Link roundup

Here are some recent market-related posts which I have enjoyed

Quote of the week: We learn from history that we do not learn from history.

― Hegel (via Daily Zen)

Weekly Drive: October 20th to October 24th, 2014

Halloween is here! There are a few more days to buy candy, carve a pumpkin, and figure out what costume to wear. Hope everyone has a safe and fun time on Friday.

THE KEY ECONOMIC LANDMARKS WE PASSED

1. Housing

News from the housing market continues to stir mixed emotions. Existing home sales increased to the highest annual rate for the year while new home sales barely squeaked out an increase off a lower than previously reported number for August. All cash deals and investor purchases ticked up a bit in September but remain lower than in 2013. In the various regions, the Midwest was the weakest with a decline of 5.6% while the West shot higher by 7.1%. Home buyers received an unexpected gift this year as rates fell nearly back to levels seen late last summer. Additionally, lenders are starting to relax standards ever so slightly. As prices rise, sellers will continue to enter the marketplace and investors will exit when distressed properties become more scarce.

New home sales took a breather after shooting higher in August and only remained positive due to a nearly 40K downward revision. Inventory levels over the last three months are better after dipping to a low of 4.4 months supply in May. Builders seem to be focusing less on building fewer more expensive homes (which has kept prices elevated). Median prices sank from $286,800 in August to $259,000 in September. The number of new homes sold for less than $200,000 accounted for 31% of the total last month compared to an average of 23% for the year.

Housing will reach a better balance when existing home prices edge up, new home prices compress, and supply of both are higher. The price gap stands at ~$50,000. Looking at Figure 1, you can see the gap has been stubbornly high in the last few years and well above the average level seen in the last housing boom.

Figure 1

price gap 1024

The Journal has a cool housing market tracker worth checking out.

2. CPI: 0.1% vs 0.0% est (MoM)

Even with the plunge in energy prices over the last few months, prices for consumers rose by 0.1% in September. Energy dropped 0.7% while food and shelter increased 0.3%. While the index for all categories is up 1.7% in the last 12 months and below the Fed target of 2%, there are areas heating up. Food and shelter are both up 3.0% in the same time frame. I have some level of concern about rising shelter costs because of the current housing market environment. It is going to take a few years to bring more first-time homebuyers back into the equation and get Johnny and Susie out of their parents’ basements. In the meantime, people will have to rent. Figure 2 below shows the jump in shelter costs

Figure 2

shelter cost 1024

LAST WEEK’S MARKET IN THE REAR-VIEW:  “LL Cool J was wrong”

In his famous song, “Mama Said Knock You Out”, the 90s rapper starts the song by saying “Don’t call it a comeback.” Last week looked like a comeback to me. Across the board, equities broke out of their bottom ranges and ended the week in a nice shade of green. Corporate earnings and upbeat economic data from aboard helped give a boost while fears of Ebola in the U.S. and shootings in Canada caused a few jitters.

Returns for the Week*

  • Small Caps: Russell 2000 Index: 3.37%
  • Mid Caps: S&P 400 Index: 4.18%
  • Large Caps: S&P 500 Index: 4.12%

*Returns represent price change

LOOKING THROUGH THE WINDSHIELD

Economic

Another month is about to end and 2014 is drawing to a close. We will see our usual dump of month-end economic reports this week, although some will hit the wires early next week (e.g. ISM Manufacturing). More consumer oriented data is on the docket as well so let’s hope our fellow citizens kept their wallets open for another month. I do not expect the Q3 GDP release to be a shocker on the downside and I think I speak for most when I say I hope to see a three handle. Chicago PMI will be a precursor to ISM next week. We are all awaiting data current enough to show whether the rising dollar and drop in eurozone growth are negatively impacting the domestic economy.

Market

The trajectory seems to be up for equities with volatility (as measured by the VIX) collapsing from highs reached two weeks ago. It is too early to say we are going to sustain these levels as the possibility of a test of lows is always in the works. The recent sell-off took us out of the trend channel when looking at a longer dated chart, but the bounce back has been sharp. A resumption of the prior trend too early would do little to quiet the bears in the crowd. Sometimes we get too caught up in the charts and the history instead of thinking about the why and the now. The difference between a chart looking good or looking bad could simply be a matter of scale or the time period selected.

SCHEDULE

calendar 1027-1031

FOMC preview

I am expecting little news from the FOMC this week. The committee should take the final tranche of QE off, which might have been an unfavorable surprise amid the financial market volatility two weeks ago, but which is likely to go unnoticed this week.

Some of the regional presidents have been advocating their views towards on the one hand a slower move to higher interest rates (President Evans of the Chicago Fed, see his speech here) or on the other hand, a faster move (President Plosser of the Philadelphia Fed, see his speech here). My personal view is closer to the raise-rates-later view of President Evans. whatever the decision turns out to be, I do not expect any committee level move with this meeting, but we might get some additional information from Chair Yellen’s press conference and the updated “dot plot”, December 17th.

-John Eckstein, Chief Investment Officer

World PMIs (October 2014, preliminary) – steady as she goes

The October preliminary Markit PMIs for major economies were somewhat stronger, on balance, than September’s. The US is off its peak but still quite strong. The Eurozone recovered a bit, thanks to Germany is my guess, though the reading is still around the 50% expansion/contraction line.

pmi.heatmap-2014-10-23.b

In Asia, Japan’s manufacturing PMI posted solid progress and China registered little change.

Overall, the preliminary PMI’s suggest to me no significant changes in global economic growth: Fairly strong in the US, moderate in Asia, weak but positive in Europe.

Weekly Drive: October 14th to October 17th, 2014

THE KEY ECONOMIC LANDMARKS WE PASSED

1. Retail Sales: -0.3% vs. -0.1% est.

A bit of a bummer report but also not completely unexpected considering sales were up 0.6% in August. Excluding autos, sales were still down -0.2% for the month. A look at Figure 1 shows weakness across many categories, including gasoline stations and clothing stores (back to school shopping over) while electronics/appliances rose a heavy 3.4% (up 5.8% YoY). Fingers were pointed at the timing of the iPhone 6 release, a strong summer buying season for cars, and lower gas prices. The question now is whether we are setting the tone for a disappointing holiday shopping season or “one month does not a new trend make.:”

Figure 1

Retail Sales Sep14

2. Industrial Production: 1.0% vs. 0.4% est.

After declining in August, industrial production blew past estimates in September.Within the main industry groups, all three were up on the month as shown below.

  • Manufacturing 0.5%
  • Mining 1.8%
  • Utilities 3.9%

Utilities jumped largely in part to a warmer-than-average September which kept A/C’s running while manufacturing got back to its upward trend. On a capacity side, overall utilization rose by six-tenths to 79.3 which stands around a full percentage point below the 40 year average. Manufacturing is 1.4% off from it’s average so there is still plenty of room to go. Much has been said about the relationship between capacity utilization and inflation. At times, there is a higher correlation and pairing between the two and at other times, not as much. Recently, inflation remains muted while utilization is steadily increasing (Figure 2).

Figure 2

caputil sep14

3. Housing Starts: 1017K vs. 1008K est.

Housing starts are a choppy a number and while the absolute level gives you some indication of activity, a simple permit or beginning of a build means little. The sales numbers which follow are where attention should rest. For the time being, we’ll say housing continues to move forward and progress past speed bumps.

LAST WEEK’S MARKET IN THE REAR-VIEW:  “One, Zero, Decimal, Zero, Percent”

The technical gurus, perma-bears, and others can all finally be satisfied the market “corrected.” Futures reached a high of 2014.3 on September 19th and a low of 1813.5 on Wednesday (SPZ4 – Dec 14 contract) to barely squeak out a 10% down move. Volatility rose sharply to follow the move with the CBOE VIX Index cresting above 30 for the first time since the mess we saw in the fall of 2011. The S&P 500 on a OHLC view made a nearly 100 handle move on Wednesday with the intraday low reaching in the -3% range. Crude oil continues to get slammed with the WTI front month briefly trading a shade below $80. Most analysis pegs profitability for certain types of drilling at $80-85/barrel. We could start to see production coming offline as the oil industry deals with oversupply due in part to the two-headed beast of slowing China demand and improved domestic production (e.g. North Dakota’s shale boom). Treasuries also experienced a wild-ride with the 10 Year falling under a 2% yield. Wednesday was one of those days you put your horse blinders on if you are a long-term investor. These things happen, it is best not to get caught up in the countdown, graphics, talking heads, and other nonsense continually thrown at you from the media. You can read the recent posts from John Eckstein and Rob Stein to get more thought from Astor’s Investment Committee.

LOOKING THROUGH THE WINDSHIELD

Economic

As we move into the week before Halloween, the data is light and mostly focused on housing. Existing and new home sales will be the more important releases for the week with a check-in on CPI likely giving further confirmation of inflation running below the Fed target of 2%. Data points like these will be put on the back burner in the near term as attention is directed toward Europe, China, ISIS, Ebola, the Fed, etc. Unless there is a major surprise, do not expect an update on housing to provide ammo for any extended market move.

Market

Will last week prove to be the bottom of the sell-off? Time will tell, but the charts in certain areas of the market look favorable. Small caps are leading the charge from the lows (at the time of writing, nearly a 6% rise from the lows on 10/15). The one concern for me is we get too hot too quick. I would like to see a test of lower levels again before setting up for the next leg higher. I say this statement mostly because I know there are a good number of people who think we are still expensive and want to see period of lower prices. Appeasing the crowd now will lead to a better tomorrow.

SCHEDULE

calendar 1020-1024

Worrying about the Wrong Things

Fever. Chills. Cold sweats. Nausea.

Ebola? No, these are the classic signs of a market-induced malaise caused by rampant fear and worry over the wrong things.

The market, which seemed to be itching for a downturn, scared itself into one over a rash of unconnected symptoms.  From Ebola fever (the media-induced variety), to concerns over slowing growth in Europe, and even some handwringing over the Fed, slushed together to create a very challenging and unsettling few days in the markets.  Volatility, an oscillating indicator, has swung back from the lows of 2013 to levels not seen since 2011 when the debt crisis was front and center.

At Astor, we systemically calculate the underlining strength (or weakness) in the economy and adjust exposure to risk assets (stocks) accordingly.  As we look out over the landscape of economic indicators we see no reason to panic. Our proprietary measuring techniques continue to show the same slow and steady growth we have experienced the past few years. If anything, we see far more impetus to increase equity exposure.

But what do we make of all these fears?  To be sure the market has been scary the past several days and volatility has increased substantially. Let me try and shed some light on the facts.

First, to draw a parallel between the markets and the Ebola scare, one person from Liberia has died in Texas, and two healthcare workers who cared for him have tested positive (as of this writing, one is in good condition and the other is stable). Although Texas state health officials have estimated Ebola exposure could involve seventy-five people, this is hardly an epidemic. It isn’t even a health hazard!

To put this in perspective and if you want to worry about a contagion, think about influenza!  Influenza kills about 50,000 people a year, according to the Centers for Disease Control. So get a flu shot, and stop watching the Ebola anxiety-inducing news segments. Or think of it this way: You have a statistically greater chance of winning the lottery than you do of contracting Ebola in the U.S. While the healthcare system needs to be responsive and have all the proper precautions in place, the rest of us would do well to “keep calm and carry on,” as the saying goes.

When people aren’t worrying about one thing then they worry about another; and in the absence of another they worry about the stock market. Specifically, when will the stimulus end and what will happen to stocks when it does?  Well, the Fed has been very vocal about its plans to ease the stimulus when the economy is strong enough to handle it. As the FOMC minutes from mid-September stated, there have been discussions about “ways to normalize the stance of monetary policies and the Federal Reserve’s securities holdings,” but that does “not imply that normalizing will begin soon.” Enough said for now.

What about Europe? China? Japan? If growth slows there, what will happen here? History provides the answer. Recessions have rarely, if ever, been the result of a deteriorating economy abroad or an escalation of geopolitical events. It’s possible we could have lighter growth if Europe slows down, but it won’t be enough to put the U.S. economy into recession. We’ll just have a little less “up” in our upward momentum.

So what’s causing all these jitters—the feverishness, sweats, cold chills?

Volatility!

As I have said on many occasion, including a few paragraphs ago, volatility is an oscillating indicator, but stocks (over time) are positively sloped.

Sure, it is a little riskier to be in stocks lately. However, the current economic fundamentals support owning stocks and taking that risk.  If you look at the Leading Economic Index (LEI), released by the Conference Board, it has shown steady increases, indicating moderate growth in the economy (see Chart 1). At Astor, we use a proprietary blend of economic indicators to gauge the strength or weakness of the economy. Current readings also indicate positive economic fundamentals.

Chart 1: Conference Board’s Leading Economic Indicator

LEI

Source: Bloomberg, NBER

Thus, the trend of fundamentals is precisely where investors ought to be focusing their attention. As the accompanying data show, over the last 30 years, exiting the stock market during any quarter in which equities were down 9 percent, while the economy was still growing above long term trends, would have been a bad idea. (See Chart 2 and 3). During those volatile moments, investors would have dodged a few bullets, but given the reduction in returns over a longer period of time, that would not have been an advantageous move. The only time it pays to be defensive because of a 9-plus percent market correction, is when the economic fundamentals are also declining.

Chart 2:  Quarters with S&P 500 down 9% or more and Economic Indicators showing strong growth (1985- Present)

quarters

Source: Bloomberg, Astor calculations

Chart 3:  Average Next Quarter Return when S&P 500 is down 9% or more and Economic Indicators show strong growth vs. the average quarter (1985- Present)

quarters2

Source: Bloomberg, Astor calculations

In fact, when economic fundamentals are positive and the markets are down 9-10 percent, history has shown these periods to be the best time to allocate to stocks. We feel confident that the current environment has the potential to produce this favorable scenario and thus have added exposure recently.

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice in any state where it would be unlawful. There is no assurance that the programs will produce profitable returns or that any account will have results similar to that of a composite. Past performance is not a guarantee of future results. You may lose money. Factors impacting client returns include individual client risk tolerance, restrictions a client may place on the account, investment objectives, choice of broker dealers or custodians, as well as other factors. Any particular client’s account performance may differ from the program results due to, among other things, commission, timing of order entry, or the manner in which the trades are executed. The investment return and principal value of an investment will fluctuate and an investor’s equity, when liquidated, may be worth more or less than the original cost. Analysis and research are provided for informational purposes only, not for trading or investing purposes. Astor and its affiliates are not liable for the accuracy, usefulness or availability of any such information or liable for any trading or investing based on such information. Please refer to Astor’s Form ADV Part 2 for additional information and risks.

 S&P 500 Index: The S&P 500 Index is an unmanaged composite of 500 large capitalization companies. S&P 500 is a registered trademark of McGraw-Hill, Inc.

 Conference Board Leading Economic Index: The Leading Economic Index represents a composite of ten different economic and market related components including stock prices, interest rate spreads, and manufacturing data. The Index is published on a monthly basis and is not investable.

Don’t Panic

The recent stock sell-off certainly has our attention. Yesterday, October 14th, the S&P 500 closed about 6.6% off its high, set only a month ago. And writing before the opening of October 15th, it looks like another bad day. As always, there is a chance of a further stock market decline, but we think the risk reward proposition of the stock market is still favorable. Accordingly. we have not reduced our exposure to stocks yet, though we are monitoring the situation closely. Why might investors want to cut their positions and why hasn’t Astor?

The fundamental argument for panicking

The strongest fundamental argument for reducing equity exposure is the possibility of a renewed recession in Europe, perhaps leading to deflationary fears in the developed markets. Recent news in Germany in particular has been disappointing, and any growth in the periphery is coming off of a very low base. We started noting weakness in the Eurozone in July, with our latest update last month here. In the last few months, the ECB has raised and disappointed expectations for a dramatic non-traditional easing. A renewed recession Europe would reduce growth prospects in the US somewhat and may have an outsized impact on large cap stocks which generate a good deal of their profits outside the US.

The “fear itself” argument for panicking

Roosevelt said, “The only thing we have to fear is fear itself.” Similarly, the sell-off in stocks itself (and the rise in the VIX, part of the same phenomena) is its own reason to cut positions. While we do understand the inclination, and we think a sober, quantitative risk control framework is important, we are not so sure that just cutting stocks because they are going down in price is always the best method. In fact, if you stayed out of the stock market every month which started with a 5% of greater drawdown you would cut your compounded annual growth rate by half over the period of 1970 – 2014. You would have to be a fearful investor indeed to be able to sacrifice half your returns.

Note that not all of the decline in the price of risky assets (such as stocks and commodities) is bad news. The decline in the price of oil, if translated into its typical relationship to retail gasoline prices could translate to a $600 per family bonus. A little stimulus at just the right time.

The stronger argument for staying the course

At Astor, the current state of the US economy is the primary input into determining the optimal mix of stocks and bonds. As far as we can see today, the state of the US economy is strong. We see it in the strength of the labor market and the strong pipeline for manufacturing. If the economy begins to slide, we will adjust positions. It is possible the current stock market weakness foretells a recession, but in general using the stock market to predict recessions is a losing bet.

In addition to the real economy, we closely monitor the level of a much broader collection of indicators which measure financial stress. The well-known VIX is included in this mix, but so are several other measures. We collect these indicators into a daily index of financial stress. So far, this measure has not risen to the levels where evidence has suggested reducing exposure.

Our conclusion: Don’t Panic

Because of its association with outsized declines, it is uncomfortable to write in October that we expect today’s stock declines to be transitory, as a gut reaction says to head for the hills. Our research counsels a steady hand, however, and as long as the fundamentals do nott change, we will not either.