Market Insights: August 19, 2014
Economic Outlook: The difference between being here and being there
- U.S. economic data continues to generally be firm. The foreign numbers, not so much.
- The NFIB’s Small Business Optimism Index increased in July to a level of 95.7, up from 95 during June.
- The Federal Reserve Board of Governors measurement of U.S. Industrial Production advanced 0.40% in July.
- One softer spot — the retail sales figures for July reported by the Department of Commerce were surprisingly flat compared to June.
- The main question being posed by economic observers is at what pace the Federal Reserve may change their zero interest rate policy. Fed chair Janet Yellen has made it clear that she is looking at a variety of indicators, and is paying particular attention to data from the labor market.
- Speaking of labor numbers, the June JOLTS report was released, and showed that job openings rose to 4.7 million. This is actually the highest number since February of 2001. This number is up by more than 750,000 jobs from where it stood at the beginning of 2014.
- It is of some interest that the number of people quitting their jobs during June reached a new high of 2.5 million. Yellen indicates this is a good statistic, since it confirms that those in the labor market feel able to make a change for a better job, and are confident about becoming re-employed. Yellen commented earlier this year, “when workers are scared that they won’t be able to get another job, they show a reduced willingness to quit their job.”
- In the survey of small business owners referred to above, the percentage of firms with one or more job openings rose to 22.5% in July. This level is the highest since March of 2008.
- By contrast, much of the international data indicates a slowing of growth conditions outside the U.S. This creates some cause for concern in the global economy even though the U.S. numbers have continued to be good.
- Japan recorded a second quarter decline in gross domestic product of 1.70%. Some of the decline in consumer demand was likely demand that was pulled forward from the second quarter into the first quarter by the proposed sales tax increase which took effect in April.
- In June, industrial production in the Euro-Zone fell by 0.30%. This follows a decline in May and therefore potentially sets up a somewhat disturbing trend, albeit only two months.
- The flash estimate for second quarter GDP in the Euro-Zone is flat at 0%, indicating no growth. The German assessment of business expectations (published by the Zew Center) fell from 27.1 to an 8.60% reading in August.
- Despite these poor economic readings out of Europe in the last couple of months, exports by China appear to be on the rebound. Merchandise exports during July hit a new record high of $2.5 trillion. The most recent reading in China’s PPI inflation rate was -0.90% year-over-year during July. While that’s a deflationary reading, it is the lowest such negative number since April of 2012. This suggests that the deflationary pressures may be receding.
Equities Outlook: Sentiment VS. Earnings Forecasting
- The recent sentiment readings for the equity markets have all declined. This most likely reflects the increased market volatility that began in July. These less optimistic sentiment readings actually send a contrarian signal and suggest it is less likely that the market has an extended pullback remaining.
- The most recent survey published by Investor Intelligence shows those in the bull market camp below 50.0%, at a reading of 46.4%. Those expecting a correction jumped to 37.4% from a previous level of 32.4%.
- While the possibility of a short-term correction remains, we have not changed our fundamental view that this bull market continues to be in the middle innings. Markets like this are fundamentally driven by rising earnings, and these depend upon increasing revenues by U.S. companies.
- Industry analysts have generally stopped decreasing their 2014 earnings estimates and are now showing expected increases in 2015 of approximately 4.0%. The most recent reading in manufacturing PMI suggests that revenues could continue to grow around 5.0% in the coming 12 to 24 months. This is consistent with the revenue growth shown during the second quarter.
- It is also interesting to note that federal tax receipts rose to a record high during July, and are up 8.4%. This metric actually has a nice correlation to corporate earnings.
Fixed Income Markets: Where are the Higher Rates and When Will They Hurt?
- The Ten-Year Treasury continues to defy expectations (including ours) of upward interest rate pressure. It had closed the previous week at a yield of 2.42%, and declined further to end last week at the 2.34% level. Continuing weakness in data from Europe is reinforcing concerns about potential global contagion.
- Eventually, of course, rates will rise. At today’s low interest rates, this may not have an immediate effect on compressing economic growth. Historically, problems begin to show up in the economy when the debt-service ratio for U.S. households approaches 9.0%. At the moment, this ratio is below 5.9%. It will require a significant move in rates before this reaches the danger point.
- The equivalent danger point for businesses is a debt-service ratio of 20.0%. Currently, this ratio is around 12.0%, pretty much in line with long-term averages.
- Bottom line: The Fed will eventually raise rates, but the immediate effect of these increases will not be dramatic in terms of slowing down economic growth.
The Week Ahead
- Consumer Price Index
- Housing Starts
- FOMC minutes released
- PMI Manufacturing Index “Flash”
- Conference Board Leading Indicators
- Existing Home Sales