Economic Outlook: Getting Behind the Noise of the Headlines
- Lyndon Johnson once remarked, “If one morning I walked on top of the water across the Potomac River, the headline that afternoon would read: ‘President Can’t Swim.’” We have certainly had plenty of scary headlines in the financial press of the last few weeks, proving Bill Gates’s point: “bad news is a headline, and gradual improvement is not.”
- We saw good news from the ISM Services Index last week, which posted a reading of 56. More importantly, the measure showed strength in new orders.
- These are encouraging numbers from the service sector and are particularly welcome since recent data from the manufacturing side has been softer.
- Construction spending rose to a cyclical high in the May numbers: $1.04 trillion on an annual rate.
- Peeling back the onion on the construction spending is revealing. Construction spending on manufacturing capacity rose more than 6.0% for the month and is up 70.0% on a year-over-year basis. That suggests that corporate management maintains significant optimism about manufacturing going forward, despite the soft patch in recent months.
- The Job Openings and Labor Turnover Survey (JOLTS) show 5.4 million job openings currently. This makes it a bit surprising that in June’s employment report, wages rose only 2.0% year-over-year. It is not illogical to expect some pressure to begin to develop on wages.
- Last week Greece voted “no” on the previous referendum, and markets generally did not like it. However, Greeks still need a restructuring bailout and this past Friday put a new deal on the table, which looks a lot like what they earlier rejected. It is being discussed over the weekend, and based on Friday’s market reaction in Europe this was a cause for celebration.
- Despite the Greek challenges, there is an observable turn-around in the Euro-zone economy. The May numbers are in for GDP in Germany, Spain, and France. Year-over-year growth rates are 4.2%, 3.4%, and 1.9% respectively. The issues in Greece do not seem to be arresting the progress in the economic turn-around.
Equities Outlook: Is the Volatility Emotional or Fundamental?
- Markets were volatile last week, driven mostly lower on the news following the Greek vote. When the newest (old) Greek proposal hit the news, however, on Friday, markets around the world rallied.
- U.S. Domestic markets generally rebounded about 1.5% on Friday, and various European stock indices were up by 2.0% to 3.0%.
- It is important not to forget that S&P 500 companies’ earnings are derived from roughly half of sales being made overseas. The strong dollar causes those foreign sales to translate less favorably, depressing reported earnings growth. The May number on U.S. merchandise exports showed a decline of 6.6% year-over-year and this has put pressure on revenues. Much of this is currency related masking the actualities of business activity.
- We’re now completing a period of about 9-10 months where U.S. equity performance has been essentially flat and stock prices have moved sideways. It’s understandable on the heels of this uninspiring period of equity performance that headlines like Greece and China would create some anxiety.
- Should we be worried? Is there a risk of contagion? American educator, Robert Conklin, has good advice… “It’s not the situation… It’s your reaction to the situation.”
- So just to keep things in perspective — the correlation factor between Chinese and U.S. equities is a very low 30.0%. That does not exactly sound like a threat. Flat periods of performance where the corporate earnings catch up to the stock price movement are not unusual.
Fixed Income Markets: The Dollar a Safe Haven
- There was a slight drop-off in yield on the 10 Year Treasury note at the end of last week, as the yield closed at 2.40%. It has moved up and down over recent weeks on the news headlines. However, we are essentially at the same level today as a month ago when the 10 Year was at 2.39%.
- The Greek crisis and the ups and downs of the Chinese equity market are boosting the U.S. dollar as the safe haven in difficult times. This makes U.S. assets, including bonds, more attractive to foreign owners and tends to put a lid on interest rates.
- While it is realistic to expect some upward trend in interest rates over time, we are not looking for any sudden near-term moves to the upside. The volatility in markets may even persuade the Fed to do further foot dragging on the funds rate.
- From the recently released Fed Minutes: Some FOMC members, warning of inflation risks and financial instability, were ready to vote for a rate hike at last month’s policy meeting while others, who were not quite ready, saw conditions falling in line with a rate hike. But in the end, according to the minutes of the meeting, most members wanted to see greater employment growth and upward pressure on inflation. Members cited uncertain risks tied to Greece and China, risks that have since grown.
The Week Ahead
- U.S., Retail Sales (Census, Dept of Commerce)
- EU, Industrial Production (Eurostat)
- China, GDP and Retail Sales
- U.S., Industrial Production (Federal Reserve)
- U.S., CPI (BLS)
- U.S., Housing Starts (Census, Dept of Commerce, HUD)