Market Insights: July 28, 2014
Economic Outlook: More data for the Economic Doomsayers to Dismiss…
- The June Industrial production number was indeed weak (+0.1% increase) and this has caused concern. Although manufacturing production was weak, it followed a 0.5% increase in May, which means it is now up 3.4% for the trailing 12 months, which is not shabby.
- Output of durable consumer goods rose 0.7% in June to a new record high, helped a lot by strong auto numbers.
- Initial Jobless Claims last week dropped to a weekly level of 284,000. You have to go back to almost 2005 to find a reading this low [Department of Labor].
- China’s HSBC/Markit PMI Manufacturing “Flash” Index has rebounded back up to 52, signaling expansion, and now stands at a 16-month high. We will see if this holds, but perhaps this is a case of where some government stimulus came at exactly the right time.
- The Euro-zone’s PMI Composite “Flash” Index rebounded to a level of 54. [Markit]. Europe has endured some weak economic data recently, and perhaps this is the first sign of some renewed strength. Comments by the IMF’s Christine Lagarde last week would suggest exactly such an interpretation.
- The Index of Leading Economic Indicators is certainly not telegraphing a recession. The LEI historically has begun to show decline about three months before the start of a recession. At present, it remains on an upward trend, and has been rising into record territory since late 2012.
Equities Outlook: Bear Markets and Recessions…
- We have written frequently about the top question we get: “When is the next bear market?” The next bear market is likely when we see the next recession. Recessions are usually caused by the Fed tightening policy. That might begin in 2015, but it is likely to go slow and proceed cautiously. Not an immediate concern…
- Remember that Janet Yellen is a monetary dove, and she will likely lean to keep interest rates low for much longer than most of her colleagues on the FOMC. We wrote last week about her testimony to Congress in which she warned about the “false dawns” that tricked Fed officials in recent years.
- Corporate earnings are not signaling recession. We are getting our first look at reported 2nd quarter earnings for S&P 500 companies as of last week. 93 companies have reported and two-thirds have beaten earnings forecasts. Perhaps more important, 68% have out-performed analysts top line forecast for sales. This represents a notable improvement over last quarter, when the comparable metric was just over 50%. Top line revenue growth is a healthy sign for future earnings.
- Also, remember that not all markets are at record levels. Smaller cap stocks–especially the biotech and social media names–have been under pressure. The Russell 2000 was down 5.1% from its most recent high at the end of last week. It’s retesting its 200-day moving average level, as it did back during May.
- Smaller company stocks have even gotten the attention of the Fed Chair. Stepping somewhat far afield from her usual territory, Janet Yellen, the Fed’s Chair, become stock prognosticator commenting on small cap valuations last week during her congressional testimony. She warned that “valuation metrics in some sectors do appear substantially stretched, particularly those for smaller companies…”
- International equities still appear quite cheap relative to their U.S. counterparts. And Emerging Markets represent the cheapest valuations. Bloomberg News reported last week that Mark Mobius (Templeton) has taken a big position in Emerging Markets and called for a 20% move in China’s market.
- Changing subjects — The Wall Street Journal reported on Thursday of last week that the California Public Employees Retirement System was reducing its allocation exposure to so-called “Alternative Investments” (hedge funds, private equity etc.). Poor returns and high fees were cited as the decision points. Finally — some media discussion of this, since we have been discussing it in Investment Committee for the past 6 years.
Fixed Income Markets: Following the Flows…
- The Ten-Year Treasury remained below the psychological 2.5% level last week, perhaps as a result of geopolitical tensions. It had closed the previous week at a yield of 2.48%, and ticked down slightly at the end of last week to close at the 2.47% level.
- The past few weeks have seen high inflows into municipal bond funds and larger outflows from high yield bond funds. As we have noted, yield spreads in high yield bonds have narrowed, diminishing some of the attraction of reaching for the extra yield.
- Improving economies are helping municipalities bolster their balance sheets. It has not gotten a lot of attention, but California’s state budget is actually back in a surplus.
The Week Ahead
- Pending Home Sales Index
- S&P Case Shiller Home Price Index
- Consumer Confidence
- ADP Employment Report
- U.S. GDP Release
- FOMC Meeting Announcement
- U.S. Construction Spending