Economic Outlook: Two Things We Learned Last Week
- Item #1: The U.S. service sector has great momentum. ISM’s non-manufacturing survey rose to 60.3 in July. This is its highest level since the summer of 2005. Strength was evident in the sub-measure of future expectations. We’ve seen strength in employment numbers and this should follow through to consumer spending.
- July U.S. retail sales were up in line with expectations at +0.6%. What may be more notable than this headline number, however, is the fact that the increase was broad-based. 11 of the 13 categories in the survey showed increases for the month. The revisions to the previous months’ data were also strong.
- Item #2: The U.S. deficit is falling. The Congressional Budget Office predicts that the fiscal year 2015 budget deficit should drop to around $425 billion, or 2.4% of U.S. gross domestic product. This level, where we were in 2007, is considerably lower than the long-term average since 1970 of 3.2% of GDP.
- Budget deficit issues are not over, that is for sure. It is clear that significant entitlement reform continues to be needed to lower the deficit. However, that said, we expect federal deficits will rise only moderately over the next 10 years as federal spending exceeds revenues. Regardless of any political frustration we all might feel about the deficit, it does not appear likely that we face a deficit “crisis” in the near-term. While we often harangue about “those brain-dead politicians”, there is a silver lining to Washington dysfunction. Gridlock acts as a check of sorts on spending.
- While the economic outlook outside the U.S. is certainly less certain to predict, our view remains still in the positive column. The latest upbeat indicator from outside the U.S. is June’s 2.0% increase in Germany’s new factory orders, led by foreign orders, to the best reading since April 2008.
Equities Outlook: George Carlin’s Wisdom on Market Calls
- Comedian, George Carlin once said, “I’m always relieved when someone is delivering a eulogy and I realize I’m listening to it.” This might be the correct response to some of the current market headlines which include the word “death”.
- The financial press (Barron’s) has been using the word “death” often in recent weeks. Reason: the Dow Jones Industrial Average has registered a technical pattern known ominously as the “Death Cross.”
- A Death Cross occurs when the 50 day Moving Average line crosses below the 200 day Moving Average. Some consider this to be a selling trigger as the cross portends a bear market.
- By the way, the reverse of this pattern, when the 50 day average crosses above the 200 day average, is considered a buying signal known as the “Golden Cross”.
- We take note of these patterns but do not consider them determinative. We are not selling or reducing equities currently because of this “death cross”. Likewise, we would not necessarily buy or increase equities solely on a “golden cross”. We’ve had a couple of these imminent death crosses during the current bull market, and they’ve proven to be buying opportunities.
- More important than a single indicator is the dominant trend and direction for the U.S. stock market. We continue to judge the major trend for U.S. stocks to be positive. The continued recovery of the U.S. economy is supported by low inflation and favorable interest rates.
- This major trend thesis is a longer term view and does not necessarily have big implications in the short term future. In fact, equities have been trading in a very narrow range so far in 2015. According to one of our favorite research sources (Strategas Research), the S&P 500 Index trading range has been confined to less than 8.0% in 2015. Amazingly, that is among the narrowest of ranges over the past 90 years.
- It seems clear to us that investor sentiment is not clearly positive. This is not really surprising, however. So far this year, we’ve had the Greek debt crisis, fear of a hard landing in China, questions about Fed policy, irregular economic growth patterns in the United States and just last week, devaluation moves by Chinese monetary authorities. The wall of worry is clearly there, but corporate earnings keep climbing the wall.
Fixed Income Markets: Is Deflation an Import?
- As most everyone knows, commodity prices are slipping steadily around the world, led by oil, which is back down to around $42. At the same time, the U.S. dollar is strong, which means the price of imported goods falls. This combination means the U.S. is importing deflation from other parts of the world.
- Combine this imported deflation with very modest domestic inflation and it means the Federal Reserve is not feeling a lot of pressure to move rates dramatically or quickly. Despite the near-term likelihood of an increase in the Funds rate, we are likely to continue with low rates for a while.
- The recent declines in yield on the 10 Year Treasury note finally reversed last week, as the yield closed at 2.20%. It closed the previous week at 2.16%.
- What is our own outlook for rates? The 10 Year Treasury yield probably remains in a 2.00%-2.50% range, even giving the possibility of a Fed rate hike. This could well continue into next year.
- The futures market seems to be signaling a 75% likelihood of a Fed move on rates by year-end. Whether it will happen at the September meeting is less predictable.
- Foreign bond prices are rallying, and yields falling. The 10 Year German bund yield is back near a miniscule 0.6%. Even Italy’s 10 Year borrowing rate is lower than the U.S. Treasury’s.
- Not all interest rates are remaining low, however. Junk bond yields have been moving up in 2015, with the Merrill Lynch High Yield index rising from the year’s low of 5.96% in late April to above 7.0% at present.
The Week Ahead
- U.S., Housing Market Index (National Association of Realtors)
- U.S., Housing Starts (Census, Dept of Commerce, HUD)
- U.S., CPI (BLS)
- U.S., FOMC Minutes
- U.S., Existing Home Sales (National Association of Realtors)
- U.S., Conference Board Leading Indicators
- U.S., PMI Manufacturing “Flash” Index (Markit)
- EU, PMI Composite “Flash” (Markit)
- EU, Consumer Confidence “Flash” (European Commission)