg survey of 96 economists ranged from increases of 140,000 to 305,000 after a previously reported April advance of 223,000.  Revisions to prior reports added a total of 32,000 jobs to overall payrolls in April and March. The agency’s survey of households, used to derive the unemployment rate, showed the participation rate, which indicates the share of working-age people in the labor force, increased to 62.9% from 62.8% in April. Employment at government agencies rose 18,000 in May, mostly due to increased hiring at municipalities.  Automakers took on another 6,600 workers, while builder payrolls rose 17,000. Retailers hired a net 31,400 workers and employment in leisure and hospitality jumped 57,000.  Payrolls at temporary-help agencies climbed 20,100. Overall this was an encouraging report but the immediate impact was felt in the Treasury market as those securities sold off, increasing interest rates, and stock futures declined based on the view the strength of the data for May would result in an earlier increase than expected in terms of the Fed increasing interest rates.

SGK Blog--Update May 28, 2015: Economy Contracts in First Quarter    

The Commerce Department reported today that gross domestic product in the U.S. shrank at a 0.7% annualized rate during the first three months of the year.  That was revised lower from a previously reported 0.2% gain.  Economists’ forecasts ranged from -1.2% to 0.2% in a Bloomberg survey as the GDP estimate is the second of three for the quarter.  The third and final release is scheduled for June when more information is available.  Historically, the biggest revisions happen between the preliminary and second estimate so experts are not expecting too much of a change next month.  The revisions showed the trade gap widened more than previously estimated, inventories growing at a slower pace and consumer spending climbing less than estimated before.  Household consumption grew at a 1.8% annualized rate, down from an initial estimate of 1.9%.  The median forecast called for a 2% gain, following a 4.4% jump in the fourth quarter.  Similar downward revisions happened to 2014 first quarter data.

The tendency of the first quarter data to be persistently weak has sparked some debate within the Fed Board and Fed banks.  The Bureau of Economic Analysis this month said it will make changes to further minimize the bias and take this into account when issuing annual benchmark revisions in July.  However, there are meaningful differences between the first quarter of 2015 and 2014.  Though bad winter weather was a common factor, especially along the East Coast, this year was also affected by falling energy prices, a strong trade dollar and the impact of West Coast Port bottlenecks related to a labor dispute.  Whereas 2014 only had to wait for the weather to warm, this year these events are likely to have somewhat of an effect on second quarter data.  Regardless, the second quarter will probably look better but the extent of the re-acceleration when compared to the 2014 Q1 to Q2 period will not be as strong.  According to Bloomberg, the economic forecast for second quarter GDP growth is 2.7% followed by 3% readings in both the third and fourth quarters.

Thus, our take is that a Fed rate hike in June is surely off the table now.  But the odds of some rate increase in 2015 still remain favorable for later in the year, likely December.  Why?  By then, GDP growth would have accelerated and unemployment will possibly be close to going below the 5% threshold.  According to the Labor Department, applications for jobless benefits remained below 300,000 for the 12th consecutive week in the period ending May 23.  Claims rose by 7,000 to 282,000 in the latest data and the four-week average rose to 271,500 but that figure is coming off a 15-year low of 266,500 the prior week.  April durable goods orders showed that orders data were generally stronger than the shipment figures which suggests that factory output will accelerate through the end of the quarter.  This data is also consistent with the recent stabilization of several purchasing manager surveys.  If Fed Chairwoman Janet Yellen and Fed governors continue to stress that tepid growth is a temporary factor, then by year-end the data should be much more convincing that a rate hike is needed.

Better employment also correlates with higher home prices.  We saw mixed results in last week’s housing data in terms of existing home sales versus housing starts.  This week the S&P/Case-Shiller index of property values rose 5% from March 2014.  This was a faster pace than projected and the second consecutive month of 5% annualized gains.  Smaller inventory of homes helps push the price of homes higher even with mortgage rates still relatively attractive.  According to the National Association of Realtors, it took about 39 days to sell a house once it came on the market.  That’s the shortest span since the middle of 2013 which shows that there are definitely buyers out there willing to bid up prices as long as they have homes to bid on.  All 20 cities in the index showed a year-over-year gain led by a 10.3% rise in San Francisco and a 10% jump in Denver.  Thus, the economy is doing better but is not quite yet at the pace that the Fed feels comfortable pulling the trigger on a hike.

SGK Blog--Update May 21, 2015: Fed Minutes Raise Doubt on Rate Hike  
The minutes from the April 28-29 Federal Open Market Committee (FOMC) meeting were released this week which raised doubts on any near-term rate hike by the Fed.  According to the minutes: “Many participants, however, thought it unlikely that the data available in June would provide sufficient confirmation that the conditions for raising the target range for the federal funds rate had been satisfied, although they did not generally rule out this possibility.”  The Fed has held a 0.0%-0.25% range for the fed funds rate since December 2008.  Inflation, measured by personal consumption expenditures data, has been below the targeted “about 2%” level for nearly three years (though the latest consumer price index data shows at least one month of higher-than-expected prices but that is not quite a trend yet).  When might there be an increase?  Committee members seem to be more confident of the medium-term: “Furthermore, a pattern observed in previous years of the current expansion was that the first quarter of the year tended to have weaker seasonally adjusted readings on economic growth than did the subsequent quarters.  This tendency supported the expectation that economic growth would return to a moderate pace over the rest of the year.”

Thus, similar to what many companies said on their first quarter conference calls, the Fed was willing to chalk up a sluggish first quarter to severe weather and the West Coast ports labor dispute.  Seeing that unemployment is moving towards 5%, they want to be ready to raise rates when they feel confident that growth is on track and will be sustainable.  According to the Labor Department, in the week ended May 16, the four-week average for jobless claims was the lowest since April 15, 2000.  Lower unemployment has not lead to higher wage growth which has been the main sticking point for Fed Chairwoman Yellen and why the Fed has kept rates near the 0% for nearly seven years.  The futures markets have been predicting for awhile that the Fed is not going to make a move.  The odds that the Fed range will move above 0.25% does not rise above 50% until December 16, 2015 which is the date of the year’s last scheduled FOMC meeting.  Low rates mixed with decent earnings growth has been a major spark to stock indices so many equity traders do not want a change in the status quo.

We received a good load of housing-related data this week.  The National Association of Home Builders/Wells Fargo sentiment gauge dropped to 54 this month from 56 in April.  Readings greater than 50 mean that more respondents report good market conditions.  The median forecasts in a Bloomberg survey called for an increase to 57 so May’s figure was a disappointment.  The drop in confidence mainly reflected reduced optimism among companies in the Midwest which is not surprising considering a lot of oil and gas servicing has fallen off in that part of the country with the decline in the prices of those commodities.

Meanwhile, a surge in April housing starts suggests that weather was indeed a big cause of the weak readings in the first quarter.  Builders broke ground on 1.14 million homes at an annualized rate last month.  It was the single biggest monthly surge since 1991 according to the Commerce Department.  Also, building permits, a proxy for future construction, climbed to the highest level since June 2008.  On Thursday, existing home sales data unexpectedly fell in April.  Contract closing fell 3.3% to a 5.04 million annualized rate according to the National Association of Realtors.  So, this was yet another sign that the industry’s recovery remains uneven.  Rising prices and a limited supply of properties combined with lingering concerns over pay growth was enough to hold these transactions back.  Those in the industry are still convinced that things will turn.  Existing home sales are tabulated when a purchase contract closes so some of the sluggishness may be related to factors that affected the first quarter spilling over into last month.  Regardless, with previously-owned homes comprising 90% of residential market transactions, investors must see continued progress in this metric month after month before they will be convinced things are truly better.

SGK Blog--Update May 15, 2015: Interest Rates and Oil Stabilize on U.S. Dollar Pullback  

For calendar year 2014 and early in 2015 U.S. interest rates seemed to defy logic by continuing to decline even in the face of improving U.S. economic data. There were several factors contributing to the pullback but a few key ones in our view. First, we had a sharp pullback in a key commodity – oil. With a 50% pullback in a relatively short time frame, it eased inflation concerns and even introduced the possibility of disinflationary pressures in some traders minds. Second, we had a significant increase in the value of the dollar relative to foreign currencies, due in part to our strengthening economy and relative weakness in Europe. Oil is priced in U.S. dollars so that pullback was exacerbated by the rising dollar. Uncertainty with respect to Greece’s continued participation the in European Union drove a flight to quality into U.S. treasuries. Contributing to the relative strength of the dollar compared to the euro was the introduction of quantitative easing by the European Central Bank (ECB) early in 2015. Third, the yield on relatively safe securities became out of whack due to the belief that our central bank was about to begin raising interest rates while the ECB was introducing a similar type of quantitative easing that Bernanke introduced after the financial crisis. So the yield on the 10 year German bund hit a low of about 0.08% in mid-April 2015 while our 10 year Treasury hovered around the 2% level, making rates here in the U.S. much more attractive from a relative yield standpoint. Add to that the fact that if you were invested in the German bund your low yield was also compounded by the potential for a further deteriorating currency and again we witnessed a flight into the U.S. treasury markets. 

So what has led to the more recent volatility in interest rates that has equity traders spooked? In relatively simple terms, a number of these factors have reversed course. Once again, hedge funds got caught with their pants down with exposed trades – as usual many piled into the popular trade of the moment – and when that reversal took place there was a furious unwinding that has taken place. But markets ultimately always revert to the norm based on the fundamentals – and that is true in this case as well. We had weaker than expected data coming out of the U.S., particularly based on results for our first quarter due in part to horrendous weather across the country. At the same time we started to see better than expected figures coming out of Europe in the broader economy and in key export-driven countries such as Germany. So since mid-March the U.S. dollar has dropped about 6% relative to a basket of major currencies. At the same time the price of oil has climbed approximately 28% (for WTI crude) from the lows we witnessed in mid-March, alleviating disinflationary concerns. Finally, the yield differential between the German bund and the U.S. Treasury has narrowed to about 159 basis points from the high back in April of 190 basis points. So the yield on the 10 year German bund has increased to approximately 0.68% from the previously mentioned low of 0.08%, making that security more attractive than it was relative to our U.S. equivalent. All of these factors contributed to the outflow from dollar denominated securities such as treasuries, sending our yields higher in volatile trading. 

Fortunately, this week we witnessed a stabilization in this activity. The price of oil settled down remaining around the closing price of last week. Interest rates also settled back down as weaker than expected data here in the U.S. actually had the more reasoned impact, it sent U.S. interest rates lower. When the retail sales figure came out for April at 0.0% (no growth) and just 0.1% excluding autos versus the +0.2% and +0.4% respectively, interest rates dropped about 4 basis points which you would normally expect. This helped send stocks higher on the day. Why would a disappointing U.S. retail sales figure send equity prices higher? That too seems illogical. Not when you factor in the Fed – traders pushed back the forecast for an interest rate hike suggesting that the Fed Funds rate would be just 0.3% by December. Thus traders predictions are flying the face of Fed policy marker’s comments. Traders are suggesting the Fed will not be in position to raise rates as quickly as the Fed is forecasting due to a weaker than expected economy. April retail sales were expected to rebound more sharply after the wet wintery weather in March which kept shoppers home. Data also suggests that the U.S. consumer is saving more than in the past and paying down debt more aggressively, even with the lower gas bills that correspond to the general decline in commodity prices. Perhaps there were valuable lessons learned from the financial crisis. 

The University of Michigan’s preliminary sentiment index for May plunged to 88.6, the lowest since October, from 95.9 the prior month. It was weaker than even the lowest estimate of 68 economists surveyed by Bloomberg. Another report showed factory production stalled in April. News that the world’s largest economy sputtered last quarter, combined with uneven employment gains, shook households this month, raising concerns that spending will be slow to pick up. A strong dollar and weak oil prices also are holding back manufacturing, further denting the likelihood of a quick rebound in the rate of expansion. The median projection in the Bloomberg survey of economists called for an unchanged reading at 95.9. Estimates ranged from 91.4 to 97.5. The gauge averaged 88.8 for the five years leading to the last recession that started in December 2007. The average for 2014 was 84.1. Auto demand has remained a bright spot as cheap fuel costs boost sales for large and luxury sport-utility vehicles. Cars and light trucks sold at a 16.5 million annualized rate in April after 17 million the prior month, according to industry data from Ward’s Automotive Group. Purchases averaged 16.4 million in 2014.  

That’s been helping to prevent manufacturing from retrenching even more. Soft export demand, caused by a stronger dollar and weaker global markets, continued to diminish U.S. manufacturing activity in April, while oil companies curtailed operations to cope with low fuel prices. Factory production was unchanged last month after a 0.3% gain in March, according to data from the Federal Reserve Friday. Excluding autos and parts, factory production declined 0.1% in April after climbing 0.1% a month before. Total industrial production dropped for a fifth consecutive month as mining companies and utilities cut back. The manufacturing picture is really pretty flat at the moment. With some of the headwinds abating, including the recent rebound in oil prices and the resolution of a labor dispute that caused backlogs at ports on the West Coast, manufacturing will probably improve a bit. It remains to be seen however to what extent. Overall this additional weak data on Friday caused a further pullback in U.S. interest rates.

SGK Blog--Update May 8, 2015: Employment Rebounds in April  
The Labor Department reported that non-farm payrolls rose 223,000 in April following an 85,000 rise in March that was the smallest since June 2012.  The actual figure for last month was slightly below the median forecast of 228,000 from a Bloomberg survey of 96 economists.  The range in that survey was 175,000 to 327,000 which was wider than normal suggesting that many pundits were unsure whether the first quarter slowdown would continue into the first month of the second quarter.  The unemployment rate dipped to 5.4% from 5.5% and matched the lowest rate since May 2008.  Leisure and hospitality employment saw a gain of 17,000 jobs last month while employment at restaurants rose 26,000.  More evidence that the first quarter was affected by weather came in the form of a surge of 45,000 jobs for construction workers in April, the biggest gain in over a year, and likely spurred by nicer skies.

Wage growth, however, remains limited.  Average hourly earnings rose only 0.1% last month which means hourly pay was up 2.2% for the previous 12 months ended April, less than the Bloomberg median estimate of 2.3%.  Yes, it is above the 2% level Fed Chairwoman Janet Yellen often refers to in terms of an inflation target but given that unemployment is the lowest in seven years, many would expect much more wage pressure at this point.  The average work week held at 34.5 hours which also can be interpreted as a headwind to higher wages because if workers are not working longer, there is no need to either hire more staff or pay them more for the work they are currently doing.  We should continue to see more employment strength next month because initial and continuing jobless claims, which are more timely indicators of the employment market because they are weekly, continued to print strong data points.  Last week, claims were 265,000, little changed from the week’s previous level of 262,000.  Figures below 300,000 are usually indicative of solid payroll growth and the four-week moving average settled at 279,500, the smallest since May 2000.  Continuing unemployment claims fell by 28,000, the sixth decline in eight weeks.

Meanwhile, overseas events garnered a few headlines this week.  On Tuesday, the European Commission (EC) raised its euro-area growth forecast in the 19-nation currency bloc to 1.5% this year, up from 1.3% in February.  According to the EC, the European Central Bank’s quantitative-easing program “is having a significant impact” on financial and markets and the economy.  Regardless, the EC’s forecast for Greece was cut from 2.5% to 0.5% in 2015 as Greek Prime Minister Tsipras is trying to convince EU and International Monetary Fund representatives that it is serious about repaying its debts and accepting austerity going forward.  The Greek 10-year bond is trading at 10.3% compared to 0.5% for Germany, 0.8% for France and 1.7% for Spain and Italy suggesting that investors are not buying what he is selling.  In the U.K., British Prime Minister David Cameron won a closely contested election and will return to office with his Conservative party holding power after passing the 326-seat threshold to allow them to discard their Liberal Democrat coalition partners and govern alone in Parliament.  The result raises the prospect of a referendum down the road on whether Britain should remain in the European Union, a pledge his party made on the campaign trail.  Once again there appears to be no easy elections and no clear victors in the world of politics.

SGK Blog--Update May 1, 2015: Weak Economic Data Trigger Stock Declines This Week 

The economy in the U.S. barely grew in the first quarter, buffeted by slumps in business investment and exports after oil prices plunged and the dollar surged. Gross domestic product (GDP), the volume of all goods and services produced, rose at a 0.2% annualized rate after advancing 2.2% the prior quarter, Commerce Department data showed Wednesday in Washington. The median forecast of 86 economists surveyed by Bloomberg called for a 1% gain. Consumer spending, the biggest part of the economy, rose 1.9%, a little better than projected. While the restraints of harsh winter weather and delays at West Coast ports were temporary, the effects of the drop in fuel prices and stronger currency will probably prove longer-lasting. Economists’ forecasts in the Bloomberg survey ranged from little change in economic growth to a 1.5% gain. The GDP estimate is the first of three for the quarter, with the other releases scheduled for May and June when more information becomes available. 

The report showed corporate fixed investment decreased at a 2.5% annualized pace, the worst performance since the end of 2009. It grew at a 4.5% rate in the previous quarter. Investment in nonresidential structures, including office buildings and factories, dropped 23.1%, the most in four years. It rose 5.9% in the prior quarter. The decline reflected weakness in petroleum exploration as oil companies slashed budgets on the heels of plunging crude prices. Spending on wells and mines fell at a 48.7% annualized rate in the first three months of the year, the biggest plunge since the second quarter of 2009 when the economy was still in the recession. It climbed 8.1% at the end of 2014. Machinery makers are suffering the brunt of the damage from slumping energy exploration, a stronger dollar and tepid overseas markets. Bookings for non-military capital goods excluding aircraft, a proxy for future corporate spending on new equipment, dropped in March for a seventh consecutive month, government figures showed last week. Halliburton Co., the world’s second-biggest provider of oilfield services, said it expects to reduce capital spending by 15% this year and accelerated the pace of job cuts ahead of its takeover of our core holding Baker Hughes Inc. 

The GDP report also showed spending on equipment climbed 0.1% after a 0.6% gain in the prior three months. The trade deficit swelled to an annualized $522.1 billion rate from $471.4 billion, as exports decreased and imports climbed. The gap subtracted 1.25% from growth, the most in a year. Exports have fallen for four consecutive months as the dollar gained more than 20% since the end of June and overseas growth remains uneven. Whirlpool Corp., the largest maker of major appliances, on Tuesday slashed its annual forecast, blaming currency fluctuations and sluggish demand in Brazil. Spending by state and local government agencies was another soft spot, dropping at a 1.5% annualized rate, the most in three years. Federal outlays were also weak, rising at a 0.3% pace. Consumer spending, which accounts for about 70% of the economy, grew at a 1.9% annualized rate, following a 4.4% jump from October to December that was the biggest since 2006. The median forecast in the Bloomberg survey was 1.7%. Purchases added 1.3% points to growth. One bright spot is automobile demand. Sales of cars and light trucks rose to a 17.05 million annualized rate in March from 16.2 million the previous month, according to Ward’s Automotive Group. 

Households may be the best hope to drive a rebound in growth as the labor market improves, gasoline prices remain low and the weather improves. Disposable income adjusted for inflation climbed at a 6.2% annualized rate, the most in more than two years. Because the gain in earnings exceeded the increase in purchases, the saving rate climbed to 5.5%, the highest since the end of 2012, from 4.6% in the fourth quarter. The GDP report also showed price pressures remain limited. A measure of inflation, which is tied to consumer spending and strips out food and energy costs, climbed at a 0.9% annualized pace, the smallest gain since the end of 2010. Economic growth may pick up to a 3.1% pace in the second quarter, according to the median forecast in a Bloomberg survey conducted April 3 to April 8. The median projection for 2015 is 2.9%. We will have to wait and see on that! The Fed’s long-awaited liftoff on its benchmark interest rate won’t happen until September, according to economists surveyed by Bloomberg, as officials try to spur inflation and hiring after the economy stumbled in the first quarter. 

As if on cue, Federal Reserve policy makers said the economy weakened, partly for reasons that will fade, after a sharp slowdown reinforced expectations officials will keep interest rates near zero at their next meeting in June or longer. “Economic growth slowed during the winter months, in part reflecting transitory factors,” the Federal Open Market Committee said in statement Wednesday in Washington. “The pace of job gains moderated,” it said, and “underutilization of labor resources was little changed.” Fed officials have said they expect to raise rates this year for the first time since 2006 as the economy nears full employment, and that their decision will be guided by the latest data. The GDP report earlier that day Wednesday showed growth almost ground to a halt in the first quarter, held back by severe winter weather and slumping business spending and exports as we noted above. “Although growth in output and unemployment slowed during the first quarter, the committee continues to expect that, with appropriate policy accommodation, economic activity will expand at a moderate pace,” the Fed said. The Fed repeated it will raise rates when it sees further labor-market improvement and is “reasonably confident” inflation will move back to its 2% goal over time. The decision was unanimous. “Inflation is anticipated to remain near its recent low level in the near term, but the committee expects inflation to rise gradually toward 2% over the medium term,” the FOMC said. Officials held the benchmark overnight fed funds rate in a zero to 0.25% range, where it has been since December 2008. They had said last month that they would be unlikely to raise rates at their April meeting. A run of disappointing economic data has cast doubt on how quickly the Fed can meet its goals for full employment and stable prices.

 In general, data on the U.S. economy came in weaker than expected this week which helped contribute to the overall decline in stock indices this week. Consumer confidence for April was much weaker than expected coming in at 95.2 versus the 102.2 economists predicted. Personal income and personal spending for March were 0.0% and 0.4% compared to the expectation for +0.2% and +0.5% respectively. The Institute for Supply Management or ISM Index for April was 51.5 versus the forecast for 51.9 and construction spending for March showed a sharp drop of 0.6% versus the +0.4% expectation. How economists expected this figure to be positive when the weather was so terrible in March we have no idea but hopefully we will see a rebound in this figure in April & May. The one bright spot was initial weekly jobless claims for the week ending 4/25/2015 dropped to 262,000 versus the forecast for 290,000. This was the lowest figure in recent memory from our standpoint and is hopefully a sign that hiring is rebounding after a tough March for employment prospects – again definitely weather related in our view. We believe the data for April and May will be very revealing and tell us whether first quarter GDP was an anomaly triggered by weather or a sign of a deeper slowdown in our economy here in the U.S. Stay tuned!


SGK Blog--Update April 24, 2015: Focus Remains on Earnings 

Another month, another mix of contrasting data from the housing market.  On Wednesday, sales of previously owned homes rose by the most in March in four years.  Then, on Thursday, purchased of new homes slumped more than forecast to a four-month low.  What could be the reason for the difference?  These two data points come from two different sources.  Existing home sales are computed by the National Association of Realtors which is a trade group for the industry.  New home sales are tracked by the Commerce Department which is the source of myriad other monthly data points.  Existing home sales are tabulated once a housing transaction is closed which could be anywhere from a few days to a few months after the buyer and seller agreed on doing a deal.  New home sales are included as soon as a sales contract is signed which means the transaction still has the risk that it will not be completed for various reasons like a failure to find financing.  During the housing bubble, existing home sales peaked at over 7 million on an annualized rate.  This March, purchases rose 6% to a 5.2 million annualized rate.  New home sales peaked at a seasonally adjusted annualized rate of over 1.3 million in 2005.  Sales dropped this March by 11% to an annualized rate of 481,000.  Clearly, existing home sales comprise the bulk of transactions but new home sales are key because they provide a more timely indicator of what is going on in the market.

The spring selling season is the important window for real estate.  The year-end holiday season followed by usually cold, precipitation-unfriendly winter months pulls many homes off the market.  By March, sellers are eager to showcase what they have and get deals done.  Closing a transaction by June or July means that possessions can be moved and any school-age children can be registered in new locales by fall.  It is hard to get a true reading on the health of the market by concentrating just on one month or by contrasting the trends in these data points.  Real estate is local but given the size of the country (122 million households covering 3.8 million square miles) aggregating data is the only useful way to make any interpretations.  The main point is to focus on trends.  We are seeing the number of first-time buyers creep up no matter what indicator is used.  Also, for previously owned homes, distressed property sales are becoming a smaller and smaller part of the market.  Inventories play a key role.  The number of existing properties for sale rose 5.3% to 2 million in March.  At the current pace of sales, it would take 4.6 months to sell those houses.  Anything under 5 months is considered a healthy market.  In fact, 40% of homes stayed on the market for less than a month.  New home inventory is affected by home builders.  Builders are confident yet poor weather may have slowed the amount of finished homes that came on the market this spring.

All housing is affected by interest rates.  The average 30-year fixed mortgage was 3.67% in the week ended April 16 according to Freddie Mac.  The rate was 3.59% in February.  The Fed has been on hold in terms of policy and has not made any definitive indication that a rate hike was imminent in the next two to three months.  Applications for unemployment benefits held below 300,000 for the seventh straight week according to Labor Department data released yesterday.  The less volatile four-week moving average rose to 284,500 from 282,750 in the prior week but still remains at a healthy level and is consistent with an improving employment picture.  The issue is jobs are not being created fast enough and certainly wages are rising slower than molasses going uphill in the winter.  Thus, Fed Chair Yellen & Co. remain stuck in neutral which should benefit the real estate industry.

SGK Blog--Update April 17, 2015: Earnings Season Kicks Off as Oil Regains Its Footing 

Retail sales rose in March for the first time since November as consumers stepped up purchases of automobiles and other goods, suggesting a sharp slowdown in economic growth in the first quarter was temporary. The Commerce Department's fairly sturdy report on Tuesday together with other data showing that producer inflation crept up last month should keep the Federal Reserve on track to start raising interest rates later this year. An unusually snowy winter undercut activity early in 2015. Labor disruptions at normally busy West Coast ports, a stronger dollar and softer global demand also have hurt growth. Retail sales increased 0.9% in March. This was actually shy of the median forecast of 87 economists polled by Bloomberg who called for a 1.1% increase. It did represent the largest gain since the same month last year and snapped three straight months of declines that had been blamed on harsh winter weather. The sales rebound, which was mainly driven by automobiles, furniture, clothing, building materials, restaurants and bars, was encouraging because of the big step back in job growth last month. Economists, however, had been expecting a sharper rebound because of the view that consumers had been cooped up and not spending due to the harsh winter conditions in many parts of the country. So from that perspective the figure was viewed as somewhat disappointing. In fact retail sales excluding automobiles, gasoline, building materials and food services rose just 0.3% after dropping 0.2% in February. The so-called core retail sales correspond most closely with the consumer spending component of gross domestic product. 

Manufacturing, which accounts for about 12% of the economy, will probably remain subdued as the effects of the dollar and fuel costs linger, even as the supply disruptions caused by the labor dispute at West Coast ports and harsh winter weather dissipate. That’s one reason economists predict Fed policy makers will be in no rush to raise interest rates. The Fed’s report on factory output showed total industrial production, which also includes utilities and mining, declined 0.6%, the biggest drop since August 2012. It was projected to fall 0.3%, according to the Bloomberg survey of 83 economists. Note that the March figure means the first quarter of 2015 now has an annual decline of 1.0% in industrial production. Why this matters is that it now represents the U.S. economy’s first quarterly decrease since the second quarter of 2009. Still, some 70% of GDP is still tied to consumer spending activities. The Fed stated, “The decline last quarter resulted from a drop in oil and gas well drilling and servicing of more than 60% at an annual rate and from a decrease in manufacturing production of 1.2%. In March, manufacturing output moved up 0.1% for its first monthly gain since November; however, factory output in January is now estimated to have fallen 0.6%, about twice the size of the previously reported decline. The index for mining decreased 0.7% in March. The output of utilities fell 5.9% to largely reverse a similarly sized increase in February, which was related to unseasonably cold temperatures. At 105.2% of its 2007 average, total industrial production in March was 2.0% above its level of a year earlier.” Capacity utilization for the industrial sector decreased by 0.6% in March to 78.4%. Bloomberg was calling for 78.7%, after the prior reading of 78.9%. While this reading is 1.7% below the long-run average, it is also the lowest reading in months.

Another report showed housing may take up some of the slack. The National Association of Home Builders/Wells Fargo sentiment gauge increased to 56 in April, the highest since January, from 52 the previous month, the Washington-based group reported. Readings greater than 50 mean more respondents said conditions were good. Warmer weather is encouraging builders to start work on more homes at a time when tight inventory has been pushing up housing prices. Sustained improvement in the job market and a long-awaited pickup in wage growth would help to further strengthen demand. “As the spring buying season gets under way, homebuilders are confident that current low interest rates and continued job growth will draw consumers to the market,” NAHB Chairman Tom Woods, a homebuilder from Blue Springs, Missouri, said in a statement. 

Later in the week however, we received data on housing starts which rose less than forecast in March from the weakest pace in more than a year, underscoring a lack of vigor in homebuilding that held back the U.S. economy. Work began on 926,000 houses at an annualized rate, up 2% from February when bad winter weather prompted a 15.3% plunge, figures from the Commerce Department in Washington showed Thursday. Starts were less than the most pessimistic estimate in a Bloomberg survey of economists and reflected slowdowns in the West and South. The figures indicate construction did little to invigorate a first-quarter economy already slowed by weakness in manufacturing and consumer spending. At the same time, an improving labor market, still-confident households and low mortgage rates are giving builders reason to be upbeat.  

Among other reports Thursday, fewer than 300,000 American workers filed applications for jobless benefits for a sixth consecutive week and consumer confidence held near an almost eight-year high. While a Labor Department report showed jobless claims increased by 12,000 to 294,000 in the week ended April 11, readings this low are typically consistent with an improving job market. The Bloomberg Consumer Comfort Index fell to 46.6 in the period ended April 12, from the prior week’s 47.9 reading that was the strongest since May 2007. Inflation also remains muted as the consumer price index (CPI) for March came in at +0.2% just shy of the +0.3% expected but the core rate, which excludes food and energy, came in exactly as expected at +0.2%. Home construction rebounded in the rest of the country as builders in areas affected by February’s bad weather got back to work. Starts in the Northeast jumped a record 115% and were up 31.3% in the Midwest. Applications for new-home construction fell 5.7% to a 1.04 million annualized rate in March. The decline included a 15.9% slump in permits for multifamily projects such as apartment buildings. Permit applications for single-family projects exceeded the number of starts, signaling some room for a pickup in construction. Basically housing’s not going to come back immediately after the harsh winter but that does not mean it’s not going to come back with some strength in the near term, especially as interest rates remain low. The fundamentals for housing are still very supportive and in place.

SGK Blog--Update April 10, 2015: Fed Minutes Released as Earnings Season Begins
Federal Reserve officials were divided at their last policy meeting in mid-March.  Some officials believed June was the right time to end their 0% interest rate policy for fed funds.  Others thought that the strong dollar and energy-related commodity declines were solid enough reasons to keep rates unchanged.  At the meeting, the key term “patience” was removed from the policy statement as a sign to the markets that the Fed was giving itself the flexibility to potentially make a move within the next two meetings.  That would include the meeting scheduled for the end of this month and the June get together.  The market’s reacted positively to the statement last month and the post-meeting conference call held by Chairwoman Yellen for two main reasons: 1) the Fed’s projections of interest rates and economic growth were reduced and came more in-line with what the market was already discounting and 2) Yellen emphasized that the flexibility to make a move meant that a move was not imminent

Since that meeting, there has been one monthly payroll report.  The Labor Department reported that nonfarm employment increased by 126,000 in March, the smallest gain since December 2013 and weaker than the most pessimistic forecast in a Bloomberg survey of economists.  The advance over the prior 12 months averaged 269,000 so this put a serious dent in that trend.  The unemployment rate held steady at 5.5% and hourly pay was a silver lining, rising at 2.1% from a year earlier.  Payrolls in February were also revised down to 264,000, and revisions subtracted a total of 69,000 jobs for the previous two months combined.  Manufacturing payrolls dropped for the first time since July 2013 and the restaurant industry saw the weakest growth since June 2012.  The mining and lodging category, which includes oilfield services, is being hit by the slump in the price of crude as payrolls have fallen by 29,000 over the past three months.  Crude oil is down 54% since last June.

William Dudley, president of the Federal Reserve Bank of New York, said on Wednesday, “Data has surprised to the downside.  It’s reasonable to think the bar is higher” to the central bank acting in June.  Was March’s data a one month aberration?  Other data points suggest that the economy, similar to the start of 2014, was affected by worse than expected weather.  The New England area was buried under snow storms deep into March and the Mid-Atlantic states also saw a delay of spring’s arrival.  Add to that the protracted labor issues that affected West Coast ports.  The Port of Los Angeles is the nation’s leading container port and year-to-date through February container counts were down 17% compared to the same period last year.  Even with the issue solved, it will take weeks before inbound and outbound operations are operating smoothly.  Expectations are for a first quarter real GDP growth rate of 1.5% which would be down from the 2.2% annualized rate in the last quarter of 2014.  Fed futures probabilities now point to a September or later increase in the federal funds rate.

Even with a cloudier economic environment, the overall economy continues to hum along.  According to the Labor Department’s Job Openings and Labor Turnover (JOLT) survey for February, the current amount of job openings now has not been matched in the last 14 years.  That data is one month behind so future reports may not be as robust, but it is clear that the employment situation is still quite solid even with March’s apparent step backwards in payrolls.  The most recent initial unemployment claims data showed that the four-week moving average is lower than at any time in almost 15 years.  The number of people continuing to receive jobless benefits declined by 23,000 in the week ended March 28 to 2.3 million, the fewest amount since December 2000.  Motor vehicle sales rose in March to a 17.1 million annualized rate according to Ward’s Automotive Group.  That would match the strongest pace since August of last year.  McDonald’s Corp. and Wal-Mart Stores Inc. are two major nationwide employers who recently announced plans to boost worker’s pay above the minimum wage.  The dollar’s appreciation is affected by central banks all over the world and commodity prices shift due to factors well beyond Yellen’s control.  So, there remain plenty of forces at play that could sway sentiment toward a sooner-than-expected boost in rates.  However, all signs currently point toward a later half of 2015 hike which may be followed by small incremental changes after that or even a pause between Fed meetings.  Stay tuned.

SGK Blog--Update March 27, 2015: Oil Rises on Saudi Airstrikes in Yemen 

Oil jumped in price approximately 5% on Thursday, its biggest daily gain in a month, after air strikes in Yemen by Saudi Arabia and its Gulf Arab allies sparked fears escalation of the Middle East battle could disrupt world crude supplies. The Saudi-led coalition launched more air strikes on Friday against the Yemeni capital, Sanaa, controlled by Shi'a Houthi fighters allied to Iran. Worries over the possible impact of the geopolitical tensions on the Bab el-Mandeb Strait, the closure of which could affect 3.8 million barrels per day (bpd) of crude and product flows, put oil prices on track for weekly gains. Brent was headed for almost a 5% weekly rise - the biggest gain since early February.  U.S crude was set for an almost 10% jump - the most since the start of 2011. But Yemen is a small oil producer, with an output of around 145,000 bpd in 2014 and analysts say the conflict there is very unlikely to hit Middle East fuel supplies. A bigger impact could come from a nuclear deal with Iran, which could result in a loosening of Western sanctions against Tehran and rising exports of its oil reserves. Iran has around 30 million barrels stored offshore ready for sale, oil that could flood an already saturated market. Although any deal with Iran would be unlikely to lead to higher Iranian oil exports before the second half of the year, it has still weighed on market sentiment. Thus there is the possibility of the Strait of Hormuz opening up which would offset the possibility of the Bab el-Mandeb shutting down. Oil prices finally retreated somewhat in Friday trading as worries began to recede over the threat of disruptions to Middle East supplies due to Saudi Arabia-led air strikes in Yemen. Goldman Sachs said the bombing of Yemen would have little effect on oil supplies as the country was only a small crude exporter and tankers could avoid passing its waters to reach their ports of destination. 

In other news, the U.S. economy expanded at a 2.2% annualized pace in the fourth quarter, led by the biggest gain in consumer spending in eight years. The revised increase in gross domestic product, the value of all goods and services produced, matched the Commerce Department’s previous estimate, according to figures issued Friday in Washington.  The report also showed corporate profits dropped in the last three months of the year, capping the worst annual performance since the recession. The rate of economic growth will prove hard to replicate this quarter as harsh winter weather, a stronger dollar, a port slowdown and a global oil glut translate into disappointing spending on the part of consumers and businesses.  Job growth -- one of the few economic indicators that charged ahead unabated in the first quarter -- will probably help support demand in the world’s biggest economy for much of the year. The median forecast of 83 economists surveyed by Bloomberg called for growth of 2.4% in GDP.  Projections ranged from 1.8% to 2.7%.  This is the final of three estimates for the quarter. An upward revision to consumer spending and exports was mostly offset by smaller gains in inventories, the report showed. 

For all of 2014, the U.S. economy grew 2.4% from the year before, the most since 2010 and following a 2.2% advance in 2013. Household consumption, which accounts for almost 70% of the economy, was revised up to show a 4.4% gain at an annualized rate in the fourth quarter, the most since the first three months of 2006.  It was previously estimated at 4.2%.  The update reflected bigger outlays on health care. For all of 2014, Consumer spending rose 2.5%, the most since 2006. The Commerce Department’s report also included data on fourth-quarter corporate profits.  Before-tax earnings fell 1.4% after rising 3.1% in the previous three months, depressed by declines among financial institutions and foreign affiliates. A 4% gain at an annualized rate in personal income made up for the drop in corporate earnings and helped propel gross domestic income up by 3.1%. For all of 2014, corporate profits were down 0.8%, the first decrease since 2008.  The outlook for 2015 has dimmed with the jump in the dollar. Bad weather and the stronger dollar are having an impact this quarter.  

Fed policy makers are keeping an eye on employment and inflation as they consider raising interest rates this year. Officials cut their economic growth estimates for this year and the next two, according to the FOMC’s quarterly Summary of Economic Projections. They also slashed their median estimate for the federal funds rate at the end of 2015 to 0.625%, compared with 1.125% in December forecasts.  Atlanta Fed President Dennis Lockhart and Chicago Fed chief Charles Evans, both of whom vote on policy this year, acknowledged last week that a stronger dollar was a headwind for growth. The biggest impact from the swing in the currency will probably be on trade as an appreciating dollar makes it difficult for some American producers to sell their goods to foreign buyers, who may consider buying cheaper products elsewhere.  At the same time, it also makes it less expensive for U.S. consumers to buy imported goods, giving U.S. companies even more competition.   

In other economic news this week, existing home sales for February came in at 4.88 million which was in-line with expectations while new home sales surprised analysts for the same month as they rose to 539,000 versus the expectation for 465,000. This was a shocker as most felt bad weather across the country would put a crimp in new home sales. Durable goods orders for February fell 1.4% while the figure excluding transportation fell 0.4%. Both were expected to be positive at +0.4% and +0.3% respectively. Initial weekly jobless claims for the week ending 3/21/2015 came in at 282,000 which was below the estimate. The University of Michigan consumer sentiment index for March came in at 93.0 which was above the estimate of 92.0.  Finally, the consumer price index or CPI was basically in-line with expectations at +0.2% with the core rate, which excludes food and energy, also coming in at +0.2%. These figures help reassure the Fed that inflation remains relatively muted.
SGK Blog--Update March 20, 2015: The Fed Is Out of Patience 

The Federal Reserve opened the door a crack to raising short-term interest rates by June, but Chairwoman Yellen emphasized that they were not impatient to do so.  The Federal Open Market Committee concluded that “it will be appropriate to raise the target range for the federal funds rate when it has seen further improvement in the labor market and is reasonably confident that inflation will move back to its 2 percent objective over the medium term.  This change in forward guidance does not indicate that the Committee has decided on the timing of the initial increase in the target range.”  The translation is that the Fed will continue to be data dependent and, assuming monthly payroll figures continue to grow nicely, will look to raise rates when inflation shows some signs of a heartbeat. 

Given that every single word the Fed writes is analyzed like an Ebola strain, the key figure to focus on going forward is “reasonably confident.”  Its last statement included the following: “the Committee judges that it can be patient in beginning to normalize the stance of monetary policy.”  Thus, “patience” become the key word for months until now since it is not mentioned at all in the current press release.  What does “reasonably confident” entail?  Yellen was asked this directly and she politically answered that it involves no single data point or metric but something along the lines of the infamous Supreme Court phrase “I know it when I see it.”  The market liked what it heard reversing a negative market within minutes of the press release publication and ending the day up over 1% on the major averages. 

What did the market like?  We believe the market was pleased with the fact that the Fed was paying attention.  The market understands numbers and focusing forward guidance back upon a clear hurdle helped.  Unlike previous squishy statements like “for an extended time” (March 18, 2009) and “for a considerable time” (December 12, 2012) and the aforementioned “patient”, market watchers can focus on the consumer and producer price indices, GDP deflator and personal consumption expenditures for clues.

Second, and more importantly, they moved closer to the market’s point-of-view.  Yellen often mentions how inflationary expectations of the future can feed into current day inflationary pressures or non-pressure.  If people think inflation will be lower two, three or five years down the road, then that affects prices and purchasing patterns today.  Many survey-based indicators (those based on taking a survey like consumer confidence) had not shown a lot of inflationary expectations, but they also have not moved at all over the past few years.  That, according to the market and also apparently according to the Fed, was unrealistic.  Market-based indicators (those based on investors placing bets with real money) showed future levels of inflation stable to falling lower.  They are reacting to lower oil prices and virtually no real wage gains.  The Fed’s “dot plot” which shows their projections for the next 2-3 years now reflects much closer to what the market is betting on.  For 2015, the Fed now expects the economy to expand 2.3%-2.7% which down from the 2.6%-3.0% expected in January.  Forecasts for 2016 and 2017 were also lowered.  Also shaved were the Fed’s estimates of inflation and also how low the jobless rate can fall before it will theoretically start creating inflationary pressures.  The market has been skeptical of growth and price pressure since the middle of last year and even more so when oil prices began to plunge.  Futures markets continue to point to less than 50% chance of an increase by the June meeting. 

SGK Blog--Update March 6, 2015: Employment Jumps and the Fed Watches 

After Thursday’s initial unemployment claims figure, the market was expecting a subdued Friday payrolls report.  They were wrong.  Non-farm payrolls jumped by 295,000 in February, and the unemployment rate fell to 5.5%, the lowest in almost seven years.  The Labor Department revised January’s figures down to a gain of 239,000, but last month’s result blew away the consensus estimate of a 235,000 increase in a Bloomberg survey of economists.  February marked the 12th consecutive month that payrolls have risen by at least 200,000, the best run since a 19-month stretch that ended in March 1995.  Payrolls rose 3.1 in 2014, the most since 1999.  The increases last month included firms in retail sector which added 32,000 positions and the leisure and hospitality industries which saw 66,000 more jobs.  Hiring in the mining sector, which includes oil and gas extraction and related services,  fell by 9,300. 

Even with the strong headline numbers, the missing link continues to be faster wage growth.    The average workweek held steady at 34.6 hours for the fifth straight month, and average hourly earnings among private-sector workers rose 3 cents to $24.78.  That translated into a 2% year-over-year growth in wages which was below the 2.2% gain we saw back in January.  Thus, despite unemployment falling from 6.7% a year ago, there remains slack in the labor market.  The labor force participation rate fell to 62.8% last month from 62.9% in January and remains near the lowest level since the 1970s suggesting millions of Americans remain on the sideline.

The Fed remains stuck between a rock and a hard place.  These type of employment gains should have the Fed “normalizing” rates at a faster pace.  However, given that half of their mandate is stable prices, and with no inflation anywhere on the horizon, there is no pressure to raise their Fed funds target anytime soon.  Historically, the Fed has erred on the side of caution for employers and raised rates after inflation had taken hold.  At this point, we believe the Fed will follow the same path.  Futures markets continue to see a raise in September not in June—odds climbed to 55% after the employment report from 49% on Thursday afternoon.  This sets up a potentially market-moving event.  If the Fed governors follow-through with their rhetoric which points to a mid-year boost, the market will be surprised and not in a good way.  But we believe that the lack of wage pressure currently does not give Chairwoman Yellen & Co. the ammunition to pull the trigger just yet.  This means that the Fed governors are going to have to alter what they tell the markets in public speeches about monetary policy and especially in their wording of their post-Federal Open Market Committee meeting communiqué due March 18.  Stay tuned.

SGK Blog--Update February 27, 2015: Janet Yellen Speaks; Traders Pay Attention 

This week all eyes were on Fed Chair Janet Yellen as she testified before Congress.  Earnings, Greece, the Ukraine – all were swept aside momentarily as traders were glued to their TV sets or Bloomberg terminals waiting with baited breath for her to hint at pending rate hikes by the Fed.  She indicated the Federal Reserve is preparing to consider interest rate hikes "on a meeting-by-meeting basis," in speaking to a congressional committee on Tuesday, a subtle shift of emphasis that helps lay the groundwork for the Fed's first rate hike since 2006.  In remarks to the Senate Banking Committee, Yellen described how the Fed's rate-setting policy committee will likely proceed in coming months - first by removing the word "patient" in describing its approach to rate hikes, then entering a phase in which rate hikes are possible at any meeting.  That approach could open the door to an interest rate increase as early as June, though investors interpreted Yellen's testimony overall as likely indicating a later date for liftoff.  By the end of her two-hour appearance before the Senate Banking Committee, short-term rate futures contracts showed traders had shifted their expectations of an initial rate hike from September to October, according to data collected and analyzed by CME FedWatch.  Yellen, however, said that even as the Fed refines its language in coming weeks, investors should not construe that as a sign the central bank is wed to a rate hike at any particular meeting.  Rather, she said, when the word "patient" disappears it means the Fed will merely have full flexibility to act if its judges the economic data warrant it.  In our view, that is actually a good clarification.  Traders have been set to almost panic once the word patient is removed and we are sick of hearing the word continuously on CNBC candidly!


The Fed has been struggling in recent months to move away from the sort of forward guidance it has relied on through the crisis to influence market behavior, without at the same time triggering a market overreaction with each tweak to its policy statement.  Yellen's comments on Tuesday marked another step in that process.  "If economic conditions continue to improve, as the committee anticipates, the committee will at some point begin considering an increase in the target range for the federal funds rate on a meeting-by-meeting basis," Yellen said.  "Before then, the committee will change its forward guidance.  However, it is important to emphasize that a modification of the forward guidance should not be read as indicating that the committee will necessarily increase the target range in a couple of meetings."  Whew!  Who would have thought the semantics were so darn important in this day and age!  Yellen's discussion of forward guidance was part of prepared testimony that included a broad overview of a U.S. economy that appeared to be surging forward with strong job growth and a continued post-financial crisis expansion - conditions largely consistent with a rise in interest rates later this year.  Analysts said the testimony did little to nail down the likely date of a rate hike, with her testimony and answers to questions veering between confidence in a "solid" recovery and continuing concerns about weak wages and other signs the labor market is not fully healthy.

Alabama Republican Senator Richard Shelby, the chair of the Senate Banking Committee, led a discussion that confronted Yellen with a broad set of concerns - from currency manipulation among U.S. trading partners to whether Congress should delve more deeply into the Fed's affairs.  Shelby has scheduled a separate hearing next week on Fed oversight, and challenged Yellen on the issue in his opening statement.  With a more than $4 trillion balance sheet from its various crisis-fighting efforts, "many question whether the Fed can rein in inflation and avoid destabilizing asset prices," Shelby said.  "I am interested to hear whether the current Chair ... believes the Fed should be immune from any reforms."  Yellen was adamant.  Pending legislation that would let the Government Accountability Office review monetary policy "would politicize monetary policy," Yellen said, and "beyond a shadow of a doubt" make the Fed less effective.  That is very true so we give her kudos on that one.  She was grilled repeatedly in front of House legislators, particularly Republicans, but she held up well under pressure. 

Just completing her first year as Fed chief, Yellen said she felt U.S. labor markets and other key economic indicators "have been increasing at a solid rate."  However, she said she still feels the job market is not fully repaired, and that the U.S. outlook remains somewhat clouded by a weaker-than-hoped-for global economy, stalled wage growth, and falling inflation.  None of those factors on their own may be enough to keep the Fed from raising interest rates later this year.  Rates have been near zero since the financial crisis hit in 2008, part of a record effort by the central bank to repair the damage of the Great Recession.  But the lack of inflation has made some Fed policymakers hesitant to commit to raising rates until they are more certain the United States is not headed down the same path as Europe or Japan, mature industrial economies that are struggling to maintain growth.  The Fed considers a steady 2 percent annual inflation rate a sign of overall economic health - consistent with its own ability to return interest rates to a normal level, and not so high or low that it distorts household and business spending and investment decisions.  Though the current weak prices are considered likely to be a temporary result of the collapse in oil prices, doubts remain.  Yellen's statement could set the stage for the Fed to remove the "patient" reference as soon as its next meeting in March, a step policymakers began discussing in January according to recently released Fed minutes.  Several policymakers, including some centrists on the committee, have said they feel an interest rate increase should be on the table by June, after the intervening Fed policy meeting in April.  The discussion of forward guidance in Yellen's testimony is an effort to extricate the Fed from a perhaps unforeseen constraint it created when the word "patient" was put in its statement in December.  Yellen defined patient as a "couple" of meetings, and policymakers soon became concerned, according to the most recent Fed minutes, that investors would view any removal of "patient" as a sign that interest rates would definitely rise two meetings later.

Yes there was other news this week, though not nearly as exciting as Janet Yellen’s testimony was!  J  We had a number of housing data points come out this week with all indications pointing to the housing sector remaining a source of strength for the U.S. economy.  Pending home sales for January were 482,000 which was just shy of the forecast for 495,000.  New home sales for January were right in line with expectations at 481,000.  The Case-Shiller 20-city Index of housing prices for December showed a 4.5% increase in year-over-year prices which was better than the forecast for a 4.3% increase.  Initial weekly jobless claims ending 2/21/2015 were 313,000 which was higher than the expected 282,000.  January’s consumer price index (CPI) dropped 0.7%, the most since 2008, compared to the forecast for a  0.6% drop.  When the volatile food and energy sectors are factored out, the so-call Core CPI, the rate actually rose in January by 0.2% which was just slightly above expectations.  There were no surprises in these figures so that lent support to the Fed’s view that inflation remains relatively tame.  Durable goods orders for January rose a healthy 2.7% largely on business demand for equipment such as machinery and computers.  This was the first increase in three months and exceeded the expectation for a 1.7% increase.  Excluding the volatile transportation sector, the January figure rose 0.3% relative to the expectation of a 0.5% rise.  Overall there were no real surprises with the data on the U.S. economy this week.

SGK Blog--Update February 20, 2015: Markets Climb as Focus on the Eurozone 

Eurozone leaders met on Friday to determine the fate of Greece’s request for a bailout extension.  Germany summarily rejected a request for an extension sent by Athens yesterday saying it “doesn’t offer a substantial proposal for a solution.  In reality, it aims for a bridging loan without meeting the terms of the [bailout] program,” according to Martin Jaeger, spokesman for Finance Minister Wolfgang Schӓuble.  The meeting in Brussels is an attempt to discuss the situation before Greece’s bailout expires at the end of the month.  That would leave the government without funding and its banks at risk of being completely cut off from the lending facilities of the European Central Bank (ECB).  If the banks get cut off, Greece would have little option but to leave the eurozone and abandon the euro as its currency. 

We have not seen the levels of panic in the markets over a potential exit that we saw in earlier years because the ECB has taken many steps to prevent such an environment.  First, they have committed to their own version of quantitative easing which is a sign to markets that ECB President Draghi is willing to bring out the “big guns” in order to keep the peace.  Second, previous “brinksmanship” has elicited a Little-Boy-Who-Cried-Wolf mentality among traders.  All those fires were put out, so why not this one?  Third, it would be surprising if newly elected Greek Prime Minister Tsipras did not use the results of the election to push for less austerity.  He believes he has a mandate to stand up to the EU powers and does not want to lose face with the Greek populace by appearing weak and conciliatory just weeks after taking power.  In early afternoon trading, the euro/dollar exchange rate was virtually unchanged intraday which suggests again that the powers in charge are likely to work out some sort of solution even if that means merely agreeing to meet again!  Preliminary reports from Bloomberg and Reuters News say that finance ministers may have reached an agreement that will extend rescue program by six months.  While details are sketchy, the late afternoon rise in the equity markets is a good sign that some deal has likely been reached.   

On the domestic  economic front, this week’s data did little to dissuade investors that the recovery is in full effect.  Wholesale prices fell in the U.S. thanks to plunging energy costs.  The producer price index fell 0.8% in January and was the largest decline since November 2009 when the new PPI series was created.  This followed a 0.2% decline in December’s figure.  Excluding food and energy, wholesale prices still fell 0.1% even though a Bloomberg survey of economists forecasted a 0.1% rise.  Year-over-year these so-called core prices are up 1.6%.  Jobless claims fell by 21,000 to 283,000 in the week ended February 14 according to the Labor Department.  The less volatile four-week moving average is down to 283,250, a three-month low.  Though labor markets continue to improve, the outlook in residential real estate remains a bit fuzzy.  Housing starts in January decline 2% to a 1.07 million annual rate according to the Commerce Department.  Permits, a proxy for future construction, also fell.  Granted, this follows a month of December which registered an almost seven-year high and comes during a time of the year which is heavily influenced by weather even though the data is seasonally-adjusted.  Tight credit also remains a headwind and uneven spikes in demand have pushed median prices higher over the past six-to-twelve months.

SGK Blog--Update February 13, 2015: Markets Climb as Ukraine Ceasefire Agreement Reached After Marathon Talks 

This week the attention of traders shifted from corporate earnings to the news being generated out of Europe. The leaders of Germany, France, the Ukraine and Russia pulled an all-nighter to come up with a ceasefire plan for the battle that has been raging and picking up steam in the Ukraine. While we have had ceasefires before, which have all crumbled, and there is no guarantee this one will hold, this negotiation seemed to have more urgency as the U.S. threatens to send weapons to the Ukraine to assist our NATO ally and the economic sanctions levied on Russia by the U.S. and the European Union continue to take their toll on the Russian economy. As of the time of this drafting, there has been no pullback of sanctions by either the U.S. or the EU as we await details of the truce to emerge and the various parties wait to see if the terms are honored.  

The situation in Greece at first seemed insurmountable as the rhetoric was flying back and forth between Greek and German representatives. In a speech before the Greek parliament, newly minted Prime Minister Tsipras actually took the step of saying Greece wanted war reparations for the four year occupation of their country by the Nazis. Talk about stoking nationalist fervor! (Not to mention ticking off the Germans!) While initially both sides seemed to dig in their heels with respect to their positions, with encouragement from non-EU parties such as British Prime Minister David Cameron, by week’s end both sides seemed to soften their stance and officials from Germany and Greece agreed to talk to each other ahead of the EU meeting of finance ministers next week. So there was at least some reason for optimism.  

The economic news here in the U.S. was somewhat disappointing as retail sales for January fell 0.8% and 0.9% excluding autos versus the expectation for declines of 0.4% and 0.4% respectively. Initial weekly jobless claims also rose to 304,000 for the week ending 2/7/2015 versus the expectation for 285,000. Business inventories for December also rose a paltry 0.1% versus the expectation for a 0.2% rise. The data was thin this week so markets were more focused on the data coming out of Europe which we highlight next. 

The euro-area economy picked up momentum at the end of last year, with Germany reasserting itself as the driver of growth, offsetting weakness in Greece and Italy. Gross domestic product rose 0.3% in the fourth quarter after expanding 0.2% in the previous three months, the European Union’s statistics office in Luxembourg said Friday.  Analysts surveyed by Bloomberg News predicted growth of 0.2%. The Greek economy shrank 0.2% which surprised analysts but is not shocking to us given the turmoil that has been going on there both leading up to and after the recent elections. The private sector had been picking up steam but a lot of decision making has been put off by businesses given the status of Greece remaining in the EU is largely an unknown at this time. While the currency bloc’s economy is overcoming its longest-ever slump, falling consumer prices and the rise to power of an anti-austerity party in Greece have increased the risks to growth.  To avert deflation in a region where consumer spending is bolstering the recovery, European Central Bank President Mario Draghi announced a 1.1 trillion-euro ($1.3 trillion) quantitative-easing package that has already pushed down bond yields and the single currency. The German economy, the region’s largest, expanded 0.7 percent in the fourth quarter, more than twice as much as forecast, while French growth slowed in line with economists’ projections.  As mentioned, the Greek economy shrank after three quarters of growth, and Italy’s stagnated after two consecutive quarters of contraction.  Growth in Portugal and the Netherlands was 0.5%, more than analysts anticipated. Spain, the euro area’s fourth-largest economy, reported on Jan. 30 that its economy expanded at the fastest pace in seven years in the fourth quarter, with GDP rising 0.7%. So the news on the economic front coming from Europe was mixed but overall it had a positive tone. This help lend stability this week to European bourses.


SGK Blog--Update February 6, 2015: The Stage is Set  

With Friday’s employment data the stage is set for the Fed to normalize interest rates in June assuming the strong jobs momentum continues.  Employers added 257,000 non-farm payrolls in January marking the biggest three-month gain in 17 workers.  December’s gain was revised upwards to 329,000.  The median Bloomberg forecast of economists called for only a 228,000 increase.  The unemployment rate actually climbed from 5.6% to 5.7%.  That tick higher is misleading because it actually means more individuals were actively seeking an entry into the labor force further underscoring the strength of the job market.

As usual, the real story lies behind the headline numbers.  It is nice that payroll gains have averaged 336,000 over the last three months, but if those jobs barely keep the employed “above water”, has there really been any progress?  One way to measure such a query is to look at the average hourly earnings.  A paycheck is great, but a salary that outpaces inflation and enables a worker to not only cover normal expenses but also have a little left over for savings or an impulse buy is even better.  Last month average hourly earnings jumped 0.5%.  That is the most since November 2008 when the country was in the midst of the financial crisis and the electorate had just elevated a first-term Senator from Illinois to the White House based on a campaign motto of “change”.  This represents a 2.2% year-over-year wage gain which is above any recent consumer or wholesale inflation measures and results in real growth.  That is why 1.05 million people entered the work force (and 759,000 found work)—because they wanted to get paid!  The participation rate, which indicates the share of working-age people in the labor force, rose to 62.9% in January from 62.9% in December.  Excluding government hiring, the figures were even better.  Private payrolls rose 267,000 last month after an advance of 320,000 in December.  Payrolls in health care and social services rose by nearly 50,000 while retailers increased their employee ranks by around 46,000. 

Consumer spending fell in December by 0.3%, the biggest decline since September 2009, after a 0.5% gain in November according to the Commerce Department.  Retailers had many pre-holiday sales in October and November which attracted the crowds but left little buyers for December.  A Bloomberg survey called for a 0.2% decline so a fall was not unexpected.  Plus, household spending rose in the fourth quarter overall according to the latest GDP report which showed consumption rising at the fastest pace since early 2006.  Cheaper gasoline is one explanation as well as more confidence by the consumer boosted by a better job market.

Today’s job report means that between now and the Fed’s next Open Market Committee meeting in March, each and every bit of economic data is going to be reviewed with a fine-tooth comb.  The Fed’s statements and speeches have pointed to a middle of the year expectation for its first interest rate increase since 2006.  If that is not going to happen, then that must be relayed to the markets, and the most appropriate time to do so would be at Fed Chairwoman Yellen’s press conference following the March 18th meeting.  Words like “considerable time” and “patience” would have to be stricken if indeed a hike was only three months away.  So between now and March there will be one more payroll report along with revisions to fourth quarter GDP, price measures like CPI and PPI, retail sales and, of course, various housing-related releases.  The markets will be paying much closer attention to these data points for any clues as to how the Fed will approach the biggest decision so far in 2015.

SGK Blog--Update January 30, 2015: Markets Remain Volatile in the Aftermath of East Coast Storm 

This week equity markets were largely focused on earnings, and an early week winter storm that had a lot of traders packing up and heading home early on Monday. The news of the Greek election not turning out the way anybody in Europe really wanted it to, except for the Greek population of course, was largely met with a collective shrug. Stock futures were off early Monday in the pre-market, but attention quickly turned to other matters when markets opened for trading on Monday.

In U.S. economic news, we had plenty to digest this week. Stocks were rocked in Tuesday trading on weak U.S. data – in particular the durable goods report for December. Equity declines were likely exacerbated by the fact that a lot of traders found themselves unable to make it to work in New York due to subway being closed based on the forecast for 2 feet of snow. Whenever volumes are particularly light as was the case Tuesday, stock market volatility usually is considerably higher and the market moves exaggerated. With that said, we need to dive into the data to determine the cause, irrespective of the size of the move.  

Orders for business equipment unexpectedly fell in December for a fourth month, signaling a global growth slowdown is weighing on American companies. Bookings for non-military capital goods excluding aircraft dropped 0.6% for a second month, data from the Commerce Department showed Tuesday in Washington. Demand for all durable goods - items meant to last at least three years - declined 3.4%, the worst performance since August. Slackening demand from Europe and some emerging markets is probably weighing on orders, making companies less willing to invest in new equipment. At the same time, brightening American consumer attitudes are leading to gains in purchases of big-ticket items such as automobiles and appliances that can ripple through the economy and underpin manufacturing. Bookings dropped last month for machinery, computers and commercial aircraft, Tuesday’s report showed. Demand for automobiles was one of the few bright spots. The December figures mark the longest streak of declines in orders for non-military capital goods excluding aircraft since the seven months ending in September 2012. The median forecast of 80 economists surveyed by Bloomberg estimated total durable goods orders would rise 0.3%, with projections ranging from a 3.5% drop to a 2% gain. Orders for non-defense capital equipment excluding aircraft were projected to rise 0.9% - so the actual results came as a real negative shock to the market, again on a day where half the trading community was working from home. Tuesday morning’s data were the latest hint at the trend in business investment before fourth-quarter gross domestic product figures were to be released Jan. 30 from the Commerce Department. The faltering demand has companies such as Deere & Co., one of our core holdings and the largest manufacturer of agricultural machinery, preparing to let go staff in Iowa and Illinois as the outlook for global orders weakens. The Moline, Illinois-based company plans to dismiss about 910 workers, according to a statement issued last week. 

It was not all doom and gloom Tuesday, consumer confidence in the U.S. increased this month as declining unemployment and lower fuel costs lifted Americans’ outlooks. The Conference Board’s consumer confidence index rose to 102.9 from a revised December reading of 93.1, the New York-based private research group said Tuesday. The latest figure was higher than the 95.5 median estimate in a Bloomberg survey of 77 economists. Also, purchases of new homes in the U.S. increased 12% in December to a 481,000 annualized pace from a 431,000 rate in the prior month, figures from the Commerce Department showed Tuesday in Washington. This exceeded the average estimate for an increase of 450,000. We had mixed economic reports on Thursday as initial weekly jobless claims came in at the lowest level in recent memory at 265,000 for the week ending 1/24/15 compared to the forecast for 301,000. Of course the Labor Department said basically the figure was skewed by the MLK Holiday and they had no idea to what degree! So we take that one with a bit of a grain of salt. The same day pending home sales for December were down a disappointing 3.7% versus the forecast for +0.6%. Providing a drag on stock markets and a boost to high quality bonds on Friday was the advanced figure for 4th quarter gross domestic product in the U.S. which came in at 2.6% versus the forecast for 3.2%. This was largely due to the fact that both government and business spending cooled during the quarter, even though consumer spending was higher than expected thanks to lower oil and gasoline prices.    

In other news, home prices in 20 U.S. cities rose at a slower pace in the year ended in November, a sign the industry struggled to find momentum even amid low mortgage rates. The S&P/Case-Shiller index of property values increased 4.3% from November 2013 after rising 4.5% in the year ended in October, the group said Tuesday in New York. The median projection of 28 economists surveyed by Bloomberg called for a 4.3% year-over-year advance. Nationally, prices rose 4.7% after a 4.6% gain in the year ended in October. Property prices slowed over the last year as home sales cooled, with demand stymied by sluggish wage growth and less household formation. More moderate price gains, combined with improvement in the labor market and low borrowing costs, may enable a wider swath of Americans to become buyers, providing a needed jolt to the industry. All 20 cities in the index showed a year-over-year increase, led by gains of 8.9% in San Francisco and 8.6% in Miami. Among cities whose annual growth rates climbed the most in November were Tampa, Florida; Atlanta, Georgia; Charlotte, North Carolina; and Portland, Oregon. Cleveland showed the smallest increase, at 0.6%. Economists’ estimates in the Bloomberg survey ranged from gains of 3.9% to 4.8%. The S&P/Case-Shiller index is based on a three-month average, which means the November figure was also influenced by transactions in October and September.  

The Federal Reserve finished their January meeting with their announcement on policy Wednesday afternoon. They maintained their pledge to be “patient” on raising interest rates and boosted their assessment of the economy and labor market, even as they expect inflation to decline further. “Economic activity has been expanding at a solid pace,” the Federal Open Market Committee said Wednesday when their statement was released in Washington. “Labor market conditions have improved further, with strong job gains and a lower unemployment rate.” Policy makers said inflation “is anticipated to decline further in the near term,” adding that price gains are likely to “rise gradually toward 2 percent over the medium term” as transitory effects of low energy prices dissipate. Fed officials are confronting divergent economic forces as they weigh the timing of the first interest-rate increase since 2006. Surprisingly strong job gains argue for tightening sooner, while inflation held down by a plunge in oil prices and a cooling global economy provides grounds for delay. The Fed acknowledge global risks, saying that it will take into account readings on “international developments” as it decides how long to keep rates low. We would take this latter point as being encouraging. It is the first time in a number of years they have given indication they appear to not just be operating in a vacuum of U.S. data, but they are also paying attention to events that transpire overseas. After all, it is a global economy. The Fed also dropped a clause from its December statement that the assurance of patience was consistent with a previous pledge to hold rates low for a “considerable time,” especially if “projected inflation continues to run below” the 2 percent target. The Fed has kept its main interest rate near zero since December 2008. All 10 voting FOMC members backed Wednesday’s policy statement, marking the first unanimous decision since June.
SGK Blog--Update January 23, 2015: The ECB Crosses the Rubicon

After months of waiting, European Central Bank (ECB) President Mario Draghi kept the markets waiting a little bit more. His 2:30pm local time scheduled conference was delayed…because the ECB elevators were running extremely slow. When he did arrive, he gave the markets what they were waiting for—quantitative easing (QE) for the eurozone. The central bank will purchase 60 billion euros a month in assets including government and private sector bonds starting in March and running through September 2016. That 1 trillion euro infusion is aimed at combating the dangerously low inflationary levels that are pressuring the region. The risks of EU institutional bonds will be shared among the eurozone central banks while purchases of other government bonds will not be subject to loss sharing. The ECB also lowered the interest rate it charges on its four-year loans to banks by 0.10 percentage point. The bank’s main lending rate remained unchanged at 0.05% while a separate rate on overnight bank deposits will earn a -0.20% meaning banks will be paying the ECB to keep its surplus funds there.

Unlike previous attempts to combat low prices through monetary policy, this week’s moves have the feel of a true buy in. There has been a lot of talk but little concrete results. Banks were not lending even though they were eagerly snapping up loans from the central banks. In a previous weekly note, we mentioned that one of the big differences between the U.S. Fed’s QE program and the ECB’s efforts was that the Fed offered a more proactive approach. Instead of waiting for the market to ask for funds, the Fed was actively and aggressively pumping liquidity into various markets.  Now, Draghi and the ECB will buy securities with maturities from two to thirty years. They will buy bonds with negative yields (e.g., Germany). The former “patient, heal thyself” approach has been replaced by “the cavalry is on the way.”

Not every country was comfortable with starting a bond buying program. We can only guess that Germany was one of this group. Draghi said a “large majority” was in favor of the program and after last week’s ruling from the EU Court of Justice which we discussed in our previous weekly report, the path was laid for QE to take place. The risk of losses on government bonds will not be shared because buying on such a large scale necessitated keeping risks largely with the individual banks. Greek debt will not be purchased quite yet given that the ECB bought so many in the 2010-2011 program, they are currently above the maximum share of a country’s debt they have set as a condition of QE.

The initial result was exactly what both the ECB economists and market makers were looking for. Spanish bonds hit record lows. German government bonds, already at low levels, saw demand spikes. The euro fell to an 11-year low at one point versus the U.S. dollar. A less expensive currency will be a boon to the export-driven eurozone because it makes their goods less expensive to buyers from abroad. That is one way to import inflation which is exactly what Draghi is hoping for. The equity markets pushed higher with the Euro Stoxx index showing a 1.6% gain on Thursday.

SGK Blog--Update January 16, 2015: Markets Remain Choppy as Oil Prices Show Signs of Stabilizing 

Oil continued to be the story this week as the price declined to below $45 a barrel for the first time since 2009 as the U.S. pumped at the fastest rate in more than three decades and OPEC resisted calls to cut production. One would think this would be a net positive for the consumer so why are markets so volatile these days? Well anytime there is a shock to the system and a major commodity such as oil sees its price decline by approximately 50% in a matter of a few months, it creates uncertainty. As we have written many times in the past, stock traders hate uncertainty! With oil falling below $45 a barrel amid speculation that U.S. stockpiles will increase, this has exacerbated a global supply glut that’s driven prices to the lowest in more than 5 1/2 years. The issue is – what does this do to the earnings of companies in the energy and materials sectors? Combined that is not an insignificant portion of S&P earnings and it makes the overall earnings for the S&P 500 less predictable. Hence the uncertainty and the sell-off in equities. The United Arab Emirates, a member of the Organization of Petroleum Exporting Countries, will continue to expand output capacity, while shale drillers will probably be the first to curb production as prices fall, according to Energy Minister Suhail Al Mazrouei. The U.S. grade briefly traded above Brent for the first time since July 2013.  

In addition, copper has also declined to a 12-year low on concerns of a global slowdown dragging mining company stocks lower and sending the currencies of raw-materials exporters down as well as concern deepened that slowing global growth will curb demand. Copper for delivery in three months on the London Metal Exchange dropped as much as 8.7% to $5,353.25 a metric ton this week. This caused the yen to gain ground along with government bonds. The U.S. 10-year Treasury declined to a level we have not seen in quite a while as it actually dipped below 1.8% in Wednesday trading. Commodity prices are tumbling as a supply glut collides with waning demand, reducing earnings prospects for producers and increasing the appeal of bonds as inflation slows. Nickel also slid 4.6% and lead fell 3.8% to the lowest in more than two years so the trend for commodities continued heading south this week. 

Retail sales in the U.S. surprisingly slumped in December by the most in almost a year, reflecting a broad-based retreat that will probably prompt economists to cut growth forecasts. The 0.9% drop, the biggest since January 2014, followed a 0.4% gain in November that was smaller than previously estimated, Commerce Department figures showed on Wednesday. Last month’s decrease was almost twice as large as the most pessimistic estimate of 87 economists surveyed by Bloomberg. Initial weekly jobless claims for the week ending 1/10/15 were higher than expected at 316,000. The producer price index, a measure of inflation at the wholesale level, declined 0.3% in December although the rate excluding food and energy, the so-called core rate, rose more than expected at +0.3%. The consumer price index for December came in exactly as expected as did the core rate at -0.4% and 0% respectively. Both industrial production and capacity utilization for December were basically in-line with expectations at -0.1% and 79.7% respectively. One bright spot this week, the University of Michigan consumer sentiment survey for January was actually better than expected at 98.2 versus the expectation for 94.1. 

The World Bank cut its forecast for global growth this year, as an improving U.S. economy and low fuel prices fail to offset disappointing results from Europe to China. The world economy will expand 3% in 2015, down from a projection of 3.4% in June, according to the lender’s semiannual Global Economic Prospects report, released Wednesday in Washington. The report adds to signs of a growing disparity between the U.S. and other major economies while tempering any optimism that a plunge in oil prices will boost output. Risks to the global recovery are “significant and tilted to the downside,” with dangers including a spike in financial volatility, intensifying geopolitical tensions and prolonged stagnation in the euro region or Japan. The Washington-based lender upgraded its forecast for U.S. growth to 3.2% this year from a 3% estimate given in June. It reduced its projections for the euro area and Japan, citing lingering effects from the financial crisis and “structural bottlenecks.” It also cut its forecast for China, saying the world’s second-biggest economy is undergoing a “managed slowdown.” The World Bank is the latest institution to lower its global estimate amid a recovery that has repeatedly disappointed policy makers. The International Monetary Fund trimmed its 2015 outlook in October to 3.8%, citing weak demand and residual debt from the financial crisis. The IMF plans to update its global forecast next week. 

On a brighter note this week, Mario Draghi won a legal endorsement for the bond-buying plan he designed to save the euro, potentially easing resistance to a similar program that could be announced as soon as this month. The Outright Monetary Transactions program that the European Central Bank president pushed through in 2012 won the conditional backing of Advocate General Pedro Cruz Villalon of the EU Court of Justice in Luxembourg, who said the measures are “in principle” in line with the bloc’s law. “The ECB must have a broad discretion when framing and implementing the EU’s monetary policy, and the courts must exercise a considerable degree of caution when reviewing the ECB’s activity,” Cruz Villalon said in a non-binding opinion today. Such advice is followed by the court in a majority of cases. The opinion could ease pressure on ECB President Draghi days before he meets with his Governing Council to consider a separate so-called quantitative-easing package to quell the threat of deflation in the euro area. Opponents of QE had raised legal concerns as one objection. 

Apparently for central banks, the road to normal is proving to be quite bumpy! Stunning monetary-policy shifts in Switzerland and India sent markets on wild rides in Thursday trading, highlighting Federal Reserve Chair Janet Yellen’s November warning that “normalization could lead to some heightened financial volatility.” Following Thursday’s wake-up calls, the Swiss franc surged as much as 27% against the dollar, moving more like the Ukrainian hryvnia than the seventh-largest reserve currency. Mumbai’s benchmark stock index posted its biggest gain in more than a year. In India, Reserve Bank Governor Raghuram Rajan cut his key interest rate for the first time in 20 months. Six hours later, Swiss National Bank President Thomas Jordan abandoned a three-year-old cap on the franc’s gains. Both decisions were unscheduled and, in Switzerland’s case, unexpected. The lessons for investors: central banks are no longer aligned and again a source of volatility rather than calm in financial markets. Also, forward guidance has its limits as policy can shift abruptly when economic conditions change and officials still like the odd surprise. The risks were emerging even before today. Investors are bracing for the first U.S. interest rate increase since 2006 and the European Central Bank is set to decide it will buy government bonds for the first time. The euro has weakened 14% the past year against the dollar on the back of the divergence trade. Before that came the “taper tantrum,” when hints of tightening from the Fed in 2013 roiled bond markets worldwide. 

Jordan dismantled the franc’s 1.20 per euro ceiling a week before the ECB’s expected announcement of quantitative easing. That move would intensify upward pressure on his currency, rendering the cap untenably expensive. Rajan acted after a weakening of inflation gave him room to support an economy growing half the pace of four years ago. Since the financial crisis erupted in 2008 and the world tumbled into recession, major central banks have deployed ultra-easy policy in the form of near-zero interest rates and cheap cash that Deutsche Bank AG estimates totaled $10 trillion. The unity and abundance of liquidity becalmed markets, yet now frictions are emerging that will likely roil them. The SNB noted the end of solidarity was one reason to discontinue the cap, saying division is “a trend that is likely to become even more pronounced.” As the Fed readies to tighten monetary policy, deflationary forces mean the ECB is looking to ease anew. The Bank of Japan has already done so. Rajan’s action also contrasted with recent rate increases in BRIC counterparts Russia and Brazil aimed at supporting exchange rates. Less noticed Thursday, Indonesia’s central bank kept its rate unchanged. As they grapple with turns in their economies, central banks also may struggle to control the message, something they’ve prided themselves on during the crisis. Forward guidance may need to be increasingly taken with a pinch of salt. Just this week, the SNB indicated its cap was here to stay, with Vice President Jean-Pierre Danthine saying, “it must remain the pillar of our monetary policy.” A U.K. lawmaker called Bank of England Governor Mark Carney an “unreliable boyfriend” for sending mixed messages on rates. In the end, central banks showed that they still have the power to stun. That may happen again at the ECB next week after markets sneered at the suggestion President Mario Draghi may limit quantitative easing to 500 billion euros ($586 billion). Stay tuned! 

SGK Blog--Update January 9, 2015: New Year Positive for Job Growth  

The Labor Department reported that nonfarm payrolls rose 252,000 in December following 50,000 of upward revisions to the previous two months.  The November surge was revised to an even more impressive gain of 345,000 which undoubtedly helped the holiday season be merrier for many families.  The median forecast in a Bloomberg survey of economists called for a 240,000 advance with a gains ranging from 160,000 to 305,000.  The industries which benefited the most were factories, health care providers and business services.  For 2014 in total, payrolls grew by 2.95 million, the most in 15 years.  The unemployment rate, which is derived from a separate Labor Department survey of households not businesses, fell to 5.6% in December from 5.8% in November.  This decline seemed positive on the surface but dig a little deeper and some issues arise.  Employment in the household survey rose by 111,000 but the labor force shrank by 273,000 making the ratio seem better than it was.  Plus, the participation rate, which indicates the share of working-age people in the labor force, fell to 62.7% from 62.9% marking a new three-decade low.

The real head-scratcher revolved around wages.  The nonfarm work week managed to stay steady at 34.6 hours, a posts-recession high.  However, those longer hours did not translate into higher pay.  Average hourly earnings fell by 0.2% versus the consensus for a 0.2% gain.  That meant wages year-over-year rose by 1.7%, barely ahead of some inflation measures.  Policy makers, especially Fed Chair Janet Yellen, want to see workers gaining ground against any rise in the general level of prices.  Since late 2012, year-over-year average hourly earnings have fallen in the range of +1.8% to +2.3%, so is this new data point a trend or an outlier?  Eventually, we will likely see wage pressure emerge sometime later this year.  Why?  We saw more part-time workers be converted to full-time workers in the latest survey.  Plus, with average hours worked at high levels, historically this has suggested employers will hire more workers rather than run their current employees into the ground or entice them to continue working hard with higher pay.  Another issue the Fed will have to deal with is the long-term unemployed.  Those out of work for more than 26 weeks comprised about a third of all unemployed.  A long time out of the workforce means skills deteriorate and make it harder for a worker to be reintroduced.

These issues are a challenge, but still pale in comparison to Europe’s issues.  The European statistics office confirmed on Wednesday that prices in the 18 countries that use the euro were 0.2% lower this past December than in December 2013.  The last time prices fell was October 2009 when the euro zone, and the world, was in the midst of the worst recession since the Great Depression.  One antidote which the market is expecting is massive bond buying in the form of quantitative easing.  European Central Bank staff presented policy makers with models for buying as much as 500 billion euros at this week’s Governing Council meeting in Frankfurt according to sources that spoke with Bloomberg reporters.  Governors took no decision on the design or implementation of any package after the meeting.  The next Governing Council meeting is scheduled for January 22nd where many market watchers anticipate some announcement will be made.  The euro, which has plunged versus the dollar recently, traded a bit higher yesterday.  With Greek elections scheduled for January 25, the markets will want some indication that the central bank is ready, willing and able to make a move to help the currency and the various economies in the bloc should the results lead to volatility.  European Central Bank President Mario Draghi has warned of deflationary risks and wants the bank to expand its balance sheet toward 3 trillion euros from 2.2 trillion euros now.  Another complicating factor is that a European Court of Justice is expected to offer its opinion on previous bond-buying purchase programs on January 14.  Should that decision deem any bond-buying illegal, we are certain to see a reaction and it will likely not be positive.

SGK Blog--Update January 2, 2015: Greece Makes Headlines; Market Reaction is Muted 

Greece leant over the precipice Monday when Prime Minister Antonis Samaras fell short of a parliamentary supermajority to elect his candidate for the country’s largely ceremonial presidency. That forced a new parliamentary election next month pitting Samaras, who came to power in 2012 after initially challenging the terms for Greece’s 240 billion-euro ($293 billion) rescue package, against Alexis Tsipras of the Syriza party, who never stopped challenging them.  Investor reaction to the Greek parliament’s failure to pick a president traced the familiar north-south divide. Greek stocks and bonds plunged and markets were buffeted in Italy, Portugal and Spain, while funds flowed into Germany, Europe’s biggest economy and hard-money bastion. Yet look closer and Italy, the euro zone’s second most-indebted country after Greece, is nowhere near a fiscal calamity. Ten-year borrowing costs are hovering around 2 percent, compared to over 7 percent at the height of the European debt crisis, and Tuesday Italy auctioned 10-year government bonds to yield less than 2 percent for the first time on record. What is different this time around? When Greece hurtled toward bankruptcy in early 2010, the European Union had no way of helping countries in need. When Greece toyed with quitting the euro in late 2011, and held a stalemated election in May 2012 before Samaras put together a unity government after a second election six weeks later, it had only a temporary bailout fund. Now, it has a full-time aid fund in the 500 billion-euro European Stability Mechanism and a central bank tiptoeing -- amid opposition from Germany -- toward large-scale bond purchases. It also boasts success stories: Ireland, Portugal and Spain have been weaned off financial aid. The risk is less a splintering of the 18-nation euro zone -- it will become 19 on Jan. 1 when Lithuania joins -- than a protracted phase of subpar economic growth that leaves a generation scarred by unemployment and tempted by political extremism, especially in the south. Stocks sold off to a greater degree on Tuesday, especially in Europe, while money flowed into higher quality assets such as U.S. Treasuries, perhaps in a delayed reaction as the Greek news set in. Concerns rose that it may cause a delay in the European Central Bank’s goal of buying sovereign bonds. If Greece is not going to play by the rules of reform and their future in the euro zone is once again marred by uncertainty, why would the ECB invest in their bonds at all? The timing could not be worse in our view as all eyes have been focused on the ECB and when they may commence their sovereign asset purchase program.

There was not much data out on the U.S. economy this week so we will focus on a key housing report and the important information contained in that. U.S. single-family home prices' rate of increase decelerated in October compared to the stronger-than-expected rise seen in the previous month. Data released from the S&P/Case-Shiller U.S. National Home Price Index indicated that both the 10-city and 20-city Composites had year-over-year deceleration in the rate of growth in October. The composite index of 10 metropolitan areas gained 4.4 percent year-over-year, slowing from the 4.7 percent rate recorded in September. The 20-city index saw a similar slowdown, rising 4.5 percent year-over-year in October, compared with the prior month's 4.8 percent growth. Over the last 12 months, Miami and San Francisco saw prices rise 9.5 percent and 9.1 percent, respectively. Prices rose faster in October for eight cities including Tampa, Denver, and San Francisco. However, Las Vegas saw a decline of 1.2 percent, making it the leader of declining annual returns. “After a long period when home prices rose, but at a slower pace with each passing month, we are seeing hints that prices could end 2014 on a strong note and accelerate into 2015," said David M. Blitzer, managing director and chairman of the index committee at S&P Dow Jones Indices. "Two months ago, all 20 cities were experiencing weakening annual price increases. Last month, 18 experienced weakness. This time, 12 cities had weaker annual price growth, but eight saw the pace of price gains pick up. Seasonally adjusted, all 20 cities had higher prices than a month ago.” So overall, this was a pretty good indication that the housing sector is maintaining price gains in this moderate interest rate environment.    

The Conference Board’s consumer confidence index increased to 92.6 in December, the New York-based private research group said on Tuesday. Greater opportunities to land a job and persistent declines in the cost of gasoline are making Americans feel more hopeful about the economy. While the gain was less than forecast, the gauge is close to the seven-year high reached two months ago. Perceptions of current economic conditions advanced to the highest since February 2008. Gasoline prices that have fallen every day since the end of September left extra cash in people’s wallets heading into the holiday gift-giving season. More consumers said they planned to buy appliances and new cars, reflecting the strongest employment gains since 1999 and record stock prices that kept households upbeat about their incomes, Tuesday’s report showed. 

Manufacturing in the U.S. cooled in December, settling into a more sustainable pace of growth as the year drew to a close. The Institute for Supply Management’s factory index dropped to a six-month low of 55.5 from 58.7 in November, a report from the Tempe, Arizona-based group showed Friday. The reading in October matched a three-year high. Figures greater than 50 indicate growth and the median forecast in a Bloomberg survey of economists called for a December reading of 57.5. A slowdown in orders growth indicates companies are beginning to scale back capital spending plans as overseas markets slow and lower oil prices hit American oil producers. At the same time, U.S. factory floors will probably stay busy early this year as employment gains and cheap gasoline boost consumer spending. Next Friday we will get the all-important December employment report which will be a good indicator as to whether or not the U.S. economy will maintain its momentum heading into 2015.
SGK Blog--Update December 19, 2014: Santa Claus Rally  

Janet Yellen should have shown up at the post-Federal Open Market Committee meeting press conference dressed as Santa Claus.  She and her fellow Fed governors provided the markets with a gift this week which pushed indices higher.  Not only did they keep the long-debated reference to “considerable time,” they also determined they could “be patient in beginning to normalize the stance of monetary policy.”  Some officials worried that removing the “considerable time” phrase would frazzle markets and signal a sooner-than-expected rise in rates.  The added “patience” component helped push the Dow Jones Industrial Average up 288 points on Wednesday and 421 points on Thursday, the best point performances this year.  No imminent rate hike continued to feed the markets which have been addicted to easy monetary policy.  That, plus the fact that next year, the Open Market Committee will replace three “hawkish” members by relatively more “dovish” voters ignited more “risk on” trades.  It was interesting that three members of the committee dissented against the statement and included both hawks and doves.  Minneapolis Fed President Narayana Kocherlakota is strongly opposed to any rate hike given the absence of price pressures.  Meanwhile, Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser both believe a rate hike should be moved forward.  This is worth noting because the last time the Fed had a three-person dissent was in 2011.  One key which marked former Fed leader Ben Bernanke’s terms was the consensus reached at these meetings especially in light of the massive market volatility at play during the 2008 crisis.  Not every meeting was unanimous—Mr. Fisher being a notable outlier—but between the Fed statements and speeches given by governors at various events, the message was mostly uniform.  If we are indeed approaching a time when rates would have to be raised for the first time since 2006, not having everyone on board would send a tricky message to markets at a very crucial time.

The Fed also updated the so-called “dot chart” which plots individual Fed governor projections for the coming years.  Fifteen of seventeen officials said they expected to raise rates in the coming year.  The median estimate put rates at 1.125% by the fourth quarter of 2015.  For 2016, that rises to 2.5% and 3.625% in 2017.  Officials project GDP growth of 2.6%-3.0% in 2015 and unemployment at 5.2%-5.3% by year-end.  Their statement emphasized the better employment picture: “Labor market conditions improved further, with solid job gains and a lower unemployment rate” which sits currently at 5.8%.  On Thursday, initial jobless claims fell by 6,000 to 289,000 in the week ended December 13 according to the Labor Department.  Claims have been below 300,000 for 13 of the past 14 weeks.  The number of people continuing to receive jobless benefits fell sharply by 147,000 to 2.37 million in the week ended December 6.  Most of the firings we have seen over the past year has been related to business-specific issues—mainly mergers or cost-savings initiatives—rather than general economic fears.  The last few weeks of the month get distorted due to seasonal patterns so the coming weeks will not carry the same weight as the last few in the eyes of investors.  The bottom line is that job growth is alive and well across most of the U.S.

SGK Blog--Update December 12, 2014: Oil Retreats on Lowered Outlook from OPEC

OPEC cut the forecast for how much crude oil it will need to provide in 2015 to the lowest in 12 years amid surging U.S. shale supplies and reduced estimates for global consumption. The Organization of Petroleum Exporting Countries lowered its projection for 2015 by about 300,000 barrels a day, to 28.9 million a day. That’s about 1.15 million a day less than the group’s 12 members pumped in the month of November, and the 30-million barrel target they reaffirmed at a meeting in Vienna on Nov. 27. The impact of this year’s 40 percent price collapse on supply and demand remains unclear, OPEC said. There are really two sides to this story. While it is painful to watch the prices of energy stocks decline on the increased volatility, the decrease in the price at the pump could not come at a better time from the standpoint of the consumer, especially given we are in the thick of the Holiday shopping season.  

On that note, the figures for U.S. retail sales came out for the month of November and they were stronger than expected. We can attribute this to continued low interest rates (Americans like to finance expensive purchases!) and the “tax cut” or “wage increase” attributable to lower gasoline prices. For November, retail sales came in at +0.7% versus the expectation for +0.4% and, excluding the robust auto segment, the figure was +0.5% versus the expectation for +0.2%. Weekly initial unemployment claims for the week ending 12/06/2014 came in almost exactly as expected at 294,000. The good news on the U.S. economy helped lend some support to U.S. equity markets in trading on Thursday. 

Stocks resumed their selling globally Friday while money flowed into high quality bonds after November Chinese factory production slowed more than estimated. Data showing a 7.2 percent gain from the year before missed the 7.5 percent median estimate in a Bloomberg News survey. U.S. equities briefly pared losses as a report showed consumer confidence improved this month.  The Thomson Reuters/University of Michigan preliminary December index of consumer sentiment increased to 93.8 from 88.8 last month.  The median projection in a Bloomberg survey of 69 economists called for an advance to 89.5. A separate report showed wholesale prices fell more than forecast in November, led by the biggest drop in energy costs in more than a year, signaling inflation pressures remain weak even as the world’s largest economy is expanding.  The 0.2 percent decrease in the producer-price index followed a 0.2 percent advance in the prior month, the Labor Department data showed. Oil at a five-year low and slowing overseas markets will subdue prices in the production chain that feed into the cost of living.  Persistently weak inflation has allowed Federal Reserve policy makers, who are scheduled to meet next week, room to keep interest rates near zero after ending monthly asset purchases in October as the economy strengthens. 

SGK Blog--Update December 5, 2014: Here and There   

Here: The economy creates 321,000 jobs in November.  There: Eurozone gross domestic product rose a measly 0.2% in the third quarter.  Here: Average hourly earnings rise 0.4%, the biggest gain since June of last year.  There: The annual rate of inflation was 0.3% in November, a far cry from the European Central Bank’s (ECB) target of just below 2%.  Here: The Institute of Supply Management’s non-manufacturing index rose to 59.3 in November, the second highest level since August 2005.  There: Eurozone unemployment is 11.5%.  In terms of developed countries, it is hard to paint a more contrasting picture than the economic conditions of the United States and 18-country eurozone.  Though not every state in the union is doing great, as a whole, the U.S. has not only recovered from the 2008 financial crisis and 2009 recession trough, but is now clearly in the picking-up-steam recovery mode.  Meanwhile, our friends across the pond are still trying to get their engine started and even workhorse Germany has not been strong enough to lift the entire continent to higher ground.

Domestically, today’s employment report was above-expectations.  Not only did the monthly nonfarm payroll figure from the Labor Department beat expectations, but previous month’s numbers was revised higher as well.  Estimates of 100 economists surveyed by Bloomberg had this month’s range of an increase stretching from +140,000 to +306,000.  The revisions added 44,000 jobs to payrolls in the previous two months.  With the labor force participation rate holding steady at 62.8%, most of the focus turned to wages.  Fed Chair Yellen has made it a point that adding jobs was good but not good enough.  Workers must feel like they are making progress by seeing their real wages rise.  With average hourly earnings rising to $24.66 in November from $24.57 in October,  and that represented a 2.1% rise over the past 12 months.  Since this rise is higher than most inflation reports which are slightly below 2%, real wages are indeed rising slowly but surely based on this one report.  The key is if this will become a trend.  The unemployment rate, which is derived from a survey of households versus the payroll report which comes from businesses, held at a six-year low of 5.8%.  With the holiday gift-giving season underway, UPS, the world’s biggest package delivery company, plans to hire as many as 95,000 workers to deliver of 580 million packages this month.  Thus, such a strong report could not have come at a better time.

Meanwhile, overseas, ECB President Mario Draghi spent Thursday coming up with excuses.  The central bank kept interest rates unchanged at 0.05% at its meeting in Frankfurt.  The deposit rate remained at -0.2% as a dis-incentive for banks to hold money at the ECB and instead lend it out for investing and job creation.  Clearly, that is not happening.  The numbers below show that the situation is not only bad but also getting worse:

Bloomberg consensus: 10/13/2014     GDP 2014: 0.8%/GDP 2015: 1.3%/Inflation 2014: 0.5%/Inflation 2015: 1.1%

Bloomberg consensus: 11/17/2014     GDP 2014: 0.8%/GDP 2015: 1.2%/Inflation 2014: 0.5%/Inflation 2015: 1.0%

ECB consensus: 9/4/2014                   GDP 2014: 0.9%/GDP 2015: 1.6%/Inflation 2014: 0.6%/Inflation 2015: 1.1%

ECB consensus: 12/4/14                     GDP 2014: 0.8%/GDP 2015: 1.0%/Inflation 2014: 0.3%/Inflation 2015: 0.7%

IMF projection: 5/5/2014                    GDP 2014: 1.1%/GDP 2015: 1.5%/Inflation 2014: 0.9%/Inflation 2015: 1.2%

IMF projection: 11/4/14                      GDP 2014: 0.8%/GDP 2015: 1.3%/Inflation 2014: 0.5%/Inflation 2015: 0.9%

The ECB started a targeted long-term loan (TLTRO) program which raised 82.4 billion Euros in September, a number that was far below estimates.  Next week will be the second installment and officials are expecting more banks to step up but there is no indication they will.  The pressure mounts further because this is the only announced significant funding program that can change the picture in the near term.  The ECB has also started buying asset-backed securities and covered bonds in an effort to provide more liquidity.  The problem is that pool is far too thin to provide the necessary boost the market needs.  These instruments have assets that serve as ready collateral to support their prices.  That in itself provides a limit—the assets themselves—and curtails the firepower.  Conversely, government bonds are “open ended” meaning sovereigns can raise unlimited funds because they can levy taxes on anything they want.  That’s a big bazooka.  As we have pointed out previously, the difference between the U.S. Federal Reserve’s QE programs and the ECB is that the Fed did not wait for banks to ask for loans, they flooded the market with massive funds sending a “shock and awe” factor to the markets.  The markets are clearly waiting for the ECB to begin a QE program which targets the deep and liquid market of European sovereign bonds.  And waiting.  And waiting.  Draghi said yesterday that the governing council will decide “early next year” whether its current policies are sufficient to raise inflation toward its target.  The council has discussed “various options of QE” but it will not happen because as one analyst from HIS Global Insight said, “There is clearly still appreciable reluctance among some ECB’s Governing Council members to engage in full-blown QE”.  In other words, that “some” is one:  Germany doesn’t want to do it.  In listening to the press conference which followed the ECB meeting, it was clear that the ECB was just stalling for more time and even threw in another problem: oil prices, which will cover more in the next section.

The real solution, which Draghi has repeatedly commented upon, is for structural change.  An article in today’s Wall Street Journal highlights how complex this is for France in particular.  President Francois Hollande touted job reform in his election campaign yet there are more job seekers now than when he took office in May 2012.  Job-preservation agreements were meant to cut working hours and wages during tough times in exchange for preserving the worker’s job position.  Yet, companies are still forced to abide by a 35-hour workweek and other nationally enshrined labor rules.  Thus, an employee who refuses to cut back hours can demand severance thereby adding costs to employers.  As a result, only a handful of firms have fully implemented the agreements.  Until each firm and region can gain more flexibility, this will not change.  The situation happens over and over again in many parts of the eurozone putting more pressure on monetary policy to save the day.  Next year, the ECB goes from twelve monetary-policy sessions to eight, so each meeting, with the next on January 22nd, will take on even more importance.

SGK Blog--Update November 26, 2014: U.S. Economy Expands 3.9% in Third Quarter 

The economy in the U.S. expanded more than previously forecast in the third quarter, reflecting bigger gains in consumer spending and business investment and capping the strongest six months of growth in a decade. Gross domestic product, the value of all goods and services produced, rose at a 3.9 percent annualized rate, up from an initial estimate of 3.5 percent, Commerce Department figures showed Tuesday in Washington. The median forecast of 81 economists surveyed by Bloomberg called for a 3.3 percent gain. After the 4.6 percent increase in the second quarter, it marked the biggest back-to-back advance since late 2003. The improving economy has been helped by a strengthening labor market and gains in consumer and business sentiment which help underpin consumer spending. The outlook for growth supports the Fed’s recent decision to complete its bond-buying program, and central bankers continue to monitor economic progress while deciding when to raise interest rates for the first time in the recovery. Economists’ estimates in the Bloomberg survey ranged from 2.8 percent to 3.8 percent. The report wasn’t universally positive. Revised data for the second quarter showed the previously estimated increase in wages and salaries was cut almost in half and corporate profits last quarter rose less than in the prior three months. Consumer spending, which accounts for about 70 percent of the economy, grew at a 2.2 percent annualized rate in the third quarter compared with the previously estimated 1.8 percent. The improvement was spread across durable and non-durable goods, including recreational vehicles and restaurant meals. 

Home prices in 20 U.S. cities advanced at a slower pace in the 12 months through September as the housing market continued to make gradual progress. The S&P/Case-Shiller index of property values increased 4.9 percent from September 2013, the smallest gain since October 2012, after rising 5.6 percent in the year ended in August, the group reported Tuesday in New York. Nationwide, prices rose 4.8 percent after a 5.1 percent year-to-year increase a month earlier. Housing prices have cooled this year as more properties are put up for sale and investors retreat to the market’s sidelines. Slower appreciation will probably help foster a pickup in homeownership, particularly among first-time buyers and people having trouble obtaining credit, once wage growth becomes more pronounced. 

Consumer confidence unexpectedly declined in November from a seven-year high as Americans became less upbeat about the economy and labor market. The Conference Board’s index of consumer sentiment fell to 88.7 this month from an October reading of 94.1 that was the strongest since October 2007, the New York-based private research group indicated this week. The figure last month was weaker than the most pessimistic estimate in a Bloomberg survey of economists. The decline this month interrupts a steady pickup in sentiment since the middle of the year and shows attitudes about the economy would benefit from faster wage growth. At the same time, further confidence will probably be underpinned as stocks rally to a record, the labor market closes in on its best year since 1999 and gas prices drop to levels unseen since November 2010. The median forecast in the Bloomberg survey called for a reading of 96. Estimates of 75 economists ranged from 93.5 to 99 after a previously reported October index of 94.5. The Conference Board’s measure averaged 96.8 during the last expansion and 53.7 during the recession that ended in June 2009. The Conference Board’s index of consumer expectations for the next six months decreased to 87 this month from 93.8. The gauge of present conditions barometer dropped to a four-month low of 91.3 from 94.4. The share of Americans who said business conditions were good decreased to 24 percent, the lowest in three months.  

This report was somewhat at odds with other readings on sentiment. The Thomson Reuters/University of Michigan preliminary November gauge reached a seven-year high, while the weekly Bloomberg Consumer Comfort Index rose last week to the highest level since January 2008. The Conference Board’s data showed Americans’ assessments of current and future labor-market conditions weakened. The share of Americans who said jobs were currently plentiful fell to 16 percent from 16.5 percent. The share that said jobs were hard to get was little changed at 29.2 percent after 29 percent in October. A smaller number of consumers expected more jobs to become available in the next six months as the share fell to 15 percent from 16 percent. The share of respondents in the Conference Board’s survey that said they expected their incomes to rise in the next half year also decreased, to 16.3 percent this month from 16.7 percent in October. Thus, the actual average worker is a little more pessimistic looking ahead than some of the recent data would indicate.  

On Wednesday we received negative news on the jobs market when the weekly initial unemployment figures were released. For the week ending November 22, initial weekly claims were 313,000 versus the expectation of 288,000 and the prior week’s 292,000. Both personal incomes and personal spending came out below expectations as well. Personal income for October was +0.2% as was personal spending, whereas the forecast was for +0.4% and +0.3% respectively. The personal consumptions expenditures index or PCE for short is one of the preferred inflation measures used by the Federal Reserve. It came in at +0.2% which was just slightly above the expectation for +0.1% but not enough so as to cause concern.  Durable goods orders rose +0.4% in October beating expectations but the figure excluding transportation came in far weaker than expected. It declined 0.9% versus the expectation for a 0.5% increase. The decline was due to the fact U.S. businesses ordered less equipment such as machinery and electrical gear. Both new and pending home sales for October also came in below expectations at 458,000 and -1.1% versus forecasts for 470,000 and +0.5%. The data for both Chicago PMI, a measurement of manufacturing activity in that region, and the University of Michigan’s consumer sentiment survey for November were also weaker than forecast at 60.8 and 88.8 respectively. Overall it was not a great week for U.S. economic data – hopefully it is not a sign the economy is cooling just as we enter the important Holiday season.
SGK Blog--Update November 21, 2014: Markets Still Setting Highs as Holidays Approach   

Housing data took center stage this week. Sales of existing homes for October rose to a 5.26 million annual pace, the strongest since September 2013 according to the National Association of Realtors. The median forecast of 78 economists in a Bloomberg survey called for a 5.15 million pace with the range stretching from 5.05 million to 5.27 million. September’s number was revised higher. The median price of an existing home was up 5.5% to $208,300. With the available inventory of homes falling 3%, it would take 5.1 months to sell those houses compared to 5.3 months at the end of September. Total sales improved in three of four regions last month led by a 5.1% gain in the Midwest. Foreclosures and other distressed property sales accounted for 9% of the total last month while the share of properties sold to first-time buyers was 29%, nearly unchanged from the month prior. While the number is good, it is still too early to call it healthy. The 13-year low of 4.11 million was reached in 2008, but we remain far from the record 7.08 million in 2005.   We do not need a return to 7+ million to be healthy, but limited wage gains, growing student dent and still strict lending standards are providing headwinds, especially for the first-time buyer crowd. What is sign of future hope is residential construction permits climbed in October to a six-year high according to the Commerce Department. Plus, the National Association of Home Builders/Wells Fargo builder sentiment gauge advanced to 58 in November, matching the second-highest level since 2005, and up significantly from 54 in October. Readings above 50 indicate good market conditions. The nine-year high of 59 was reached this past September. Of course, builder enthusiasm does not always translate into sales as some realtors claim it takes 2-3 written contracts on one house before a buyer gets the financing to actually buy the property thanks to tighter standards.

Any sales of homes are predicated on a healthy job market. Jobless claims fell by 2,000 to 291,000 in the week ended November 15 according to the Labor Department. This was the 10th straight week that claims have been lower than 300,000—that has not happened since 2000. Thus, it is apparent firms are holding onto more workers in order to meet rising demand rather than firing them. The four-week average of claims climbed to 287,500 which is still considered a good number.

The pricing environment remains benign. Wholesale prices in the U.S. according to the Labor Department, rose 0.2% in October. Excluding the more volatile and food and energy sectors, the measure rose 0.4% after no change a month earlier. Therefore, the so-called core rate rose 1.8% year-over-year. Consumer prices rose slightly last month as well. The core consumer price index, which excludes food and energy, rose 1.8% from October 2013 while the overall index was 1.7% higher over the past year.  The average price of a gallon of regular unleaded gas was $2.86 as of November 18 according to auto club AAA. That was the lowest figure since November 2010. We will comment below in the Performance section how these trends affect today’s markets.

SGK Blog--Update November 14, 2014: Consumer Confidence and Retail Sales are on the Increase 

Consumer confidence rose more than forecast in November, reaching a seven-year high and indicating Americans will be in the mood to step up holiday spending. The Thomson Reuters/University of Michigan preliminary sentiment index increased to 89.4, exceeding the highest estimate in a Bloomberg survey and the strongest since July 2007, from a final reading of 86.9 in October.  The median projection called for a gain to 87.5. A stronger labor market, cheaper fuel costs, and near-record stock prices are brightening consumers’ spirits as the busiest time of the year for retailers gets under way.  Bigger wage gains would probably drive sentiment and boost household spending, which accounts for almost 70 percent of the economy. The lower cost of gasoline is analogous to giving every American a tax cut heading into the holidays! Estimates in the Bloomberg survey of 71 economists ranged from 85.9 to 89.  The index averaged 89 in the five years before December 2007, when the last recession began, and 64.2 in the 18-month contraction that followed.  

The increase in confidence this month follows a rebound in retail sales in October.  Purchases rose 0.3 percent as 11 of 13 major categories showed gains, indicating broad-based growth, figures from the Commerce Department showed today. The gauge of Americans’ expectations about the economy six months from now climbed to 80.6 in November, also the highest since July 2007, from 79.6 last month. The gauge of current conditions, which measures Americans’ views of their personal finances, jumped to 103, the highest in more than seven years, from 98.3. They have gauges for everything these days! Today’s figures are in line with other recent measures of sentiment.  The Bloomberg Consumer Comfort Index was the second-highest since January 2008 in the week ended Nov. 9 as Americans grew more upbeat about the economy. The Conference Board’s measure of confidence climbed last month to a seven-year high as consumers’ expectations for the next six months rose to its highest since February 2011.  

Employment on track for the best year in 15 is helping to underpin Americans’ spirits.  Employers have added an average 228,500 workers a month to payrolls so far this year, the strongest pace since 1999.  Economists surveyed by Bloomberg from Nov. 7-12 project the economy will add an average of 225,000 workers a month to their payrolls this year. A report yesterday from the Labor Department showed the number of unemployed vying for each available job is dropping.  About two jobless workers were pursuing each opening in September, the fewest since early 2008 and down from almost seven in July 2009. Bigger wage increases are probably in store for Americans, who are also finding relief at the gas pump. The average nationwide cost of a gallon of regular fuel was $2.91 yesterday, the cheapest since December 2010 and down from a 2014 high of $3.70 in April, according to figures to AAA, the biggest U.S. auto group.  

The drop in gasoline prices helps explain why households are more sanguine about inflation.  Consumers expect inflation to be 2.6 percent higher five years from now, matching the smallest increase since September 2002.  Further declines in the expected rate of inflation represent a risk to the outlook for demand should consumers hold back on purchases in anticipation of even lower prices. Longer-term inflation expectations as measured in the survey are at the lower end of the range that they’ve been in over the past decade. We do not want to see a persistent decline in inflation expectations below this range.  

While the news here in the U.S. was generally upbeat, the same cannot be said for information coming from overseas. Italy’s economy shrank in the third quarter pushing the nation into a fourth year of a slump that has complicated Prime Minister Matteo Renzi’s efforts to revive growth and keep public finances in check. Gross domestic product fell 0.1% from the previous three months, when it declined 0.2%, the national statistics institute Istat said in a preliminary report in Rome Friday.  That matched the median forecast in a Bloomberg survey of 22 economists.  Output was down by 0.4% from a year earlier. GDP in the euro region’s third-biggest economy has fallen in all but two of the last 13 quarters as the jobless rate rose to the highest on record.  Renzi is relying on estimated 0.6% growth next year to rein in a public debt of more than 2 trillion euros ($2.50 trillion) and preserve a tax rebate to low-paid employees aimed at reviving consumer demand. The Bank of Italy said yesterday in a report that the country needs to avoid a “recessionary demand spiral” due to the “persistence of economic difficulties, which have been exceptional in terms of duration and depth.” Italians rallied in Rome last month to protest an overhaul of labor market rules that Renzi proposed to make it easier for businesses to hire and fire workers.  The premier has repeatedly said the plan is a way to attract investments and that its framework will get parliamentary approval by year’s end before being fully implemented in 2015. Well we wish him luck in that department! 

Credit growth in China weakened last month, adding to signs that the world’s second-largest economy slowed further this quarter and testing policy makers’ determination to avoid broader stimulus measures. Aggregate financing in October was 662.7 billion yuan ($108 billion), the People’s Bank of China’s said in Beijing yesterday, down from 1.05 trillion yuan in September and lower than the 887.5 billion yuan median estimate in a Bloomberg survey of analysts.  Earlier this week, reports showed deceleration in industrial output and fixed-asset investment. The evidence underscores concern that, outside the U.S., the global economic outlook is deteriorating.  For Premier Li Keqiang, the question is whether to stick with targeted liquidity injections or embrace nationwide monetary or fiscal easing that reignites the risk of a jump in debt. The key in our view is not to further expand credit, given the weak credit demand, but to lower funding costs. A benchmark interest rate cut is likely more urgent. The central bank has added liquidity while refraining from broad-based interest rate or reserve requirement ratio cuts.  China’s benchmark money-market rate fell for a second week on speculation it will conduct more targeted fund injections.

SGK Blog--Update November 7, 2014: Unemployment Drops to Six-Year Low Near End of Earnings Season 

We will touch briefly on this week’s election results.  After the 2012 election we wrote three paragraphs in this space about what the results meant.  In retrospect, that was a waste of three paragraphs, and this time we will listen to our own advice from our November 5, 2010 weekly email: “Generally, mid-term elections result in subsequent gains for the market and even split party control of Congress has positive historical results.  Regardless, past results are no guarantee of future results and we stress that interest rates and earnings are much more important than anything that Capitol Hill does on a daily basis.”   How did the markets react?  A “calamitous” 0.01% fall in the S&P 500 on the day of elections, and a “whopping” 0.57% gain on the day after.  In other words, investors saw no real change in market direction based upon how many votes went to either major party on Tuesday.  This has been one of the most unproductive Congresses in memory, and the consensus on Wall Street is that trend will not end anytime soon.  

The employment picture got more data points this week.  According to the Labor Department, employers added 214,000 non-farm payrolls for October and September’s figure was revised higher by 31,000.  The consensus figure was for an advance of 235,000 but with the six month average job growth at 235,000 and the three month average at 224,000, a miss below the consensus figure is not a big issue since we remain well into the 200,000+ number for the ninth consecutive month.  A survey of households revealed that the unemployment rate fell to 5.8% last month from 5.9% the previous month.  The 5.8% figure is the lowest since July 2008.  Job growth was broad-based with retailers, restaurants and factories all adding to positions.  The labor force participation rate also crawled higher to 62.8% from 62.7% in September.  These numbers show that job creation has not been a problem recently and with initial jobless claims falling to 278,000 in the week ended November 1, companies are firing less and less.  The one criticism that can be levied revolves around wage growth.  Average hourly earnings rose 0.1% in October from the prior month.  That means wages were up 2% over the past twelve months.  With the consumer price index up 1.7% over the past year and the personal consumption deflator higher by 1.4%, both proxies for inflation, workers are indeed making some ground in “real” gains.  But the progress has been uninspiring and slower than trend considering the recession officially ended six years ago and we recently have had so many months of payroll growth.  This means that the slack that has been present in the labor market is just now beginning to lessen.  The Fed mentioned this last week when they referred to an “underutilization of labor resources” that is “gradually diminishing.”  The greatest fear for the Fed is a repeat of the horrible mistake of 1937 when, during the depression, the central bank increased interest rates to fight inflation before the economy was fully recovered thus crushing the nascent recovery and further worsening the situation.  This exact problem is happening in Sweden.  Sweden’s central bank, the Riksbank, is the world’s oldest yet that experience did not prevent them from raising rates in 2010 and 2011 only to turn around and aggressively start cutting them shortly after.  That country has now experienced falling prices in 16 of the pasts 24 months and last week cut their interest rate to 0% to counter the deflation.  The Fed fears following in these same footsteps.    

Meanwhile, U.S. manufacturing expanded in October according to the Institute of Supply Management (ISM).  It’s factory index rose to 59 last month, matching August as the highest figure since March 2011.  A reading above 50 indicates expansion.  The new orders measure rose to 65.9, the second highest level since August 2009.  Even though the majority of the U.S. economy is related to services not manufacturing, this gauge shows that the slice devoted to factories hit on all cylinders in October.  In contrast, European manufacturing barely grew last month as output in France and Italy contracted.  This shows that U.S. managers are confident enough in the future to keep their production lines going hoping to capture some of the demand created by a stronger job market, relatively cheaper gasoline and near rock-bottom interest rates on everything from cars to houses.  Additionally, the ISM services index also released this week showed growth with a 57.1 reading for October.  While that was lower than September’s 58.6 figure, it exceeded the 54.4 average for the first six months of the year.  The services survey covers industries such as retailing, health care, agriculture and finance among others and make up 90% of the U.S. economy.

SGK Blog--Update October 31, 2014: Fed Bets on Job Gains, Unshaken by Global Market Turmoil

On Monday, the European Central Bank and the European Banking Authority announced the results of a nearly yearlong effort to assess the finances of 150 banks. Past efforts have not been credible, largely because in the past they did not disclose their methodology or much detail on the results. It did not help that several banks they had passed previously soon ran into financial difficultly and a number actually failed. So this time around, they were determined to get it right. They identified 13 banks that needed to come up with an additional $12 billion in extra capital. Overall, 25 failed the more rigorous stress tests, modeled after ours here in the U.S., but 12 of these banks had already taken steps throughout the year to raise capital to fund the shortfall. To pass the tests, banks had to show they had ample capital to survive a crisis that would cause Europe’s economy to fall 7% below current forecasts and the unemployment rate to rise to 13%. This was important because for the European Central Bank (ECB), this marked the final milestone before they take over supervision of major eurozone banks on November 4th. Turning the ECB into the currency union’s bank watchdog is a key step to setting up a so-called eurozone banking union. We have been arguing for years this would be in important step for the European Union. The hope of course is that moving control over important banks out of national hands will prevent the kind of banking crisis that rocked Ireland, Spain and Cyprus in recent years. 

When the Federal Open Markets Committee met this week, they basically left policy unchanged – perhaps disappointing some traders that were hoping for a more dovish outlook given recent volatility in markets. Federal Reserve officials dismissed recent turmoil in global financial markets, and focused instead on “solid” employment gains that will keep them on a path toward an interest-rate increase next year. A majority of U.S. policy makers at their meeting Wednesday also set aside concerns, both among their own members and in financial markets, about too-low inflation, voting to proceed with plans to end their third round of asset purchases. The Federal Open Market Committee maintained its commitment to keep interest rates low for a “considerable time.” The committee cited “solid job gains and a lower unemployment rate” since its last gathering in September. It said “underutilization of labor resources is gradually diminishing,” modifying earlier language that referred to “significant underutilization.”  

Non-farm payroll gains have averaged 227,000 this year, heading for the best showing since 1999. That has helped push the unemployment rate down to 5.9 percent in September, just 0.4 percentage point above the top end of a range Fed officials consider full employment. Such indicators of a strengthening economy outweighed policy makers’ concerns about decelerating inflation. Oil prices are down about 17 percent this year, partly due to weaker global growth prospects. Inflation expectations, measured by yield differences on U.S. Treasury notes and government inflation-linked bonds, signal inflation could remain below the Fed’s 2 percent target for several more years. The personal consumption expenditures price index rose just 1.5 percent in August from a year earlier, the 28th month in a row it has been below 2 percent. Policy makers want to maintain a minimum level of inflation, because falling prices can encourage businesses and consumers to delay spending in the expectation of further price declines, reducing demand. “Although inflation in the near term will likely be held down by lower energy prices,” the FOMC said in its statement, policy makers determined that the risk of inflation remaining “persistently below 2 percent has diminished somewhat.”  

The economy in the U.S. expanded more than forecast in the third quarter, capping its strongest six months in more than a decade, as gains in government spending and a shrinking trade deficit made up for a slowdown in household purchases. Gross domestic product grew at a 3.5 percent annualized rate in the three months ended September after a 4.6 percent gain in the second quarter, Commerce Department figures showed Thursday in Washington. It marked the strongest back-to-back readings since the last six months of 2003. The median forecast of 87 economists surveyed by Bloomberg called for a 3 percent advance. Growing oil production is limiting imports and contributing to a pickup in manufacturing, allowing the economy to overcome slowing growth in overseas markets from Europe to China. At the same time, job gains and cheaper gasoline are giving American consumers the confidence and the means to spend, brightening the outlook for the holiday-shopping season and helping explain why the Federal Reserve ended its bond-buying program in their announcement Wednesday. Another report Thursday showed jobless claims rose by 3,000 to 287,000 in the week ended Oct. 25, in line with the median forecast of economists surveyed by Bloomberg, according to the Labor Department. The four-week average, a less volatile measure than the weekly figures, declined to 281,000, the fewest since May 2000.  

The economy’s second quarter’s 4.6 percent jump in gross domestic product reflected a rebound from a 2.1 percent slump in the first quarter that partly reflected a harsh winter. Now the economy appears to be maintaining a pretty good pace off of that rebound. Consumer spending, which accounts for almost 70 percent of the U.S. economy, climbed at a 1.8 percent pace last quarter after growing at a 2.5 percent rate in the previous three months, the Commerce Department report showed. The gain in household consumption compared with a 1.9 percent median forecast in the Bloomberg survey. Purchases added 1.2 percentage points to growth. Improving consumer sentiment may help lift the biggest part of the economy this quarter. Confidence this month jumped to a seven-year high coming in at 94.5, according to figures from the Conference Board, and this compared to an expectation for a figure of 87.2 and September’s figure of 89.  

The Bank of Japan surprised markets overnight Thursday by boosting stimulus measures and this lifted global equity indices and U.S. S&P 500 futures in pre-market trading Friday. Their central bank raised its annual target for monetary expansion to 80 trillion yen ($724 billion) from as much as 70 trillion yen. Additionally, Japan’s Government Pension Investment Fund (GPIF) said it will put half its holdings in local and foreign stocks, double previous levels, and invest in alternative assets. While this is only one fund and may not seem significant on the surface, they are taking their allocation to Japanese stocks to 25% from the previous 12% level and they are increasing their exposure to foreign stocks, including U.S. equities, to 25% as well from the previous 12% level. This fund has $1.2 trillion in assets so this news, combined with their central bank stimulus, sent their Topix index along with the Nikkei 225 index soaring overnight. 

Finally, in other U.S. economic news, we saw early in the week weakness in durable goods orders for September as that figure came out at -1.3% versus the expectation for +0.6%. Excluding transportation, the so-called core rate, it came out at -0.2% versus the expectation of +0.5%. The Case-Shiller 20-city Index of home prices for August rose 5.6% which was relatively in-line with expectations. This showed that despite some volatility in recent housing figures, the recovery in home prices remains intact. On Friday figures for personal income and personal spending for September at +0.2% and -0.2% respectively were below expectations. This does raise concerns as to whether the pace of growth can continue here in the U.S. without a substantial improvement in employment. With wage gains just barely keeping pace with inflation and home prices cooling, this clearly dampened consumers thirst to spend money, at least in the month of September. Finally, the Chicago purchasing managers index or PMI came out well above expectations at 66.2 showing a pick-up in manufacturing in that region while the University of Michigan consumer sentiment survey also came out Friday slightly above expectations at 86.9.

SGK Blog--Update October 24, 2014: Earnings Make Headlines  

Most of this week’s news surrounded quarterly earnings reports from companies. However, there was economic data which was released and will play a role in how the Federal Reserve reacts going forward. The Conference Board’s index of leading indicators climbed 0.8% in September after an unchanged reading in August. The gauge measures the outlook for the next three to six months and shows that, in general, the environment remains positive. The Labor Department released consumer price data for September which showed a moderate inflationary environment. The index rose 0.2% or 1.7% in the 12 months ended in September, the same as in the year ended August. Excluding food and energy, the so-called core measure advanced 0.1% and also climbed 1.7% year-over-year. The current figures remain close to the 2% level the Fed is looking for. However, disinflationary trends are becoming more evident. The average cost of a gallon of regular gasoline fell to $3.09 according to AAA, the biggest U.S. motoring group. That is the lowest level since 2011. Food costs actually rose 0.3% but the bull market in such commodities is likely over. The trade weighted dollar is gaining strength versus other currencies which makes exports more expensive to overseas buyers and lowers the price of imports brought into the country. With inflation in the eurozone running closer to 0.3%, the fear is that such disinflationary pressures will make their way to our shores. That matters because the Fed will become more and more reluctant to raise its target rate for overnight loans through their main tool, the Fed funds rate. The interest rate futures market has for some time expected the first rate increase to happen in the second half of next year and not in the first half as implied by the latest Fed minutes. So far, they have been right while the Fed’s economic crystal ball seems a little cloudy.

In terms of domestic housing, another key economic data point, we received two pieces of housing data this week. Existing home sales rose 2.4% to a 5.2 million annual rate according to the National Association of Realtors on Tuesday. The median price of an existing home rose 5.6%, and distressed sales, comprised of foreclosures and short sales, account for only 10% of the total. On Friday, new home sales data was released from the Commerce Department. These sales rose 0.2% to a 467,000 annualized pace from a 466,000 rate in August. The median sales price of a new home dropped 4% from September 2013 to $259,000. New home sales are tabulated when contracts are initially signed making them a timelier barometer than existing home sales which are totaled when the transaction actually closes. Home buyers got a piece of good news when regulators proposed that banks did not have to require 20% down payment on a transaction if the bank decided to package that loan into a mortgaged backed security. This requirement has been sighted as one of the main reasons why the private MBS market has had such a hard time recovering and why real-estate groups and consumer advocates have argued that credit for mortgages has been too tight. Banks either had to require the 20% level or hold 5% of the risk from the mortgages they packaged which ultimately frightened off many institutions. New rules proposed by Federal Housing Finance Agency also are attempting to expand credit by allowing giants Fannie Mae and Freddie Mac to guarantee loans with down payments of as little as 3%. Might this lead to the same problems which were are the root of the 2008 financial crisis? Potentially. As long as private lenders can verify the ability to pay the loan and ensure that the debt-to-income ratio does not exceed 43%, the regulators argue the previous requirements are unnecessary. Regardless, the potential for unforeseen consequences remains high: What happens if someone loses a job? Who is going to bail out the firms that go under—the government or the public? No rules have been changed yet, but it is imperative that regulators do think through all the potential outcomes of changing the market.

Meanwhile, across the Atlantic Ocean, on Sunday the European Central Bank (ECB) will release results of their latest and greatest stress tests. The tests, administered by the European Banking Authority, will determine how lenders can weather differing degrees of economic downturn. The previous stress tests were deemed failures because their results were soon discredited when banks that passed the test only weeks later were forced into the arms of bank regulators for not having enough capital. The ECB will begin to oversee eurozone banks on November 4 which is seen as a key moment because it will be a pan-European authority with regulatory power over individual private, national banks for the first time. However, even that power is limited. The ECB can tell a bank it needs to inject capital, but it cannot promise that a government will do so if the bank cannot or is not willing. Many analysts also blame these tests as the reason why recent ECB quantitative measures have been met with ho-hum responses. Banks are afraid to reach for more lending if the results show they are undercapitalized. Bottom line: be prepared for some fireworks from Europe come early morning Monday trading.

SGK Blog--Update October 17, 2014: Earnings Season Kicks Off While Indicators Point to Slowing International Growth 

The week started out on a sour note as late day selling on Columbus Day drove the major averages further into the red for the month of October – putting the Dow into negative territory for the year. Trading is typically light on a pseudo holiday but all the same stocks did not react well to the fact that the bond market was closed for trading. What prompted the selling Monday? Clearly mutual funds were hit by redemptions as a lot of the decline occurred in the last hour of trading. This is part of the reason we are thankful here at SGK we do not have to manage a mutual fund as frequently the timing of investor redemptions in mutual funds is terrible. The other factors were simply a carryover from the prior week. Fed officials said over the weekend that the threat from an international slowdown may lead to rate increases being delayed. The remarks highlighted mounting concern over the improving U.S. economy’s ability to withstand foreign weakness and a strengthening dollar. The International Monetary Fund cut its forecast for global growth the prior week and said the euro area faces the risk of a recession. The IMF also said that the chances of equity losses in 2014 have risen and stock valuations may be “frothy.” European Central Bank President Mario Draghi indicated the prior week that there are signs the euro-area’s economic growth is slowing and policy makers must lift inflation from an “excessively low” level. So we witnessed a sell-off the previous week that carried over to trading on Monday, in a market that clearly showed signs that liquidity was lacking as stocks could not take direction from the bond market due to the holiday.

Markets continued the negative trend in Tuesday and Wednesday trading before stabilizing Thursday and rebounding in Friday trading. So what drove all the volatility this week? Before we get to the economic data, it would appear judging from the way the U.S. ten year Treasury bounced around during the week that some of the volatility was driven by hedge fund trading, in addition to the aforementioned mutual fund redemption activity. Many hedge funds had been producing sub-par results on a year-to-date basis so a number of the top hedge fund managers had simply gone long the equity market. They had finally thrown in the towel and adopted the “why fight the tape” philosophy. When that directional movement rapidly reversed course, we witnessed a large amount of selling take place to try to get in front of the tape as they say. Hedge funds will tend to use leverage to enhance returns so when the trend starts to move against them it can result in a rapid amount of sell orders hitting the market all at the same time. The flip side of that trade is if they shifted strategy and went short the market then they were again caught off guard by some of the better U.S. economic data on Thursday/Friday and some comments from the Fed. So once again we potentially witnessed a high level of short covering in Friday’s market. This is why we do not run a hedge fund here at SGK – it is too expensive and risky a structure in our view.  

Helping matters too is the fact that as companies here in the U.S. have released earnings results, the results have been not that bad, in fact many of our core holdings are producing very good results. So traders may have over-compensated during the sell-off earlier this week and last week for weakness in Europe and the negative currency adjustment that would inevitably show up in earnings due to the strong U.S. dollar. We have listed the earnings below for four of our companies that did release results this week and even in the oil and natural gas segment – the results were pretty good. As far as the data on the U.S. economy this week, early week releases were not very encouraging. Retail sales were -0.3% for September and -0.2% excluding autos – both were below expectations. The figures for the producer price index (PPI) and core PPI (excluding food and energy) were -0.1% and 0% respectively, again both below expectations and stoking deflation concerns. Finally on Tuesday, the Empire manufacturing figure came out at 6.2 for October which was well below the forecast for 20.4.  

Thursday and Friday we had more encouraging news on the U.S. economy and U.S. markets responded the way they should, with interest rates coming off the lows and stocks stabilizing then rebounding on Friday. Initial weekly jobless claims ending 10/11/2014 fell to 264,000 compared to the estimate for 290,000. Industrial production and capacity utilization, indicators of factory output in our economy, came out at +1.0% and 79.3% respectively for September, both figures exceeding expectations. The Philadelphia Fed for October beat expectations at 20.7. Finally on Friday we had reports on housing starts and building permits and at 1,017,000 and 1,018,000 for September both indicators showed the housing sector remains robust. Despite all the turmoil in equity markets over the past two weeks, the University of Michigan consumer sentiment survey for October released mid-morning Friday came in at 86.4 which was well above the expectation for 84.0 and the prior month’s 84.6. 

One of the things that does provide us with an advantage over other economies such as those in Europe, is the resiliency of the all-mighty U.S. consumer. Call it America’s $11 trillion advantage: Consumer spending is likely to steer the U.S. economy safely through the shoals of deteriorating global growth and turbulent financial markets. There is no question in our minds the combination of more jobs, falling gasoline prices and low borrowing costs will help lift household purchases. Such tailwinds probably matter more than Europe’s struggles or the slackening in emerging markets that caused the Dow Jones Industrial Average to erase its gains for the year earlier this week. Household purchases make up almost 70 percent of the $16.8 trillion U.S. economy and have climbed an average 2 percent in the recovery that’s now in its sixth year. Spending growth will accelerate to 2.7 percent next year after 2.3 percent in 2014, according to the latest Bloomberg survey of economists. The poll, taken from Oct. 3 to Oct. 8 in the midst of the meltdown in equities, showed little change in the median projections from the prior month. The economy is forecast to expand 3 percent in 2015 after 2.2 percent growth this year, according to the survey. While consumer sentiment can correlate with sharp movements in stock prices, so far economists have not adjusted their forecasts lower.
SGK Blog--Update October 3, 2014: Fed Still on Hold as Market Shakes

With companies just beginning to report third quarter earnings, investors turned all their attention to the release of the minutes of the Federal Open Market Committee’s September meeting. After a depressing 1.5% decline in the S&P 500 just a day earlier, many were expecting further trouble. The International Monetary Fund had released updated estimates for global growth on Tuesday which were even lower than the estimates released just a few months earlier. The world economy was predicted to grow at 3.8% in 2015, down from the 4% rate given in the July forecast. The World Economic Outlook stated: “In advanced economies, the legacies of the precrisis boom and the subsequent crsisi, including high private and public debt, still cast a shadow on the recovery.” In fact, they went so far as to call stocks overvalued: “Downside risks related to an equity price correction in 2014 have also risen, consistent with the notion that some valuations could be frothy.” They did not name specific markets, but considering that the S&P 500 has registered five consecutive years of annual gains, not a lot of guessing was involved. But they did name the U.S. as one of the few bright spots. The IMF expects the U.S. economy to grow at 2.2% for 2014, higher than the 1.7% rise expected back in July. Next year, that growth is expected to expand to 3.1%. This compares to the euro area where growth of 1.3% in 2015 is slower than the 1.5% pace previously estimated. This follows an anemic 0.8% gain this year.

The reaction to the release of the Fed’s minutes on Wednesday afternoon provided a boost of unexpected optimism. The key phrases were, first: “a number of participants noted that economic growth over the medium term might be slower than they expected if foreign economic growth came in weaker than anticipated…” Additionally, “Some participants saw the current forward guidance as appropriate in light of risk-management considerations, which suggested that it would be prudent to err on the side of patience while awaiting further evidence of sustained progress toward the committee’s goals.” In other words, the Fed was in no hurry to change their current outlook. This ran counter the belief in the markets that they might indeed move to raise interest rates sooner than anticipated; that is, before June of 2015. The Fed has not raised rates since 2006 so even the hint of a jump is enough to push equities lower since low rates plus quantitative easing have been the main fuel for adding liquidity to the markets and herding investors to the higher risk, higher return profile of stocks. Plus, with the euro down against the dollar by around 7% this year, the stronger currency is acting a pseudo-tightening because it lowers inflationary pressures by making imports cheaper.

With the unemployment rate at 5.9%, it is getting close to levels where there is pressure to start normalizing policy. In the week ended October 4, initial jobless claims declined by 1,000 to 287,000 according to the Labor Department. That is the lowest level in eight years for that stat. Earlier this week, the Labor Department released their monthly Job Openings and Labor Turnover Survey (JOLTS). It showed the number of available jobs rising by 910,000 in the year ended August, the biggest 12-month gain since records began in December 2000. However, the hiring rate dropped to 3.3%, the lowest since January, from 3.6% in July. Fed chairwoman Yellen said the divergence between openings and hirings could point to economic slack. Nevertheless, it is hard to argue that with the three month average payroll creation hovering around 225,000, the labor market is not strengthening. We have yet to see a real breakthrough in the real wages yet, but it seems only a matter of time at this point. Over time, history has shown that the more jobs are created, the higher wages eventually rise. Since wages comprise about 70% of the average private payroll, that will be the trigger to get the Fed’s attention. Until that happens, investors will just have to keep watching the data, just like the Fed is doing.

SGK Blog--Update October 3, 2014: Signs of Slowing Growth in Europe and China Dampen Enthusiasm for Stocks 

The first trading day of the fourth quarter did not start well for stocks as a number of international issues seemed to rear their ugly heads all at the same time. Data came out Wednesday indicating euro-area factories reduced prices by the most in more than a year and German manufacturing shrank, underlining the mounting challenge policy makers faced before the European Central Bank meeting Thursday. A spokesperson for the German government said Russia risks an escalation of sanctions given the continued turmoil in the Ukraine. This conflict escalated again this week and it threatens to tip Europe back into recession. Italy cut its growth forecast this week. Economists are forecasting growth in Asian countries, including China and Japan, may continue to slow through 2016. Our Treasury yields here in the U.S. have gained versus German bunds for a record nine quarters as the European Central Bank has unveiled a series of stimulus measures to boost credit lending and combat the threat of deflation. The ECB was forecast to announce Thursday details of its plan to buy asset-backed securities. The ECB is on a mission to avert deflation as the euro region’s economic landscape deteriorates. Purchasing Managers’ Indexes from Markit Economics showed manufacturing also contracted in France, Austria and Greece, with a gauge for the 18-nation region pointing to near-stagnation. A separate report showed spillover to the U.K., with factory growth there at a 17-month low. All this negativity and the increase in our yields here in the U.S. relative to other countries has resulted in a steady increase in the value of the U.S. dollar compared to other currencies. The Brazilian real depreciated 1.3 percent and South Korea’s won dropped to a six-month low this week. Pro-democracy protests continued in Hong Kong for a sixth consecutive day this week with markets in the city and China shut for holidays. All this added up to a sell-off in stocks and a rally in high quality bonds, emphasizing the importance of maintaining proper balance in our portfolios.

When the European Central Bank did come out and announced their asset purchase plans, equity markets in Europe did not respond well as traders criticized the program as lacking “the big bazooka” – in other words not being large enough to shake European countries from the slow growth mode and deflationary trend. The ECB announced they will buy assets for at least two years to boost inflation and economic growth in the euro area, ECB President Mario Draghi said. The Frankfurt-based central bank will start buying covered bonds this month and plans to purchase asset-backed securities starting this quarter, Draghi said Thursday at a press conference in Naples, Italy, after the ECB left interest rates unchanged at record lows. “These purchases will have a sizable impact on the balance sheet,” he said. Unlike our program that our Fed Chair Ben Bernanke announced with his quantitative easing measures, Draghi was vague and, when asked, he was not very specific as to whether there would be set target amounts for purchases on a monthly basis. This caused traders to question the enthusiasm behind the program, Germany has been against it from the start, and made them wonder just how big Draghi was willing to expand the ECB’s balance sheet. The ECB’s asset-buying plan is part of a range of stimulus measures it has announced since June to fight the threat of falling prices in the 18-nation currency bloc. Inflation slowed to 0.3 percent last month, the least in almost five years, and the central bank’s preferred measure of medium-term inflation expectations has extended its decline.  

Here in the U.S., compounding the sell-off Wednesday, a report showed U.S. manufacturing cooled in September following the strongest rate of growth in three years, while, according to the report from payroll company ADP, companies accelerated hiring for the first time in three months. The concern here is that although the economy may be showing signs of slowing, with more hiring that could lead to wage inflation and that would be a bad combination. It may prompt the Fed to take action on interest rates sooner than expected. The Fed is set to end later this month its asset purchases under its so-called quantitative easing programs. The Russell 2000 tumbled 7.7 percent in the third quarter, its worst performance in three years, as traders sold speculative stocks. There has also been pressure on riskier assets such as junk bonds as the Fed increases its scrutiny of asset classes such as leveraged loans. We consider these latter two asset classes riskier areas of the market and as such we avoid these types of securities. The Russell 2000 Index is approaching a 10 percent retreat from an all-time closing high on March 4. 

For the most part, the economic data here in the U.S. had a slightly negative tone to it this week. The Institute for Supply Management’s manufacturing index dropped to 56.6 from 59 in August, the gauge’s average over the past three months was the highest since early 2011, figures from the Tempe, Arizona-based group showed Wednesday. Construction spending in the U.S. fell 0.8% in August versus the expectation for a 0.4% gain and the prior month’s 1.2% gain. A measure of consumer confidence for September dropped to 86.0, below the expectation for 92.0 and having dipped from the prior month’s 93.4. Early in the week personal income and personal spending came in at about expected levels at +0.3% and +0.4% respectively. Pending home sales in August declined 1.0% compared to the forecast for a 0.2% drop while home prices for July increased 6.7% relative to the forecast for a 7.4% year-over-year gain. Initial weekly jobless claims figures for the week ending 9/27/2014 were a bright spot as they came in at 287,000 versus the expectation for 297,000. However enthusiasm was dampened that day as August factory orders here in the U.S. declined 10.1% versus the expectation for a 9.3% drop. So overall the data was not bad – just not as good as expected.  

Helping salvage stocks on Friday was the surprisingly strong September jobs report here in the U.S. Employers added 248,000 new jobs versus the expectation for 210,000 and the August figures were revised upwards to 180,000 new jobs created compared to the previous estimate of 142,000. The jobless rate fell to 5.9% from the figure for August of 6.1%. Average hourly earnings were unchanged in the report, which although considered a negative from the standpoint of an economist, a trader would view that as a sign that we are not seeing the wage inflation that would potentially spook stock traders. Stocks rallied and interest rates on the short end of the yield curve rose but overall we did not see a spike higher in the yield on the U.S. 10-year Treasury despite the strength of the report and in fact the yield on the 30-year Treasury actually declined Friday. So we witnessed a relief rally in stocks Friday and potentially some short covering as well as the market remained fairly robust throughout the day, although it did close down for the week.
SGK Blog--Update September 26, 2014: Market Looking for Guidance  

With the earnings conference call season about three weeks away, the market was able to focus on economic data this week.  First up was information about housing.  New home sales surged in August to the highest level in more than six years.  According to the Commerce Department, sales rose 18% to a 504,000 annualized pace last month.  That was higher the highest forecast in a Bloomberg survey of economists and the strongest since May 2008.  The median sales price of a new home rose 8% from August 2013 to $275,600.  The supply of new homes at the current sales rate dropped to 4.8 months from 5.6 months in July.  This is a sign of a healthy market.  New home sales are viewed as more timely than existing home sales because the former is tabulated when contracts are signed.  New home sales, however, only make up about 8% of the residential market.  Speaking of which, on Monday data for previously owned homes was also released.  According to the National Association of Realtors, existing home sales dropped 1.8% to a 5.05 million annual pace in August.  The median forecast in a Bloomberg survey was for a 5.2 million pace.  The median price of an existing property sold rose 4.8% to $219,800 in August from $209,700 a year earlier.  At the current pace, it would take 5.5 months to sell the 2.31 million in inventory.  This is still considered a healthy pace especially considering that the share of properties sold to investors was the lowest in almost five years.  These transactions, which include foreclosures and short sales accounted for only 8% of the market, the fewest since records began in October 2008.  Existing home sales are tabulated when a purchase contract closes making them a little less timely than new home sales by a few weeks to a few months.  Currently, the sales pace is closer to the middle-bottom range of the record 7.08 million sold in 2005 and low of 4.11 transactions in 2008.  Our conclusion is that the residential housing market continues to grow but the recovery has been slow and steady instead of robust.  In general, the economic recovery has had a less steep slope than in past cycles.  This is not unexpected given the severity of the financial crisis in 2008-2009.   

First time jobless claims rose 12,000 to 293,000 in the week ended September 20 according to the Labor Department.  Claims reached a 14-year low of 279,000 in mid-July so we are not that far from that figure.  The figure fell near the middle of estimates that ranged from 275,000 to 320,000.  Demand for durable goods, those meant to last at least three years, fell 18% in August.  Looking inside the numbers, the headline figure is not as bad as feared.  Commercial aircraft orders jumped in July and given that these orders often come in irregular chunks, a fallback was not unexpected.  Civilian aircraft bookings fell by 74% after rising 316% in July.  Excluding aircraft figures, the index actually rose 0.6% for non-defense capital goods according to the Commerce Department.  Similarly, demand for automobiles fell 6% last month, but this was after a 10% surge in July.  Excluding all transportation equipment, durable orders were up 0.7% which reflects a favorable environment for growth.

The final economic data point of the week was released on Friday and involved the latest revision of second quarter GDP.  The U.S. economy expanded in the second quarter at the fastest rate since 2011.  GDP grew at a revised 4.6% rate compared to the previous estimate of 4.2%.  Inventories added 1.42 percentage points to GDP while final sales, which exclude inventories, rose 3.4% compared with a previously reported 3.1%.  Overall, a fairly positive report as the third calendar quarter and government year-end arrives next Tuesday.

SGK Blog--Update September 19, 2014: Federal Reserve Vows To Keep Interest Rates Low While Adjusting Rate Forecasts Higher 

The Federal Reserve maintained a commitment to keep interest rates near zero for a “considerable time” after asset purchases are completed, saying the economy is expanding at a moderate pace and inflation is below its goal. “Labor market conditions improved somewhat further” while “significant underutilization of labor resources” remains, the Federal Open Markets Committee said Wednesday in a statement in Washington, DC. “Inflation has been running below the committee’s longer-run objective.” In July, the Fed said inflation was “somewhat closer” to its goal. Policy makers tapered monthly bond buying to $15 billion in their seventh consecutive $10 billion cut, staying on course to end the program in October. Bond purchases intended to hold down long-term interest rates have swelled the Fed’s balance sheet to $4.42 trillion. Even so, Fed officials raised their median estimate for the federal funds rate at the end of 2015 to 1.375 percent, compared with 1.125 percent in June. The rate will be at 3.75 percent at the end of 2017, the Fed said today for the first time as it included that year in its Summary of Economic Projections. That is the same as Fed officials’ longer-run estimate. The median estimate in June for the long-run fed funds rate was also 3.75 percent.  

Fed Chair Janet Yellen and her Fed colleagues are debating how much longer to keep interest rates near zero as they get closer to their goals for full employment and stable prices. At the same time, they are considering a change in guidance on the outlook for borrowing costs to give them more flexibility to react to the latest economic data. “The likelihood of inflation running persistently below 2 percent has diminished somewhat since early this year,” according to the statement. The personal consumption expenditures index, the central bank’s preferred price gauge, increased 1.6 percent in July from a year earlier and hasn’t exceeded the Fed’s 2 percent objective since March 2012. The Fed repeated that it will consider a wide range of information in deciding when to raise the benchmark federal funds rate, which it has kept near zero since December 2008. Bond purchases will be divided between $10 billion in Treasuries and $5 billion in mortgage-backed securities.  The Fed also said it will maintain its policy of reinvesting maturing debt. Dallas Fed President Richard Fisher and Philadelphia Fed President Charles Plosser dissented. The Fed published new guidelines for its exit strategy, saying that the phaseout of reinvestment “will depend on how economic and financial conditions and the economic outlook evolve.” FOMC participants said the main tool to move the federal funds rate will be changes in the interest rate it pays on excess reserves. Fed officials said reverse repurchase agreements will be used “as needed” to help control the fed funds rate and will phase out later. 

Stocks actually got a lift after the Fed meeting despite the fact that interest rates did move higher, especially on the short end of the yield curve. Perhaps this was due to Yellen’s calming comments during her news conference after their statement was released. They did articulate the procedures and mechanisms for altering policy very clearly even if they were a little vague on the exact criteria. The Fed in our view is doing a very good job of articulating policy and the news conferences are a great way to expand on their views. Janet Yellen is so far doing a fine job. Considering the current Fed Funds rate is between 0-0.25%, we were a little surprised the increase in their forecast to 1.375% by year end 2015 did not have more of an impact on both stock and bond prices. The bond market is predicting that the Fed Funds rate will not be that high. The fact that bond prices did not actually move much after their announcement had a calming effect on the stock market, which had actually turned negative immediately following the release of the statement.  

Also helping matters was the release earlier in the day of the figures for the Consumer Price Index (CPI) for the month of August which showed a decline of 0.2% versus the expectation for a flat figure. The core rate, excluding food and energy, was flat versus the expectation for an increase of 0.2%. Earlier in the week, the producer price index (PPI) came out exactly in-line with expectations as it was also flat for August with the core rate increasing only 0.1%. Contributing to the relative calm markets demonstrated this week, housing starts and building permits came out and were well below expectations at an annualized rate of 956,000 and 998,000 respectively in August. Initial weekly jobless claims for the week ending 9/13/2014 were below expectations (a positive) coming in at 280,000 versus the expectation for a figure of 305,000.  Industrial production for August was -0.1% while capacity utilization slipped to 78.8% from the prior month’s 79.1%. Both figures were also below expectations. The fact that the U.S. economic news was very mixed this week with many figures coming in below expectations helped alleviate concerns the Fed would act to increase rates too quickly. Earlier in the week amidst signs of a slowdown in manufacturing and slipping home prices in China, their central bank provided monetary easing in the form of adding 500 billion yuan to the nation’s largest commercial lenders via its standing lending facility. This helped lend support to Asian markets overseas and that spilled over to U.S. markets this week too.

SGK Blog--Update September 12, 2014: Apple Unveils New Products as U.S. Retail Sales Rise  

During the week that many were focused on the new products from Apple, the Commerce Department reported retail sales for August climbed at the fastest pace in four months.  The 0.6% gain matched the median forecast surveyed by Bloomberg and came after a stronger-than-prior reading of 0.3% in July.  Auto dealers and building materials stores led the advance with auto dealers registering a 1.5% rise, the best since March.  Sales of cars and light trucks rose to 17.5 million annualized in August according to Ward’s Automotive Group, the highest level since January 2006.  Excluding autos, retail sales rose 0.3% which also matched the median forecast.  The auto group AAA reported that regular gasoline sold at an average of $3.42 a gallon as of September 10, the lowest in more than six months.  The U.S. produced 8.59 million barrels a day of crude oil production in the week ended September 5 based on EIA data.  In 2008, that figure was 5 million barrels a day.  Volume may soon eclipse the 1970 high of 9.6 million barrels a day if the trend continues. 

Higher spending by consumers goes hand-in-hand with a better job picture.  Though last week’s job data was below estimates, it did not derail confidence.  This week the Labor Department reported that the number of Americans filing for unemployment benefits rose 11,000 to 315,000 in the week ended September 6.  This was the highest reading since June 28 and exceeded the median of 300,000 forecasted.  The less volatile four-week average rose to 304,000 from 303,250 a week earlier.  This data will be heavily analyzed by the Fed in its regularly scheduled meeting Federal Open Market Committee meeting next week.  It will be an important meeting because it will also include a post-meeting press conference with Fed chair Yellen.  This will be the last time the Fed will have before the media before their latest quantitative easing program is expected to end next month.  So we assume that if there is anything truly market-moving to be revealed, it will be done next week.  That said, we are not expecting any earth-shaking event.  The job market has improved since the Fed started its tapering program late last year but we have yet to see any real, sustainable growth in real wages.  That is, nominal growth minus inflation equals real changes.  With inflation running about 1.8%-2.0% on a yearly basis and wage growth near that range, employees have kept pace but not really made progress in accumulating wealth through wage income.  From a company perspective, that is good because demand is increasing for goods and services, yet employers are not pressured to raise wages quickly because the available pool of labor remains deep.  At some point, that will change but no one, not even the Fed, knows when it will.  In the interim, Yellen & Co. are fixated on making sure that companies are still willing to hire and invest hoping that eventually such wage pressures will develop.  The key is not to create a salary problem for companies but to give employees an incentive to find work—namely, to better their lives on a real basis through employment.  All this liquidity that the Fed has pumped into the economy has lifted the price of financial assets as a result.  How much has contributed to the record-breaking levels of the S&P 500 we will find out when rates start to move up sometime next year.

SGK Blog--Update September 5, 2014: August Employment Data Disappoints 

The week began with the dollar strengthening to a seven-month high against the yen and Treasuries falling as data showed U.S. manufacturing expanded. The Institute for Supply Management’s index of manufacturing unexpectedly climbed to 59, the highest level since March 2011, from July’s 57.1, the Tempe, Arizona-based group reported Monday. Readings greater than 50 indicate growth. The median forecast in a Bloomberg survey of economists was 57. Gauges of factory output in Europe and China released Monday when U.S. markets were closed signaled slower growth overseas, boosting speculation that policy makers will need to boost stimulus measures there. Early in the week, European money markets were pricing in about a 50 percent probability that the European Central Bank would cut interest rates by 10 basis points at their next meeting, according to BNP Paribas SA. Commodities tumbled as oil and gold sank, while energy companies led U.S. stocks lower Tuesday when U.S. markets reopened for trading. The U.S. dollar climbed 0.7 percent to 105.10 yen at mid-day in trading in New York and gained 0.7 percent to $1.6488 per British pound. Yields on 10-year Treasury notes increased seven basis points on Tuesday alone, the most in more than a month, to 2.414 percent. The Standard & Poor’s 500 Index lost 0.3 percent after the biggest monthly rally in August since February, as energy companies tumbled 1.6 percent. Gold slid 1.7 percent and oil retreated 2.7 percent. Commodities are generally priced in U.S. dollars so the decline Monday was not supply or demand related, it was almost exclusively due to the combination of strong U.S. economic data combined with weak data from overseas, including the U.K., and the impact this had on the U.S. dollar. Of course this also bolstered the case for the Federal Reserve to raise interest rates sooner than anticipated. The U.S. dollar has been in a strong upward swing in recent months and the early week data lent support to that trend continuing. 

When the European Central Bank finally did meet this week, they decided to cut interest rates and start buying assets, in a bid to boost the flow of funding for the euro-area economy while stopping short of broad-based quantitative easing. All eyes were on the news conference as ECB President Mario Draghi’s plan to buy asset-backed securities and covered bonds pushed the euro below $1.30 for the first time since July 2013. When he spoke he said the inflation outlook had worsened. Germany’s Jens Weidmann opposed the rate cut and ABS plan, according to two officials. The ECB “will purchase a broad portfolio of simple and transparent securities,” Draghi said at a press conference in Frankfurt Thursday. “Some of our council were in favor of doing more than presented.” Euro-area inflation languished at 0.3 percent last month, far below the ECB’s 2 percent target. The ECB on Thursday also cut its macroeconomic forecasts for 2014 from its previous assessment in June. Gross domestic product is now predicted to expand by 0.9 percent this year and 1.6 percent in 2015, instead of the previous 1 percent and 1.7 percent. Inflation is seen at 0.6 percent this year instead of 0.7 percent previously. The inflation outlook for 2015 is unchanged at 1.1 percent. “We took into account the overall subdued outlook for inflation, the weakening in the growth momentum in the recent past,” Draghi said. “The Governing Council sees the risks around the economic outlook on the downside.” The ECB reduced all three of its main interest rates by 10 basis points. The benchmark rate was lowered to 0.05 percent, the deposit rate is now minus 0.2 percent, and the marginal lending facility is 0.3 percent. The euro fell to as low as $1.2952 and traded at $1.2932 at 5:50 p.m. Frankfurt time on Thursday. The dissent from Bundesbank President Weidmann highlights the resistance in Germany, the region’s largest economy. In July, he called ABS purchases “problematic” and warned against supporting bank profits while socializing the losses. The ECB President finds himself pressed into action for the second time in four monetary-policy meetings. The 18-nation euro area is struggling with a stalling economy and escalating sanctions against Russia due to the situation in the Ukraine that threaten trade flows. In June, the ECB cut rates and announced a three-year targeted loan program for banks, called TLTRO, aimed at boosting lending to households and businesses. Draghi said at the time that interest rates were “for all the practical purposes” at the lower bound. This just shows confirms the disconnect between the U.S. and European economies as their central bank adds stimulus while ours is pulling it. 

As if to confirm this trend, the same day the ECB cut rates here in the U.S. we had information released showing service providers such as retailers and construction firms expanded in August at the fastest pace in nine years, pointing to greater momentum in the economy that’s generating jobs and brightening Americans’ spirits. The Institute for Supply Management’s non-manufacturing index climbed to 59.6, the highest since August 2005, from 58.7 a month earlier, the Tempe, Arizona-based group said today. Bloomberg’s weekly measure of consumer sentiment rose to the second-highest level in a year and filings for were little changed, other figures showed on Thursday. The improvement at service providers was broad-based and, combined with faster manufacturing growth, raises the odds of a self-supporting cycle of more spending and job gains that could further propel the expansion.  Shifting the world’s largest economy into a higher gear depends in part on a pickup in worker pay that has been elusive. With that said, a significant pick-up in wages could also trigger inflation and cause the Fed to raise interest rates sooner than expected, which would be a headwind for both stock and bond markets. The strong ISM services data did help propel U.S. rates higher in Thursday trading as well.  

Throwing a wet blanket over the enthusiasm for U.S. economic data this week was the August jobs report which came out on Friday at 8:30 am. American employers hired fewer workers than forecast in August and the jobless rate dropped because people left the workforce, which bolsters those on the Federal Reserve who want to be more deliberate in removing monetary stimulus. The 142,000 advance in payrolls was smaller than the lowest estimate in a Bloomberg survey and followed a revised 212,000 gain in July, figures from the Labor Department showed. The median estimate was for a 230,000 increase. The unemployment rate fell to 6.1 percent from 6.2 percent in July, reflecting a drop in joblessness among teenagers. Employers who boosted headcounts in the first half of the year may be more restrained in their hiring as they await even faster economic growth. Fed Chair Janet Yellen and her colleagues will use today’s report to help discern the extent of slack in the labor market as they pare back record monetary stimulus, while keeping interest rates low at the same time. So time will tell if this is just a one month blip or if it is the beginning of a trend. Perhaps companies were simply waiting it out in August to gauge September back-to-school demand and if the general pick-up in economic activity we have recently witnessed here in the U.S. is here to stay. Stocks declined and bonds rallied on the report given it was weaker than expected.

SGK Blog--Update August 29, 2014: S&P Reaches 2000  

During the last week of August, Wall Street is usually in full vacation mode.  This year seems to be following that script pretty closely.  Things overseas have heated up in the Ukraine conflict and evidence of a new outbreak of the deadly Ebola virus in West Africa have grabbed the headlines.  The biggest monetary-related issues were related to economic releases.  The U.S. economy expanded at an annualized 4.2% in the second quarter, up from an initial estimate of 4% according to the Commerce Department.  The median Bloomberg economists’ survey called for a 3.9% rise.  The pickup came from bigger gains in corporate spending and a smaller trade deficit.  Business investment increased at a 8.1% annualized rate, the most since the first quarter of 2012.  Household consumption which provides the bulk of GDP, grew at a 2.5% annualized rate which matched the early estimate.  However, consumers’ purchasing power improved.  Disposable income adjusted for inflation rose at a 4.2% rate in the second quarter versus a 3.4% rise in the first quarter.  Excluding inventories and trade, so-called GDP final sales rose 3.1%, up from a previously reported 2.8% rise, the biggest advance in four years.  Cleary, the recovery is becoming more entrenched.  This is also evidenced by initial employment claims remaining below 300,000 in the week ended August 23 according to the Labor Department.  The median forecast called for an increase to 300,000 while the final number came in at 298,000.  U.S. firms added more than 200,000 employees to payrolls in July for a sixth consecutive month, the longest such streak since 1997.  Nevertheless, Janet Yellen said during her speech at the Kansas City Fed’s annual conference in Jackson Hole, Wyoming last week that the “labor market has yet to fully recover.”    She added: “a key challenge is to assess just how far the economy now stands from attainment of its maximum employment goal.”  We believe that Yellen & Co. are taking the right approach by taking into account not only payroll figures but also other indicators like whether jobs are easy to get, how willing employees are to quit and the underemployment rate which includes those who want to work full-time but cannot.  That gives a more complete picture of the labor market.  The big risk in this approach is that it is slow.  All this information does not come out at one time and some is more dated than other tidbits.  The Fed has to see at a minimum nine months in the future because their actions take time to filter through the entire $16 trillion economy.  In reality, they have to predict years in advance because of the global effect of their decisions.  So far, they have been on the right side of caution but the time is coming when they will need to begin to apply a less generous approach to monetary policy.

Other data released this week included new home sales which fell in July for the second month.  According to the Commerce Department, sales fell 2.4% to a 412,000 annualized pace which was weaker than the lowest estimate in a Bloomberg survey.  With the median sales price up 2.9% from July 2013 to 269,000, builders are benefitting but the question of affordability will become an issue if prices continue to rise and consumers become hesitant.  New home sales account for only about 5% of the residential market.  They are tabulated when contracts are signed making them a timelier indicator than existing home sales which are totaled when the deal is actually closed which could be weeks or months later.  Thus, the momentum we have seen in existing home sales suggests that consumers awoke from a difficult winter to conduct deals in late spring but the latest new home sales figures show the follow-through has not really been there.  The bottom line is that the housing market remains mixed.  A stronger job market will benefit but that momentum could be slowed if rates rise which is another reason why Yellen & Co. have been reluctant to take away the proverbial punch bowl.

We did see orders for durable goods rise in July by the most on record thanks to a surge in commercial aircraft orders according to the Commerce Department.  Boeing said it received 324 orders for planes last month, almost three times the 109 total in June.  Excluding transportation equipment, the figure fell 0.8% after a 3% rise the month earlier.  We are seeing a jump in appliance demand which makes sense given the stronger existing home sales data we mentioned earlier.  The ISM reports on manufacturing also are corroborating an increase in the workload of the nation’s factories.  The latest figures have been consistently above a 50.0 reading which suggests overall growth in both goods and services. 

SGK Blog--Update August 22, 2014: Strong Data and Tame Inflation Help Lift Stocks for the Week  

The week started off on a positive note as international tensions eased somewhat.  Ukrainian Foreign Minister Pavlo Klimkin met his Russian counterpart Sergei Lavrov for more than five hours of talks in Berlin last Sunday, as they sought to ease tensions after officials in Kiev said troops had partially destroyed an armed convoy from Russia last week.  Klimkin said the talks had brought “moderate progress,” though he called on Russia to follow words with actions.  Iraqi and Kurdish forces retook control of the Mosul Dam over the weekend, Iraqiya television reported, citing military spokesman Qassem Ata.  The U.S. widened its airstrikes in Iraq over the weekend to help secure the dam near Mosul, Iraq’s largest northern city, after it was seized by Islamist militants.  Iraq is OPEC’s second-biggest oil producer.  This helped ease pressure on oil prices as well.  The S&P 500 had fallen as much as 3.9 percent from a record reached on July 24 amid growing concern over global conflicts from Ukraine to Gaza and Iraq.  The benchmark index jumped in Monday trading also due to signs of a slowing economy that stoked bets central banks will leave interest rates near record lows for longer.  Reports showed the euro area’s recovery stalled in the second quarter, spurring speculation the European Central Bank will boost stimulus measures.  In the U.S., July retail sales registered the worst performance in six months and consumer sentiment slipped in the previous week.

Helping the early week optimism was a report showing the National Association of Home Builders/Wells Fargo sentiment measure climbed to 55 from 53 in July, the Washington-based group reported Monday.  Confidence among U.S. homebuilders rose in August to the highest level in seven months, demonstrating the industry is making more headway after weakness earlier this year.  Readings above 50 mean more respondents said conditions were good.  The median forecast in a Bloomberg survey of economists projected it would hold at 53.  Historically low mortgage rates and increased employment are bringing home purchases within reach of more Americans.  Faster wage gains would help provide an additional push for the industry, which is struggling to lure first-time buyers beset by tougher credit conditions.  “As the employment picture brightens, builders are seeing a noticeable increase in the number of serious buyers entering the market,” NAHB Chairman Kevin Kelly, a homebuilder from Wilmington, Delaware, said in a statement.  “However, builders still face a number of challenges, including tight credit conditions for borrowers and shortages of finished lots and labor.”  

Tuesday’s data showed that home construction rebounded in July and the cost of living rose at a slower pace, showing a strengthening U.S. economy has yet to generate a sustained pickup in inflation.  A 15.7 percent jump took housing starts to a 1.09 million annualized rate, the strongest since November, and halted a two-month slide, the Commerce Department said in Washington.  This was well above the expectation for a 964,000 annualized rate according to economists’ forecasts.  The figures for building permits for July was also better than expected.  The consumer price index (CPI) increased 0.1 percent in July after rising 0.3 percent in June, the Labor Department also reported.  An improving job market and cheaper borrowing costs are helping revive residential real estate, helping boost sales at companies such as Home Depot, which also came out with a strong earnings report Tuesday.  The core rate for CPI, which excludes food and energy, came out in-line with expectations helping boost traders confidence.  As inflation continues to run below the Federal Reserve’s target, it gives the central bank room to keep interest rates low well after the projected end of its bond-buying program in October.

Federal Reserve officials raised the possibility that they might begin removing aggressive stimulus sooner than anticipated, as they neared agreement on an exit strategy, according to minutes of their July meeting.  “Many participants noted that if convergence toward the committee’s objectives occurred more quickly than expected, it might become appropriate to begin removing monetary policy accommodation sooner than they currently anticipated,” the minutes, released Wednesday in Washington, read.  Rates did rise slightly on this news, but most traders were waiting and eagerly anticipating Fed Chair Janet Yellen’s comments at Jackson Hole on Friday.  She has so far committed monetary policy to stronger labor markets, which she measures with an array of indicators, so long as inflation remains in check.  The minutes said “many participants” still see “a larger gap between current labor market conditions and those consistent with their assessments of normal levels of labor utilization.”  Many members noted, however, that the characterization of labor market underutilization might have to change before long, particularly if progress in the labor market continued to be faster than anticipated,” the minutes said.  A factor we believe will be important in their decision making will be if we start to see signs of wage inflation as labor markets tighten, which we have not really seen so far.

On balance the remaining week’s economic news, primarily released on Thursday, was positive.  Initial weekly jobless claims for the week ending 8/16/2014 were 298,000 compared to the expectation for 308,000 and the prior week’s 312,000.  Existing home sales for July were 5.15 million compared to the forecast for 5.00 million and the prior month’s 5.03 million.  The Philadelphia Fed survey, a measurement of the robustness of the manufacturing sector in that region, came in at 28.0 for August compared to the expectation for 15.5 and the previous month’s 23.9.  Finally, the Index of Leading Indicators, often cited as a predictor of future economic growth although it is based on historical data, came in for July at +0.9% which was better than the forecast for +0.7% and the prior month’s figure of +0.6%.  All of these data points were trending in the right direction.

All eyes were on Fed Chair Janet Yellen’s and European Central Bank (ECB) President Mario Draghi’s speeches Friday at the Kansas City Fed’s annual economics conference in Jackson Hole, Wyoming.  The expectation was that Yellen would make dovish comments with respect to the fact in the Fed’s view the labor market here in the U.S. has not reached its full potential therefore more needs to be done, or rather more time is needed to allow it to fully heal.  With respect to Draghi, given the recent data indicated the broader European economy sputtered in the second quarter, it was expected that he may hint at further central bank stimulus to come.  Federal Reserve Chair Janet Yellen began her remarks by saying slack remains in the U.S. labor market even after gains made during the five years of economic recovery.  “The economy has made considerable progress in recovering from the largest and most sustained loss of employment” since the Great Depression, she stated.  Even so, she underscored the Federal Open Market Committee statement last month that “underutilization of labor resources still remains significant.”  Yellen’s remarks appeared in line with the message from minutes of the July FOMC meeting, which showed officials growing more aware that labor markets are approaching full employment.  Still, pinpointing a full recovery in the job market is difficult given the “depth of the damage” from the recession, she said.  Her speech walked through the arguments of how much slack might be related to weak demand as opposed to more permanent trends.  Overall, there were no real surprises in her remarks.  There was some profit taking Friday based on her comments and also an increase in tensions yet again in the Ukraine.

SGK Blog--Update August 15, 2014: Deals Make Headlines  

There were a number of economic releases this week.  Retail sales failed to ignite much excitement with a flat July reading according to the Commerce Department after a 0.2% rise in June.  Declines in electronics and furniture stores offset gains in clothing and groceries.  Excluding autos and gas, the increase was only 0.1% compared to an expectation of a 0.4% rise.  The back-to-school season has begun and next month’s reading will be a key indicator.  The lackluster retail figure coincided with initial unemployment filings which rose more than forecast in the week ended August 9.  Jobless claims climbed by 21,000 to 311,000 which is the highest in six weeks according to the Labor Department.  The median forecasts was for a figure of 295,000.  As we have mentioned previously, summer is a difficult month to forecast due to car companies which often shutdown in July-August to retool their lines for the new car season.  We have not seen much of that so far and there was nothing unusual in the data according to officials.  That said, the four-week average remains below 300,000.  Moreover, the Labor Department reported its monthly Job Openings and Labor Turnover (JOLT) survey this week which showed the number of unfilled positions rising by 94,000 to 4.67 million, the most since February 2001.  This report combines resignations, help-wanted ads and the pace of hiring to give a broader view of the labor market than the usual payroll or unemployment figures.  There are about 2 unemployed people jockeying for each opening compared to 1.8 job seekers per opening in December 2007.  The JOLT report is part of Fed Chair Yellen’s so-called “dashboard” which she monitors for signs of improvement in the economy.  The “quits rate” which measures the willingness of the employed to leave their jobs held at 1.8% versus 2.1% when the recession started in late 2007.  Given that we are not quite back to pre-recessionary levels, the pressure for a Fed move has not increased and the market continues to expect low levels for a “considerable time” if the quantitative easing ends as expected later this fall.

Producer prices also provides evidence that the economy is still in need of extra medicine.  Wholesale prices rose at 0.1% in July according to the Labor Department following at 0.4% gain in June.  Excluding the volatile food and energy sectors, the so-called core rate rose 0.2%.  Year-over-year, the overall rate rose at 1.7%, and the core rate was 1.6% higher.   The latter figure matches the rise in the personal consumption expenditures index which the Fed watches closely.  These numbers show that inflation is under control and remains present but is not a threat.

The pricing situation in Europe is somewhat different.  Eurostat, the European Union’s statistics office in Luxembourg said this week that yearly inflation was 0.4% in July.  That is way below the “around 2%” level that the European Central Bank (ECB) has been looking for.  Eurozone GDP results confirm this stagnation.  For the second quarter the region was flat compared to the first quarter, when it increased 0.2%.  Germany’s economy shrank 0.2% for its first contraction since 2012.  France was flat, and Italy fell into its third recession since 2008 with GDP falling 0.2% in the April to June period.  Positives included growth in Spain, Belgium, Austria and in smaller countries like Latvia and Slovakia.  The euro-area economy grew 0.7% in the year.  In June the ECB predicted a 1% growth for 2014 and 1.7% in 2015.  Those numbers now look doubtful and ECB president Draghi said risks to the outlook are growing because of the recent flare up of the Ukraine crisis.  The sanctions placed on Russia directly led to the lowest level of German investor confidence since 2012.  Sanctions are hurtful but they can change in a hurry so it is not inconceivable that Germany can remain a growth engine going forward.   But that is assuming the crisis subsides and sanctions have a brief life.  The uncertainty is weighing on investors as German bond yields reached record lows are traders sought safety and return of principal over any return on principal.  The yield on German 2-year securities actually turned negative meaning, at maturity, an investor would be locking in a loss by buying at such prices.  Europe still needs to have long-term structural change to accomplish long-term growth.

SGK Blog--Update August 8, 2014: Stocks Volatile as Overseas Tensions Grow 

U.S. stock sentiment was generally negative this week, as the Dow Jones Industrial Average hit its lowest level since April and pushed the average into negative territory for the year, as concern that the escalating conflict in the Ukraine offset better-than-estimated second quarter earnings and generally positive U.S. economic news. Russia has massed troops along its border with Ukraine, prompting the U.S. to say there’s a risk of an invasion. President Putin retaliated Wednesday against European Union and U.S. sanctions by ordering restrictions on food imports from countries that seek to punish Russia. No one likes a trade war and obviously an actual war is worse! Putin appeared to back-off his stance when he indicated he was interested in de-escalating the situation which helped equities on Friday. He declared Friday that exercises on the Ukraine border were over, but we have heard that before from him and actions speak louder than words. European Central Bank President Mario Draghi said the risks to the recovery from conflicts including that in Ukraine are increasing. Headwinds facing the 18-nation euro area’s recovery are intensifying after reports this week showed that Italy slipped back into recession and German industrial output for June was much weaker than expected. The standoff between Russia and the U.S. and its allies has unfortunately escalated into the worst such conflict since the Cold War and it is having an impact on both the Russian economy and the neighboring countries that do business there. Not helping matters was the news that the U.S. had resumed bombing runs in Iraq against the militant group the Islamic State in Iraq.

Traders also pay a great deal of attention to data coming from the world’s second largest economy – China. So when a indicator came out Tuesday showing weakness, stock futures reversed course and turned sharply negative in the pre-market, even though there was no news emanating from U.S. markets to suggest that a reversal was pending. China’s service industries stagnated in July as a private index fell to a record low, suggesting the government’s stimulus measures are failing to gain traction outside of manufacturing. The services Purchasing Managers’ Index declined to 50.0, the dividing line between expansion and contraction, from June’s 53.1, according to HSBC Holdings Plc and Markit Economics. A similar official gauge released Aug. 3 dropped to a six-month low of 54.2. Asian stocks extended losses as the HSBC-Markit index’s lowest reading since it began in 2005 signaled that falling home prices and new construction are dragging on services, which account for almost half of gross domestic product now in China. The International Monetary Fund’s China mission chief warned last week real estate is the biggest near-term risk to the economy. The weakness in the headline number likely reflects the impact of the ongoing property slowdown in many cities. Given the Chinese economy is more of a managed economy than one driven by free markets, the report points to the need for continued policy support to offset the drag from the property correction and consolidate the economic recovery. 

Interestingly, Tuesday’s equity markets were also negatively impacted by strong U.S. data when both factory orders and the ISM Services Index were released. This seems counterintuitive but it raised concerns the Federal Reserve would begin the process of raising interest rates sooner than expected. Factory orders for June rose 1.1%, over twice the +0.5% expected. The report showed bookings for non-military equipment excluding aircraft, a proxy for capital equipment demand, advanced 3.3%. The Institute of Supply Management’s Service Index for July expanded to 58.7, well above the expectation for a 56.5 increase as it reached an almost 9 year high. This survey covers an array of industries including utilities, retailing, healthcare and finance that make up almost 90% of the economy. It also factors in construction and agriculture. Improving conditions were evidenced in virtually every industry surveyed. So it is a case where good news turned out to be bad for stocks because it was almost too good, again stoking fears the Fed will have to make an interest rate move prior to the date economists have forecast. 

On balance, the rest of the news coming out on the U.S. economy this week was quite positive. Jobless claims decreased by 14,000 to 289,000 in the week ended Aug. 2 from 303,000 in the prior period, a Labor Department report showed Thursday in Washington. The median forecast of 47 economists surveyed by Bloomberg called for an increase to 304,000. Companies are holding on to more workers in an effort to keep up with increased orders and stronger consumer demand, contributing to a virtuous cycle of growth as the economy accelerates. Fewer layoffs and more jobs would support further gains in incomes and household spending, which accounts for 70 percent of the economy. A separate report showed consumer borrowing rose in June as American households took out auto and student loans. The $17.3 billion increase in consumer credit followed a $19.6 billion May advance, the Federal Reserve reported Thursday in Washington. Non-revolving loans, including borrowing for cars and college tuition, climbed $16.3 billion. Stronger employment and gains in home values are giving households the confidence to borrow and make big-ticket purchases such as cars and appliances. Banks also are showing greater willingness to lend, which could boost consumer demand, the biggest part of the economy. So enthusiasm for equities this week was really dampened by the news coming from overseas. Markets were helped Friday though by the report that second quarter productivity here in the U.S. increased at a 2.5% rate versus the expected 1.4% gain. The same report showed that unit labor costs in the U.S. grew at a modest +0.6% pace in the second quarter versus the expectation for a 2.0% gain. High productivity combined with low unit labor costs is positive for markets as it relieves concerns that heightened inflation may result given the recent economic strength.  

SGK Blog--Update August 1, 2014: Fed Continues Taper as Employment Picks Up

It was a busy week for both economic data and also company earnings.  On Wednesday, the Federal Reserve concluded their regularly scheduled Open Market Committee (FOMC) meeting with little change to their outlook.  They stated: “Labor market conditions improved, with the unemployment rate declining further.  However, a range of labor market indicators suggests that there remains significant underutilization of labor resources.  Household spending appears to be rising moderately and business fixed investment is advancing, while the recovery in the housing sector remains slow.”  As such, the Fed governors are comfortable with keeping the target interest rate on federal funds at 0%.  In order to support their dual mandate of “maximum employment and price stability”, they feel the need to continue to purchase fixed income securities but at a reduced pace.  Beginning in August, the FOMC will purchase $10 billion per month of mortgage-backed securities and $15 billion per month of longer-term Treasury securities.  This is a reduction of $10 billion in total from the previous month.  Thus, technically it is still quantitative easing yet, de facto, it is tapering.  The Fed stated that “asset purchases are not on a preset course” which gives them wiggle room in case they need to change the pace of tapering including the unlikely possibility of once again increasing the amount of purchases.  They continue to stress “that it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends, especially if projected inflation continues to run below the Committee’s 2 percent longer-run goal, and provided that longer-term inflation expectations remain well anchored.”  The last thing the Fed wants is to spook the market into thinking that rate increases will come prematurely or involve massive spikes.

On Friday, the Labor Department reported that the U.S. added more than 200,000 jobs for the sixth straight month in July, the longest such period since 1997.  The 209,000 advance followed a 298,000 rise in June that was stronger than previously reported and blunted the fact that the expectation for July’s increase was 230,000.  The unemployment rate, taken from a survey of households, increased to 6.2% from 6.1% as the participation rate rose to 62.9% from 62.8% a month earlier.  Private payrolls, which exclude government workers, rose 198,000 last month.  The only negative with today’s report was that average hourly earnings were unchanged at $24.45.  Though it is up 2% over the past 12 months, it is not growing much faster than inflation which suggests that workers are merely running in place rather than building future wealth.  With the average work week holding steady at 34.5 hours, this indicates, as the Fed hinted earlier, slack in the labor force.  Fed Chair Janet Yellen told lawmakers last month that she remained concerned about the low participation rate and sluggish wage growth.  After the latest report, her fears are not likely to be go away but might be helped by the fact that the more timely weekly initial unemployment report for the week ended July 26 showed 302,000 filers.  Though that number climbed from the week earlier, the four-week average of 297,250 was the lowest since April 2006 and remains consistent with a strengthening labor market.

These solid labor market figures are showing up in other government data released this week.  The first reading of second quarter GDP was released on Wednesday which showed an annualized gain of 4% according to the Commerce Department.  That was a nice rebound from the 2.1% contraction for the first quarter of the year, which itself was revised up from a previously reported 2.9% decline.  The rise was led by gains in consumer spending and business investment.  There was a surge in inventories which added 1.7 percentage points to the second quarter as stockpiles were rebuilt at a $93.4 billion annualized pace versus the $35.2 billion rate in the first quarter.  That could mean that future quarters will not be as strong as consumers and businesses labor to work off that build-up.  But, if demand is indeed strong enough, it will lead to a virtuous cycle of needing to replace liquidating inventory regularly.  Nevertheless, consumer spending rose at a 2.5% pace which was more than twice the 1.2% advance during the first three months of the year.  A separate report released on Friday by the Commerce Department showed that for the month of June, household purchases rose 0.4%.  Incomes also advanced 0.4%.  A key pricing measure showed that excluding food and fuel, prices rose 0.1% in June from the prior month and was up 1.5% from a year ago.  Total prices rose 1.6% in the year ended June, after advancing 1.7% in May. That is still below the 2% range expected by the Fed but not so far below the target to become a worry…yet.  On the manufacturing side, the Institute of Supply Management’s index was 57.1 in July.  An indicator above 50 is defined as expansionary and this was the highest since April 2011, up from 55.3 a month earlier.

With so many positive indicators, there is little doubt that after a winter-ravaged first quarter, the economy has indeed rebounded in the second quarter as many had anticipated.  The question is can the pace continue to improve?  Also, how fast will the Fed let it happen before they decided that higher interest rates are needed?  We are not economists but expect that the Fed will do as it says and stop the quantitative easing program in October and look to raise rates next year.  Most indicators are pointing towards spring of next year for the first hike.  Yet, as we have seen over the past few years, there are lot of domestic and international events which could conspire to either accelerate or delay this timetable.  Stay tuned.

SGK Blog--Update July 25, 2014: Earnings Season Continues

Before we get to our long list of earnings reports, we’ll take a look at a good week of economic releases.  The consumer price index (CPI) rose 0.3% in June according to the Labor Department.  That matched the median Bloomberg figure and was down slightly from the 0.4% figure from May.  The core measure, which excludes food and fuel, rose just 0.1%.  For the 12 months ended in June, the core measure rose 1.9% and overall measure was 2.1% higher.  That is very close to the “target” level that the Fed is looking for in terms of inflation.  The Fed’s preferred gauge, the personal consumption expenditure price index, rose 1.8% in May from a year earlier.  So, both of these measures are quite close to that “around 2%” goal that Fed chairwoman Yellen has spoken of in the past.  The biggest boost to the CPI came from gasoline costs which rose 3.3%.  A decline in the cost of new cars and hotel rates helped curb the overall gain. 

Sales of previously owned U.S. homes rose to an eight-month high in June.  All four U.S. regions showed gains and resulted in a 5.04 million annual sales rate last month according to the National Association of Realtors.  Prices rose at the slowest pace since March 2012 and inventories rose to an almost two-year high.  Even with the higher stock, at the current sales pace, it would take 5.5 months to sell all those houses in inventory, the same time period as in May.  The median time a home was on the market fell to 44 days from 47 days in May with 42% of homes on the market for less than one month.  First-time buyers accounted for 28% of all purchases, and there are a far lower percentage of distressed deals taking place when compared to two years ago.  Sales of new homes painted a different picture when the Commerce Department reported its data later in the week.  New home sales are tallied when purchase contracts are signed and are considered more timely than existing home sales which are counted when a sale is final.  Sales of newly built homes fell 8.1% to a 406,000 annualized pace, lower than the any economist surveyed by Bloomberg.  One of the biggest issues that remain for both new and existing home buyers is access to mortgage credit.  Thus, the overall outlook for housing is more “measured” than “enthusiastic”.  Confidence among homebuilders rose in July with the National Association of Home Builders/Wells Fargo sentiment measure climbing to a six-month high of 53 from 49 in June.  With the average rate for a 30-year fixed mortgage at 4.13% in the week ended July 17 according to Freddie Mac, that is higher than the 3.35% figure from May 2013. 

What can overcome this uneven data is the fact that more people are employed.  Higher employment has historically led to higher spending and higher home sales.  The number of people filing for first time unemployment benefits dropped in the week ended July 19th to 284,000 according to the Labor Department.  That is the fewest since February 2006.  As we noted before, applications can be quite volatile during the summer because auto makers schedule plant shutdowns in order to change over lines for the production of new models.  Fewer claims suggest employers are reluctant to let staff go and may indicate better sales figures overall headed into the fall.  Michigan, New Jersey and Ohio reported the biggest decrease in claims and those states are known for auto plant employment which might indicate that improving demand for autos at least is here to stay.  The number of people continuing to achieve jobless benefits fell by 8,000 to 2.5 million in the week ended July 12.  With employers adding 288,000 non-farm jobs in June, the hope is that the momentum continues as we enter August, the month of back-to-school shopping which the second most important time of the year for retailers.    We continue to feel that the economy has already achieved a measure of sustainable growth which will take time to present itself in more data.  We have already seen better sales figures from a number of the firms we follow which is a direct result of a healthier economy.  Outside of geopolitical events, there are not a lot of hurdles ahead for the economy as a whole to overcome as we enter a traditionally quiet time of the year in terms of trading.  Of course, events often conspire to lay waste to expectations… 

SGK Blog--Update July 18, 2014: Janet Yellen Testifies Before Senate Banking Committee; Tensions Rise in the Ukraine


The central bank must press on with monetary stimulus as ‘‘significant slack’’ remains in labor markets and inflation is still below the Fed’s goal, Fed Chair Janet Yellen said in semi-annual testimony prepared for delivery to the Senate Banking Committee. Yellen cited labor-market weaknesses even after an unexpectedly fast decline in unemployment put pressure on Fed officials to consider accelerating their timetable for an interest-rate increase. Yellen said today that rates are likely to stay low for a ‘‘considerable period’’ after bond purchases end, which she said could happen following the Fed’s October meeting. Minutes from the Fed’s June meeting, released last week, showed some policy makers were concerned investors may be growing too complacent about the economic outlook and the central bank should be on the lookout for excessive risk-taking. Fed Chair Yellen warned she sees signs of asset price bubbles forming in some markets such as those for leveraged loans and lower-rated corporate debt, while indicating stocks aren’t overvalued. “We’re seeing a deterioration in lending standards, and we are attentive to risks that can develop in this environment” of low interest rates. We would add these are areas of the market we avoid.

Tensions rose sharply in Europe this week centered once again on the Ukraine, causing stock indices to decline sharply in Thursday trading. A Malaysian Airlines jet appeared to have been shot down over eastern Ukraine by a Russian-made mobile air-defense missile, according to U.S. military and intelligence officials. While the matter is still being reviewed, evidence so far indicates that the plane was struck by a weapon known as the SA-11 Gadfly, a widely used system in Eastern Europe. It’s not clear who fired the weapon at the airliner, killing all 295 people on board today, or whether those responsible knew they were shooting at a commercial flight. The government in Kiev blamed pro-Russian rebels and the separatists denied the accusation. Ukraine’s state security service said it intercepted phone conversations among militants discussing the missile strike, which knocked Flight 17 from the sky near the eastern town of Torez, about 30 kilometers (18 miles) from the Russian border. The Boeing 777 was en route to Kuala Lumpur from Amsterdam.   There is a growing belief that Russian-backed separatists in eastern Ukraine or Russia may have mistaken the airliner for a Ukrainian military cargo aircraft. Some of the separatists are veterans of the Russian or Ukrainian militaries who may have been trained on the Gadfly system, a U.S. intelligence official said. This came just as the U.S. and European allies stepped up economic sanctions on Russia for their ongoing involvement in the conflict. The stepped up sanctions and the airplane strike sent Russian stocks tumbling this week and the Russian economy is now threatened with the likelihood of a severe recession taking hold. 

In U.S. economic news, retail sales showed a broad-based gain in June, which probably helped the U.S. economy rebound in the second quarter. Overall sales increased 0.2% after a 0.5% advance in May that was larger than previously reported, Commerce Department figures showed today in Washington. The reading fell short of the 0.6% increase projected by the median estimate of 83 economists surveyed by Bloomberg, restrained by a drop among auto dealers. Demand climbed in nine of 13 major categories last month. Consumers are more comfortable opening their wallets as a strengthening labor market lifts earnings. Higher wages give American households the wherewithal to withstand recent increases in food and gasoline costs that had chipped away at buying power.  

In other economic news, we received relatively good reports on the U.S. manufacturing sector. An early look at July through the Empire Manufacturing gauge suggests that we are definitely witnessing a pick-up in activity as it rose to 25.6 from the prior month’s 19.3 and the expectation of 13.2. Industrial production and capacity utilization for June were not quite so robust coming in just shy of expectations at +0.2% and 79.1% respectively. The National Association of Home Builders index for July was 53 relative to the 50 expected and the prior month’s figure of 49. The closely watched Producer Price Index or PPI, a measure of inflation at the wholesale level, was +0.4% for June which was above the expectation for +0.2%. This is concerning given we need to be wary of any signs that inflation may be building at any level in the economy. When the more volatile food and energy portion was stripped out however, a measurement known as core PPI, the figure came in exactly as expected at +0.2%. Like we don’t have to eat and fill our gas tanks! 

Weekly jobless claims for the week ending 7/12/2014 fell to 302,000 which was below expectations. Adding to stock market declines Thursday was the fact we had a much weaker than expected figures for housing starts and building permits for June as they fell to 893,000 and 963,000 respectively. Economists had been forecasting a pick-up in activity in these areas so this was disappointing. On Friday, the University of Michigan consumer sentiment survey for July was 81.3 versus the expectation for 84 while the index of leading indicators for June rose just 0.3% versus the expectation for an increase of 0.5%. We will have to keep a close eye on the trends in the economic data going forward as many economists were forecasting a very strong rebound in activity in the second quarter here in the U.S. after the sharp slowdown in the first quarter due to the severity of the winter across the country.

SGK Blog--Update July 11, 2014: Markets Trend Lower as Earnings Season Begins  

The minutes of the Federal Reserve’s June policy meeting were released this week.  They agreed to end the monthly bond-buying program by later this year stating: “If the economy progresses about as the Fed expects, warranting reductions in the pace of purchases at each upcoming meeting, this final reduction would occur following the October meeting.”  At its peak, the latest round of quantitative easing amounted to $85 billion per month in U.S. Treasury and mortgage-backed securities.  Starting late last year, the Fed began to “taper” this program generally reducing the amount by $10 billion with the current level set at $35 billion.  This has led to a massive expansion of its balance sheet which currently stands around $4.4 trillion in bonds, loans and other assets.  This was the first time the Fed was explicit about an end date, but simple math revealed that it was going to come to an end within the next six months assuming the current tapering pace continued.

The minutes showed that there remained some difference of opinion.  In terms of employment: “Most participants projected the improvement in labor market conditions to continue, with the unemployment rate moving down gradually over the medium term.”  With the latest monthly reporting showing national unemployment at 6.1% for the month of June, the trend there has been quite positive.  This week jobless claims declined by 11,000 to 304,000 in the week ended July 5 according to the Labor Department.  The median forecast was for 315,000 which suggest that the labor market is gaining momentum as the second half of the year begins.  Upcoming weeks are likely to be volatile as auto plants begin their usual summer shutdowns to retool equipment for new model year cars and trucks.  That is why the four-week average is important to note.  That number dropped to 311,500 last week from 315,000 the week before.

Where Fed officials did not agree was on the subject of financial conditions.  The minutes stated “Favorable financial conditions appeared be supporting economic activity.  However, participants also discussed whether some recent trends in financial markets might suggest that investors were not appropriately taking account of risks in their investment decisions.”  In other words, there may be pockets of excessive risk-taking which is another way of saying that bubbles are forming.  Obviously, the concern is not sharp enough or widespread enough to state specifically or appoint the appropriate agency to take a closer look at.  However, it shows that the policy of quantitative easing does have unintended consequences which we saw a lot of during the heart of the financial crisis back in 2008-2009.  With the Fed still maintaining a zero interest rate policy, the market is fine with the tapering pace.  The real question will arise when the tapering is done and some signs of inflation begin emerging in the economy.  How will the Fed begin to apply the brakes facing a $4 trillion plus balance sheet?  Stay tuned.

SGK Blog--Update July 3, 2014: Economy Adds 288,000 New Jobs in June 

July began on a positive note as a report Tuesday showed manufacturing in China expanded in June by the fastest pace this year. Their purchasing managers’ index rose to 51.0 for June from 50.8 in May, according to the National Bureau of Statistics and China Federation of Logistics and Purchasing. The reading matched economists’ median estimate. A similar gauge from HSBC Holdings Plc and Markit Economics, which some feel is more reliable than statistics provided by the Chinese government, advanced to 50.7 from the prior month’s 49.4. This is a critical gauge because it demonstrates the Chinese government is back on track in their attempts to revive growth in that country back up to the 7.5% annual level. A figure less than 50 signals contraction and earlier in the year that is where the manufacturing measures in China had been coming in. By the time our markets opened Tuesday, European equity bourses were already sharply in the green on the news. 

On the home front, we continued to receive positive data on the economy. Chicago PMI, a measure of the manufacturing sector in that industrial region, came out at 62.6 for June compared to the expectation for 61.0 while pending home sales for May rose at a relatively robust rate of 6.1% compared to the expectation for +1.5%. The Institute of Supply Management’s ISM Index, a gauge of manufacturing across the nation, was 55.3 for June, just shy of expectations. Construction spending in May was also shy of forecasts at +0.1% compared to the expectation for +0.4%. Factory orders for May fell 0.5% compared to the forecast for a decline of 0.4%. We will see if the June numbers pick up as sometimes construction spending and factory orders take a while to kick into gear after a winter like the one we had. The ISM Services Index came out at 56 for June, just shy of the 56.5 expected. 

Thursday’s employment figures were impressive to say the least. The report came out a day earlier than normal because of the Holiday Friday. Employers added more workers than projected in June and the unemployment rate fell to an almost six-year low of 6.1 percent, underscoring a brighter U.S. labor market that will help spur the economy. The addition of 288,000 jobs followed a 224,000 gain the prior month that was bigger than previously estimated, Labor Department figures showed today in Washington.  The median forecast in a Bloomberg survey of economists called for a 215,000 advance.  The number of long-term unemployed Americans fell to 3.1 million, showing they’re having greater success finding work. Factories took on the most workers in four months, while payrolls at private service providers climbed by the most since October 2012. The number of people out of work for 27 weeks or longer -- the so-called long-term unemployed -- decreased as a percentage of all jobless to 32.8 percent, the lowest since June 2009. Payroll estimates of 94 economists in the Bloomberg survey ranged from gains of 145,000 to 290,000 after a previously reported 217,000 advance.  The unemployment rate, which is derived from a separate Labor Department survey of households, fell to the lowest since September 2008.  It was projected to hold at 6.3 percent, according to the survey median. Revisions to prior reports added a total of 29,000 jobs to overall payrolls in the previous two months.  

A separate report from the Labor Department today showed little change in the number of Americans filing applications for unemployment benefits last week, a sign that employers are limiting dismissals. Jobless claims rose by 2,000 to 315,000 in the week ended June 28.  The median forecast of economists surveyed by Bloomberg called for 313,000 claims. Today’s payrolls report showed that private employment, which excludes government agencies, rose by 262,000 in June after a 224,000 gain the prior month. The so-called participation rate, which indicates the share of the working-age people in the labor force, held at 62.8 percent.  Recent strides in the labor market underscore the economy’s snapback from a first-quarter contraction.  The economy shrank at a 2.9 percent annualized rate from January through March, the biggest drop-off since the first quarter of 2009, the Commerce Department reported last month. Consumer purchases grew at the weakest pace in five years. Gross domestic product probably bounced back in the second quarter and will expand at an average 3.1 percent rate in the remaining two quarters of 2014, according to the median forecast in a Bloomberg survey conducted June 6 to June 11. Household purchases are also expected to improve, it showed. Based on the positive news on the labor market, interest rates rose across the yield curve Thursday and gains in stock futures were muted because of the increase in the rate on the U.S. 10-year Treasury.   

SGK Blog--Update June 27, 2014: Economic Data Mixed as We Approach Earnings Season 

The week started out well as we received generally positive news on housing, demonstrating that the market for homes was recovering from our snowy winter. Purchases of new homes in May rose by the most in 22 years. Sales increased 18.6%, the biggest one-month gain since January 1992. The figure came in at an annualized pace of 504,000, according to the Commerce Department, and this far exceeded the average forecast of the 74 economists surveyed by Bloomberg. That information followed the release of data Monday indicated existing home sales in May also exceeded forecasts coming in at 4.89 million relative to the forecast for 4.80 million. The Case-Shiller 20-city Index of housing prices for April rose 10.8%, which is relatively robust even though it came out just shy of estimates. The housing data coincided with a release Tuesday on consumer confidence which also exceeded expectations as it rose for June to 85.2 from the previous month’s 82.2.

Stocks started to trade lower and bonds higher though as the week progressed when we received other important data on the U.S. economy. Durable goods orders for May dropped 1.0% compared to the expectation for a 0.4% rise. Even excluding the more volatile transportation component, the figure dropped 0.1% while that forecast had also been for a 0.4% rise. The same day we had the third revision to 1st quarter gross domestic product (GDP) down to a level of -2.9% compared to the previous estimate of -1.0% and the forecast for it to drop to -1.8%. Although this appears to be a pretty ugly number at first glance, and it was, the market shook it off a bit in the sense that it is viewed as somewhat old news. We know the economy did poorly in the first quarter for a variety of reasons. We are not in a recession though (defined as two consecutive quarters of negative GDP) because of the strength of the economic numbers we have seen since we received the data from the peak of the winter doldrums.  

On balance, there were no real surprises the rest of the week from the standpoint of the economy. Initial weekly jobless claims ending 6/21/2014 were 312,000 compared to the estimate for 310,000. Personal income and personal spending for the month of May came in at +0.4% and +0.2% respectively compared to forecasts of +0.4% on incomes and +0.4% on spending. The closely watched personal consumption expenditures index – a key inflation measurement the Fed observes – came out for May exactly as expected at +0.2%. Not too weak and not too strong is a definite positive! Finally, the University of Michigan consumer sentiment measure for June came in at 82.5 which was up from the prior month’s 81.2 and the expectation for 81.7. It was clearly evident at times this week that traders were paying more attention to World Cup soccer, especially when the U.S. was playing mid-day Thursday, as volumes were low throughout the week and volatility was very limited. It will get interesting as second quarter corporate earnings are released during the month of July and early August. World Cup ends just in time for earnings to really kick into gear!
SGK Blog--Update June 20, 2014: Fed Says U.S. Economy is Rebounding; Raises Interest Rate Forecast for Next Two Years

The Federal Reserve said growth is bouncing back and the job market is improving as ti continued to reduce the monthly pace of its asset purchases. “Economic activity is rebounding in the current quarter and will continue to expand at a moderate pace thereafter,” Federal Reserve Chair Janet Yellen said at a press conference in Washington Wednesday following a meeting of the Federal Open Market Committee. Even with declines in unemployment, “a broader assessment of indicators suggests that underutilization in the labor market remains significant,” she went on to add. The FOMC trimmed bond buying by $10 billion for a fifth straight meeting to $35 billion, keeping it on pace to end the program late this year. Now Yellen and her fellow policy makers are debating how long to keep interest rates near zero as the U.S. labor market improves and inflation moves closer to the Fed’s 2% goal. They did repeat in their statement they expect rates to stay low for a “considerable time” after the bond buying ends.  

What was probably more important than their actual statement, which did not change a whole lot, is the update Fed officials made to their economic forecasts. They predicted their target interest rate will be 1.13% at the end of 2015 and 2.5% by the end of 2016. These rates are higher than they had previously forecast. Also significant, they lowered their long term estimated rate to 3.75% from 4%. By doing this they are acknowledging they expect growth in the U.S. economy to be slower than has been the historic norm. Fed participants estimated long term growth at 2.1% to 2.3% compared with 2.2% to 2.3%. One of the chief concerns we have cited in our weekly is the risk of inflation due to their easy money policies. On this subject Yellen stated, “Inflation has continued to run below the committee’s 2% objective. Low inflation could pose risks to economic performance. At the same time, longer term expectations are still well-anchored.” The personal consumption expenditures index, the Fed’s preferred inflation gauge, rose 1.6% from a year earlier in April, the most since November 2012. The consumer price index, a separate inflation measure, rose 2.1% in May on an annualized basis.  

Lastly, Yellen indicated policy makers are discussing a new set of principles to guide an eventual exit from record easing and expects to announce them later this year, so that should be very interesting. She stated, “The committee is confident it has the tools it needs to raise short-term interest rates when necessary. The Fed will continue to have a very large balance sheet for some time.” That last one is stating the obvious! 

In economic related news this week, capacity utilization and industrial production, both measures of factory utilization which can be indicators of the health of the U.S. manufacturing sector, came out at 79.1% and +0.6% for the month of May respectively. These numbers were basically in-line with expectations. The same can be said for housing starts which came in at 1,001,000 for the month of May, basically in-line with forecasts. Initial weekly jobless claims were as expected at 312,000 for the week ending 6/14/2014 and the index of leading indicators for May was right in-line with expectations as it increased +0.5%. In general, when economic indicators come in so close to expectations, it is considered a positive for stock and bond markets as generally traders dislike surprises, The only worrisome figure that came out this week was the consumer price index (CPI) which rose +0.4% in the month of May alone, which was greater than the forecast for +0.2%. Obviously the Fed would prefer not see to a sharp rise in inflation so this bears watching
SGK Blog--Update June 13, 2014: Equities Retreat on the Escalating Conflict in Iraq 

Islamist fighters extended their advance in Iraq Friday, entering two northeastern towns as government forces failed to halt an offensive that triggered concern over a civil war and prompted the U.S. not to rule out airstrikes. Prime Minister Nouri al-Maliki’s security forces left Jalulah and Saaiydiyah after militants called on them to give up their weapons and leave their posts, according to news reports. The Interior Ministry started to prepare a new plan to defend Baghdad against an attack by members of the Islamic State of Iraq and the Levant, or ISIL. In a sign that the Sunni militants are pushing the country toward another round of sectarian conflict, a representative of Iraq’s top Shiite religious leader called on citizens to carry arms and fight terrorism. He said in the town of Karbala that those killed in a “holy” war would be considered martyrs. The Iraqi insurgency highlights the risks to oil supply from a nation forecast to provide about 60 percent of OPEC’s output growth for the rest of this decade, according to the International Energy Agency. 

The gains made by the Islamic State of Iraq and the Levant, or ISIL, which split from an al-Qaeda affiliate last year, pose the biggest risk to Prime Minister Nouri al-Maliki’s government since the U.S. withdrawal from Iraq three years ago. They also threaten the stability of oil production in the north of the country. The extremists may “eventually” pose a direct threat to U.S. interests, President Obama said in a news conference. “What we’re going to have to do is combine selective actions by our military to make sure that we’re going after terrorists who could harm our personnel overseas or eventually hit the homeland.” Maliki last month asked the U.S. to mount air attacks against militant training camps in western Iraq, according to U.S. officials. Obama yesterday said he wouldn’t rule out that option. He emphasized there are no plans to put U.S. troops on the ground in Iraq. The Pentagon will announce today increased surveillance over Iraq, U.S. defense officials said. This heightened conflict put upward pressure on oil prices which can lead to a drag on economic output as eventually that will translate into higher prices at the pump – especially just as many kids are coming out of school and parents are about to head out on summer vacations. 

Investors are also watching data to determine the strength of the world’s largest economy here in the U.S. Reports yesterday on jobless claims and retail sales fell short of estimates. Retail sales rose 0.3% in May as many American consumers took a respite following a three-month surge in shopping. The expectation was for a 0.7% rise in the May overall figure. Applications for unemployment benefits in the U.S. rose to 317,000 last week. The median forecast amongst 52 economists surveyed by Bloomberg called for 310,000 claims. Wholesale prices in the U.S. unexpectedly fell in May, suggesting demand isn’t robust enough to push inflation closer to the Federal Reserve’s target. The figure came in at -0.2% versus the expectation for +0.2%. The Thomson Reuters/University of Michigan index of consumer sentiment unexpectedly fell to 81.2 this month from 81.9 in May and relative to the expectation for an increase to 82.9. Overall this created a gloomy mood for stock traders this week and the major averages reflected that.

SGK Blog--Update June 6, 2014: Employment Report Highlights Week

The Labor Department reported that nonfarm payrolls grew by 217,000 in May, and the unemployment rate stayed at 6.3%.  The median estimate from a survey of Bloomberg economists was for 215,000 new jobs so the actual number was quite close.  It was the fourth consecutive monthly report above 200,000, the first time that’s happened since early 2000.  Average hourly wage growth was 2.1% for the past 12 months, but the average workweek remained unchanged at 34.5 hours.  On a positive note, the number of discouraged workers—those who are no longer looking for a job because they think they cannot get one—fell to 697,000 last month compared to 780,000 in May 2013.  Also encouraging is the fact that the number of people unemployed for 27 weeks or longer as a percentage of total unemployed fell to 34.6%, the lowest level since August 2008.  Also the underemployment rate—those who are part-time workers who would prefer full-time positions plus those who want to work but have given up—declined to 12.2%, the lowest level since October 2008.  With the current report, all of the jobs lost during the recession have been recovered.  With the 217,000 gain, the nation has surpassed the payroll peak of 138.4 million reached in January 2008, a time right before the country faced the brunt of the worst recession since World War II. 

We also got positive news in the more current weekly employment data.  The number of initial unemployment claims climbed to 312,000 in figures reported on Thursday.  The four-week average for jobless claims fell to 310,250 in the period ended May 31, the lowest since June 2007 according to the Labor Department.  The number of people continuing to receive jobless benefits dropped by 20,000 to 2.6 million in the week ended May 24, the fewest since October 2007. 

Outside of employment, this week’s data continued to point to a strengthening economy.  The Institute for Supply Management’s factor index rose to 55.4 in May from the prior month’s 54.9.  The non-manufacturing index climbed to 56.3 last month from 55.2 in April.  Readings above 50 in either survey signal expansion.  Vehicle sales rose to a 16.7 million annual pace in may, the strongest since February 2007. 

Overseas, the mood is a bit different.  The European Central Bank (ECB) made some well-anticipated moves at their interest rate meeting yesterday.  The main lending rate was reduced to 0.15% from 0.25% and the ECB dropped the rate on bank deposits to -0.1%.  In other words, the central bank is going to be charging commercial banks for keeping their money at the ECB, an unprecedented move for an entity the size of the Europe’s central bank.  Speaking at a news conference, ECB President Mario Draghi said, “We think it is a significant package.  Are we finished?  The answer is no.  If need be, within our mandate, we aren’t finished here.”  Thus, Draghi and his colleagues were prepared to take further “unconventional” measures if Thursday’s measures ultimately prove to be inadequate.  He added: “A broad-based asset-purchase program is certainly one of those instruments.”  The ECB did not hang the banks out to dry, however.  A new series of targeted long-term refinancing operations will give banks access to low-interest rate loans.  The amount they can borrow will be linked to the scale of their new lending.  ECB economists also published new forecasts for inflation and growth which prompted the actions taken by the central bank.  They now expect the annual rate of inflation in 2014 to be 0.7%, down from the 1.0% forecast back in March.  The euro-zone economy is now expected to grow by just 1.0% this year, lower than the 1.2% forecasted at the end of the first quarter.

What do we make of the plan?  It was necessary.  Draghi’s “whatever it takes” rhetoric in past sessions was enough to halt the bleeding at that time but the threat of deflation was becoming too great.  According to him, “We don’t see deflation…we don’t see households postponing their spending plans.”  In our opinion, it’s not a question of postponing, it has become more a question of whether they had any to begin with.  Euro zone inflation weakened to 0.5% in May, the lowest level in more than four years and well below the ECB’s target of around 2%.  That is not a sign of a well-functioning, demand-driven economy.  Japan has grappled with deflation for two decades, so Europe is right to be fearful.  European bourses loved the news with the Germany DAX index briefly topping 10,000 for the first time ever.  In the last five years, it has nearly doubled.  But what’s good for the market may not be good for main street.  The price of the euro has been a key roadblock for the central bankers.  It is slightly weaker versus the dollar year-to-date, but, in the interim, it has shown spikes higher even in the face of a declining economic picture.

Will this plan work?  Time will tell but it’s clear that Europe must do more.  The exports of goods and services comprised 27% of the entire European Union’s (including countries that do not use the euro as currency) GDP.  That compares to 13% for the U.S.  So a slowdown in major markets like China and Japan hurts them much more than the U.S. which derives a much higher percentage of GDP from the output of its citizens buying things from other U.S. citizens.  A higher push to lend via a negative interest rate offers some incentive but, at the margin, there is not much difference between the current 0.1% “fee” and the previous 0% rate.  It is more a nuisance than a real catalyst.  Draghi & Co. have kept the “nuclear option” under wraps; namely, quantitative easing through the purchase of sovereign bonds with no strings, consequences or sterilization attached.  The ECB is now likely to give time for these new policies to take effect then reconvene to see the results.  In fact, the first of the new long-term refinancing operations will not take place until the September, still nearly three months away.  With government bond yields from France to Portugal at low levels, they do not feel pressure to do more as these economies continue to get their fiscal houses in order.  But the combination of still-in-place austerity measures at various locales plus falling commodity prices shows that, unlike what Draghi says, they may not see deflationary pressures but the populous is certainly starting to feel it.

SGK Blog--Update May 30, 2014: GDP Falls During First Quarter

Gross Domestic Product in the first quarter fell at a 1.0% annualized rate as reported by the Commerce Department this week.  This figure was a revision to an earlier 0.1% gain that the government reported last month.  The last decline in GDP was the first quarter of 2011.  The median forecast of economists surveyed by Bloomberg was for a 0.5% contraction.  Companies increased inventories by $49 billion in the three months ended March, less than the $111.7 billion in the final three months of 2013.  This subtracted 1.62 percentage points from GDP, the most since the fourth quarter of 2012.  Ironically, because inventories rose, but not as much as in the fourth quarter, it is deemed as a liquidation and subtracts from GDP growth.  Non-residential investment fell at a 1.6% annualized rate.  Spending for equipment fell 3.1%, the most since the third quarter of 2012.  Consumer spending, which accounts for over two-thirds of GDP, increased at a 3.1% annualized rate and added 2.1 percentage points to GDP.  Many pundits were not concerned with the overall decline because consumers did continue to spend even in the face of harsh winter weather.  Retail sales picked up near the end of the quarter and construction spending also showed signs of improvement as the quarter came to a close.  The median projection for growth in the second quarter is a 3.5% rise.  For all of 2013, the expectation is for a 1.9% gain after a 2.8% rise in 2013.

Recent trends in employment also point towards more improvement.  Initial jobless claims fell by 27,000 to 300,000 in the week ended May 24 according to the Labor Department.  A Bloomberg survey of economists estimated a range from 300,000 to 330,000 after an initial reading of 326,000 in the prior week.  The less volatile four-week average declined to 311,500 from 322,750 the week prior.  The number of people continuing to receive jobless benefits fell by 17,000 to 2.63 million in the week ended May 17.  Durable goods which are items meant to last at least three years, rose 0.8% in April according to Commerce Department figures released Tuesday.  The median forecast was for a 0.7% decline so this was an unexpected surprise higher.  Orders for military hardware rose for the most since December 2012.  There was also a 7% gain in the demand for computers and a 3.4% rise in orders for fabricated metals.  If the housing market continues to improve, albeit slowly, it will create more demand for goods such as electrical equipment and appliances.  Bucking this trend was data released today which shows that consumer spending unexpectedly fell in April.  The Commerce Department said household spending fell 0.1%, the first decrease in a year, after a revised 1.0% rise the prior month that was the strongest reading since April 2009.  Though a bit disappointing, it makes sense that pent up demand that was released in March once all the snow melted and winter storms passed took a breather the following month.  Disposable income rose 0.2% in April after climbing 0.3% in the prior three months.  The risk is that the consumer will fall into a pattern of unimpressive spending during the summer months.  We continue to believe that the economy will show further signs of strength as we conclude the second quarter next month.

SGK Blog--Update May 23, 2014: Earnings Growth Lackluster in First Quarter 

As first quarter earnings season comes to a close, the results can best be described as lackluster. We have written it the past that stock prices tend to be driven over time by two main factors, future projected earnings (or better yet free cash flow) and interest rates. While the backdrop for interest rates remains subdued, earnings are perhaps a little more worrisome. More than 90% of S&P 500 companies have reported their first quarter results to date and profit gains were just 2.1% overall compared with a year earlier and this was well below the prior quarter’s year-over-year gain of 8.5%. Now we are seeing softer reports on industrial production, housing starts, consumer sentiment and European economic growth and overall this is concerning. We can no longer chock up soft data to weather related issues. Analysts are forecasting a 6% gain in year-over-year profits for the second quarter and in our view this is ambitious. Of the companies so far offering guidance, 72% of them have warned that second quarter profits will be below expectations. Thus, earnings expectations for the second quarter need to come down. Particularly given the weakness we have seen in growth in both Europe and China in recent weeks. We never underestimate the predictive power of the yield curve either, and the recent direction has been troubling. If the economy were strengthening, market interest rates should be rising. We are not complaining, lower rates helps stimulate activity and the less the Federal Reserve is involved in terms of manipulating rates the better. At least the yield curve remains upwards sloping, so we can interpret the curve as suggesting that expectations for both U.S. economic growth and inflation remain subdued. If the yield curve were to flatten or become inverted, than that becomes a worrisome event. 

In other important news this week, the Federal Open Markets Committee (FOMC) released the minutes from their April meeting. Policy makers discussed the need to improve guidance on the likely path of interest rates and tools to raise short term borrowing costs. Although they did not see much change in the economic outlook from the meeting prior, the release of the minutes and in particular the discussion surrounding how to communicate future interest rate increases better caused an immediate reaction in the bond market. Treasuries sold off and interest rates rose and in addition the yield curve steepened as the spread between 5 and 30 year Treasuries widened to the most in more than a month. The extent of the interest rate move was muted however as they also discussed the fact that the continued stimulus to push the unemployment rate lower does not appear to be causing a corresponding spike in the inflation rate or an increase in inflationary expectations. This hints that they are comfortable remaining accommodative for now and continuing on their path of gradually reducing accommodation while the economy gains traction. 

The economic news this week was generally positive. The Markit Economics preliminary index of U.S. manufacturing rose to 56.2 in May from 55.4 a month earlier as output accelerated. Readings above 50 for the purchasing managers’ measure indicate expansion and the May figure was the highest in three months. Helping matters in terms of global markets as well was a preliminary reading of a purchasing managers index in China from HSBC Holdings PLC and Markit Economics came in at 49.7, exceeding the 48.3 median estimate of analysts surveyed by Bloomberg and a final reading of 48.1 in April. Although below the magic number of 50, the number is trending in the right direction. Previously owned U.S. home purchases increased in April as a bigger supply of properties lured buyers and raised prospects for a stronger spring buying season. We have also witnessed interest rates decline from where they stood at the end of last year, and this helps home borrowers. The 1.3% gain, the first this year, pushed sales to a 4.65 million annualized rate, National Association of Realtors data showed. The number of available properties climbed to almost a two year high helping slow the pace of price appreciation. New home sales for April, released Friday, rose by the most in six months on the backs of falling interest rates. The 6.4% increase to a 433,000 annualized rate followed a revised 407,000 in March that was larger than initially estimated, according to the Commerce Department in Washington. Economists had forecast a rise to 425,000 in the month of April. Surprisingly, more Americans filed applications for unemployment benefits last week, showing progress in the labor market remains choppy. Jobless claims increased by 28,000 to 326,000 in the week ended May 17 after 298,000 filing the prior week. The forecast of 50 economists surveyed by Bloomberg called for rise to 310,000. With the exception of the labor data however, this was a pretty good week all-in-all.

SGK Blog--Update May 16, 2014: Markets Pause and Bonds Move Higher  

In economic news this week, initial jobless claims fell below 300,000 for the first time since 2007.  In the week ended May 10, jobless claims fell by 24,000 to 297,000 according to the Labor Department.  The forecast was for 320,000 claims.  The four-week average fell to 323,250 from 325, 250 the week before.  The number of people continuing to collect benefits fell by 9,000 to 2.67 million in the week ended May 3, also the fewest since 2007.  Following last month’s 288,000 payroll increase, the economy is showing some strength.  Given that initial claims are a more timely indicator than the jobs report, expectations will be high for the May payroll data to be released on June 6.

On the pricing front, there was more of push upward last month than in previous periods.  The consumer price index rose 0.3% in April, the biggest advance since June, after rising 0.2% the prior month.  Over the past 12 months, prices were up 2% after a 1.5% year-over-year rise in March.  Stripping out volatile food and energy costs, the so-called core measure rose 0.2% which was a little above the median forecast of a 0.1% rise.  The core measure was up 1.8% year-over-year, the biggest yearly change since August.  Producer prices which measure whole goods and services rose 0.6% in April, the largest gain since September 2012.  Over the past 12 months, producer prices rose 2.1% with food prices surging by the most in three years.  An 8.4% rise in the cost of meats helped push up that category.  The producer price core measure, which also strips out food and fuel, rose 0.5% after increasing 0.6% in March.  Good prices rose 0.6% last month while service costs such as airline fares were up a similar amount.  Both the consumer and producer price measures showed that long-term inflation expectations remain stable.  The Federal Reserve has targeted 2% as the preferred target and consumer prices have not reached that level since March 2012.

The story in Europe is different.  The euro area grew just 0.8% at a seasonally adjusted annualized rate in the first quarter as France stalled and Italy shrank.  Germany grew 3.3% but that was not enough to offset weaker territories like Portugal that was down 0.7%.  European Central Bank (ECB) President Draghi said last week that further stimulus was coming in June.  This week word spread that Germany’s Bundesbank was also comfortable with more accommodative measures.  That was a key pivot because German reluctance to any loosening has always been a major roadblock against more forceful action.  Granted, outright bond purchases and unrestrained quantitative easing is not up for discussion, but at least Europe is coming to grips with the fact that the euro area’s recovery from a record-long recession is still quite fragile with the inflation rate at less than half the ECB’s target.  Unemployment was 11.8% in March, near the all-time high of 12% last year.  With the Bundesbank warning that the German economy will slow “noticeably” in the second quarter, the pressure to act is building.

SGK Blog--Update May 9, 2014: Stocks Trade in a Range as Earnings Season Comes to a Close 

Traders shook off the early week doldrums Monday as equity indices began the day on a sour note based on heightened tensions in the Ukraine and weak Chinese manufacturing data, but reversed course at 10 am when the Institute of Supply Management’s (ISM) Services Index was released. This latter figure rose to 55.2 in April from the prior month’s 53.1. A reading over 50 signals expansion and a survey of economists had predicted the figure would come in at 54. Services account for approximately 90% of the U.S. economy so this is an important figure. It shows that the economy continues to shake off the winter blues and weather related issues that occurred during the first quarter. On the flip side, futures had been pointing to a negative open Monday based on the fact that China’s manufacturing industries contacted for a fourth month in April. HSBC Holdings Plc and Markit Economics said Monday their purchasing managers’ index for China came in at 48.1. That missed the median estimate of 48.4 and numbers below 50 signal a contraction. JP Morgan also hit markets Monday with a warning that fixed-income and equities trading revenue would be down about 20% from a year earlier amid “a continued challenging environment and lower client activity levels.” Violence in the Ukraine made headlines over the weekend amid the tragic situation there and that made traders jittery as well at the week’s outset.

American workers were less productive in the first quarter as harsh winter weather prevented some from getting to their jobs, causing the economy to stall. The measure of employee output per hour (productivity) dropped at a 1.7 percent annualized rate, the weakest reading in a year, after rising at a 2.3 percent pace in the last three months of 2013, a Labor Department report showed. The median forecast in a Bloomberg survey of 59 economists called for a 1.2 percent drop. Unit labor costs climbed at a 4.2 percent rate, more than estimated. The pullback in productivity came as snow and unusually cold weather covered much of the U.S., depressing economic activity as consumers stayed indoors and companies put off investment plans. As growth recovers in the months ahead, some companies may be induced to either take on more workers or invest in equipment to keep up with demand. Productivity is important because it helps determine the pace at which an economy can grow without stoking inflation, which economists term its speed limit. That reflects the rate of growth of the labor force plus how much each worker can produce. Smaller gains in productivity therefore mean advances in gross domestic product will also be restrained. Last quarter’s increase in expenses per worker, which are adjusted for efficiency gains, was the biggest since the last three months of 2012. Costs were forecast to rise 2.8 percent last quarter, according to the Bloomberg survey median. This spike in unit labor costs is concerning because high labor costs can squeeze corporate profit margins and also because labor costs are a key metric in the calculation of inflation measures. Lower margins and higher inflation are a major headwind to advancing stock prices so this bears close watching in the months ahead. 

The Treasury market’s yield curve steepened this week by the most in almost eight months after Federal Reserve Chair Janet Yellen eased investor concern that policy makers would accelerate interest-rate increases. Five-year notes, more susceptible to changes in Fed rate policy expectations, outperformed 30-year bonds after Yellen told Congress in testimony Thursday rates are unlikely to rise unless the recovery is stronger.  U.S. job openings fell in March, a report on Friday showed.  Demand for Treasuries at this week’s note and bond auctions fell to the weakest level in seven months on bets a rally may have gone too far, too fast. Basically shorter term rates stayed relatively flat this week while longer term rates rose. In our view, Janet Yellen definitely moved the needle for when rates rise to the back half of 2015 as she confirmed her dovish bias with her discussion this week. We had been concerned as rates had flattened out and the yield curve is one of the best predictors of a slowing economy.

SGK Blog--Update May 2, 2014: GDP Figures Reflect Harsh Winter  

The Labor Department released non-farm payroll numbers for the month of March and the numbers at first blush were impressive. The 288,000 gain in employment was the biggest since January 2012 and followed a revised 203,000 increase the prior month that was stronger than first estimated, Labor Department figures showed.   This handily surpassed the expectation for a 210,000 increase and showed that the economy rebounded from the bad weather months of December-February. Unemployment dropped from 6.7 percent to the lowest level since September 2008 as fewer people entered the labor force.  The jobless rate plunged to 6.3 percent from the previous month’s 6.7% figure as companies grew confident the U.S. economy is emerging from a first-quarter slowdown. Gains in equities on the strong report was tempered by increased violence in the Ukraine during the Friday trading session, and that made traders reluctant to be long stocks heading into the weekend.

Gross domestic product grew at a 0.1% annualized rate during the first quarter, compared with a 2.6% gain in the fourth quarter according to figures released by the Commerce Department on Wednesday.  The median forecast of 83 economists surveyed by Bloomberg called for a 1.2% increase.  This is an “advance” reading which means this figure will be revised twice more.  The second estimate will be based on more complete data and is scheduled for release on May 29.  Many pundits attributed the shortfall to the severe winter weather than blanketed much of the middle and eastern U.S.  Average snow cover in the contiguous U.S. from December through February was the 10th largest for the period since 1966 according to the National Oceanic and Atmospheric Administration.  New York, Philadelphia, Boston and Chicago each had one of their 10 snowiest winters ever.  Real exports fell 7.6% in contrast to a 9.5% increase in the fourth quarter.  Real nonresidential fixed investment fell 2.1% in contrast to a 5.7% rise in the previous quarter.  Real personal consumption expenditures, which comprises the lion’s share of GDP, rose 3.0% compared to a 3.3% in the fourth quarter even with the pressure on retailers from the harsh weather.  Services, which is a subsector of this area, accelerated to a 4.4% increase versus the 3.5% increase in the final quarter of last year.  Thus, the headline number may be weak, but looking at the details shows that the economy continues to chug along at a nice pace.  Moreover, all of this data is “backward” looking.  We are already in May and the most recent data we see—from weekly initial unemployment claims, monthly consumer and wholesale pricing data and monthly purchasing managers’ surveys show that the Federal Reserve’s outlook for a slowly strengthening economy remains on track.  A separate Bloomberg survey of economists shows that growth will pick up to 2.7% pace for all of 2014 which means that a lot will be expected of the last three quarters of the year if this advance GDP number sticks through future revisions.  The latest consumer spending data shows that March was a bumper crop month for individuals to hit the auto-dealer lots and malls.  It rose 0.9% according to the Commerce Department, the most since August 2009, after a 0.5% gain in February that was larger than previously estimated.     

Speaking of the Federal Reserve, they conducted a regularly scheduled meeting of the Federal Open Market Committee this week.  The result was as expected which meant it was largely overlooked by the market.  While acknowledging that growth has picked up recently, the Fed said that labor conditions remain “mixed” and the unemployment rate “remains elevated.”  In fact, the weekly initial unemployment claims were a bit elevated this week compared to consensus.  In the week ended April 26, jobless claims rose by 14,000 to 344,000 while the median forecast was for a rise of 320,000.  Springtime data is often overly influenced by the Easter holiday and spring break items, so too much stock cannot be put into this uptick.  The trend remains for lower firings.  Therefore, beginning in May, they will taper their purchases of mortgage-backed securities and U.S. Treasuries to a total of $45 billion per month from the current pace of $55 billion per month.  They will likely continue scaling back purchases in steady steps unless the economy or broader geo-political climate throws them for an unexpected loop somehow.  Since that appears to be a remote possibility, the market is working under the belief that by mid-term elections, the Fed could be all tapered out.  Then the real guessing begins:  When will they start to raise rates explicitly?  Chairwoman Janet Yellen, after some unscripted remarks at the March post-Fed meeting press conference, has been more direct in her main message.  That is, a “wide range” of economic indicators will be used including labor, financial and market indicators rather than one figure or a given time frame.  Her desire to build consensus among the Fed governors is evident in this meeting’s result being voted upon unanimously.  Granted, there are three empty seats on the policy voting committee as those vacancies have not been filled yet.  Regardless, the Fed is showing a unified, calming presence to the market as the summer months approach. 

Meanwhile, the European Union’s statistical agency reported that consumer prices rose by 0.7% in April from a year ago, a slight pickup from the 0.5% March figure, but still way below the target of closer to 2%.  April was the seventh straight month in which inflation was less than half the target rate.  European Central Bank (ECB) officials thought that last month would see a pickup thanks to Easter travel and shopping and the introduction of warmer temperatures spurring seasonal merchandise and service sales.  Admittedly, ECB President Mario Draghi thought April would “pick up somewhat” and then remain low in subsequent months before rising to the target rate by late 2016.  That might very well occur, but that is over two years away, and businesses are not likely to thrive in an environment of such “lowflation.”  The ECB cut its benchmark rate last October when inflation first dropped below 1%, but in the interim it has done nothing of consequence.  We did see a rise in the service inflation to 1.6% and net demand for corporate loans turned positive for the first time since the second quarter of 2011.  Those are positive data points but remain more anecdotal than sustainable.  The ECB is reluctant to implement more quantitative efforts like we see here in the U.S., but eventually they may be forced to do so.

SGK Blog--Update April 25, 2014: Economic Data Mixed Amongst Earnings Deluge 

This was a mixed week in terms of the economic data we received on the U.S. economy. On the one hand, figures for manufacturing showed a rebound from the effects of the winter doldrums, but the housing data seemed to indicate deeper issues than just a weather related slowdown. Durable goods orders for March came in much stronger than expected. These are goods designed to last longer than one year so it would include appliances, airplanes, etc. The overall number showed an increase of 2.6% compared to the 2% forecast while excluding the more volatile transportation sector the figure was +2.0% compared to the estimate for +0.5%.  The big gains were driven by the highest increase in computers and electronics orders since November 2010. This may have been helped by Microsoft’s decision to end support for Windows XP at the end of March.  Initial weekly jobless claims for the week ending 4/19/2014 were higher than expected at 329,000, but this does tend to fluctuate week-to-week and the basic trend over the past few weeks has been heading in the right direction, which is lower. 

Housing data released this week was more concerning. Although existing home sales at 4.59 million for March was basically in-line with expectations, new homes sales at 384,000 for the same month was well below the expected 455,000 figure. New home sales are counted when contracts are signed so it is a more current measure of the health of the housing market. Home builders from NVR to Toll Brothers have also noted that they have seen a recent sharp slowdown in activity. The Wall Street Journal noted in a front page article Friday that overall mortgage lending (both home purchases and refinancing) declined to the lowest level in 14 years in the first quarter of the year. They attributed this to a combination of higher interest rates but also higher housing prices, particularly in certain parts of the country. They noted that the average 30-year fixed rate mortgage stood at 4.5% last week compared to 3.6% just last May. That may still seem low by historical standards but consumers have been used to low rates for quite some time, and combined with tougher lending requirements, it clearly has had a negative impact on overall lending activity. 

Tension remain high in Europe as the situation in the Ukraine remains highly unstable and very unpredictable. Five rebels were killed by Ukrainian forces at a checkpoint on Thursday, causing Vladimir Putin to warn the Ukraine against continuing their offensive against pro-Russian forces. More troubling is the fact that he has 40,000 Russian troops amassed along the border with the Ukraine and they stepped up exercises in the area as a result of the conflict. The situation creates heightened uncertainty across European economies. In response, European Central Bank President Mario Draghi indicated the bank may start broad-based asset purchases in a radical shift similar to our central bank’s stimulus efforts if the inflation outlook in Europe worsens. He gave a speech in Amsterdam where he stated, “the objective here would not be to defend the current stance, but rather to increase meaningfully the degree of monetary accommodation.” He went on to say, “the Governing Council is committed – unanimously – to using both unconventional and conventional instruments to deal effectively with the risks of a too-prolonged period of low inflation.” That sounds eerily familiar to our central banks stance over the past several years. Clearly they have been monitoring our progress with unconventional forms of stimulus carefully. In other European news, German business confidence unexpectedly rose in April, signaling optimism that Europe’s largest economy may withstand risks from the tension in the Ukraine and price weakness in the area. If a major conflict breaks out in the Ukraine however, then all bets are off!
SGK Blog--Update April 17, 2014: Earnings Season Begins 
The consumer price index climbed 0.2% in March as food and rents rose according to the Labor Department.  Excluding the volatile and fuel and food categories, the so-called core figure rose the same 0.2% after rising 0.1% the previous month.  Over the past year, the overall increase has been 1.1% with the core up 1.7%.  These figures remain below but still close to the sweet spot the Federal Reserve is looking for around the 2% range.  The Fed stopped short of including a “quantitative element” as part of its outlook.  They tried using such static figures on the employment front but found that wanting as well once the guidepost came into range without the economy responding the way they had hoped.  Instead, they will consider a multitude of factors according to the minutes of the Federal Open Market Committee’s latest meeting last month.  At the least the U.S. is not alone in terms of below-expected inflation.  According to data covering 121 economies tracked by Bloomberg, nearly two-thirds are experiencing smaller gains in consumer prices than a year ago.  This is a big topic especially in Europe where their latest price figure was nearly flat and fears of deflation are becoming more pronounced.

Even if prices are not rising, American consumers have released some of their cold weather-suppressed pent-up demand when it comes to retail sales.  The Commerce Department reported that sales rose 1.1% in March, the biggest gain since September 2012.  Plus, February’s figure was revised upwards more than twice as large as previously reported.  Ten of 13 categories showed an increase.  Sales excluding gas stations rose 1.4%, the most since March 2010.  One of the biggest contributors was the jump in auto purchases.  Sales at auto dealers rose 3.1% in March after rising 2.5% in February.  Not surprisingly, as the weather warmed somewhat in March, dealerships become busier.  Cars and light trucks sold in March at a 16.3 million annualized pace, the fastest since May 2007 according to data released by Ward’s Automotive Group.  But buying was not limited to cars, consumers spent more at department stores, sporting-goods outlets and building-supply shops.  Internet sales also rose.  With jobless claims this week hovering near their lowest level since 2007, companies may not be robustly hiring but dismissals are certainly on the decline.  The last time the four-week average of claims was this low was October 2007 which was the month and year that marked the previous market peak.  That marked a high point for employment before the financial crisis began in earnest the following year.  Currently, we are seeing employment begin to pick up after being stagnant for years.    

Meanwhile, housing starts climbed 2.8% to a 946,000 annualized rate in March according to the Commerce Department.  Permits for future projects declined 2.4%.  Work on single-family properties rose 6% while construction of multifamily projects such as condominiums and apartment buildings fell 3.1%.  The National Association of Home Builders/Wells Fargo builder sentiment rose to 47 in April from 46 in March.  Readings above 50 mean more respondents report good market conditions.  Thus, we have seen both severe winter weather as well as less affordability via a higher interest rate affect the market.  The average 30-year, fixed rate mortgage was 4.34% for the week ended April 10 according to Freddie Mac.  This compares to 3.43% a year ago.  In general, the U.S. requires between 1.6-1.9 million new units a year to accommodate population growth and household formation according to the Harvard Joint Center for Housing.  So while the market is returning to health, builders have yet to supply the needed capacity.  That bodes well for future demand, but presently it remains a data point in the not too hot, not too cold economy. 

SGK Blog--Update April 11, 2014: Global Equity Indices Are Choppy Ahead of First Quarter Earnings Season  

Before earnings season officially got underway this week, analysts’ forecasts for profits for companies in the S&P 500 index indicate a decline of 0.4% compared to the comparable quarter last year, according to FactSet.  This would mark the first drop in operating profit since the third quarter of 2012 and represents a downward revision of the estimates 3 months ago at year end when analysts’ had forecast an increase of 4.4%.  Can we put all the blame on the “polar vortex” (sorry to bring up that term again!) that settled over the Midwest and Northeast and swept in snowstorms that shuttered businesses and government offices, snarled highway traffic and grounded thousands of flights?  Or is this just a classic case of analysts’ revising down their forecasts as we get closer to the timing of corporate releases.  It seems a familiar pattern, although this quarter companies have issued negative guidance at a near record pace with 93 members of the S&P warning that first quarter profit could miss forecasts.  The reality though is bad weather did in fact halt construction projects, disrupted rail lines and hurt auto sales.  Even if people could get to a dealership, who wanted to take a test drive in six inches of snow!


Stocks continued their retreat in early week trading, especially the high flying momentum stocks in the biotech and social media space that had been so strong last year.  Valuations were skewed and a number of these high profile names such as Facebook, Biogen and Vertex Pharmaceuticals fell sharply during the period when the NASDAQ declined so abruptly.  It seemed almost all stocks in the NASDAQ were subject to the move away from the momentum players, but we tend to hold names such as Amgen and Check Point Software Technologies that trade at much more reasonable valuations, and those securities held up better during the downdraft.  A big part of this pullback is based on the notion that it will be challenging for many companies to deliver on earnings expectations and therefore, how does one actually justify the price relative to earnings of a company such as Amazon or Netflix?  Many stocks simply got way ahead of themselves and were overdue for a correction.

U.S. equities got a bit of a lift in Wednesday trading when the minutes of the Federal Reserve Open Markets Committee (FOMC) were released.  Several Fed policy makers said a rise in their median projection for the main interest rate exaggerated the likely speed of tightening, according to minutes of their March 18-19 meeting.  Even after rates rise, officials said last month, they might have to be kept at levels considered below normal for longer because of tighter credit, higher savings and slower growth in potential output. Treasury yields rose last month after policy makers predicted that the benchmark interest rate would rise faster than previously forecast.  Janet Yellen, presiding over her first meeting as chair, later downplayed the importance of the forecasts, even as she said that rates might start to rise “around six months” after the Fed ends its bond-purchase program.  Again, this helped calm traders fears and we witnessed “short covering” particularly in names that had sold off hard recently. 

In other economic news, the fewest number of Americans since before the last recession filed applications for unemployment benefits last week, pointing to more progress in the labor market.  Jobless claims decreased by 32,000 to 300,000 in the week ended April 5, the lowest since May 2007, a Labor Department report showed Thursday.  The figure was lower than the most optimistic forecast in a Bloomberg survey of 52 economists.  A report also released Thursday showed China’s exports and imports unexpectedly fell in March, adding to concern that expansion in the world’s second-largest economy will deteriorate further.  Premier Li Keqiang said the nation will roll out more policies to support growth while avoiding stronger stimulus.  Attention was squarely focused on the economic data being released worldwide this week while that attention will likely shift to the health of corporations as we get into the thick of earnings releases over the next 3-4 weeks.

SGK Blog--Update April 4, 2014: Payrolls rise by 192,000; Unemployment Rate Steady  

The Labor Department reported that March saw an increase of 192,000 in non-farm payrolls.  February’s totals were revised higher to 197,000, up from the 175,000 gain announced in early March.  The median forecast in a Bloomberg survey of economists projected a rise of 200,000 so the final number was a little shy but not by too much especially in light of the previous month’s revision.  In fact, both January and February were revised higher—by a total of 37,000—which means that poor winter weather did not have as much of a detrimental effect as originally thought.  Private payrolls, which do not include government agencies, rose by 192,000, the most in four months.  With March’s increase, total private payrolls reached 116.1 million, surpassing the pre-recession peak.  When government agencies are included, the U.S. has recovered all but 437,000 of the 8.7 million jobs lost during the last recession.  The report also showed an increase in hours worked which is taken by many to be a precursor of continued job gains in the future as current workers become less productive and employers turn to new hires to maintain output.  A jump in temporary workers by 28,500 is another sign of future hiring.

The unemployment rate, derived from a survey of households, held steady at 6.7%.  The labor force participation rate rose to 63.2% from 63.0% last month which was a good sign because it showed that more workers are trying to enter the workforce, yet overall that had no effect on the number of those employed.  We still remain far removed from the 65.7% rate that existed when the recession was deemed over at the end of June 2009.  Regardless, there were many positives in this month’s report.  Janet Yellen’s Federal Reserve said it would stop using the unemployment rate alone as a determining factor when the central bank might start raising short-term rates.  As such, traders and investors will be looking at every detail of the employment situation.  More workers and higher participation might be viewed as a sign that things were heating up quickly.  However, average hourly earnings month-over-month was flat and year-over-year it was up only 2.1%, below the market’s expectation of a 2.3% rise.  We will get another dose of data next Tuesday when the Labor Department will release their JOLT report which gives a view of job openings.  It will track how willing people are to quit their current job and how hard, in their estimation, it is to find a new one.  Our conclusion is that the winter weather did indeed mask some of the economic growth that we saw building during the last months of 2013.  There still remains slack in the labor market which is what we saw with a rise in the initial unemployment claims data this week.  The global pool of labor continues to grow rapidly, so the firming of prices is unlikely until sometime later this year.  We continue to believe that the economy continues headed in the right direction.

Overseas, the European Central Bank (ECB) is dealing with conflicting signals.  The euro zone is expected to emerge with a GDP growth of 1.2% this year after last year’s contraction, but unemployment remains near a record high.  Euro zone inflation slowed to 0.5% in March, the lowest level since November 2009, which is pressuring companies who are having a hard time raising prices.  ECB Vice President Vitor Constancio said on April 1 that he expects “the low figure in March will be corrected to a high figure in April”.  ECB staff projections show the rate climbing to 1.5% in 2016.  According to the International Monetary Fund’s Christine Lagarde, the euro zone needs more monetary easing.  ECB president Mario Draghi has pledged since September 2012 to buy bonds of stressed countries if their governments commit to reforms.  German Bundesbank leader Jens Weidmann has in the past criticized such pledges and other quantitative easing measures. 

International investors are returning to the region with buyers emerging for Spanish and Italian bonds and Greece contemplating the first public offering of debt since it was frozen out of the markets years ago.  We think the market is telling the ECB that the common currency bloc needs a lift—whether that is through QE or new long-term loans to banks or posting a negative deposit rate virtually forcing money centers to lend out excess cash rather than lose it via “negative interest” while sitting at the ECB.  It is wise to listen to what the market is saying—politicians usually don’t lose their jobs giving the people what they want.  A far more difficult question is dealing with what the markets actually need.  The key to that answer is determining correctly whether the current trend of low prices is cyclical or secular.  If it is the former, then a sit tight approach is correct.  If it is the latter, then much more is needed from the ECB to fend off even the hint of deflation.  Stay tuned. 

SGK Blog--Update March 28, 2014: Global Stocks Hold Steady in the Face of Rising Tensions in the Ukraine 

As the quarter comes to a close, traders were focused on events going on globally and the data coming out on the economy. Stocks were weaker during the week when Obama spoke out against the actions taken by Russia in annexing Crimea, formerly part of the Ukraine. When rhetoric rises, tensions mount and traders get nervous. It is hard to imagine Russia stepping up their occupation of other portions of the Ukraine, but Putin is notoriously unpredictable. The actions he has taken to date have been enormously popular at home, even if not good for the broader economy or stock market in Russia, not to mention the decline in the relative value of the ruble – their currency. With all that said, Russian military exercises continue near the Ukrainian border as Putin is clearly sending a signal that he will not be swayed by western sanctions or talk. Countering tensions in Eastern Europe, there was speculation amongst traders this week that the recent data coming out of China in terms of their exports and industrial production would prompt the government to take measures to stimulate their economy. So the weaker than expected Chinese manufacturing data for March that came out on Monday actually helped stock indices firm up and even rise this week in anticipation of possible stimulus measures being taken at some point. 

Helping equity indices remain resilient this week was the important data that came out giving us insights into the health of the U.S. economy. We are just now getting over the measurement period that was heavily impacted by weather related issues that hit the country in January and February. Housing data tends to come out with the most significant lag, as it takes time to pull together. The Case-Shiller 20-city Index showed that housing prices rose in January 13.2% year-over-year continuing the trend towards a recovery in that sector. New home sales for February were 440,000, slightly below expectations, while pending home sales for the same month decline 0.8% which was worse than expected. Part of this we can attribute to weather, but other factors include the aforementioned rising house prices, which brings affordability into question, and also rising mortgage rates. Personal incomes for February rose 0.3%, slightly better than expected, while personal spending for the same month also rose 0.3%, which was in-line with expectations. The personal consumption expenditures index, or PCE for short, is a measure the Fed uses to gauge inflationary pressures in the economy and it came in exactly as expected at +0.1%, which is good. 

Orders for durable goods for February were much higher than expected at +2.2%, but excluding the more volatile transportation segment, the increase was only 0.2% which was actually slightly below expectations. As far as March is concerned, initial weekly jobless claims for the week ending 3/22/2014 were better than expected at 311,000 compared to the forecast for 330,000. We also had two measures of consumer confidence for March released this week with the Conference Board’s measure rising to 82.3 from 78.3 in February and compared to forecasts for a figure of 78.2, while the University of Michigan consumer sentiment survey came in right in-line with forecasts at 80.0. Thus, we can conclude the American consumer and U.S. businesses have remained resilient in the face of snowy and cold conditions!
SGK Blog--Update March 21, 2014: Fed's Message Gives Markets Pause 

In her first press conference at the helm of the Federal Reserve, Janet Yellen left the markets with something to remember. The Federal Open Market Committee met as scheduled and offered no bombshells when it released its conclusions in the usual post-meeting press release. It stated: “Labor markets were mixed but on balance showed further improvement.” They also said: “Inflation has been running below the Committee’s longer-run objective, but longer-term inflation expectations have remained stable.” Beginning next month, the Committee will reduce its monthly purchases of agency mortgage-backed securities and longer-term Treasury securities from $65 billion per month to $55 billion per month. The hope is that the “sizable and still-increasing holdings” will continue downward pressure on longer term rates, help the housing markets and provide further fuel for a still recovering economy. As expected, they also stated that they expect to further taper such purchases in the coming months assuming “ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective.”

Here is where things got tricky. Everyone who invests or lends money is wondering how long the Fed will keep being accommodative. It’s one thing to taper purchases down to zero, and quick math says at the current $10 billion reduction per month, that should be done by the fall of this year. It is another thing to actually raise rates. That is important distinction is what former chair Bernanke spent the second half of last year trying to get the markets to understand. It is not that Yellen undid those efforts, but her responses during the press conference created more doubt about when that would happen. The Fed Committee’s statement merely said that “it likely will be appropriate to maintain the current target range for the federal funds rate for a considerable time after the asset purchase program ends.” Not exactly a “save the date” type statement. Yellen, when asked to clarify the timing more exactly, said it is “hard to define” but that it could mean “something on the order of around six months or that type of thing.” Another quick math exercise results in the Fed raising rates by April 2015. The market did not expect that although the Fed also released quarterly updates to its central tendencies and ranges of economic projections that saw 13 members expecting policy firming in 2015. The exact date of that firming was not stated in the projections, however. But thanks to Yellen, we now know the answer.

What is our take? Much ado about nothing. The Fed statement said their “assessment will take into account a wide range of information” and went on to lists four indicators including labor market conditions and “readings on financial developments” (whatever that means). In her press conference, Yellen herself mentioned 10 different labor-market indicators she is tracking including the rate at which people are quitting their jobs and portion of workers in part-time positions. Thus it would be naïve to assume that come April 2015, the Fed will flip a switch and the fed funds rate will rise on cue. Were the markets expecting a rate increase? Yes, someday, but clearly the sharper path for a potential hike was not in the cards which led to the Dow Jones Industrial Average selling off around 210 points on Wednesday afternoon before rebounding into the close. This confusion was bound to happen because the Fed has shifted from giving timelines via their quarterly central tendencies to using more quantitative measures like the 6.5% unemployment rate threshold. Yellen made a point to state that the Fed was going to drop such direct measures in favor of a broader array of indicators within no set timeline. The real message to take from all of this is that after all-time highs in some equity indices and a long-term 10-year Treasury bond that remains lower than what some might expect, there are a lot of nervous investors out there.

Recently released data shows that the economy continues on the pace of slow but steady improvement. Initial jobless claims rose by 5,000 to 320,000 in the week ended March 15th according to the Labor Department. The less volatile four-week average fell to the lowest level since late November. The number of people continuing to receive jobless benefits remains near a three-month low. Inflation was little changed in February with the consumer price index increasing only 0.1% from January in the latest Labor Department report. The twelve month gain was only 1.1%, the smallest since October and considerably below the preferred guideline of about 2% the Fed looks for. Excluding food and fuel, the so-called core measure was up 1.6% year-over-year, the same as in January. The housing market presented a bit of a downer this week as sales of existing homes fell in February to a 4.6 million annual rate according to the National Association of Realtors. Prices rose 9.1% with the median price up to $189,000. The slowdown can be traced to a number of factors: higher borrowing costs, declining affordability, tepid job growth and, very importantly, bad weather. Not surprisingly, the endless winter has dampened the desire to drive around unfamiliar neighborhoods in search of a new abode, and it has hampered closings for deals which do get done. According to data provider Planaytics Inc., February ended with its cold final week since 2003 with the second week being the snowiest such period since 2007. At the current sales pace, it would take 5.2 months to sell the approximately 2 million previously owned homes currently on the market. That compares to the 4.9 months supply in January. Below 5 months is considered a tight or sellers market so we are not that far removed from healthy conditions even with the slight setback last month. Housing starts reported by the Commerce Department were little changed in February from January’s numbers. The 907,000 annualized pace was not far from the 910,000 median figure reported in a Bloomberg survey. On a positive note, permits filed for future construction surged 7.7%, the most since October. Nevertheless, it really will not be until April when a true picture of health can be determined and, hopefully, the disruptions of winter are put behind us.

SGK Blog--Update March 14, 2014: Global Stocks are Weaker on China Data and Heightened Ukraine Tensions 

Global stock indices were generally negative this week on concerns over weakness in export data coming out of China and on concerns the situation in the Ukraine would escalate. China experienced that country’s first bond default as China’s Chaori Solar failed to make an interest payment. As the world’s second largest economy, China draws a great deal of attention when it comes to headlines. China’s exports unexpectedly tumbled 18% in February, even though a good portion of that slide was attributed to the timing of their Lunar New Year holidays during which, as far as we can tell, hardly anybody seems to do productive work in that country! However, given we here in the U.S. are also significant importers of Chinese goods, it also raises questions about how big an impact our lousy weather in February has had on the global economy. Certainly, our expectation is that we will see a weather related impact on first quarter earnings as companies begin to report in about a month’s time. We do not own the stock, but a major American company DuPont warned that their first quarter earnings would be negatively impacted by “the cold and the Ukraine.” As China is such a large manufacturer of goods globally, commodity prices sharply declined on the export news and this put pressure on the currencies of commodity driven countries such as Australia and Canada. Later in the week we received additional data indicating that Chinese industrial output, investment and retail sales growth cooled more than estimated in January and February and this contributed to a sharp decline in stock prices in Thursday trading and particularly overnight in Asian markets. 

Not helping matters, tensions between Russia and the Ukraine added to investor unease. In Crimea, unidentified armed men fired in the air as they moved into a Ukrainian naval post in the latest confrontation since Russian military groups seized control of the Black Sea peninsula. There does not appear to be a quick resolution to this conflict in site and tensions between the U.S. and Russia continue to mount. If the situation is not resolved peacefully then this would have a ripple effect across European economies, which have just recently turned the corner as a number of countries rely on Russian exports of commodities such as natural gas to drive their production. We can certainly hope for a peaceful resolution, but a quick end to the matter does not appear to be in sight. 

In U.S. economic news this week, the story was somewhat mixed. Thursday’s data releases were strong, which in a strange way may have contributed to stock market declines here as it reinforces the notion that the Fed does not need to keep buying Treasuries and mortgage-backed securities each month. Their stimulus program is expected to continue to be reduced by $10 billion in purchases after each FOMC meeting with the target end date prior to year end. The strong data on retail sales and initial unemployment claims supported this view. Retail sales rose 0.3% in February, excluding autos it rose the same amount, versus expectations for both figures to rise 0.2%. This was welcome news as clearly retailers in many parts of the country were impacted by the weather. Initial weekly unemployment claims fell to 315,000 for the week ending 3/8/2014 which was well below the expectation for 329,000 and the prior week’s figure of 323,000. 

A significant risk to markets for 2014/2015 would be if we saw indications of inflation accelerating in the economy. Friday’s release of the producer price figures was welcome from that standpoint. PPI actually declined 0.1% for February and excluding the more volatile food and energy segment, referred to as core PPI, this decline was actually 0.2%. The expectation was for an increase of 0.2% for PPI and 0.1% for core PPI. One factor though that is worth noting, Janet Yellen has indicated that the Fed needs to look at broader indicators to gauge the health of the labor market other than just the unemployment rate. In the last employment release, the rate for those that have been out of work less than 27 weeks (short term unemployed) was just 4.2%. This is an indicator that some parts of the labor market are actually tightening. Two points to make here, labor is a key cost component for any company. As labor costs rise, margins get squeezed and that is a clear negative for the stock market. Second, tighter labor markets and rising wages can lead to inflation, as this is key metric in many of the measures the Fed uses to gauge inflationary pressure in the economy. Inflation leads to higher interest rates which in turn would present a major headwind for the stock market. So this bears watching closely. Finally, the University of Michigan released their consumer sentiment survey for March and this came in at 79.9, which was below the expectation for 82.0. This may be an indication that consumers are paying attention to events as they transpire in the Ukraine and are worried. It may also be a by-product of the fact that for many high income tax payers, especially those that spend and help drive the U.S. economy, they saw sharp increases in their tax bills this year thanks to the new higher rate for the top bracket and the new tax – the Medicare surcharge on unearned income as part of President Obama’s Affordable Care Act. This latter tax was new for 2013.

SGK Blog--Update March 7, 2014: Employment Rises Above Expectations  

According to the Labor Department, employers added 175,000 non-farm jobs in February.  This followed a revised 129,000 increase the prior month.  The median forecast for February was for a gain of 149,000 with a range of +100,000 to +220,000 according to a Bloomberg survey.  The unemployment rate climbed up slightly from 6.6% to 6.7%.  Private employment, which excludes government agencies, saw payrolls rise by 162,000 after a gain of 145,000 in January.  The now closely watched participation rate, which measures the percentage of people eligible for jobs actually working, held steady at 63.0%. The payroll data is constructed from a survey of businesses while the unemployment rate is comprised of household responses. 

The labor market improvement is one of the reasons why the Fed has begun dialing back its bond buying by $10 billion per month as part of its quantitative easing program.  A big question facing today’s data release was how much weather would affect the results.  The week ended February 15 was the coldest second week of February since 2011.  The South Atlantic region, according to weather-data provider Planalystics Inc., saw the most snowfall since 1983.  February’s conditions followed the chilliest January in three years.  The government data shows that 601,000 people were not at work because of the weather during the survey week, the most since 2010.  Hours worked declined as well with the average workweek falling to 34.2 hours last month, the lowest since January 2011.  Thus, we have our answer: it is clear that weather has had an effect on the data for the first few months of the year.  We have seen payrolls steadily climb each month: from +84,000 in December, to +129,000 in January to the current 175,000 addition.  It would be presumptuous to assume that the numbers keep going up from here because this data is often revised and the economy is not growing strongly at this point.  But the newest and, from an investors point-of-view more important, more important question to ask is how will earnings and outlooks change based upon the weather interruptions.  The bond market viewed today’s report as a sign that weather has muted a strengthening economy.  Traders pushed the price of a 10-year Treasury note down and, as a result, yields went higher.  We are still not back to the 3.00% yield level that the bond was trading at near the beginning of the year, but the trend since the beginning of the month has been toward higher rates.

The European Central Bank (ECB) left its main interest rate at 0.25% and offered no hints at other measures to bolster euro zone growth.  Inflation, the other mandate the ECB has to worry about, has been below 1% for five consecutive months.  A level closer to 2% is considered just right to spur growth and allow some pricing by firms but not high enough to stoke negative results.   The non-move is important because ECB president Draghi had said that by March, the ECB would have enough information to judge the need for fresh stimulus.  One option would be to halt so-called sterilization operations which soaks up money spent on Greek and other troubled countries bonds.  That would have freed up nearly $240 billion in excess liquidity in the financial system and brought down interbank lending rates.  Draghi said there was no need to act because there was no sign of crisis in money-market rates adding “…the injection of the liquidity would really last only a relatively short time, less than a year for sure.”  The issue that Draghi and his colleagues face is whether to turn to more U.S.-style easing through the removal of sterilization tools, for example, or hope that inflation returns (the expectation is for 1.5% by 2016).  If it does not, the euro zone could be faced with what Japan is now dealing with—entrenched deflation causing economic stagnation.  Events in the Ukraine may yet stoke inflation if the prices of energy rise in a protracted conflict and a lower euro would make imports more expensive.  But these are two items mostly out of the ECB’s control.  Central bankers worldwide hope that the patient approach does not turn into a situation they cannot get themselves out of down the road.

SGK Blog--Update February 28, 2014: Yellen Mentions Weather, Provides Lift to Equity Markets  

Federal Reserve Chair Janet Yellen said the central bank is likely to keep trimming asset purchases, even as policy makers monitor data to determine if recent weakness in the economy is temporary.  “Unseasonably cold weather has played some role,” she said in response to a question Thursday from the Senate Banking Committee.  “What we need to do, and will be doing in the weeks ahead, is to try to get a firmer handle on exactly how much of that set of soft data can be explained by weather and what portion, if any, is due to softer outlook.”  Yellen repeated the Fed’s statements that the central bank intends to reduce asset purchases at a measured pace, and she said in response to a separate question that the bond-buying program was likely to end in the fall.  At the same time, “if there’s a significant change in the outlook, certainly we would be open to reconsidering, but I wouldn’t want to jump to conclusions here.”  Yellen’s testimony to the Senate panel, originally scheduled for Feb. 13, was postponed because of a snowstorm, creating an unusual two-week gap between her appearances before the two committees that oversee the central bank.  Since her House testimony, weaker-than-forecast data on retailing, manufacturing and home construction have suggested the economy is slowing, in part because of harsh winter weather.  Yellen, in the second day of her semi-annual testimony on the economy and monetary policy, also repeated the Fed’s pledge to keep the benchmark interest low at least as long as unemployment stays above 6.5 percent and the outlook for inflation doesn’t exceed 2.5 percent.


Federal Reserve policy makers, at their Jan. 28-29 meeting, said they would soon have to modify the year-old commitment, according to minutes released last week.  This caused concern amongst equity traders after the minutes were released.  Yellen’s words Thursday were “soothing” to market participants in that there were no surprises.  So far so good!  Yellen, 67, declined to say whether the Fed would scrap the unemployment threshold, while also indicating that policy makers can’t rely on the jobless rate alone to assess the condition of the labor market.  Responding to a question, she said that “the unemployment rate is not a sufficient statistic for the state of the labor market.  There is no hard and fast rule about what unemployment rate constitutes full employment, and we will need to consider a broad range of indicators.”  Yellen, in her prepared comments, said the recovery in the labor market is “far from complete.”  At the same time, “My colleagues on the FOMC and I anticipate that economic activity and employment will expand at a moderate pace this year and next, the unemployment rate will continue to decline toward its longer-run sustainable level, and inflation will move back toward 2 percent over coming years.”

A February 13 report showed that sales at U.S. retailers declined in January by the most since June 2012 amid slower employment and wage growth, along with colder-than-normal temperatures.  Cold weather also weighed on factory production, which unexpectedly declined in January by the most since May 2009.  The jobless rate fell to 6.6 percent in January, prompting San Francisco Fed President John Williams to say Feb. 19 that the central bank should abandon its unemployment threshold for the federal funds rate and switch to qualitative descriptions about progress toward the central bank’s mandate for full employment and stable prices.  Boston Fed President Eric Rosengren said Wednesday that there remains “significant slack” in labor markets and called for “a very patient approach” in removing stimulus.  Neither Rosengren nor Williams is a voting member of the FOMC this year, though they participate in meetings.  Yellen wrapped up her testimony by saying, “I am committed to achieving both parts of our dual mandate: helping the economy return to full employment and returning inflation to 2 percent while ensuring that it does not run persistently above or below that level.”  The 12-month rate of inflation, measured by the personal consumption expenditures price index, has been below the Fed’s 2 percent target every month since May 2012 and rose at a 1.1 percent rate for the 12 months ending December.  Again, her words provided reassurance to market participants that Janet Yellen is providing a steady hand at the helm of the Fed. 

In economic news this week, the Case-Shiller 20-city Index of home prices rose 13.4% in December, about as expected.  This was welcome news in view of the fact that sales had been slowing due to poor weather across the country.  Economists had forecast slow sales in January so the figure for new home sales at 468,000 compared to the expectation for 400,000 was welcome news indeed.  Initial weekly jobless claims rose to 348,000 compared to the expectation for 335,000 for the week ending 2/22/14 (blame the weather!)  Durable goods orders for January slumped 1.0% about in-line with expectations but excluding transportation the figure actually rose 1.1% which was considerably higher than expected.  The fourth quarter estimate for GDP came in slightly below the previous estimate at 2.4%, but was still better than expected at this time last year when forecasts were dismal.  The Chicago Purchasing Managers Index for February rose to 59.8, considerably higher than expected and possibly pointing to a manufacturing recovery after that sector had slowed in December & January on rough weather in that region.  Finally, both the University of Michigan consumer sentiment survey for February at 81.6 and pending home sales for January at +0.1% were both in-line with expectations.  With no major surprises this week on the economic front and Janet Yellen’s soothing testimony, markets responded favorably.  The economy continues to chug along but at a pace moderate enough to comfort traders concerned over the potential for the Federal Reserve to begin the process of raising short term interest rates.  Typically, when that process begins, that is when stocks come under significant pressure.

SGK Blog--Update February 21, 2014: Economic Data Makes Headlines  

With corporate earnings season winding down, economic data took more center stage this week.  Events overseas like the situation in the Ukraine means that investors will be focused on the top-down view until the next period of earnings “confessions” take place in the spring.  The Labor Department revamped wholesale prices which now means the monthly producer price index (PPI) will encompass 75% of the economy, up from only a third for the old index.  The old data also only reflected the cost of goods alone, while the new methodology includes services.  Services such as financial advice, wholesalers and transportation providers will account for about 63% of the new index, goods will count towards approximately 24%, prices received from government purchases and exported good will represent about 11% and construction will fill in the last 2%.  The top-line category is now known as “final demand” while the old measure will be called “finished goods”.  The final demand PPI rose by 0.2% in January from the prior month.  That was just above expectations of a 0.1% increase and follows a 0.1% rise in December.  The new “core” measure was also adjusted.  One without food, energy and trade services which is defined as changes in margins received by wholesalers and retailers and is the most volatile services category.  It rose 0.1% last month.  Excluding just food and energy, final demand rose 0.2%.  Year-over-year, PPI final demand rose 1.1% while excluding food and energy, the index rose 1.3%.  The major benefit of the revision in methodology will be for investors to see how various slices of the larger economy are rising or falling in terms of prices.  For example, the cost of pharmaceutical preparations rose a record 2.7%.  And, we are all now well aware that last month’s rise in the price of finfish and shellfish was the largest since 1984!  Good things to know.

Consumer prices rose 0.1% in January after a 0.2% gain in the prior month according to the Labor Department.  Year-over-year the measure rose 1.6%, the smallest 12-month gain since June of last year.  A rise in the price of hotel rooms and medical care was offset by lower costs for new and used cars and airline fares.  The CPI did not have a major overhaul but yet is still considered one of the broadest price measures the government tracks with about 60% of its index covering services. 

Meanwhile, the housing market seemed to be very affected by the winter weather which should come as no surprise considering its harshness.  Housing starts fell 16% to an 888,000 annualized rate according to the Commerce Department.  It was the biggest decrease since February 2011.  Existing home sales fell 5.1% to a 4.62 million annual rate in January according to the National Association of Realtors.  Harsh weather in addition to low supply slowed demand. First time homebuyers accounted for 26% of purchases, the lowest since record keeping of that stat began in October 2008 suggesting that affordability and the sluggish job market also played a role.  The National Association of Home Builders/Wells Fargo sentiment gauge fell to a surprising 46 in February from 56 in January.  Readings less than 50 indicate more respondents reported poor market conditions than good.  According to the NAHB Chairman, “Significant weather conditions across most the country led to a decline in buyer traffic last month.  Builders also have additional concerns about meeting ongoing and future demand due to a shortage of lots and labor.”  The last statement is head scratching because unemployment has been stubbornly high and participation of those eligible for jobs has been near record lows.  This week initial unemployment claims declined by 3,000 to 336,000 but still remain above the psychologically important 300,000 level.  So what’s happening?  The people with the skills are not always matching up with the openings.  That is a sign of cyclical unemployment issues, not structural.  That is, the jobs are out there but with consumers still getting credit-healthy and the housing market just starting to function closer to normal, it will take time for those matches to be made.

SGK Blog--Update February 14, 2014: Stocks Steady on Acquisitions and Yellen Testimony  

Equity indices continued to recover from the January jitters despite the impact of frigid weather on the economy here in the U.S.  Markets were buoyed Thursday by the announcement of a proposed mega-merger between Comcast and Time Warner Cable – the two largest providers of cable services in the U.S.  Comcast would actually be acquiring Time Warner for $45.2 billion.  Wall Street loves acquisitions of this size as it means a large payday for the investment bankers involved.  Estimates put the fees associated with this one at well over $100 million.  It looks like jobs on Wall Street will become popular again!  Janet Yellen, the new Chairman of the Federal Reserve, helped soothe traders’ anxieties as she pledged to maintain the policies of her predecessor, Ben S. Bernanke, scaling back bond-buying under the quantitative-easing stimulus strategy in “measured steps.”  She testified before the House Financial Services Committee, delivering the first semi-annual report on monetary policy since she was sworn in last week.  She was supposed to appear before the Senate Banking Committee Thursday but was snowed in like the rest of us.  The central bank has cut its purchases of Treasuries and mortgage debt to $65 billion a month from $85 billion last year, citing economic improvement.  The buying is designed to hold down long-term borrowing costs and fuel growth.  Traders are also relieved that the spike in interest rates we witnessed late last year and early this year has settled back down into a normal trading pattern with the Ten-year Treasury rate below 3%. 


The economic data here in the U.S. continues to show signs of a weather related impact.  Retail sales were weaker than expected as they fell in January the most since June 2012.  The Commerce Department reported that sales for January decreased 0.4% as winter weather kept consumers away from auto showrooms and stores.  This followed a revised decline of 0.1% for December.  Excluding autos, retail sales for January were flat.  Jobless claims increased by 8,000 to 339,000 in the week ended Feb. 8, from 331,000 the prior period, a Labor Department report showed.  Economists surveyed by Bloomberg called for a decrease to 330,000.  This weaker than expected data helped improve the bid for Treasuries as interest rates declined on the news.  Rates on Treasury one-month bills declined for a fourth day, helped after Congress approved a suspension of the nation’s debt ceiling Wednesday until March 2015.  The only real benefit to slightly weaker than expected data on the economy is that it does help keep interest rates in check.  This can offset the impact on rates of the Federal Reserve’s gradual reduction in stimulus.  Lower interest rates tend to support stocks, but in the absence of good news now that earnings season is coming to a close, we will see how long that lasts.

SGK Blog--Update February 7, 2014: Market Volatility Increases  

According to the Labor Department, nonfarm payrolls rose by 113,000 in January continuing a disappointing trend begun last month. December’s revised 75,000 was also below expectations when it was released early in the New Year. The median forecast of economists in a Bloomberg survey called for a 180,000 advance. The unemployment rate, taken from a survey of households not businesses, fell to 6.6% from 6.7% last month. These figures are disappointing but far from disastrous.  In fact, the now closely watched participation rate actually rose to 63.0% from 62.8% meaning there was a higher percentage of people actively looking for jobs. The Labor Department also issued its annual benchmark update which aligns employment data with corporate tax records and provides a further check on the data released. The revision showed payrolls grew by an additional 347,000 workers from April 2012 through March 2013.

More than half the gain in employment came from construction and manufacturing which seems a bit odd given all the talk about weather-related issues affecting industries from coast to coast. Retailers, affected by a below-average holiday shopping season, reduced payrolls by about 13,000, the most since June 2012. In a positive sign, average hourly earnings rose by 0.2% in January and increased 1.9% over the past 12 months. The report also showed an 8,100 increase in hiring by temporary-help services. These signs suggest that companies may not be in a robust hiring mode, but they continue to muddle along with enough employees to get the job done.

Will these figures affect the Fed’s tapering program? We anticipate that they will not. Seasonally adjusted or not, it is apparent that the harsh winter that has struck over December and January is having some type of an effect on production and, thus, investing in human capital. A year ago, the employment numbers seemed too high for the winter months and too low for the spring months and data smoothing was blamed for such gyrations. The Fed is going to take this information and couple it with data it receives from bank lending officers, housing surveys and reports from other central banks to see how it will proceed. The Federal Open Market Committee meeting scheduled for March 18-19 will have extra focus. We will have one more monthly jobs report by then in addition to numerous weekly initial unemployment claims updates. Plus, it will be new chairman Janet Yellen’s first meeting she presides over as the new chief, and the press and public will be eagerly awaiting the post-meeting press conference.   

Meanwhile in Europe, European Central Bank (ECB) president Mario Draghi said stimulus measures could come as early as March for the euro zone. The ECB kept its main lending rate at 0.25% and next month the ECB will publish inflation forecasts into 2016, the first time it will release estimates that far into the future. Its current projections are for inflation of 1.1% in 2014 and 1.3% in 2015, well below the medium-term target of just below 2%. If the inflationary expectations into 2016 stay well below target, it is likely the ECB will act with the most likely move being a rate cut. Other options include more loans to banks through Long-term Refinancing Operations which would complement loans due in early 2015. However, banks remain reluctant to lend this cash to consumers. With retail sales falling 1.6% in December, the consumer is not picking up the slack. Another option is to stop “sterilizing” money injected into markets. Currently, under the Securities Market Program, the ECB withdraws funds from the banking system in amounts equal to what they have purchased in government bonds from Greece, Ireland, Portugal, Spain and Italy. Such a program allow the central bank to say they are not involved in the markets because no funds have theoretically been created. Ending the equal withdrawal of funds would be one way to boost monetary easing.

SGK Blog--Update January 31, 2014: Stocks Continue Retreat on Global Currency Concerns and Mixed Earnings 

Global stock indices were roiled Wednesday ahead of the Fed meeting outcome as events in Turkey made headlines, continuing the theme so far in 2014 of high levels of volatility in emerging market currencies. Why do we care about Turkey? It plays to the broader theme of the uncertain global economic picture, particularly in the world’s second largest economy – China – amidst a scenario where the U.S. Federal Reserve will likely continue on its path of reducing monetary stimulus. The Turkish currency – the lira - dramatically reversed course in early trading Wednesday after early gains when the Turkish central bank doubled interest rates to assuage concerns that the Turkish economy will be left exposed by a slowdown in China and a reduction in U.S. monetary stimulus. The Turkish currency had initially gained more than 4% on the central bank’s midnight decision, then rapidly depreciated 2.4% compared to the previous day’s close to trade at 2.2690 per dollar at 4:30 pm Istanbul time, which was early morning here. Yields on their two-year benchmark notes were at 10.88% and the Borsa Istanbul 100 Index of stock prices slumped 2.6%. Bank Governor Erdem Basci is fighting to restore credibility eroded by a currency run that gained speed amid domestic upheaval and a global rout of emerging markets. Prime Minister Recep Tayyip Erdogan, who said yesterday he’s always opposed higher rates, is caught in a graft scandal that has ensnared several ministers and the chief executive officer of a state-owned bank. Wow – and we thought our politics were bad! This spooked investors just as the reduction of U.S. monetary stimulus began sucking money out of riskier assets. The dilemma for Turkey is that foreign investors may not be enticed by the significantly higher yields given the downside potential of the currency. 

Wednesday also saw the release of the Federal Open Market Committee’s (FOMC) statement on interest rate policy. There really were no surprises here as the Fed decided to stick with its plan to continue to reduce its monthly bond purchases from the current pace of $75 billion per month to $65 billion per month. In our view, their decision to continue with tapering, despite the unfolding turmoil in emerging markets, suggests the Fed has a domestic policy compass firmly in hand. They are sending a clear message that unless a much larger scale crisis emerges, do not expect them to deviate from their current policy path. In a clear message in terms of the direction they are headed, their statement included the following: “if incoming information broadly supports the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective, the Committee will likely reduce the pace of asset purchases in further measured steps at future meetings.” This implies by year-end at the latest, the Fed will be no longer purchases bonds on a monthly basis. Given their balance sheet is in the neighborhood of $4 trillion, this makes sense in our view. In order to calm market concerns, they gave further clues about policy saying the unemployment rate probably would have to decline “well past” the original benchmark of 6.5% before the FOMC would consider hiking its zero-bound target interest rate – the Fed Funds rate. What is interesting is that although stocks sold off on the day, the bond market was relatively calm. In fact, given the flight to quality with the tumult in emerging markets, the interest rate on the U.S. Ten-year Treasury actually declined to close that day with a yield under 2.7%, which we have not seen in a while. We should also point out that for the first time in a long time the vote from committee members was unanimous. 

Economic data was a mixed bag this week. In the U.S., the housing data for December for both new home sales at 414,000 and pending home sales showing a decline of 8.7% came in much worse than expected on weather related issues. Initial weekly jobless claims for the week ending 1/25/2014 at 348,000 were also considerably higher than expected, which is also concerning particularly given December’s lousy employment report. On a positive note, 4th quarter gross domestic product (GDP) came in at +3.2% which was above consensus estimates. This was largely driven by consumer spending as household purchases grew at a 3.3% pace, the best since the end of 2010, and this helped overcome cutbacks in government spending. The pickup in demand was broad based as business investments and exports also accelerated, helping offset the damage from the 16-day partial government shutdown. Reports late in the week on personal income and personal spending showed that while incomes were flat coming in at 0% for December, spending at +0.4% was higher than expected for that same month. Overseas, German unemployment declined more than forecast in January – helping their stock index in Thursday trading – while a report from China indicated that manufacturing had shrunk for the first time in six months. China continues to bear close attention as we read a report this week that 65% of China’s consumer wealth is tied up in real estate. A bubble bursting in that country’s real estate market would have serious negative global repercussions. In Friday trading, global equity indices were roiled by a report from the European Union’s statistics office in Luxembourg showing that consumer prices rose at an annual rate of just 0.7%, below the expectation for +0.9%, and this fueled deflationary concerns in Europe amongst traders. The European Central Bank’s target inflation rate is 2% so this puts pressure on the bank to lower interest rates when they meet next week.

SGK Blog--Update January 24, 2014: Earnings Season Begins

With snow storms pummeling the East Coast, the Federal government was shut for one day this week.  It turns out that this week was light for economic releases, so the winter weather did not cause many unintended disruptions in that aspect.  We did get the usual weekly initial unemployment claims which remained near a six-week low.  For the week ended January 18, the number of jobless claims rose to 1,000 to 326,000 from the week prior.  That was a little below the median forecast of 330,000 in a survey of economists conducted by Bloomberg.  The Labor Department said there were no unusual circumstances surrounding the data.  Given the surprisingly tepid December jobs report, seeing these figures makes that number seem more and more like an aberration rather than the start of a trend.  The next monthly payroll figure will be released on February 7.

Though the trend remains positive, there still remain millions out of work.  The number of people continuing to receive jobless benefits rose by 34,000 to 3.06 million in data from the Labor Department for the week ended January 11.  The report also showed that 1.35 million unemployed people lost emergency extended benefits after Congress allowed the program to expire at the end of 2013.  The program began in 2008 and at one point provided a total of 99 weeks of benefits, including 26 weeks of standard state-funded benefits.  By the end of 2013, the maximum was down to 73 weeks covered.  The weekly initial jobless claims shows that companies are slowing their pace of firings, but those continuing to remain jobless remain numerous.  Job growth averaged 182,170 per month in 2013 compared to 182,750 in 2012 but even these figures have not been strong enough to absorb these long-term unemployed.  The Fed continues to struggle with this issue because the longer someone remains unemployed, the more his or her skills deteriorate.  Frustration often leads to curtailing job search efforts completely.  That, in turn, affects the nation’s collective productivity level and its standard of living.  Granted, these changes take time to fully be felt, but we are now nearly six years beyond the collapse of Lehman Brothers which is widely viewed as one of the low points of the financial crisis and jobs are still not abundant.    

There was good news on the housing front.  Existing homes sales rose 1% to a 4.87 million annual pace according to the National Association of Realtors.  December’s figures capped the strongest year for the industry since 2006.  The supply of homes fell 9.3% in December from November.  At the current pace of sales, it would take 4.6 months to clear out the inventory compared to 5.1 months at the end of November.  A number between 5-6 months is considered a healthy market.  Another piece of good news is that distressed property transactions accounted for only 14% of the total.  This is a far cry for the nearly 40%+ we saw back in 2009 and 2010.  Given the poor weather and cold conditions in December, the numbers look even better since it proves there are determined buyers in the market even in the face of mortgage rates which are higher.  The average 30-year fixed rate was 4.41% for the week ended January 16, compared to 3.38% a year ago according to Freddie Mac.  The spring selling season is coming up which could further provide a tailwind to the industry.

SGK Blog--Update January 17, 2014: Stocks Drift Sideways as Earnings Season Approaches  

Concerns on the part of traders over corporate earnings and stock valuations helped push equity indices sharply lower in Monday trading.  As the week progressed, the major averages did recover ground but concerns remain.  In 2013, the 500 companies in the Standard & Poor’s 500 Index delivered average revenue and earnings growth of 2.7% and 3.9% respectively.  Forecasts by analysts put those figures at 5.1% and 9.5% respectively.  That seems lofty to us at this point and it is likely these estimates will come in as we progress throughout the year.  Goldman Sachs warned this week in a research piece they consider valuations on stocks to be somewhat lofty at 15.6 those estimated 2014 earnings compared to an average of 14.1 over the past 5 years.  According to Goldman, further price-to-earnings multiple expansion will be difficult to achieve.  Fed Bank of Atlanta President Dennis Lockhart said Monday the U.S. economy is on “solid footing” and he would support continued cuts to stimulus.  The Fed, which next meets January 28-29, last month announced a reduction in its monthly bond-buying program, citing a recovery in the labor market.


After a couple of slow weeks, we had plenty of data out on the U.S. economy this week.  Helping lift equity markets higher in Tuesday trading, the retail sales report for December came out better than expected despite all the bad weather.  More and more people are shopping on-line which tends to immunize sales from snowy conditions, even though many did not get their deliveries in time for Christmas.  The retail sales figure for December was +0.2% compared to the expectation for flat sales although the figure for November was revised downwards to +0.4% from the previously reported +0.7%.  Excluding autos, retail sales rose a relatively robust +0.7% compared to the estimate for a +0.4% increase while again the figure from November was revised lower to +0.1% from the previously reported +0.4%. 

In other economic news, inflation measures came out roughly in-line with expectations this week as the producer price index for December came out at +0.4% and +0.3% excluding food and energy, the so-called core rate.  The consumer price index for December was +0.3% and +0.1% for the core rate.  Initial weekly unemployment claims were slightly better than expected for the week ending 1/11/2014 with 326,000 claims compared to the expectation for 335,000.  Measures for manufacturing for January were better than forecast as Empire Manufacturing (a gauge of the New York area) was 12.5 vs. the forecast for 3.5 and the Philly Fed survey was 9.4 vs. the expected 8.0.  Industrial production and capacity utilization for December came out basically in-line with forecasts at +0.3% and 79.2% respectively.  Finally, we received important information on the all-important housing sector as housing starts for December were 999,000 while 986,000 were expected while building permits were 986,000 versus the 1,000,000 expected.  Overall it was a relatively robust week for economic data at this early stage of the new year and this bodes well in terms of the potential for the U.S. economy in the year ahead.

SGK Blog--Update January 10, 2014: Payrolls Less Than Expected  

Given the feel-good vibe recent economic data have thrown off, it was a bit of surprise when payrolls in December increased at the slowest pace in three years.  The 74,000 gain was less than the median projection in a Bloomberg survey of 197,000.  In fact, the gain was lower than the most pessimistic forecast of a 100,000 gain.  What happened?  Weather was one issue.  Last month was the coldest December since 2009 and snowfall was 21% above normal.  In a country as wide and diverse as the U.S., that should not play so much of a role but given that the majority of the population still lives east of the Mississippi river, weather issues will play a role in housing construction, on-site motion picture/television personnel or the need for higher staff in restaurants or retail stores.  Industry reporter ShopperTrak said that U.S. holiday sales for the November-December period were up only 2.7% year-over-year, the smallest gain since 2009 as foot traffic fell 15%.  Less customers means less need for checkout clerks, mall security and cleanup crews.  The Labor Department said that 273,000 Americans were not at work last month because of weather.

On a positive note, revisions to prior reports added a total of 38,000 jobs to overall payrolls the prior two months.  The unemployment rate, which is derived from a household survey in comparison to payrolls which come from business surveys, fell to 6.7%, the lowest since October 2008.  But even that piece of good news had a drawback:  the labor participation force rate fell to 62.8% in December from 63.0% the month prior.  Less people actively looking for a job can artificially lower the employment rate and mask weakness in hiring.  We have discussed this trend previously.  Though it is an important indicator, it is one of many.  The weekly initial jobless claim figure reported by the Labor Department fell by 15,000 to 330,000 in the week ended January 4.  The four-week average dropped to 349,000 from 358,750.  This data is more timely than the monthly payroll figures which themselves are often subject to multiple revisions.  Our take is that the labor market is improving but it will not be in a straight line.  If this one data point becomes two or three months of below-market expectations, then there is likely to be some concern.

Will these results change the Fed’s attitude toward tapering?  This Wednesday, the Federal Reserve released minutes from its December policy committee meeting.  They concluded: “A majority of participants judged that the marginal efficacy of purchases was likely declining as purchases continue.”  Thus, at the margin, it was decided that it was time to curtail some of the buying.  And it is only a curtailing as the members explained: “While deciding to modestly reduce its pace of purchases, the Committee emphasized that its holdings of longer-term securities were sizable and would still be increasing, which would promote a stronger economic recovery…”  If the Fed governors saw a 74,000 gain in jobs reports one month after a 200,000+ figure, it might lead some to reconsider, but rather than resort to a knee-jerk reaction, our guess is that the tapering announcement would still have been made—though Bernanke would have had a little more explaining to do in the post-meeting press conference.

SGK Blog--Update January 3, 2014: Happy New Year! 

We would like to take this opportunity to wish our clients a happy, healthy and prosperous 2014!

After posting the strongest annual gains in over 15 years, equity markets got off to a rocky start in 2014 on the first day of trading as the major averages lost close to 1% on January 2nd. This can be attributed to a variety of factors, including portfolio rebalancing and investors waiting until the new year to realize gains in taxable accounts. Warnings on China from high profile hedge fund manager George Soros also helped spook traders. Not helping matters was weak economic data coming out of that country on the first day of trading in the new year here in the U.S. A China services index fell to a four month low in December, following on declines in key manufacturing gauges in that country. The non-manufacturing Purchasing Managers’ Index slid to 54.6 in December from 56 in November, the Beijing based National Bureau of Statistics and China Federation of Logistics and Purchasing indicated. The key issue in China to watch, and risks cited by Soros, is the fact that the ruling Communist Party is trying to restructure the economy for more sustainable long-term growth, while maintaining a sufficient pace of expansion to protect jobs. A jump in money-market rates, surging property prices in some cities and swelling local-government debt threaten to undermine the government’s efforts. China is a key country to keep an eye on in 2014.

In domestic economic news, the initial weekly jobless claims for the week ending 12/28/2013 rose to 339,000, which was above the expectation for 333,000 but below the previous week’s figure of 341,000. It is expected approximately 1.3 million will lose their long-term unemployment benefits here in January although Congress is working on a fix for that. If that happens it would have a negative impact on the economy in terms of consumer spending. Construction spending rose 1.0% in November, above expectations, while the Institute of Supply Management’s ISM Index came in at 57.0 in December, a slight decline from November’s very strong 57.3. A figure above 50 indicates expansion in the manufacturing sector. Richmond Fed President Jeffrey Lacker also helped fuel stock declines when he stated policy makers will continue to weigh reductions in bond-buying at upcoming meetings. While news the Fed will continue their efforts at “tapering” their bond buying here in 2014 should not come as new news to market participants, traders still don’t like to hear it coming from a Fed policy maker’s lips. Next week will be an exciting week for market participants as we have plenty of important economic data to evaluate including factory orders, the ISM Services Index, the FOMC minutes from their last meeting and, of course, the all-important employment report for December. We will be evaluating these closely for our clients and monitoring your portfolios daily here in 2014 and we thank you for the trust you have placed in us. We value your business highly!

SGK Blog--Update December 27, 2013: Happy Holidays!

We would like to take this opportunity to thank our clients for a great year, and continued health and prosperity in 2014 for all! 

Holiday sales in the U.S. rose 3.5% helped by steep discounts at malls and purchases of children’s apparel and jewelry, according to SpendingPulse. Sales of holiday related categories such as clothing, electronics and luxury goods rose 2.3% from Nov. 1 to Dec. 24 compared to a year earlier, according to Purchase, the New York based research firm. Sales were propped up as retailers such as The Gap, concerned about slow traffic this season, offered deals as much as 75% off, especially on apparel. Don’t be surprised to see these deals continue as retailers try to work down inventory early in the New Year. It was definitely a mixed season for retailers as store visits actually declined 21% for the week ending Dec. 21st, according to ShopperTalk. Some of that can be attributed to more online shopping by consumers. A heavyweight battle in terms of the “blame game” erupted between Amazon and UPS as numerous packages were not delivered on-time before Christmas despite promises from Amazon. UPS blamed the weather and an unexpectedly high volume this year.  

U.S. consumer confidence rose to a four month high as an improving job market and holiday discounts put Americans in the mood to shop. The Bloomberg Consumer Comfort Index rose to minus 27.4 in the period ending December 24, the fifth straight gain, from minus 29.4. Applications for unemployment also declined to 338,000 for the week ending Dec. 21 compared to the estimate for 350,000 and the prior week’s figure of 380,000. We actually had plenty of data out on the economy despite Christmas falling in the middle of the week. Durable goods orders for Nov. rose 3.5%, 1.2% ex-transportation, compared to estimates for a 2.2% and 0.6% increase respectively. Personal income rose 0.2% and personal spending rose 0.5% for November compared to estimates for increases of 0.5% and 0.5% respectively. New homes sales climbed to 464,000 for November relative to the estimate for 433,000 and the University of Michigan consumer sentiment survey for December came in at 82.5 compared to the estimate for 83.3 and the prior month’s figure of 82.5. Overall, this was a pretty good week for economic data here in the U.S. and stock indices continued their Santa Claus rally for the week.

SGK Blog--Update December 20, 2013: Fed Tapers, Markets Soar  

The Federal Reserve delivered an early Christmas present to the markets this week.  In outgoing Federal Reserve Chairman Ben Bernanke’s last post-meeting conference call, he detailed the Federal Open Market Committee’s (FOMC) plan with comments that were viewed as dovish for equity securities.  According to the press release distributed by the Fed, the governors stated: “In light of the cumulative progress toward maximum employment and the improvement in the outlook for labor market conditions, the committee decided to modestly reduce the pace of its asset purchases.”  So instead of $85 billion per month of bond buying, the FOMC will reduce that to “only” $75 billion per month split between $40 billion in long-dated Treasuries and $35 billion in mortgage bonds starting in January.  The policy has been vetted and supported by current Vice-Chair and likely new chairperson Janet Yellen—once she is officially confirmed by the Senate.  The Committee will “closely monitor incoming information on economic and financial developments in coming months” in case the tapering needs to be adjusted emphasizing that “asset purchases are not on a preset course.”

The FOMC clearly had gained more confidence from last summer when talk of tapering first emerged.  First, the fiscal overhang from Congressional issues was alleviated recently when a bipartisan agreement was reached to keep the government funded for two more years thus preventing another partial or full shutdown in January similar to the one that occurred this past fall.  Second, more employment information was released.  The last two monthly employment reports showed payrolls swelling 200,000 in October and 203,000 in November with the unemployment rate falling to 7.0%.  Data related to jobs such as average hourly earnings and initial unemployment claims were also trending in the positive direction.

A big push that has contributed to the overall more positive outlook has been the housing market.  Auto sales are on pace for their best year since 2007, but the housing market’s effect on so many industries makes it a crucial contributor to the wealth effect and better consumer confidence overall.  Housing starts jumped 22.7% to a 1.09 million annualized rate, the most since February 2008 according to the Commerce Department.  Three of four regions showed an increase in activity led by a 41.7% increase in the Midwest and a 38.5% jump in the South.  Confidence among U.S. homebuilders increased more than forecast in December according to the National Association of Home Builders/Wells Fargo builder sentiment gauge.  It rose to 58, exceeding the highest estimate projected in a Bloomberg survey, and surpassing the previous month’s 54 reading.  An index above 50 means more respondents report good market conditions.  The one negative has been existing home sales which decline for the third consecutive month in November according to the National Association of Realtors.  Purchases dropped to a 4.9 million annual rate compared to a survey consensus of 5.02 according to Bloomberg.  Nevertheless, the association projects 2013 will be the best year for the industry in seven years.  Compared to a 13-year low of 4.11 million in 2008, the figures are not too bad though not the record 7.08 level reached in 2005.

Today, the markets received another boost when the Commerce Department revised their estimate of annualized third quarter GDP growth from the previous level of +3.6% to +4.1%.  It is the second-largest quarterly result since the recovery began in 2009.  The revision was driven by a larger increase in consumer spending which now grew at a 2% annual rate rather than the previously estimated 1.4%.  Inventories accounted for a third of the gain, but with the revision higher in consumer spending—which comprises nearly 70% of GDP—the hope is that consumers will absorb some of these added goods.  Various economists predict the current fourth quarter will see GDP growth of around 2.0%-2.2% which is not all that bad against the backdrop in higher inventories and a somewhat lackluster holiday shopping period so far.

SGK Blog--Update December 13, 2013: Traders Brace for Fed Meeting Next Week

While healthy economic data and relative calm in Washington political circles would normally provide a lift to equity trading, this week it has had the opposite effect as concerns have risen that the Fed may surprise markets by announcing a tapering of their bond purchases as soon as next week. The next meeting of the Federal Reserve’s Open Markets Committee (FOMC) is scheduled for December 17-18. All signs are pointing to the Federal Reserve beginning to “taper” their bond purchases at some point, but we feel it is more likely they will begin the process at their January 24-25, 2014 meeting. Or they may provide a timetable at that time for these reductions in purchases. Both meetings are accompanied by press conferences from the Chairman. As we have mentioned, the “taper” refers to the process whereby the Fed begins to gradually reduce the pace of their monthly bond purchases from the current $85 billion level. It is possible they do announce a timeline at their upcoming meeting next week for when the reduction in purchases will begin. It is this very real possibility that accounted for the sell-off in stocks this week. The issue is that it is unpredictable right now and stock traders dislike uncertainty. Irrespective of when the process begins, accompanying an announcement of a timeline, there will very likely be language hinting that the Fed reserves the right to vary the pace of purchases depending on market conditions. That caveat would provide them the opportunity to accelerate or decelerate purchases based on the strength of the economic data they see throughout 2014. Again, they will emphasize that the reduction in bond purchases is separate and distinct from the decision as to when to begin the process of actually raising interest rates in the form of the Federal Funds rate and the discount rate. Of course, working in their favor has been the relatively benign inflationary environment we have been operating in since the financial crisis. There is a lot of uncertainty associated with the issue and it is a real focal point amongst traders as we approach year end. Communicating a clear path forward would be very helpful and we do hope the Fed will provide some clarity around this. 

Speaking of relative calm in Washington, politicians on both sides seem to be in a Merry mood as we approach the Holidays. At least on the surface it appears that way and in some of their public comments. We suspect they are saving their best salvos for when we get closer to election time. The modest budget agreement arrived at between House Budget Committee Chairman Paul Ryan (R. Wis.) and Senate Budget Committee Chairman Patty Murray (D-Wash.), while not very meaty, was refreshing in the sense it was not hashed out in the media in a contentious fashion and was an example of how Washington should actually work – in the spirit of bipartisan compromise. The agreement basically restores about $63 billion in federal sequester cuts, there was no extension of long-term benefits for the unemployed, deficits are cut by $22 billion over the next decade and pensions are trimmed for military retirees younger than 62 and for new federal workers. One of the key points is that it avoids the threat of another government shutdown through October 2015. While no one would call the agreement completely satisfactory and nobody on either side loves it, it is likely to pass in Congress and it represents a foundation from which to build off of. A significant grand bargain appears to have been a fantasy all along under the current leadership structure of both parties therefore small steps and narrower accomplishments appear to be the way forward. There is a lot of work to be done! 

On the economic front, we had generally positive news for the week here in the U.S. Wholesale inflation remained tame for November as the Producer Price Index came in exactly as expected at +0.1% and -0.1% on the core rate, which excludes food and energy. Retail sales in November exceeded forecasts as the 0.7% rise, 0.4% increase excluding autos, was the fastest increase in five months. Consumers flocked to stores and auto dealerships, a sign the consumer is shaking off the third quarter doldrums. Sales were also boosted by the release of new products such as Apple’s new iPads and Microsoft’s new Xbox One product as those flew off the shelves. Another report showed consumer confidence rose for the third straight week. The Bloomberg Consumer Comfort Index advanced to minus 30.9 in the period ending December 8, the best reading since the first week of October, from minus 31.3. The gauge is making progress after sinking to a one-year low in early November in the aftermath of the partial federal shutdown the prior month. The one negative bit of news this week was the unexpected rise in weekly jobless claims as that came in at 368,000 for the week ending December 7 compared to the expectation for 315,000 and the prior week’s revised figure of 300,000. At this time of year, seasonal adjustments to these figures tend to skew them which is why we always put more emphasis on the four week trend. With that said, employment being such a focal point of the Fed, this bears close watching. 

SGK Blog--Update December 6, 2013: The Economy is on a Roll        

The unemployment rate dropped to a five year low of 7% as employers added more workers than forecast last month.  According to the Labor Department, 203,000 non-farm payrolls were added in November following a revised 200,000 in October marking the first strong back-to-back months in a long time.  Estimates in a Bloomberg survey called for an increase in the range of 115,000 to 230,000 with the median forecast at +185,000.  The unemployment rate, derived from a separate Labor Department survey of households rather than employers, was forecast to fall to 7.2%.  Another key positive was the participation rate, which measures the share of working-age people in the labor force, rose to 63% after falling to 62.8% in October, the lowest level since March 1978.

Private employment, which excludes government agencies, rose 196,000 last month after a revised 214,000 advance in October.  The median rise for private payrolls called for a figure of 180,000 so that number was easily exceeded.  Moreover, average hourly earnings rose by 0.2% and has climbed 2% over the past 12 months.  The average work week rose six minutes to 34.5 hours last month.  Hourly earnings and average work week are forward-looking gauges.  A rise in these numbers generally indicates a tightening labor market.  This week’s initial unemployment claims is also a leading indicator.  Payroll and employment data collection often stops near the middle of the month so that the figures can be tabulated by the first Friday of the following month.  Initial unemployment claims are more timely because they are done weekly.  In the week ended November 30, jobless claims fell 23,000 to 298,000 compared to the median Bloomberg forecast of 320,000.  If these trends continue through the first half of this month, it is quite likely the employment figures for December released in early January will show a sub-7% unemployment rate and further 200,000+ job gains.

More people with jobs usually indicates more money to spend.  That is exactly what we saw in data from the Commerce Department today.  Consumer spending rose 0.3% in October after a 0.2% rise in September.  These numbers might be tempered a bit once the final details from the Black Friday shopping season are tallied.  According to various reports, Black Friday sales were lackluster across the country and with a winter storm about to hit the East Coast this weekend, the number of shopping days will be further reduced.  However, according to cloud-based analytics from IBM, Cyber Monday—the first Monday after Black Friday—was the biggest online shopping day in history, growing 20.6% over 2012.  Mobile traffic grew to 31.7% of all online traffic, increasing by 45% over 2012.  (As a footnote, on average, Apple’s iOS users spent $120.29 per order versus $106.70 per order for Google’s Android users).

Gross domestic product grew at a 3.6% annualized rate in the third quarter, up from an initial estimate of 2.8%.  This was primarily due to the biggest increase in inventories since 1998.  Stockpiles added 1.68 percentage points to GDP last quarter, double the initial estimate.  Why are businesses producing so much?  It can be due to various reasons but likely linked to more confidence by management that consumer and business demand will soak up the extra inventory.  Final GDP sales, which excludes the effect of inventories, rose 1.9% in the third quarter after a 2.1% gain in the second quarter.  Consumer spending, which is nearly 70% of the economy, rose 1.4%, the smallest gain since the fourth quarter of 2009.  Though we have seen GDP rise from 1.1% in the first quarter to 2.5% in the second to the latest figure over 3%, continued growth will be heavily dependent on the consumer.  A better job market and healing residential real estate market—new home sales rose 25.4% in October—will  help this trend but it is still a bit concerning to see so much inventory accumulation in one quarter.

SGK Blog--Update November 27, 2013: House Prices Rise Most Since 2006       

House prices in 20 major U.S. cities rose 13.3% over the course of the year ending in September. The median forecast in a Bloomberg survey of 31 economists called for a 13.0% increase. Sellers are standing firm on asking prices as buyers compete for a limited number of available properties. Higher home values are helping propel gains in Americans’ net worth, boosting confidence amongst homeowners and creating momentum for consumer spending. Housing demand has clearly improved this year as prices have benefited from fewer foreclosures with distressed housing transactions back to pre-crisis levels. More applications for home construction were issued in October than at any other time in the past five years. Building permits increased 6.2% last month to a 1.03 million annualized rate, the most since 2008, according to the Commerce Department. Housing starts data will be delayed until December 18 due to the government shutdown in October. The strength of the housing recovery has helped with our post crisis recovery as it is such an important and influential sector here in the U.S. The only negative on housing this week was the fact that pending home sales fell in October 0.6% versus the expectation for a 1.3% increase. The concern here is that higher mortgage rates and a tighter supply of houses are keeping some prospective buyers out of the real-estate arena. We will have to keep a close eye on this, especially with the likelihood rates will rise with the Fed beginning to ease up on their quantitative easing programs in 2014.  

In other economic news this week, initial weekly jobless claims for the week ending 11/23/2013 were 316,000 which was better than the forecast for 330,000. The balance of the data on the week was mixed. Durable goods orders for October were weaker than expected at -2.0% and when transportation goods were factored out it was -0.1%. The Chicago purchasing managers index for November was 63.0 which was better than the expectation of 58.0. The University of Michigan’s consumer sentiment index for November was a better than expected 75.1 as was the index of leading indicators for the month of October which rose 0.2% compared to the expectation for a 0.1% decline. Overall we would say that the impact of the government shutdown on the broader economy was less than expected.     

Third quarter earnings from U.S. companies finished better than most analysts had predicted. Of the 500 companies in the S&P 500, 489 had reported at the time of this draft and the average results were impressive. Year-over-year growth in earnings was a relatively robust 5.6%, which was 3% higher than analysts had expected, although this was lower than the 8% average growth over the past 13 years. Top-line growth (the increase in revenues) was 4%, which was the best since the second quarter of 2012. 67% of companies beat analysts’ average forecasts with the strongest sectors being information technology, healthcare and consumer discretionary stocks. Right now large company stocks on average are trading at approximately 17 times trailing earnings, which is above the long term average of 15. Small capitalization stocks in particular are more expensive given this has been the strongest segment of the market this year. We have been pleased in general with the results from our core list of equity holdings. Given the strength of the stock market this year, we are not inclined to be particularly overweight stocks at this point in client portfolios. Given we avoid what we refer to as high risk sectors such as junk bonds, leveraged loans and the stocks of lesser quality, more highly leveraged companies, we feel we are well positioned heading into a more uncertain environment in 2014 with the high caliber of our holdings – both on the stock and the bond side.

November 22, 2013: New Records for Stocks as Taper Questions Continue Minutes from the Federal Reserve?s October 29-30 meeting did not provide any further clues pertaining to the beginning of the end of the quantitative easing program. According to the release, the governors ?generally expected that the data would prove consistent with the Committee?s outlook for ongoing improvement in labor market conditions and would thus warrant trimming the pace of purchases in the coming months.? Those ?coming months? can be anything from December to June of next year. A recent interview with a Fed district president revealed that ?taper talk? would be on the agenda for December?s meeting. However, given that current chairman Ben Bernanke is stepping down in January and nominee and current vice-chairperson Janet Yellen is likely to take charge, that change may play into the committee?s thinking. Moreover, as we have previously pointed out in our weekly musings, the same government shutdown and debt ceiling issues the markets had to face in October will be revisited in the first two months of next year. If the Fed previously pointed to such fiscal items as a reason not to cut back on their monthly $85 billion of bond buying, there is little reason to believe that upcoming potentially contentious debates won?t also play a major role in their decision making. Leadership change and Congressional dysfunction aside, the Federal Open Market Committee is most concerned about how tapering asset purchases will be seen by the markets given the sharp spike in interest rates that happened this past summer after such talk emerged. The meeting minutes showed extensive discussion on how to increase the clarity of their message. This week, chairman Bernanke in a speech wanted to clearly state that quantitative easing was separate and distinct from actually raising interest rates. Though asset purchases may decline in the ?coming months?, the near 0% policy for fed funds is likely to continue into 2015. By tying moves to the unemployment rate, the Fed is attempting to provide clear signals of their intentions to market participants. St. Louis Fed President James Bullard even proposed an inflation floor, below which the Fed would not raise rates. The rest of the committee found the benefits of such a proposal ?likely to be rather modest.? Bottom line, the Fed is unlikely to act until the labor market has improved ?substantially.? Bond yields moved higher when government data did point to a better economic outlook. Applications for unemployment benefits fell by 21,000 to 323,000 in the week ended November 16. That was the fewest since September 28 and was below a survey of Bloomberg economists of 335,000. Yields on the benchmark 10-year Treasury finished the week at 2.76% after last week?s close at 2.71%. The next employment report does not come out for two weeks, but given the strong report for October (a gain of 204,000 non-farm payrolls), if November also is solid, there will be more signs of bond weakness (yields move in the opposite direction of prices). Inflation remains tame. Wholesale prices, as measured by the producer price index, fell 0.2% according to the Labor Department during the month of October. Excluding food and energy, prices rose 0.2% after a 0.1% gain in September. The consumer price index (CPI) fell 0.1% last month according to a separate Labor Department report released this week. Over the course of the last 12 months ended in October, the CPI rose 1%. Excluding food and fuel, the so-called core rate rose 1.7%. Energy costs decreased 1.7% last month, the most in six months. The price of a barrel of oil traded at $95 today and has fallen 17% since it peaked at $110 per barrel in early September. The average cost of a gallon of regular gasoline so far this month is $3.21, down $0.58 from this year?s peak of $3.79 in February according to AAA motor group. The price of food, new autos and medical care services also all fell last month. This week many retailers have publicly stated that they are willing to sacrifice margins this upcoming holiday season in order to match price discounting from competitors with popular toys serving as a main loss leader. Many kids will get their G.I. Joe with the kung fu grip on sale this year!
SGK Blog--Update November 15, 2013: Yellen Speaks; Market Reacts       

In testimony before Congress, Janet Yellen, the nominee to be the next chairman of the Federal Reserve, signaled she will continue the Federal Reserve’s stimulus efforts. While we perhaps anticipated she might take a slightly more hawkish tone given her dovish reputation, she dispelled all sense of doubt by indicating the central bank should take care not to withdraw stimulus too early from an economy that is operating well below potential. “It’s important not to remove support, especially when the recovery is fragile and the tools available to monetary policy, should the economy falter, are limited given that short-term interest rates are at zero,” she said in testimony to the Senate Banking Committee in Washington Thursday. Stock traders responded favorably to these comments by pushing indices higher. According to a Bloomberg survey of economists done on Nov. 8th, the median forecast of 32 estimates suggested that central bank policy makers will probably pare the $85 billion monthly pace of bond buying to $70 billion at their March 18-19 meeting. We have been receiving mixed signals from other members of the Federal Open Markets Committee on how much longer this quantitative easing will continue at current levels. The reality is we are in a recovery and it has to end sometime. Markets usually move ahead of actual actions so that is why this particular issue has so much influence on trading activity. 

This week we did not have a ton of economic data as the government is now back to being on schedule after the shutdown. Third quarter unit labor costs fell 0.6% versus the expectation for a gain of 0.8%. This is important because labor is a key component of the inflation measurement. If the Fed is not seeing sign of inflation then there is not a huge impetus to reduce stimulus and they can focus on growing the economy. Third quarter productivity came in slightly below expectations rising 1.9%. Initial weekly jobless claims for the week ending 11/02/13 came in at 339,000, which was 9,000 higher than expected. Capacity utilization and industrial production for the month of October were both weaker than expected at 78.1% and -0.1% respectively. Our trade balance for the month of September was also worse than expected at -$41.8 billion. This was another example of a week where bad economic data sent equity indices higher, which may seem counterintuitive but demonstrates how focused traders are on the question of when the Fed will start to reduce their support for the economy.

SGK Blog--Update November 8, 2013: Payrolls Break 200,000 Barrier    
According to the Labor Department, employers added 204,000 non-farm payrolls during the month of October. In addition, September’s number was revised from +148,000 to +163,000. October’s actual number blew away the Bloomberg survey estimate of +120,000. The unemployment rate, which is derived from a survey of households and not businesses, rose to 7.3% last month compared to 7.2% in September. The strong figures led to a sell-off in the bond market as traders believe that a stronger economy will prompt the Fed to move closer to tapering their monthly purchases during the latest phase of quantitative easing. The benchmark 10-year Treasury note finished the week yielding 2.XXX% versus a Thursday close of 2.60%.

The health in the payroll number was broad-based. Retailers added about twice as many workers as the month before, and leisure and hospitality employment was the strongest in six months. Some employers are adding to seasonal jobs in preparation for holiday shopping. Amazon.com Inc. is expected to convert many of their full-time seasonal positions to permanent roles after the season ends as it did in 2012. Amazon relies on fourth quarter sales for about 35% of its annual revenues. In addition to Amazon’s 85,000 seasonal hires (including the U.S. and the U.K.), Wal-Mart will add 55,000, Target is targeting 70,000 more and Kohl’s will add approximately 50,000. Private employment, which excludes government agencies, added 212,000 jobs in October, after a revised increase of 150,000 last month.

The labor participation rate, which indicates the share of working-age persons in the labor force, fell to 62.8% last month from 63.2% in September. That is the lowest level since March 1978. We have argued before that there are a number of reasons why this number is falling including a return to school or further training or a desire to settle for part-time employment rather than remain full-time unemployed. The worst reason is, of course, searchers become more discouraged and dropping out of the labor force altogether. The longer an individual remains unemployed, the further that worker’s skills erode and eventually becomes unemployable no matter what the economic environment. That is the key concern for the Federal Reserve and why they are so keen on reducing the unemployment rate and less worried about a rise in the general level of prices. Though it is a worry, the bottom line for now is that the economy is productive enough to continue to grow even with lower participation.

Gross domestic product, GDP, grew at an annual rate of 2.8% in the third quarter according to the Commerce Department. That followed a 2.5% gain in the second quarter and was above the 2.0% expectation from a Dow Jones survey of economists. The main factor contributing to the surprise was an increase in inventory which added 0.8 percentage points of growth to the quarter. That translates into a $86 billion annualized pace in the expansion of firm stockpiles. Final sales, which excludes inventories, rose 2.0% following a 2.1% gain in the second quarter. Consumer spending, which comprises nearly 70% of GDP, rose 1.5% on an annualized basis. The question to ask is if this increase in inventories will be absorbed by demand during the current quarter which includes a holiday shopping season which is shorter than last year. Moreover, the partial government shutdown, which began on October 1st just as the fourth quarter began and lasted 16 days, is likely to be somewhat of a drag on final figures. If sales do not pickup, many economists now predict a modest 1.5%-2.0% fourth quarter which would leave overall 2013 growth around 2.0%. That is below 2012’s 2.8% growth rate and below the long-run growth rate of approximately 2.5%. A poor holiday season would put on hold the hopes of all those seasonal workers who are hoping for more permanent positions. 

Other data released this week leaned towards the positive. The Institute for Supply Management’s (ISM) non-manufacturing index rose to 55.4 in October from 54.4 in September reflecting that the largest section of the economy made it through the federal government partial-shutdown. A figure above 50.0 indicates expansion. A gauge of employment in service industries rose to 56.2 from 52.7 and business activity increased to 59.7 from 55.1. Last week, the ISM manufacturing index rose to 56.4, the highest level since April 2011. 

The European Commission (EC) on Tuesday trimmed its forecast for growth in the euro zone for 2014 to 1.1% from the previous expectation of 1.2%. The unemployment forecast was nudged slightly up to 12.2% from 12.1%. For this year, the EC expects a contraction of 0.4% which is unchanged from its May forecast. In their press release, they stated: “In recent months, the composition of global economic growth has shifted, and the external environment for the EU economy has become more challenging.” That fear has not manifested itself in higher sovereign bond rates which is a testament to the European Central Bank’s (ECB) efforts to stand as lender of last resort against such challenges. On Wednesday, the central bank lowered its benchmark interests rate to 0.25%.  ECB President Draghi said the euro area was facing a “prolonged period” of low inflation and pledged to keep borrowing costs low for an “extended period.” In language eerily familiar to central bankers on this side of the Atlantic, Draghi said “We are ready to consider all available instruments.” The euro has climbed almost 5% against its major peers this year which creates a big obstacle for exporters—especially its strongest country, Germany. With euro zone inflation at only 0.7% the threat of deflation became too great to ignore and the ECB was forced to act. The Achilles heel of the region seems to be its banking system which could now be facing negative deposit rates as the benchmark rates tumbles toward zero. There still remains far too little capital on the balance sheet of most European banks and the fact that 80% of sovereign and private sector public debt is held by the banks. This concentration of risk means that not having an adequate capital base continues to put the monies of the European public at risk. So far, they have avoided disaster, but it doesn’t mean they are not tempting it. 

SGK Blog--Update November 1, 2013: No Scare in the Markets for October   
With the federal government running again, investors and the Federal Reserve could look forward to some overdue economic data.  This last week in October we received news concerning retail sales in September.  According to the Commerce Department, excluding auto sales, retail sales gained 0.4% following a 0.1% for the month of August.  Overall sales fell 0.1% which was a bit below 0.0% median estimate in a Bloomberg survey.  Nine of 13 major categories advanced in October led by a 0.7% rise at electronic dealers and a 0.9% increase at both grocery stores and restaurants.  Electronic stores got a boost with the release of Apple Inc.’s two new iPhone models while game stores fueled the latest Take-Two Interactive release: Grand Theft Auto V.  With stocks hitting record highs, the so-called “wealth effect” cannot be overly discounted.

The Fed ended a regularly scheduled two-day meeting on Wednesday with little fanfare.  In their press release they highlighted that “Fiscal policy is restraining economic growth.”  As a result it will “await more evidence that progress will be sustained before adjusting the pace of its purchases.”  Therefore, the tapering of the $85 billion per month bond-buying program known as QE3 is unlikely to end soon.  There is one more Fed meeting this year but it would be surprising if Bernanke and co. would begin to de facto tighten monetary policy smack in the middle of the holiday shopping season.  Could it happen?  Yes, it could and we and many others were surprised when they didn’t taper purchases at the September meeting.  But last week’s delayed payroll figure was not impressive, and this week’s ADP private payroll survey was also underwhelming.  According to the median estimate of an October 17-18 Bloomberg News survey, the Fed will not reduce the pace of purchases until its March 18-19, 2014 meeting.  By then, current Vice-chairperson and White House-nominated candidate Janet Yellen will likely be confirmed by the Senate to take over for Bernanke, and she would have had time to disperse her thoughts to not only her colleagues but also the investment community at large.  Could make for an interesting first few months of the new year.     

Wholesale and consumer price data for September was also released this week.  The Labor Department reported a 0.1% fall in producer prices which was below a 0.2% advance estimated in a Bloomberg survey.  Excluding food and energy, this “core” reading was higher by 0.1% from the month earlier after being unchanged in August.  Consumer price data rose as projected as fuel charges climbed.  The index was up 0.2% from August while its so-called core reading was higher by 0.1%.  For the twelve months ending September, overall consumer prices were up 1.2%, the smallest year-over-year gain since April.  The core year-over-year rate was an increase of 1.7% which is barely in the range that the Fed is looking for in terms of price increases. 

In housing, the S&P/Case-Shiller index of property prices in 20 cities rose 12.8% in August compared to year-ago levels.  Tight inventories continue to boost prices even in the face of mortgage rates which have crept higher since spring.  Incidentally, rates are lower as of the week ended October 24th versus the week ended August 22nd according to Freddie Mac.  As of  August, average home prices were back to mid-2004 levels.  The August figure is influenced by transactions in June and July making it really a three-month average.  Values rose in all 20 metro areas.  Earlier this month, the index’s co-creator Robert Shiller was one of three economists awarded the 2013 Nobel Prize in Economic Sciences for research on how financial markets worked and assets are priced.

SGK Blog--Update October 25, 2013: September Payrolls Rise Less Than Expected   

We finally received data on the U.S. economy that had been delayed due to the government closure with the September payroll figures dominating headlines this week. 148,000 new jobs were added in the month of September and this was well below the median forecast of the 93 economists surveyed by Bloomberg who called for a 180,000 advance. On the positive side, the figure for August was revised up to 193,000 from the previous figure of 169,000. The unemployment rate dropped to 7.2% from the previous month’s 7.3% level. Although this latter figure is the lowest rate we have seen since November 2008, we have to note that the labor participation rate is stuck at 63.2%, which matches the lowest level since August of 1978. Ugh! Interestingly, the bad news lifted stocks in early trading Tuesday as traders anticipate that this labor report, combined with the uncertainty created by the dysfunction in Washington and its impact on the real economy, reduces the likelihood of the Fed beginning to taper their bond purchases this calendar year.  

In other economic news, on the housing front, existing home sales for September came in about as expected at 5.29 million while construction spending for August climbed 0.6%, higher than the 0.4% anticipated. Housing and construction have been key drivers here in the U.S. economic recovery after the recession ended in 2009. Initial weekly jobless claims for the week ending 10/19/2013 came in at 350,000 versus the expectation for 341,000. Orders for durable goods here in the U.S. in September rose the most in three months as strong demand for commercial and military aircraft outweighed a drop in business equipment. Bookings for goods meant to last at least three years rose 3.7% after a revised 0.2% gain in August. The median forecast by 67 economists surveyed by Bloomberg called for a 2.3% advance. A gauge of demand for capital equipment slumped 1.1 percent, a sign companies pulled back ahead of the federal government shutdown. Orders excluding transportation equipment, where demand is often volatile month to month, fell 0.1 percent after a 0.4 percent decrease in August. 

On the manufacturing front the news globally was somewhat mixed for the month of October. The Markit/HSBC Purchasing Managers Index for China rose to 50.9 this month from 50.2 in September, which was the fastest expansion in 7 months. But here in the U.S.. factory output was negatively impacted by the government shutdown as U.S. factory output contracted here in October for the first time since late 2009, according to financial data firm Markit. Markit’s “flash” Composite Purchasing Managers Index for the euro zone remained above the all-important 50 level but it retreated to 51.5 in October after hitting a two-year high of 52.2 in September. German factory activity grew, although their service industry saw a surprising fall in the pace of growth. It was a much bleaker picture in France, where manufacturing activity declined at a much faster pace and services expansion all but ground to a halt. Hmmm – maybe taxing business owners at 75% was not such a great idea after all! Certainly not according to French soccer clubs as they announced this week they will not play a round of league matches in the entire month of November to protest President Francois Hollande’s tax on the highest salaries kicking in next year. C’est la vie! 

In terms of third quarter earnings, so far results on average have been pretty good. As of Thursday afternoon, of the 212 companies in the S&P 500 Index that had released earnings to that point, 76% exceeded analysts’ predictions for profits while 53% beat sales estimates according to Bloomberg. Earnings for members of the gauge increased 2.5% while sales growth is on track to increase 2.2% overall, again according to analysts’ estimates compiled by Bloomberg. Of course we are always interested in looking under the hood and understanding the quality of these earnings. We want to understand whether they are based on actual revenue growth and cost controls or if they are manufactured through financial engineering. So far so good with our core holdings, with just a couple of exceptions.

SGK Blog--Update October 18, 2013: We Have a Deal  
Who wouldn’t want a 16-day paid vacation?  Congressional leaders finally came to a deal about re-opening the government and raising the debt ceiling after many weeks of acrimonious debate.  The markets responded favorably, but the question remains: “Was it all worth it?”  In our view, the current debate and ideological divide is unlikely to be bridged between now and early 2014 when, once again, the government will face a shutdown and the debt ceiling limit is reached.  Markets never really panicked even though many were calling a potential default another “Lehman event” in regards to the meltdown that struck the markets after Lehman Brothers declared bankruptcy in 2008.  Instead, the S&P 500 dipped about 1.5% below its September 30th close by October 9th only to see it rebound and close at new record levels.  The potential political fallout is best debated in another forum.  As far as we are concerned, we are glad it is over and the market can refocus on the fundamentals…for now.

Government economic data will begin to resurface with fits and starts over the next few weeks including the missed payroll data and information from the Energy Information Administration which tracks the nation’s use and inventory of commodities such as gasoline and natural gas—important indicators given that the U.S. consumes the most amount of energy of any country on the planet.  Specifically, the Labor Department said that the Employment Situation report will be released next Tuesday and October’s payroll data will be delayed a week from the normal first Friday of the month until the following Friday, November 8.  Meanwhile, the National Association of Homebuilders/Wells Fargo index of builder sentiment was released this week for the month of October.  It showed a decline to 55 this month from a revised 57 in September.   The median forecast in a Bloomberg survey was for a 57 reading.  Readings above 50 mean more builders view conditions as good than poor.  The outlook for sales in the next six months also fell to a four-month low reflecting the gridlock situation in Washington.  Overall, we still believe the environment in the residential real estate market is positive.

The government data which was released can best be characterized as “noisy”.  Weekly initial unemployment claims were 358,000 in the week ended October 12 from a revised 373,000 in the prior period according to the Labor Department.  Applications in California were still elevated due to a computer issue, and the total also included some non-federal workers dismissed due to the shutdown but did not include furloughed Federal employees.  To further muddy matters, about 70,000 claims were filed by Federal workers but that data is two weeks old.  In other words, there is no discernible trend that can be seen from data released the last few weeks.  As the agencies get back up to speed, we will get a clearer picture in the days to come.

SGK Blog--Update October 11, 2013: Equity Markets Shift Course on Deal Prospects in Washington  

After stock markets sold off in Monday and Tuesday trading on light volumes, professional traders got what they were looking for Thursday on signs that the impasse in Washington was headed for some type of resolution. Equity indices shot higher based on a thawing of the tensions in DC that had been lingering between the President and the Speaker of the House. The chief concern amongst market participants was the possibility that politicians would push the timetable to resolve the debt ceiling increase right to the limit. The consequences of a stalemate in DC were so uncertain it was hard for traders to even fathom that our political leaders could be so stupid as to let some type of default event take place. On Thursday, Republicans announced they were seeking a debt ceiling increase until November 22 and President Obama hinted that he was receptive to a short term delay in order to continue the dialogue. While an imperfect solution, and some would argue no real solution at all, this at least released some of the tension that had been building up as professional traders stepped in and acquired stock sending the major averages up over 2% in trading Thursday. Call it a relief rally!    

It has been challenging to interpret the economic data that has been coming out from the various departments in Washington because half of the reports are missing due to the government closure. So after last week’s non event when the September employment report was to be released, missing in action this week were reports on the trade balance, retail sales, the producer price index and export/import prices. While not as high profile as the monthly employment report, these are still very important data points in gauging economic health in our domestic economy. The data that did come out too was subject to some distortion as evidenced by the weekly jobless claims report released Thursday. At first glance the report was terrible as claims for the week ending 10/5/2013 came in at 374,000 versus the expectation for 318,000. However upon further review, it could be explained by two factors: first, furloughed federal workers applying for unemployment benefits given there is no clear end is sight to the shutdown; and second, California was playing catching up on claims after changing over their computer systems over the past two weeks which resulted in that state underreporting claims during that time frame. We did have an indicator on consumer confidence issued by a non-government entity – the University of Michigan’s consumer sentiment survey for the month of October came in at 75.2 versus the expectation for 74.5. We like these surveys because they are some of the most up-to-date data that we get and this figure was a welcome relief when issued given all the turmoil taking place in Washington. 

Normally the nomination of the next Central Bank chief here in the U.S. would have captured front page headlines but, given all that is going on in Washington, the announcement that President Obama’s nominee for the next chairman of the Federal Reserve was to be Janet Yellen was simply noted by market participants, although it did help take the edge off of nervous traders the day the announcement was made. President Obama has made it clear in numerous speeches that he is generally hawkish on rates in the sense that he is very concerned about the potential instability associated with future financial bubbles. Hence originally his first choice was to be Summers until he took himself out of the running. Yellen is considered to be somewhat dovish and expected to follow the path that Ben Bernanke laid out in terms of balancing the focus between full employment and the risks of inflation. Thus, market participants would interpret her nomination as being beneficial for markets in keeping rates low and stimulus applied for as long as it is warranted. Of course, she may come in and attempt to prove to critics that she is in fact tough we believe that risk to be minimal and that may simply be over-thinking the issue. Stability and predictability are always welcome by traders and her views on monetary policy are well known, hence the positive market response to the announcement of her nomination during an otherwise uncertain week. 

SGK Blog--Update October 4, 2013: Government Shutdown Greets End of Quarter 
The federal government shutdown on Tuesday after Congress failed to agree on a continuing resolution that would keep it running.  Most of the government’s 3.3 million workers are deemed “essential” and are still working.  However, over 800,000 individuals were asked not to show up for work anymore which will have far reaching effects in many industries if the work stoppage is prolonged.  If the shutdown continues for three-to-four weeks, an analyst at Moody’s Analytics estimates it would cost the economy $55 billion.  The last time the government shutdown it was late 1995 which stretched into 1996 for a total of 21 days.  Then President Clinton was at odds with House Representative Newt Gingrich.  Today’s major players are President Obama, House Speaker John Boehner and Senate majority leader Harry Reid.  Many politicians such as Senator Cruz from Texas, Representative Meadows from North Carolina and George Representative Graves have raised the stakes, and possibly risked their careers, by standing in the way of a “clean bill” that funds the government.  In their minds, the risk is worth it if spending is strictly controlled even if that means the government has to shut down in order for that to happen.

We have no idea when this might be over.  The key point is that it does come to an end.  What makes the situation trickier is that the government is also running out of money to stay afloat at all.  The debt ceiling debate is due to take over the headlines.  Treasury secretary Lew sent a letter to Congressional leaders stating that “extraordinary measures will be exhausted no later than October 17”.  There’s probably some wiggle room in those days since the Treasury will still have $30 billion left at that point to spend but a so-called technical default would likely occur soon after that.  On November 1, a $67 billion outlay including Social Security and Medicare benefit payments and military pay is due which would certainly not be made given the current status.

A government shutdown, though unwelcome, is manageable.  These individuals are not fired but furloughed.  The country survived 21 days of shutdowns in 1995.  In fact, there have been 17 shutdowns since 1976 according to Bloomberg data.  Not paying sovereign obligations is a totally different ballgame.  The U.S. dollar is the world’s de facto global currency.  Obligations denominated in that currency also carry that status.  When Standard & Poor’s downgraded the U.S. of its AAA credit rating in August 2011, prices for bonds actually rose not because of the rating change but because investors flocked to the securities as a symbol of strength and security given the overseas fiscal turmoil in Europe.  In the ultimate act of faith, buyers of short-term paper have accepted a negative real return (nominal rate minus the inflation rate) meaning they are willing to lose purchasing power simply as a way to get a return of principal rather than a return on principal.  All of that would change if the borrower, in this case the U.S. government, didn’t payback its lenders.  Calling it a catastrophe would be putting it lightly. 

The equity and bond markets have taken this political wrangling in stride. And why not?  Since 1976, the S&P 500 has risen 11% on average in the 12 months following a government shutdown.  The S&P remains within 3% of its all-time high set last month.  The common refrain from traders has been: “I’m a buyer on weakness” meaning that dips in the indices will be met with buy orders.  After the S&P fell 11% in three days in response to the stalemate between President Obama and Congress in August 2011 surrounding that debt ceiling debate, the following 12 months, the S&P gained 25%.  Some investors are secretly or not so secretly wishing for a plunge to send a message to Congress that this type of brinkmanship is not acceptable (and to buy on the cheap).  But nobody is voting with their feet as averages remain near record highs and the yield on the 10-year Treasury not remains solidly within its 3-month range of 2.48%-2.99% finishing the week at 2.XXXX%.  So, until the politicians on the Hill decide to act like adults and settle this matter, all we can do is stay tuned.

SGK Blog--Update September 27, 2013: Traders Follow Budget Negotiations With Trepidation 

Stocks started out the week on shaky ground as traders were still digesting the implications of last week’s Fed meeting.  Comments from influential Fed members this week just seemed to add to the confusion. Fed Bank of New York President William C. Dudley stated Tuesday the central bank may reduce the pace of its quantitative easing program beginning in 2013 but that it was dependent on the economy’s performance. Last week Fed Bank of St. Louis President James Bullard said policy makers may decide to reduce their monthly bond purchases at the meeting in October. Our view is that it seems more likely, barring a really strong September employment report, that the process will begin in December, just in time to rain on, or should we say reign in, our Christmas stock rally! We just don’t believe there are enough data points between now and the October meeting to change their view dramatically from the September meeting. The December meeting will be followed by Bernanke’s last press conference before his tenure ends in January so it seems right in terms of the timing. Of course – they could surprise us again! Most believe that the process of buying bonds to suppress interest rates and assist the economy was really driven by the current Fed Chairman and that he will want to see the process of unwinding the program begin on his watch. Just in time to pass the baton! Negotiations over the budget and whether or not the government will remain open beyond September 30th added to the uncertain environment pressuring stocks throughout the week. The administration also warned this week that unless the $16.7 trillion debt ceiling is increased, the Treasury will have less than $50 billion in cash by mid-October.  

Home prices continued to demonstrate strength as the S&P/Case Shiller index of property values in 20 cities increased 12.4% from July 2012, the largest increase in 7 years. This data is backward looking and somewhat dated when released as it takes a while to compile. Given it runs through July 2013, it would not surprise us to see this slow in the coming months as the effects of the rapid rise in interest rates over the past few months takes hold. Still this is a far cry over where we were during the depths of the financial crisis and housing has been a major contributor to the rebound we have experienced here in the U.S. economy. This report was tempered on the day of the release by the consumer confidence figure for September which dropped to a four month low of 79.7 from a revised level of 81.8 for August. Again, we have come a long way since the financial crisis as this figure averaged 53.7 during the recession that ended in June 2009.  

New home sales in the U.S. rose 7.9% to 421,000 for August which was ahead of expectations although the July figure was revised down slightly. Although a nice increase for August, given demand had slumped 14.1% in July this raised concerns that higher interest rates are having an undesired impact on the housing market. Pending home sales reflected this as well as they were down 1.6% in August although that was better than expected. Orders for durable goods rose less than forecast for August at +0.1% versus the expectation for +0.5%. Excluding the volatile transportation component, orders actually came in at -0.1% versus the expectation for +0.9%. Weekly initial jobless claims for the week ending 9/21/13 came in 20,000 less than expected at 305,000. The third estimate for second quarter GDP was slightly below expectations at +2.5% versus the +2.6% forecast. Wrapping up the week we had figures for personal income and personal spending which were both slightly better than expected at +0.4% and +0.3% respectively.    

Germany is benefiting from unemployment near a two decade low and the end of the euro area’s longest recession. The Ifo institute’s business climate index, based on a survey of 7,000 business executives in that country, climbed to 107.7 for September from a revised 107.6 in August. The gauge has gained in five consecutive months reaching its highest level since April 2012. This helped propel Chancellor Angela Merkel’s Christian Democrats to take the largest share of the vote in their September 22nd elections and set her up for a third term as leader. The European Central Bank has pledged to keep interest rates low to support what it calls a fragile euro area recovery. The euro area region’s GDP finally expanded 0.3% in the three months ending June, snapping six quarters of contraction. ECB President Mario Draghi indicated this week that the ECB is ready to use another longer term refinancing operation if needed to curb market rates. The bank had introduced two three year LTROs starting in December 2011, which we had written extensively about back then, to ease the credit crunch at the time. As we stated then, this was done to buy time and that is exactly the impact that it has had.

SGK Blog--Update September 20, 2013: Surprise!  No Taper by Fed

The Fed blinked. There is really no other way to describe the result of the latest meeting of the Federal Reserve Open Market Committee where they decided to stay the course and continue buying $85 billion of fixed income securities per month. What the market found surprising was that Fed officials had spent months dropping hint after hint that a tapering of the latest quantitative easing was quite likely. In May Bernanke said the job market’s improvement and anticipated faster GDP growth would lead to a pullback on the bond-buying program. In June he said slowing bond purchases would be like “letting up a bit on the gas pedal as the car picks up speed, not applying the brakes.” In subsequent meetings and speeches, there was always a nod to interpreting the latest economic releases—the so-called “data dependent” clause—but  few solid signs that the tide had turned against tapering. Nevertheless, the press release disseminated yesterday stated, “the Committee decided to await more evidence that progress will be sustained before adjusting the pace of its purchases.” They added, “the Committee will, at its coming meetings, assess whether incoming information continues to support the Committee’s expectation of ongoing improvement in labor market conditions and inflation moving back toward its longer-run objective.”  In a press conference after the meeting, Bernanke said, “Conditions in the job market today are still far from what all of us would like to see.” Apparently, it was a close call, but that only counts in horseshoes and hand grenades.

Frankly, we were surprised by the announcement as well as a little disappointed and somewhat confused. Granted the most recent economic data on employment was not robust by any means. The unemployment rate was at 7.3% in August according to the Labor Department. That was an improvement from the 9.6% for 2010, 8.9% for 2011 and 8.1% for 2012. However, much focus recently has been placed on the labor participation rate. With that number declining, it brings into question the robustness of the nationwide unemployment rate. This is a key point because the Fed had stated that a reduction of the bond buying program would likely occur, in the absence of inflation, when that rate reached 6.5%. Or was it 7%? In June, Bernanke said at that post-meeting press conference that officials expected the jobless rate to be about 7% when the Fed ended the program. When asked specifically about that 7% level on Wednesday, he played it down, responding, “There is not any magic number…We’re looking for overall improvement in the labor market.” Adding to the confusion, he stated this week that the unemployment rate was “perhaps the best single indicator of the state of the labor market” but later proposed “the unemployment rate is not necessarily a great measure in all circumstances of the state of the labor market overall.” 

As if that confusion wasn’t enough, the Fed as a whole seems to be a poor predictor of the future. Granted, their job is not easy, and we are well aware of the challenges of steering a $15 trillion economy with blunt monetary tools while having no input into fiscal policy. Yet, since mid -2011 the Fed has been guilty of overestimating the growth of the economy. The “central tendency”, or best estimate excluding outliers, for annual GDP growth for 2013 was 3.5%-4.3% as of 4/27/11, fell to 2.7%-3.1% by 4/25/12 and currently stands at 2.0%-2.3%.    Meanwhile, their projections on unemployment have been underestimated. Chairman Bernanke has conceded these mistaken forecasts but refuses to face the terrifying fact that the Fed’s QE’s programs haven’t worked. Maybe they saved the country from a outright economic depression, but they have not ignited the country’s output at the level they thought it would. So, by decreasing GDP forecasts at the latest meeting, it would have been highly irrational to also decrease the bond purchase program in the face of such weakness. This reminds us of the timeless saying: Beatings will continue until morale improves. In other words, these policies have not worked as intended, so they must be continued until they do.

Europe has similar problems. Several banks, especially those in the financially challenged south, have started to lobby the European Central Bank (ECB) for a lending program to replace a current one—over a year before it is due to end. In late 2011, the ECB disbursed about €1 trillion in three-year loans to hundreds of banks that could not borrow through ordinary channels. This program, called long-term refinancing operation or LTRO, is widely credited with easing some of the eurozone’s crisis. Yet with only €334 billion paid off, banks are already anxious for another plan to replace it before they come due in 2015.

The message is clear: the markets like quantitative easing and it will not be easy to remove this “drug” from the system. On a short-term basis, in the midst of emergency conditions, that is fine. We have argued for the use of a monetary “bazooka” to help jawbone the markets back in line both here and abroad. However, is the patient, i.e., the U.S. economy, still on life support? Is there more of a political angle at play with Bernanke side-stepping the question concerning the end of his term? With Vice Chairman Yellen confirmed this week by the White House as the front-runner to replace him after Obama-favorite Summers dropped out over the weekend, might Bernanke be trying to keep a clean slate for his well-respected colleague? Was the Fed spooked by the spike in 10-year rates to touch 3% earlier this month and the steady rise in mortgage rates? Sales of existing homes rose in August to the highest level in more than six years to an annual rate of 5.48 million. The median price rose by the most since October 2005. Skeptics point that it was a surge in August before borrowing costs really began to bite and affordability issues began to play more of a role. In fact, builders began work on fewer homes than projected in August as housing starts rose to a 891,000 rate that was below the median Bloomberg economists forecast of 917,000. Is that a temporary slowdown? Sentiment in the industry according to the National Association of Home Builders/Wells Fargo index held in September at the highest level in eight years. Regardless, there is no mistaking that Freddie Mac’s 30-year home loan average of 4.57% will have an effect on demand compared to the 3.81% level at the end of May.

Our biggest reason for concern is that the great experiment of QE has neither an end date nor a justifiable reason at this point given the economy’s signs of life that make life-support-type measures seem like overkill. It is quite likely that when tapering begins it will be accompanied by a press conference and since none are scheduled until December, the buying will continue even though Bernanke says they could switch gears at any time. Even after comments on Friday from St. Louis Fed President James Bullard which indicated October may be possible taper date, that only allows for one more employment reading instead of the three were a move made in December, with the added bonus of an early view into the holiday shopping season. We are in agreement with Fed officials that the economy is not yet healed. Yet, the Fed is putting $85 billion…that’s $85 BILLION (we used caps to emphasize the point)…per month into the economy. Banks and corporations are awash in cash. Somehow all this money is NOT finding its way into more loans, into new value-added projects, into job-creating activities. We know where it is going—into an already fully valued stock market.

SGK Blog--Update September 13, 2013: Uncertainty Mounts as Traders Await News on Syria & Fed 

Stocks rallied early in the week on news that a deal on Syria’s chemical weapons was in the works between the United States and Russia. As the week progressed we could sense nervousness as traders weighed the tough talk coming from Kerry and as they tried to anticipate what the Fed would say and do next week at their September meeting. Speculation that they would announce a reduction in their bond buying stimulus program has been tempered lately by mixed economic data, encapsulated by the August employment report which was weaker than anticipated. So the question on traders’ minds this week has been what will the Fed do? We anticipate some clarity around when they plan on reducing their purchases of Treasuries and mortgage-backed securities, even if they choose not to begin that process immediately. On Syria, it is a matter of wait and see as negotiations progress. Traders seemed to have discounted into prices a resolution not involving conflict as evidenced by the retrenchment in the price of oil this week. 

For the U.S. economy, traders were jolted awake Thursday morning with the headline that weekly jobless claims dropped to 292,000 for the week ending 9/7/2013 compared to the expectation for 327,000 until it was announced by the Labor Department that two states had underreported due to the fact they were upgrading their computers. Traders quickly shook off the report and stock futures remained stable. The retail sales figures for August released Friday were disappointing as they showed a 0.2% increase versus the expectation for a 0.4% increase. Even when the figure excluding autos (a less volatile measure) was released it still came out below expectations at +0.1% versus the +0.3% expected. Combined with the disappointing figure released by the University of Michigan on consumer sentiment for September which came in at 76.8 versus the expectation for 82.0, this actually caused stocks to rally. Why you ask? In the view of many traders, disappointing economic figures here in the U.S. means that the Fed may be less likely to announce a reduction in their bond buying stimulus program next week. The release of the producer price index for August helped support this view as although the headline number came out a little hotter than expected at +0.3% versus the expectation of +0.2%, the less volatile core rate measure which excludes food and energy came out flat (no increase, no decrease) versus the expectation for a +0.2% increase.  So equity traders fed off of the combination of weaker than expected data and tame inflation figures while fixed income traders basically were waiting to see what the Fed will actually say in their meeting next week as bond prices barely moved at all Friday. 
SGK Blog--Update September 6, 2013: Employment Data Breed Doubt in Taper  
Payrolls in the U.S. rose 169,000 in August following a revised 104,000 increase in July that was smaller than initially estimated according to the Labor Department.  Given that the forecast of 96 economists surveyed by Bloomberg called for an August increase of 180,000, some view the actual figure as a disappointment.  Unemployment dropped to 7.3%, the lowest level since December 2008.  Treasury bonds rose as investors interpreted these numbers as a roadblock to the Federal Reserve and its efforts to “taper” the $85 billion per month of bond buying.  The benchmark 10-year Treasury bond saw its yield drop to 2.904% after reaching 3.005% overnight on Thursday according to Tradeweb data.  Incidentally, that was the first trade over the 3% yield level since July 2011.  Stocks initially rose in pre-market futures action before being weighed down by further military action on Syria.

What is our take on the payroll figure?  As we have previously mentioned, focusing on one number is likely a mistake.  These monthly amounts are revised frequently (as July’s figure was) and they are not as timely as the weekly initial unemployment claims.  Actually, those claims fell by 9,000 in the week ended August 31.  The figure of 323,000 was just shy of the 322,000 reported in January 2008.  This suggests that employers are not aggressively paring their ranks, but they are not robustly hiring either.  A lot of focus has been put on the labor force participation rate which indicates the share of working-age people in the labor force.  For August, this number declined to 63.2%, the lowest since August 1978 when it reached 63.4%.  This is an important number until it is not an important number.  That is, there could be a number of explanations for this including the rise of adult offspring returning to live at home, dual income households dropping to one income or a rise in “black market” activities which generate income and no W-4 forms to fill out.  The importance of this statistic is further reduced when a plethora of other economic data is nothing short of awesome.  Cars and light trucks sold in August at the fastest annualized rate since 2007 according to Ward’s Automotive Group.  All the major brands—GM, Ford, Toyota and Honda—exceeded analysts’ estimates.  Ford said it will boost fourth-quarter production by 7% and, in the telecom world, AT&T needs to fill hundreds of positions in the San Francisco Bay area.  The Institute of Supply Management’s manufacturing index rose in August at the fastest pace since June 2011 and the service index posted the highest reading since December 2005.  It will not be until next Friday when retail sales for the month of August will be released, but estimates are calling for decent gains during the crucial back-to-school selling season.

The unemployment rate has been falling because there have been less people in the workforce and more discouraged folks who cannot find full-time employment (though the number of male discouraged workers actually fell year-over-year).  However, families are finding a way to afford a new car and are confident enough to provide fuel for a resurgent housing market.  The measure of employee output per hour rose to a 2.3% annualized pace in the second quarter which was not far from last week’s GDP figure which came in right at 2.5% growth.  The average annual gain in productivity in the 2000-2011 period has been 2.4%.  In other words, businesses are more productive than they have ever been and a low participation rate may be one result of that.  We cannot predict where this figure will go, but we can guess that demand for workers will likely increase especially if we see a rebound in Europe (which decided this week to remain very accommodative on their rates) and a lack of government shrinkage from the effects of the sequester (in fact, government workers actually increased in August).  We will find out in about two weeks what decision the Fed has come to about their purchases.  Stay tuned.

SGK Blog--Update August 30, 2013: Tensions Over Syria Cause Stocks to Retreat  

Equities rebounded from Tuesday’s eight week low for the major indices as energy stocks climbed on higher oil prices. Oil prices were sent higher amid growing speculation that a military strike by the United States and our allies in response to a chemical weapons attack near Damascus last week would disrupt supply. Throughout the course of the week Obama administration officials were in consultations with NATO allies including the U.K., France, Germany and Turkey as well as Arab nations to determine which countries would participate in a military strike against Syria. The British parliament voted “no” to participating in a limited military engagement leaving the Obama administration without a key ally. The situation is complicated because Syria maintains a relatively robust air force and counts as allies both Russia and Iran. In Tuesday trading, stocks here in the U.S. dropped 1.6% as financials, industrials and technology stocks led declines. Markets behaved worse overseas as European indices declined 1.8% on average and emerging market indices were varied. The Dubai DFM General Index plunged 7% on the news of possibly military action by the U.S. 

News of potential instability in the Middle East also caused commodity prices to rise as oil spiked higher throughout the week. The price of Brent crude popped up briefly over $117 per barrel in Wednesday trading. West Texas Intermediate, or WTI for short, also rose to finish the day over $109 per barrel. WTI is the pricing we often reference in our weekly email as it is a more pertinent price to us here in the U.S. We should draw a distinction for you between the two – Brent crude and West Texas Intermediate. Brent crude is actually considered a better indicator of global oil prices. Brent essentially draws its oil from more than a dozen oil fields located in the North Sea. It represents the Northwest European sweet market, but since it’s used as the benchmarks for all West Africa, the Mediterranean and now also for some Southeast Asian crudes, it’s directly linked to a larger global market. Anyway, you look at it – prices rose this week and this can spill over and have a dampening effect on major economies across the globe. This is particularly concerning for Europe given they already pay high taxes for gasoline and are just now showing signs of coming out of their economic slump.    

Events in Syria overshadowed a mixed but not bad week for economic data here in the U.S. The week did start out on a bit of a sour note with the report on durable goods orders. For July, durable goods (goods built to last longer than one year) declined 7.3% relative to the expectation for a 5% decline. Stripping out the volatile transportation segment (autos and airplanes) it still showed a decline of 0.6% versus the expectation for a 0.6% gain. The impact of the sequester is evidenced in these figures as military spending on big ticket items was down sharply for the month. The Case-Shiller 20-City Index for home prices rose 12.1% for the month of June (year-over-year) which was slightly better than expected. Any positive news on the housing sector is welcome indeed! This was followed on the same day (Tuesday) by the release at 10 am of the consumer confidence figure for August which was a robust 81.5 versus the expectation for 77 and up from the prior month’s level of 81. Pending home sales for July were slightly lower than expected at -1.3% compared to the expectation for +0.2% but this is not a total surprise as we have witnessed quite a jump in mortgage rates over the previous three months. Initial weekly jobless claims for the week ending 8/24/2013 fell to 331,000, which was in-line with expectations and down from the prior week’s figure of 337,000. Second quarter GDP (Gross Domestic Product) here in the U.S. was revised upwards to +2.5% up from the previous estimate of +1.7% as a smaller trade deficit and gains in inventories overshadowed the effects of federal budget cutbacks under the sequester. Does this mean the Fed will announce the beginning of their “taper” at their September 17-18 meeting? We will have to wait and see – stay tuned!

SGK Blog--Update August 23, 2013: Fed Views "Mixed" on Economic Direction  

Remember when Europe was on the brink of collapse?  Actually it was just last summer when bond yields on Italian and Spanish debt widened versus the benchmark German bund and had many economists and traders thinking the days for the eurozone were numbered.  Flash forward to 2013 and the consensus is markedly different.  According to data provider Markit, the euro-zone purchasing managers indexes showed expansion in August including the previous trouble children Spain and Italy.  The composite—which combines data from the services and manufacturing sectors—rose to 51.7 from 50.5 in July.  The 50.0 level separates contraction from expansion.  Germany’s manufacturing index rose to 52.0, the highest level in 25 months.  Other nations were not as high, but new orders were solid and expectations were positive for the future.  This comes on the heels of a 0.3% eurozone GDP reading for the second quarter which broke a string of six consecutive negative quarterly figures.  The 17-nation common currency bloc cannot be considered completely healthy, but clearly it is on much better ground than many had predicted.

Meanwhile, the U.S. economic engine continues to look solid based on reported data.  The number of weekly initial jobless claims rose by 13,000 to 336,000 in the week ended August 17 but the four-week average was down.  Separately, the National Association of Realtors reported that sales of previously owned homes climbed more than forecast in July to the fastest pace since November 2009.  Friday saw a decline in new home sales but that was more related to builders holding back construction rather than a sharp decline in demand.  Though units of new home sales were down compared to the previous month, the median price increased 8.3% last month from a year ago to $257,200.

This week, the general public got to read the minutes from the Federal Reserve’s July policy meeting.  Officials are divided about the appropriate timing of the first reduction in their $85 billion per month bond-buying program.  Some members thought growth would pick up in the second half of the year while “a number of participants indicated, however, that they were somewhat less confident about a near-term pickup in economic growth than they had been in June.”  The minutes also stated, “it might soon be time to slow somewhat the pace of purchases as outlined in the plan.”  According to a Bloomberg survey taken August 9-13, 65% of 48 economists believe there will be a cut in purchases at the Fed’s September 17-18 meeting.  The median estimate called for a cut to $75 billion per month.  That two-thirds number is not high enough to claim it will definitely happen, but it does show the market is leaning in that direction.  As we have written previously, the Fed’s direction is no longer in doubt, the only question which remains in how quickly and convincingly they want to end the quantitative easing program.  Anything more than baby steps would be a surprise.

SGK Blog--Update August 16, 2013: More Good Economic News  

With only a few more weeks left before the unofficial end to summer arrives with Labor Day weekend, the U.S. economy has been heating up.  Retail sales rose in July for the fourth consecutive month.  The 0.2% increase followed a 0.6% gain in June.  Though that was slightly below the 0.3% expectation, it was offset by the fact that June’s figure was revised higher from an original 0.4% increase.  At clothing chains, sales were up 0.9% and 0.4% higher at general merchandise stores.  Heading into the very important back-to-school period, these figures are promising.  Meanwhile, there remains an absence of pricing pressure.  The consumer price index rose 0.2% in July.  Excluding food and energy, the “core” figure was up a similar 0.2%.  On a year-over-year basis, overall prices were up 2% but only 1.7% in the core figure.  That is still within the 1%-2% range the Fed likes to see, but there has not been a worrisome disinflationary trend either.

Fueling these gains has been the employment picture.  Claims for jobless benefits fell to the lowest level in almost six years.  In the week ended August 10, unemployment insurance payments fell by 15,000 to 320,000 from the week previously.  That was the fewest since October 2007 and below the median forecast of 44 economists survey by Bloomberg which called for a 335,000 claims.  As mentioned in previous weeks, the summer months can be quite volatile due to season factors, but the Labor Department said that there was nothing unusual about this week’s data and no states were estimated.  The number of people continuing to receive jobless benefits dropped by 54,000 to 2.97 million in the week ended August 3.  These better payroll figures is fueling a better housing market, too.  Housing starts climbed 5.9% to an annualized 896,000 in July according to the Commerce Department.  Multifamily construction—i.e., apartment buildings—surged about 26%.  Building permits rose 2.7% also helped by a jump in multifamily.  Building applications for single-family homes exceeded the number of starts which bodes well for a pickup in construction in the coming months.  The National Association of Home Builders/Wells Fargo index rose to 59 in August from a revised 56 in July (previous level=57).  Readings above 50 suggest builders view conditions as good.  This is the highest measure for this index since November 2005 when it reached 61.  A rise in mortgage rates may temper some of this enthusiasm in the coming months but it is clear that things are on solid footing in the real estate area. 

Also, surprisingly, there was some good news out of the eurozone in terms of economic growth.  Gross domestic product in the 17-nation financial bloc rose 0.3% in the second quarter after a 0.3% contraction in the previous three months according to the EU’s statistics office in Luxembourg.  That was higher than the median estimate of 0.2% and ended six straight quarters of contraction.  Germany and France led the way with 0.7% and 0.5% growth, respectively.  Still, four of the 17 nation’s remain in contraction including both Italy and Spain.  With the eurozone’s collective unemployment rate at 12.1%, the highest since the euro’s inception in1999, European Central Bank President Mario Draghi called progress “tentative.”   We would call it a miracle given the state of affairs just last year.  Of course, the continent is far from out of the woods.  Growth rates still remain too low to help bring down that dramatically high unemployment rate, and, though interest rates on sovereign debt are relatively calm, they remain perilously close to danger levels.  Nevertheless, the spread between Italy’s and Spain’s 10-year yield premium over benchmark German bunds shrank to the smallest level in two years this week.  For example, in Spain, the spread now is only about 265 basis points (a basis point is 1/100 of a percent) compared to 650 basis points in July 2012. 

While it is too early to claim a global recovery is underway, the signs are obvious that the worst of the recession is past and sustainable growth is apparent in the U.S.  That means the Federal Reserve will have to take a long and hard look at its policies to see if a change is needed.  Many market players are betting that the Fed removes some fuel from its quantitative easing program next month and futures are expected a 10-year yield over 3% by year end (versus this week where it closed near 2.78%).

SGK Blog--Update August 9, 2013: Stocks Held in Check on Speculation Fed Will Announce Start of "Taper" at September Meeting  

Stocks were weaker this week on speculation the Fed will announce a tapering of their quantitative easing stimulus or bond buying program when they meet in September. According to a Bloomberg poll, 44% of economists predict the Fed will reduce their bond buying by $20 billion to $65 billion when they meet on September 17-18. Further fueling this speculation were comments from Fed Bank of Cleveland President Sandra Pianalto when she said, “a tapering of the central bank’s stimulus may be warranted if the labor market continues to strengthen.” The Bank of England raised its outlook for the economy for this year and next year and said price stability remained a primary objective. But for the first time, the Bank of England followed in the Fed’s footsteps by linking interest rates specifically to the jobless rate. Their magic number is 7% unemployment as opposed to our central bank’s target of 6.5%. In summary, concerns about the Fed’s quant easing removal are outweighing the economic data now that we are through the bulk of second quarter earnings reports. The focus has shifted from how companies are doing to what the Fed plans on doing.

For the most part, the data we had on the U.S. economy was solid this week. Our Institute of Supply Management (ISM) Services Index beat expectations coming in at 56 in July relative to forecasts for 53.2. We are a services and consumer spending driven economy here in the U.S. so this is an important indicator. Our trade balance fell to $34.2 billion for June relative to expectations for $43.4 billion as oil and gas imports continue to drop here in the U.S. based on our continued output. Will we eventually become a net exporter of oil and/or natural gas? We will have to wait and see but it will be nice when we are less reliant on oil imports from the Middle East. We have not written about OPEC meetings in many months whereas in years past they had much more influence on market prices. Initial weekly jobless claims were 333,000 for the week ending 8/3/2013 relative to the forecast for 340,000. On the whole then, the major releases on our economy this week were pretty strong. 

The National Association of Realtors reported that prices for single family homes climbed in 87% of U.S. cities in the second quarter as the national housing recovery accelerated amid competition for properties in the marketplace. The median transaction price rose from a year ago in 142 of 163 metropolitan areas measured. At the end of the second quarter, 2.19 million previously owned homes were available for sale, 7.6% fewer than last year. The median price for an existing single family home was $203,500 nationally in the second quarter, up 12% from a year ago. At the same time, in a separate report the Mortgage Bankers Association indicated that the share of U.S. mortgages that are seriously delinquent plunged to the lowest level in almost 5 years based on the improving employment picture in this country. The percentage of home loans more than 90 days behind or in the foreclosure process fell to 5.88% in the second quarter compared to 7.31% in the same period last year. All good news on the home front! 

Finally, data points released on the Chinese economy this week helped lend a measure of support to stocks in Thursday trading. China’s exports and imports exceeded economists’ forecasts, adding to signs that the world’s second largest economy is stabilizing following a two-quarter slowdown. Improved trade may bolster Premier Li Keqiang’s chances of achieving the year’s 7.5% target for expansion, after manufacturing and service-industry indexes rose in July as well. We will have to wait and see as China’s stock index has been a drag on global indices with it down over 7% year-to-date. They are due for a rebound there!

SGK Blog--Update August 2, 2013: Fed Has Tough Balancing Act 
The Fed has to remove accommodative bond buying but at the same time make sure the economy does not slip back into a recession.  That’s a tough balancing act.  Data this week showed that the economy grew more than projected in the second quarter.  According to the Commerce Department, GDP rose at a 1.7% annualized rate after a 1.1% gain during the first quarter of the year.  Consumer spending, which is the biggest part of the economy, rose 1.8% after increasing 2.3% in the first quarter.  That added 1.2 percentage points to growth while a gain in stockpiling inventory boosted the second quarter growth by 0.4 percentage points.  Domestic final sales while excludes inventories, exports and imports rose 1.3%, a strong rebound from the 0.2% bump in the first quarter.  The Commerce Department also issued comprehensive revisions to all previous GDP data—all the way back to 1929.  It showed that the recovery from the latest recession in 2009 was actually stronger than previously estimated.  With the effects of fiscal drag from the sequester lessening as the year progresses, many economists project that the second half of the year will have even stronger growth.  With employees now re-adjusted to a higher payroll tax (it reverted to the 2010 level of 6.2% in January after being at 4.2% for two years), we could see much stronger retail data especially if the job market stays healthy.  With big-ticket items like autos remaining strong, a key indicator coming up will be back-to-school sales over the next six weeks.  This time period represents the second most important time of the year for retailers after the holiday season as stores from discount chains to electronic boutiques try to capture sales from families as they gear up for the fall and the next school year.

This week at the regularly scheduled Federal Open Market Committee meeting, the Fed governors did not change the overall tone of their outlook.  The press release stated: “Labor market conditions have shown further improvement in recent months, on balance, but the unemployment rate remains elevated.”  Further, they believe, “economic growth will pick up from its recent pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate (maximum employment and price stability).”  Of the 54 economists polled by Bloomberg News in a July 18-22 survey, none of them expected the central bank to alter the pace of bond purchases linked to their quantitative easing.  They were right.  The Fed will continue purchasing $40 billion per month of mortgage-backed securities and $45 billion per month of longer-dated Treasuries.  That same survey, however, says that 50% of those economists believe that the Fed will first reduce bond buying at its September 17-18 meeting.  The Fed is well aware that is making a bet on the economy to start to grow faster.  In order for the economy to reach the lower end of the 2013 Fed’s GDP growth forecast range of 2.3%-2.6%, that metric will have to rise at an annualized rate of 3.2% in the second half of the year.  An even stronger spike will increase the pressure to stop the bond buying and maybe even give some thought to increasing the Fed Funds rate which has remained near 0% since December 2008.  It will not be hyperbole to state that the eyes of the financial world and beyond will be squarely focused on the Fed’s next meeting in mid-September. 

Friday’s payroll figures were a bit less than expected, but there were signs of hope.  For July, the Labor Department reported that nonfarm payrolls grew 162,000 following a 188,000 rise in June.  The median forecast from Bloomberg called for a 185,000 gain and there were some whispers of as high as 200,000.  Private employment, which excludes government agencies, rose to 161,000 versus the 195,000 median expectation.  Average hourly earnings fell 0.1% in July from June but was up 1.9% over the past 12 months.  Meanwhile, the unemployment rate fell from 7.6% to 7.4%.  The unemployment rate is based on a different survey than the payroll jobs figure so there are times when one figure could be improving while the other declines.  The household survey showed that part-time employment rose by 174,000 in July and the number of discouraged workers, those not looking for a job because they do not believe they will get one, rose to 988,000 from 852,000 a year ago.  The bottom line is that these numbers were not up to expectations but they were far from a disaster.  The six-month average for private sector growth is 199,000 which is quite good.  Today’s figures show that the economy still remains vulnerable on the employment front even with the better data we see in the housing market.  That weakness is, in fact, getting weaker.  The weekly initial jobless claim data for the week ended July 27 was 326,000, the smallest figure since January 2008.  The weekly data is thought to be more timely than the monthly job data and is a better indicator of the current direction of job growth.  Plus, the monthly data is subject to far more seasonality adjustments especially during the summer months when auto factories re-tool their lines for new model years, teachers are hired or fired and newly graduated students seek employment plus much more overall building construction takes place between June and August than other months of the year due to the better weather.  Data released this week also shows that consumer spending rose in June by 0.5% versus the 0.2% increase in May suggesting that rising home values, stock price gains and an improved job market compared to previous years is encouraging the masses to spend and their spending comprise nearly 70% of GDP. 

SGK Blog--Update July 26, 2013: Earnings Season Continues 
We received two different reports on the housing market this week. On Monday,, the National Association of Realtors reported that sales of previously owned houses, a.k.a. existing home sales, unexpectedly dropped in June. Purchases fell 1.2% to a 5.08 million annualized rate. That was below the Bloomberg median forecast of economists of 5.26 million. The drop was primarily because the supply of homes was the fewest for any June since 2001. Rising prices depleted the amount of less expensive homes on the market. With home mortgage interest rates creeping higher, this was enough to slow down the previously robust trend we were seeing in these numbers. The median price climbed 13.5% to $214,200 from $188,800 a year earlier. At the current sales pace, it would take 5.2 months to clear out the inventory of 2.19 existing homes on the market. That is still a healthy pace but recent worries have risen about how first-time home buyers were being priced out of the market. They are a key contributor to the “upgrade” cycle as money from first-time buyers is often used as the fuel for previous first-time buyers to upscale to bigger and more expensive properties.

On Wednesday, the Commerce Department reported that sales of new U.S. homes rose more than forecast in June to the highest level in five years. Sales rose 8.3% to an annualized pace of 497,000 homes from May’s figures. The median selling price of a new home appreciated 7.4% to $249,700 and purchases rose in three of four U.S. regions, led by an 18.5% rise in the Northeast. The supply of homes at the current sales rate was 3.9 months which matched this January’s level as the lowest since 2004.

How can these numbers move in such opposite directions? First, clearly existing home sales dominate the transactions in the housing market and with such a large base, it is harder to move the needle. Second, sales of new homes are counted when purchase contracts are signed. Sales of previously owned houses are counted when sales are final, i.e. after closing, which may take place one to two (or more) months after the sales contract is signed. Thus, the current health in the housing market seems to be true as new home sales are more indicative of current trends. Third, higher borrowing costs spur demand in the short run for those “on the fence” and with the median price of new home sales higher than existing homes, there is more to finance. Thus, they are more sensitive to rates which have risen to 4.37% last week for a 30-year fixed mortgage according to Freddie Mac, versus a record low of 3.31% in November. The bottom line to take from this exercise is that the housing market has enough underlying demand to move supply which is on the market, but with prices rising future data points are likely to be influenced more and more by the increasing interest rate environment.

The picture from the employment sector has not changed much this week. Jobless claims rose by 7,000 in the week ended July 20 according to the Labor Department. Retooling at carmakers and school closings influenced figures as they usually do during the summer. We are no passing the peak of the drag from government budget cuts and the trend in claims is fairly stable which is good news for the economy. However, as we have pointed out previously, there is not a great deal of momentum in hiring leading to a sharp drop in the weekly claims figure. This optimism is also reflected in orders for durable goods defined as goods meant to last at least three years. That metric rose 4.2% in June after a revised 5.2% gain in May.

SGK Blog--Update July 19, 2013: Earnings Show Signs of Continued Corporate Health  

While this week we had plenty of news out on the U.S. economy, we had several companies release earnings as well so we will focus more on the results down below. With that said, we had several important indicators of the health of the U.S. economy out this week. It began with the retail sales figures for the month of June which came out below expectations. Economists had forecast growth of +0.7% and +0.4% excluding the volatile auto sector which fluctuates a lot month to month but those figures came out at +0.4% and 0% respectively. Housing starts for June were also substantially below expectations at 836,000 versus the forecast for 958,000 while building permits also came out below expectations at 911,000 versus the 1,000,000 expected. Is this a sign that higher interest rates are taking their toll? We will have to wait and see if the trend continues show up as we receive the July and August figures. The index of leading indicators for June was also below expectations coming in flat versus the expectation for +0.3%.  

Not all was negative as the figures gauging the health of the U.S. manufacturing sector were pretty solid for the month of June and so far here in July. Empire manufacturing (NY area gauge) for July was above forecasts at 9.46 vs. the anticipated 3.6 while the Philadelphia Fed, a survey of businesses in that region, was a robust 19.8 for July vs. expectations for 5.3. Both U.S. industrial production and capacity utilization for June came out about as expected at +0.3% and 77.8% respectively. Finally the all-important figures for the consumer price index (CPI) for June were not too bad as the overall figure was +0.5%, which was above the forecast for +0.3%, but when the volatile food and energy components are stripped out, the core rate was as expected at +0.2% for June. Traders closely watch this gauge for hints of inflation which may cause the Fed to “taper” their bond buying sooner than expected. On that note, Bernanke in Congressional testimony this week helped ease concerns that this process would begin real soon as he continued to emphasis that for the Fed to stop acquiring bonds, the economy would have to improve from current levels. He has been consistent with this message so despite rumblings from other Fed members, this helped ease market concerns a bit this week. 

SGK Blog--Update July 12, 2013: Markets Zoom to New Records
It was another interesting week concerning the Federal Reserve. On Wednesday, Fed officials released minutes from the June policy meeting which showed a split amongst the group about the end of bond buying.    According to the minutes: “While recognizing the improvement in a number of indicators of economic activity and labor market conditions since the fall, many members indicated that further improvement in the outlook for the labor market would be required before it would be appropriate to slow the pace of asset purchases.” Given that these minutes are released with a three-week lag, it did not come as too much of a surprise to traders and the markets were much more focused on the press conference remarks of chairman Bernanke. Wednesday’s activity in the market can best be described as tepid. Yet, after the market closed, at a conference held by the National Bureau of Economic Research, Bernanke stated, “You can only conclude that highly accommodative monetary policy for the foreseeable future is what’s needed in the U.S. economy.” That was enough to spur markets higher on Thursday both here and abroad.

That left us scratching our heads a bit. Is there something different about what is written and what is spoken even though they say the same thing? The Fed minutes themselves, released at 2pm on Wednesday said, “Many members indicated that decisions about the pace and composition of asset purchases were distinct from decisions about the appropriate level of the federal funds rate.” This is nothing new. But the front page headline in The Wall St. Journal the next day was “Fed Affirms Easy-Money Tilt” with an emphasis on Bernanke’s talk at the conference where he highlighted the fact that pulling back on bond purchases does not mean the Fed is stopping its easy-money policies. It just seems a little weird that it took Bernanke’s words to spur a market reaction as if traders either did not read the minutes or were ignoring them in case Bernanke said something different later that day.   Adding a little more mystery is the fact that the days are pretty much numbered for Bernanke to hold that position. This episode merely highlights the challenge Bernanke faces in trying to develop consensus among 19 Fed governors and not let his personal views overwhelm the need to talk with one voice. 

Markets also may have received a little boost from the weekly read on initial employment claims. In the week ended July 6, those filing for unemployment benefits rose by 16,000 to 360,000, a two-month high.  The median Bloomberg forecast of 47 economists called for a drop to 340,000. The four-week moving average climbed to 351,750 from the previous 345,750. The number of people continuing to receive jobless benefits rose by 24,000 to 2.98 million in the week ended June 29 according to the Labor Department. Thirty-three states and territories reported an increase in claims, while 20 reported a reduction. One factor that could explain the increase is the typical summer auto plant shutdown to retool for the new model year. Ford said it would idle most of its North American assembly plants for one week this summer instead of two while Chrysler and GM will mostly skip this scheduled output slowdown. Higher unemployment will keep the Fed in status quo mode with $85 billion in bond buying per month, but higher production will lead to higher incomes and a sooner end to this quantitative easing. 

We continue to hold to our view that the Fed will be culling its monthly bond buying program no later than spring of next year. Of course, a blowup in Europe or exogenous event in the Far East may change that outlook, but, for now, the economy seems to have gained the necessary traction to grow itself back to health. When all is said and done, a healthy, functioning economy is in the best interest of both Wall St. and Main St. It is in these “transition” periods when economic data is improving but not robust that creates the uncertainty that traders dislike. 

SGK Blog--Update July 5, 2013: Stocks Rise on Employment Report Shaking Off Global Tensions 

Traders that were working on Wednesday were glued to their TV’s watching the protests and events unfold in Egypt. Oil futures spiked up as high as $102.18 per barrel in volatile trading before settling at around the $101 level that day. Apparently people in that country were not happy with waiting in mile long lines for fuel and food despite President Mohamed Mursi’s promises of a brighter future. We should say ex-President Mursi because after defying an ultimatum from the Egyptian military who gave him 48 hours to work out a political solution to the unrest in that country, they simply ousted him and voided the constitution he had put in place after trading closed here in the U.S. Wednesday. The military announced an early presidential election as well to calm the citizens concerns. This contributed to stock market declines in Europe in early trading but in U.S. trading the impact was muted as we have seen the military act this way before and in this case the general consensus is they potentially acted prudently. European markets were also negatively impacted on the same day when the Prime Minister of Portugal told voters in a televised speech from Lisbon that he is trying to hold his coalition government together after Foreign Affairs Minister Paulo Portas, leader of the junior coalition party CDS, quit. This was considered a move to protest the austerity measures the country has been enduring. This caused Portugal’s ten year bond to rise above the 8% level and drove down their stock market, particularly their key bank stocks. Again, U.S. markets shook this move off as our economic data painted a rosier picture than the events that were unfolding overseas. 

This was a slow week for trading as many traders had left NYC for the Holiday shortened trading week. With that said, we did have a fair bit of key economic data released this week including the employment report for June. 195,000 new jobs were added to nonfarm payrolls and this exceeded economists’ average forecast for 166,000 for the month of June. The jobless rate stayed at 7.6%, above the estimate for 7.5%, and average hourly earnings rose 0.4% which was twice the expectation and the most since July 2011. Although stocks responded favorably, trading remained light and the U.S. Ten-year Treasury yield climbed above 2.7% for the first time in recent memory.  The growth in jobs was primarily driven by the service sector as retailers, business & professional services, health care, leisure and hospitality industries all posted job gains while manufacturing and government workers were shed in the month.  

There was plenty of other news out on the U.S. economy as our Institute of Supply Management (ISM) Index for June, a gauge of manufacturing health in the U.S., came out at 50.9 which was above the expectation for 50.5. May’s figure had been 49 which would technically signal a contraction so the release of this figure was welcome news. Factory orders for May were slightly above expectations at +2.1% while construction spending was in-line with expectations at +0.5%. Initial weekly jobless claims for the week ending 6/29/2013 were 343,000 which was less than the forecast for 348,000. The ISM services figure for June was weaker than expected at 52.2 versus the expectation for 54.0. All-in-all it was not a bad week for U.S. economic data. 

By Friday, some measure of calmness had taken hold in overseas markets as European Central Bank (ECB) President Mario Draghi pledged that key rates in Europe would remain at present or lower levels for an “extended period of time.” This definitely shook up the foreign exchange markets as this was a departure from ECB tradition as they put a downward bias on interest rates for the foreseeable future. “An extended period of time is an extended period of time, it is not six months, or twelve months,” said Draghi, when pressed for a time frame by journalists. “Our exit is very distant.” God bless the Europeans as you never know what is going to come out of the mouths of their central bankers! If Bernanke uttered such comments here traders would be freaking out at the vagueness of his statements! Draghi also indicated he was open to all rate options, including a negative deposit rate to stimulate growth. This position was seconded by the Bank of England, which in another departure, also provided longer term guidance. So it seems European monetary policy is deviating from U.S. monetary policy and this caused the euro to decline sharply relative to the dollar in currency trading. It did provide a boost to European equity indices in Thursday trading as their markets were open while ours were closed for Independence Day. Events in Portugal and Egypt seemed to at least settle down a bit too on Friday which helped calm markets further, even though a high degree of uncertainty remains in terms of how both situations will play out.
SGK Blog--Update June 28, 2013: Stocks and Bonds Continue Volatility Streak on Fed and China Concerns  

Rising interest rates continued to worry traders on speculation a reduction in accommodation by the Federal Reserve will lead to slowing economic growth. Bernanke has indicated the central bank may begin to taper its bond purchases this year and end it mid-2014. The Treasury auctioned $99 billion in notes this week and it is almost as though the primary dealers, there are 21 that trade direct with the central bank, do not want to step in front of a speeding train. Following suit, yields on ten year securities in countries across the globe, as diverse as Germany, Australia, Belgium and Portugal, rose in tandem with our own U.S. Ten-year Treasury. Particular attention is being paid to the daily release of economic data as with the Fed having less of an influence on markets, daily fluctuations in interest rates have more to do with how the actual economy is doing. 

In China, the Shanghai Index got off to a rocky start this week dropping 5.3% in Monday trading on concerns a cash crunch there will hurt the economy. China’s central bank said there is a reasonable amount of liquidity in the financial system and urged banks to control risks from credit expansion. This was interpreted as a signal that there will be no immediate relief from their tightened liquidity platform. Their overnight repurchase rate was running at 6.47% early in the week which was double this year’s average. As a result the U.S. dollar continued its advance relative to 16 major currencies and this will potentially have an impact on the value of overseas sales for many companies when translated back to U.S. dollars so this bears watching. 

Equities were lifted in Wednesday trading interestingly on a weaker than expected update on first quarter gross domestic product (GDP) here in the U.S. This was the third revision to first quarter GDP so the market expectation was for it to be at least close to the previous figure of 2.4%. When it came out at 1.8% that was a surprise and the lowered estimate was driven by a lower figure for household expenditures. This latter figure was revised down to 2.6% from the previous estimate of 3.4%. Households cut back on travel, legal services and personal care expenditures along with curbing expenditures on health care as the 2% increase in the payroll tax took a bite out of paychecks causing incomes to drop the most in 4 years. Bonds reacted as they should as interest rates declined as prices rose. Stocks therefore got a lift as equities have become very sensitive to movements in interest rates. Stock prices are driven by several factors but two primary focal points are earnings and interest rates. Rising interest rates make future cash flows less valuable when discounted to a present value figure and they can also squeeze corporate margins through higher debt expense. This becomes part of our analysis here at the firm so companies we own such as Accenture, for example, tend to be insulated from this latter factor as they have no debt. According to Bloomberg, second quarter earnings are expected to grow 3.4% year-over-year but this has been revised down from forecasts at the beginning of the year calling for 6.8% growth. Additionally, revenues for companies in the S&P 500 are projected to grow at an anemic 0.46% which, if not cause for concern, is certainly a reflection of the current stage we are at in the business cycle. Given these factors, the additional volatility we are witnessing these days is not surprising at all. 

Tuesday’s rebound in equity trading was triggered by some healthy data here in the U.S. and comments lending support to banks and money market funds in that country by the central bank in China. Orders for durable goods here in the U.S. (good built to last longer than 1 year) for the month of May were up 3.6% and excluding transportation the figure was up 0.7%. Both figures beat expectations for +3.0% and -0.5% respectively. The housing figures were really good as the Case-Shiller 20-city Index for April was up 12.1% year-over-year, above the forecast for an increase of 10.5%. New home sales for May at 476,000 also beat the expectation for 460,000. This may have helped contribute to the strong consumer confidence figure for the month of June which came out at 81.4 relative to the forecast for 75.0 and the previous month’s figure of 74.3. Later in the week we received a lot of data as pending home sales for May rose a very robust 6.7% versus the expectation of 1.5%. Personal income for May rose a healthy 0.5% compared to forecasts for a 0.2% rise while personal spending rose 0.3% compared to forecasts for a 0.4% rise. Initial weekly jobless claims at 346,000 for the week ending 6/22/2013 were about as expected.  Chicago PMI for June on Friday disappointed investors sending equity indices down in initial trading as it came out at 51.6 versus forecasts for 55.5. All-in-all the data for the week generally had a positive tone with a couple of exceptions. 

SGK Blog--Update June 21, 2013:   Bernanke Speaks, Markets Listen  
Judging from the reaction of the markets, June 19th may go down as one of the more important recent dates in financial history. The Federal Open Market Committee completed its scheduled two-day meeting and issued a press release followed by a press conference with Fed president Ben Bernanke. The release stated: “Labor market conditions have shown further improvement in recent months.” It also added: “The Committee sees the downside risks to the outlook for the economy and the labor market has having diminished since the fall.” The Committee decided to continue to purchase $40 billion of mortgage-backed securities and $45 billion of longer-term Treasury securities per month but there was no mistaking the shift in tone in the language of the press release or the responses of Bernanke. He said the bond buying program could be completed by the middle of next year as the jobless rate reaches a projected 7%. In fact, economic projections released by the Fed lowered the expectation for unemployment for 2013-2015 from their March projections. For example, instead of an unemployment rate range of 6.7%-7.0% in 2014, the current members believe it will be closer to a range of 6.5%-6.8%. Real GDP projections for next year also raised the lower and upper range of forecasts. As a result, 15 of 19 policy makers said the federal funds rate will be increased in 2015 or later. (The federal funds rate is a separate monetary tool from the quantitative easing bond buying program. It is the rate Federal Reserve banks charge each other for overnight loans. Before the 2008 financial crisis, it was the primary monetary tool.)   On the surface, this is good news for “Main Street.” It means the economy is growing, unemployment is falling, interest rates are likely to remain on hold for a few more years. For Wall Street, the picture was less rosy.

As we have suggested, the push by equity markets to higher record levels and the decline in interest rates to record lows was due in large part to the aggressive actions of the Fed. After pushing the fed funds target to nearly zero in December 2008 and announcing multiple rounds of quantitative easing or QE, the Fed’s balance sheet has ballooned to a record $3.41 trillion. The $3.41 trillion question was always, “What’s next?” How does the Fed shrink this massive stock of securities without doing harm to bond markets and indirectly the equity indices? How much was QE priced into the markets? We are getting the answer to the last question this week as both equity and fixed markets decline. Rates on the 10-year Treasury bond touched 2.4% in early trading Thursday morning, the day after Bernanke’s conference. They have not been this high since the spring of 2012. Traders assumed that QE was responsible for about 60-80 basis points (0.60%-0.80%) meaning that without it, rates would be higher by that amount. Since the rate on the 10-year touched 1.38% in July 2012, one would expect a jump to about 2.0%-2.20% which is close to what we have seen. Remember, the Fed will continue buying $85 billion of fixed income securities. That has not changed. And one would argue that the Fed would be its own worst enemy if it held over $3 trillion in bonds and actively supported a sharp rise in yields (prices move in the opposite direction of yields). Clearly, the bond market has been nervous since Bernanke testified before Congress on May 22 that the Committee “could” consider reducing bond buying within “the next few meetings.” That day was getting closer with each passing month. At the end of the day, the Fed is charged with two mandates: stable prices and full employment. Nothing in those mandates require new equity records or steady financial markets. Of course, Wall Street and Main Street must work hand-in-hand for the U.S. economy to function. Nevertheless, Bernanke knew it would be a thankless task to notify traders and investors that the party was still going and the punch bowl was still on the table, but it would not be refilled.

SGK Blog--Update June 14, 2013 Stocks Retreat on Strength of U.S. Economic Data  

So why would equities retrench this week on stronger than expected U.S. economic data? It seems counterintuitive but basically stronger than expected U.S. data implies higher interest rates and an increase in the likelihood the Federal Reserve will begin to taper their bond buying program sooner than expected. As we wrote last week, Ben Bernanke hinted at this in his prior testimony before Congress. This does not mean to imply the Fed will begin the process of increasing interest rates in the form of the Fed Funds rate any time soon. They established a target of 6.5% unemployment with the caveat that inflation must be within 0.5% of their target tolerance level (2%), implying less than or equal to a 2.5% rate. Neither of these bogies has been hit. The market however is distinctly having a difficult time establishing an appropriate target level for interest rates. We can see the competing forces at work and we can imagine the discussions amongst traders, particularly at the large institutions that acquire Treasuries directly from the Treasury Department. Do they step in front of the Fed and risk getting creamed if they are wrong? It is time now or is it still too early? Remember the Fed has hinted at tapering their buying program but that implies they are still buyers in the market. In their last statement they indicated they have the flexibility to increase or decrease bond buying at any time. Despite their so-called new transparency, this effectively leaves traders in the dark as to what exactly they are doing at any given moment. As we wrote last week, market rates have reset at higher levels and that trend continued this week. Although Thursday trading was confusing – we had better than expected data on retail sales and initial weekly claims, as we highlight below, yet bonds rose in price and stocks were relatively stable at the open. So it boils down to the market has become less predictable and a little more volatile and that can certainly create opportunities in attractive stocks and bonds for our clients as we monitor events very closely.

Retail sales were better than expected here in the U.S. for the month of May coming in at +0.6% versus the expectation for +0.3%, a sign of increased consumer confidence. When autos were stripped out of the equation, a less volatile indicator month-to-month, they came in at +0.3% which was as expected. Initial weekly jobless claims were also better than expected at 334,000 for the week ending 6/8/2013 versus the expectation for 345,000. Part of what offset the potential for further declines in stock and bond prices when these data points came out Thursday was the release of the World Bank’s outlook for global growth in which they tempered expectations for future growth. The World Bank in their report forecast the global economy will expand at a 2.2% rate for 2013 versus their previous forecast of 2.4%. They lowered their forecast for developing economies and said the euro area’s gross domestic product will decline 0.6%. International equity indices retrenched on this report, and it was particularly felt in Asia as indices in Hong Kong and Shanghai dropped over 2% while the Japanese stock market erased its gains for the year dropping another 6.35% in overnight trading. So we had a situation where there was a global flight to quality in the form of overseas investors buying U.S. Treasuries and this helped lend support to high quality bond prices. The decline in interest rates helped spark some buying in stocks here in the U.S. as well in Thursday trading.    

Friday we had several data points released that caused bond prices to push higher (interest rates declined) and stocks prices to trend lower as most of the data points missed their mark. Industrial production for May was flat versus the expectation for a +0.1% increase, capacity utilization came in at 77.6% versus the expected 77.8% and the University of Michigan consumer sentiment index for June was 82.7 versus the forecast for 83. The producer price index initially spooked traders coming in at +0.5% for May versus the expectation for +0.1%, but the less volatile core rate, which excludes food and energy, came in exactly as expected at +0.1% so traders quickly shrugged off that bit of news. So Thursday and Friday were very good trading days for high quality bonds but mixed results for the equity markets. We are quickly approaching the second quarter earnings season and we have two of our core holdings due to release earnings in two weeks, Accenture and General Mills, so it will be interesting to get their take on the outlook for the remainder of the year.

SGK Blog--Update June 7, 2013 Equities Retreat Early in Week on Concerns Fed Will Reduce Stimulus 

Actually, the pullback in equity indices earlier this week was related to two factors. Markets are still jittery over Fed Chairman Ben Bernanke’s comments two weeks ago, combined with the release of the Fed minutes from their last meeting, which hinted that the Fed is considering reducing their bond purchase program at some point over the next few meetings. This would effectively have the impact of reducing liquidity in the market and could potentially send market interest rates higher, even though they will not take action on the Fed Funds rate for many months. These concerns, combined with weaker than expected data on manufacturing here in the U.S., gave stock market traders reason to pause.  

The primary concern would be that we are still not fully recovered from the last recession to the point where the economy can stand on its own without support from the Fed. We should caveat this by saying we do not fully support that viewpoint, but that is the concern amongst market participants. The fact is the Fed at some point will reduce their bond buying program – it cannot continue perpetually – and the market for stocks and bonds is starting to discount that fact. Interestingly, after the initial reset of interest rates post-Ben Bernanke’s comments two weeks ago, interest rates are now actually behaving as they should. When we get weak economic data they drop and when the data is stronger they rise. Some would welcome the day when the Fed is out of the bond market in terms of purchases as they clearly have had the effect of distorting stock and bond prices. Also, their actions by their nature increase the appetite for riskier assets. That is part of their plan, so it is not all negative, but it clearly carries its own set of unwelcome risks. We read in Wednesday’s WSJ that the London desks of both JP Morgan and Morgan Stanley are back to creating synthetic CDO’s based on “client demand.” Certain forms of these products, when not used for strictly hedging purposes, were a contributor to the financial crisis back in late 2007, 2008. As we have stated before, the best hedge against current volatility in both stock and bond markets is a well-balanced and diversified portfolio. You may notice additional liquidity in your portfolios at this time. There are periods of time where that additional liquidity can be beneficial. If we are not finding value in either stocks or bonds at a given moment, then holding some levels of added cash becomes a component of our decision making process. When volatility strikes, it allows us to take advantage of those opportunities that additional volatility can create. Sometimes we do receive questions from clients about cash levels in accounts and we always view that as temporary in nature. 

On the economic front this week, the Institute of Supply Management’s (ISM) Manufacturing Index for May came in well below expectations at 49 versus the forecast of 50.9. One month does not indicate a trend but a number below 50 signals contraction so it is a cause for concern. Construction spending for April was +0.4% versus the expectation of +1.1%. Factory orders for April at +1.0% were also below the expectation of +1.6%. The one bright spot this week was the ISM Services Index which at 53.7 for May was ahead of the forecast of 53.5. Services do account for a large part of the U.S. economy. We mentioned in the previous paragraph the issue over the higher level of interest rates and that interest rate reset has had an impact. An index of homebuilders slumped 2.4% as mortgage applications fell for the fourth month in a row. In fact for the week ending 6/1/2013, the Mortgage Bankers Association weekly mortgage applications index dropped 11.5%. This is a direct reflection of the sharp move in interest rates that occurred last week. Housing has been a key component of the success story here in the U.S. recovery. The news this week, combined with the manufacturing data, was cause for concern. Productivity in the first quarter of 2013 at +0.5% was as expected. Unit labor costs for the first quarter fell 4.3% and this was largely ignored as traders paid more attention to the words uttered by central bankers as opposed to this particular data point. 

The national unemployment report came out Friday and provided a welcome relief to stock market traders. It basically boiled down to the fact that the report was not too weak but was not overly strong either. It was very close to expectations. The economy created 175,000 new jobs in the month of May compared to the expectation for 158,000. The unemployment rate ticked up to 7.6% (remember the Fed’s target is 6.5%) compared to expectations for it to remain the same at 7.5% and average hourly earnings were flat compared to an expectation for an increase of +0.2%. So basically jobs were created in the month but not enough to push the unemployment rate down. The fact that it actually rose was welcomed by stock traders as they figure the Fed is a little further away from reducing their bond buying as a result. The fact that wages did not rise was also viewed as a positive from the standpoint of traders as wages are an important component of the inflation measures the Fed uses. So overall, this was almost an ideal report from the standpoint of equity traders and as a result they pushed up the prices of stocks in the early going Friday.      

SGK Blog--Update May 31, 2013 Economic Data Helps Keep Indices High
The second estimate of first quarter GDP rose at a 2.4% annualized rate, slightly lower than the 2.5% first estimate rate according to the Commerce Department.  Consumer spending increased at a revised 3.4% annualized rate which was higher than the previous estimate of 3.2%.  The gain added 2.4 percentage points to GDP.  Business investment on equipment and software also grew faster than previously estimated.  Government outlays declined again.  They were down for the 10th time in the past 11 quarters.  In particular, defense spending dropped at an 12.1% annualized rate.  When combined with a 22.1% fall in the fourth quarter of 2012, it was the largest consecutive decline on average since 1954 when the U.S. was finishing the Korean War.  Inventory accumulation was slower than initially estimated.  While that hampered first quarter growth a bit, it sets the stage for second quarter growth if higher sales encourage more stockpiling.  Inventories added 0.63 percentage point to GDP.  Domestic sales, which exclude inventories and net exports, rose 1.8%, more than the prior estimate of 1.5%.  According to a Bloomberg survey, GDP is expected to grow at 1.6% this quarter and an average pace of 2.4% in the second half of the year.

Besides GDP figures, the Commerce Department released data this week on personal incomes and expenditures.  Incomes were unchanged versus the expectation of a 0.1% increase.  Personal spending fell 0.2% compared to an estimate of no change.  The drop in spending was the first since May 2012.  Strength in consumer spending is being supported somewhat by a wealth effect due to a better housing market.  According to the latest S&P/Case-Shiller index of property values, home prices rose in the 12 months through March by the most in seven years.  Specifically, the index rose 10.9% after advancing 9.4% in February.  The index is based on a three-month average which means the March data were influenced by transactions during the first two months of the year.  Thus, when April’s data is released it will incorporate a solid February and March.  All 20 cities in the index recorded a year-over-year gain, led by a 22.5% rise in Phoenix and a 22.2% increase in San Francisco.

The one headwind this week came from initial unemployment benefits.  Applications rose 10,000 to 354,000 in the week ended May 25 according to the Labor Department.  The median called for 340,000 claims.  The less-volatile four-week moving average rose to 347,250 from 340,500 in the week prior.  The number of people continuing to collect jobless benefits rose to 2.99 million in the week ended May 18.  The continuing claims figure excludes about 1.7 million who are receiving extended or emergency benefits under federal programs.  Next week, the monthly payroll figure will be released on June 7.  Economists predict employers hired a net 165,000 workers, the same as in April.  Private payrolls, which exclude government hiring, are expected to be 175,000 higher with an unemployment rate holding steady at 7.5%.  In order for GDP growth to have a chance of reaching 2%+, there will have to be more robust payroll hiring as the second half of the year approaches.

SGK Blog--Update May 24, 2013 Ben Bernanke Rattles Global Markets with Comments

In testimony before Congress this week, Fed Chairman Ben Bernanke rattled markets by appearing to contradict himself, thereby shaking international confidence in the direction of U.S. Federal Reserve policy.  In prepared remarks released prior to Q&A, he stated that a premature withdrawal of quantitative easing would put the economic recovery at risk.  Equity indices initially opened strongly higher on this thesis.  Demonstrating he has markets on a string with traders hanging on every word, when he subsequently said in answer to a question that the central bank would “step down” the pace of asset purchases in the next few meetings, equity indices proceeded to drop as if he had given that string a strong tug.  He based this response on the criteria of an improving labor market and if “we have confidence that that is going to be sustained.”  Many economists had been forecasting that the asset purchases would be reduced beginning in 2014 so this indication that the process could begin prior to that clearly sent global markets on a tailspin.  In overnight trading Japan’s Nikkei stock index dropped a whopping 7.32%!  Europe opened down 3% across the board but as U.S. indices showed resilience throughout the day Thursday, the European bourses clawed their way back to show approximate 2% declines across the board.  The Fed minutes released late Wednesday also hinted that a number of members were willing to consider tapering their bond buying as soon as their June 17-18 meeting if economic reports show “evidence of sufficiently strong and sustained growth,” according to the record of their April 30-May 1 gathering.  As we have indicated, it is easier to implement these policies than to taketh away!  It will get very interesting when that process begins.  Interest rates reset across the board on Bernanke’s testimony Wednesday and the release of these minutes as the U.S. ten-year Treasury closed above 2% for the first time in a while.


Not helping matters in overnight trading Wednesday/Thursday was the release of a manufacturing report in China that was considerably weaker than expected.  The preliminary reading for their Purchasing Managers Index for May was 49.6 which missed the average forecast of economists who called for a reading of 50.4.  The reading in the prior month of April was 50.4 and given a figure below 50 represents a contraction, this did not sit well with traders on the heels of Bernanke’s testimony.  Hence the volatility in intraday trading Thursday!  There was not a lot of data on the U.S. economy released this week but what came out was generally positive and helped account for the rebound in trading in U.S. equity markets on Thursday.  Our economy is proving to be resilient in the face of global economic uncertainty.  Helping matters is the slow and steady recovery in our housing market.  While the data on existing home sales for April released early in the week came in as expected at 4.97 million, Thursday’s release of the figures for new home sales for April helped lift spirits.  Sales of new U.S. homes rose to 454,000, the second-highest level in 5 years as lower borrowing costs and an improving job market drew more buyers into the market.  Economists had forecast a figure of 425,000 so this was a nice surprise to the upside.  Housing prices continued to climb as well as the FHFA Housing Price Index for March rose 1.3%.  Also helping matters Thursday was the fact that initial weekly jobless claims for the week ending 5/11/2013 stopped the recent negative trend by coming in better than forecast at 340,000 while continuing claims fell below the 3 million level which is the first time that has occurred in recent memory.   

SGK Blog--Update May 17, 2013 Busy Economic Week Powers More Records
With earnings season mostly complete, investors and traders turned their attention to the economic calendar.  This week was a busy one with a lot of information to digest.  On Monday, retail sales data was released which surprised to the upside.  Versus the 0.3% decline expected in April versus March figures, the Commerce Department reported that sales rose 0.1%.  Excluding the volatile auto industry, sales did fall 0.1% month-to-month.  Overall, nine of the 13 major categories showed gains last month with clothing stores up 1.2%, the largest move in more than a year.  Lower prices at the fuel pump also helped.  On Wednesday, the Labor Department reported that producer prices fell 0.7% in April from March, the biggest decline since February 2010.  Excluding food and energy, producer prices were up 1.7% year-over-year.    Essentially, input costs are benign.  Taking a peek further down the production line does not change that view.  Charges for intermediate goods (compared to finished goods which make up the producer price overall index) declined 0.6% last month while costs for crude goods (the raw materials where the whole process begins) fell 0.4%.  The Labor Department was busy on Thursday with the release of the monthly consumer price index.  Excluding food and energy, those prices were up 0.2% in April after a 0.1% rise in March.  Year-over-year, this so-called core indicator was up 1.7%, decelerating from March’s year-over-year rise of 1.9%.  The cost of hospital and related services fell 0.6%, the most on record while clothing and air fares also registered decreases.

Given the release of this data, the question arose once again if the economy is slowing down.  The Federal Reserve is assuming that inflation remains moderate, but must be on the watch for an increase in disinflationary price trends or outright deflation.  Other data pointed to this being a definite possibility. Initial jobless claims jumped by 32,000 to 360,000 in the week ended May 1.  According to a Bloomberg survey, the median forecast was for a rise to 330,000 with estimates ranging from 315,000 to 355,000.  Thus, the actual figure was even outside the broad range which is a rare event and certainly an unwelcome surprise.  This was the biggest jump in claims since the aftermath of superstorm Sandy in November.  Housing starts fell 16.5%, the biggest decline since February 2011, to an 853,000 annualized rate after a revised 1.02 million pace in March.  This number was below consensus, too, with the Bloomberg median at a 970,000 annualized figure.  Offsetting this disappointment was the fact that building permits rose to an almost five-year high.  Permits rose 14.3% to a 1.02 million annualized rate, the highest level since June 2008.  When permits are a higher number than starts, it usually is a positive sign as it suggests that construction will rebound in the months to come.  However, a permit is not the same as a start and builders can always not follow through on a permit application once it is time to break ground.

Our view is that the economy continues to be solid.  The volatility of initial unemployment claims means it will take at least another two or even three weeks of poor figures to bring up the four-week moving average.  Even with modest expectations of GDP growth for 2013 around the 2.5%-3.0% range, the U.S. remains on much better footing than other parts of the world.  The 17 nation eurozone suffered its sixth consecutive quarter of declines.  Eurostat, the EU’s statistics office, said this week that region contracted at 0.2% in the first quarter from the fourth quarter of last year.  Though that is an improvement on the 0.6% decline in the fourth quarter, it  shows that the single currency bloc continues to struggle with their problems.  This recession is not as deep as the one in 2008-2009, but it is the longest in the history of the euro which was launched in 1999.  The wider 27-country EU saw its quarterly rate shrink by 0.1% in the first quarter following a 0.5% drop in the previous period thereby technically dragging it, too, into recessionary territory.  Recently, there has been some signs that governments are willing to relax deficit-reduction targets and austerity programs.  In fact, some economists are predicting a return to growth in the second half of the year.  The troubling sign is that the main engines of the eurozone—Germany and France—are showing signs of wear and tear.  Germany barely grew at 0.1% while France actually contracted a 0.2% for the second consecutive quarter.  What has saved these nations is the growth coming from the U.S. and China and some emerging markets.  But China’s GDP looks to be stuck under 8% growth—still robust but not enough of a change from previous quarters to pull the eurozone out of its misery.  And, as discussed, the U.S. seems to be on solid footing and is a major trading partner with Europe.  Nevertheless, recent economic data does not show a significant pickup in imports versus exports suggesting that our nation will not be the panacea either.  As we have reiterated for some time, the financial jawboning from the European Central Bank has averted a panic but it has not solved the myriad problems on the Continent—inflexible labor policies which contributes to high unemployment, high taxes which supports and validates the welfare-state status of many countries, extensive black market operations in countries like Greece and Italy where graft is merely a way of life—which can be best summed up as a lack of competitiveness in today’s global economy.

SGK Blog--Update May 10, 2013 Earnings Season Winds Down

In international economic news this week, China’s General Administration of Customs in Beijing reported that export growth for that country has accelerated in April by 14.7% even as shipments to the U.S. and Europe fell, begging the question as to how that is even possible!  Economic data reported by China’s government agencies is frequently somewhat suspect.  Adding to the speculation of bogus data, the increase was fueled by a 57.2% jump in shipments to Hong Kong, raising speculation that false transactions were used to mask capital flows into China.  This would involve speculative money flowing into China chasing a yuan that’s already exceeded last year’s gains against the dollar.  A customs spokesman said that they would investigate the “extraordinary” gain in trade with Hong Kong.  Translation – that is probably the last we will hear of it!  By comparison, South Korea indicated that exports rose just 0.4% in April from a year earlier while Taiwan said their shipments actually fell 1.9% in the same period.  At first glance, the data from China hinted at a possible turnaround there boosting global economic growth, but given the weak figures out of other countries it was taken with a grain of salt.


On the flip side, we saw positive data coming out of Germany.  German industrial production rose for a second straight month in March, contrary to forecasts, in a sign their economy may be returning to growth.  This would provide a boost to the entire euro region.  Production increased 1.2% from February when it gained 0.6% over the previous month.  Economists had forecast a decline of 0.1%.  Additionally, factory orders unexpectedly jumped for a second month in March according to their Economy Ministry, whose data is in fact reliable!  Germany actually benefits from using the euro which is why Merkel is adamant about keeping the union together. Otherwise if they reverted back to the deutsche mark they would experience the same time of currency appreciation the Swiss have found so difficult to control using the franc.  These economic reports helped boost Germany’s DAX stock index this week.

We had a relatively light week for U.S. economic news as traders focused more on earnings announcements in setting market direction.  So far the results have been pretty good.  At the time of this draft writing, 425 of the 500 S&P 500 companies had released results and of those 72% had exceeded profit expectations and 53% had missed revenue projections.  As we have written, it has been difficult for firms to increase their top-line revenues in a relatively anemic global economic recovery.  At the same time, many companies have been doing a good job managing their cost structure and they have been able to increase their earnings per share through frequent share buyback programs.  This reduces the number of shares outstanding (the float) and helps the figures come earnings release time.  This is not a bad thing for shareholders, we just need to be wary of firms overpaying for their own company stock and really focus on other important metrics in evaluating stocks, such as price relative to free cash flow, global revenue growth and profit margins to name but a few.  Initial weekly jobless claims for the week ending 5/4/2013 fell to 232,000 relative to the expectation for 336,000 continuing the downward trend for this figure.  U.S. consumers tightened their belts a bit in the month of March as U.S. consumer borrowing climbed $7.97 billion which was well below the expectation for a $16.3 billion rise following February’s $18.6 billion increase.  This can be a volatile measure on a month-to-month basis so we will not read too much into it.  As we indicated, the data was very light on the U.S. economy this week.

SGK Blog--Update May 3, 2013 Another Record Week 
This was a busy week for economic data.  On Monday consumer data was the focal point.  Personal consumption rose 0.2% in March according to the Commerce Department, above the 0.1% consensus expectation but below the 0.7% rise in February.  The same group also reported that personal incomes rose 0.2% in March after climbing 1.1% the previous month.  Disposable income which is the money left over after taxes, rose 0.3% versus a 0.7% rise the prior month.  It seems that the jump in the payroll tax at the beginning of the year coupled with the $85 billion in automatic budget cuts (known as the infamous sequester) that began March are finally beginning to be felt in the broader economy based on these figures.  That may lead to a decline in GDP numbers for the second quarter according to a survey of Bloomberg economists taken in early April. 

On Tuesday, the S&P/Case-Shiller index of property values in 20 cities rose 9.3% from February 2012 to February 2013.  That compares to a 8.1% advance in the year ended in January suggesting that the housing market is gaining momentum.  The index is based on a three-month average, which means the February figure was influenced by transactions in December of last year and this past January, months that are traditionally weaker than the warmer spring and summer months.  For the second straight month, all 20 cities in the index showed a year-over-year advance.  Phoenix was up 23%, San Francisco 19% higher and Las Vegas up by 18%.  Price figures from the National Association of Realtors (NAR) showed the median value of an existing home rose by 11.8% in March.  The NAR survey includes more than just 20 cities so it gives a broader view of the industry.  According to the NAR, there were only 1.93 million previously-owned homes on the market in March, the fewest of any March since 2000.  Tight inventories as well as low mortgage rates have been the prime drivers of better pricing figures.

Wednesday brought more subdued data.  The Institute of Supply Management’s factory index fell to 50.7 from the prior month’s 51.3.  A reading of 50 is the dividing line between expansion and contraction so the manufacturing component just barely remains in the growth state.  Manufacturing makes up only 12% of the economy but is a key bellwether in the pace of change because factories start humming in response to higher demand figures weeks to months before product starts to show on the shelves.  If the index is falling, then the need to rebuild inventories a few months down the road is not pressing.  China’s manufacturing index also showed some weakness with its Purchasing Managers’ Index at 50.6 in April, down slightly from the 50.9 in March.  A gauge of new orders  and new export orders also fell.  The benchmark Shanghai Composite Index is down 11% from the high reached on February 6.

Also on Wednesday the Federal Open Market Committee ended its regularly scheduled two-day meeting.  As expected, there was little changed in their response to the current economic environment.  They will continue to buy $85 billion in total of mortgage-backed securities and longer-term Treasury securities which, according to their post-meeting statement, “…should maintain downward pressure on longer-term interest rates, support mortgage markets, and help to make broader financial conditions more accommodative.”  The committee will “increase or reduce the pace of its purchases” which is a slight change from previous releases where only curtailing of the program was discussed.  Whether the added language is merely to provide more flexibility or a hint that an increase may be coming is unknown.  Regardless, the market took it in stride with government bonds trading higher in general on the day of the release.   

Thursday brought confirmation of a move that was expected for some time as the European Central Bank (ECB) dropped their main interest rate by 0.25% to 0.50%.  It was at 0.75% since last July.  ECB president Draghi seems to think that weak euro zone activity has filtered from the periphery countries—Greece, Italy, Ireland, etc.—to the core nations like Germany and France.  Falling business confidence in those countries is the latest sign of this weakness.  Over nineteen million people are out of work in the euro zone, a 12.1% unemployment rate for the area.  Meanwhile, inflation remains subdued at 1.2% in April, well below the ECB’s target of about 2%.  Draghi also signaled an openness to more “drastic” action such as a negative deposit rate on funds held at the ECB (thereby nearly forcing banks to lend money rather than hoard it) and the purchase of private-sector assets as the central bank in Japan is planning to do.

The biggest highlight of the week was Friday’s employment report.  Thursday’s initial unemployment claims gave the market some hope.  Applications fell 18,000 to 324,000 in the week ended April 27, the lowest figure since January 2008 according to the Labor Department.  Friday’s number did not disappoint, in fact it fueled another record run in the major averages.  Payrolls increased 165,000 in April following a revised 138,000 in March according to the Labor Department.  Revisions added a total of 114,000 jobs to the initial reports of February and March.  The unemployment rate fell a tick to 7.5%, the lowest level in four years.  A median survey of 90 economists called for a 140,000 advance with a range of 100,000 to 238,000.  Private payrolls, which does not include government data, rose by 176,000 in April after a revised gain of 154,000 in March.  Government employment dropped by 11,000.  Industries adding jobs include leisure and hospitality, retail and health services.  The only slight negative in the report was the fact that employees worked on average 12 minutes less than the prior month.  That suggests that pressure to continue hiring may be abating.  Conversely, there was an increase in part-time employment and the average hourly earnings rose 1.9% for a year earlier.  Those two signs mean employers may actually be needing more permanent workers soon and higher rate pressure means jobs are harder to get.  The civilian labor force participation rate was 63.3% in April, unchanged from March but down from the 63.6% in January. 

The last bit of Friday news might have been overlooked due to the robust jobs report.  The Institute of Supply Management’s non-manufacturing index fell to 53.1 in April from 54.4 in March.  With the U.S. economy heavily dependent upon services (88%), this is a key statistic.  It was above the 50 level indicating expansion in these industries, but the gauge averaged 53.6 since the recession ended in June 2009 suggesting that growth is slowing.

What does all this data suggest to us?  We continue to believe that the economy has reached a stage of sustainable, moderate growth.  With the sequester having started on March 1st, we knew it would take a few weeks to filter through the economy.  We saw some of that with the flight controllers issue which led to coast-to-coast flight delays in April.  Second quarter GDP is likely to take a bit of a hit, but not seriously enough to bring us back to stall speed.  While we are unlikely to see any 5%+ GDP numbers anytime soon, there is enough momentum in both the labor markets, corporate investments and the resurgent housing market to support the consensus 2.5%-3.0%.  While that means a slow slog to the sub-7% level for unemployment, we remain headed in the right direction. 

SGK Blog--Update April 26, 2013 Earnings Drive Markets as U.S. 1st Quarter GDP Weaker Than Expected 

The week started on a bit of a sour note as we got a negative surprise in an important housing number released Monday. Sales of previously owned homes unexpectedly declined in March to 4.92 million from 4.95 million in February and below the expected 5.01 million. One positive note within this report, prices did climb, reflecting more demand for higher priced homes. Tuesday saw the release of new U.S. homes sales which were more robust coming in at 417,000 in at 417,000 for March compared to February’s 411,000 and the expectation for 415,000. This figure lends support to the economic lift the housing sector is providing to the U.S. economy as it continues to recover. Combined with strong earnings reports from Netflix and our core holding and Dow component Travelers Companies, this provided a lift to equity indices in Tuesday trading. 

While earnings have helped support markets, as our headline would indicate, there are signs of cracks in the global economic growth story that we are hearing as we listen to corporate executives and in some of the data we are receiving even here in the U.S. Obviously Europe is weak and has been for some time. Some companies have indicated that the situation there is worse than the headlines would have you believe. Secondly, Asia is really mixed right now. Many companies have said they see solid growth in China but sales in Japan have weakened considerably, despite effort on the part of their central bank and government to try to stimulate their economy. This is in part due to the dramatic weakening of the yen relative to the dollar, which negatively impacts the value of sales in Japan when the currency translation takes place, but also there has not been evidence of much of an uptick in demand in that country.  

Here in the U.S. durable goods orders for March came in at -5.7% vs. the expectation of -3.1% and when transportation is factored out (a less volatile number) the figure was still negative at -1.4% vs. the expectation for it to be flat. The figure for first quarter gross domestic product (GDP) here in the U.S. came in at +2.5% which was lower than the estimate for +2.8%. Many economists had forecast GDP to be in excess of 3% after the weak +0.4% final figure we got for 4th quarter GDP 2012 so this was a negative surprise and helped contribute to the weakness in trading Friday. On a positive note, initial weekly jobless claims for 4/20/13 were 339,000, well below the estimate of 351,000 and the University of Michigan consumer sentiment survey for April surprised to the positive side coming in at 76.4% versus the expectation for 72.4 and the prior month’s figure of 72.3. As we said, we are getting mixed signals regarding economic growth across the globe.

SGK Blog--Update April 19, 2013 Markets Rocked By China Weakness and Boston Bombings  

China made headlines this week causing stock and commodity markets to fall sharply in Monday trading as first quarter growth in gross domestic product came in at 7.7%, lower than the expectation of 7.9%, according to their National Bureau of Statistics. March retail sales in that country grew at 12.6% year-over-year but this was down from 15.2% at the end of 2012. Many economists cite the burgeoning up-and-coming middle class in China and their ability to spend money as a significant opportunity for global companies so any downward tick in the retail sales trend raises worries. Combined with the fact their industrial production growth faded in March, all together it provides evidence that a late 2012 rebound may be losing some steam. China continues to have one of the world’s fastest expanding economies, but it faces a painful downshift from annual growth rates that spiked at 14.2% in 2007. Two key drivers of growth – demand for Chinese goods abroad and breakneck investment at home – have since slowed.  Many companies, including those in our core portfolio, have cited China as one of the most significant opportunities for future growth in history. Combined with the fact that it can be challenging to do business in China, any hints of slowing growth dampens investors enthusiasm for owning global stocks. 

Once the tragic and unfortunate events in Boston – our hearts and prayers go out to the victims and their families of this senseless tragedy - were digested by traders, markets once again turned to the domestic front and the economic data and earnings. Equity indices were lifted Tuesday by the strong earnings releases of two of our core holdings Coca Cola and Johnson & Johnson. Based on the solid first quarter results from these two companies, many analysts determined that both these companies would be able to meet or exceed their full year forecasts and this lent support to a shaky market. Helping matters in Tuesday trading was the strength of the U.S. economic data released that day. Housing starts for March at 1,036,000 were much higher than the expected 930,000 although building permits at 902,000 were weaker than the expectation for 945,000. Also for March data, industrial production at +0.4% and capacity utilization at 78.5% were both a tenth of a percent higher than expected. The data for the consumer price index indicated that inflation remains subdued. The CPI figure for March was -0.2% while the core rate, excluding the volatile food and energy data, was +0.1% and again both figures were a tenth of a percent below expectations. For the CPI data though, coming in lower than expected is a positive as it would reinforce the fact that the Federal Reserve is not seeing hints of inflation creeping into the economy putting pressure on them to end their stimulus programs. 

The Federal Reserve each month releases their beige book which is a summary of their assessment of the economy across the country as reported by businesses surveyed across their 12 regional banks across the country. They noted, “most districts noted increases in manufacturing activity since the previous report.” Also that most regions reported, “residential and commercial real estate improved markedly” as housing prices rose in many areas and demand for home loans was “steady to slightly up.” They noted that consumer spending “grew modestly” but was hindered by higher gasoline prices, higher payroll taxes and severe winter weather in places at times. Overall, their assessment for April was that the U.S. economy grew modestly. Subsequent to that release we received more data on the economy as the Philadelphia Fed survey came in at +1.3 versus the expectation for +2.5 for April. The index of leading indicators fell 0.1% versus the expectation for it to be flat for March. Finally we had initial weekly jobless claims for the week ending 4/13/2013 come in at 352,000 versus the expectation for 355,000. All-in-all the Fed’s assessment of the economy seems to be on target at this point.   

SGK Blog--Update April 12, 2013 Fed Debates Monetary Policy as Earnings Season Heats Up 
Minutes from the March 19th and 20th Federal Open Market Committee were released early on Wednesday morning instead of that afternoon as is the usual practice.  These minutes were actually released apparently by mistake a day earlier—around 2pm on Tuesday—to congressional employees and some trade groups.  So far there have been no evidence to suggest foul play or trading done to take advantage of this error.  However, with markets keenly tuned to the Fed’s actions and words, it was a crucial mistake.  Had the minutes included any bona fide “insider” information, it might have gone down as one of the worst mistakes in premature release history.  As such, it was a disaster averted but not easily forgotten.

As for the minutes themselves, they showed that “all but a few” Fed officials wanted to keep the aggressive monetary stance going “at least through midyear (2013).”  They concluded that the economy was performing better than expected but were worried that higher taxes and spending reductions through the sequester might hold back growth.  There were also some Fed governors who wanted to keep the program going at its current pace--$85 billion of Treasury and mortgage-backed security buying per month—through 2013 and into 2014.  In conclusion they stated: “Several participants emphasized that the asset purchase program was effective in supporting the economic expansion, that the benefits continued to exceed the costs, and that additional purchases would be necessary to achieve a substantial improvement in the outlook for the labor market.”  We had heard through various Fed speeches since this meeting took place those desires to throttle back the program.  As we have stated, the markets’ current record-breaking environment has been fueled in large part by the accommodative monetary policies.  If this was taken away, it would surely lead to a decline unless the economy was performing so strongly that it could be easily dismissed.  Currently, the economy is not at that point.  Last Friday’s below-expected payrolls report shows that growth is happening but not at a pace that can be considered “substantial improvement”.  This Friday the Commerce Department reported that retail sales for March fell by the most in nine months on the heels of a 1% gain in February.  Even excluding the volatile auto sales component, retail sales were unexpectedly weak, down 0.4% compared to a flat consensus expectation in a Bloomberg survey of economists.  Additionally, a 0.6% drop in producer prices reported by the Labor Department will keep any inflation fears muted.  But the 0.2% rise in wholesale prices excluding food and energy continues to suggest sluggishness in the economy as a whole.   

We also track a weekly report called the National Financial Conditions Index (NFCI) released by the Federal Reserve Bank of Chicago.  The adjusted NFCI indicates financial conditions that are tighter or looser than on average (dating back to 1973).  Currently, we are in a period where the adjusted NFCI is looser on average than would be typically suggested by economic conditions.  This suggests that the not-so-secret fact that the globe is nearly drowning in liquidity as evidenced by last week’s action by the Bank of Japan to spark their moribund economy with their own version of quantitative easing.  Various sub-indices on risk, credit and leverage give more detailed examination of the NFCI.  It would be hard to conclude that a red warning light is flashing, but it is not a stretch to say that economic fundamentals are not the key driver of financial asset value growth at the present moment.  As we recently pointed out, today’s record-setting levels have better ratios when compared to 2007 on a debt-to-capital and earnings growth basis.  However, markets always move in cycles and the current length of the economic recovery and financial bull market lends itself to comparisons to overextended and overvalued periods of the past.  Which is why the next few quarterly earnings periods will be closely monitored to see if companies deserve their current valuation heights and if further buying is warranted.

SGK Blog--Update April 5, 2013 Stock Traders Jittery on Mixed Economic Data 

This week we saw signs of cracks in the strong economic data we have recently witnessed here in the U.S. The Institute of Supply Management’s (ISM) manufacturing index came out at 51.3 for the month of March. While a figure above 50 signals expansion in the economy, this was down from a level of 54.2 for the month of February and the expectation was for 54. Mid-week we had the ISM services index which also came in below expectations at 54.4 although the margin for the miss was not as dramatic. Still, U.S. economic growth is very dependent on health in the services sector so this tick downwards was concerning for traders. Also coming out mid-week, the ADP employment report, which we discuss in more detail below, was weaker than economists had projected by a fairly wide margin. Adding to traders jitters ahead of the March employment report, Thursday’s initial weekly jobless claims figure for the week ending 3/30/2013 at 385,000 was considerably higher than the expectation for 345,000. On a positive note, both construction spending at +1.2% and factory orders at +3% for February exceeded expectations. All eyes were focused on Friday’s release of March’s jobs report and it was disappointing to say the least! The negative trend in initial weekly jobless claims over the past 4 weeks was an effective precursor to the national report which came out in today’s trading. For the month of March, nonfarm payrolls rose by only 88,000 versus the expectation for 192,000. While the unemployment rate dipped to 7.6%, this is in large part due to people leaving the labor force, particularly individuals seeking part-time work. This dropped by 350,000 in March and could be because they have simply given up their efforts in finding jobs. Average hourly earnings were flat versus the expectation for an increase of 0.2%. January and February payroll growth was revised higher by a total of 61,000. Other than this latter fact, if one was perusing the data for a silver lining, there was none. Stocks opened sharply lower in Friday trading, reflecting the inherent weakness in the jobs report. We can attribute this weakness to a number of different factors. Hiring in construction slowed substantially, probably as a result of the rebuilding effort post superstorm Sandy slowing down. The services sector job growth was weak. If we stop for a moment and think about this – it makes sense. For example, we have been hearing from people in the restaurant sector that as a result of the payroll tax increase, people are eating out less. Think about all that goes into maintaining a restaurant. We have hostesses, waiters, cooks, etc. We are still a services driven economy so naturally if restaurant owners see their business slowing they are going to hire less people. This is sometimes why we point out that a lot of economic data is frequently like looking in the rear view mirror. Stock prices are a reflection of future expectations. If the expectation is that economic growth is slowing, whether due to concerns over the impact of the sequester or whatever, then this often will not show up immediately in the economic data. But it makes sense to us that businesses would hire more conservatively when faced with economic uncertainty.    

While we here at SGK focus on fundamentals in doing our equity and fixed income research and, as you can tell from our weekly summaries, in our approach to analyzing the broader global macroeconomic data, it is interesting to note that from a technical perspective on markets, there were some concerning signs that crept into trading patterns early in the week. We first noted that there was a clear divergence between trading patterns in the Dow Transportation Index and the Dow Jones Industrial Average (DJIA). The Dow transports tend to be somewhat of a leading indicator – the trend in terms of the direction they go frequently precedes a similar move in the DJIA. This can make sense as the transports are followed very closely and the typical companies within the index, companies like FedEx and Norfolk Southern, are highly sensitive to a pick-up or a slowdown in economic activity due to the nature of their businesses. We also saw a clear divergence between the S&P 500, the large cap index, which was up 0.52% on Tuesday, and both the S&P 400 mid-cap index and the S&P 600 small cap index which were both down 0.4% and 0.48% respectively on that same day. That is highly unusual and we would have to go back a long way in reviewing trading records to find a similar patter, at least one that dramatic. Both the small and mid-cap sector have been very strong over the past six months and we have trimmed back on our weightings in these areas on concerns over valuation. There were a number of other indicators highlighted in an article written by Doug Kass who gets a lot of attention from CNBC in part because he is not afraid of making bold short-term markets calls, although his record on that count is somewhat spotty. Regardless, he made several good points in his article. Bank and brokerage stocks lagged the broader indices while safe plays such as consumer staples and healthcare stocks have recently led market advances. He noted too that despite a positive index performance in Tuesday trading, the actual total number of stocks that declined in New York Stock trading on that day eclipsed stocks that advanced by over 200. We would also note that the U.S. ten year Treasury declined steadily throughout the week and that can be an indication that traders are concerned about the outlook for economic growth, not just here in the U.S. but globally. Stocks tend to climb a wall of worry, but the worries seemed to be mounting this week. 

While it seems like the world has been revolving around the U.S. economic data, at least from the standpoint of our stock market, we cannot ignore the information we are getting from overseas. Contributing to heightened losses in trading Wednesday were concerns over rising tensions between the U.S. and North Korea. Equity indices took another leg lower and high quality bond prices rose when it was announced that the U.S. would supply missile defense technology to Guam. Additionally, the 17 nation euro-area jobless rate rose to a record 12% in February and the January figure was revised up to the same level from the previous estimate of 11.9%. That is the highest level since they started collecting data for the region in 1995. The euro area zone has contracted for five straight quarters and it is expected that trend will continue in the first three months of this year. The European Central Bank has forecast the economy will shrink 0.5% in 2013. The strains in the region have also spread to the U.K., where a measure of manufacturing contracted for a second month amid weak demand in Europe for British exports. A gauge of factory activity was 48.3 in March, the second month of contraction, according to Markit Economics. For the euro area region their March manufacturing gauge came in at 46.8 and for the all-important German economy, the largest in the region, the figure was 49. Again, a figure below 50 signals contraction. China, the world’s second largest economy, on the other hand is showing signs of trending in the right direction. Their Purchasing Managers Index for March rose to 50.9, an 11 month high and this was up from 50.1 in February. Hence why we have the term “mixed economic data” in the title of this weekly! Finally, coinciding with our release of payroll data for March, Statistics Canada noted that employment in that country in March fell by the most since the last recession four years ago, which caught both economists and traders off-guard. That country tends to be highly sensitive to shifts in the global economic outlook because, similar to Australia, it is a country rich in natural resources. This contributed to weakness in equity trading Friday, while high-grade fixed income securities rose in price.
SGK Blog--Update March 28, 2013  Records Are Made To Be Broken
Another week brings more positive economic news.  The U.S. economy grew at a faster pace than previously estimated in the fourth quarter of last year.  Real GDP rose at a 0.4% annual rate, up from the 0.1% prior estimate according to the Commerce Department.  This was down from the 3.1% pace in the third quarter thanks to lower military spending and a reduction in the rate of inventory building.  The boost from the prior reading was due to a bigger gain in business spending and a smaller trade gap.

According to the S&P/Case-Shiller index of property values in January, prices climbed 8.1% from the same month in 2012.  This follows a 6.8% rise in December and the latest figure exceeded the median forecast by economists in a Bloomberg survey.  This is the biggest gain since June 2006 suggesting that the residential real estate market continues to strengthen.  All 20 cities in the index showed a year-over-year increase led by a 23.2% rise in Phoenix.  San Francisco also showed the big adjusted monthly increases while prices also advanced in areas that were hit hard by the housing bubble bursting such as in Las Vegas, NV and Tampa, FL.  The average rate on a 30-year fixed loan fell to 3.54% compared with 4.08% a year ago according to Freddie Mac.  That, plus continued strong housing formations, are leading to more demand for property.  The Commerce Department also reported this week that purchases of newly built homes fell 4.6% to a 411,000 annualized pace in February.  Nevertheless, it was the best back-to-back months in more than four years.  Importantly, the median sales price rose 2.9% in February from the year-ago level.  Last week, existing home sales sold at a 4.98 million annualized pace in February.  The figures for both new and existing homes saw price increases even in the face of new supply on the market. 

The Commerce Department also reported that goods meant to last at least three years, also known as the durable goods report, rose 5.7% in February.  The data were boosted by a 95.3% surge in bookings for commercial aircraft.  Excluding demand for transportation equipment, orders declined 0.5%, the first decline in six months.  However, January’s figure was revised upwards.  Unfilled orders for non-defense capital goods excluding aircraft, rose 0.2% even with the decrease last month.  This indicates that manufacturers are struggling to keep up with demand and this category is used as a proxy for future business investment in items like computers and engines.

What can stop this upward momentum in the economy?  First, the full effect of the budget sequester still has yet to be fully felt.  While the cutback officially began March 1st, it takes time for layoff notices to be sent and previous contracts to run out.  It may not be until the second or third quarter when GDP figures really reflect the issue.  Plus, this week Dallas Fed President Richard Fisher, who is not a currently voting member of the Fed’s monetary setting committee, said he would like the U.S. to reduce its mortgage-backed security purchases thanks to these signs of stronger economic growth.  The Fed has committed to buying $40 billion of mortgage-backed securities and $45 billion of Treasuries each month until the labor market improves “substantially.”  Given that this week’s initial unemployment claims actually rose by 16,000 to 357,000 in the week ended March 23rd, his comments may not have been the most timely.  However, it would be a mistake to assume that line of thinking is not going on in the heads of Fed members who do currently vote on policy.  If the Fed takes away the proverbial punch bowl, the markets are likely to react negatively unless growth is very strong at the time.  We believe that the Fed is likely to follow tradition and react later than it should.  The real question is how much later which will have a real affect on both the markets and the real economy.

Internationally, the Cyprus situation seems to have calmed.  The latest proposal will involve setting up a “good bank” and a “bad bank”.  The nation’s second largest bank will be effectively shut down and transferred to the country’s largest bank.  Deposits above €100,000, which under EU law are not insured, will be frozen and used to resolve debts.  It is not sure how much funds will come from which bank so it is uncertain the extent of the losses that will be imposed upon depositors.  When the banks reopened today after being closed since March 16th, there were lines of those waiting to withdraw funds but not the widespread panic some had feared.  In fact, some depositors turned their anger toward the media, handing out pamphlets reading “Why must international media be so greedy of horror scenarios?  Is decent and investigative journalism dead?”  We could not agree more especially after the hype of the dreaded Fiscal Cliff and the feared Sequester dominated domestic outlets for the past few months.  News should be reported, not created.

SGK Blog--Update March 22, 2013 Equity Indices Feel Pressure of Fed and Cyprus Uncertainty 

Two items in the aftermath of the FOMC meeting stood out for traders this week: 1) concerns over the uncertainty as to how and when the Fed will reduce their stimulus in the form of their bond buying program and 2) whether or not Ben Bernanke, the mastermind of the Fed’s creative stimulus programs, will be around to unwind the programs he put in place. These are legitimate concerns. The Federal Reserve is developing a strategy to gradually reduce its $85 billion monthly bond buying program. Bernanke indicated the Fed will vary the amount of its bond purchases depending on how the economy is performing. Translation – they will reduce the amount of buying they do as they see progress on the jobs front, provided inflation remains contained. As this notion became digested by traders, it was determined that this heightens the level of uncertainty as to when the Fed’s historically novel stimulus programs will officially come to an end. As we have said, they cannot continue forever and it carries its own set of risks. The second area of concern relates to a passing comment Bernanke made in response to a question as to whether or not he is going to stick around for another term. He declined to answer the question directly, but he commented, “I don’t think that I’m the only person in the world who can manage the exit.” This clearly spooked traders. The reality is, as controversial as his policies have been, traders have developed a sense of confidence in the man himself. He has been steady at the helm and he is an effective communicator, something that was sorely lacking at the Fed under Greenspan. Traders dislike uncertainty and because of these two factors, equity indices sold off the day after the Fed indicated with their official statement they were basically not changing their policies at the present time. 

Who would have thought that a nation the size of Cyprus, which accounts for less than half a percent of European Union GDP, could cause such a ruckus in financial markets? The brilliant strategists at the helm of the EU and the IMF decided that instead of actually simply bailing out the Cyprus banking system, which is actually approximately 800 times the size of the nations actual economy, they would have depositors, including foreigners, at the Cyprus banks contribute significantly to the eventual bailout. In other words, the government would basically step in and take a portion of a depositor’s money.  This would include both individuals and corporations, both foreign and domestic. This came about, without overcomplicating the explanation, because bailout weary people in Germany, in particular the Social Democrat Party, are not comfortable giving money to banks to insure the deposits of Russian mobsters. Are we being a little facetious here? Well maybe but given Cyprus role as a (former) bank haven, this is actually a legitimate concern. Of course it would hurt everyone – not just the depositors of those engaged in illegal activities, but also average hard-working Cypriots as well. Irrespective of the percentage, at the time of this drafting none of this had passed the Cypriot parliament, it’s the precedent that would be established if this went through that concerned traders. We have come full circle from a plan in Europe to have a central banking authority and a form of depositor insurance backed by the European Stability Mechanism (ESM) to a plan to raid people’s bank accounts in order to bail out a country’s banking system. While not leading to panic in financial markets, it clearly led to panic on the part of a number of Cypriot depositors – understandably so! Would it ultimately lead to a run on their banks? Would people with deposits in smaller banks in Italy, Spain or Portugal think twice about holding large deposit accounts in those systems? Who knows, like we said, this is uncharted territory. So far markets have to a certain degree taken it in stride, but when/if the backing of the ECB for the Cypriot banking system runs out (March 25th is their established deadline for coming up with a solution) then things will get really interesting. As always, stay tuned! 

On the economic front, the data on housing continues to show us heading in the right direction, helping cushion the impact of the above mentioned uncertainty. Housing starts and building permits for February nicely exceeded consensus estimates from economists. Existing home sales came in just slightly below expectations for February but it was close enough it was considered basically in-line with expectations. Initial weekly jobless claims for the week ending 3/16/2013 came in at 336,000, below the expectation for 345,000 and this continued this winning trend of coming in better than forecast. The index of leading indicators was positive for February coming in at +0.5% which was as expected. The Philadelphia Fed survey for March was +2.0 which exceeded the forecast of -3.0. All-in-all, not a bad week for those actually paying attention to the economic data and not their NCAA tournament brackets!

SGK Blog--Update March 15, 2013 Blue Skies  

In February, sales at retailers rose by the most in five months according to data from the Commerce Department.  The 1.1% rise exceeded projections in a Bloomberg survey of 0.5% and followed a revised 0.2% gain in January.  Excluding the more volatile auto and gasoline categories, sales rose 0.4%.  In the overall report, eight of the 13 major categories reported increased sales, led by a 5% jump in receipts at gasoline stations.  Spending rose 1.1% at auto dealerships which reversed a decline in January’s figure.  According to data from Ward’s Automotive Group, cars and light trucks sold at an annualized rate of 15.3 million last month versus a 14.4 million rate a year ago.  Retail sales are a coincident indicator.  This means they take the temperature of what is going on in the economy and the stock market basically as it is happening.  That is, strong retail sales seem well matched with the solid economic numbers and record-pushing stock indices.

Sales are being boosted by a better job market.  Last week’s payroll number was strong.  This week’s initial unemployment claims figure suggests that momentum is going to continue.  The number of people filing for unemployment claims fell by 10,000 to 332,000 according to the Labor Department.  That was below the Bloomberg median estimate of 350,000 and brought the less-volatile four-week moving average down to 346,750, the lowest level since March 2008.  Even though monthly payroll figures are a lagging indicator (i.e., it gives a snapshot of economic health from a recent past), initial claims are seen as a leading indicator.  The latest data are for a week that has already occurred, March 9th, but the trend in the figures point to what is going to happen in the near future.  On November 30 of last year, the four-week average was 408,300.  Since that peak, it has been sharp drop to the most current level just below 350,000.  It would take a number of weeks of above-trend figures to reverse this trend which suggests that when the next monthly figure for payrolls is released in early April, it will be strong, too. 

This growth is taking place without pronounced inflation.  Although with rising gasoline prices, health care costs and tuition payments some would disagree. Producer prices for February climbed overall due to higher energy costs.  Without the volatile food and energy component, producer prices rose only 0.2%, the same as January’s rise.  Moreover, the bump due to energy costs is likely to dissipate because the cold winter months where heating oil is used most heavily are about to end and the summer driving season is months away.  We had a great deal of data come out on Friday which influenced the direction of both stock and bond indices. The consumer price index was hotter than expected, sending equity indices lower in initial trading. Higher numbers for inflation are considered a negative because they would give the Federal Reserve pause in continuing their stimulus programs. The core CPI number came in as expected at +0.2%. Figures for both industrial production and capacity utilization came in better than expected at +0.7% and 79.6% respectively. This is in part a reflection of the domestic boom going on in energy production. A wet blanket was thrown over stock and bond markets when the Michigan consumer sentiment survey for March came out showing a decline to 71.8 versus the expectation for 77.6 and the February figure of 77.6. This is one of the early indicators and first data points we have received for the month of March and is concerning given how dependent the U.S. economy is on the consumer. Are higher taxes, delayed refunds, political strife and the higher payroll tax finally starting to impact the consumer? We will have to wait and see. As mentioned, a better job market will help alleviate a great deal of pain! 

As spring approaches, the question is whether the economy and the market can break the cycle we have seen the last two years where positive data in the first 2-3 months of the year was overshadowed by various events starting in April that brought down the equity averages.  Or will the positive momentum continue into the summer months and beyond?  Stay tuned!

SGK Blog--Update March 8, 2013 Europe in the News as Dow Sets Record 

Europe made headlines early in the week as the reality of the Italian election mess sunk in. The main politicians in Italy have been bickering through the media as Bersani, the “austerity” candidate, is claiming victory and indicating he is not willing to form a government with Berlusconi. Meanwhile comedian-turned-politician Beppe Grillo said he won’t form a coalition government with anyone. Really? The fact that a comedian won 25% of the vote given the history of Italian politics I guess is not terribly surprising. Italy may hold new elections this year if Bersani and his Democratic Party fail to win enough backing in parliament to form a government. Clearly Italian voters revolted against imposed austerity measures creating a backlash that sent Italian bonds higher. Their 10-year bonds jumped 34 basis points last week to 4.79%, as compared to our 10-year yield of 1.86%. German Chancellor Angela Merkel, whose party seems to always be in a dog-fight for power over there given how unpopular bailouts for the southern bloc of countries have been amongst German voters, had the following comments post Italy election: “Now in Europe, after the Italian election, it seems to be a case of either austerity and savings programs or growth, but that’s a completely false premise.” That’s easy for her to say but the average Italian voter does not see it exactly like that. In a speech in Greifswald on Germany’s Baltic coast last week she urged Italy not to stray from reforms, saying that her stance on deficits is “not about liking to whip people.” Frankly, that is just giving incredible material for Italian comedian Beppe Grillo! It’s a mess, and that is putting it politely. Germany, for understandable reasons as they are the primary ones financing the whole endeavor, is also balking at supporting direct bailouts for struggling European banks via the European Stability Mechanism (ESM). Wait, did we not write last year that they all had agreed on that? Apparently, the agreement carried some caveats, like Germany now insisting that ultimately the sovereigns are responsible for the funding of their own struggling banks. Wait a minute, we thought that was the whole point of coming to terms last year, to alleviate the pressure on already debt-straddled sovereign nations and come up with a central banking authority with backing from the ESM. Well apparently that was hugely unpopular in Germany, again for understandable reasons, so it looks like the agreed upon deal will play out once again not exactly as agreed upon. As always, stay tuned! 

China’s services industries expanded last month at the slowest pace since September. The non-manufacturing Purchasing Managers’ Index fell to 54.5 in February from 56.2 in January, according to the Beijing-based National Bureau of Statistics and China Federation of Logistics and Purchasing. The new Chinese government also took additional steps to curb their real estate market over there, intensifying a three-year effort, and that clearly spooked traders over there with property and housing companies declining the most in trading on their exchange. Traders here focus on every data point coming out of China given its prominence as the world’s second largest economy. In early Friday trading a figure showing that China’s exports exceeded forecast helped propel markets higher. Overseas shipments increased 21.8% which is a clear indication of growing global demand for their goods and probably an indication of a resilient U.S. consumer. Economists had forecast a figure of 8.1%. 

Here in the U.S., markets seem to have shrugged off the sequester as it was refreshing to see President Obama reach out to and have dinner in DC with several members of the Republican party. Senator McCain walked out and gave the press the thumbs up so we will assume some progress was made on introductory discussions regarding debt reduction and tax reform. Hopefully this will ease tensions somewhat on the Hill and real progress can be made on tackling tough but necessary issues such as entitlement reform. In economic data this week, the ISM Services index for February was 56 and surprised to the upside with its strength. Factory orders for January declined 2% but that was actually slightly better than anticipated. Both initial weekly jobless claims, 340,000 for the week ending 3/2/2013, and the ADP employment report for February at 198,000 we both much better than expected establishing hopes that Friday national employment figures would be robust. In Thursday reporting, 4th quarter productivity was revised to -1.9% while unit labor costs were revised to +4.6%. As we mentioned when the figures first came out, lower productivity and higher labor costs is not an ideal combination from either the standpoint of corporate earnings or continuing action on the part of the Fed.  

Equities were helped in Friday trading on the heels of the U.S. employment report for February. The U.S. jobless rate fell to a five-year low of 7.7%, which was not surprising to us given the recent trend in weekly claims and the ADP report which came out earlier this week, but it did surprise economists as they expected it to remain at 7.9%. Employment rose 236,000 in February after a revised gain of 119,000 in January that was smaller than initially forecast. Economists had forecast 165,000 new jobs created. Private sector payrolls increased 246,000 and this was consistent with the ADP report released earlier in the week. Hiring in construction at +48,000 new workers jumped the most in almost six years, a reflection of the improvement in the housing and commercial real estate markets. These figures point to signs that the world’s largest economy may weather both higher taxes and lower federal spending as a result of the sequester. Employers also boosted the average workweek to 34.5 and hourly earnings by +0.2%, both positive indicators for the typical worker. Governments shed 10,000 workers for the month and we will wait and see what happens for the balance of the year. It is estimated that reductions in the rate of government spending will reduce GDP growth by 0.5% this year and potentially wipe out 350,000 jobs if the sequester remains in place through December. That figure is likely high in our view as so far the discussion has been centered on furloughs rather than lay-offs and there are already bills flowing through Congress to adjust the impact of sequester cutbacks on certain critical areas of government spending. So we will have to wait and see how that plays out over the course of the year.
SGK Blog--Update March 1, 2013 Close to a Record but Not Quite There
This week it was hard to escape the sequestration barrage.  We are not going to spend a lot of print space here talking about it for that reason and also because the market is not really worried about it.  It is a convenient “excuse” to pullout when the equity markets decline or when a company needs a reason why they are lowering guidance.  However, its importance has been overstated.  The $85 billion figure is actually the amount that federal spending authority will be reduced.  According to the Congressional Budget Office (CBO), the actual amount of payments reduced will be about half that amount.  Though $42.5 billion is nothing to sneeze at, it doesn’t make for quite as dramatic a headline as “almost $100 billion.”  The CBO estimates that the impact of the sequestration will be to reduce real GDP growth by about 0.5% in 2013 and 0.2% in 2014.  Again, in a $13 trillion economy, even small percentages matter.  However, what seems to be lost in all the partisan rhetoric is the fact that this is happening because of the federal debt ceiling debate that came to a head in the summer of 2011.  As a nation, we cannot keep our foot on the accelerator and brake at the same time.  The reason why Standard & Poor’s downgraded U.S. federal debt in the late summer of 2011 was partly because of the bi-partisan bickering and also because spending was out of control.  The budget deficit has already fallen from over 10% of GDP in 2009 to 7% of GP in 2012 as the economy recovered.  Both S&P and Moody’s have stated that budget cuts would help put the U.S. on a more sustainable fiscal path.  Yes, that is good news.  We have argued over and over in these weekly reports that our fiscal problems were going to a combination of tax increases and spending cuts.  Neither are welcome, but some degree of both are necessary. 

What is more important in our opinion is the now nearly constant supply of good economic data news.  On Tuesday, the S&P/Case-Shiller index of property values increased 6.8% from December 2011, the biggest year-over-year gain since July 2006.  This followed a 5.4% rise in November.  Nineteen of the 20 cities in the index showed gains.  Particularly strong were Atlanta and Detroit which posted their biggest yearly gains dating back to 1991 and Dallas, Denver and Minnesota showing their biggest advances since 2001.  Only houses in New York lost value, falling a mere 0.5% over the 12-month period.  With the 30-year fixed mortgage rate at 3.56% in the week ended February 21 according to Freddie Mac, we remain near the record low of 3.31% reached in November. 

Orders for U.S. durable goods excluding transportation climbed in January 1.9% according to the Commerce Department data released Wednesday.  Total orders, including volatile items like commercial and military aircraft, fell 5.2%, the first decline since August.  However, those transportation items are often excluded when economist try to paint a picture of true underlying demand for goods and equipment meant to last at least three years.  Ex-transportation, this was the fifth consecutive month of gains.  Helping boost demand is the American automaker.  Cars and light trucks sold at a 15.2 million annual rate in January.  When combined with the November and December data, car sales in the past three months have been the strongest seen in the past five years.

Even modest bad economic news is being overwhelmed by a positive outlook.  Consumer incomes fell 3.6% in January thanks to payroll tax increases and rising gasoline prices.  It was the biggest decline since January 1993 and followed a 2.6% increase in December.  But instead of pulling back, consumers maintained their level of spending with purchases up 0.2% according to the Commerce Department.  The savings rate fell to 2.4% from 6.4% as consumers continued buying cars and other goods.  The Conference Board’s sentiment index rose in February 11.2 points, offsetting much of the 15 point slide over the previous three months.  A revised fourth quarter real GDP figure showed a meager 0.1% gain compared to a preliminary 0.1% contraction reported last month.  That was below the 0.5% Bloomberg survey median forecast.  Nevertheless, consumer purchases remained steady and a smaller gain in inventories contributed to the upward revision.  Depleted inventories could be a sign that a pickup in production will follow if demand stays constant or increases.

And, finally, weekly jobless claims once again fell.  In the week ending February 23, they declined 22,000 to 344,000 below the Bloomberg estimate of 360,000.  We will get the monthly payroll report next Friday which is anticipated to show another solid increase.  Recent increases in hourly earnings and average workweek suggest that hiring is likely to accelerate somewhat.  So even as President Obama and Congress bicker back-and-forth today about some sort of sequester “rollback”, there are plenty of signs showing that the economy is rolling along well and a sequester may end up being just a speed bump in the weeks to come.

SGK Blog--Update February 22, 2013 Sequester Looms Large

With equity indices trading just 4% below the all-time 2007 high for the S&P 500 of 1565 and the Dow just 2% below its high of 14,164, the wind was taken out of the markets sails with the release of the Federal Open Markets Committee (FOMC) minutes from their Jan. 29-30th meeting. Several participants at the meeting “emphasized that the committee should be prepared to vary the pace of asset purchases, either in response to changes in the economic outlook or as its evaluation of the efficacy and costs of such purchases evolved,” according to the actual minutes. One of the concerns highlighted by the committee is the question over whether it fosters excessive risk taking on the part of both individuals and institutions. Although we have not seen signs of inflation creep into markets, there is no question that the supply of junk bonds and demand for junk bonds is at the highest level since pre-financial crisis. Last year companies issued $274 billion of junk bonds, up 55% from the previous year and more than double the level seen before the 2008 financial crisis. If that is not a sign of froth than we are not sure what is! Many shaky companies are issuing covenant-lite paper to take advantage of this demand and the Fed’s policy of keeping a lid on rates. The concern is over whether this is creating another bubble in credit markets. Bernanke is inclined to believe it is not and that the Fed has a good handle on it but this is the same Chairman of the Fed that was in place prior to the previous financial crisis taking hold. The problem with asset bubbles is they are in fact hard to predict and when something comes out of left field it is the spillover effect in terms of loss of confidence that rattles markets. The fact is the Fed does not make money, they print it, so on their current schedule if all goes as planned they will have acquired $4 trillion of U.S. securities by the end of this year on their balance sheet that they will have purchased from the U.S. government. At some point, the bond buying has to slow down and stop and the market will not like it. Similarly, Congress has to come up with a fiscal plan that markets perceive as realistic and achievable long term, while limiting damage in the near term. We won’t write at length about the sequester as you are hearing about it in the news every day, but the fact is it is not the ideal way to address spending issues. We wrote favorably on the Simpson-Bowles plan in its original form when it was first announced but it never gained traction at that time. Time is running out and it looks like Congress will get more serious about negotiations after the sequester has actually kicked in, given they are all on break at the moment! 

As far as the economic news was concerned this week, we had a number of key data points out on the economy that were enlightening. Housing data remained solid although housing starts in January were below expectations coming in at 890,000 vs. the forecast for 914,000 and the previous month’s figure of 973,000. Existing home sales were also slightly below expectations for January at 4.92 million versus the 4.94 million expected. Building permits were slightly better than forecasts called for coming in at 925,000 for January versus the expectation for 914,000. Despite the mixed results the housing sector recovery remains a bright spot for the U.S. economy. The inflation numbers were tame as the producer price index came in at +0.2% for January as did the core rate (excluding food and energy) and the consumer price index was flat with the core coming in at +0.3% for the same month. The core rate is considered a more accurate measure as it is less volatile. The core rate for both figures was a tenth of a percent higher than expected so this bears watching as the Fed pays close attention to inflation figures these days. Helping add to pressure on equity indices the day after the FOMC minutes were released, the Federal Reserve Bank of Philadelphia’s general economic index for February (known as the “Philly Fed Survey” for short) dropped to minus 12.5, the lowest reading since June, from minus 5.8 in January. Readings lower than zero signal contraction in the area covering eastern Pennsylvania, southern New Jersey and Delaware. The median forecast of 48 economists surveyed by Bloomberg projected an increase to +1. This is one of the early data points we received for the month of February and it bears special attention as we approach the sequester scheduled to hit at the beginning of March. It is possible business decisions are slowing as is investment ahead of the uncertainty surrounding the impact on the overall economy. The index of leading indicators rose +0.2% in January versus the expected +0.3%. 

In Europe, continued problems arose when the euro-area services and manufacturing (a combined report) survey of purchasing managers for the 17 member currency bloc fell to 47.3 for February from 48.6 in January. Just when economists, who had forecast a reading of 49, were predicting that European economies were starting to turn the corner. A German services measure also came in below expectations, although at 54.1 it still signals their economy is expanding. This demonstrates that in fact the recession in Europe actually deepened early in 2013 as opposed to stabilizing or getting better. One of the main issues in Europe is that business surveys indicate that the recent growth impetus in Europe is coming almost exclusively from foreign demand. The problem with that is that it can be hampered by an appreciating European currency and a slowing U.S. economy due to all the uncertainty. The big question mark is will things continue to get worse before they get better. European stock indices witnessed sharp declines this week on the gloomy outlook for demand and the scare put into markets from the Fed minutes. Stocks did rebound some in Friday trading on a news report that Bernanke had addressed the “asset bubble” question in early February at a meeting with the Treasury Borrowing Advisory Committee when they brought up the issues in the junk bond market and the risks associated with mortgage real estate trusts. Apparently, Bernanke dismissed or minimized these concerns at the meeting, although that statement alone certainly does not give us confidence. The other newsworthy item sending stock indices higher was a report out on German business confidence, which jumped to a 10 month high amid the strength in corporate earnings in that country at such bell-weather companies such as BMW. The Ifo Institute’s business climate index based on a survey of 7,000 business executives rose to 107.4 in February from 104.3 in January and the expectation of economists for a figure of 104.9. Again, this combination of news lifter equity indices in Friday trading, although for the week they were decidedly in the red.     

SGK Blog--Update February 15, 2013 Earnings Season Continues
The economy received more good news this week.  According to the Commerce Department, retail sales rose in January for the third consecutive month.  Department stores and online merchants showed particular strength as improving job prospects boosted consumer confidence.  Purchases climbed 0.1% which matched the median forecast of economists surveyed by Bloomberg.  The gain was smaller than the 0.5% increases in both December and November.  Excluding automobile sales, which have been strong lately, the figure was still positive at 0.2%.  Ford’s deliveries rose 22% last month and General Motors sales climbed 16%.

The positive retail sales number are a reflection of the improvement in the job market.  The Labor Department reported that in the week ended February 9, jobless claims decreased by 27,000 compared to the week before to 341,000.  The median Bloomberg survey figure was 360,000.  In fact, the actual figure was below the lowest estimate in the survey of 350,000.  The less volatile four-week moving average increased slightly to 352,500 after last week’s figure was revised upwards by 2,000.  There still are about 2 million individuals who have used up their traditional benefits and are collecting emergency and extended payments.  Regardless, the trend is definitely moving in the right direction.  Monthly payrolls, which will not be released for a number of weeks, still need to increase sharply to bring the national unemployment rate, now at 7.9%, down further.

SGK Blog--Update February 8, 2013 European Worries Offset by Strong Earnings Reports  

The week started out on a rough note as Europe once again made headlines and they were not positive. Just before a European Union summit meeting this week, opposition political forces in Spain were calling for the resignation of Spanish Premier Mariano Rajoy based on allegations of illegal payments. At the same time news hit the wires that a 541 year old Italian bank, Monte dei Paschi di Siena SpA, was so strapped for cash in 2011 that it negotiated a covert $2.7 billion loan from the Bank of Italy at the same time executives were publicly describing the lender’s funding position as comfortable. We will spare you the complicated details, but needless to say the bank was in fact running short of liquidity based on two complex structured finance deals it had arranged with investment banks. These deals basically started to head south during the European financial crisis as the value of the Italian government bonds used as collateral were pummeled. This financial scandal has embroiled the Bank of Italy as well because they essentially turned a blind eye to what bank executives were disclosing and not disclosing to the public under the guise of not wanting to roil Italian capital markets further. This is yet just one more example of the far superior approach the U.S. took in undergoing rigorous stress tests post financial crisis in order to disclose fully and publicly problem areas (and areas of strength) in the U.S. banking system. Knowledge is power and provides confidence amongst traders. Cover-ups do not and this is yet one more example of why they need a central banking authority for the European Union. 

All eyes were also focused on European Central Bank President Mario Draghi Thursday as he signaled policy makers are concerned that the euro’s strength will hamper efforts to pull the economy out of recession. He stated, “the exchange rate is not a policy target, but it is important for growth and price stability.” This helped send equity markets here in the U.S. lower on the day as concerns continue to mount over the possibility of a global currency war occurring. With our Federal Reserve buying billion in bonds each month issued by the Treasury in an attempt to keep interest rates low, this also can be viewed as a strategy not just to support our domestic housing market but also to keep a lid on dollar appreciation relative to other currencies in order to support our export business and other central bankers are clearly taking note of this. Thus, Draghi’s comments were generally viewed as somewhat downbeat – he indicated that an economic recovery in the eurozone should begin later this year as an absence of inflation risks allows the ECB to maintain record low interest rates. We could see the impact in trading immediately as the euro declined sharply in value relative to other currencies. Part of what has driven our recovery here in the U.S. since the financial crisis has been the strong rebound in our export manufacturing sector so anytime the dollar appreciates sharply in trading relative to the euro and other currencies this is viewed as a negative for U.S. equities.    

Domestically, markets have been driven by earnings as we have written most recently. It seems like most of the bickering has been over what to do with the giant cash hordes that companies like Apple have accumulated, as evidenced by the lawsuit against the company filed by David Einhorn, the famous hedge fund manager who seems to relish the limelight. As we indicated in previous e-mails, many companies have set conservative expectations for first quarter 2013 earnings, particularly given the uncertainty surrounding the pending sequester negotiations and the higher payroll taxes consumers are paying and what impact that will have on consumer spending. In general the economic data on the U.S. economy was weaker than expected this week. Factory orders increased 1.8% for the month of December but the expectation was for a 2.4% increase. The Institute of Supply Management Services index for January was 55.2 (a number above 50 signals expansion) which was slightly below the expectation for 55.6. Initial weekly jobless claims for the week ending 2/2/2013 came in at 366,000 versus the expectation for 360,000, ending the trend of expectations being soundly beaten in a positive way that we experienced for almost the entire month of January. Fourth quarter productivity declined 2.0% versus the expectation for a 1.2% drop while unit labor costs rose 4.5% far exceeding the expectation for a 2.4% increase. These latter figures are troubling because from a corporate earnings standpoint that is not the combination we want to see. Paying workers more for less productivity obviously eats into corporate profit margins and can definitely squeeze the bottom line. The productivity number can in part be explained by the sharp drop in government spending on the military as the fiscal cliff loomed. We would expect productivity to rebound somewhat over the next two quarters as some of these temporary issues get resolved.
SGK Blog--Update January 25, 2013 Overall Real GDP Declines but Job Growth is OK 
Real gross domestic product, the volume of all goods and services produced in the country, fell at a 0.1% annual rate during the fourth quarter according to the Commerce Department.  Though the overall number was negative, by digging deeper into the figures, a more positive picture emerges.  Household consumption rose at a 2.2% rate following a 1.6% advance in the third quarter and compared to a 2.1% median forecast in a Bloomberg survey.  Consumer spending comprises approximately two-thirds of total GDP so it is the key figure to focus on each quarter.  This sector contributed 1.5 percentage points to growth.  Nonresidential fixed investment (i.e., corporate spending) and residential fixed investment (i.e., homes) contributed 1.2 percentage points to growth last quarter.  Corporate spending had declined at a 2.6% rate in the previous quarter, the most in more than three years.  The headwinds which pushed the overall number into negative territory were inventory changes and government spending.  Combined, they subtracted 2.6 percentage points from growth.  Businesses built up inventories in the third quarter in anticipation of the holiday selling season late in the year.  By the fourth quarter, with consumers a little more tepid in their spending, companies decided to sell items from the warehouse and let store shelves become sparser rather than place new orders with manufacturers.  Government outlays fell at a 6.6% annual pace last quarter.  Highlighting this decline was a 22% fall in defense spending, the largest contraction since 1972, following the Vietnam War.  State and local governments continued to trim their budgets.  Virtually every state in the union is required by law to have a balanced budget so politicians, wary of increasing debt loads, must turn to layoffs in order to balance the books.  Real final sales, which is real GDP less the change in private inventories, was 1.1% in the fourth quarter following a 2.4% rise in the third quarter.  Thus, there definitely was some slowing which took place October through December of last year, but not to the sharp degree which the overall number suggests.  For all of 2012, the economy expanded 2.2% after a 1.8% rise in 2011.

GDP numbers are backwards-looking, plus this latest figure will be revised twice more before a final number is released sometime in March.  That is why the monthly jobs report takes on more meaning.  It is not only more frequent but a better indicator of what direction the economy is going since jobs and income are the lifeblood of what GDP is really all about.  Non-farm payrolls in January rose 157,000 according to the Labor Department.  December’s number was revised higher to a 196,000 increase and November’s was moved up to a 247,000 gain—a 127,000 improvement overall in those two months.  The jobless rate, which is based on a survey of households versus the business-centric payroll figure, rose slightly to 7.9% from 7.8% in December.  A Bloomberg survey had a median forecast expecting a gain of 165,000 payrolls in January.  The Labor Department also released data showing that the economy had recovered 5.5 million of the 8.7 million jobs that were lost during the recession.  Private payrolls, which do not include government agencies, rose 166,000 last month following a revised increase of 202,000 the previous month and versus a consensus figure of 168,000.  Average hourly earnings rose 0.2% while the average work week held steady at 34.4 hours.  This is a sign that people are getting paid slightly more for working the same hours.  Should the trend continue or intensify, there is a definitely possibility that wage pressures may start to be felt across the economy.  The GDP report showed that after-tax income rose at a rate of 6.8% adjusted for inflation, the fastest pace since the recession. 

Concerning incomes, the Commerce Department in a separate release said that incomes rose in December by the most in eight years.  Though the weekly initial jobless claims did rise by 38,000 in the week ended January 26 according to the Labor Department, this has been one step back for the two steps forward the economy has taken recently in this metric.  The Commerce Department income report says that disposable income, or the money left over after taxes, rose 2.8% inflation adjusted while the savings rate increased to 6.5%, the highest since May 2009.  Granted, some firms paid dividends and employee bonuses earlier than usual late last year before tax rates went up this year.  Thus, it would not be a surprise to see these income numbers more moderate when January and February data is released. 

Nevertheless, there can be no doubt that the economy is growing.  Not tremendously.  Not robustly.  But we have often characterized the $16 trillion U.S. economy as a massive battleship.  Once it starts going in one direction, it takes something massively unexpected to stop the momentum.  The Federal Reserve still sees the need to treat the recovery as fragile.  As such, in their regularly scheduled two-day meeting this week, they had no change in their policy of monetary easing stating, “The Committee expects that, with appropriate policy accommodation, economic growth will proceed at a moderate pace and the unemployment rate will gradually decline toward levels the Committee judges consistent with its dual mandate (maximum employment and price stability).”  That involves purchasing $40 billion per month of mortgage-backed securities and $45 billion per month of longer-term Treasury securities (and reinvesting principal payments for both).  Until unemployment reaches the “magic” level of 6.5% and forward inflationary pressures remain absent, this policy will not be altered.  Today the pace of the recovery puts these targets still far off in the future.  However, it cannot be ruled out that markets could be surprised with better than expected data in the months to come.

SGK Blog--Update January 25, 2013 Traders Focus on Earnings and China Data  

We will get to the earnings reports from companies we own below but before we do we will discuss the other drivers behind market moves this week, primarily based on global economic data. We will begin with China as we pay close attention to this important market economy although it does not often receive headline attention in major news publications. This week we received a key data point indicating that growth in the important Chinese factory sector accelerated to a two-year high in January. This was indicated by the HSBC purchasing managers index (PMI) which rose to 51.9 and indicates that the country’s two-year slowdown is at worst receding and at best moving the other direction. What’s interesting about China right now is the factory report indicated that there is a healthy demand for both export related goods and for domestic purchases. That has been one of the issues with respect to their economy – it has been so export dependent. With Europe embroiled in recession and growth having been relatively slow in the U.S., this has put a damper on demand for Chinese goods over the past two years. The entire Asia-Pacific region seems to have regained its footing and you have a burgeoning middle class in China demanding items such as smartphones and tablets, and this is a real opportunity for many companies – both foreign and domestic. So this bears watching and if China begins to trend upwards in terms of their economic growth it would translate into better earnings for many companies. 

Domestically the economic data we did receive this week was generally positive. Initial weekly jobless claims came in at 330k for the week ending 1/19/2013 which was much better than expected. This follows the week prior which also exceeded economists’ forecasts. This is a hopeful sign that here in 2013 the job market is improving. The index of leading indicators for December came in at +0.5% which was in-line with expectations but an improvement over November’s figure which was flat. Existing home sales were slightly below expectations, bucking the recent trend on housing data, but the FHFA Housing Price Index for November rose 0.6% which is again a positive sign for that sector and consumer confidence in general.  

The CBOE Volatility Index, an options measure of market fear, is hovering around the 12.5 range. The VIX, as it is called, has only traded below 14 about 21% of the time in its 21 year history and has closed below 10 just nine times in nearly 6,000 trading days. Typically, based on our experience, that level of market complacency frequently does not end well. It makes sense therefore to treat general equity prices at these levels with real caution. That is not to say that there are not value opportunities within the market. Traders are responding to a more benign macro environment with China showing signs of improvement and Europe not making negative headlines on a daily basis. We would note however that for companies that have reported so far in the S&P 500, fourth quarter year-over-year profit growth has come in at approximately 3% (vs. the expectation for 11% growth just a few months ago) and 70% of those companies have lowered their guidance for the first quarter of 2013. It makes sense to pick and choose our opportunities carefully in this environment. 

SGK Blog--Update January 18, 2013 Stocks Move Higher As Earnings Season Heats Up
Applications for jobless benefits fell by 37,000 to 335,000 in the week ended January 12 according to the Labor Department. That is the lowest level since the January of 2008. A Bloomberg survey had predicted that the level would be closer to 369,000 so this was a positive surprise. Based upon monthly data, the national unemployment rate is 7.8% but the weekly indicators are deemed to be more timely so there is clear evidence that the employment picture is improving bit by bit. Nevertheless, we did get a number of negative headlines this week from American Express which will be eliminating 5,400 jobs this year and Morgan Stanley which will cut its ranks by 1,600 jobs in the upcoming weeks. Such events are not unusual in an expanding or contracting economy as individual firms adjust their size to deal with the factors affecting their particular industry. 

Another bit of good news came on the housing front. According to the Commerce Department, housing starts rose 12.1% last month to a 954,000 annual rate. This was the most since June of 2008. Low borrowing costs, less foreclosures and a slowly improving employment picture is aiding household formation. This in turn spurs builders to break ground on more planned houses. Building permits climbed less than housing starts and suggests that builders may take a breather in the coming months. On an annual basis, housing starts rose 28.1% in 2012 versus 2011, the biggest annual gain since 1983. The number of starts averaged 1.74 million from 2000 through 2004, so current figures still allow some room for growth and remain below the peak year of 2005 when 2.07 million housing starts occurred.

On the inflation front, both consumer and producer prices remained tame. Consumer prices rose 2.4% over the past decade, but for the month of December, the reading was for 0% change. The core index, which excludes food and energy costs which are volatile and can distort the month-to-month analysis, rose 0.1%. For 2012, core prices rose 1.9% compared with a 2.2% increase in 2011 according to the Labor Department.   Producer, or wholesale, prices actually declined 0.2% in December. Excluding food and energy, core producer prices rose just 0.1%. These figures helped spur solid retail sales last month. The 0.5% increase according to the Commerce Department followed a revised 0.4% in November and was more than double the 0.2% expected by economists surveyed by Bloomberg. For all of 2012, retail sales climbed 5.2% after a 7.9% gain in 2011. Excluding autos, retail sales rose 0.3% in December after falling 0.1% in the prior month and that figure was in-line with expectations. The Federal Reserve compiles activity in its 12 districts on a monthly basis and releases it in the so-called beige book. It showed for January that economic activity expanded at either a moderate or modest pace in recent weeks with consumer spending picking up which matches the retail sales figures just discussed. The bottom line was “cautiously positive” about the economy gathering steam over the course of the year. There remains a lot of uncertainty about hiring plans and also the looming sequestration and debt ceiling debate could play a big role in how the various districts react.

SGK Blog--Update January 11, 2013 All Eyes Focused on Earnings Season  

Given there was not much in the way of news out on the economy and we are waiting for the 4th quarter earnings results from companies, we thought we would touch on an item that did not make front page news this week but has important implications for future periods of financial stress, which will inevitably take place. We wrote extensively over a year ago about the positive aspects of the new Basel III rules that were to come into effect in the coming years. The Basel Committee on Banking Supervision, a group of the world’s top regulators and central bankers, had come together back in 2010 and they had finalized a set of rules, particularly relating to capital ratios of large global banks, with the idea of preventing future financial crisis of the extent we experienced in 2008. A much needed and, as we wrote, a positive development in our view. Now they have come out and, go figure, relaxed the rules making it easier for banks to comply with the rule known as the “liquidity coverage ratio.” While seemingly innocuous, it is an important metric and it appears as though the committee has bowed to the pressure from the intense lobbying by financial institutions over the past two years. So they have delayed the full implementation of the rule until 2019 and it is up to individual countries to decide how to apply the rules. Basically the liquidity rule requires banks to be holding enough liquid assets, originally limited to cash and government securities, to be able to withstand an intense 30-day liquidity crisis similar to what was experienced in 2008. The liquid assets were to total 100% of the funds a bank would theoretically lose access to in a crisis. The biggest change to the rule involves what banks can now count as “high-quality liquid assets.” So now banks are allowed to use less traditional assets to satisfy up to 15% of their requirements under the rule. These include, for example, highly rated residential mortgage-backed securities (wait isn’t that what triggered the financial crisis in the first place!) That change was obviously precipitated by the large U.S. banks which hold a lot of these types of securities. The banks argue the rules would restrict lending, we would argue that banks are going to lend if demand is there and the point of the rules is to prevent what happened before. So we are disappointed frankly the regulators seemed to have caved on this issue and it is not the only Basel III rule that has been watered down since they have been announced unfortunately. 

Battle lines have already been drawn on the next hurdle Congress faces and this issue is approaching faster than many politicians are ready for. So Republicans in the House and the Senate have indicated that further tax increases are off the table as we approach the deadline for breaking through the current debt ceiling and the two month delay for the automatic spending cuts known as the sequester. Republicans argue cuts have to involve entitlements such as Social Security, Medicare and Medicaid, which Democrats have been reluctant to target. We had been outspoken supporters of the Simpson-Bowles Plan when it was first announced what seems like eons ago. The approach was a multi-faceted plan that tackled the tax code along with entitlement spending and seemed a common sense approach at the time. Basically, as we have written in the past, we need a plan! Hopefully Congress will come around to supporting a similar approach to Simpson-Bowles but, as always, getting there will not be pretty! Both sides are now once again staking out their positions in the public press. 

As indicated, there was not much out on the economy this week and we have not really kicked into 4th quarter earnings season yet. What little data we did get on the economy was mixed. Initial weekly jobless claims for the week ending 1/5/2013 came in at 371,000 which was a bit disappointing as that figure had been trending lower and it was slightly higher than expected. The figure for wholesale inventories came out for November at +0.6% vs. the expectation for +0.2%. This is considered positive as it is an indication businesses were stocking up in anticipation of brisk sales. Alcoa is typically the first big high profile company to release earnings and they have a history of disappointing investors. This time they issued a surprisingly positive forecast for 2013 which took analysts off-guard but set a positive tone for the early going in terms of earnings season. Wells Fargo however was the first high profile bank to release earnings Friday and consistent with the headlines in the Wall Street Journal on the same day, it is evident from sifting through their results that banks are sitting on large amounts of cash but are having difficulty finding credit worthy borrowers demanding loans. One of the key financial metrics used to measure banks success is the net interest margin. This is the basic difference between what banks pay on deposits relative to the rates they earn lending. When they are flush with deposits but not finding enough businesses or people to lend to this margin gets squeezed. This is not unique to Wells, we believe we will see this in all the banks results this quarter. This is not a bad problem at all from the standpoint of the economy and also avoiding future financial crisis in our view. On the first point, as demand picks up in the economy it means banks will be eager to lend. On the second point, irresponsible lending is one of the key contributing factors that led to the previous financial crisis so the fact that banks are being more prudent is not a bad things at all. It does inspire us to run our stock screens though in the search for a quality perhaps regional financial institution that is doing it right and whose net interest margin is heading in the right direction.
SGK Blog--Update January 4, 2013 Half of Fiscal Cliff Deal Passed  

First off we want to wish our clients a hearty Happy New Year! We here at SGK had a record year in terms of our assets under management thanks to you our clients. Our client retention sets a standard that we believe may be unmatched in our industry. We are looking to add an associate financial planner to our staff this year and we are excited about the candidates for this position. We will keep you posted on our progress! 

First, here is a quick summary of some of the major components of the tax package that passed the Senate and the House this week. When we say half the job got done, we are being only slightly facetious. They focused on the tax aspect of the cliff and postponed the tough decisions on spending. For example, here is a component of the bill. It simply postpones for two months the start of the $1.2 trillion in automatic spending cuts over 10 years, known as the “sequester.” For those two months, $24 billion in savings would be substituted. Half of those savings would be split between defense and non-defense programs. The other half includes new revenues.   

So the key component of the bill that passed is on the revenue side of the equation.  It raises $600 billion in revenue over 10 years through a series of tax increases on wealthier Americans. It permanently extends tax cuts made in 2001 by President Bush for income below $400k for individuals and $450k for families. Income above that level will be taxed at 39.6% vs. the current 35% rate. Above that income threshold, capital gains and dividends would return to the 20% tax rate from the current 15% (add on 3.8% for high income earners for the Medicare surcharge under the new health plan). It caps personal exemptions and itemized deductions for income above $250k on individuals or $300k per family. It raises the estate tax to 40% for estates of more than $10 million from the current level of 35%. The other key component is that it permanently fixes the alternative minimum tax and builds in a cost-of-living adjustment which had been sorely lacking. There are other components to the legislation but those are the key points potentially impacting our client base. One last thing, it cancels a cost-of-living raise for members of Congress – which makes sense to us! If you have specific questions on how it will impact you personally, Darren Koch our CFP here in the office is currently studying the legislation and can help answer your questions. 

Helping markets firm up on Friday were two pieces of key economic data. First the December employment report here in the U.S. showed that 155,000 new jobs were created in the month of December. While only slightly better than expected, November figures were revised upwards by 15,000 to 161,000 new jobs. Even better, private sector payrolls for November were revised up to 171,000 from 147,000 and this was in the face of concerns that levels would fall in the aftermath of hurricane Sandy. The overall unemployment rate remains stubbornly stuck at 7.8% however. This may have quelled some concerns after the Fed minutes from their December meeting were released Thursday showing that at least half the members of the committee wanted to end the bond buying program as early as the mid-point of this year. Either way, we believe the market is beginning to price in an end to the Fed Stimulus, whether that occurs at the mid-point of the year or the end of the year. We witnessed a relatively dramatic increase in the interest rate of the U.S. ten-year Treasury this week as it is beginning to approach the 2% level. Also released Friday was the Institute of Supply Management’s ISM Services index which came out a 56.1 versus the 53.5, a surprisingly strong number. The services sector accounts for a good portion of economic activity here in the U.S. so this was a positive development and surprised many economists. The ISM index for manufacturing released earlier in the week was 50.7 which was pretty much in-line with expectations.  

It is an interesting phase of the business cycle as we really will be looking for a bigger dent in the unemployment picture in order to propel corporate earnings higher. This however would be tempered by the potential for rising costs for companies if we see movement in either labor costs or a sharp increase in interest rates. The latter would typically occur ahead of any actual movement by the Fed as traders anticipate their next move. It is always much easier for the Federal Reserve to add stimulus to the economy than remove it. At some point however the continual trajectory of ballooning their balance sheet, combined with the large amount of debt we have fiscally, can potentially lead to a more dramatic shock to the system down the road when they do try to reign the stimulus in. This can lead to sharper business cycle fluctuations, including those retrenchments which are so painful, and that is something the Fed desperately wants to avoid. All the more reason to develop a sound fiscal plan for the country as a whole – we are hopeful the new Congress has more success than the last!
SGK Blog--Update December 28, 2012 The Final Countdown
All those New Year’s Eve countdown clocks have been replaced by the Fiscal Cliff countdown clock.  Sad but true.  Even the Y2K fad wasn’t this bad.  Only three days left to get a deal done.  We will see if the weekend can bring about some sanity on Capitol Hill. 

Meanwhile, the economy just keeps chugging along.  On Thursday, initial unemployment claims showed that in the week ended December 22, applications fell by 12,000 to 350,000.  That brought the four week average to 356,750, its lowest level in more than four years according to the Labor Department.  The news on housing was also positive.  New home sales rose 4.4% in November to an annualized 377,000 pace according to the Commerce Department.  The median price rose 14.9% last month compared to the year-ago figure.  Dwindling foreclosures and less inventory are giving a boost to the housing market.  Low interest rates are not hurting either.  The Standard & Poor’s Case-Shiller index of 20 major cities released Wednesday showed that prices rose 4.3% in the 12 months ended in October.  Chicago and New York were the only two cities with negative annual returns in October.  In Phoenix, home prices rose for the 13th month in a row, and Detroit, which fell severely during the housing crash, saw a 10% annual gain.  Housing is a very key variable in the economy because it fuels so many other industries—homebuilders, insurance, home improvement, furniture, gardening services, etc.  If this momentum can continue into the spring then, assuming no ill effects from the fiscal cliff,  the economy will be well positioned for better growth in 2013 given the friendly interest rate environment. 

SGK Blog--Update December 21, 2012 Ferris Bueller's Day Off

We can only imagine a similar conversation with President Obama calling from the White House playing the role of Ferris and House Speaker Boehner playing the role of abused best friend Cameron:

Ferris: I'm serious man, this is ridiculous making me wait around the house for you.
Cameron: Why can't you let me rot in peace?
Ferris: Cameron, this is my ninth sick day. If I get caught, I don't graduate. I'm not doing it for me, I'm doing it for you.
Cameron: Do you know what my diastolic is?
Ferris: Be a man, take some Pepto-Bismol, get dressed and come on over here, I'm tired of this stuff.
Cameron: Oh, shut up!

After pulling the infamous “Plan B” from the House floor without a vote, Speaker Boehner disbanded the group and left until after Christmas.  Clearly this will not help improve the approval rating of Capitol Hill.  But the elections are over so popularity contests are not important right now.  What is important is that the country continues to barrel towards the “fiscal cliff” with no brakes.  An article in the Wall St. Journal mentioned September 2008 when the Republican House voted down the Bush administration’s first Wall Street bailout plan.  By the close of business that day, the Dow had fallen 778 points.  News of the latest setback was not greeted fondly on Wall Street but not to that degree.  In what can be viewed as a bit snippy, Boehner’s written statement after he walked out stated: “Now it is up to the president to work with Senator Reid on legislation to avert the fiscal cliff.”  The problem is that Boehner could not even muster enough support from his own party to pass Plan B.  Bottom line, this was a personal embarrassment to him.  It initiated rightful questioning of his leadership and is a setback to the GOP.  Representative LaTourette (R., Ohio) put it best: “We are going to be seen more and more as a bunch of extremists that can’t even get a majority of our own party to support policies we’re putting forward.”  If the party’s losses in the November elections were not a low point, this is close.  The disappointment extends to the c-suite, where many CEO’s have expressed frustration going so far as to say, “…as an American, I’m embarrassed.”

Meanwhile, economic data points to an improving economy.  Though initial unemployment claims came in ahead of expectations, consumers are still earning and spending more than previously.  Personal income in November rose 0.6% compared to October according to the Commerce Department.  Personal spending rose 1.7% at an annual rate in the third quarter and November was the strongest reading of this metric since August 2009.  There is no hint of inflation with the personal consumption expenditure index, the Fed’s preferred method of measurement, flat last month.  Non-defense capital goods excluding aircraft rose 2.7% last month and October’s figure was revised higher.  U.S. auto sales in November rose to a five year high for that month thanks to some pent up and replacement demand following Superstorm Sandy in October. 

The Commerce Department also said that GDP rose to an annualized rate of 3.1% in the third quarter.  This followed earlier estimates of 2.7% growth.  New data revealed that spending on health care and exports were stronger than previously estimated.  A potential negative could be that businesses’ inventories contributed 0.73 percentage points of growth.  Thus, it boosted third quarter GDP, but, unless sales begin to pick up this quarter, it will be a drag on the current quarter and future quarters as manufacturers cut back on production rather than have unsold goods pile up along the distribution chain and on retailer shelves.  Also, federal government spending contributed 0.71 percentage points of growth but that will likely be seriously curtailed in the future as the “cliff” approaches.

Housing was also a positive contributor.  This week, the National Association of Realtors said purchases of existing homes rose 5.9% to a 5.04 million annual rate, the most since November 2009.  Property values rose 10% over the past year as inventories dropped to the lowest level in 11 years and buyers responded to ultra-low mortgage rates.  The current sales pace suggests that it would take 4.8 months to sell the 2.03 million previously owned homes on the market.  That ratio is the lowest since September 2005 and a number below 6.0 is considered healthy.

Thus, even with all the trouble over fiscal concerns, the American economy is finding ways to heal itself.  As we have previously stated, the growth is not robust and there remain millions upon millions out of work and struggling from day to day.  That is why the rhetoric on Capitol Hill is so toxic.  It could provide a real roadblock to future growth.  It harkens back to another movie released recently based upon J.R.R. Tolkien’s The Hobbit.  The following is a riddle proposed to the story’s hero Bilbo Baggins:

This thing all things devours:
Birds, beasts, trees, flowers;
Gnaws iron, bites steel;
Grinds hard stones to meal;
Slays king, ruins town,
And beats high mountain down.

Just before the protagonist was eaten by the creature Gollum, he stumbled upon the answer:  Time.  That is exactly what Congress does not have much of anymore yet it will not stop as the end of the year approaches.

SGK Blog--Update December 14, 2012 Fiscal Cliff Drama Continues

The saga continues and as it is on the front page of every newspaper and news report every day, we won’t bore you with the details of progress or lack thereof regarding fiscal cliff negotiations. They are operating with very little time so you would think that House Speaker John Boehner would choose not to head off to Ohio for an extended long weekend after meeting the President at the White House last night, but we do not pretend to have insight into the Republican negotiating strategy so it is a head scratcher! As most Americans and business executives that are polled have a strong preference for a compromise solution to be reached you would think they would get the message on Capitol Hill so we can only hope there is more being done between their respective staffs to work out a deal than they are saying publicly.

Europe made progress this week on the banking front as EU finance ministers agreed to a joint banking supervisor for big banks in the euro zone. This is a positive step as an agreement was in no way guaranteed and it paves the way for the first time since the start of the euro crisis for a permanent mechanism for the pooling of debts and fiscal transfers (albeit limited) within the currency bloc. This deal was hard to achieve because Germany (the principal underwriter) insisted on a transfer of sovereignty within the euro zone. So henceforth the European Central Bank will take direct responsibility for supervising Europe’s biggest banks; those with assets of more than 30 billion euros ($39.22 billion), or banks that make up more than 20% of their country’s gross domestic product, or that operate in at least two countries.  This is a big step for the region and the real impact will ultimately be felt if they move onto the next planned phase which will be the creation of a single euro-zone bank resolution authority backed by a common resolution fund. This will involve a significant degree of potential fiscal transfer and is therefore being delayed until 2014 by which point leaders are hoping the crisis will have eased up by then, the hope being the common resolution fund would never need to be actually tapped into. The creation of this fund would go a long way to breaking the link between the banks and the sovereigns that has fueled the crisis. So, remarkably and unlike our fiscal cliff situation here in the U.S., the Europeans are making slow but steady progress. Who would have thought we would be writing that a year ago! 

On the economic front, the main focus of attention this week on the part of traders was the announcement by the Fed at the regularly scheduled meeting of their open markets committee (FOMC) that they are going to purchase $45 billion a month beginning in January of Treasury securities in addition to the $40 billion a month of mortgage-debt securities.  This effectively continues their path of infusing plenty of cash in the system in order to prevent any type of stresses showing up in the credit markets with what could be a slowdown in the economy on concerns over the fiscal cliff. Ben Bernanke in his speech continued to apply pressure on Congress to resolve the issue or it will be damaging to the economy. What was interesting about this announcement was that the Fed set a precedent by establishing firm parameters around unemployment and inflation before they would begin the process of raising interest rates. This approach continues Bernanke’s philosophy of being considerably more open and transparent as opposed to the secretive nature of the Fed under Greenspan. They do not expect to raise the main interest rate until 2015 when they forecast the jobless rate to fall to between 6% and 6.6%. The Fed expects gross domestic product to be between 2.3% and 3% next year, which is fine but there is obviously a lot riding on a resolution to the fiscal cliff. While their long-term target for inflation remains at 2%, they did seem to provide for some wiggle room on that by allowing it to get as high as 2.5% if the unemployment rate remains above 6.5%. As we said, this is interesting because it is the first time in one of their statements they have actually set specific parameters around inflation and unemployment rates before taking action. 

In other economic news, figures for both the consumer price index and the producer price index for November came in below the expected rates (a good thing) at -0.3% and -0.8% respectively.  November retail sales came in below expectations at +0.3% despite what was considered to be a record setting Thanksgiving period. Initial weekly jobless claims ending 12/8/2012 was a surprisingly good 343,000 compared to the expectation of 375,000 as economists anticipated hurricane Sandy to have a more meaningful impact on the figures. The week ended on a strong note as both industrial production and capacity utilization for November came in above expectations at +1.1% and 78.4% respectively. Overall the economic data for the month of November has been better than expected.
SGK Blog--Update December 7, 2012 Silver Bells
We are a few weeks removed from Black Friday and Cyber Monday, and the tone of the holiday season got a little merrier with the release of the monthly payroll data.  Superstorm Sandy suggested that this month’s figures and maybe a few to come would be negatively affected by the event.  However, nonfarm payrolls grew by 146,000 following a revised 138,000 gain in October.  The median estimate from Bloomberg was for a gain of only 85,000.  According to the Labor Department, Sandy “did not substantively impact” the data.  The unemployment rate fell to 7.7%, the lowest since December 2008, and was below the 7.9% median forecast from Bloomberg surveys.  This month’s info still had a number of twists and turns to contemplate.  The household poll, used to calculate the jobless rate, showed that 369,000 people were not a work because of bad weather.  The average of the last ten Novembers was 70,000.  The Labor Department also conducted its survey a week earlier than typical because of the Thanksgiving holiday.  Nonetheless, private payrolls, which exclude government agencies, rose by 147,000 in November which was much higher than the 90,000 expected.  A key factor which is somewhat hurricane-proof is average hourly earnings.  That gauge rose to $23.63 from $23.59 in the prior month while the average work week held at 34.4 hours.  That is good news because it shows that real earnings are moving in a positive direction for employees which can translate into better economic growth down the road.

Job data was not the only positive news print this week.  Industry sales of cars and light trucks rose to 15.5 million at an annual rate in November which was the best pace since February 2008.  The ISM Services index for the month of November was 54.7.  A reading above 50.0 indicates expansion.  Productivity data for the third quarter was revised up from 1.9% to 2.9%.

However, everything did not come up roses.  ISM Manufacturing failed to meet expectations and came in at 49.5 for November signaling a contraction in that part of the economy.  This disappointing reading matches the purchasing managers’ indices from various parts of the world—France at 44.5, Germany at 46.8,, U.K. at 49.1, Australia at 45.2 and Greece at 41.8.  In a slight twist, China’s reading was 50.6 according to their National Bureau of Statistics following a 50.2 in October.  According to the bank HSBC, that figure was 50.5 in November after a 49.5 reading in October suggesting that last month was the first in which the manufacturing part of the economy switched from contraction to expansion.  The difference between the two sources means that China’s official bureaucracies may not be putting forth accurate numbers—but that was not a big surprise to anyone.  The bottom line is China seems to have arrested some of the decline that was evident in the summer and fall periods.  Whether that turns to robust growth is still very much open for debate.

SGK Blog--Update November 30, 2012 Fiscal Cliff Countdown Continues  

It is just 31 days until we potentially careen off the fiscal cliff so it remains the central focus of attention as traders once again are paying very close attention to the words and actions taken by our political leaders. For example, overshadowing positive news Tuesday on U.S. housing coinciding with announcements on progress being made in Europe, were comments from majority Senate leader Harry Reid when he said little progress had been made to date to avert the fiscal cliff and specifically, “we only have a couple of weeks to get things done so we have to get away from the happy talk and do specific things.” Well we would agree with that and we would hope and expect that political leaders are working around the clock to resolve the potential crisis. That may simply be too much to expect – at the same time it is difficult to conceive of them actually coming to a broad agreement over the next two weeks. Obviously from his comments they do not plan on working weekends! 

On Tuesday we had surprisingly upbeat news on the U.S. economy as durable goods orders came in flat which was better than the -0.4% expected. Excluding the transportation sector (airplane orders tend to be erratic and can skew the figures fairly dramatically from month-to-month), the figure came in at +1.5% which was a solid beat over the -0.4% expected. The news on the housing front continued to be good as housing prices climbed in the year ending in September by 3.0%, the most since July 2010. That in part explains the figure for consumer confidence which climbed to 73.7 for November which was the highest in 4 years and better than expected despite hurricanes and fiscal cliffs! Thank goodness for the resilient and happily spending American consumer! On-line sales on “cyber-Monday” apparently increased 28% year-over-year according to a report from IBM so the Thanksgiving holiday proved to be a robust one for retailers. This just proves to us that a) the American consumer is oblivious to the fiscal cliff or b) they will simply worry about it after Christmas or c) they can’t really believe that our politicians would be so blatantly incompetent to allow us to actually go over it! Anyway, despite all the good economic news and news coming from Europe Tuesday, Harry Reid managed to send the major indices lower with his simple but probably realistic comments with respect to the lack of progress on the all important cliff issue. 

In Europe, finance ministers agreed to cut the rates made under the first bailout of Greece in May 2010. They also suspended interest payments for a decade on lending agreed under the country’s second bailout. The ministers outlined a plan for the Mediterranean nation to buy back its debt at distressed rates. They authorized Greece to receive a 34.4 billion euro ($44.6 billion) loan installment in December. “All initiatives decided upon today will bring Greece’s public debt clearly back on a sustainable path,” Luxembourg Prime Minister Jean-Claude Juncker told reporters in Brussels after chairing a 13 hour meeting that ended early Tuesday. This certainly helped the European bourses in Tuesday trading and perhaps the happiest country of all was Spain as it also facilitated a robust auction of their debt in a relief rally as their yields declined. In fact both Spanish and Italian bond yields dropped to 8 month lows this week at auctions based on the news coming from the finance ministers regarding Greece. 

In other economic news this week, further dampening enthusiasm for equities in Wednesday trading was the release of information on new home sales for October which surprisingly weakened. Sales dropped 0.3% to 368,000, a far cry from the estimate for 388,000. Additionally, the figure for September was reduced to 369,000 from the previously reported 389,000 pace. All-told this was disappointing to say the least as the majority of housing data we have received recently has been positive and relatively robust. The median price for a new house did climb 5.7% in October from the same month last year to $237,700 so that was a move in the right direction. Now we would add that data from the Northeast did seem to drop an unusually high amount dragging down the national figures as it declined 32.3% which may be partially attributed to hurricane Sandy. Initially, traders focused on the headline number but the selling subsided as they dug deeper into the data. Third quarter figures for gross domestic product (second estimate) came in about as expected at 2.7% as did the figure for initial weekly jobless claims ending 11/24/12 at 393,000, still at elevated levels due to the a