Brexit Fallout Puts Next Round of U.S. Economic Data in Spotlight

As fallout from the Brexit vote continues to be felt—most acutely in currency and confidence—attention on this side of the pond turns to the next round of economic reports for clues as to how the U.S. economy will withstand the inevitable headwinds from the event.

From a market perspective, Brexit is best understood as an event—one that has sent the stock market down sharply and caused bond yields to plunge. Our research has shown that markets tend to recover from “events” if economic fundamentals are solid. This “if” is putting even more emphasis on upcoming data on employment, GDP, and manufacturing.

Before Brexit, our proprietary Astor Economic Index® (AEI) has shown growth in the U.S. economy, although there has been some minor slowing over the past several months. Obviously the Brexit vote, itself, has not had any fundamental effect on the economy; the process of Britain’s exit will be both complicated and prolonged. However, there have been undercurrents of concern voiced about the recent pace of U.S. economic growth, including by  Federal Reserve Chair Janet Yellen in her recent testimony before Congress.

To be clear, our AEI reading has not signaled any warnings about an economic downturn or recession. The economic “arrows” have been pointing upward, although to a lesser degree than in previous months. Any significant change in the angle of those arrows going forward, indicating the economy is slowing further, would mean the market likely faces a much tougher time recovering.

Rather than dwell in the land of “what-ifs,” economic data gives concrete evidence of what is happening now, which is far more significant for the nearly $18 trillion U.S. economy than any projection. Data will help clear the uncertainty that has swirled in the wake of the Brexit vote, the results of which took many by surprise and triggered a wave of remorse, as more than 3 million British people signed an official online petition for a “do-over” vote. Amid shaken confidence, investors and business leaders alike are raising questions about a slowdown and even a possible recession in Britain, the impact on the European economy, and fears for global economy overall.

On the currency side, since the Brexit vote the British pound has come under intense pressure, as the sterling has fallen to its lowest level versus the U.S. dollar in more than three decades. The British government announcement that it has put in place “robust contingency plans” to deal with the financial aftermath of the Brexit vote thus far has done little to stop the sterling’s decline.

If the U.S. dollar resumes its rally from 2015, that could cause an additional slowdown in U.S. exports. Likewise, a strong dollar would further pressure U.S. manufacturing—which brings us to the economic data to be released starting later this week.

The manufacturing sector has been faring somewhat better since its downturn last fall and winter, with May logging the third consecutive month of growth. Whether June has continued that growth will be closely watched when the Institute for Supply Management (ISM) manufacturing report is released on Friday, July 1.

Also in the spotlight will be the Employment Situation for June, scheduled to be released on Friday July 8. The big question here is whether hiring has picked up after May’s disappointing report that showed nonfarm payroll employment increased by only 38,000. The Federal Reserve, in its decision not to increase rates at its June meeting, has trained its sights on the employment number, as has much of the market.

Later in the month, on July 29, we will get a first look at Q2 GDP with an advance reading for the quarter. This will be eagerly awaited given the slowdown in Q1 to 1.1%, the weakest pace in a year. While slow, Q1 output was raised from earlier readings for the quarter of 0.5% (advance) and then 0.8% (second estimate).

Amid the uncertainty and speculation about various “what-if” scenarios—from whether the British will have a “re-do” vote, to whether there will be other “exit” referenda in the EU—economic data provide the proverbial ground to stand on. That’s why our investment philosophy is grounded in assessment of economic fundamentals, to determine the appropriate weighting of risk assets (i.e. equities) within a portfolio given the current state of the economy. It makes far more sense in our view to deal in the reality of economic fundamentals than to rely on projections of what might occur, when and how.

Rob Stein is the CEO of Astor Investment Management LLC, a registered investment advisor that provides advisory services to approximately $1.9 billion (as of March 2016) in client assets across various product channels, including separately managed accounts, mutual funds, and model delivery arrangements. Astor’s investment philosophy is based on the belief that diligent analysis of economic data can provide valuable signals for longer-term financial market allocations.

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. 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.

The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® is not an investable product. When investing, there are multiple factors to consider. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results in the future. The Astor Economic Index® is a tool created and used by Astor. All conclusions are those of Astor and are subject to change.

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The Brexit ‘Event’: Uncertainty and Volatility But Not the Dot to Connect to a U.S. Economic Downturn

News that the U.K. voted to leave the European Union sent a shockwave through the markets, which reacted—as markets do—to the unanticipated with a sharp selloff from the Nikkei to the FTSE 100, with the U.S. markets opening sharply lower [down about 3% at the time of this post].  Given that polls had predicted the U.K. would remain in the E.U., continuing its 43-year association, the event disappointed the market, which had rallied earlier on prospects of the union remaining intact. Of note, the S&P finished last week at the 2050 level and 30 days before that at about the 2050 level and ironically finished the first quarter of 2016, you guessed it, around 2050. With the rally earlier this week into the vote being evaporated, it will be interesting to see what price the S&P closes at for this week and this month and quarter end.

As historically or politically significant this event is, even with the U.K. Prime Minister David Cameron resigning, it is still an “event.” Unless this event leads to some change in economic fundamentals in the U.S., the long-term outlook remains positive for U.S. equities.

Investing based on events is challenging, requiring a good deal of luck. Several studies put event-investing into context by explaining correctly that events typically trigger a rush for protection.  Investors sell risk assets like stocks and buy low risk or no risk assets like cash or Government bonds.  Our research has shown that markets tend to recover from “events” if economic fundamentals are solid. Furthermore, to the extent that uncertainty is the main cause of U.S. stock losses, we believe that factor will dissipate over time.

As of today, our read on the economy based on our proprietary Astor Economic Index® (“AEI”) still supports a meaningful weighting in U.S. stocks. To be clear, if economic fundamentals were below long-term and shorter-term trends, risk assets would have a challenging time recovering. But if that were the case, we would in all likelihood have already decreased our exposure to stocks based on those economic fundamentals, even before the event occurred.

AEI June 24

Our read on the U.S. economy has been pointing to a minor slowing over the past several months and we have made minor reductions in equity exposure accordingly. It’s important to understand that lower AEI readings are not necessarily an indication of recessions or bear market if the reading is still above the long term average tend. We make adjustments as we attempt to manage risk/reward outcomes not market time short term moves.

But as of this writing we still hold meaningful weighting to stock indices. Meanwhile, our fixed income holdings and low-risk, non-correlated assets appear to be accretive to the portfolios, helping to mitigate risk and offsetting drawdowns on the equity side.

We consider it unlikely for the Brexit news to trigger substantial reductions in equity exposure—unless economic fundamentals deteriorate below multiyear levels. If that were to occur, we could get very defensive and even take inverse positions.

That said, we’ll be closely watching the economic trends. For example, if the U.S. dollar’s strength carries forward into another significant broad rise, that would likely put renewed pressure on the U.S. manufacturing sector. But if we try to drill down on what changes in the E.U. mean to trade and export data, along with capital flow expectations, it is too soon to make a forecast about long-term implications.   After all it will take years to implement Britain’s exit from the EU and a lot can happen before that.

What we do know is uncertainty creates volatility, which we’re certainly seeing in the markets. But it’s hard to connect the dots from shock over the Brexit vote to a recession or bear market.

We are comfortable with the current portfolio and have high confidence in our robust “now-cast” tools such as the AEI. The gradual reduction in risk exposure over the past several months has helped the portfolio achieve desired results.  And, if the economy picks up as is expected later this year, we would re-examine increasing beta.

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. 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.

The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® is not an investable product. When investing, there are multiple factors to consider. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results in the future. The Astor Economic Index® is a tool created and used by Astor. All conclusions are those of Astor and are subject to change.

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Fed Watch: Welcome to Square One

The Federal Reserve’s decision this week to hold short-term interest rates where they are and to reiterate its uncertainty about the pace of rate hikes in the future came as a “shock” to some. The Wall Street Journal called the Fed’s inaction a “sharp reversal” from a few weeks ago when even Fed Chair Janet Yellen hinted strongly that rates would likely rise in June or July.

The media and the markets have been parsing Yellen’s words from the post-Fed meeting press conference when she declined to “specify a timetable” about when rates will be raised next. “We are quite uncertain about where rates are heading in the longer term,” Yellen reportedly said.

Rather than being upset or shocked by the Fed’s “uncertainty” over the direction of rates, we remind ourselves that it’s really the continuation of the status quo. (Since we can probably rule out interest rates going lower from here, the only options are unchanged and up—eventually.)

So while some might be flummoxed by the Fed hitting the brakes on raising rates, it’s good to step back and realize that we haven’t gone anywhere. We’re right back to a familiar Square One: ultra-low interest rates, slow growth (but growth nonetheless), and a low-return environment. This is hardly an exciting economic picture, but growth is still growth, and when compared to the rest of the world—especially Japan and Europe—the U.S. remains the bright spot.

The Astor Economic Index®, a compilation of non-correlated economic data, shows U.S. economic growth is still above average (although modestly so). Government and other forecasts are for GDP to grow by about 2% per year, while inflation remains modest, and unemployment stays below 5%. Even the disappointing Employment Situation report for May, which showed only 38,000 jobs added, could very well be revised upward in June or July.

It might not take much for the clouds to part for the Fed to see its way clear, from uncertainty to the long-expected 25 basis point move (which will only be the second, after December’s 25 basis point hike in almost 10 years). Even a better employment picture could prompt the Fed to move from inaction to action. When that might happen is anyone’s guess, and we’re not going to lose sleep over trying to pinpoint when.

For many months, we’ve been saying that people are overly concerned about rising interest rates. Whether rates remain here or go up 25 basis points between now and Labor Day just doesn’t make that much of a difference. To use a weather analogy (admittedly an unseasonable one for the start of summer), if it’s -10 degrees Fahrenheit outside and then “warms up” by 5 degrees to -5 or even 10 degrees to 0, it’s hardly a heat wave. You’ll still feel just as cold. By the same token, whether rates stay here or go up 25 basis points, they are still unusually low.

So while the Fed retreats to Square One, we should all keep doing what we do best. At Astor, that means continuing our vigilant study of economic data to determine whether there is any significant change in the picture that warrants a different view. For now, we see modest growth, low returns for stocks and bonds, and an environment that rewards risk assets overall.

The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® is not an investable product. When investing, there are multiple factors to consider. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results in the future. The Astor Economic Index® is a tool created and used by Astor. All conclusions are those of Astor and are subject to change.

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Second Fed Rate Hike? Much Ado About Not Very Much

Imagine this scenario: You are at the next regular board meeting at Apple, Microsoft, Tesla or some company of your choosing. As you glance down the agenda, where do you picture the discussion of the Federal Reserve’s expected interest rate hike? At the top? Somewhere near the bottom?

My guess is that it isn’t mentioned at all. The reason? The widely anticipated 25 basis point hike in the fed funds rate, whether it happens in June or, barring that, then most definitely before the labor day weekend (read: end of summer).

A June or July increase would be only the second rate rise in six months. The previous move in December—a 25 basis point hike that inched the fed funds rate to the current range of 0.25-0.50%—was the first in 10 years.

Personally, although to be clear I don’t have a vote, lean toward a small hike occurring in June and possibly another hike later in the year. The Fed’s habit is to lower rates in response to events, while it raises them according to plan. The Fed’s plan has been obvious. Recently, Federal Reserve Chair Janet Yellen said that “in the coming months, such a move would be appropriate,” given the Fed’s plan to “gradually and cautiously increase our interest rate over time.”

Those who like to worry about the Fed’s actions have voiced concerns such as what would happen to the stock market. Would higher interest rates put a damper on the economy, hurt capital-goods investment, or slow the housing market? Or maybe their concerns are more philosophical, such as whether a 25 basis point hike would be premature with inflation below the Fed’s 2 percent target. Or maybe they fret about a stagnant global economy or the outcome of the “Brexit” vote over whether Britain should leave the European Union.

All of these worries are much ado about not very much. First of all, the Fed has stated it does not want the international picture to be too much of an influence in making its decisions. (For the record, a U.S. rate hike would not be particularly constructive for the rest of the world.) Rather, the Fed is focusing on the U.S.—the driver of the world economy.

And the U.S. economy is certainly strong enough to handle one or two modest rate hikes. Employment trends are strong: the four-year moving average of unemployment claims is at the lowest rate since the 1970s. We’re starting to see signs of tightening in the labor market, with wages on the service side up about over 6 percent, year over year—albeit slightly offset by the manufacturing sector. GDP growth over the past 12 months is running at about 2 percent, which is not out of bounds from what the Fed said it needs to see in a healthy economy. Furthermore, the still-strong dollar will likely become a tailwind for the U.S. economy as the rest of the world bottoms out (We’re seeing signs of green shoots in Europe, and Latin America has probably troughed.) and the dollar continues to stabilize.

Beyond these statistics, the bigger reason a rate hike of 25 or even 50 basis points won’t hurt the economy is it will remove uncertainty. For consumers, knowing where rates are likely to be over the next six to eight months helps them make decisions about such big-ticket purchases as a home or a car. Corporations do better with rate certainty as does the overall stock market.

Take away the uncertainty of rates, growth and elections and you have a support beam in the market that may be the catalyst for a surprise!!

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. 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.

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June Quick Read on the US Economy

The economic news softened somewhat from my last update.  The payroll numbers for May were especially weak, following a modest April.  However, we should not exaggerate one reading of a volatile series Overall the economy still looks like it is on a decent heading, but evidence has accumulated of at least a small pause in growth.  This is likely to make the FOMC  put off rake hikes.

 

Our Astor Economic Index® (“AEI”) shows growth is lower than last month, though slightly above this year’s lows posted in February.  However, I still see the US as growing above average today. The AEI is a proprietary index that evaluates selected employment and output trends in an effort to gauge the current pace of US economic growth.

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Source: Astor calculations

 

In remarks made on June 6th, Federal Reserve Chair Janet Yellen called the May jobs report “disappointing and concerning”  but she still believed that the fundamentals of the economy are strong.  I tend to agree with the Chairman.  How weak was the jobs report?  In the chart below, I averaged the last three month’s increase in payrolls to smooth out the numbers.    As a result, the increase in payrolls has dropped to an average of 116,000 jobs over the last March-May period.  For most periods since 2012, the increase in payrolls has been in the 175,000-250,000 range, though it has printed this low a few times.  At this stage in the recovery, the s that it will take only 70,000-90,000 jobs a month to keep the unemployment rate stable.  In my opinion the current jobs  report is poor but we need to see additional signs of weakening before we move from concerned to alarmed.

 

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Source:Bureau of Labor Statistics

 

It is not just Astor Investment Management who is still seeing the growth picture as somewhat positive.  The nowcasts maintained by the Federal Reserve Banks of Atlanta and New York both show stronger growth than the first quarter.  The Federal Reserve Bank of Atlanta is currently estimating 2.5% and the Federal Reserve Bank of New York is estimating 2.4%.  Both have been updated since the employment report.

 

Where does this leave the Federal Reserve?  The market no longer believes that the June meeting is a real possibility for a rate hike anymore.  I agree.  In Ms. Yellen’s speech, mentioned above, she gave cases both for and against another hike.  The main case for hiking rates is that as long as inflation is expected to return to its target of 2%, in the medium term the Federal Reserve should soon raise rates slightly, so as not to have to raise them a lot later.  The case against another hike is that there is probably still additional labor market slack beyond the 4.7% unemployment rate and that inflation has spent very little time above what is supposed to be a symmetric target in the last ten years.  In addition, the inflation expectations seem to be drifting down slightly, something Ms. Yellen said she will be watching closely.

 

Should the payroll weakness continue or inflation expectations drift down further, rate hikes would likely be off the table.  If, on the other hand, those indicators show renewed signs of a strong economy then the Federal Reserve may finally make the second hike.  Will the election delay things?  The Federal Reserve wants to be seen as divorced from the political scene. The Federal Reserve moved rates in the summer or early fall in 3 of the last 6 presidential elections, not including the crisis year of 2008.  September 21st is another press conference FOMC so expect speculation to be attracted to that meeting, assuming no dramatic surprises in the economy.

 

Overall, I am concerned about the state of the economy and while I expect the last, weak payroll to be an aberration, I will be watching the numbers with more than usual interest next month.

 

 

All information contained herein is for informational purposes only. This is not a solicitation to offer investment advice or services in any state where to do so would be unlawful. Analysis and research are provided for informational purposes only, not for trading or investing purposes. All opinions expressed are as of the date of publication and subject to change. 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. 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.


The Astor Economic Index® is a proprietary index created by Astor Investment Management LLC. It represents an aggregation of various economic data points: including output and employment indicators. The Astor Economic Index® is designed to track the varying levels of growth within the U.S. economy by analyzing current trends against historical data. The Astor Economic Index® is not an investable product. When investing, there are multiple factors to consider. The Astor Economic Index® should not be used as the sole determining factor for your investment decisions. The Index is based on retroactive data points and may be subject to hindsight bias. There is no guarantee the Index will produce the same results in the future. The Astor Economic Index® is a tool created and used by Astor. All conclusions are those of Astor and are subject to change.

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