About Us
Wealth Management
Contact Us


Please remember that past performance may not be indicative of future results. Different types of investments involve varying degrees of risk, and there can be no assurance that the future performance of any specific investment, investment strategy, or product (including the investments and/or investment strategies recommended or undertaken by Steigerwald, Gordon & Koch, Inc.), or any non-investment related content, made reference to directly or indirectly in this blog will be profitable, equal any corresponding indicated historical performance level(s), be suitable for your portfolio or individual situation, or prove successful. Due to various factors, including changing market conditions and/or applicable laws, the content may no longer be reflective of current opinions or positions. Moreover, you should not assume that any discussion or information contained in this blog serves as the receipt of, or as a substitute for, personalized investment advice from Steigerwald, Gordon & Koch, Inc. To the extent that a reader has any questions regarding the applicability of any specific issue discussed above to his/her individual situation, he/she is encouraged to consult with the professional advisor of his/her choosing. Steigerwald, Gordon & Koch, Inc. is neither a law firm nor a certified public accounting firm and no portion of the blog content should be construed as legal or accounting advice. A copy of the Steigerwald, Gordon & Koch, Inc.’s current written disclosure statement discussing our advisory services and fees is available for review upon request. Please Note: Steigerwald, Gordon & Koch, Inc. does not make any representations or warranties as to the accuracy, timeliness, suitability, completeness, or relevance of any information prepared by any unaffiliated third party, whether linked to Steigerwald, Gordon & Koch, Inc.’s web site or incorporated herein, and takes no responsibility therefore. All such information is provided solely for convenience purposes only and all users thereof should be guided accordingly.


Markets End Quarter on a Choppy Note  

June 30, 2017 

**An unexpected decline in U.S. orders for business equipment in May indicates cooling capital-goods investment may weigh on second-quarter economic growth, Commerce Department data showed Monday. Orders for non-military capital goods excluding aircraft fell 0.2% (the estimate was for a 0.4% gain) after a 0.2% increase in the prior month. Shipments of those goods, which are used to calculate gross domestic product, fell 0.2% after 0.1% gain the prior month. Bookings for all durable goods fell 1.1% (the estimate was for a 0.6% drop) following 0.9% decline in the previous month.   Excluding transportation equipment demand, which is volatile, orders rose 0.1% (the estimate was for a 0.4% gain). The broad slowdown in equipment orders and shipments raises the risk that business investment will provide less of a boost than anticipated to the economic rebound this quarter, leaving the heavy lifting to household spending. The outlook for capital-goods production is clouded by cooling automobile sales, while overseas markets -- though improving -- are yet to show the kind of demand acceleration that would spur exports of U.S. made goods. In addition, some companies may be waiting for clarity on more favorable tax policies from Congress before stepping up investment. 

We had a couple of Fed governors giving speeches this week with comments that were worthy of note. New York Fed President William Dudley indicated that easier financial conditions support the Fed tightening policy. A muted market response to plans to shrink Federal Reserve’s balance sheet “suggests that these communications have generally been effective in fostering an orderly adjustment in expectations about how we are likely to normalize our balance sheet,” he went on to say. “Monetary policymakers need to take the evolution of financial conditions into consideration,” Dudley said in remarks delivered Sunday at the Bank for International Settlements’ Annual General Meeting, in Basel, Switzerland and posted online Monday. “For example, when financial conditions tighten sharply, this may mean that monetary policy may need to be tightened by less or even loosened. On the other hand, when financial conditions ease, as has been the case recently, this can provide additional impetus for the decision to continue to remove monetary policy accommodation.” Additionally, Federal Reserve policy maker John Williams also spoke this week indicating he sees interest rates rising as inflation moves up. He made the case Monday for further gradual increases in interest rates, saying he expects inflation to rise to the central bank’s 2 percent target next year as unemployment edges lower. “Gradually raising interest rates to bring monetary policy back to normal helps us keep the economy growing at a rate that can be sustained for a longer time,” Williams said in remarks prepared for delivery at the University of Technology Sydney. The comments by the president of the Federal Reserve Bank of San Francisco suggest that he’s lining up with Fed Chair Janet Yellen, his predecessor at the bank, in an emerging debate on how to respond to an easing in inflation during the last few months. While some Fed officials have argued for a pause in the rate-hiking campaign to wait for clearer signs that inflation is indeed headed higher, Yellen has played down the significance of recent weak price data and suggested that the Fed remains on course for higher rates. Williams seemed to agree. “Some special transitory factors have been pulling inflation down,” he said. “But with some of these factors now waning, and with the economy doing well, I expect we’ll reach our 2 percent goal sometime next year.” 

Those special factors include a steep drop in the cost of mobile-phone services. That helped pull down the Fed’s favorite inflation gauge to 1.7 percent in April from 1.9 percent in March and 2.1 percent in February. Williams also saw a danger in the Fed allowing the unemployment rate to fall too far. “The very strong labor market actually carries with it the risk of the economy exceeding its safe speed limit and overheating, which could eventually undermine the sustainability of the expansion,” he said. At 4.3 percent in May, the U.S. jobless rate was already below what Williams thinks is its long-run sustainable rate of 4.75 percent. And he sees it dropping some more. “Given the strong job growth we’ve been seeing in the United States, I expect the unemployment rate to edge down a bit further and remain a little above 4 percent through next year,” Williams said. The Fed earlier this month raised interest rates for the second time this year. Policy makers have penciled in one more rate increase for 2017 and three more for 2018, according to projections released after their June 13-14 meeting. Williams is not a voting member of the Federal Open Market Committee this year but will vote in 2018. Williams affirmed the Fed’s intention to begin trimming its $4.5 trillion balance sheet this year, saying the central bank would start off “nice and easy.” The aim will be to gradually reduce bond holdings in a widely telegraphed and predictable fashion, he said. “I hope I’ll not be perpetuating an unfair stereotype about economists if I say that ‘boring’ is a virtue,” Williams said. “Indeed, my new mantra is, ‘Boring is the new exciting.’”  It’s nice to see a Fed governor with a sense of humor! 

In European Central Bank news, Mario Draghi called for continued euro-area stimulus this week even as the economy enters a new phase in its upturn, saying support is still needed to entrench the trend. “All the signs now point to a strengthening and broadening recovery in the euro area -- deflationary forces have been replaced by reflationary ones,” the European Central Bank president said on Tuesday in Sintra, Portugal. “However, a considerable degree of monetary accommodation is still needed for inflation dynamics to become durable and self-sustaining. So for us to be assured about the return of inflation to our objective, we need persistence in our monetary policy.” The comments at the annual ECB Forum reflect the intensifying public debate over whether the central bank should continue pumping liquidity into the financial system after more than four years of economic growth and improving resilience.  Policy makers didn’t use their latest policy meeting to discuss whether to wind down their 2.3 trillion-euro ($2.6 trillion) bond-buying program, which is scheduled to run until the end of this year, meaning investors may get relatively short notice of any change. The euro jumped as Draghi said that most factors damping inflation are temporary. The Governing Council used its June 8 meeting to say that risks to growth are now broadly balanced instead of tilted to the downside, and dropped its expectation that interest rates might be cut again. Draghi acknowledged that further changes in the policy stance are coming, but said they should be slow. “In the past, especially in times of global uncertainty, volatility in financial market prices has at times caused an unwarranted tightening of financial conditions,” he said. “So in the current context where global uncertainties remain elevated, there are strong grounds for prudence in the adjustment of monetary-policy parameters, even when accompanying the recovery. Any adjustments to our stance have to be made gradually, and only when the improving dynamics that justify them appear sufficiently secure.” The ECB president did leave room for policy steps that would signal a reduction in the pace of stimulus, without necessarily tightening financial conditions. That could encourage more hawkish members of the Governing Council to push for action. “As the economy continues to recover, a constant policy stance will become more accommodative,” Draghi said. “The central bank can accompany the recovery by adjusting the parameters of its policy instruments -- not in order to tighten the policy stance, but to keep it broadly unchanged.” We respect Mario Draghi and his position – traders seem to also have a great deal of confidence in his ability to lead the central bank. 

In other European news, euro-area economic confidence jumped to the highest level in a decade as the European Central Bank edged toward unwinding unprecedented stimulus. An index of executive and consumer sentiment rose to 111.1 in June from 109.2 in May, the European Commission in Brussels said Thursday.  The reading is the strongest since August 2007 and compares with a median estimate of 109.5 in a Bloomberg survey of economists. The report comes two days after ECB President Mario Draghi confounded investors by arguing that there’s room to adjust stimulus measures as the economy improves, even though he called for prudence and patience.  A gauge for private-sector activity signaled the euro-area economy recorded its fastest expansion in six years in the second quarter as business confidence in Germany hit a record and consumer sentiment in France surged. 

The job market continues to boost U.S. consumer confidence as expectations rise. An unexpected rebound in U.S. consumer confidence reflects a buoyant labor market and improved business conditions, though Americans are slightly less optimistic about where things will be in six months, data from the New York-based Conference Board showed Tuesday. The Confidence index rose to 118.9 (the estimate was for 116) from 117.6 in May. The present conditions measure increased to 146.3, highest since July 2001, from 140.6 the prior month. The gauge of consumer expectations for the next six months fell to 100.6, the lowest level since January, from 102.3 the previous month. Americans are drawing encouragement from an economy that continues to provide jobs, rising stock and home prices and steady pay gains, as the share of respondents expecting higher incomes was the second-highest since 2002. At the same time, the easing of the overall expectations index adds to other sentiment figures that suggest mounting skepticism about the ability of Washington lawmakers to enact economic policies that will drive growth. “Expectations for the short-term have eased somewhat, but are still upbeat,” Lynn Franco, director of economic indicators at the Conference Board, said in a statement. “Overall, consumers anticipate the economy will continue expanding in the months ahead, but they do not foresee the pace of growth accelerating.” 

Sustained increases for home prices in 20 U.S. cities in April indicate the housing industry is juggling stable demand with a shortage of inventory, figures from S&P CoreLogic Case-Shiller showed Tuesday. The 20-city property values index rose 5.7% year-over-year (the estimate was for a 5.9% gain). The national price gauge increased 5.5% year-over-year. The seasonally adjusted 20-city index climbed 0.3% month-over-month (the estimate was for a 0.5% increase). Stubbornly low inventory in housing, particularly for more affordable properties, has helped drive steady home-price gains. While rising property values are helping cushion homeowners’ balance sheets, they also are inhibiting lower-end buyers, especially first-timers, from getting a piece of the action, as wage gains haven’t kept pace. At the same time, industry demand remains healthy, with solid job gains and low mortgage rates supporting purchases. “Since demand is exceeding supply and financing is available, there is nothing right now to keep prices from going up,” David Blitzer, chairman of the S&P index committee, said in a statement. “The supply of homes for sale has barely kept pace with demand and the inventory of new or existing homes for sale shrunk down to only a four-month supply. All 20 cities in the index showed year-over-year gains, led by a 12.9 percent advance in Seattle and a 9.3 percent rise in Portland, Oregon.  

The U.S. economy’s first-quarter growth was less tepid than previously reported, as consumer spending and trade added more to expansion, Commerce Department data showed Thursday. Gross domestic product rose at a 1.4% annualized rate (the forecast and previous estimate were for 1.2%). Consumer spending, the biggest part of the economy, rose 1.1% (the forecast and previous estimate were for 0.6%). Exports grew at a 7% rate, which was revised up from the prior estimate of 5.8% growth. While the revision was more positive than most analysts anticipated, the report still underlines a relatively weak start to the year, with consumer spending growing at the slowest pace since 2013.  Weather and other temporary factors in the period, along with rising wages and salaries, support the idea of a consumer-led rebound in the second quarter.  Federal Reserve policy makers raised interest rates earlier this month, seeing the first-quarter slowdown as transitory as the labor market improves further. The Commerce Department attributed the latest upward revision to spending data for financial services, insurance and health care.  Exports of industrial supplies and materials were higher than previously reported, boosting trade’s contribution to expansion in the period. Analysts estimate the U.S. economy will grow at a 3 percent rate in the April-to-June period, though the slowdown in equipment orders and shipments reported earlier this week raises the risk that business investment will provide less of a boost than anticipated.  Cooling automobile sales and a housing sector limited by a scarcity of affordable homes also remain headwinds for the economy this year. 

As always, stay tuned!

SGK Blog--Update November 23, 2016: Happy Thanksgiving from All of Us at SGK Wealth Advisors!!

SGK Blog--Update November 23, 2016: Happy Thanksgiving from All of Us at SGK Wealth Advisors!!

Technically the trading week is not over yet as both the stock and the bond market are open Friday the 25th until 1 pm. There is so little volume on that day typically, we elect to give our staff an extra day off to enjoy the Thanksgiving break and spend it with their families. We wish you all well and safe travels if you are flying or embarking on a road trip. We at SGK really appreciate your business and thank you for referrals to friends, family and business associates. 

For a short week, there was a decent amount of economic data released here in the U.S. The dollar strengthened and Treasuries retreated after better-than-estimated durable goods orders bolstered the outlook for quickening the pace of raising interest rates. The dollar gained against all but one of its 16 major peers after orders for U.S. business equipment climbed in October for the fourth month in the last five. Bookings for non-military capital goods excluding aircraft -- a proxy for future spending on items like computers, engines and communications gear -- rose 0.4 percent, Commerce Department data showed Wednesday.  The median forecast of economists surveyed by Bloomberg called for a 0.3 percent gain.  Demand for all durable goods -- items meant to last at least three years -- jumped 4.8 percent on a surge in orders for commercial aircraft. The figures signal a gradual turn in investment spending that has suffered from contraction in the energy sector, an inventory overhang and weak export demand.  While a recent surge in the dollar may become a headwind for equipment makers, prospects of more infrastructure development improve the outlook for capital outlays in the coming year. 

Consumer confidence rose more than previously reported to a six-month high in November, showing Americans became more optimistic about their finances and the economy after Donald Trump won the presidential election. The University of Michigan said Wednesday that its final index of sentiment rose to 93.8 from 87.2 in October, after a preliminary reading of 91.6 that reflected pre-election views. The split was stark between respondents in the month’s survey before and after the Nov. 8 vote, with sentiment rising 8.2 points in the post-election group from the pre-election cohort. The lift suggests that Americans were heartened on the whole by Trump’s victory over Democrat Hillary Clinton, with broad gains in confidence across incomes, ages and regions, according to the report.  At the same time, the increase may reflect a “honeymoon” period that could fade unless actual economic conditions improve, said Richard Curtin, director of the Michigan survey. 

Minutes of the Federal Reserve’s November policy meeting confirmed that officials were creeping closer to their first interest-rate increase in a year before the Nov. 8 election, and developments since have only served to bolster the case for a hike. The record of the Nov. 1-2 meeting, during which policy makers left the federal funds rate target in a range of 0.25 percent to 0.5 percent, was released at 2 p.m. Wednesday in Washington. Inflation was firming and the job market continued to post gains in the run-up to the meeting, but the U.S. presidential election loomed as a potential risk. Republican Donald Trump won the contest and his party retained control of Congress, which markets have taken as paving the way for more fiscal policy action that will lift inflation.  Since Trump’s victory, investors increased their bets on a move and now see a 100 percent probability that the Fed will act, according to pricing in federal funds futures contracts. 

Sales of previously owned U.S. homes unexpectedly climbed in October to the highest level since February 2007, a sign of momentum in the housing market a month before a jump in borrowing costs, National Association of Realtors data showed Tuesday. The actual contract closings rose 2 percent to a 5.60 million annual rate versus the forecast for 5.44 million. Actual sales increased 0.5 percent from October 2015 before the seasonal adjustment and the median sales price rose 6 percent from October 2015 to $232,200. Also, the inventory of available properties fell 4.3 percent from October 2015 to 2.02 million, marking the 17th straight year-over-year decline. It appears that steady hiring, a pickup in incomes, and better household finances are propelling demand in the repeat sales market, even as a shortage of available properties limits choices and pushes up prices.  Bigger advances may prove difficult after a surge in mortgage rates on speculation President-elect Donald Trump’s economic plans will spark inflation.  Higher borrowing costs could discourage first-time buyers who may already have trouble qualifying for a loan --a hurdle for further improvement in the housing recovery. On that note, purchases of new U.S. homes declined in October to a four-month low, showing the residential real estate market for new homes began to soften a month prior to a jump in borrowing costs. Sales decreased 1.9 percent to a 563,000 annualized pace, Commerce Department data showed Wednesday.  The median forecast in a Bloomberg called for a 590,000 rate. The government’s new-home data, while volatile from month to month, have been advancing in uneven fashion over the last five years, bolstered by steady job gains and income growth.  As mentioned, the overall market now faces a test after mortgage rates climbed last week by the most since mid-2013.  

Filings for unemployment benefits in the U.S. rebounded last week from a four-decade low while remaining consistent with a firm labor market. Jobless claims rose by 18,000 to 251,000 in the period ended Nov. 19, a Labor Department report showed Wednesday.  The median forecast in a Bloomberg survey called for 250,000 applications.  In the previous week that included the Veterans Day holiday, applications slumped to 233,000, the lowest since 1973. Companies have balked at outright dismissals as a tighter job market leaves fewer skilled workers available for open positions.  Filings for unemployment benefits have been below 300,000, a level synonymous with a thriving labor market, for 90 straight weeks -- the longest streak since 1970. 

On the global front, euro-area economic growth accelerated to its fastest pace this year as growing order books prompted companies to add more workers and raise prices. A Purchasing Managers’ Index for manufacturing and services rose to 54.1 in November from 53.3 a month earlier, IHS Markit said on Wednesday.  That’s the strongest level in 11 months and above the 50 mark that divides expansion from contraction. The signs that recovery is gathering momentum should give some relief to the European Central Bank as it faces a complex decision on Dec. 8 whether to extend its 1.7 trillion-euro ($1.8 trillion) quantitative-easing program.  President Mario Draghi said this week that the recovery remains reliant on continued monetary support. Germany continued to be a growth driver among euro-area economies and France was enjoying its best expansionary spell since the start of the year, according to Markit. The euro-area manufacturing PMI jumped to 53.7 in November, 34-month high, while a gauge for services rose to 54.1. IHS Markit said that companies are taking on staff at the fastest pace since early 2008.  Average prices charged for goods and services showed the biggest rise for more than five years as companies passed on higher input costs to customers. “The preliminary PMI results for November indicate the sharpest monthly increase in business activity so far this year, with plenty of signs that growth will continue to accelerate,” said Chris Williamson, chief business economist at IHS Markit.  “ECB policy makers will also be pleased to see inflationary pressures are intensifying steadily.” 

Overall, it was a pretty good week for economic data across the globe. As always, stay tuned!

SGK Blog--Update November 18, 2016: Markets Move Higher 

At a hearing on Capitol Hill in front of Congress’s Joint Economic Committee on Thursday, Federal Reserve Chairwoman Janet Yellen not only gave the markets another definitive indication of the direction of future interest rates but also made it clear where she stood on her term and the Fed’s role in the economy.  Yellen said a rate increase could come “relatively soon” which largely reiterated what officials said following their November meeting earlier this month when only “some” further evidence was needed in the economy before raising rates again.  She stated, “U.S. economic growth appears to have picked up from its subdued pace earlier this year.”   

Her comments have been supported by more and more data pointing towards an uptick in prices, either soon or in the not too distant future.  Consumer prices, according to the Labor Department, rose for a third consecutive month.  Energy costs rose 3.5% with gasoline up 7% and accounting for more than half of the increase in the overall index.  Excluding volatile food and energy prices, the gauge rose 2.1% from October 2015, down just slightly from the 2.2% in the prior 12-month period.  Though overall producer prices fell month-to-month in an unexpectedly weak October according to Labor Department figures releases Wednesday, prices rose 0.8% from a year earlier, the fastest gain since December 2014.  A report released Tuesday showed that U.S. imports rose by the most in four months.  Housing starts surged 25.5% in October to a nine-year high reported the Commerce Department.  The increase from September was the biggest since July 1982 with multifamily-home building (townhouses and apartment buildings) up a stunning 68.8%.  Permits, a proxy for future construction, rose 0.3% and an index from the National Association of Home Builders/Wells Fargo remained near the highest level of the year based on figures released Wednesday.   

Against this backdrop, the labor market continued to show strength.  The Labor Department said that the fewest number of Americans since 1973 filed for unemployment benefits in the week ended November 12.  Continuing claims fell below 2 million to a 16-year low.  This is the 89th consecutive week when claims have come in below 300,000 which is a benchmark economists use as a proxy for future payroll expansion.  With only one more employment report before the Fed meets on December 14, even a figure below expectations—assuming it is not drastically horrible like a negative number—is unlikely to change the course the Fed will take next month.  The futures market is assigning a 98% probability to a 0.25% hike.  When probabilities reach that high, they are a virtual lock. 

The Fed will have to take into account any fiscal stimulus which Congress will unleash.  Potential tax cuts and increased government spending for infrastructure would put greater pressure on the deficit.  In response, Yellen stated: “…with the debt-to-GDP ratio at around 77% there is not a lot of fiscal space should a shock to the economy occur, an adverse shock that did require fiscal stimulus.”  She also mentioned the elephant in the room of every Fed meeting—productivity.  It has been “exceptionally slow” over the past decade, and it serves as the greatest long-term threat to the economy.  Lower interest rates alone are not going to solve this problem.  Investment in both human capital (more and better access to educational programs to enhance skilled labor) and technological breakthroughs (R&D, grants, public/private partnerships) are the two undisputed keys to better overall productivity yet the execution of that message has not happened for one reason or another.  That is a job for Congress who frankly need to stop worrying about what side of the aisle someone is on and figure out how we all can do better.  

In response to a question of whether she will join the ranks of others in federal posts who have stepped down following the election, Yellen said, “I was confirmed by the Senate to a four-year term, which ends at the end of January of 2018, and it is fully my intention to serve out that term.”  That squashes any rumors that she may be pressured into relinquishing her role though President-elect Trump and some of his advisors have hinted that she probably would not be reappointed when her term is up.  We have often espoused that election outcomes have little long-term effect on the markets and continue to hold by that theory emphasizing that cash flows and interest rates have a much more profound influence.  One qualification to that view is when it comes to the independence of the Federal Reserve and its Open Market Committee.  The U.S. monetary system is, by far, the envy of the world because of the confidence that investors place in its independence and stability.  Its dogged pursuit of its mandate regardless of political or economic climate is religiously followed.  As Yellen stated this week: “And sometimes central banks need to do things that are not immediately popular for the health of the economy.”  Should that come under attack for purely political reasons, the results will be devastating.  Fed officials are appointed by the president and will obviously have a certain political leaning.  However, even with January 2018 nearly two years away, it would be a dire mistake now or then to challenge that status that the Fed is full of independent thinkers who, though they may not be the best forecasters in history, at least come to their own conclusions void of promoting any agenda, agitating any platform or fulfilling any campaign promises.  And, just to add fuel to the fire, Ms. Yellen is the first woman to head the Fed in its 100-year-plus history during a campaign which saw the first major party female candidate lose the election while winning the popular vote.  And you thought the November 2018 election would be the next political flash point!

SGK Blog--Update November 11, 2016:  U.S. Equity Markets Close Sharply Higher for the Week  

Well when we were tracking the election results in the middle of the night Tuesday and the tide turned clearly in Donald Trump’s direction, we witnessed the Dow futures down over 800 at one point. Bond futures were rallying sharply. Interestingly, when stocks opened for trading Wednesday morning, the stock indices were very stable despite the overnight volatility and interest rates actually climbed on the election result. Why you might ask? When it became clear the Republican Party would control not only the Presidency, but also both houses, analysts started to digest what it may actually mean for the economy. We frequently remind clients that politics over extended periods of time tend not to influence markets much when compared with corporate earnings and interest rates.   Actions by the Federal Reserve on interest rates has more of an impact on market direction than whoever occupies the White House. Several analysts on the morning business news shows made the point that many Republican policies were pro-growth leaning. Both Republican candidates and Trump himself have talked about lowering personal income tax rates across the board along with significantly reducing corporate tax rates. These policies tend to provide stimulus to the economy and actually help corporate earnings. We witnessed the yield curve actually sharply steepen in early Wednesday trading on anticipated economic growth and higher inflation. Trump himself has indicated he leans towards spending on infrastructure for highways and roads for example, a position President Obama has spoken of the need for as well. Federal Reserve governors have frequently spoken of the need to provide fiscal stimulus to promote growth to complement their efforts through interest rate policy. The bottom line is, throughout the morning in the pre-market and when trading opened, we witnessed a gradual move higher in stock indices and a move upwards in both interest rates and the slope of the yield curve. An interesting reaction for sure! 

As we have written as well, our portfolios that we construct for clients are designed to weather a variety of potential outcomes and headwinds. Utilizing high quality investment grade bonds and high quality investment grade stocks that pay higher than market average dividends has been an excellent recipe for success for us in our clients’ portfolios – our families are clients of our firm as well. We put a strong emphasis on an appropriate balance and healthy diversification across sectors. Also, we control positions sizes so our clients’ portfolios do not have too much exposure to a given company or a given sector. This lends itself to greater stability in our portfolios when compared with the broader indices and portfolios we take over from other firms – and there have been a lot of those lately! J   (Thank you all for your referral activity!) 

In our opinion, and this will be our last comment on the election as we are confident you are all sick and tired of it and thankful it is now over, it was very refreshing to see both candidates show class after the bitterness of the campaign by accepting the outcome graciously. Also, President Obama and both candidates reminded us we are all Americans and it is important to work together to bring us closer – not to further divide us. Markets hate uncertainty, the fact that the result was very certain – no recounts, lawsuits or close calls – meant that traders could focus on the fundamentals and what the outcome meant, as opposed to worrying about how long the aftermath might drag on for, or whether one party or candidate would accept the outcome or not. We had closure in a certain sense after all the tension in the build-up to the actual voting day – so call Wednesday’s market move a partial relief rally as well. 

Now on to important matters with respect to the economy and our specific securities! This week we had very little U.S. economic data out as is typical in an election week. Filings for U.S. unemployment benefits declined from an almost three-month high ahead of the presidential election, indicating the job market remains competitive for employers. Jobless claims fell by 11,000 to 254,000 in the week ended Nov. 5, a Labor Department report showed Thursday in Washington. The median forecast in a Bloomberg survey called for 260,000. Continuing claims rose, though the four-week average dropped to the lowest since 2000. Steady progress in the U.S. in the labor market has kept layoffs near a four-decade low, as managers resist firings in face of a shrinking pool of qualified applicants. The figures come on the heels of last week’s monthly jobs report showing employers continued to add to payrolls at a steady pace in October. A second report this week showed consumer confidence increased for a third straight week as Americans grew more upbeat about the economy than at any time since the start of the year, figures from the weekly Bloomberg Consumer Comfort Index showed Thursday. The comfort gauge rose to 45.1 in the week ended Nov. 6 from 44.6 the prior week. The index has climbed 3.8 points in last three weeks which is the strongest advance over a similar period since October 2015. The measure of views on economy climbed to 37.7 from 36.9, which is the highest since Jan. 17. The personal finances measure rose to 58.5 from 57.5. This can be interpreted as the sanguine views about the economy and personal finances show Americans were looking beyond Tuesday’s presidential election, laying the ground for a pickup in household purchases. A tightening labor market is beginning to fuel the wage gains needed to sustain increases in the spending that fuels economic growth. 

It certainly was an interesting week. As always, stay tuned!

SGK Blog--Update November 4, 2016:  Fed Still on Hold With Elections Next Week 

With less than a week before a contentious U.S. presidential election, the Federal Reserve decided to stay apolitical with its stay the course announcement this week following their regularly scheduled two-day Open Market Committee meeting.  The federal-funds rate range remained 0.25%-0.50%.  Yet the Fed governors appear quite close to nudging that range higher, saying they only needed “some further evidence” of economic progress before moving higher.  What is this mysterious “some”?  They used the same term following their July 2015 meeting which ended up being half a year before finally pulled the trigger in December last year.  The futures market is assigning a 76% chance to a rate hike at the next meeting on December 14 but might we wait another six months?  That’s unlikely for a number of reasons.

First, there are more dissenters this time around compared to last summer.  Kansas City Fed President Esther George and Cleveland Fed President Loretta Mester cast dissenting votes on Wednesday, preferring the Fed to raise rates a quarter point instead of doing nothing.  This marks the fifth dissent this year for Ms. George and the second for Ms. Mester.  At the September meeting, there were actually three dissenters.  Eric Rosengren, Boston Fed President, voted with the majority this time.   Though Janet Yellen remains the chair and far-and-away most recognizable member of the voting group, she must build consensus among the 10 members who vote.  If the markets were to see a 5-5 tie, investors would believe that such uncertainty is worthy of selling first and asking questions later.  A “taper tantrum” that would benefit no one.  Based upon the minutes of recent meetings, many Fed presidents seem more on the fence than solidly in one camp or another so pushing a majority to raise the range does not seem like a monumental task. 

Second, employment continues to be solid.  On Thursday, weekly initial unemployment claims from the Labor Department rose higher than expected, but they remain at the lowest level in several decades.  Claims have stayed below 300,000 for an incredible 87 consecutive weeks, which is the longest stretch since 1970.  The Labor Department reported today that nonfarm payrolls rose 161,000 in October and a net total of 44,000 additional jobs were added to revised figures for the previous two months.  The median survey in a Bloomberg poll called for a 173,000 October advance, but considering the large amount of revisions, the tone of the report cannot be considered disappointing.  Excluding government jobs, private sector payrolls advanced 142,000 which was a solid addition.  The unemployment rate dropped to 4.9% from 5.0% returning to the level it reached in August.  The U-6 unemployment figure, which is considered the underemployment rate because it includes “marginally attached workers and those working part-time for economic reasons”, fell to 9.5% from 9.7% last month.  This is the lowest reading since April 2008 when it reached 9.2% and the current reading is slightly below the 12-month moving average of 9.7%.  The U-3 unemployment rate is the “official” rate and one cited most often but the U-6 is important because it shows those on the fringe of the labor force and is used by economists almost as a leading indicator.  Once these individuals become more solidly attached to the workforce it bodes for further increases in labor similar to how acceleration or deceleration measures how the speed of a car changes.  So it appears as if the gas pedal is being pushed down harder judging from these stats, another factor favoring an increase. 

Third, signs of inflation are not omnipresent but are a little more than just anecdotal.  The employment report showed that average hourly earnings jumped 0.4% last month, better than the expected 0.3% boost and higher than the upwardly revised September figure of +0.3% (from +0.2% previously estimated).  That means over the last 12 months, average hourly earnings advanced by 2.8%, the highest pace of growth since June 2009.  Consumer purchases rose in September by the most in three months as incomes grew according to the Commerce Department.  The 0.5% rise in spending, following a 0.1% decline in the prior month, was above the 0.4% median expected in a Bloomberg survey of economists.  Nominal incomes rose 0.3% and the savings rate decreased to 5.7% from 5.8%.  The personal consumption expenditure (PCE) deflator—the Fed’s preferred measure of inflation—rose 0.2% for the month and the core rate—excluding energy and food—was up by 0.1%.  That brings the 12-month pace of overall inflation to 1.2%, slightly higher than August’s 1.0% pace, and core inflation to 1.7%, the same as the prior month.  Neither PCE metric, therefore, has reached the Fed’s 2.0% target level.  The last time both of these measures met that hurdle was April 2012 when the headline PCE annual deflator was 2.1% and the core was 2.0%.  Since that time, the 12-month average has been 1.2% for the headline and 1.6% for the core.  These figures are way better than we have seen in other developed areas like the Eurozone and Japan, but since they have not yet moved appreciably higher, there still remains some doubt as to when they will.  The bond market is suggesting they are moving in that direction with the yield on the benchmark 10-year Treasury note hovering near the high end of its 3- and 6-month range.  There will be one more personal income and spending report and one more employment report before the December Fed meeting so the picture could become potentially clearer by then.  Nevertheless, the Fed decided to omit previous language from its statement saying that inflation would probably “remain low in the near term.”  Stay tuned to see if their crystal ball is seeing things that will occur or events that they hope will occur.  A lot more than the election is riding on them being right.

SGK Blog--Update October 28, 2016:  Strong Corporate Earnings & Healthy U.S. Economic Data Keep Markets Stable

Stocks and bonds held steady this week with generally upbeat corporate earnings and signs of improvement in the world’s biggest economies. The Stoxx Europe 600 Index and the MSCI Asia Pacific climbed to their highest levels in more than two weeks. The Aussie (Australia dollar) led gains among the currencies of resource-exporting nations, while the Bloomberg Dollar Spot Index held near a seven-month high. Rising steel output and prices in China spurred jumps in zinc and iron ore, while Japanese bonds rose after demand firmed at an auction. About 80 percent of S&P 500 Index companies to have announced earnings so far exceeded analysts’ forecasts and that’s supporting investor sentiment as improving U.S. economic indicators bolster the case for the Federal Reserve to raise interest rates. American manufacturing is the strongest in a year and the euro area economy is expanding at the fastest pace of 2016, data showed Monday. Big name companies reported results this week as Apple Inc., the world’s biggest company, released results on Tuesday and second-ranked Alphabet Inc. reported Thursday.

Home prices in 20 major U.S. cities continued to rise at a steady pace in August, according to data Tuesday from S&P CoreLogic Case-Shiller. The 20-city property values index increased 5.1 percent from August 2015 (forecast was 5 percent) after climbing 5 percent in the year through July. The national home-price gauge was up 5.3 percent from 12 months earlier. On a monthly basis, the seasonally adjusted 20-city measure rose 0.2 percent from July. Home prices have been rising at a pace of around 5 percent for two years, supported by continued hiring, rising wages and low-cost mortgages amid a limited supply of houses, especially on the cheap end. The report follows more timely data showing sales of previously owned homes increased more than projected in September, helped by a bigger share of first-time buyers, considered vital to the housing recovery.  Higher prices may persuade more owners to put their properties up for sale and alleviate shortages. “Supported by continued moderate economic growth, home prices extended recent gains,” David Blitzer, chairman of the S&P index committee, said in a statement. “Other housing data including sales of existing single family homes, measures of housing affordability, and permits for new construction also point to a reasonably healthy housing market.” We would agree with his conclusions – we will see what impact a rate increase the Fed is potentially going to make in December will have. 

Consumer confidence in the U.S. declined more than forecast in October as households became less upbeat about the economy and labor market, figures from the New York-based Conference Board showed Tuesday. The Confidence Index decreased to a three-month low of 98.6 (forecast was 101.5) from a revised 103.5 the prior month. The present conditions gauge fell to 120.6 from 127.9 the previous month. A measure of consumer expectations for the next six months declined to 83.9 from 87.2 and the share of those who said jobs were currently plentiful decreased to 24.3 percent from 27.6 percent. Sentiment merely corrected after a recent run-up. Less optimism about the labor market coincides with a recent slowdown in hiring as companies adjust to a slower pace of demand from businesses and overseas customers. The Conference Board’s figures also showed Americans have a more tempered view of business conditions. At the same time, households are still relatively upbeat about their income prospects, which will help keep consumer spending on a solid pace. 

Tracking estimates of third-quarter U.S. growth are rising because of a shrinking merchandise trade deficit, though a drop in September imports shows a step back in underlying demand in the economy. The goods-trade gap narrowed 5.2 percent to $56.1 billion in September, the smallest since March, based on Census Bureau data, while figures on wholesale and retail inventories showed increases, according to a preliminary report issued Wednesday by the Commerce Department. Barclays Plc analysts boosted their tracking estimate of gross domestic product to 3 percent from 2.6 percent as a result. Even with the boosts to forecasts, the government’s first estimate of GDP on Friday may reflect a tempering of demand, given that imports of industrial supplies, capital goods and consumer merchandise all declined in September from the previous month. The data also show that an earlier surge in food exports, bolstered by sales of soybeans, was temporary and will “continue to unwind,” according to Citigroup Inc. analysts. 

Purchases of new U.S. homes in September stayed close to an almost nine-year high, showing residential real estate was maintaining momentum heading into the quieter selling season. Sales climbed 3.1 percent to a 593,000 annualized rate from an August pace that was weaker than initially reported, Commerce Department data showed Wednesday. The median forecast in a Bloomberg survey called for 600,000 pace in September. Purchases in June and July were revised lower. Durable employment gains and historically low mortgage rates are combining to lift housing demand, paving the way for homebuilding to contribute to economic growth. An acceleration in incomes and construction of entry-level properties would help provide an additional spark for the market. 

Durable goods orders for September here in the U.S. fell 0.1 percent (forecast was no change) after a revised 0.3 percent advance the prior month. Orders for non-defense capital goods excluding aircraft slumped 1.2 percent, erasing the revised 1.2 percent August increase. Shipments of non-military capital equipment minus planes rose 0.3 percent after little change the previous month. The bottom line is business investment has been mired in a slump, with few signs of any real get-up-and-go. The drop in capital goods bookings -- a proxy for future corporate spending on computers, engines, communications gear and the like -- was a reminder businesses remain cautious. Shipments of such goods, which go into calculating gross domestic product, declined an annualized 4.4 percent for the quarter. That indicates a small drag on growth, a continuing contrast with consumers, whose spending has done most of the heavy lifting for the economy this year. Nonetheless, an annualized 5.2 percent increase in business equipment orders in the third quarter should be a sigh of relief for factories in coming months.              

Weekly jobless claims for the week ending October 22 fell by 3,000 to 258,000 (forecast was 256,000) while the four-week average was 253,000 compared with 252,000 the prior week. Continuing claims dropped to 2.04 million, the fewest since June 2000.  It appears hiring managers are holding onto their current workers in the face of a shrinking pool of skilled and experienced candidates. Claims continue to reflect favorable labor market conditions. While there’s been evidence of some hurricane-related filings in recent weeks in the southeastern U.S., the total remains near its lowest level since the 1970s, holding below 300,000 for 86 straight weeks.  

U.S. economic growth picked up in the third quarter after an uninspiring first half of the year as a build in inventories and a soybean-related jump in exports helped cushion softer household spending. The 2.9 percent annualized increase in gross domestic product, the value of all goods and services produced, was the biggest in two years and followed a 1.4 percent gain the prior quarter, Commerce Department data showed Friday.  The median forecast in a Bloomberg survey called for 2.6 percent growth. Consumer spending, the biggest part of the economy, rose a less- than-projected 2.1 percent. The data are in sync with the views of Federal Reserve policy makers that the economy is making slow and steady progress.  At the same time, solid employment and steady income gains are a sturdy base for households to continue in the role as the economy’s main driver of growth, a contrast with the drag from business investment. 

On a sour note to end the week, consumer confidence dropped more than previously reported to match the lowest level since 2014, with Americans less upbeat about both current and future conditions in the weeks before the presidential election. The University of Michigan said Friday that its final index of sentiment fell to 87.2 from 91.2 in September.  The median projection in a Bloomberg survey called for 88.2 after a preliminary reading of 87.9 earlier this month.  Long-term inflation expectations declined to a record low. The drop in sentiment suggests that consumer spending may continue to moderate after a separate report on Friday showed it was less of a driver for third-quarter economic growth than in the previous period.  While hiring has been solid and wages are rising, the uncertainty of the election could also be weighing on confidence.      

SGK Blog--Update October 21, 2016:  Earnings Season Continues 

On the economic front, a healthy amount of housing data was released this week.  Existing home sales for September rose more than forecast according to National Association of Realtors data distributed on Thursday.  Previously owned homes comprise over 90% of all residential transactions.  They are tabulated at the time of closing so there is a slight lag between when a deal is reached and when the transaction is actually counted for the record.  Versus a forecast of 5.35 annualized sales, contract closing rose 3.2% to a 5.47 million annual rate.  Year-over-year sales climbed 2.8% before seasonal adjustments.  The median sales price rose 5.6% to $234,200 as the amount of inventory dropped 6.8% from a year earlier.  Transactions increased in all four regions and, at the current pace, would take 4.5 months to sell the houses on the market, down from 4.6 months in August.  A level less than five months is considered a tight market according to realtors. 

This data contrasts with info from the Commerce Department concerning housing starts last month.  According to their data, residential starts fell 9% to a 1.05 annualized rate, the lowest since March 2015.  The National Association of Home Builders/Wells Fargo index of homebuilder sentiment fell in October from an 11-month high based on figures released on Tuesday.  Builders are complaining that construction is being constrained by a lack of available lots for building and a shortage of skilled workers.  Is the housing recovery stalling out?  This is only one month worth of data and given that building permits, a proxy for future construction, rose 6.3% to the fastest pace since November, that conclusion is not likely at this point.  Plus, the continued low mortgage rate environment and solid job creation picture bode well for future buyers.  Though weekly initial jobless claims rose according to the Labor Department, that was off a four-decade low level.  Hurricane Matthew may have affected some of the data, too, with several affected states showing a rise in filings before seasonal adjustments.  We are entering a seasonal housing slowdown as buyers and sellers take a break for end-of-year holidays and travel so data for the next few months is likely to be influenced more by seasonal adjustments than an actual trend change in the raw data.

We are also seeing baby steps of inflation showing up in price data.  The consumer price index (CPI) rose 0.3% in September from the previous month matching the forecast of economists according to the Labor Department.  The year-over-year increase was 1.5%, the most since October 2014.  Excluding the volatile food and energy components, the yearly gain was 2.2%, a slight dip from the 2.3% annual reading in August.  Housing costs, a large component of the index, continued to climb as well as prices for airfare.  The CPI includes the cost of all goods and services produced for the month, but it is not the Federal Reserve’s preferred measure.  That benchmark, the Commerce Department’s personal consumption expenditures (PCE) measure, was only 1.7% for August.  It is preferred because its weights are updated more frequently.  The more frequent updates, theoretically, make for a better basket of goods and services because it accounts for the substitution of items quicker.  For example, if beef prices go up, people buy more chicken, it is assumed.  The next release of the PCE is scheduled for Halloween.  Will we see something spooky in those figures?  October is an infamous month for chilling days.  It was October 19, 1987 that marked Black Monday when the Dow Jones Industrial Average fell 22% which still remains its sharpest single-day percentage plunge on record.  Hopefully nothing that bloodcurdling happens this time around!

SGK Blog--Update October 14, 2016: Fed Releases Minutes as Earnings Season Begins 

Minutes from the latest Federal Reserve meeting in late September were released on Wednesday.  Fed officials said they are prepared to raise rates “relatively soon” although the exact timing remains in question.  According to the minutes: “It was noted that a reasonable argument could be made either for an increase at this meeting or for waiting for some additional information on the labor market and inflation.”  There is a mounting evidence that the U.S. economy can withstand a hike.  The unemployment rate is hovering around 5% while consumer confidence hit a post-recession high last month.  But the Fed, increasingly cognizant of its effect on international monetary flows, must contend with the fact that the British pound continues to fall against a basket of global currencies as investors worry about the consequences of Brexit.  Should that continue, and the dollar moves higher, the Fed would being swimming against the tide of most central banks which are in easing mode while also hurting U.S. multinationals which derive sales and earnings overseas. 

There was also a growing divide among Fed members about the employment rate.  Some members believe that we are at “full employment” and the rate will not go much further.  Others, including Chairwoman Yellen and New York Fed President William Dudley, believe that a growing labor force participation rate means that the workforce is still going to expand to absorb those workers who were on the sidelines for so long.  That rate—which shows the share of adults working or actively looking for jobs—has risen in recent months but still remains near multi-decade lows.  There will be two more employment reports before the Fed’s December meeting so we could see a shift in this figure or in other key data points like average hourly earnings growth which has been rising at a solid 2%+ rate on an annual basis.  Yesterday, the Labor Department released another week of above-consensus weekly unemployment figures, and retail sales data released Friday from the Commerce Department rose in September by the most in three months.  This suggests that employers are reluctant to let go of workers, and those with jobs are spending their paychecks.

The odds of a rate hike at the December meeting according to the futures market is now at over two-thirds.  Two months ago, that probability was only 42%.  The next official Fed meeting is the second of November.  With the U.S. elections on the following Tuesday, it is highly unlikely the Fed will be do anything at that meeting or be accused of tampering with the outcome.  Republican nominee Donald Trump has already accused the Fed of keeping rates artificially low in order to help his Democratic opponent win over voters.  We view this as pretty close to preposterous.  In fact, if that was the case, we would assume the futures market would be calling for a 100% chance of a hike in November or at least something over 50%.  Instead, the chance is only 20% according to the calculations.  Regardless of who wins the White House, the Fed is likely to come under increased scrutiny going forward.  Hillary Clinton has said she would support changes to its top ranks by removing bankers from the boards of directors and increasing diversity within the Fed.  Donald Trump has said he would likely replace Yellen when her term is up in 2018.  Either way, increasing uncertainty is absolutely the last thing the market needs.  The Federal Reserve is not a perfect governmental organization but its independence is what gives markets the confidence that monetary policy is being thoroughly discussed, vetted and analyzed with the sole purpose of fulfilling its dual mandate of full employment and stable prices.  It would be a crime should politics become a higher priority in its operations. 


SGK Blog--Update October 7, 2016: Strong U.S. Economic Data Bolsters Prospects for December Rate Hike


The United States dollar strengthened this week as interest rates climbed after evidence of strength in the U.S. manufacturing sector bolstered bets the Federal Reserve will raise interest rates this year. American manufacturing expanded in September after unexpectedly shrinking in the previous month, fueling confidence in a recovery that is key to determining the Fed’s path toward higher interest rates. The probability of a U.S. rate hike by December rose to 64 percent late this week, up 13 percentage points from a week earlier, futures show. Fed Bank of Chicago President Charles Evans said that one rate increase by year-end is likely if data continue to improve. Central bank efforts have brought down yields on bonds around the world, so that $12 trillion of securities now yield less than zero. The measures have also helped push stock markets in the U.S. to record highs. The combined size of the balance sheets of the world’s six major central banks has grown to $16 trillion from $6 trillion in 2008, according to Bianco Research. The Institute for Supply Management’s index advanced to 51.5 from August’s 49.4 reading that marked the first contraction in six months, figures from the Tempe, Arizona-based group showed Monday. A reading above 50 signals growth. New orders and production swung into expansion territory last month, indicating prospects are gradually improving across America’s manufacturing landscape. At the same time, factories continued to focus on becoming leaner by trimming inventories and cutting employment.  

American service companies expanded in September at the fastest rate in almost a year, returning the economy’s biggest segment to a steady growth path after a slump in the prior month. The Institute for Supply Management’s non-manufacturing index jumped to 57.1, the highest since October 2015 and exceeding all forecasts in a Bloomberg survey, the Tempe, Arizona-based group’s data showed Wednesday. The August reading of 51.4 was the lowest in more than six years. Measures of employment and orders led the advance, which signals that businesses that make up almost 90 percent of the economy see enough demand to keep expanding. As mentioned, the group’s factory survey released Monday showed manufacturers also made up some ground last month, suggesting that the slowdown in both ISM measures in August probably overstated softness in the U.S. expansion. It appears the consumer continues to put the economy on their back and they’re spending aggressively. In our view, the key is going to be housing and the job market. So far the housing market appears to be moving in the right direction, as do the employment figures.   The ISM services survey covers an array of industries, including retail, health care, agriculture and construction. 

Friday’s employment report initially was viewed negatively as job creation was lower than expected, but as we sifted through the data there were some bright spots. Employers continued to add to payrolls in September as record openings drew more Americans into the workforce and most found jobs, indicating the U.S. labor market is settling into a pace that will support the economy. The 156,000 increase followed a 167,000 rise in August that was more than previously estimated, a Labor Department report showed Friday in Washington.  While the September figure was weaker than the 172,000 median forecast of economists, payrolls included the biggest drop in government employment in a year. The jobless rate rose to 5 percent as the labor participation rate ticked up to a six-month high. Companies face a limited pool of available and qualified workers at the same time that improving prospects for employment are drawing more people into the labor force. Steady progress will underpin further wage gains and consumer spending, the main driver of U.S. expansion this year, and encourage Federal Reserve policy makers to follow through on their forecast for an interest-rate increase by the end of 2016. In our view, the job market continues to move forward. The data keep the Fed on track to raise interest rates in December, and nothing in the report should raise a red flag for the central bank. 

Oil maintained gains this week, approaching $50 a barrel in New York, after government data showed that U.S. crude stockpiles dropped last week.  Crude stockpiles slipped 2.98 million barrels last week, according to the Energy Information Administration in a report released on Wednesday. That contrasts with the 1.5 million barrel increase forecast by analysts surveyed by Bloomberg and a 7.6 million barrel decrease reported Tuesday by the industry-funded American Petroleum Institute. The $50 level is a psychologically important level as it potentially provides incentives for U.S. producers to raise production. OPEC has been unable to substantially reduce the potential for U.S. production as American producers have proven to be very nimble. A deal between OPEC and non-members could trim output by 1.2 million barrels a day and boost prices by as much as $15 a barrel, according to Venezuela’s oil minister. Oil had advanced about 10 percent since the Organization of Petroleum Exporting Countries agreed last week to cut production for the first time in eight years.  OPEC, which pumped at a record in September, will decide on quotas for the group’s members at an official meeting in Vienna on Nov. 30. Hurricane Matthew is also potentially going to disrupt East Coast fuel shipments. All of these factors contributed to oil’s continued march higher this week. 

In international news, the pound declined on concern Britain may face a so-called hard Brexit after Prime Minister Theresa May pledged to start pulling the U.K. out of the European Union by March of 2017. Sterling dropped to its weakest level in almost three months versus the dollar, helping support British shares. The pound has sunk about 13 percent this year, making it the worst-performing major currency, on concern Britain’s decision to quit the EU will force it out of the single market, hurting exports and denting financial services. With negotiations on the terms of the exit yet to start, business groups and foreign capitals are grasping for more detail. May told her Conservative Party’s annual conference in Birmingham, central England, that she’ll invoke Article 50 of the EU’s Lisbon Treaty -- the formal trigger for two years of talks -- by the end of March. “Monday the impression participants got was that the pendulum has swung towards a hard Brexit,” said Neil Jones, head of hedge fund sales at Mizuho Bank Ltd in London. “Hard Brexit is a sell for the pound. I know the government line is that they don’t see a need to differentiate between hard and soft Brexit, but the market certainly does.” And indeed he got that right!  

China’s official factory gauge stayed at the highest level in almost two years for a second month and services increased in the latest evidence of continued economic stabilization, reducing prospects for more policy easing. The manufacturing purchasing managers index remained at 50.4 in September, the National Bureau of Statistics said last Saturday, compared with a median estimate of 50.5 in a Bloomberg economist survey and 50.4 the prior month. The non-manufacturing PMI rose to 53.7 from 53.5 in August. Last Friday, the private Caixin Media and Markit Economics China Manufacturing PMI showed an increase to 50.1 last month. Numbers above 50 indicate improving conditions. The data, released ahead of this past week’s closure of China’s financial markets for the National Day holidays, add to evidence of improvement as government fiscal support and a soaring property market help underpin growth. Fresh signs of stability may lead policy makers to remain on hold after keeping the benchmark interest rate at a record low for almost a year. The economy appears to be stabilizing on all the support that the government has given through monetary easing and fiscal spending. This has helped fuel investment and supported more upbeat growth forecasts. Expansion in the world’s second-largest economy slowed to 6.6 percent in the third quarter, according to economists surveyed before a report due on Oct. 19, after two consecutive quarters of 6.7 percent growth. The Bloomberg Intelligence China gross domestic product tracker rose to 7.16 percent in August. The data came as three of China’s biggest cities took new steps to cool property markets. Home prices in the world’s most populous nation rose the most in six years in August, defying policies to curb excessive speculation in big cities and warnings about asset bubbles. Beijing last Friday required bigger home down-payments after new house prices jumped 23.5 percent in August from a year earlier, while Tianjin introduced housing purchase limits. Hangzhou last week raised down-payment requirements and capped land auction prices. “Policy has already started to swing away from all-out stimulus toward a slightly greater focus on containing financial risks and pushing through reforms," Fielding Chen, an economist for Bloomberg Intelligence in Hong Kong, wrote last Saturday. "Sustained momentum in the economy should provide policy makers with cover to continue that agenda." That is smart policy in our view. 

On a down note, the euro-area economy appeared to be losing steam as political uncertainty looms large over the 19-nation region. A Purchasing Managers’ Index for the manufacturing and services sector slid to 52.6 in September from 52.9 in August, London-based IHS Markit said on Wednesday, confirming a Sept. 23 estimate. That’s the lowest level since January 2015. A reading above 50 signals expansion. Policy makers are struggling to shore up growth and inflation in a region increasingly beset with populist political movements. Ahead of national votes in some of the bloc’s largest economies, challenges from how to deal with the U.K.’s decision to leave the European Union to integrating migrants into a workforce strapped by high unemployment need to be met. The pound ended up having a mini flash crash on thin volume, dipping over 6% within a matter of minutes, in Asia trading in the wee hours of Friday morning before stabilizing. The slowing rate of growth across the region in part reflects growing caution among businesses. This trend could persist into next year, as the impact of Brexit is exacerbated by uncertainty surrounding elections in France and Germany alongside ongoing political unrest in Italy and Spain. PMI for services fell to 52.2 in September from 52.8, according to the report. Among the region’s four major economies, France was the only one registering a pick-up in momentum, with stronger growth in services more than making up for near-stagnant manufacturing. Activity slowed in Germany, Italy and Spain. PMI data suggest the euro-area economy expanded by 0.3 percent in the third quarter, the same rate recorded in the previous three months. But there are signs the recovery is slowing down. The euro-zone economy could expand by 1.6 percent in 2016, but even this modest growth is looking unattainable in 2017 given the heightened political uncertainty that lies ahead. 

As always, stay tuned!


SGK Blog--Update September 30, 2016: Markets Turn to Fourth Quarter

The headline news this week emanated from Algiers where the Organization of the Petroleum Exporting Countries, aka OPEC, met.  The 14 oil ministers agreed they need to cut crude output in order for prices to rise.  This “understanding” after their six-hour meeting meant that they reached consensus on a set of parameters.  However, nothing is yet finalized.  Determining which countries will cut and by how much has been deferred to the November 30 meeting in Vienna.  With OPEC supplying around 40% of the world’s oil, their decisions are very important to the price of the commodity, which is priced in dollars.  The broad outlines of the deal call for the group to drop production to 32.5 million barrels a day, about 750,000 barrels a day lower that what it pumped in August.  OPEC’s current market share is smaller than in the 1970s when OPEC’s might was stronger and their decision to cut back on supply sent the global economy into a recession.  Nevertheless, the ramifications of their actions reach beyond the marketplace into the murky world of geopolitics where there is no such thing as one single, market-clearing solution.     

What caused this sudden kumbaya moment?  Saudi Arabia in 2014 announced that it was going to open the spigots full blast and pump until forever.  The hope was that the supply gut would push production out of the market and prices would eventually rise.  That didn’t happen.  From over $90 per barrel at the end of September 2014, the price fell to a low of $26 in January and February of this year before rebounding to the low-to-mid $40’s for the second half of the summer.  U.S. production, which peaked at over 9 million barrels per day last year, was more resilient than some expected.  Technological advances allowed drillers to continue pumping even as the price fell.  Though many firms did go under, fantastically low interest rates meant that companies could extend their leases on equipment at minimal costs in order to pump their way out of debt.  And, for those companies that did declare bankruptcy, that process enabled them to remove costly liabilities from the balance sheet and begin anew.  Most importantly, unlike the 70’s, when the supply cut meant that demand exceed supply by over 10%, today’s gap between demand and supply is only about 1%.   

Saudi Energy Minister Khalid al-Falih said the market needed a “gentle adjustment” which was a 180-degree turn from his predecessor Ali al-Naimi, who said during his long reign that the days of production cuts were over.  Libya and Nigeria want to increase production.  Iran, especially, wants to pump more in order to reach its pre-sanctions level.  Venezuela has fallen into near chaos as oil revenues cratered leading to mass food shortages.  Even Saudi Arabia, the world’s second largest producer, is facing a massive budget deficit of nearly 13% of GDP due to lower revenues.    

The key question is even with similar goals amongst the members, will this new harmony really work?  Odds point to no.  First, non-OPEC members now make up 60% of global supply.  Russia, the world’s largest producer, said it is pumping 11.1 million barrels a day in September, up 400,000 from August.  That is a new post-Soviet oil-supply record.  U.S. drillers may have focused this year on shale plays that are most profitable, but that does not mean that other wells are dry.  Thousands of already drilled sites remain which are just not being pumped given their cost economics.  A sustained spike above $50 or certainly $60 per barrel would revitalize those projects.  Second, there remains a vast oversupply of oil that already has been put in storage either on land or off-shore tankers.  Higher prices means these volumes will find their way back to the markets. Third, the cartel has a history of saying one thing and doing another.  Cheating by producing above production targets is as common as sand in the Sahara.  The market knows this going to happen given the incentives for being deceitful.  Thus, there could be the sort of short-term spike in oil which we saw on Wednesday when the “understanding” was communicated, but, in the long-run, it is going to take good old fashioned demand for macro oil picture to improve.

SGK Blog--Update September 23, 2016: Fed Remains on Hold 

The Federal Open Market Committee decided this week to leave its benchmark federal funds rate unchanged but hinted that an increase is not that far away.  The reason behind the continued pause in normalizing monetary policy is the sluggish pace of the current expansion.  Fed officials update their projections each quarter for various economic indicators.  This time they cut their growth forecast for 2016 to 1.8% from 2.0% in June.  They also lowered their long-run view on the economy’s growth rate to 1.8%, down from 2.0%.  In the rate outlook, also known as the “dot plot”, officials projected one more rate increase in 2016.  That boost will likely come at their December meeting given their next meeting on November 2 falls within a week of the presidential election.  Chairwoman Janet Yellen explicitly stated at the post-meeting conference call that the Fed is agnostic when it comes to political events and every meeting is “live”.  However, in reality, many investors know that the Fed will not make any moves at that meeting especially since it is not followed by a press conference where she can explain in full any change in policy.

The Fed’s projections also suggest that the employment picture is going well.  The median projection for the jobless rate this year rose to 4.8% from the 4.7% figure in June.  For next year, the outlook is for 4.6%.  Currently, the national unemployment rate is 4.9%.  Even with a strong level of employment, the personal consumption expenditure is expected to come in at 1.3% by year-end and rise to 1.9% by next year.  The target inflation rate is 2.0% which the Fed believes the economy will reach by 2018 when the jobless rate is expected to be closer to 4.8%.  Initial jobless claims in the week ended September 17 fell by 8,000 to 252,000 according to the Labor Department representing the largest drop since early July.  The median estimate in a Bloomberg economist survey called for 261,000 with a range of 255,000 to 270,000 so the final number finished below even the lowest estimate.  With application for unemployment insurance close to a four-decade low, filings have been below 300,000 for 81 consecutive weeks.  In the views of Yellen, these numbers “strengthened the case for an increase in the federal funds rate.”

The continuing issue vexing the markets is that the so-called dot plot continues to be above where the market believes rates are going.  The overnight index swap (OIS) market prices policy rates based upon how traders believe rates will move.  Since 2014, this market has consistently predicted—correctly—that the dot plot was too aggressive in the number of rate hikes coming in the future.  A year ago, the Fed expected to move rates up four times in 2016.  We still have not seen one year-to-date.  Meanwhile, the OIS market was betting that we would get one or at most two for this year.  The current September projections show that the Fed, based on the median estimate, is looking for two increases in 2017 (bringing fed funds to between 1.00%-1.25% by year end or 1.125% avg), three times in 2018 (1.75%-2.00% or 1.875% avg.) and three times in 2019 (2.50%-2.75% or 2.625% avg).  Meanwhile the current OIS curve is suggesting 0.699% for 2017, 0.814% for 2018 and 0.891% for 2019.  In a $16 trillion economy, a difference of a half of a percentage point is beyond massive.  Will the Fed succumb to the market’s wishes yet again next year?  If their projections ultimately turn out to be too aggressive, then that will be the case.  The tricky issue is that full employment, one half of the Fed’s Congressional determined mandate, has either been met or is very close, yet inflation is not yet near the Fed’s preferred level.  The Fed is sitting at a critical juncture because it does not want to boost rates too soon even though there were three dissensions at this week’s meeting voting to do just that.  Yet, is there a need to keep rates this low, especially if monetary stimulus is needed during the next downturn?  The biggest fear is becoming the next Japan.

That country has been mired in a quagmire of either very slow growth or outright recession for over 20 years.  Obviously, there are a lot of differences between the U.S. and Japan.  The diversification of the U.S. economy overwhelms what Japan has at its disposal in addition to the fact that Japan’s demographics profile is in much more dire condition than the U.S.  Yet, it still serves as a microcosm, more so for aging Europe, of what does and does not work in the so-called “new normal”.  This week, the Bank of Japan (BOJ) made a much anticipated move in how it shapes its monetary policy.  In a nutshell, the BOJ is introducing a yield curve target while pledging to overshoot inflation.  Instead of targeting the quantity of money (through measures such as quantitative easing), the BOJ is targeting the price on 10-year bonds at near 0%, a rate which is above where the debt has traded recently (bond prices move in the opposite direction of yields).  This will help steepen the yield curve, a corrective measure to its negative-interest rate program unveiled just this past January.  That program worked almost too well because it suppressed long-term rates and flattened the yield curve making it hard for banks to make money on their net interest margin, or difference between lending and borrowing.  What makes this strategy unique and interesting is that central banks rule very short-term rates by offering loans as short as overnight to various institutions.  The “long end” of the curve with maturities 10 years and longer belonged to the markets—traders who priced in the time value of money, inflation and other risk factors to determine a price.  Now, the BOJ is saying, “We will do that for you.”  They will still continue the ¥80 trillion a year asset purchase program because it wants to “raise inflation expectations in a more forceful manner.”  A timetable to achieve this is out the window.  The BOJ is aiming to overshoot its 2% target “at the earliest possible time”.  Inflation is no longer the monster in the closet because the BOJ is essentially saying that even if prices rise and rise, they will not turn off the spigot of money being thrown at the market.  Bring it on.  They have been fighting this specter of inflation for two decades only to see that it never really was there in the first place and now they are stuck with the reality of deflation which won’t let go.

SGK Blog--Update September 16, 2016: All Eyes Were On Fed's Brainard After Last Friday's Sell-Off 

Federal Reserve Governor Lael Brainard counseled continued prudence in tightening monetary policy, even as she said the economy is making gradual progress toward achieving the central bank’s goals. Stocks had a relief rally on her comments Monday after Friday’s indiscriminate sell-off. Friday’s market reaction was caused by Federal Reserve Bank of Boston President Rosengren’s hawkish comments and the announcement of a surprise speech by Brainard on Monday. Concerns rose she also would turn hawkish and hers is the last speech prior to the next Fed meeting on September 20-21st. “The case to tighten policy preemptively is less compelling” in an environment where declining unemployment has been slow to spur faster inflation, Brainard said Monday, according to the text of her prepared remarks in Chicago. She made no reference to a specific meeting of the policy-setting Federal Open Market Committee. 

As mentioned, Brainard’s comments are the last before the Fed enters its quiet period, during which officials abstain from publicly speaking about monetary policy in the run-up to an FOMC meeting. Recent comments from the committee’s voters have not projected a cohesive signal about whether they will lift interest rates or stay on hold. “Asymmetry in risk management in today’s new normal counsels prudence in the removal of policy accommodation,” Brainard said, arguing that with interest rates near zero, it’s easier for the Fed to react to faster-than-expected demand than to a negative surprise that upsets the economy. “I believe this approach has served us well in recent months.” Brainard has consistently urged patience in hiking rates, pointing to the uncertain global economic environment and unconvincing improvement in inflation as reasons for caution. Her most recent speech before today was on June 3. In Monday’s speech, Brainard highlighted five major reasons for caution: inflation is less responsive to labor-market improvement than in the past, labor-market slack seems to persist, financial transmission from foreign markets is strong and poses a risk, and the interest rate where policy moves from easy to tight is lower than in the past -- and is likely to stay there for some time. Her final point is that monetary policy is less able to respond to negative shocks than to a quick pickup in demand.  

Despite that cautious view, Brainard also pointed to recent developments that show the economy is moving toward achieving the Fed’s goals of maximum employment and 2 percent inflation. She said the job market is making progress and getting closer to full employment and the Fed has “seen signs of progress on our inflation mandate.” Inflation has not advanced as much as the Fed had hoped, with both its preferred gauge of headline and core price pressures still beneath the central bank’s 2 percent target. U.S. gross domestic product growth has also been slow. Still, Brainard said recent data suggest that third-quarter growth will accelerate. Looking at the longer-term outlook for monetary policy, Brainard opened the door to considering a reframing of how the Fed looks at the economy. San Francisco Fed President John Williams has said he and his colleagues should consider their future framework in a world where neutral interest rates, those that neither stoke nor slow growth, may be permanently lower. “There is a growing literature on such policy alternatives, such as raising the inflation target, moving to a nominal income target, or deploying negative interest rates,” Brainard said. “These options merit further assessment. However, they are largely untested and would take some time to assess and prepare.” Lael Brainard seems to take a well thought out and carefully considered approach to monetary policy in our view. 

Sales at U.S. retailers dropped more than forecast in August, indicating a pause in recent consumer- spending strength that has carried the economy. Purchases declined 0.3 percent from July, the first drop in five months, after a revised 0.1 percent advance in the previous month, Commerce Department figures showed Thursday in Washington. The median projection of economists surveyed by Bloomberg called for a 0.1 percent decline. Excluding cars, sales unexpectedly fell 0.1 percent. An easing in vehicle buying matched a lackluster performance elsewhere, with sales falling in seven of 12 retail categories outside autos. While low borrowing costs, cheap gasoline prices and steady job gains should keep a floor under demand, wage growth remains slow and sustained weakness in consumer spending could limit any second-half economic rebound. The report represents one of the last major data releases before Federal Reserve policy makers meet next week to debate raising interest rates. While officials are split on the urgency to increase borrowing costs, most investors and economists expect the central bank to hold off this month. This report lends support to this view and that is why the stock market rallied the day of the release, even though the news itself was negative. 

Wholesale prices in the U.S. were little changed in August, held back by a second straight month of lower costs for food and fuel. No change in the producer-price index followed a 0.4 percent decline the prior month that was the steepest pullback in nearly a year, a Labor Department report showed Thursday in Washington. Price pressures in the production pipeline have yet to show a sustained build, especially for goods, which are more exposed than services to global headwinds. Inflation continues to stay below the goal of Federal Reserve officials, who are meeting next week to consider whether to lift interest rates. The median forecast of economists surveyed by Bloomberg called for a 0.1 percent rise. From a year earlier, producer prices were also unchanged after a 0.2 percent decrease in the prior 12-month period. The details of the producer price report reflected a 0.8 percent month-over-month decline in energy costs and a 1.6 percent decrease in food. Excluding food and energy, wholesale prices rose 0.1 percent from the previous month following a 0.3 percent drop. 

The number of applications for unemployment benefits barely rose last week, indicating employers remain comfortable with staffing levels. Jobless claims edged up 1,000 in the week ended Sep. 10 to 260,000, a report from the Labor Department showed Thursday. The median forecast in a Bloomberg survey called for 265,000. Continuing claims were also little changed. Applications for unemployment insurance are staying close to a four-decade low as companies with a record number of job openings keep workers on board. The figures are consistent with tight labor conditions, which Federal Reserve policy makers will consider when they gather next week to debate whether to raise interest rates. The less-volatile four-week average of jobless claims dropped to 260,750, the lowest level since the end of July, from 261,250.  

Americans’ incomes jumped in 2015 by the most since the last recession and the poverty rate fell, signs of U.S. economic health that could potentially boost Democratic candidates this year. Fresh yearly data from the U.S. Census Bureau showed median, inflation-adjusted household income rose 5.2 percent to $56,516 in 2015, the highest level since $57,423 in 2007, when the recession began.  Gains were spread across the income spectrum and by race, while women’s earnings inched closer to men’s. The data suggest incomes are getting a boost from job gains to help break out of the stagnancy that’s been a blemish on the seven-year U.S. economic recovery. Republican presidential nominee Donald Trump and Bernie Sanders, who gave Hillary Clinton a strong challenge for the Democratic nomination, have tried to appeal to voters in part by capitalizing on weak wage gains. The poverty rate was at 13.5 percent, representing 43.1 million Americans -- a drop of 1.2 percentage points from 2014, the agency said.

Output at American manufacturers fell more than economists forecast in August, a sign the industry is having trouble finding its footing. The 0.4 percent decline at factories was the biggest drop since March and followed a 0.4 percent increase the prior month, a Federal Reserve report showed Thursday in Washington. The Bloomberg survey median called for a 0.3 percent drop. Total industrial output, including mines and utilities, dropped 0.4 percent, also a steeper decline than anticipated. The data add to concerns sparked last week by a private survey of purchasing managers that showed manufacturing contracted last month. Any slowdown in U.S. or global demand would further worsen the outlook for producers, who are trying to recover from the energy sector pullback, bulging inventories and lingering effects of the dollar’s surge. The weakness in capital investment appears to be a global phenomenon. The latest results are consistent with the Institute for Supply Management’s factory survey for August, which signaled a contraction, albeit for the first time in six months. Orders plunged, production was cut by the most since 2012 and employment fell, that report showed. Manufacturing, which makes up 75 percent of total industrial production, accounts for about 12 percent of the U.S. economy. Fed officials, meeting next week, are weighing economic data to determine when to raise interest rates, as we have noted. 

In important international news, Bank of England policy makers indicated there’s still a chance of another rate cut this year as they assess the potential longer-term fallout from Britain’s decision to leave the European Union. While the nine-member Monetary Policy Committee noted that recent near-term data had been stronger than anticipated since the Brexit vote, it couldn’t draw inferences for its longer-term forecasts.  Even though initial reports had been “slightly to the upside” of projections published in August, officials said their view of the “contours of the economic outlook” hadn’t changed. Should the outlook in November remain “broadly consistent” with last month, when the BOE announced a new stimulus package, “a majority of members expected to support a further cut in bank rate to its effective lower bound” later this year. The committee sees that lower limit at close to, but just above, zero. They appear to be cautiously optimistic. In our view, if the data shows modest growth in the third quarter overall, they’d probably be happy to cut rates again. If it starts to pick up even more then they’ll probably take a pause and wait and assess for another quarter or so. 

We will be closely watching the Fed rate decision next week and look forward to updating you on that in this forum. As always, stay tuned!

SGK Blog--Update September 9, 2016: Markets Close to Records as Summer Fades

After last week’s employment numbers, the economic calendar was mostly bare for the past few days.  The Labor Department released the latest initial unemployment figures which showed claims falling to the lowest level in seven weeks.  For the week ended September 3, jobless claims fell by 4,000 to 259,000 versus the median Bloomberg economist estimate of 265,000.  Filings remain near four-decade low as employers are focused on retaining and attracting employees rather than letting them go.  With only anecdotal evidence of higher wage demands, it makes sense that companies are not afraid to let their employment ranks stay the same or rise slightly.  Modest GDP growth is a result of modest demand growth which flows from modest income growth.  With the four-week average of claims at 261,250, it marks the 79th consecutive week that figure has been below 300,000.  That benchmark is widely considered a barometer for a healthy labor market and we saw that last Friday in the monthly payroll data that was not overly robust but far from a disappointment. 

Overseas, the European Central Bank (ECB) left interest rates and its €80 billion per month bond-purchase program unchanged yesterday.  President Mario Draghi argued that there was really nothing from them to do.  This summer’s Brexit vote, after a few days of turmoil, has not lead to unsettling European Union markets so far.  However, markets were slightly disappointed in Draghi’s comments which led to stocks in the EU falling and euro and bond yields rising.  The pressure will just continue to rise suggesting that markets are becoming addicted to central-bank flows.  Ultralow yields are becoming a problem because the ECB cannot buy bonds that yield less than its deposit rate (-0.4%).  The German 7-year yield stands close to -0.4%, the 5-year around -0.5% and the 2-year at approximately -0.6%.  Switzerland is dealing with its own negative interest rates with Sweden and the Netherlands not far behind which means a wide swatch of Eurozone bonds are off limits.  The expectation is that the ECB will extend its bond buying—a.k.a. quantitative easing (QE)—to beyond March 2017.  Thus, between now and then, Draghi & Co. better start to bend the rules or come up another plan because QE doesn’t work when there are no bonds to buy.

SGK Blog--Update September 2, 2016: Economy Adds 151,000 Jobs in August vs. Expectation for 180,000 

Companies kept adding to payrolls in August while measures of slack in the labor market were little changed, signaling steady hiring in the face of lackluster global growth. Payrolls climbed by 151,000 last month following a 275,000 gain in July that was larger than previously estimated, a Labor Department report showed Friday in Washington.  Revisions subtracted a net 1,000 jobs from overall payrolls in the previous two months, as June’s increase was cut to 271,000 from 292,000. The median forecast in a Bloomberg survey called for 180,000.  The jobless rate and labor participation rate held steady, while wage gains moderated and hours worked were the lowest since 2014. The August figure is consistent with a simmering-down of payrolls growth so far this year as the economy slogs through a period of weak investment and some companies have difficulty finding workers.  Federal Reserve officials will have to weigh the jobs data as they decide whether to raise the benchmark interest rate for the first time in 2016. 

The impact on markets was felt immediately as many traders had been waiting for the data to take or alter positions. The U.S. dollar fell and stocks rose along with the price of oil. The Bloomberg Dollar Spot Index, which tracks the currency against 10 major peers, fell 0.2 percent as of 9:30 a.m. in New York Friday, reaching the lowest level since Aug. 26.  The greenback dropped 0.4 percent to $1.1240 per euro and declined 0.4 percent to 102.87 yen. Yields on two-year notes, the coupon securities most sensitive to Fed policy, were little changed.  Oil halted four days of declines as Vladimir Putin said he’d like Russia and OPEC to reach an output freeze while exempting Iran as it raises production to pre-sanctions levels. The odds of a hike this month dropped to 26 percent, from 34 percent yesterday, according to fed fund futures data compiled by Bloomberg.  The chance of an increase by December retreated to 55 percent. There are key data points between now and the December meeting, but this was the major release traders were paying attention to because it is the last employment report before the Fed meets later this month. There does not seem to be a compelling argument for them to raise rates at that meeting based on this latest release in our view. 

There was a great deal of additional economic news out both here in the U.S. and in other key countries globally this week which we will summarize below.   Manufacturing in the U.S. unexpectedly contracted in August for the first time in six months amid slumping orders and production that raise concern of renewed industrial weakness. The Institute for Supply Management’s index dropped to 49.4, weaker than the most pessimistic estimate in a Bloomberg survey, from 52.6 in July, figures from the Tempe, Arizona-based group showed Thursday. The decline of 3.2 points was the biggest since January 2014. Fresh orders to American factories shrank for the first time this year, as production was cut by the most since 2012 and employment fell, the report showed. The figures are surprising considering other data points to an economy that is bouncing back on the heels of still-robust consumer spending and progress in paring inventories. It will be interesting to see how the Fed processes this in their interest rate decision making.   They raise rates too quickly and that sends our dollar higher which further puts pressure on our manufacturing and export sector. The Fed has to walk a fine line here. 

Home prices in 20 U.S. cities continued to moderate in June, according to S&P CoreLogic Case-Shiller data released Tuesday. The 20-city property values index increased 5.1 percent from June 2015, matching the median forecast and the smallest gain since August, after a 5.3 percent year-over-year advance in May. The national home-price gauge also rose 5.1 percent from 12 months earlier. On a monthly basis, the seasonally adjusted 20-city gauge fell 0.1 percent for a second month. The report shows more gradual price appreciation that’s allowing the housing market to strengthen. New-home sales unexpectedly surged in July to the strongest level in more than nine years. At the same time, consistent appreciation might convince more sellers to put their homes on the market, and cheap borrowing costs and solid labor-market gains are supporting potential buyers. David Blitzer, chairman of the S&P index committee, summed it up nicely, “Overall, residential real estate and housing is in good shape.” He went on to add, “While the real estate sector and consumer spending are contributing to economic growth, business capital spending continues to show weakness.” We could not have said that better ourselves! 

Consumer spending advanced for a fourth straight month in July, bolstered by stronger income gains, sending the biggest part of the U.S. economy to a solid third-quarter start, Commerce Department figures showed Monday in Washington. Purchases climbed 0.3 percent (matching the median estimate) after a 0.5 percent rise that was revised up from the previous month. Incomes grew 0.4 percent (matching the median forecast) following a 0.3 percent advance that was also revised upwards from the prior month. The saving rate increased to 5.7 percent from 5.5 percent and disposable income adjusted for inflation climbed 0.4 percent, which was the most this year. The figures support economists’ projections that economic growth will rebound this quarter after the weakest first half since 2011.  Adjusted for inflation, a 0.3 percent advance in July purchases followed an upwardly revised 0.4 percent gain in the previous month, indicating a better start to the third quarter. The bottom line is the consumer is going to remain the main driver of growth in our economy here. Continued improvement in the labor market is supporting income growth and that is consistent with a solid third quarter. This was reflected in the consumer confidence figure for August which rose to 101.1 versus the prior month’s 96.7 and the expectation for 97.0. All positive signs and support the Fed’s case to raise rates this year, possibly as soon as their next meeting. 

In international news, we had a couple of positive economic indicators from key overseas markets. China’s official factory gauge unexpectedly rose last month to the highest level in almost two years, suggesting the economy’s stabilization remains intact and that a weakening in July was flood-related and temporary. Their manufacturing purchasing manager’s index rose to 50.4 in August from July’s 49.9 and that beat the 49.8 median estimate of economists surveyed by Bloomberg. Non-manufacturing PMI stood at 53.5 compared with 53.9 in July - numbers above 50 indicate improving conditions. From a big picture standpoint, floods across southeastern regions responsible for about a fifth of China’s economic output interrupted production in the summer. The rebound in August gives policy makers breathing space to push ahead with reforms of state-owned firms and cutbacks in overcapacity sectors such as coal and steel. This positive news impacted currencies as the offshore yuan strengthened while the Australian dollar -- a proxy for China’s economy because of its shipments of raw materials -- climbed. 

In the other market that has been garnering attention ever since the disastrous Brexit vote, U.K. factory activity reached a 10-month high in August as the weaker pound helped manufacturing bounce back from the post-Brexit slump. IHS Markit said its Purchasing Managers Index, which dropped below the key 50 level in July, jumped by a record to 53.3. That was far better than economists had forecast; the median estimate in a Bloomberg survey was for a reading of 49. New orders rose, with sterling’s recent drop “by far the main factor” for the improvement in exports, Markit said. “Companies reported that work that had been postponed during July had now been restarted, as manufacturers and their clients started to regain a sense of returning to business as usual,” said Rob Dobson, senior economist at Markit. This had a positive impact on their currency as well as the pound advanced 0.8 percent after the data were published to reach $1.3249. It still remains down more than 10 percent against the dollar since Britain’s decision on June 23 to leave the European Union. 

As always, stay tuned!

SGK Blog--Update August 26, 2016: Markets Shrug After Yellen Speech 
The markets have been eagerly waiting for weeks for Federal Reserve Chairwoman Janet Yellen to speak at the Jackson Hole symposium in Wyoming today.  While they did not get any breaking news, there were small steps in the direction that most pundits have anticipated—a rate hike is coming.  The real question, however, continues to be when and there were no new clues on that front.  In her prepared remarks, Ms. Yellen stated: “In light of the continued solid performance of the labor market and our outlook for economic activity and inflation, I believe the case for an increase in the federal funds rate has strengthened in recent months.”  In fact data this week supported that conclusion.  Weekly initial jobless claims fell by 1,000 to 261,000 in the week ended August 20 according to the Labor Department.  This was the lowest level in five weeks and the 77th consecutive week that filings have been below 300,000.  That level is typically consistent with an improving job market according to economists and it matches the longest such stretch since 1970.  The number of people continuing to file jobless benefits also fell, by 30,000 to 2.1 million in the week ended August 13.  Though sales of existing U.S. homes dropped for the first time in five months, new homes sales, a more timely indicator of residential real estate strength, rose to an almost nine year high in July according to the Commerce Department.  The average rate on a 30-year, fixed mortgage was 3.43%, close to the record low 3.31% reached in 2012, according to Freddie Mac. 

Clearly the labor market has been very good and housing has shown an uneven but still positive trend.  However, Yellen does not seem to be in any particular hurry to raise the benchmark rate.  With full employment either attained or close to it and prices well under control, the question becomes how to sustain economic growth while still keeping an eye on inflation.  According to her, “The [Fed] expects moderate growth in real domestic product, additional strengthening in the labor market, and inflation rising to 2% over the next few years.  Based on this economic outlook, the [Fed] continues to anticipate gradual increases in the federal funds rate will be appropriate over time.”  The emphasis in that last sentence is “over time.”  According to the fed funds futures markets, where traders bet money on where rates are headed, the chance of a 0.25% rate increase at the next Federal Open Market Committee meeting in September is 30%.  By the scheduled December 14 meeting, that probability rises to 58%.  These numbers have not changed much.  Last Friday, the odds were a 22% chance in September and 51% chance in December.  So, they have both risen but not quite enough to say that by next month, the Fed will swing into action for sure.  The committee does have a meeting on November 2, but given the proximity to the Presidential election and the lack of a post-meeting conference call, there is little chance of any action on that date.  The Fed has also begun playing the probability game.  In June, the Fed had a median estimate for the federal funds rate at the end of 2017 of 1.625%.  Today, Ms. Yellen said there was a 70% probability that rates would be between zero and 3.25% at the end of next year.  That’s just enough of a range to drive an 18-wheeler through.  She stated, “The reason for the wide range is that the economy is frequently buffeted by shocks and thus rarely evolves as predicted.”  In other words, she just gave the reason why economists and weather reporters remain employed even though the track record of both professions is pretty dismal.  

SGK Blog--Update August 19, 2016: Fed Minutes Show Little Concern on Inflation Front 

For all of their differences, one thing most Federal Reserve officials seem to agree on is that there’s not much risk of inflation running away from them anytime soon, regardless of what they do with interest rates. Most on the 17-member Federal Open Market Committee responsible for setting U.S. interest rates in late-July "saw relatively low risk that a further gradual strengthening of the labor market would generate an unwanted increase in inflationary pressures,” according to minutes of that meeting published Wednesday in Washington. Moreover, "several suggested that the committee would have ample time to react if inflation rose more quickly, and they preferred to defer another increase in the federal funds rate until they were more confident that inflation was moving closer to 2 percent on a sustained basis," the minutes showed. There was no specific mention of the timing of their next policy move. The next FOMC meeting is scheduled for Sept. 20-21.

The benign inflation outlook gives policy makers more time to sort out longer-term uncertainties that have been introduced by recent U.S. labor market data and the U.K. vote to leave the European Union, even if some of them would like to get going with rate hikes sooner rather than later. In a statement they published following the July 26-27 meeting, they acknowledged that "near-term risks to the economic outlook have diminished." The record of that meeting added major caveats. Some Fed officials “noted that the Brexit vote had created uncertainty about the medium- to longer-run outlook for foreign economies that could affect economic and financial conditions in the United States,” according to the minutes. We must remember that meeting was coming pretty fresh off of the vote in the U.K. All of this keeps the outlook for additional interest-rate increases this year unclear. Investors put the odds of a hike in 2016 at roughly 50-50, about the same as before the minutes, according to the prices of federal funds futures contracts. And despite seeing a strong rebound in employment in June following a dismal reading in May, officials were still split on whether a broader slowdown in job growth means the labor market is nearing full employment, or whether it was indicative of a weakening economy. "A couple of members indicated that, in light of their judgment that labor market conditions were at or close to the Committee’s objectives, some moderation in employment gains was to be expected," the minutes showed. "In contrast, several other members expressed concern about the likelihood of a further reduction in the pace of job gains, and it was noted that if that slowing turned out to be persistent, the case for increasing the target range for the federal funds rate in the near term would be less compelling." The FOMC has left rates unchanged since raising them in December for the first time in nearly a decade, in part because of concerns over global growth, sagging inflation expectations, and mixed readings on the U.S. economy. We are aligned with their view, although we still question the need to maintain the size of their securities holdings on the current balance sheet. They appear to be, as they have indicated, data dependent. The next Fed watch event will be Janet Yellen’s speech at Jackson Hole at the annual gathering of central bankers which comes at the end of August.    

In other U.S. economic news, fewer Americans than forecast filed applications for unemployment benefits last week, indicating the U.S. job market remains healthy. Jobless claims fell by 4,000 to 262,000 in the week ended Aug. 13, the fewest in a month, a Labor Department report showed Thursday in Washington. The median forecast of 42 economists surveyed by Bloomberg called for 265,000. Low firings combined with continued healthy hiring should theoretically help spur wage increases and boost the outlook for consumer spending, the biggest part of the economy, amid weak investment by companies. Businesses are holding on to existing employees to meet demand, while some are also facing a shortage of skilled workers. The figure has been below the 300,000 level for 76 consecutive weeks, the longest stretch since 1970. That is typically consistent with an improving job market.  

The index of leading indicators, a forward looking measure which includes moves in stock prices, came in right on target with estimates at +0.4% for July. Housing in the U.S. remains a bright spot as July housing starts came in well above expectations at 1,211,000 while building permits, a sign of future growth, were relatively robust at 1,152,000 during the same month. Manufacturing figures for July also came in above expectations as capacity utilization and industrial production for July were +0.7% and 75.9% compared to expectations for +0.3% and 75.7% respectively. The consumer price index or CPI for the month of July reaffirmed the Fed’s view that we are not seeing significant inflationary pressures in the economy as it came in at exactly 0.0%, which was in-line with expectations, while the core rate was +0.1%, which was actually lower than the expected rate of +0.2%. Although this is not the Fed’s preferred gauge of inflation, it looks like they have it right so far! 

As always, stay tuned!

SGK Blog--Update August 12, 2016: Markets Close to New Records   

After a few super busy weeks dealing with earnings and economic reports, the markets downshifted this week in terms of volume and headlines.  Fear not, between presidential candidates Clinton and Trump, the news media (and late night talk shows) will undoubtedly have plenty of material to fill the blogosphere.  Traders are trying to squeeze a week or two of vacation into this month before things start to pick back up again with Fed Chairwoman Janet Yellen speaking at the Jackson Hole Policy Symposium on August 26.  In the interim, the neighborhood pools are full and picnic spots are taken as the last days of summer come into focus.  We won’t mention that peak hurricane season begins mid-month…but we have to get through the latest East Coast heat wave first.  

This week, we will focus on a report that does not get a lot of publicity, but its attention to detail deserves a close look.  The Labor Department released its Jobs Openings and Labor Turnover survey (JOLTS) for June that showed that there is real strength in the market for workers.  Higher job listings combined with fewer headcount reductions reinforces the payrolls data we saw last week.  The monthly employment report is timelier as JOLTS lags by a month, but JOLTS gives detail that cannot be gleaned from elsewhere.  The quit rate, or the willingness to voluntarily leave a job because a worker is confident of finding another, was 2%.  Some 2.91 million people quit compared to 2.94 in May.  That rate was 1.5% in December 2010 and 1.7% by the end of 2013.  Thus, the number has climbed but it has remained around 2% since January of this year.  This suggests that workers are confident in other, presumably higher-paying opportunities elsewhere, but not so bold as to rapidly decamp on a moment’s notice.  Therefore, there could be still some labor market slack in the marketplace which could be the reason why it has only been recently that average hourly earnings have moved above the threshold 2% level that Fed Chair Yellen and her compatriots are looking for as a sign of continued health.  Workers are just not confident enough yet to lay it on the line: give me a raise or I walk out the door.  Nevertheless, overall hirings rose to a three-month high.  With the ill-defined “full employment” Fed mandate deemed accomplished by some or at least within reach, the question becomes whether the Fed lets the economy “run hot” and risk inflation somewhere down the road when employees get the gumption to demand higher remuneration.  With estimates of a 3%+ third quarter GDP estimate circulating, the pressure may rise on the Fed to make a move.  But if companies begin to see their margins shrink in the face of more hiring and marginally higher wages, the resulting pressured profit cycle may make a robust GDP reading last no longer than a period or two at the most.  Meanwhile this week’s initial jobless claims data shows that figure, for the 75thconsecutive week, was below 300,000 matching the longest streak since 1970.  Can it continue?  Many of these questions will get answers in the coming months, so hopefully traders enjoy their vacations while they can.  

SGK Blog--Update August 5, 2016: July Employment Report Lifts Equity Indices; Increases Likelihood of Fed Rate Increase  

Employment jumped in July for a second month and wages climbed, pointing to renewed vigor in the U.S. labor market that should help sustain consumer spending into the second half of the year. Payrolls climbed by 255,000 last month, exceeding all forecasts in a Bloomberg survey of 89 economists, following a 292,000 gain in June that was a bit larger than previously estimated, a Labor Department report showed Friday.  The jobless rate held at 4.9 percent as many of the people streaming into the labor force found jobs. The rate of hiring is more than enough to whittle away at the jobless rate over time and gradually eliminate labor-market slack, a goal of Federal Reserve officials who’ve kept interest rates low to spur growth.  The median forecast in a Bloomberg survey called for a 180,000 advance.  Estimates in the Bloomberg survey ranged from gains of 140,000 to 240,000 after a previously reported 287,000 June increase. Revisions added a total of 18,000 jobs to overall payrolls in the previous two months. 

The unemployment rate, which is derived from a separate Labor Department survey of households, was little changed as employment climbed by 420,000, more than making up for the 407,000 increase in the labor force. The labor force participation rate, which indicates the share of working-age people who are employed or looking for work, increased to 62.8 percent from 62.7 percent. Wage growth offered more promising signs of acceleration, with average hourly earnings rising a more-than-forecast 0.3 percent from a month earlier, the most since April, to $25.69. The year-over-year increase was 2.6 percent in July, the same as in June. The average work week for all workers also increased by 6 minutes to 34.5 hours in July from 34.4. The gain in payrolls was broad-based, including manufacturers, health-care, retailers, temporary-help agencies and leisure and hospitality.  Government agencies also took on 38,000 workers, the most since September 2014, reflecting gains at local schools. 

The report did come with one caveat.  The underemployment rate climbed to 9.7 percent in July from 9.6 percent as many of the people entering the workforce had to settle for part-time jobs.  The number of people working part-time for economic reasons rose to 5.94 million from 5.84 million. Also, the number of discouraged Americans, those who stopped looking for work because of bleak prospects, rose to a five-month high of 591,000. Last week’s Commerce Department data showed the economy expanded in the second quarter at a 1.2 percent annualized rate, less than half the median projection by economists surveyed by Bloomberg.  Gross domestic product growth probably will pick up to a 2 percent rate by year-end, according to Bloomberg survey data. Fed policy makers’ decision last week to leave interest rates unchanged was accompanied by affirmation that risks to the U.S. economy have eased and the job market has continued to tighten -- all suggesting that a boost in borrowing costs at their next gathering Sept. 20-21 remained on the table before Friday’s Labor Department data. 

In other important economic news this week, here in the U.S. the Institute of Supply Management released their ISM manufacturing index and, later in the week, their ISM services index for the month of July. Both figures at 52.6 and 55.5 showed the economy continues to expand, despite the figures being slightly lower than estimates. Construction spending and factory orders for June were disappointing coming in at -0.6% and -1.5% respectively, both figures coming in below the prior month’s number. Initial weekly jobless claims for the week ending 7/30/2016 came in at 269,000 which was slightly above the estimate for 264,000.  

We continue to follow global news, in particular events unfolding in the U.K. as they react to the shocking Brexit vote outcome. Mark Carney, the Governor of the Bank of England, unleashed a package of stimulus, including the Bank of England’s first interest-rate cut in seven years, and said more easing could come as Britain feels the effects of its decision to leave the European Union. Officials led by the BOE governor voted unanimously to reduce the benchmark by 25 basis points to a record-low 0.25 percent.  They split over other elements of the plan that will expand the central bank’s balance sheet by as much as 170 billion pounds ($223 billion) via purchases of gilts and corporate bonds and a lending program for banks. “We took these steps because the economic outlook has changed markedly,” Carney told reporters in London on Thursday. “Indicators have all fallen sharply, in most cases to levels last seen in the financial crisis, and in some cases to all-time lows.” Policy makers slashed growth forecasts by the most ever and Carney declared that all elements of the stimulus can be taken further, including another rate cut.  The Monetary Policy Committee’s measures include a plan to buy 60 billion pounds of government bonds over six months, as much as 10 billion pounds of corporate bonds in the next 18 months and a potential 100 billion-pound loan program for banks. Should their outlook for the economy prove correct, “a majority of members expect to support a further cut in bank rate to its effective lower bound” later this year, they said in a statement.   

Carney said multiple times that this doesn’t mean rates will be negative. The interest-rate reduction marks the first change in the benchmark since March 2009, at the height of the financial crisis.  The pound slipped a further 1.5 percent to $1.3121 the day of the announcement as officials in England continue to scramble to contain the damage to their economy as a result of the vote. To put it in perspective, the pound traded at $1.50 on the day of the June 23 referendum. What were people thinking? We heard an English comedian note that two days prior to the vote when a poll was taken, 40% of respondents there said, “what’s an EU?” They could not say what the initials stood for. The good news is, when our core companies have reported earnings, there seems to be little impact as a result of the vote other than the currency effect.  

As always, stay tuned!

SGK Blog--Update July 29, 2016: Earnings Season Heats up as Fed Votes 

The Federal Reserve met this week to debate whether it was time to raise their benchmark federal funds rate.  As expected, they decided to make no changes.  However, they did seem to be laying the groundwork for a potential rate hike before year end.  According to their statement: “Job gains were strong in June following weak growth in May.  On balance, payrolls and other labor market indicators point to some increase in labor utilization in recent months.”  They also mentioned that household spending, which comprises two-thirds of GDP, was “growing strongly.”  They added, “Near-term risks to the economic outlook have diminished.”  According to the futures markets, the chance of a rate hike does not top 50% until March, 2017.  However, their next meeting, on September 21, will occur two months from now.  Thus, Fed officials will have two more months of key economic data including retail sales, housing figures, income and spending details and, of course, payroll and unemployment data points.  A lot can happen in two months.  Remember, two months ago the markets were placing bets on Brexit not happening.  The next key Fed date will be when Fed Chairwoman Yellen speaks at the Kansas City Fed’s Jackson Hole, Wyoming, symposium on August 26.  The event has held significance in the past as it was the site where former Chairman Ben Bernanke initially spoke of quantitative easing which dominated monetary policy for years.  Yellen will likely not be talking about such a key policy move, but her thoughts on the economy’s progress will be of utmost importance especially as Wall Street returns from summer vacation. 

There was other evidence this week that the economy is indeed on firm footing.  New home sales for new single-family homes rose in June to the highest level since February 2008 according to the Commerce Department.  Figures for May were revised higher.  Home demand jumped 10.9% in the West with a 10.4% increase in the Midwest which reached an annualized rate of 85,000, the largest since November 2007.  The median price of new home sales rose 6% from June 2015.  Last week we saw previously owned home purchases rise to the strongest level in more than nine years according to National Association of Realtors’ data.  Better home data is in direct correlation to the better employment environment and why the Fed is keeping a keen eye on what is going on in the labor market.  Initial jobless claims rose by 14,000 in the week ended July 23 according to the Labor Department, but the less volatile four-week average actually dropped to stay at the second-lowest level since 1973.  The four-week average of people continuing to receive jobless benefits fell to the lowest level since November 2000.  The next payroll report, due August 5, is expected to show a gain of 175,000 based on a survey of economists by Bloomberg.  That would be in-line with the 2016 year-to-date average of 172,000.  If we get a number closer to June’s 287,000 gain, the pressure on the Fed will rise considerably especially if there is also a decline in the unemployment rate which sits at 4.9%.  There is little evidence that layoffs are rising and more people are voluntarily leaving their jobs suggesting that we are close to “full employment.” 

Gross domestic data for the second quarter is running counter to this growth trend, however.  Economists in a Wall Street Journal survey expected a seasonally adjusted annualized growth of 2.6% for the three month period ending in June, but the Commerce Department said that the U.S. economy only grew at 1.2%.  The first quarter was also downgraded to a 0.8% growth rate, lower than the 1.1% original figure.  This marks the third straight period that the economy has grown less than 2%.  The consumer is doing its part.  Personal consumption expanded at a 4.2% pace.  Spending on services rose 3%.  Conversely, non-residential fixed investment, a proxy for business spending, fell 2.2%, the third consecutive quarterly decline.  Inventories declined which subtracted 1.2 percentage points from overall growth.  Somewhat counterintuitively, inventory liquidation shows up as a subtraction from growth because goods are not being produced during the quarter to replace them.  GDP is a measure of production, so less production means lower GDP even though the level of finished goods is falling.  Government spending also was a subtraction from growth as that sector fell 0.9% led by a decrease in federal defense spending.  In the first quarter, that segment gained 1.6% so this was a dramatic turnaround.    Today’s release is considered an “advance print” meaning it will be revised twice more so there is a chance that the number could move higher.  Moreover, the Bureau of Economic Analysis which calculates this data within the Commerce Department initiated a new strategy to improve so-called “residual seasonality” issues whereby the first quarters of recent years were extremely weak  only to have the second quarters rebound sharply.  Revised 2014 and 2015 figures now have a smoother trajectory between the first and second quarters and there was not a big gap this year either.  Nonetheless, such a big shortfall from consensus and the weaker revisions suggest that the economy is not as solid as previously thought.  More issues for the Fed to contemplate as summer turns to fall and the general election looms on the horizon.

SGK Blog--Update July 22, 2016: Positive Earnings Set Tone For Equity Markets This Week 

Positive earnings set the tone for equity markets, pushing U.S. stocks to fresh records this week, while the dollar traded at a seven-week high as speculation grew the U.S. will raise interest rates this year. There was a front page article in the Wall Street Journal that was in a small box in the bottom right hand corner of Wednesday’s edition that caught our attention.   It was titled, “Optimistic Fed Sees Rate Rise Before End of the Year.”   We think that title basically sums up the article nicely – it seemed to be planted by the Federal Reserve itself in order to begin to reset market expectations. Given this article and the most recent data on earnings and the U.S. economy, we would not be surprised to see a rate hike come as soon as their September meeting. Corporate earnings are helping sustain a run that’s added more than $4.5 trillion to the value of equities worldwide in three weeks. That along with better-than-estimated U.S. economic data is providing comfort to investors even as concern mounts that the U.K.’s vote to leave the European Union will damp global growth. The earnings seasons so far has delivered more positive surprises than negative ones. Analysts see profit at S&P 500 companies falling 5.8 percent in the second quarter, which would mark a fifth consecutive slide, the longest streak since 2009. We will have to wait and see – so far our core group of companies have delivered good results and we hope that streak continues. We report on a handful of those results below.  

On the domestic economic front, the U.S. housing sector continues to churn out impressive numbers.   Housing starts and building permits for June came in at 1,189,000 and 1,153,000 – both above the expected amounts. Later in the week we received figures on existing home sales which also beat expectations coming in at 5.57 million for the month of June. Initial weekly claims for the week ending July 16, 2016 were less than expected (that is positive in terms of the employment sector) at 253,000. Finally, the index of leading indicators, a measure of future economic expectations, came in as expected at a positive 0.3% for the month of June. The figures overall on the U.S. economy for the week gave reason for optimism with respect to our growth trajectory here in the U.S., and ammunition to support the Fed should they in fact hint at their July meeting of future rate hikes to come. 

We will dedicate the majority of this week’s email to the results from eight of our core holdings as they reported on their second quarter.   As always, stay tuned!

SGK Blog--Update July 15, 2016: Markets Set New Records

Earnings season began this week and we had two of our Core holdings report results.  Meanwhile, the economic calendar was filled with new releases which we will discuss first.  The labor market continued to show strength with the initial unemployment claims in the week ended July 9 unchanged at 254,000 compared to the week prior according to the Labor Department.  In April, applications dropped to a four decade low of 248,000.  Weekly claims have been below 300,000 for 71 straight weeks, the longest period since 1973.  The number of people continuing to receive jobless benefits rose by 32,000 to 2.15 million in the week ended July 2.  When paired with the monthly payroll report which showed a 287,000 gain in June, it is apparent that the weak number we saw for May was an outlier.

Wholesale prices rose by 0.5% in June according to the Labor Department, the most since May 2015.  The median forecast of 64 economists polled by Bloomberg called for a 0.3% advance.  Food prices rose 0.9% and gasoline prices were 9.9% higher.  Excluding food and energy, producer prices rose 0.4% following a 0.3% increase in the month prior.  Those costs were up 1.3% from a year ago.  So, outside of commodity pressures, there appears to be very manageable inflationary forces at work from producers.

For consumers, the price index for June rose 0.2% for the second consecutive month.  For the 12 months ended in June, prices increased 1%.  Core consumer prices, which excludes food and fuel, also rose 0.2% for a third consecutive month.  That measure if up 2.3% from June of last year, up from 2.2% in the prior 12-month period.  That exceeds the Fed’s goal of 2% but is the only major price index to do so.  Wholesale prices, as reported above, have not reached that threshold.  And, the Fed’s preferred gauge, the Commerce Department’s personal consumption expenditures measure, has not hit that target since April 2012.  Retail sales, according to the Commerce Department, rose 0.6% compared with expectations of a 0.1% increase.  Eleven of the 13 major categories showed stronger demand in June from the prior month including a 1.1% increase in receipts at online merchants, a 3.9% rise in building supplies/garden supplies and a 1.2% jump in receipts at gas stations.  Excluding automobiles, retail sales rose a still healthy 0.7% in June and April was revised up a tenth to 0.9%.  This was the strongest quarterly annualized change at 7.1% since the second quarter of 2014.

Even with the strong consumer and retail data, it is unlikely the Fed will change its outlook on rates.  The next Federal Open Market Committee meeting is scheduled for July 26-27 and given the various political elements at work, especially following another apparent terrorist attack in France, the odds of a hike are close to zero based on the futures markets.  Concerning fallout from Brexit, Federal Reserve Bank of St. Louis President James Bullard said, “I think the ultimate impact on the U.S. economy will be close to zero.”  He believes that a tightening labor market is not going to trigger significantly higher inflation because GDP growth will likely remain too weak.  As we have argued recently, the solution to the global tepid growth issue is more fiscal input.  Bullard stated, “We badly need a growth agenda.  We’re talking but I think it’s falling on deaf ears.”  Given that Capitol Hill is already in full (re)election mode, that is an unlikely event anytime soon and governments overseas are dealing with various issues above and beyond Brexit matters.

The Bank of England left its key interest rate unchanged at 0.5% this week which surprised investors who had priced in a rate cut.  According to minutes of the meeting, “Most members of the committee expect monetary policy to be loosened in August.  The central bank will publish its quarterly Inflation Report on August 4 which will be the first chance investors will get to peruse new forecasts for growth and inflation post-referendum.  Politically, things were taking shape in the U.K.  Home Secretary Theresa May succeeded David Cameron as Prime Minister after her only opponent, Andrea Leadsom, dropped out.  She will become the country’s second woman prime minister, after Margaret Thatcher.  Her cabinet has already taken shape with Boris Johnson, the former Mayor London and main Brexit advocate, appointed Foreign Secretary and Phillip Hammond as the new treasury chief.  The main issues she has to confront are whether to call for new elections and when to formally trigger Article 50 of the Lisbon Treaty, which begins two years of negotiations to leave the EU bloc.  The key negotiating points will be access to free trade in goods and services with the EU and the level of continuing obligations for the U.K. in terms of movement for labor.  Ms. May is unlikely to rush into anything until she can complete her cabinet and work with not only the central bank but also EU counterparts on the finer details.  Stay tuned.
SGK Blog--Update July 8, 2016: Jobs Report Sends Stocks Higher as Focus Turns to Upcoming Corporate Earnings Releases 

After the U.K.’s June 23 referendum led a vote to withdraw from the EU, policy makers around the world are watching for signs that weakness stemming from the heightened uncertainty is damping growth.  Central banks have pledged to support global liquidity levels, and Fed officials say they are closely monitoring the situation. Minutes from the Fed’s June meeting revealed that the policy makers wanted proof that job creation would resume a healthy pace and economic momentum remained intact. They also cited their concerns and the risks to the global economy due to the uncertain outcome at that time of the vote in Britain. Futures put the probability of the Fed raising interest rates by December at 12 percent, down from 50 percent at the time of the U.K.’s June 23 referendum.  

Europe was still suffering as investor sentiment over there took a knock in the wake of the so-called Brexit vote. Seven U.K. property funds froze withdrawals amid a surge in redemptions. Business confidence in the U.K. slumped to the weakest it’s been since 2011, a report showed Thursday, adding to evidence that the decision is blighting growth. With investors anxiously awaiting data on the consequences, the gauge compounds signs the referendum has hindered an economy that was already losing momentum.  The Brexit effects won’t appear in the official data until mid-August, but a growing number of surveys show pessimism is intensifying.  House prices -- only just starting to feel the impact of last month’s vote -- gained 1.2 percent in the three months to June, down from 1.5 percent in the same period to May, casting doubt on prospects for the rest of the year. Bank of England Governor Mark Carney has warned of a material slowing and signaled interest rates could be cut within months.  Central bank officials began meeting on the matter on Wednesday and are due to announce their next policy decision on July 14. The consequences of Britain’s vote are “chaos, uncertainty and a lack of understanding,” Eurogroup head Jeroen Dijsselbloem told lawmakers in The Hague on Thursday.  “The U.K. will be worse off in every thinkable way.” As if to reinforce that comment, on Friday a release came out showing U.K consumer confidence plunged the most in 21 years. The British pound sank to a 31-year low of $1.2798 on Wednesday relative to our dollar.  

The spillover effects were being felt in other parts of Europe as well.   Take Germany for example, German industrial production unexpectedly declined in May in a sign that the headwinds from a global economic slowdown and political uncertainty in Europe damped activity. Production, adjusted for seasonal swings, fell 1.3 percent from the previous month, when it rose a revised 0.5 percent, data from the Economy Ministry in Berlin showed on Thursday.  Economists in a Bloomberg survey had predicted a 0.1 percent rise in the typically volatile gauge.  Output fell 0.4 percent from a year earlier. The report underscores the challenges facing German manufacturers, with signs of fragility in the global economy now likely to be exacerbated by the U.K.’s decision to quit the European Union.  The British vote in June could further weaken the German economy, Bundesbank President Jens Weidmann warned last week. The decline was led by investment goods, which dropped 3.9 percent, while consumer goods gained 0.5 percent.  Construction fell 0.9 percent from April and intermediate goods declined 0.3 percent, the ministry report showed.  Output of manufacturing fell 1.8 percent, while energy gained 3.9 percent. The bottom line is, much of Europe remains in shock after the vote and the after-effects are uncertain and still to be measured. 

America’s job market stirred to life in June as payroll growth accelerated by the most since October after a two-month lull, assuaging fears of broader cutbacks by companies. Payrolls climbed by 287,000 last month, exceeding the highest estimate in a Bloomberg survey, after a revised 11,000 gain in May, a Labor Department report showed Friday.  The median forecast in a Bloomberg survey called for an 180,000 increase.  The jobless rate rose to 4.9 percent as more people entered the labor force.  Wages advanced less than projected. The figures will help reassure workers and Federal Reserve policy makers alike that companies are staying the course on hiring in the face of weaker profits and overseas developments such as Britain’s vote to leave the European Union.  Even with the outsized June advance, job growth over the last three months averaged 147,000, down from almost 200,000 in the first quarter and a sign of moderation as the economy approaches full employment. Payrolls in leisure and hospitality registered the biggest gain since February 2015, health care providers took on the most workers since October and factories added the most jobs in five months. June payrolls were boosted by the return of 35,100 striking workers at Verizon Communications Inc.  Estimates in the Bloomberg survey for total employment ranged from gains of 50,000 to 243,000 after a previously reported 38,000 May increase.  Revisions to prior reports subtracted a total of 6,000 jobs to overall payrolls in the previous two months. 

The unemployment rate, which is derived from a separate Labor Department survey of households, increased from 4.7 percent in May. The labor force participation rate, which indicates the share of working-age people who are employed or looking for work, crept up to 62.7 percent from 62.6 percent. The Labor Department’s underemployment rate dropped to 9.6 percent in June, the lowest since April 2008, from 9.7 percent, reflecting a slump in the number of people working part-time for economic reasons.  Some 5.8 million workers, the fewest since October, were in part-time jobs but wanted to be employed full time. Wages improved modestly, with average hourly earnings climbing 0.1 percent from a month earlier.  The year-over-year increase was 2.6 percent, less than the 2.7 percent median forecast. The average work week for all workers held at 34.4 hours in June. Factories increased payrolls by 14,000 after a 16,000 decline the month before, the latest indication that the industry is stabilizing after damage wrought last year by a strengthening dollar and plunging oil prices.  Employment at construction companies was unchanged after falling in May. Among services providers, retailers boosted payrolls by almost 30,000, while employment in health care climbed 58,400.  In leisure and hospitality, payrolls jumped 59,000 in June.  Governments added 22,000 workers, the most in almost a year.  

Other data on our economy released this week demonstrated the resilience of the U.S. economy.   Our services data Wednesday for June showed strength as the figure came in at 56.5 which was well above the expectation for 53.3 and the prior month’s 52.9. Weekly initial jobless claims were a precursor to Friday’s jobs report as they showed that claims were down to 254,000 for the week ending June 2 versus the expectation for 268,000 and the prior week’s 270,000. Factory orders for May were the one downer this week as they fell 1% which was slightly worse than expected.   Overall though it was a pretty good week from the standpoint of us as investors here in the almighty USA! Now we await corporate earnings reports – one concern is with the current valuation of certain equities and the strength of the US dollar, it will be interesting to hear how companies will project foreign currency adjustments on their overseas income. That will likely be a headwind in the near term. 

As always, stay tuned!


SGK Blog--Update July 1, 2016: Markets Rebound After Brexit

A week after the U.K. made their historic decision to leave the European Union, many markets rebounded after the sharp declines that characterized last Friday and Monday of this week.  After the initial shock of the vote, traders began to realize that, at least outside of the U.K., not a lot was going to change in terms of the outlook for 2016.  The strength in the bond market is a sign that the “mission accomplished” banner should not be hung just yet, however.  Last week we covered in great detail the initial fallout and global affects.  We will touch upon the rebound this week a little more in the performance section below.  We will have a special Brexit-themed commentary distributed with your quarterly reports that will be available shortly through our website.  In the meanwhile, there were a number of economic reports released this week worthy of discussion. 

Jobless claims rose by 10,000 in the week ended June 25 according to the Labor Department to bring the total to 268,000.  For 69 consecutive weeks, initial claims have been below the 300,000 level that is typically consistent with an improving jobs market according to economists.  This is the longest stretch since 1973.  Next Friday the June monthly payroll report will be released.  Expectations are for expansion of 175,000 which would be a big improvement from the 38,000 reported for May.  The April and May figures were affected by a Verizon workers strike and other non-recurring items which makes it difficult to draw conclusions about the labor market’s health.  The June report is expected to be “clean” which will help determine if the market is indeed slowing or if these months were just anomalies. 

The Commerce Department reported May consumer income and spending data.  Incomes rose a less-than-forecast 0.2% during the month while purchases rose 0.4% after a 1.1% jump a month earlier.  Over the past 12-months, incomes have advanced 4.0% but disposable income, or money left over after taxes, was up a smaller 3.2%.  The savings rate dipped slightly from 5.4% in April to 5.3% in May.  Core personal consumption expenditures, which exclude food and energy components, rose 1.6% and inching closer to the 2.0% inflationary level the Fed is looking for.  Including the volatile and slightly deflationary energy and food items, year-over-year expenditures have advanced at only a 0.9% pace.  Thus, things are looking better for GDP growth in the second quarter.  The first quarter’s reading was revised upwards to 1.1% this week from the previously reported 0.8%.  Regardless, many saw that period as disappointing and the slowdown in monthly payroll figures had many thinking that the economy may have lost any forward momentum.  Now economists are predicting a second quarter GDP figure closer to 2.5% against a decidedly volatile geopolitical environment.   We will get an advance estimate of the second quarter on July 29.  

These stronger income and spending levels are leading directly to steady housing figures.  The S&P/Case-Shiller results released this week showed the twenty-city property values index rose 5.4% from April 2015 after rising 5.5% in the year through March.  All cities in the index showed a year-over-year gain led by a big jump of 12.3% in Portland and a 10.7% rise in Seattle.  Better prices might entice buyers sitting on the sidelines to jump into he market before being priced out while at the same time encouraging some to put their houses on the market to capture the upward trend.  The overall pace does not seem to be too sharp to discourage first time buyers who often do not have the capital for down payments.  The spring selling season is almost over but many realtors would consider the first half of the year a success.  It can still considered a seller’s market given the lack of inventory and sub-six month sales pace, but low mortgage rates help cushion any sticker shock on the part of buyers. 

The economy also is showing strength in areas that were weak before.  The Institute of Supply Management’s index for June rose to 53.2, the highest level since February 2015 indicating that the manufacturing sector is firming.  A reading above 50.0 is an indication of expansion and the new orders gauge rose to 57 while the index of bookings from overseas customers rose by 1 point.  Given the Brexit, some of this optimism may be fleeting.  A stronger dollar will hurt exporters are goods become more expensive to overseas buyers.  A rebound in oil prices helped.  Energy firms who survived the plunge in prices were given a breather as any new orders had less competition.  Solid numbers from auto companies also show that manufacturers are keeping their lines running as long as the demand fueled by the better job numbers continues.

SGK Blog--Update June 24, 2016: British Vote to Leave the EU 


Britain’s vote to leave the European Union came as a shock to many traders, particularly those involved in the currency markets. The pound plunged to the lowest since 1985, while European equity bourses saw their worst declines we have witnessed in a long time.   Here in the U.S., stocks pretty much gave up the gains that had been building ahead of the vote, while bonds sharply rallied as the U.S. Ten-year Treasury once again dipped below 1.6%.  European stocks bore the brunt of the decline Friday, with the Stoxx 600 Index falling 8.6%, France CAC 40 declining over 8% and the German DAX falling 6.8%. Interestingly, the FTSE 100 in England fell just 3.15%. We had been following their futures market last evening and it was bouncing around indicating declines of as much as 10% at certain points. Prime Minister David Cameron resigned, saying he’d serve another three months, after a 52% majority rejected his pro-EU campaign.  

The market volatility will almost certainly have repercussions for the Federal Reserve -- and those could play out over days or months. On Friday, the Fed said it’s ready to act with its global central bank partners to shore up liquidity in markets, if needed.  In the medium term, the post-Brexit market turmoil could delay a rate increase, while in the longer term, secondhand effects could bleed into U.S. economic data. As mentioned, the Fed joined other major central banks Friday in saying it was prepared to take action to help calm global financial markets. “The Federal Reserve is prepared to provide dollar liquidity through its existing swap lines with central banks, as necessary, to address pressures in global funding markets, which could have adverse implications for the U.S. economy.” Earlier on Friday, the Bank of England and the European Central Bank made similar statements. “To support the functioning of the markets, the Bank of England stands ready to provide more that £250bn ($350 billion) of additional funds through its normal facilities.   The Bank of England is also able to provide substantial liquidity in foreign currency, if required.” - Mark Carney, Governor, Bank of England. “The ECB stands ready to provide additional liquidity, if needed, in euro and foreign currencies.” – ECB statement. 

G-7 finance ministers and central bank chiefs also issued a joint statement promising coordinated action in an attempt to prevent “excessive volatility and disorderly movements in exchange rates.” The fallout from Brexit could delay the Fed’s plan to increase interest rates in coming months, particularly given the dollar strength after the vote. The British vote to leave comes at a time when Fed policy makers were already sounding less confident that a rate hike was imminent -- Chair Janet Yellen had been saying that an increase could be appropriate “in coming months,” but that language has been conspicuously absent from her speeches following a weak May jobs report.  Now, if markets are roiled and a flight to safe assets drives up the dollar and tightens financial conditions on a sustained basis, it could be even harder for the Fed to move. Futures pricing discounted the odds of a rate increase and showed the probability of an actual rate cut running as high as 19 percent in both September and November as of 8:15 am in New York on Friday.  Investors on Thursday saw zero chance of a rate cut this year. 

Here in our markets, as we discussed, stocks bore the brunt of the pain while bonds rallied sharply. At SGK we favor balanced portfolios using high quality securities both in terms of stocks and bonds.   As we witnessed with the market volatility early in the year, our portfolios are designed to mitigate volatility to the degree possible with this emphasis on all investment grade securities, controlled position sizes, healthy diversification and an effective balance for clients. As we have mentioned on numerous occasions, stocks frequently tend to climb slowly and steadily but when a sudden and, in this case, unexpected event occurs, they can decline in a hurry. We have weathered these instances before very well for clients and we expect to do so again this time. Prior to the vote, we at the firm here had gone through every one of our securities to make sure we were comfortable holding these positions in case the vote went against the consensus. Our view is that polls have become very unreliable, and in this case they were swinging back and forth and it was really tight anyway.   We determined we were comfortable with the positioning we have.

The U.S. dollar strengthened Friday significantly relative to the two major currencies, the pound and the euro, most negatively impacted by the vote. We here at the firm hold U.S. investment grade stocks and bonds. The individual holdings – unlike most mutual funds and exchange-traded funds – pay us healthy dividends and interest payments. It is great in our view to be paid on a regular basis in our portfolios in the all-mighty U.S. dollar – particularly today as it goes a lot further than it did a week ago.   This should help control inflation pressures and keep interest rates low here in the U.S. – so there are some definite positives that come out of this.   Also many companies have limited exposure to the UK – how does it impact a local defense contractor like CACI International or a U.S. health insurer like Anthem? One of the issues we recognize which we need to hear that companies are preparing for in their upcoming earnings calls is that the strong U.S. dollar will impact earnings through the foreign currency adjustment.   Stocks trade on the forward outlook, interest rates will be working in our favor while earnings will be impacted by the British vote.   So companies that do business in England will continue to do so, but when they translate those pounds into dollars it will mean less dollars.   So there will be an impact, at least over the next few months, on earnings but the companies we hold have generally accommodated those foreign currency adjustments well in the past.   So we expect to hear them account for that in their upcoming calls which we participate in. 

We would just add too that it is always important to keep things in perspective, with the 3-4% drop in our major averages here in the U.S., we ended the week down just about 1.5% on average for the major indices. The U.S. economic data, overshadowed by Friday’s news, was actually not too bad this week. Existing home sales for May exceeded expectations coming in at 5.53 million while new home sales were a healthy 5.51 million. Initial weekly jobless claims for the week ending 6/18/2016 came in better than expected at 259,000 versus the estimate for 273,000. Durable goods orders for May were below expectations coming in at -2.2% but excluding the volatile transportation component it just showed a 0.3% decline. The University of Michigan’s consumer sentiment index was a healthy 93.5 for June. So the U.S. consumer is feeling pretty good at the moment – we will have to wait and see what impact the vote in Britain will ultimately have on the U.S. economy.   At this point that remains uncertain. As always, stay tuned!

SGK Blog--Update June 17, 2016: Markets Waiting for the Next Headline 

Federal Reserve Chair Janet Yellen seems to be coming around to what her one-time rival, Lawrence Summers, has been arguing for a while: Some of the forces holding down interest rates may be long-lasting and secular. That’s reflected in a marked downgrade in rate projections released by policy makers after their meeting on Wednesday.  Six of 17 now only see one rise this year, after the central bank lifted rates effectively from zero in December. Officials also slowed the pace of expected moves in both 2017 and 2018: They now only foresee three increases in each of those years, down from the four they expected in March, according to their latest median forecast. Yellen in the past has ascribed the low level of rates mainly to lingering headwinds from the financial crisis -- tight mortgage credit, for instance -- and suggested that they would dissipate over time. On Wednesday, though, she also pointed to more permanent forces that could depress rates for longer, namely, slow productivity growth and aging societies, in the U.S. and throughout much of the world.

In a press conference after the Fed held policy steady, Yellen spoke of a sense that rates may be depressed by ”factors that are not going to be rapidly disappearing, but will be part of the new normal.” Summers, who was in the running to get the Fed job before losing out to Yellen in 2013, has been contending for several years that the U.S. and other industrial countries are mired in “secular stagnation” of scant economic growth. A key component of his argument: An excess supply of savings and a paucity of demand is depressing equilibrium interest rates in the advanced world, making it difficult for central banks to ease credit enough to lift growth and inflation. The equilibrium, or neutral rate, is the one that balances the supply of and demand for savings in an economy.  If a central bank wants to spur growth it has to cut rates below that level. 

At least one Fed policy maker seems to be listening, based on the so-called dot plot of Fed officials’ rate forecasts released today.  The official sees the Fed holding rates steady in 2017 and 2018 after raising them once this year. In contrast, Yellen said many Fed policy makers expect to increase rates in the coming years as the headwinds from the financial crisis dissipate further. She did though take note of other forces that could keep rates low for years.  “There are also more long lasting or persistent factors that may be at work that are holding down the longer-run level of neutral rates,” she said. Fed officials reduced their estimate of the long-run equilibrium federal funds rate to 3 percent from 3.25 percent in March, according the median forecast released on Wednesday.  Yellen suggested though that for now, the neutral rate may be around zero, after taking account of inflation.  

The debate over the appropriate stance of monetary policy -- and in particular the level of the equilibrium interest rate now and in the future -- is taking place against an international backdrop where rates have turned negative in many countries. The yield on Germany’s 10-year government bund, Europe’s benchmark security, fell below zero for the first time on record on Tuesday, as investors sought safe-haven assets ahead of next week’s vote by the U.K. on whether to remain in the European Union. Yellen said the U.K. referendum was a factor in the U.S. central bank’s decision to hold interest rates steady at its meeting Wednesday in Washington. “It is a decision that could have consequences for economic and financial conditions in global financial markets,” she said.  A vote on June 23 by Britons to leave the EU “could have consequences in turn for the U.S. economic outlook,” she said. 

On that note, campaigners for the U.K. to leave the European Union poured scorn on the government’s bleak vision of a post-Brexit Britain, as anxiety about next week’s knife-edge referendum spread to our Federal Reserve. Justice Secretary Michael Gove, one of Brexit’s leaders, criticized the austerity budget that the Remain camp says would be necessary to shore up public finances if the U.K. votes to leave.  The plan’s main author, Chancellor George Osborne, is fighting a growing rebellion as lawmakers from his Tory party lined up to reject the proposed tax hikes and spending cuts. Osborne sought to stem the revolt in a keynote speech at the Mansion House in the City of London on Thursday evening.  There he was joined by another leading advocate of staying in the EU: Mark Carney, governor of the Bank of England, which announced an interest-rate decision at noon London time. As with our Fed, they chose to remain on hold ahead of the referendum next week.  Japan’s central bank also refrained Thursday from adding stimulus even as it weakened its outlook for inflation.  While the Bank of Japan statement made no specific mention of the looming referendum, it cited "geopolitical risks" fueling market volatility. With a week left before the vote, five of the last six published polls have showed Brexit ahead, a prospect that has unnerved investors.  Global equities have lost more than $2 trillion over the past week.  From the Fed to EU headquarters, policy makers were preparing for the fallout. 

From the standpoint of our portfolios, while equities declined this week our holdings have held up quite well.   Our high quality investment grade bonds also did well with the volatility in interest rates we witnessed this week.   We do not see a direct correlation between our individual holdings and the Brexit vote.   We are opposed to Britain leaving the EU, but either way it is hard to see much of an impact on our stocks and bonds in the intermediate to long term.    

In U.S. economic news this week, retail sales for May looked healthy coming in a little better than expected at +0.5% and excluding autos at +0.4%.   Both the producer price index (PPI) and the consumer price index (CPI) for May came in about as expected at +0.4% and +0.2% respectively.   The core rates (excluding food and energy) were +0.3% for the PPI and +0.2% for the CPI. Initial weekly jobless claims for the week ending 6/11/16 were slightly higher than forecasts at 277,000 versus the expected 269,000.   Factory capacity utilization and industrial production for May were both lower than expected coming in at 74.9%, down from the prior month’s 75.3%, and -0.4%, down from the prior month’s +0.6%, respectively. Finally, housing indicators remained strong as both housing starts and building permits were basically in-line with expectations coming in at 1,164,000 and 1,138,000 in May.  

All eyes will be focused on Britain next week as their citizens go to the polls to vote on Thursday. As always, stay tuned!

SGK Blog--Update June 10, 2016: Markets Waiting for the Next Headline

With the second quarter rapidly coming to a close, markets had a number of milestone events to get through before closing the books at the end of the month.  Next week, the Federal Reserve will meet as scheduled on June 14-15 and reveal their decision in a statement followed by a press conference with Chairwoman Janet Yellen.  The members will update their annual projections for GDP growth, inflation and unemployment.  Their last projections released on March 16 saw the median expectation for GDP to be 2.2% in 2016 and 2.1% in 2017.  The unemployment rate for this year should finish below 5% at 4.7% according to median estimates with a longer-run expectation of 4.8%.  In general, their March figures were below the December projections which reflected a general slowdown in the economy.  For the markets, a more cautious view seemed to jive with bets placed in the futures market which saw no reason to anticipate robust growth anytime soon.  Currently, the odds of a Fed rate increase at next week’s meeting is 0.0%.  However, this figure is incredibly volatile.  One week ago, that number was 22.0% and one month ago it was 4.0%.  The chances do not go above 50% until the December 14 meeting which assign a 55.9% probability of a move.  Traders have also begun to focus more on July’s meeting.  That will not entail any updated projections or a post-meeting presser, but, if the foundation of a hike is well laid before that date arrives, the Fed and the markets could be comfortable with a move. 

The following week, Ms. Yellen will deliver her semiannual monetary policy report to the Senate Banking Committee on June 21 and then appear before the House Financial Services Committee the following day.  Ms. Yellen has become more comfortable appearing before Congress and is unlikely to set off any waves especially so soon after the Fed meeting.  Nevertheless, having listened to many of these events before, there is always the chance that a member of Congress asks an off-the-wall question whose answer gets misconstrued by the markets.  Members of Congress are politicians so their questions are always laced with some sort of political undertone which oftentimes has only the thinnest of connections to what the Fed and its chairperson actually do on a daily basis.  We often feel sorry for the chairperson when a question about gun control laws or Medicare becomes somebody’s soap box topic.  If you will be following along at home, it might be best to watch with the TV on mute. 

Just days later, voters will go to the polls in the United Kingdom to vote on whether they should remain a member of the European Union.  The country never did join the monetary union which meant that its currency continued to trade independently of the euro when it was introduced in 1999.  A vote to leave would have ramifications well beyond the borders of Europe.  London has developed into the financial capital of the continent even with the EU headquarters in Brussels.  U.S. and European banks, for one, would have to completely restructure operations which now benefit from the open border regulatory environment within the EU.  It is no surprise that many large banks are against the so-called Brexit due to the massive confusion that would affect trading and clearing relationships.  Manufacturers of exported goods would also have to put up with more regulatory red tape—and higher transport costs—if goods could no longer flow freely to England, Wales, Scotland and Northern Ireland.  Most exit polls for the June 23 vote continue to point toward a “no” vote, meaning the U.K. remains a member, but recent data has delivered a mixed message with some favoring a “yes” majority.  Immigration continues to be a key issues for most voters along with the ability of Britain to make its own laws without EU influence.  The vote is close enough that any negative headlines—say a terrorist bombing at the upcoming European soccer championships in France that start today and run through early July—could be a huge swing factor. 

With the markets only about 1% below the all-time highs reached last May, indices may meet resistance if negative headlines dominate over the next few weeks.  Conversely, averages historically do not just edge past a record level, they often shoot higher and continue the upward momentum for a number of trading sessions as traders who missed out try to jump on the boat, especially if it’s near the end of the quarter for window dressing purposes.  Stay tuned.

SGK Blog--Update June 3, 2016: Employment Head Scratcher

Most of the focus this week was on economic data as new information about first quarter earnings has mostly come to an end.  The headline number on the week was the monthly employment report from the Labor Department.  For May, non-farm payrolls rose 38,000 versus an expectation of a 160,000 gain.  The estimates in a Bloomberg survey of economists ranged from increases of 90,000 to 215,000 so the final number was far below target.  Additionally, revisions to prior reports subtracted a total of 59,000 jobs from payrolls in the prior two months.  This was the fewest number of jobs added since September 2010 when the U.S. economy was still trying to climb out of the lethargy caused by the Great Recession of 2008-2009.  The number of part-time workers who would rather have full-time jobs climbed 6.4 million in May, up from 6.0 million a month earlier.  Factories cut employment, mining and lodging lost jobs and there was an overall slowdown in service hiring.  Private sector hiring was just 25,000 in May, far below the 173,000 increase reported by ADP Research just a day earlier.    


However, average hourly earnings rose by 0.2%, in-line with expectations.  Thus, year-over-year, employees are being paid 2.5% more than last May.  April’s number was revised upward from originally +0.2% to now +0.4%. Fed Chairwoman Yellen has emphasized that it is not only the amount of workers but also what they are getting paid will be key determinants in how the Fed sees future interest rate policy.  This rate is above the 2.0% benchmark and suggests that the headline figure is a bit misleading in terms of labor market strength.  Additionally, the Labor Department said that a work stoppage at Verizon Communications involved about 37,000 workers and skewed the data.  The workers were able to secure an 11% rise in wages, much higher than the 6.5% originally offered by management and yet another sign of higher wage growth.  The weekly initial unemployment data, a more timely indicator of the job market, saw claims fall by 1,000 to 267,000 in the week ended May 28, below the median forecast of 270,000.


To add to the confusion, the unemployment rate fell from 5.0% to 4.7%.  That may be a good result to boast for politicians running for office, but looking inside the numbers, the conclusion is quite the opposite.  The size of the labor force fell by 458,000.  Some seekers may have become so frustrated they just dropped out altogether.  Their job skills will continue to erode as they stay on the sidelines.  The participation rate fell from 62.8% in April to 62.6% last month.


So was the monthly figure just an outlier?  Or was it an ominous omen of things to come?  The bond market answered by pushing yields lower (bond prices move in the opposite direction of yields).  The benchmark 10-year U.S. Treasury Note finished Thursday with a yield over 1.8% but closed Thursday much closer to 1.7% which, in bond terms, is a large move.  Moreover, it likely ended for now any talk of a June rate increase at the Fed’s next meeting on June 14-15.  The odds of a June hike implied by futures trading had risen to as high as 34% in late May.  After today’s employment report, they plunged to 4%.  That sets up an interesting situation.  June’s meeting will involve an update of the Fed’s projections on the economy, employment and inflation.  It will also include a post-meeting press conference with Ms. Yellen.  If this was indeed an anomaly and data rebounds (June’s employment report will be released on July 8…and all those Verizon workers are now back on the job) by the Fed’s following meeting on July 27, do they pull the trigger then even with no update on projections or conference call?  Fed Chair Yellen will address the World Affairs Council of Philadelphia on Monday at a luncheon event and she will testify before Congress on June 21-22 as required on a semi-annual basis.  Besides the June 15 presser, those are two more clear opportunities to defend a Fed move if that is indeed the path the Fed as a whole is on.  If the speeches only halfheartedly tilt in that direction, the chances of two rate increases in 2016 will be greatly reduced.


Meanwhile, overseas, the European Central Bank (ECB) left its main policy rates unchanged at its meeting in Vienna.  The ECB’s forecast for inflation was raised marginally from 0.1% to 0.2% for 2016.  The 2017 and 2018 forecasts were left unchanged at 1.3% and 1.6%, respectively.  For the ECB, its sole mandate is stable prices.  Conversely, the Fed has a dual mandate of a stable inflation and full employment.  For the ECB, making sure it is reaching its objective of returning inflation close to 2% is paramount.  A critical point is arriving for Mr. Draghi and his colleagues at the ECB.  In September, another set of forecasts will be released and it will mark six months before the announced end date for asset purchases.  Mr. Draghi said this date could be extended if necessary.  Markets are going to want answers.  Namely, when and for how long more stimulus will be applied (corporate bonds were just added to the quantitative easing approved list of purchases) since it is clear that, so far, top line growth has been absent primarily because of an absence in wage pressures.  While unemployment remains stubbornly high in numerous euro countries outside of Germany, it is clear that inflation is not going to come anywhere close to that objective by March of 2017.  The clock is ticking.


Europe was also the locale for the 169th Organization of Petroleum Exporting Countries (OPEC) conference which was held in Vienna, Austria yesterday.  It was described by many as a “lovefest”.  Why not?  The price of Brent crude has risen 100% since late January as the strategy of all out drilling ironically seems to be working.  According to new Saudi Arabia oil minister Kahlid Al-Falih, “I believe that the strategy that OPEC adopted in 2014 has indeed succeeded.  We see supply and demand converging.”  It helps that fires in Canada, political upheaval in Libya and attacks in Nigeria have removed about 3.7 million barrels per day from the global equation.  Though Canadian supply can come back online soon, issues in Nigeria, Libya and politically unstable Venezuela will take longer to solve.  Reportedly 83 tankers were backed up at Venezuelan ports, and oil service companies are pulling back since they are no longer being paid for their work.  A bigger reason for the balance is that U.S. production has fallen from about 9.6 million barrels per day a year ago to around 8.8 million currently, according to data from the Energy Information Administration.  Many drilling rigs have been taken offline and fracking crews have been dismissed from once hot areas like North Dakota.  To bring all that back online simply because oil is hovering around $50 per barrel is not going to happen.  But, it still may be a stretch to think that everything is fine and dandy and $100 oil prices are around the corner. 


OPEC is likely never going to have the power it once did.  Saudi Arabia and Iran remain rivals and global stockpiles hover near record levels.  An output cap was not expected at this week’s meetings so the outcome had little effect on spot prices.  Saudi members did float the idea of restoring a group production ceiling, but Iran continues to reject such a proposal until it restores its production from 3.8 million barrels per day currently to the 4.7 million barrels per day it enjoyed before sanctions were levied.  But, in reality, OPEC’s plan did work.  Billions in capital spending has been deferred or canceled, mature oilfields are seeing a higher decline rate due to more intensive drilling and various U.S. drillers are mothballing their equipment.  That all leads to higher prices.  It is unfortunate that Venezuela seems to be falling apart and Nigeria cannot handle pipeline thieves, but OPEC has always been about what is in the best interests of Saudi Arabia.  It does not want prices too high or too low.  It just wants to make sure it gets a cut and remains relevant in the global picture.  They could obviously go it alone in the global oil market, but why put a target solely on its back when it can operate under the cover of OPEC and offer many options for the ire of environmentalists to politicians.  In the interim, post-Memorial Day in the U.S., the summer driving season has begun.

SGK Blog--Update May 27, 2016: Markets Stabilize in Anticipation of US Rate Hike


U.S. stocks joined a rally in European shares in Tuesday trading as growing conviction that the Federal Reserve will raise interest rates this summer sparked gains in financial shares.  The dollar rose and Treasuries fell as housing data reinforced confidence in the strength of the American economy.  The dollar touched its strongest level since March against the euro, weighing on gold, which is poised this week for its longest losing streak since November.  Sterling was boosted by a poll showing the campaign to keep Britain in the European Union is gaining strength.  Traders are now pricing in a better than even chance that the U.S. central bank will raise interest rates by its July meeting, after Fed officials signaled their willingness to make such a move if the economy shows sustained progress.  Heightened speculation on higher borrowing costs has resulted in the S&P 500 struggling for direction, alternating between daily gains and losses for the past several sessions, as investors sought clarity on the Fed’s monetary path and the health of the world’s largest economy.


U.S. data on Tuesday showed purchases of new homes surged in April to the highest level since the start of 2008.  Investors are monitoring discussions by euro-area finance ministers on how to conclude Greece’s bailout review, including debt-relief measures and contingency plans in case budget targets are missed.  Purchases of new homes in the U.S. surged in April to the highest level since the start of 2008, pointing to a robust spring selling season for builders.  Sales jumped 16.6 percent to a 619,000 annualized pace, and purchases in the first three months of the year were revised higher, Commerce Department data showed Tuesday.  The rate exceeded the most optimistic forecast in a Bloomberg survey.  The median sales price climbed to a record, reflecting a pickup in signed contracts for more expensive properties.  The rebound in purchases signals housing was returning to more stable footing, helped by healthy employment gains and cheap borrowing costs.  The number of homes sold and not yet under construction climbed to the highest level since May 2007, indicating homebuilding will help add to economic growth.  The median forecast in the Bloomberg survey called for the rate to accelerate to 523,000, with estimates ranging from 508,000 to 533,000.  The Commerce Department revised the March reading up to a 531,000 pace from a previously estimated 511,000.


Internationally, German investor confidence dropped for the first time in three months in May in a sign that growth momentum is set to slow amid concerns over a U.K. exit from the European Union.  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, fell to 6.4 from 11.2 in April.  Economists in a Bloomberg survey predicted an increase to 12.  While the German economy expanded at its fastest pace in two years at the start of the year on consumption and a surge in investment, the Bundesbank predicts growth will slow somewhat this quarter.  The setback in confidence comes as European Central Bank President Mario Draghi and his colleagues gauge whether they’ve done enough to sustain an economic recovery in the euro area, or if more stimulus is needed.  "The strong growth of the German economy in the first quarter of 2016 appears to have surprised the financial market experts,” ZEW President Achim Wambach said in a statement.  “However, they seem not to expect the economic situation to improve at the same pace going forward.  Uncertainties regarding developments such as a possible Brexit currently inhibit a more optimistic outlook.”  The U.K. will vote on its future in the EU on June 23.  ECB policy makers, who will convene in Vienna next Thursday, have pumped liquidity into the euro area via asset purchases and record-low interest rates as they try to revive inflation.  The ECB is set to start buying corporate bonds starting next month and will offer cheap loans to banks to spur credit growth.


Back to U.S. economic news, orders for business equipment unexpectedly declined in April for a third straight month, indicating American manufacturers continue to pull back, Commerce Department data showed Thursday.  Orders for non-defense capital goods excluding aircraft fell 0.8 percent versus the forecast for a 0.3 percent gain and this was a five-year low of $62.4 billion.  Shipments of such business equipment rose 0.3 percent, erasing the March decline and total durable goods orders climbed 3.4 percent compared to the forecast for a 0.5 percent gain and after a 1.9 percent advance the prior month.    Some companies may be paring investment plans as they assess the demand outlook in the wake of weaker first-quarter growth and earnings, raising doubts about how quickly manufacturing can pull out of its slump.  Global economies are struggling to improve, the oil industry has retrenched and factory customers are also bringing inventories more in line with sales.


Jobless claims fell for a second week, indicating the surge at the start of May reflected temporary dismissals.  Initial applications for unemployment benefits dropped by 10,000 to 268,000 in the week ended May 21, a report from the Labor Department showed Thursday.  The median forecast of 49 economists surveyed by Bloomberg projected 275,000 claims.  Sustained declines in claims from the more than one-year high at the start of the month signals those increases were due to transitory events such as the spring break holiday at schools in New York and auto plant shutdowns in Michigan.  That shows employers remain intent on retaining experienced workers amid prospects demand will start to firm after the economy stumbled in the first quarter.  Contracts to purchase previously owned U.S. homes climbed in April by the most since October 2010, adding to signs that the industry’s busy selling season was off to a good start, according to data released Thursday by the National Association of Realtors.  The index of pending home resales increased 5.1 percent (forecast was 0.7 percent) after a revised 1.6 percent gain in March.  Running counter to the strong housing data this week, consumer confidence retreated last week as Americans became less upbeat about their household finances and the state of the economy, the weekly Bloomberg Consumer Comfort Index showed Thursday.  The overall comfort index fell to 42 in week ended May 22, matching the second-lowest level this year, from 42.6 in the prior period.  The personal finances gauge declined to 55.3, weakest since mid-January, from 56.5.


The U.S. economy expanded at a slightly faster pace in the first quarter than initially estimated, reflecting less damage from trade and inventories, Commerce Department data showed Friday.  Gross domestic product increased at a 0.8 percent annualized rate in three months through March versus the forecast for a 0.9 percent gain but this compares with the plus 0.5 percent initially estimated.  The revised figure was paced by a larger reading on inventories and a narrower widening of the trade gap.  Consumer confidence in the U.S. climbed less than forecast in May as Americans were a little less ebullient about the economy’s prospects in the run up to the presidential election.  The University of Michigan’s final index of sentiment rose to 94.7 from 89 in April.  The median projection in a Bloomberg survey of 62 economists called for 95.4, with estimates ranging from 93 to 96.5.  A preliminary reading earlier this month was 95.8.  Household purchasing power is getting a boost as more Americans than at any time in the last 10 years said they expect their finances to improve over the next 12 months.  A pickup in consumer spending, the biggest part of the economy, is key to helping spur economic growth this quarter after a U.S. slowdown earlier in the year.


Crude oil prices surpassed $50 a barrel for the first time in six months this week before falling back amid signs the global supply glut is coming to an end, buoying currencies where oil is produced.  A drop in U.S. stockpiles and shrinking output in Nigeria and Venezuela contributed to the gains in Brent, which is up more than 80 percent from January’s low of $27.10.  The Bloomberg Commodity Index touched the highest level since November as metals also advanced.  Shares of energy and raw-material producers in the U.S. and Europe advanced.  The Norwegian krone led gains in major currencies, while Malaysia’s ringgit was among the best performers in emerging markets.  Brent is recovering after tumbling to a 12-year low in January that helped roil global financial markets and raise concern over the strength of the world economy.  Now, the International Energy Agency and Goldman Sachs Group Inc. say a glut is dissipating as low prices take their toll on supplies.  That may leave prices high enough to alleviate the threat of deflation and still low enough that they don’t impinge on economic growth.


Next week’s U.S. employment report should provide insight into whether or not the Fed raises rates this month or next.  As always, stay tuned!

SGK Blog--Update May 20: Fed Keeps Door Open


On Wednesday, the Federal Reserve released minutes from its April meeting.  While the Fed was not committed to moving interest rates higher at its meeting next month, it wanted to clearly get across the message that a hike was not out of the possibility.  According to the minutes: “Most participants judged that if incoming data were consistent with economic growth picking up in the second quarter, labor market conditions continuing to strengthen and inflation making progress toward the 2% objective, then it likely would be appropriate for the [Fed] to increase the target range for the federal funds rate in June.”  As we emphasized previously, the unsettled global economic environment of January and March left the Fed less than confident that a rate boost would go over well in the larger worldwide community.  With many central banks in easing mode, having the Fed unilaterally go the other direction would work against coordinated efforts of the past.  As such, the Fed added: “Participants generally agreed that the risks to the economic outlook posed by global economic and financial developments had receded over the intermeeting period.” 


Obviously, anything can happen in financial markets, and the Fed has the stature to act alone if need be.  But, in reality, the Fed is merely giving itself wide latitude to act if they want to but also stand pat if they feel it would not hurt the U.S. economy.  The futures market is taking note.  On Tuesday, before the minutes were released, there was a 3.8% chance of an interest rate hike in June according to the overnight index swap market.  After the release, that figure jumped to 19%.  September’s meeting has a 57% probability when earlier this week a 50% or greater level was not anticipated happening until 2017.  A move in June is still not a given, but there is still plenty of time and numerous data points to come between now and June 14.  The consumer price index is one such important barometer. 


Consumer prices rose 0.4% in April, the biggest gain since February 2013, following a 0.1% rise in March according to the Labor Department.  Stripping out food and energy costs, the so-called core measure was up 0.2%.  That means that year-over-year, core prices were up 2.1% after climbing 2.2% the prior month.  It was boosted by increases in rent, medical care, auto insurance and airline fares.  Declines in clothing and new and used cars were detractors from the increase.  In the overall measure, gasoline prices jumped 8.1%, the most since August 2012.  The price of a barrel of crude is only a few dollars short of $50.  West Texas Intermediate crude prices were last this high in October of last year when they reached $49.63 per barrel.  Year-to-date, prices have been solidly higher after a swoon in January and February to start the year.  The consumer price index is the broadest of three price gauges from the Labor Department.  The wholesale price index, includes about 75% of all U.S. goods and services.  It was up 0.2% in April from the month before.  So, inflation is far from running rampant, but the signs of buds are definitely there. 


Initial unemployment claims also registered good news.  According to the Labor Department, applications filed in the week ended May 14 fell by 16,000 to 278,000.  The decline was primarily due to fewer filings in New York which was affected by spring break issues and a Verizon strike.  Filings have been below 300,000 for 63 consecutive weeks, the longest such stretch since 1973.  Numbers below that benchmark are commonly referred to as a healthy labor market according to economists.  Seasonality might distort the figure for a few more weeks but the four-week moving average continues to also point towards a level that is consistent with solid job growth.  That momentum is being felt in the housing market.  Sales of previously owned homes rose in April to a three-month high according to the National Association of Realtors.  The median price of an existing home rose 6.3% from April 2015, the highest since last June.  At the current pace, it would take 4.7 months to sell all the existing homes on the market.  Anything under five months’ supply is considered a tight market according to the group.  Clearly, with home prices recording 50 consecutive months of year-over-year gains, the spring selling season has been a success.  Housing starts also are strong, with construction up 6.6% in April according to Commerce Department data released this week, obviously undaunted by the ridiculously wet weather in the DC metro region

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 10thlargest 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 li