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Market Insights

Market Insights: March 14, 2016

Economic Outlook:  “Surprise, Surprise; Come on Open Your Eyes”

  • Bruce Springsteen sang it in his Working on a Dream album: “Surprise, Surprise; Come on open your eyes.” Citigroup’s Economic Surprise Index tries to open our eyes to the economic data by measuring the strength of actual economic data versus what analysts are forecasting.
  • Last week the Citigroup Index climbed again to a level of minus 9.8 which is now the highest closing level since last November. It has risen from a low of minus 55 in early February. The direction of movement is what is important and this clearly shows positive momentum.
  • In our summary last week, we reminded you of the ADP payroll numbers during the previous week and their showing of strength. Last week’s Initial Jobless Claims report represented a follow-through on this with initial jobless claims declining to 259,000.
  • This brings the 4-week moving average of Initial Jobless Claims down to 267,500 which in historical context is a pretty low level and has typically represented a good leading indicator for a continuing strong employment market.
  • The International Energy Agency (IEA) stated in its monthly market report last week that it believes oil prices have now bottomed. After reaching a 12-year low near $26 in early February, WTI has rebounded by more than $10/bbl. The IEA noted that its numbers are indicating market forces have now acted to constrain production from U.S. shale producers.
  • Since the beginning of the decline in oil prices in late 2014, producers have been shutting down rigs at quite a pace. The rig count fell by 9 in the latest week tracked by Baker Hughes and now stands at 480. The number of working rigs has never been lower than this since Baker Hughes started tracking this data in 1940!
  • All of our clients and friends in the energy business are hoping, of course, that the IEA is right. And just for the record, we are inclined to agree with the IEA. However, in the interest of maintaining some humility, we need to remind ourselves that a number of authorities have called a bottom (incorrectly) since September of 2014.
  • Harold Hamm (Bakken shale expert) called $77 the bottom in November 2014. Both Vitol and JP Morgan called $42 the low after WTI rebounded to around $59 in the spring of 2015. Ministers from Qatar pronounced $39 to be the low after a rebound to $57 in October 2015. So we still will have to allow some time to pass before being able to say the IEA has it right in calling the mid-20s the low.
  • The European Central Bank announced a number of measures last week to further signal the markets that it is willing to do whatever it takes to get the Euro-zone economy moving forward. As we note below, several key interest rates were reduced. The QE program was increased by 20 bn Euros to 80 bn per month. These moves were generally more aggressive than forecasters had expected.
  • To be fair observers, we must acknowledge that so far these moves have not shown the kind of impact in the numbers that the ECB would hope for. We’ll have to wait and see if the desired results begin to materialize and if the central bankers have the resolve to stay the course.
  • Meanwhile, not garnering much attention, the Chinese Yuan has recovered to its strongest level since last December, as some of the frantic China concerns have retreated.

Equity Markets:  Back to Even

  • We had a pretty strong rally on Friday to close out the week. Year-to-date returns (including dividends) are now just about break even for the S&P 500 stock index (-0.56 percent actually).
  • Despite the rebound over the last four weeks, there is certainly a great deal of cynicism regarding the stock market. This cynicism is not just showing in what people are saying, but in what they are doing. Lipper’s weekly figures on equity fund outflows for the past 3 weeks are -$2.4 bn, -$2.8 bn, and -$5.7 bn. Those are all after the market began its rebound.
  • If you listen to the talking heads, investors are worried about pressure on corporate earnings, slowing Chinese growth rates, and possibly increasing interest rates.
  • Liz Ann Sonders, chief strategist at Charles Schwab & Co., stated on Bloomberg Radio last week that this pervasive pessimism is the best evidence around in favor of the bull market run continuing. Bull markets normally end on excessive optimism, not excessive pessimism.
  • Ironically, the best historical evidence is that when people withdraw money from stocks at above-normal levels, the market typically follows with an above normal gains in the following six months. This has happened 12 times since 1984.
  • We have discussed several times in our open meetings during the past six months that we lack confidence that hedge funds and other highly touted “alternative” investments packaged by Wall Street will fulfill investors’ expectations. After a bad year generally in 2015, hedge funds are apparently off to a bad start as well in 2016.
  • The University of California’s endowment fund announced last week that it would cut the number of hedge funds it invests in to about 10 from the current level of 32. Several of the highest profile hedge fund managers are nursing double-digit losses thus far in 2016.

Fixed Income Markets & the Fed:  Free Money

  • The European Central Bank made a 5 basis point cut last week in its refi rate which brings that to a record low of zero percent. The ECB made other cuts in several rate benchmarks at the same time. In his comments at the announcement, Mario Draghi suggested that interest rates might well remain low even after the QE program is complete. He hinted, however, that this may be the final rate cut and that statement saw recovery in the Euro.
  • We finally saw a further upward movement in the Treasury market as confidence rebuilds regarding the U.S. economic data. The yield on the U.S. 10 Year Treasury note closed up another 10 basis points at 1.98 percent last Friday to end the week. The previous week’s close was 1.88 percent. Global stock markets and commodity markets have recovered from their slumps at the beginning of the year and this eases some of the demand by investors to buy Treasuries.
  • We mentioned last week to you the comments from conversations with PIMCO about junk bond opportunities. We note that following the lousy year for junk bonds in 2015, they are now posting positive year-to-date returns in 2016.
  • We are focused on interpreting the significance of this turn-around. It could be a clue that the economy is in more solid shape than people believed. Or, maybe it is simply a reaction to this mini-commodities rally we’ve seen since last November. Regardless of the meaning, the fund-flow data for the last week reported showed an inflow of $5 bn into junk bond mutual funds.

The Week Ahead

Tuesday

  • U.S., Producer Price Index (BLS)
  • U.S., Retail Sales (Census Dept.)
  • U.S., Housing Market Index (National Association of Realtors)

Wednesday

  • U.S., Consumer Price Index (BLS)
  • U.S., Housing Starts (Dept of Commerce, HUD)
  • U.S., FOMC Meeting announcement

Thursday

  • U.S., JOLTS (BLS)
  • U.S., Conference Board Leading Indicators

Friday

  • U.S., University of Michigan Consumer Sentiment