Carl’s Corner – 2015

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Carl Perthel, CMT

Disclaimer: The views expressed are those of Carl Perthel, CMT. These views are subject to change at any time and The American Asset Management Group, Inc. (AAMG) disclaims any responsibility to update such views. These views may not be relied upon as investment advice and, because investment decisions for AAMG are based on many factors, may not be relied upon as an indication of trading intent on behalf of AAMG.

 

*** Carl’s Corner for October 2015 ***

For you readers of Carl’s Corner through the years, you might remember we typically recognized August-October as the three worst consecutive performing months in the equity markets. Historically, on average it’s a statistical fact. Also, it’s a time for greater than average volatility. It’s been a few years since we’ve witnessed a meaningful correction during this seasonally “unfavorable” time. Therefore, we should put this correction in perspective; it fits into the framework of historical market price action and it invites a “wait and see” posture as price tests the August low of 1867 and quite possibly the October 2014 low of 1820. 1820 to 1867 on the SP500 should offer meaningful support for prices. These prior lows will often entice buyers to enter the market since the stock market moved higher after reaching these lower levels the last time the market corrected.

The financial markets have been obsessing about the U.S. Federal Reserve (Fed) raising rates for the past year. An improving economy and therefore the specter of higher interest rates scare the equity market since higher rates are perceived as an earning’s detractor. Stocks believe rising interest rates will squeeze profits and in turn, reduce company earnings.

The financial markets and the economy have witnessed the absence of “easy money” polices since the end of quantitative easing last October. Arguably, the economy has been improving over the past year with positive GDP numbers, declining unemployment and stronger housing data. These economic improvements point to the possibility of higher rates sometime in the future. Even with improving data, the Fed has not started to hike interest rates. We’ll get to this later…

One rate hike does not make a trend. The rate amount and frequency for further interest rate hikes after the Fed’s first move is problematic. Only with a vastly improving economy going forward would the Federal Reserve continue a “tight money policy,” implementing additional hikes. Given the trend in the current economic data, it will be difficult for the Fed to justify large, frequent interest rate hikes after the first move.

We relayed in last month’s Notes that the stock market rarely waits for the evening news to decide whether it should move higher or lower. The headlines are the “hind lines.” Therefore, if you accept the premise that the stock market as a discounting mechanism, then it’s likely that the correction in equity prices equates to factoring in the first hike. The first rate hike may be a “non-event” when all said and done.

In addition to the stock market “discounting” mechanism, let’s not forget that interest rates are at 50 year lows. Even modest rate hikes after the initial rate hike, when they occur, will see interest rates at historically low levels. Interest rates at these low levels are still conducive for economic growth and rising stock prices. Coupled with inflation running below 2% it’s hard to imagine an economic environment that’s going to promote “raising the roof” on interest rates.

Now having explained why low interest rates and an initial rate hike might not be so bad, let’s explore possible reasons why Chairwoman Janet Yellen and her team might further delay making the decision. First of all, with core inflation (ex-food & energy) below 1.2% it’s hard to justify raising rates. Factors that are driving the slowdown in inflation include a drop in durable goods prices. The low inflation backdrop does not support raising rates. Secondly, even with lower unemployment (5.1% in August), the unemployment rate may have to fall to 4% before the Fed sees wage inflation. Slow wage growth may be a result of a fair amount of slack in the labor market, the so-called “shadow unemployed.” These folks have either given up looking for work or want full-time jobs but can only find part-time work. The Civilian Force Labor Participation Rate is at 62.8%, the lowest level since March 1978. Third, a stronger U.S. dollar and lower commodity prices are not kindling global economic growth, either. The Fed will respect other central banks by holding off on raising rates here in the United States. Global central banks have started their own quantitative easing programs to bolster their sagging economies. The fact remains, it’s slow all around. The Eurozone is expected to cut their interest rates again by the end of the year.

The latest consensus among economists have priced in only a 30% probability for a rate hike by the Fed in December. Looking out further, “odds-makers” have the Federal Reserve looking to make its first move in May 2016.

Carl Perthel, CMT

 

*** Carl’s Corner for September 2015 ***

Price finally cast its vote regarding the sideways consolidation, or “trading range” we’ve enumerated many times over the past seven months in prior Carl’s Corners. The SP500 equity bench mark broke to the downside on August 18th and over the next five trading days, eventually ending down negative (-10.94%); or about 10 months’ worth of hard-earned gains.

Prior to this greater than 10% loss, investors had not experienced such pain since August 2011. It’s been four years without a 10% correction. Such an event is out of the ordinary. Prior to 2011, a 10%+ correction occurred about every 18 months. Therefore, statistically, 48 months without a 10% correction gives one pause to reflect and begs the question, “what has made the past 48 months different from prior cycles?” U.S. monetary policy comes to mind, first and foremost.

The August 2011 stock market correction likely occurred because of the fears of contagion from the European sovereign debt crisis. That episode was marked by weakness in Spain and Italy, as well as concerns over France’s credit rating worthiness. The U.S. was continuing to stagnate economically, while S&P and Moody’s decided the U.S. should have its credit rating downgraded. Remember that, not so long ago? Volatility in the U.S. equity markets continued for the rest of that year. Up until the August 2011 stock market break, the SP500 had enjoyed a gain of approximately +30% in the prior 12 month period. Perhaps the market was just giving investors a “reality check?”

In the past four years since the end of that -10% correction, the SP500 has enjoyed a cumulative gain of 80%+, or an average gain of approximately +20% every 12 months, for the past 48 months. Most of the gains occurred until the beginning of this year. Since January 2015 we’ve experienced “flat price action” with the SP500 gaining little ground on a relative basis. Given these outstanding performance numbers against an average annual return of approximately +8% a year, on average, for the past 30 years, should we be surprised at a “market break?” I think not. And it’s this thread we’ve tried to keep in front of you during the market consolidation phase of the past 8 months before the breakdown in price on the SP500. Remember all that talk about ranges and “support” and “resistance?” Since price is a proxy for supply and demand we noted that price seemed undecided in continuing its rise.

I bring out these points citing the quantitative evidence regarding the market breakdown in 2011 and 2015. The market ran up 20%-30% annually, prior to those “market breaks” and that’s quite the “overshoot” from an 8% annual return. Some might refer to the August 2015 breakdown a “reversion to the mean.”

Other analysts, investors and news makers like to cite news events as “the reason” markets move. Personally, I believe that the “headlines are the hind lines” and price typically reflects all the known and unknown market inputs. Therefore, news follows price, not the other way around. For example, China was blamed for the recent market slide. Yet, we’ve experienced numerous China “bubbles” for many years now and our stock market rose +20% annually in light of these problems before the recent Chinese stock market bubble and the yuan devaluation. Maybe the imminent rise in interest rates from the Federal Reserve was the cause for the current pullback? Yet, we’ve been anticipating the rise in interest rates for the past year or more. Maybe the global slowdown was the reason for the stock market drop? Yet, the global slowdown has been going on for the past two years. Regardless of the reason, perhaps we should embrace this “reality check” and start realizing that the complexion of stock market may be changing.

Still, we look around the world and see global central banks following in the footsteps of the U.S. Federal Reserve from 2010-2014. “Easy money” is back in vogue and QE is all the rage in many of the developed and developing countries outside U.S. borders. So maybe things aren’t so different after all. On one side, as The Economist states on March 9, 2015, “If QE convinces markets that the central bank is serious about fighting deflation or high unemployment, then it can also boost economic activity by raising confidence.” On the other hand, could the flood of cash encourage reckless financial behavior or what might happen when central banks sell the assets they have accumulated? “Will interest rates soar, choking off future recoveries?” questions The Economist.

Maybe the recent break in our equity market is an example of Newton’s Third Law, “for every action, there is an equal and opposite reaction.” Maybe the complexion of our stock market is changing as an opposite reaction to the “easy money” and easy ride we’ve had thanks to QE since the 2008 Credit Crisis? As we get back to some sort of economic normalcy, without a Fed punch bowl, maybe a “reversion to the mean” in the stock market makes sense in a Newtonian sort of way?

Carl C. Perthel, CMT

 

*** Carl’s Corner for August 2015 ***

July’s Fed Meeting minutes saw little change in its language that would make one believe Ms. Yellen and the Federal Reserve will raise interest rates in the near-term. Ms. Yellen cited improving economic strength in housing and noted inflation rising, albeit slightly, trying to close in on 2%. Not a whole lot to hang one’s hat on for economic improvement, and therefore, no mention of a rate hike at the next Fed meeting in September. Even more evidence for rates remaining steady in the near-term may be found in the news that was not relayed. It’s darn hard to raise interest rates right now, in the aftermath of the July Greek credit crisis, a global economic slowdown, falling commodity prices and a stronger U.S. Dollar.

Over the past year, many Fed members have telegraphed their desire to raise rates. Ms. Yellen wants to raise rates, given the first opportunity, which has yet to present itself. In the Q & A session of the Fed meeting she stated, “We are close to where we want to be, and we now think that the economy cannot only tolerate but needs higher interest rates.” Close, but no cigar…

What might we glean from the second quarter 2015 GDP report just released?  It looks like Americans are out spending money again! While GDP increased 2.3% in the advanced estimate for Q2, that number was highlighted by improvements in real final sales, an increase in real personal consumption and improved numbers in goods and services spending. We cited in past Notes to be on the lookout for good consumer news. Our evidence was based on improving labor markets and falling energy prices; two reasons consumers have more money in their pockets to spend on stuff. This has benefited the Services sector of the economy. In fact, so much so that our in-house research sees upgrades this month in the sub-industry groups, Entertainment, Resorts & Casinos. With the vacation season upon us, America is finding good airline and hotel deals right now at gambling destinations around the country and at Disneyland- type venues.

While consumer spending was +2.9% in the second quarter, other metrics that comprise the U.S. Gross Domestic Product (GDP) were down. Equipment spending fell 4.1% and business spending declined 1.6%. With the annual revisions to the second quarter report, GDP now expands to 0.6% compared to the negative number (- 0.2%) previously reported. The newly revised GDP number of 2.3% puts us in what many economists consider a “slow growth” range of 2.0% to 2.5%. A print of 2.3% on GDP reflects the Federal Reserve’s reluctance to raise rates in a “slow growth” economic environment.

As I put the finishing touches on this issue of Carl’s Corner, here at the end of the month, I see the Employment Cost Index was released. The Employment Cost Index, the broadest measure of labor costs, edged up 0.2 percent according to the Labor Department. The consensus forecast by economists targeted the employment cost index to rise by 0.6 percent. This is a large miss. This print represents the smallest gain since the series started in the second quarter of 1982 and followed an unrevised 0.7 percent increase in the first quarter. Wage costs are decelerating. This weak economic data point is another strong reason for the Fed not to consider raising rates by their next meeting in September. But, this number is good news for the stock market since lower labor costs mean higher profit margins for business.

In last month’s “Corner” we cited June’s price action, explaining, “The SP500 is finding support at 2,050. 2,030 and 2,000 are the next two support levels.  Throughout most of 2015 we’ve found major support (a floor) at 2,000 and major resistance (ceiling) at 2,120.” July’s price action in the SP500 maintains what we’ve termed “trading range price action.” The 2,050 level we cited last month as support was tested and held in July, reaching an intraday low of 2,044. Market price action rebounded from the low end of the price zone at 2,044 and moved back to the ceiling by July 20th at 2,132. To summarize, the stock market is still stuck in a trading range going back to the beginning of February 2015, bounded by 2,050 on the low end of the range and 2,130 on the high end. The Greek crisis and earnings reports this past month have not been enough to move price above or below these parameters.

Please stay tuned…

Carl Perthel, CMT

 

*** Carl’s Corner for July 2015 ***

The volatility in the global markets we’ve experience the past two days is a result of Greece deciding not to pay back its debt ($1.5Billion Euro) to its major creditors (i.e., IMF, European Stability Fund, European Central Bank; where 80% of the debt is being held). Greek banks are closed this week in an effort to stem a possible collapse and prevent money from leaving the country. Its citizens are set to vote in a July 5 referendum to accept or reject the latest bailout terms from Europe and the International Monetary Fund. Financial odds makers give a 40%-50% probability of Greece exiting the European Union (EU). Greece owes $367 Billion (U.S.) to all its creditors. Stocks around the world do not like the uncertainty associated with a debt laden country like Greece leaving the EU. The big worry is the fear of a “spillover” and then a cascade of global debt problems as a result of this default.

Most of the financial world thought Greece would accept austerity terms, implement a mediated solution, get a debt extension and continue membership in the EU. The major creditors would then absorb the debt and write it off. This impasse is both surprising and uncomfortable, especially for the 20% of private creditors outside the scope of the IMF and ECB. In the meantime, the ECU will continue massive quantitative easing through aggressive bond buying to keep Greek contagion risk low. Keep an eye on the July 5th referendum and its aftermath for further clarification. What is interesting… even though the deadline has past; a referendum is still taking place. Even more interesting, the Greek government that proposed the referendum is actively protesting its passage. And I thought that Alice in Wonderland was merely fiction, impossible to be played out in the real world. Greece has proven me wrong. (***Addendum- see last paragraph).

Puerto Rico is $72 Billion in debt and will likely miss its July 1st payment. This default does not come as a surprise. The main concern is additional risk of default on some of its general obligation bonds (GOs), a greater degree of concern than the problematic Power Authority bonds. Most municipal fund managers are 5% or less exposed to Puerto Rico at this time. Thus far, bond market pricing in these instruments is treating this news as an isolated event.

Throughout most of June the S&P failed again to break through the 2,130 area. Low volume on “up thrust” days reflect a lack of demand. The Greek news has the SP500 down about -3.0% this week. The SP500 is finding support at 2,050. 2,030 and 2,000 are the next two support levels.  Throughout most of 2015 we’ve found major support (a floor) at 2,000 and major resistance (ceiling) at 2,120. Even with the Greek situation, continued narrow price action in the equity markets looks likely. The 50 and 200 Day Moving Averages, along with overhead supply, converge at 2,100. The 2,100 zone may offer significant resistance for the time being.

Not only are we in the market’s “unfavorable” six-month season (May 1 – October 31), but we face the expectation of a tepid earnings season that officially starts on July 8th. The expectation in the second half of the year is a view for slower earnings growth. In total, 2015 is expected to be flat from 2014. Energy has held overall earnings back. Couple the fundamental earnings outlook with the historically “flat” seasonal price action in the equity markets, and then we might expect price action in the next 5 months to continue in our defined trading range of 2,000 to 2,130 in the SP500.

In past reports, we’ve noted that the markets will often discount news through its price action long before the real news hits the tape. In the fixed income market, we’ve seen the benchmark 10 year Treasury yield move from 1.67% on February 2 to its current yield at 2.34%, without the Fed having to make an announcement of a rate hike; a move higher by +40%! By the time the Fed gets around to “hiking rates,” the fixed income market may have already discounted the news. It’s possible the rate hike could have little impact on yields once the hike is announced.

The last few weeks have witnessed a decline in the Chinese equity markets.  The China 25 Index (FXI) has dropped almost -5.6 in June and down -12.5% since late April. By June 29th, the Shanghai Composite Index had closed down 22% since its high on June 12; bear market territory. In regards to its monetary policy, you may have noticed that China will typically “ease” a few times and then “tighten” the third time, or vise-versa. China’s monetary policy is a result of trying to control the asset bubbles popping up every few years as money seeks to find the best investments in its Politburo managed economy.  Last year its asset bubble was real estate. That bubble prompted tightening in 2014. In an effort to stem its recent fall in the equity markets, China implemented monetary easing over this past weekend. On the last trading day in June, China rallied +6%. Even better news yesterday, China announced that it will allow state pension funds to buy more securities (about $100 Billion U.S.). These purchases should boost its flailing equity markets. Chinese markets remain volatile and are not for the weak of heart.

Our in-house analysis is witnessing strength in these sub-industry groups over the past month: Copper, Regional Banks (which like higher interest rates), Industrial & Electrical Equipment and Heavy Construction. Weakness continues to occur in interest rate sensitive groups like REITS and Utilities.  Closed End Debt, Grocery Stores and Department Stores have consolidated their recent gains.
Aluminum has trended lower this past month, ahead of the Alcoa earnings report due out on July 8th. Alcoa officially starts a new “earnings season.”

***ADDENDUM – Breaking A.M. News this morning has Greece (through a letter to its major creditors) reconsidering its position, effectively conceding to pay back its loans. European officials are assessing the reversal, and will present their initial findings on a call with Eurozone finance ministers later Wednesday. This unexpected turn of events (should it take place) will likely take weeks to implement. Under the Emergency Assistance Liquidity program, Greek’s creditors can effectively start funding Greece, once again, since the Greek government appears to have accepted the original terms and conditions for paying back its debt.

Carl Perthel, CMT

 

*** Carl’s Corner for June 2015 ***

This past month’s “tale of the tape” has been a reflection of not what the Federal Reserve plans to do regarding interest rates, but WHEN it plans to raise the federal funds rate. The perception of rising rates may likely cause volatility and lower stock prices before the Fed ever makes its announcement as to “when.” In essence, the market is a discounting mechanism. That’s why we witnessed a -1.5% drop in the equity benchmarks immediately after Fed Chair, Janet Yellen, spoke last week. Her speech re-introduced the specter of rising rates before year end, although she couched her remarks by saying ultimately the decision would be “data driven.”

The three years prior to 2015 were marked by a steady rise in stock prices, thanks to Federal Reserve “easy money” programs termed, “quantitative easing.” Quantitative easing ended last year, and since then, the stock market has witnessed a small variation in price, moving within a tighter “trading range.” This new range is a result of market participants contemplating a stronger economy with the Federal Reserve providing no outward signs of monetary stimulus.

Initially, a stronger economy will present investors with new opportunities. A rising rate environment favors banking, insurance, real estate and brokers.  A stronger economy may mean more people going back to work. The extra money earned through gainful employment will likely be spent on apparel, autos and trucks, business supplies, construction and construction materials, consumer goods, entertainment, recreation, restaurants, hotels and in retail outlets.

Looking out even further, the next stage of the economic cycle should see strength in the transportation index and technology. With an increase in consumer demand, compliments of a stronger economy and the yield curve becoming steeper, general transportation, railroads, shipping and air freight start to shine. Concurrently, the technology sector favors software, hardware, measuring & control equipment, electronics, semiconductors and networking.

The Federal Reserve has not raised rates since 2006! Absolute interest rate levels have not been this low since the Eisenhower Administration. On a relative basis, even a slight rise in rates should not be seen as a negative, but an opportunity to invest in industry groups likely to move higher in a rising rate environment.

Now having presented future opportunities, what’s in front of us right now? The elephant in the room is the most recent GDP number of +0.2% for the current quarter, down from a +2.2% reading from the prior quarter and down from the +5.0% GDP reading from Q3, 2014. These consecutive GDP declines are part of the “data driven” numbers the Fed is examining and a big reason why the Fed has not raised rates. Since GDP reflects U.S. spending, it’s safe to say if consumers are spending less (saving more) and businesses are spending less (due to a lack of business policy direction from Capitol Hill), when you add these two events up, that equals weaker growth.

Based on additional economic data, the Federal Reserve believes the economy is still too weak to support higher rates. The unintended consequence of a low interest rate environment means money will have to seek yield somewhere other than bonds. Fundamentally sound equities that pay solid dividends should continue to attract investors, thereby supporting the stock market for the time being.

Our in-house analysis is witnessing strength in these sub-industry groups for the past month: Gold, Major Integrated Oils, most of the regional banks, surety & title and credit services, farm machinery, general building materials, shipping and wireless. Weakness has occurred in interest rate sensitive equities as a result of Janet Yellen’s most recent remarks.

In the past few months we’ve witnessed global central bankers implementing “easy money” policies in their respective countries.  Monetary easing helped spur the U.S. equity markets from 2010-2014. Perhaps new “easy money” policies in these countries may lead to rising equity prices abroad. These countries include: Australia, Canada, Chile, China, Denmark, Egypt, India, Indonesia, Israel, Peru, Poland, Singapore, Sweden, Switzerland, Turkey and the big kahuna, the Euro Zone. And some of you thought it was just the Eurozone cutting rates?  That’s a lot of global easing.

The “unfavorable” six month season is upon us. Please see additional remarks regarding the May-October seasonal phenomena at www.aamg.com, “Past Market Views – Archives” to view The Markets – Unplugged XIII Conference Call Transcript (May 13, 2015).

Carl Perthel, CMT

 

*** Carl’s Corner for May 2015 ***

“Carl’s Corner” May edition may be viewed at www.aamg.com, “Past Market Views – Archives” — The Markets – Unplugged XIII Conference Call Transcript (May 13, 2015). Carl gives his bi-annual update on the markets through this transcript.

Carl Perthel, CMT

 

*** Carl’s Corner for April 2015 ***

Happy Anniversary! We’ve just passed the 72 month mark (six years!) for the current cyclical bull market. This bull, which started in March 2009, is one of the longest “cyclical” bull markets since 1901. Let the good times roll…but for how long?

Tighter monetary policy inhibits economic growth which leads to recessions. Typically, to de-rail a bull market, it boils down to interest rate hikes.  Higher rates squeeze company earnings, leading to smaller profits. When these events occur over time, business activity will turn down.  Economic recessions kill bull cycles, and it’s the progressing frequency of these rate hikes that induce a topping process in equity market price action.

But, since the U.S. recovery is on a “slow growth” path, the Federal Reserve is in no hurry to raise rates. The March FOMC meeting put an explanation point on this fact. Chairwoman Yellen cited the lack of wage growth as a major factor for not raising rates. Interesting though, since that meeting (and the market moving back to all-time highs), numerous Fed officials are again speaking out:  Fed Vice-Chair Stanley Fischer, San Francisco Fed President John Williams and St. Louis Fed President James Bullard are communicating the need to raise rates. These speeches are akin to “jaw-boning” and are effectively putting a lid on an arguably “over-valued” equity market.  The back-and-forth between the “dovish” Yellen and these “hawks” has created volatility and a very narrow trading range in 2015, with the SP500 up only +0.44%, not including dividends.

In last month’s Notes (March 1) we stated:  “…price action broke through the December 2014 high at 2,093. Since old price ceilings typically become new price floors, look for 2,060 to become the new floor on the SP500.” Since then, the SP500 has held 2,050 all month long except for one day and rests above 2,060 at this juncture. The SP500 matched February’s all-time high in March at 2,117. Since price lows at the end of the month were higher than price lows at mid-month (coupled with new all-time highs), market price action is still exhibiting an uptrend.

Fundamentally, there are potential clouds on the horizon for the coming month; primarily, first quarter earnings results. Expect a cut in consensus estimates because of the drop in energy prices and a stronger U.S. Dollar. A strong U.S. dollar equates to lower earnings for U.S. multi-nationals. Also, a strong U.S. dollar hurts American exporters, since a stronger dollar makes American products more expensive for foreign purchasers. Weak order flow from abroad may pull down the U.S. GDP next quarter.
But, lower gasoline prices may off-set this negative in GDP. Money saved at the pump by the consumer may be re-directed toward higher personal expenditures, which was the largest growth component in last quarter’s GDP. Government reports yesterday showed that consumer spending and incomes rose in February.

The drop in energy prices will cut into energy sector earnings and overall SP500 earnings. Lately though, chart action for the energy group is headed in a positive direction. Price is attempting to “base” in a number of the energy sub-industry groups. Since 1970, the mean price for a barrel of oil on an inflation adjusted basis is $44.  With WTI resting at $47.50 a barrel, we are likely closer to equilibrium in the oil patch than most people think. Our work shows that the Major Integrated Oils, Refining and Oil & Gas Pipelines are pockets of strength in the energy patch.

Also, our in-house analysis sees strength and an “upgrade” in the sub-industry group, Residential Construction; the stocks that comprise this group are the home builders. According to the U.S. Census Bureau, new home sales rose to 539,000 in February, about 25% higher, year-over-year. Rising employment, lower energy prices and low mortgage rates have given a boost to this part of the economy. Stock prices in this group have been trending higher in 2015.

April is the last month of the stock market’s “favorable” 6-month season. The majority of market gains, over time, occur between November and the end of April. From a fundamental perspective, 2015 is similar to 2011. In 2011we experienced a “downturn” during the summer months. In both instances we see slower economies with stimulus programs now absent. Both years exhibit receding energy prices. And today, like 2011, Greece is unable to meet its debt payments. We’ve not seen a -10% correction in the stock market since 2011, which is highly unusual. Given our cycle work and the similarities to 2011, it might be best not to become too complacent.

Carl Perthel, CMT

 

*** Carl’s Corner for March 2015 ***

In February, the stock market went from a “risk-off” (bearish) stance to a “risk-on” (bullish) posture. The -3.10% performance in January was wiped out by the +5.49% SP500 return in February, giving the SP500 benchmark new life, thanks to a number of factors which we will cover in this month’s issue of Carl’s Corner.

Given recent economic data points, the Fed feels it’s not in a position to raise interest rates now. This week brought to light additional news from the Fed that the unemployment rate may have to fall to a certain target before rates will be raised. Is this news further evidence that the Fed is not eager to “pull the trigger” too quickly?

Last year the consensus was for the Fed to raise rates by year-end 2015. Last quarter the consensus was for rates to be raised sooner; by mid-to-late 2015. This month, Fed Chair Janet Yellen stated that the Fed would monitor economic data “month-to-month,” before making a determination. It appears that the Fed is trying to “talk down” the stock market by threatening to raise rates sooner, rather than later.  But, the market wasn’t listening this past month.

The Fed’s vacillating posture leads one to believe that the Fed does not know when it will raise rates. The stock market, understanding this, continues to rise because the “best yields in town” for investors can be found in large cap, dividend paying equities. Therefore, money continues to flow into the stock market, seeking yield. Fed policy continues to drive investors away from bonds and into stocks.

Currently, the economic news is anemic, while inflation is benign. These factors bode well for the Fed not having to raise rates. It’s the same old story, and the stock market knows it; an anemic economic environment will keep rates steady. Low rates keep borrowing costs down and contribute to smaller liabilities on the balance sheet. Profit streams for corporations can be tracked easier in a stable rate environment.  Who doesn’t love low interest rates?

Current economic worries in February have assisted the stock market to climb its own “Wall of Worry;” a periodic stock market tendency to surmount a host of negative factors and keep ascending.

Global oil supplies are plentiful while U.S. commercial inventories are increasing. Oil closed above $50 a barrel for the first three weeks in February, before falling below $50 a barrel at month end. Analysts still expect better demand for oil and energy going forward through the end of the year.

Although the recent rise in crude oil prices over the past week have put pressure on the Transportation sector, longer term, lower oil prices will benefit the railroad, trucking and airline industries. Relatively speaking, the Transportation Index will happily accept oil at $50 to $70 a barrel versus the $100+ a barrel it saw last summer. Gasoline is the basic input for these three sub-industry groups. Cheaper gas means higher profits for companies involved in transportation.

Not only do the transports like lower oil prices, rails in particular are the beneficiaries for transporting energy around the country. With the Keystone Pipeline on hold, rails should have a steady business in 2015. If oil demand increases, railroads will have more business and larger profit margins with cheaper gasoline (inputs); even at $70 a barrel. Did you know that trains get 468 miles per ton, per one gallon of gas?

There are a myriad of reasons to “think” the market should go down. One glaring concern is this past quarter’s earnings deterioration. Stocks continued higher with SP500 companies guiding earnings lower. P/E valuations can be argued seven ways to Sunday. Wall Street would have one believe that the “acceptable” valuation method is to base P/E’s on forward earnings estimates. Well, if forward estimates (earnings) are guiding down, while prices are rising, then P/E’s continue higher, creating higher valuations. The big question is this: how high is too high?

According to Standard & Poor’s recent research, the collapse in crude oil prices has trimmed about 10% off the 2015 SP500 expected earnings. Although a detriment to earnings, resulting in higher P/E valuations, there are benefits to falling oil prices that may propel the stock market higher for a while. Consumer spending comprises over 70% of U.S. GDP. Cheaper oil gives the U.S. consumer more disposable income that should boost economic activity through greater consumer spending. The consumer discretionary sector should benefit going forward. In the S&P Capital IQ February 20, 2015 Note(Lookout Report from Global Markets Intelligence), authors Michael G. Thompson and Robert A. Keiser report, that in Q4, 2015, 40 of the 56 companies that comprise the SP500 Consumer Discretionary sector had positive price action after their earnings were released; leading all SP500 sectors in the 4th quarter. The economy and the stock market enjoy seeing the American consumer spending their money. Don’t discount the American consumer in 2015.

Should oil stay at historically low levels for a while, inflation will remain at bay, helping the Fed to keep a lid on rising interest rates; possibly enhancing the ability of corporations to increase earnings, show profits, retain earnings and increase dividends.

As we’ve reported in past Corners, “The 200 Day Moving Average (DMA), which typically represents institutional support, resides at 1,974.60. We mentioned in the October edition of CC that 1,960 to 1,975 represented “intermediate support.” Thus far, price has held above the 200DMA and 1,960.” Last month the SP500 held 1,981and bounced higher from there over this past month. Price support(s) continue to hold and the stock market grinds higher.

It is very difficult for investors (myself included) to execute this strategy: trade what you see, not what you think. What have we seen over the past month? This month the SP500 price action broke through the December 2014 high at 2,093. Since old price ceilings typically become new price floors, look for 2,060 to become the new floor on the SP500.  The 200 Day Moving Average on the SP500 resides at 2,065. Prices on the equity indices continue to move higher, followed by pauses and retracements. The definition of an uptrend is higher highs and higher lows; and presently, that’s the environment we are in until price tells us differently.

Carl Perthel, CMT

 

*** Carl’s Corner for January 2015 ***

Last week, the Bureau of Economic Analysis released its “third estimate” for the Q3, 2014 Gross Domestic Product (GDP). Real GDP was revised higher; from 3.9% to 5.0%! This number represents the best annual rate since 2003. Q2, 2014 GDP was 4.6%. We’ve noted for a number of years that a stronger economy may likely lead to higher interest rates over time, squeezing profits and earnings for the stock market in the long run. This has yet to happen. Maybe this 5% number will give the U.S. economy some traction?

The Federal Reserve already believes the economy has turned the corner; outwardly ending the bond buying program that had been in place since November 2008. The Fed balance sheet grew from $800 billion to approximately $4.5 trillion by October 2014 when the program ended. Another important data point for a stronger U.S. economy is the hiring number, averaging 250K-300K per month. Unemployment rates are now down to 5.8%, from a high of 9.7% in January of 2010. Employers have added more jobs in 2014 than in any year since 1999. The labor market has started to tighten enough to lure the long-term unemployed off the sidelines to rejoin the job market. Wage gains are picking up, also. This may be a tailwind for the U.S. economy.

In mid-December, the Federal Reserve gave forward guidance on interest rates. Along with three dissenting Board Members, the Fed substituted the phrase “considerable time” for raising rates with the word “patience,” as the Fed Board begins to normalize its stance on monetary policy. Sounds like more of the same, which is why the SP500 is +2.75% since the announcement. If inflation remains below the 2.0% Fed target, the Fed feels it can keep rates low for a considerable time. A stronger economy, over time, may de-rail this stance. The three Board “dissenters” no doubt feel the Fed is starting to get behind “the curve.” As the economy strengthens, the dissenters are fearful that Fed inaction to raise rates now will force the Board to hike rates faster than desired in the future. Typically, a stronger economy bodes well for the equity markets in the initial stages. But, over time, as interest rates rise, the rising cost of money to conduct business cuts into company profit margins. Stock prices move lower on lower profit projections. Beware of an improving economy and pick your spots as the U.S. economy tries to recover (again) in 2015.

We mentioned last month that falling gas prices historically promote a rise in global equities within one year after a 25% drop in oil prices. Oil fell from $109 in June to $54 a barrel by year end.  Domestic beneficiaries include the American consumer.

Already, we have seen a stronger holiday shopping season, thanks to more money in the pockets of the American consumer. A decline in the price of gas is akin to a tax cut.  Spending less at the pump gives Americans a wealth transfer. Besides the consumer, other beneficiaries of falling gas prices might include the auto industry, agriculture, domestic equities and the airline industry. Alternative fuels will feel the pain of lower oil prices.

Consensus opinion at the beginning of 2014 was for bonds to sink as rates were expected to rise, given the inevitable tapering in the Fed’s bond buying program. Quantitative Easing (QE) was to end gradually throughout 2014. Well, tapering took place; right on schedule, but bond prices staged an impressive move higher all year long! Given the economic troubles around the globe, foreign money flowing into the U.S. bond market for safety could have been a major reason for supportive bond pricing. And who really knows what kind of “off the books” purchases are being made by the Federal Reserve? Hidden purchases by the Fed may continue to support bonds in 2015.  One thing is for certain, “easy money” policy will continue to encourage investors to bid up prices in the equity markets. This March, the equity bull will celebrate 6 years (72 months) of prosperity. Only two of the past 32 bull markets since 1900 have lasted longer than this one. The 1921-1929 bull market lasted 97 months, while the 1990-2000 bull market lasted 117 months. If the economy does not get too “over-heated” we just might survive a few more innings.  An accommodative Federal Reserve has supported the bulls on Wall Street at every turn.

Sub-industry group analysis for year-end 2014 continues to show strength in the Consumer Goods, Health Care, and Service sectors.  Look for Technology to be a possible strong performer in 2015. New application software will fuel hardware upgrades to replace obsolete technology.  Cloud computing should be a major driver in the coming year. Basic Materials and Energy are still lagging. Some of you contrarians may want to keep an eye on these two sectors for a turnaround as the year progresses.

Welcome to the New Year! As the old Gaelic blessing goes: “May the road rise up to meet you. May the wind be always at your back. May the sun shine warm upon your face and the rains fall soft upon your fields, until we meet again…”

Carl Perthel, CMT