Operations As a Vehicle for Business Success

By Brian Durbin, Managing Director of Operations

All investment advisers have an asset target in mind. In order to reach that finish line, you need to have a solid vehicle. Having a qualified portfolio manager (i.e. the driver) is a large part of the race, but it is certainly harder to accomplish without efficient and effective systems and processes in place. A streamlined and prepared operations department will help take you the extra mile.

These days, there is no shortage of new regulation and technology to keep the operations departments of investment advisers on their toes. In order to fluidly maneuver through a changing landscape, it might be helpful to think of operations as a rally car. Here are five points to help visualize this reference.

Wear protective gear

Race car drivers know the importance of wearing helmets and harnesses to prevent injury in the event of a crash. The unexpected can happen. In investment operations, a technology glitch can create a trade error or an inattentive worker can input the wrong data. Risk controls and flags should be present in any adviser operations. Insurance products such as Errors & Omissions (E&O) can help provide financial protection.

 Remove unnecessary weight

In order to maximize speed, race cars are stripped down to be as light as possible while maintaining safety and function. Operations departments should be lean as well. However, there is a fine line. Too light and you might tip over if you need to adjust quickly. You want to be nimble in case you need to build up. The key is designing systems and processes that are easily scalable so the addition or removal of an employee, group of accounts, etc. does not disrupt workflow.

Inspect and know your vehicle

Racers know their cars inside and out. Similarly, in investment operations a thorough review of systems and processes should be conducted at least annually. Dismantle each process and walk through it step-by-step to determine the weak points. If you do not have the headcount to complete this review, find a qualified consultant. Drivers may have to conduct small repairs or inspections themselves but a mechanic is often on hand as well. Similarly, third-parties provide additional value to the review of operations by removing bias and familiarity which can cause you to miss crucial gaps in processes. By knowing where risks lie and the capabilities of the systems, you will know what protective gear to use as mentioned above.

Use a co-driver

Rally car drivers often have a co-driver sitting in the passenger seat. The co-driver is part navigator, part handyman, and part safety (they counter-balance the weight distribution). For investment operations, compliance, legal, and portfolio management personnel should be integrated into operations to provide information on upcoming regulatory or industry changes that will impact operational processes. Given that the investment industry is ever-changing, being provided with information on the road ahead is valuable.

Prepare for the conditions

Heavy rain, mud, gravel, and other factors can determine the types of tires used during a race. Similarly, different market conditions and business channels can change how an investment adviser views operations. Using the proper systems for the current conditions is important, but preparing for upcoming changes is equally important. If a driver knows the first quarter of a race is in rain, but the rest will be dry, the decision may be to sacrifice better rain tires due to the limited amount of time they would be needed. Likewise, an investment adviser may forego the purchase of an order management system due to expected changes in account type (e.g. moving from discretionary management to model delivery).

Whether you compare operations to a rally car or construct it using another visualization, the key is to see the larger picture and shape processes according to the path your business is on.

 

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.

311161-546.  

What Are You Looking At?

Fed-watching. Oil prices. The latest geopolitical headline. All sources of anxiety, some of them manufactured. The real question is, what should you be focusing on?

Even as markets persist near all-time highs, volatility not indicating too much concern, the subconscious anxiety appears to be growing. As we’ve seen in recent years (and, more recently, during Brexit) any number of things can create uncertainty in the market and cause investors to make a kneejerk reaction. The key is avoiding that.

Such event-driven market gyrations raise the questions about how investment professionals and their clients should make portfolio decisions. How you construct your portfolio goes a long way in how you view market activity. While there is no shortage of so-called rationale for buying and selling (as the cable TV pundits will attest), solid portfolio allocation decisions require equally solid rationale.

In other words — What are you looking at?

Investors who don’t make investment decisions based on specific rationale are more apt to put their money on the line based on what they think/hear or, worse yet, on attempts to time the market. The New York Times recently highlighted the potential danger of such an approach: “By buying and selling too frequently and at the wrong times and not benefiting fully from compounding, people typically do even worse than they would have done if they simply held on to their investments.” Investors get penalized for being reactionary. The less fundamental and the more ad hoc their reasoning for making asset allocation decisions, the more susceptible investors will be to react to market noise.

We believe a macroeconomic-driven asset allocation, at least for a portion of portfolios (i.e., the strategic or dynamic holdings—typically 20%), make the most sense for investors to construct portfolios that are adaptable to the current environment, while also maintaining their focus on long-term results. After all, corporations focus on economic trends. The Fed focuses on economic trends. Why wouldn’t investors?As a fundamentally driven asset allocation firm, we’ve made our careers determining why economic data matter—what data points mean and where the economy is going. Our macroeconomics-based approach is all the more important in today’s evolving capital market landscape, with potentially changing risk and return dynamics, from fixed income and more assumed risk in traditionally allocated portfolios. As we observe, in these conditions, investors are taking on more risk to pursue the same return.

For example, in today’s investment environment, realistic fixed-income return targets are becoming harder to achieve without taking on more risk. The choice for many investors has been to take on more risk for the same yield‘(1):

  • In 1995, a 100% portfolio allocation to Treasury Bonds would have an approximate 7.5% target return, with a 6.5% standard deviation.
  • In 2015, to have a 7.5% target return:
    • Treasury bonds were reduced to 12% of the portfolio
    • Equities were almost two-thirds of the portfolio
    • The standard deviation for the target 7.5% return portfolio rose to more than 17%

‘(1) Source:  Wall Street Journal/Callan Associates: http://on.wsj.com/1XN7VyS

 Without a rationale grounded in the fundamentals, investors potentially could make risky decisions without having a good reason—or worse, decisions that are not in line with their risk tolerance, which will put more emphasis on managing risk for the foreseeable future. This adds more weight to have a good answer to the question: What are you looking at?

At Astor, we believe the only acceptable answer is the economic fundamentals. That’s what matters when you’re focusing on what matters to you.

 

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.

309161-484

July’s Jobs Number Supportive of Steady Growth

The July Employment report came in with an upside surprise—255,000 jobs created during the month, which was well above expectations of 179,000. Making the jobs picture even rosier was the upward revision for June, to 292,000 from 287,000.

Strength in the labor market for June and July has helped bring people back into the workforce, which kept the unemployment rate steady.  Average hourly earnings bumped higher by 0.3%, a number supportive for consumer spending.

As we have said previously, we expect the Fed to raise rates one more time—perhaps as early as September. And, as we have also said, given the fact that rates are essentially zero, a small upward move will be of little real consequence, in our opinion.

That said, even a 25 basis point hike by the Fed, would be a vote of confidence for the U.S. economy. The Astor Economic Index®, our real-time snapshot of the U.S. economy, continues to show steady growth.

In the U.S., it’s all been about jobs. And just to put things in context, keep in mind that this is a presidential election year. No political commentary here, just stating the obvious.

The highlights of the July jobs report showed strength in the private sector, which added 217,000 jobs. The public sector added 38,000 jobs; while not a big number, this does add a little push to the tailwind for the job sector right now.

Other highlights from the Employment Report:

  • The unemployment rate stayed at 4.9%
  • The labor force participation rate rose slightly to 62.8% from 62.7%
  • Overly the year, average hourly earnings have risen by 2.6%. Average hourly earnings for all employees on private nonfarm payrolls increased by 8 cents to $25.69.
  • The change in total nonfarm payroll employment for May was revised from +11,000 to +24,000. Over the past 3 months, job gains have averaged 190,000 per month.
  • Sectors adding jobs are professional and business services, health care, financial, and leisure/hospitality.

 

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.”  308161-466

A Rebuttal

This week an article entitled “Should You Fear the ETF?” was written by Ari Weinberg of the WSJ. While I would prefer not to give this type of article any attention (as that seems to be the main goal), I feel like it cannot be left to exist without an industry participant’s opinion attached to it. ETFs are the primary investment vehicle for Astor’s strategies. As such, we have strong opinions on the merits of using them for investment allocations. Mr. Weinberg’s main critique of ETFs is centered on market action on August 24th. The events of this day have been thoroughly covered in many articles already, including several from the WSJ (see list at the bottom). Mr. Weinberg appears to be trying to stir up old drama by writing this several months after the fact without adding any new ideas or information to the discussion. The addition of the massive image of a demon-like face staring down a small human figure on the article page only makes me shake my head.

To ask whether someone should fear an investment product is clearly an attempt at sensationalist journalism. Fear is often caused by a lack of information or uncertainty. So often in history, new ideas are shunned solely because information does not exist. It begins a wicked cycle. Since there is fear, there is an unwillingness to obtain more information which then reduces the chance of people becoming educated which means fear continues. The better question for ETFs is “Do Investors Fully Understand ETFs and Trading?” Instead of trying to instill fear, Mr. Weinberg should use his position to disseminate information to retail investors. Mr. Weinberg’s attempts to provide education are continually steamrolled by comments and selective quotes that seem to enforce an idea of ETFs being an uncertain and risky investment product.

Now on to the trading discussion. What Mr. Weinberg only passively alludes to in the following quote (and subsequently seems to dismiss) is that there were a variety of market wide issues that day. “Critics say stock-market swings on Aug. 24 exposed the flaws in ETFs they have been warning about for years. Proponents say ETFs mostly were caught in the crossfire of marketwide trading issues that had little to do with them. One thing is for sure: It wasn’t the first time ETFs have surprised investors.” When you fully understand how ETFs and markets work, there is little surprise at the events of that day.

Bank of New York Mellon – NAV Calculation Issues

Due to an issue with an update of SunGard’s accounting system as Bank of New York Mellon, there was an issue calculating fund NAVs for several days (ETFs and mutual funds). The impact spanned nearly 1,200 funds from a variety of providers. This issue only added to the day’s woes.

Single Stock Pricing Issues

The majority of ETFs that experienced disruptions on August 24th were domestic equity ETFs due to a variety of issues with individual stocks. Due to the below issues, it was difficult to accurately price an ETF (remember ETFs are priced based upon underlying holdings).

  • A substantial segment of the stocks in the S&P 500 Index were not opened by the time the opening bell rang.
  • More than 700 stocks saw intraday moves in excess of 10%
  • A number of stocks experienced trading halts during the opening minutes and throughout the day

 Volume of Market Orders

According to the NYSE, there was an overwhelmingly larger number of market orders executed on August 24th than on a normal day (~4x). Resting stop loss orders were triggered as prices moved down the order book. Selling led to more selling as triggers were eclipsed on trading systems.

 Market Maker Responsibilities

Many people likely assume that market makers have to stand firm during volatile times and bear the brunt of risk. That’s not the case. By rule, NYSE Designated Market Makers (“DMMs”) need to only provide a quote for 10-15% of the trading day and the quote can be as wide as +/-8% of the National Best Bid and Offer (“NBBO”).  As the paper “US Equity Market Structure: Lessons from August 24” from BlackRock put it, “This is important to note because in times of extreme stress, market makers do not “support” the market. They are not buyers of last resort. Because market makers must manage their risk and maintain adequate capital, their capacity can be overwhelmed in the face of broad-based and unabated buying or selling. During periods of market-wide uncertainty, market makers can become risk averse.” APs and other providers of liquidity are not required to be active at all times. APs provide a conduit for the ETF mechanism, but those firms are also trying to stay in business and make money. Additionally, the absence of prices on underlying securities creates a large barrier to the creation/redemption process.

Two of the ETFs that experienced large price dislocation were AOK and EMQQ. Both of these ETFs typically have limited daily trading as can be seen by the 30 day average daily volume figuers below. What these numbers mean is that there is limited natural market liquidity down the order book. A single small trade could remove the entire on-screen liquidity (i.e. current bid/ask volume) at a set price and move down to the next price level where an order exists. You could sweep the book down rather quickly and end up with trades below NAV if there is no support. Liquid ETFs will have tens of thousands of shares available in the open market at each incremental price level.  You may be able to trade 200,000 shares on bid/offer or a penny down/up. Additionally, AOK is an ETF of ETFs so if any of the underlying ETFs have an issue, AOK surely will too.

iShares Core Conservative Allocation ETF (AOK) – $242M in Assets, 74K shares traded/day

aok
Emerging Markets Internet and Ecommerce ETF (EMQQ) ~$12M in Assets, 8K shares traded/day

 emqq

While these two charts look severe during the opening period, they look similar to the stock of Ford (F) a $55Bn company. Once again, there were market wide issues.

Ford (F)

 f

A Few Statements to Clarify

“In normal markets, ETF traders who profit from zooming in and out of the ETFs and their underlying holdings keep the values in line, but investors have been startled to see that balance can be disrupted at times.” ETFs have two sources of liquidity: primary market and secondary market. The primary market consists of Authorized Participants (“APs”) who create and redeem shares of ETFs by either purchasing the underlying basket of securities and exchanging for shares of ETFs from the issuers (creation) or by exchanging shares of an ETF for the basket of securities to unload onto the market. APs seek to arbitrage any mispricing which helps to keep markets tight. If underlying securities are cheap relative to the ETF, an AP will buy the securities and exchange for shares of the ETF and vice versa. The secondary market consists of shares of ETFs held by investors and other parties being bought and sold between each other. What Mr. Weinberg fails to point out is the difficulty an AP would have in providing liquidity if the underlying holdings are not priced accurately or halted. An ETF is an investment vehicle designed to provide investor access and price discovery for groups of assets. If the players on a few sports teams decide they do not want to play hard and their teams lose, do you blame the idea of a team or do you focus on the underlying factors? Here, the blame needs to shift to the underlying securities.

 “Exchanges, as well as some fund providers, are examining how to prevent these rare trading anomalies. Meanwhile, the risk that ETFs may not always trade or price as expected is one that investors need to consider.” Mr. Weinberg is trying to make ETFs sound scary here. Should investors also shun single stocks because they can be halted, price incorrectly, or experience other issues? The bottom line is investors need to consider all investments. There is a reason so many SEC Regulations relate to disclosure. Investors need to have the proper information in order to gauge whether a particular investment makes sense. Risk is part of the game. Any security can price differently than what you expect.

 “What matters most—and what investors should focus on—is whether a fund’s underlying portfolio fits with their goals, says Rick Ferri, the founder of Portfolio Solutions and long a proponent of index investing. “Look under the hood,” he advises, because many funds that seem similar really aren’t and will produce very different results. From there, investors can assess the product’s structure and whether the costs involved in holding or trading it are a good fit for them.“ I think there needs to be a distinction here. You would be hard pressed to find a passive, broad index-based ETF perform materially different from another ETF following the same index. Active ETFs are a different story and should be treated as such. There are ETFs which may track lesser-known indices, no indices, or consist of holdings in other ETFs and funds. This statement seems to hint at a level of deception by ETFs and I think that is a misleading.

 “ETFs can be traded all day on exchanges, which usually makes it easier for investors to get into or out of positions at a market price quickly (except, of course, on days like Aug. 24).” Investors were still able to trade ETFs on August 24th, except for those that were halted. However, as listed above, a large number of single stocks were also halted. Once again, Mr. Weinberg is trying to isolate ETFs here.

“As the Dow Jones Industrial Average plunged 1,000 points, triggers went off for mandated halts in many stocks held by ETFs, as well as the ETFs themselves. Then, a number of ETFs stunned investors by trading at prices far below their NAV, highlighting concerns that ETFs might not be as easy to move in and out of at “fair” prices when markets are in disarray.” ETFs are by name “exchange-traded” which means if a buyer and a seller are willing to enter at a price, a trade will happen. If a market order is entered or a resting order is out there, a trade happens regardless of where NAV is. Mr. Weinberg seems to be saying here that it is “unfair” if a trade is executed below certain levels. Unless someone held a gun to an investors head and forced him/her to enter the trade, there is no fair/unfairness to deliberate over. Financial markets can be cruel. Take for example the recent story of Joe Campbell, a retail investor who shorted a high-risk biotech stock in his $37K E*TRADE account only to end up with a margin call of $106,000 after the stock soared on takeover news.

The Real Issue: Investor Education

To his credit, Mr. Weinberg did include a few statements which actually describe the real issue: investor education. I have highlighted a few of the most appropriate quotes below.

  • Meanwhile, it may be more advisable than ever for investors to use limit orders—orders to buy or sell a security at a specific price or better, literally putting a limit on how low the price can go.
  • “Have good trading hygiene,” says Dave Nadig, director of ETFs for FactSet. “The vast majority of ETFs deliver on their core promise to investors. But if you trade them poorly, that’s probably on you.”
  • While some advisers love that—it gives them an easy, low-cost way to provide clients with exposure to certain market segments—the concern is that some less-sophisticated investors may be buying complex, heavily marketed funds without fully understanding what they are getting.
  • If you don’t have the knowledge or time to build and manage a complex portfolio, it may be best to stick with broad-based index ETFs with significant assets and trading volume, experts say, and leave the niches to the pros.

We cannot blame an exchange-traded product for trading on exchange, even if the executed price is below NAV. Retail investors need to understand that certain periods of the day can have greater volatility and that pre-open issues can cause disruption at the opening bell. Market orders should not be used during volatile markets. Additionally, a more esoteric ETF is no different than a single stock. You have to know what you are buying and selling. Every available security requires research and analysis to determine the risks. That is Investor 101 material.

 Summary

We believe in the merit of ETFs and do not believe the multi-faceted issues of August 24th point to a broken product. When prices of underlying securities were unavailable, the ETFs provided the best level of price discovery available (i.e. what a market participant was willing to buy or sell at, regardless of whether it was a resting stop loss). As soon as trading resumed in a more normalized fashion, pricing issues eased and prices came back in line. It was a temporary disruption. Going forward, there are questions to be answered. Does there need to be additional regulation to force liquidity providers to stay involved during certain periods? Do exchanges need to re-think regulations and processes to ensure we do not repeat the situation we had at the open? I believe the events of August 24th have provided a painful but necessary catalyst to open further discussion. ETFs are still a “new” idea to many investors even though they are now over 20 years old. However, the vast majority of the ETF universe has only existed since the mid-2000s or later. Due to the increased popularity and adoption by retail investors, we need to ensure as an industry that we are providing the proper education and structure for the next phase of ETF growth. The influx of ETFs in the past few years (including the so called *cringe* “smart beta” ETFs) have provided an increased need for due diligence on behalf of investors. Markets which were mostly inaccessible to the majority of investors (e.g. commodities) can now be purchased with a share of an ETF. Instead of spending several thousand dollars on initial margin for a contract of WTI Crude Oil, you can purchase a share of the United States Oil Fund LP (USO) for about $12. Maybe that is a bad example with the recent trend in energy prices, but I think you see the point.

On a related note since Mr. Weinberg brought it up, the rise of “robo-advisors” is less of a threat to the ETF industry than it is to the investment manager industry. Many of the robo-advisors primarily use ETFs in their models. ETFs are the ideal product for robo-advisors because they can provide exposure to broad asset classes with a single purchase and have advantages over mutual funds such as lower fees and intraday pricing. In fact, the robo-advisor industry might actually further the growth of ETFs rather than challenge them as a product. The example of Wealthfront’s direct indexing service is the exact reason why people use ETFs. You need $100,000 or more to buy shares in some or all of the stocks within the available indices. I am sure the required initial amount is a barrier to many investors. Speaking of barriers to entry, the robo-advisor industry is starting to become saturated. All you need is a few algorithms and you’re mostly set. Some firms, such as Schwab are cannibalizing other service channels with their robo divisions. Instead of generating fees from individual trades in client accounts, Schwab will earn its keep through the management fees on the Schwab ETFs used within its Intelligent Portfolios product. Investment managers like Astor will need to prove our worth. I would not be surprised if these robo-advisors merge with the UMA and model delivery firms of the industry. Maybe you will see sub-advised strategies on the robo platforms. The real threat is to the brick and mortar financial advisor as the world moves towards a full embrace of technology. I do not think the handshake and face-to-face will go away as human interaction is part of our existence. It will certainly be interesting to see how the rise of the robo-advisor progresses in the coming years.

A brief list of articles covering August 24th

http://www.etf.com/sections/features-and-news/mini-flash-crash-bites-some-etfs?nopaging=1

http://www.cnbc.com/2015/09/25/what-happened-during-the-aug-24-flash-crash.html

https://www.blackrock.com/corporate/en-us/literature/whitepaper/viewpoint-us-equity-market-structure-october-2015.pdf

http://www.bloomberg.com/news/articles/2015-10-06/etf-firms-tackle-wall-street-on-ways-to-prevent-another-aug-24

http://www.wsj.com/articles/wild-trading-exposed-flaws-in-etfs-1442174925

http://www.barrons.com/articles/the-great-etf-debacle-explained-1441434195

http://www.cnbc.com/2015/08/24/stocks-dramatic-slide-hits-etfs.html

http://www.wsj.com/articles/trading-in-stocks-etfs-paused-more-than-1-200-times-early-monday-1440438173

http://www.wsj.com/articles/hedge-funds-devise-trades-to-benefit-from-etfs-woes-1443605580

http://www.wsj.com/articles/stock-market-tumult-exposes-flaws-in-modern-markets-1440547138

http://www.wsj.com/articles/for-stock-markets-the-moment-when-humans-matter-1441148923

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.  312151-341

Economic Durability

Data for July Durable Goods Orders was released today and provided further support for a positive view on the U.S. economy.   On a headline level, orders rose by 2.0% from June which was revised up to a 4.1% increase from the initial report of 3.4%.  Great news there, especially considering expectations were for a -0.4% decline.  If we take a deeper dive into the numbers, do we still maintain our optimism? Below is a quick analysis (Spoiler Alert: The answer is yes).

Excluding volatile segments – Check. 

One of the trickiest aspects of the Durable Goods Orders report is the inclusion of highly volatile segments such as aircraft. For example, the monthly change for nondefense aircraft and parts was  -31.7%, 69.7%, and -6.0%, respectively, for May through July. When we exclude transportation, new orders rose 1.0%.

Capital goods – Check. 

Many people use new orders for core capital goods (nondefense, excluding air) as a proxy for business investment.  We saw a 2.2% rise there from a 1.4% increase in the previous month.  Capital goods represent items used in the production of goods and services so it represents spending for future growth.

Capital Goods (nondefense, ex air)

Additionally, shipments of core capital goods rose 0.6%.  Shipments are important as an economic gauge as they are used in the calculation of GDP. With an upward revision to 0.9% for June (initial -0.1%), we could see a nice bump in Q2 GDP revision to be released on Thursday.  In a note published this morning, Brian Wesbury, Chief Economist at First Trust, stated “Plugging these and other recent data into our models, we are forecasting real GDP grew at a 3.3% annual rate in Q2 and will be up at a 2.0% annual rate in Q3.”

Additional notes

There is weakness year-over-year in certain parts of the data. However, we must consider oil producers have buttoned up spending and production in recent quarters due to the sharp decline in oil prices and a stronger USD has impacted exports.  2015 is not 2014 and 2014 was not 2013.  The rate of growth in manufacturing declined for the first part of the year before finding a floor in the spring.  Since then we have seen an uptick.  The key is we are still seeing growth (above 50 = expansion).

ism

An earlier report in the month showed business inventories rose 0.8% largely in part to a 1.4% increase in the auto industry.  The focus is whether sales are pacing alongside stock buildup.  Auto sales have been one of the brightest spots in the economy: recently and since the Great Recession.

autos

Sales overall ticked up 0.2% to move the seasonally adjusted inventories/sales ratio to 1.37.  This ratio has moved higher over the last year so we will keep a close watch to see if there are any signs of a slowdown in demand.

invsales

With back-to-school shopping largely unaccounted for in the data and strong retail sales growth (0.6% in July), we could see a normalization in the ratio in the coming months.  On the other hand, too much inventory  and not enough demand can cause problems for subsequent quarters of growth as inventory buildup is a large factor within GDP.  Inventory growth added 0.87% to Q1 GDP which helped to reduce the level of contraction to -0.2%.   As David Ross, Managing Director of Global Transportation & Logistics at Stifel, states in a recent note, “We believe we are going through a destock (or rightsizing of inventories) presently. It appears to have begun in 2Q15 and we expect it to continue through 3Q15.” Inventory buildup and drawdown is part of the natural ebb and flow of healthy industry.  We will see how August and September set up for the Q4 holiday shopping season.

Summary

The durable goods number from today adds more paint to the canvas that recent data for employment, housing, and the consumer have already put their strokes on.  From where we sit, the picture is appealing.  It may not be a Picasso or da Vinci, but it’s certainly no airbrush caricature from a carnival either. As we discussed on Monday, the Astor Economic Index® shows above average growth. Hopefully China, Greece, etc. do not trip and accidentally put their fists through the picture.

 

 


 

Disclosures

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. An investment cannot be made directly into an index.

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.

August 2015 is to October 2014 is to Fall 2011

Bringing it back to Rob Stein’s 2015 Outlook Report and discussion about the Fed and the expected rate hike for 2015. The possibility of this change in the rate dynamic would, in his opinion (and the rest of the Investment Committee’s), introduce volatility into the market. The report ended with this statement: “Whether the market rises by a single-digit percentage, is flat for the year, or even goes down 5-10%, the outlook still appears positive for accretion over time – as long as above-trend economic growth remains…” We are seeing the down 5-10% play out now.

Markets were belligerent in their downward assault last week. Based on early session activity, this movement appears to still have legs. Global selling pressure that started over a month ago has caught up to domestic markets. New concerns on growth coupled with global selling have turned the focus now to the “safe haven” U.S. stock market. The last few days, including this morning, have made the U.S. markets look indistinguishable from the developing and emerging nation markets half a world away.  Now the pundits who have been waiting to talk about a break in the dam have a clear pedestal and will no doubt make it sound extremely scary for investors who will listen.

To put things in perspective, one week ago we were within ear shot of all-time highs in the S&P 500 Index. Today we are within one current trading day from a two-year low set last October, when investors were spooked. October’s move ended up whipsawing many of those who panicked. The October tape looked similar to 2011, but it also felt similar as well. Even though there was a spike in volatility and selling pressure, 2011 was only a distant cousin to 2008. We must be careful not to make similar comparisons to certain periods any time markets feel tired or growth feels uneven. We run the risk of creating this reaction time and again if we do.

Astor focuses on the “Why?” behind market behavior, using economic trends as a proxy. The markets behave in many ways in the short-term. Over time, Astor believes it is the economy that determines true direction and stocks are valued due to economic signals.

Based on recent reading as of last week, the economy is still strong. As such, we expect this market move to be temporary. Even in the last two days: PMI shows expansion, jobless claims remain low, and nonfarm payrolls are over 200K (This scenario was not the case in 2008 or even 2011). See Figure 1 & 2 below.

Figure 1: ISM Manufacturing

ISM

Source: Bloomberg  Data: January 2000 to July 2015

Figure 2: Nonfarm Payrolls

nfp

Source: Bloomberg  Data: January 2005 to July 2015

Without a doubt, there are concerns about emerging markets. However, the developed world seems to have found its footing. Recent economic measures in Europe have even surprised higher (See Figure 3). We are seeing signs of financial stress spreading to 2012 levels, which we are monitoring closely. We will also get new rounds of economic data in the next 10 days to help paint a more detailed view of the current environment.

Figure 3: Eurozone PMI

eupmi

Source: Bloomberg   Data: August 2012 to July 2015

The debt crises that plagued 2008 and 2011 are a fraction of what they were. Investors (over)focused on the rate move are missing the picture there. Corporate America (the actual value of the market) is as healthy as it’s been. Companies are hiring. Even though manufacturing has been a bit weaker in recent quarters than what we want: it remains positive and moving forward. The consumer has picked up some of the slack as seen by increasing home price indexes and home sales.

We do not see overheating economy, an overvalued stock market, an over exuberant consumer/investor, or a treacherous debt issue. The signs of excess are not there. Expanding economies and bull markets do not typically end with a backdrop like the one we have currently. Although recent market action may have you believe otherwise. Pullbacks are part of bull markets but moves as aggressive as the past few days sometimes catch you in the frenzy of the moment.

As we stated before, this market reminds us of 2011 when the S&P 500 Index saw a summer through fall drawdown of approximately 16% due to bad news which changed sentiment. Equities were volatile for a time before shooting back higher with a near 11% rate of return in October for the S&P 500 Index.  Since the beginning of October 2011, the Index has returned almost 90% on a total return basis. The stock market losses last October on (hypothetical) concerns were negated and appreciation resumed within a few weeks. What we wrote during that period still applies now. (See October 15, 2014 – Don’t Panic)

SUMMARY:

  • The recent market move will be temporary and is not indicative of a faltering economy (in fact, recent data has shown the economy is holding steady and continues to growth at above average levels of growth). See Figure 4
  • If a comparison is to be made, you should look to October 2014 or Fall 2011 and not 2008.
  • The media and the strength of the selloff may sway you to believe the bull market is over, but we do not believe bull markets end in this type of environment.

Figure 4: Astor Economic Index®

AEI

Source: Astor  Data: January 2000 to July 2015

Also, see additional commentary from Brian Wesbury at First Trust.

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. An investment cannot be made directly into an 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.

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.

308151-293

Employment day economic read

Employment day is a good day to check in with the economy.  Overall, we remain cautiously optimistic and hopeful for stronger growth in the second half.

This month’s payroll number came in at 233,000 net new jobs, only slightly below its one year average of 250,000 jobs and at a pace to move the economy close to full employment. At Astor we had been assuming that the first quarter’s weakness – while real – should turn out to be transitory. My favorite summary chart on the economy is printed below, showing the level of total non-farm payrolls and the ISM manufacturing index since 2012

Source: Bloomberg, Astor calcuations

Source: Bloomberg, Astor calculations

 

I feel that as long as people are still getting jobs, and the manufacturing activity as measured by the ISM survey continues to expand, we can hope for continued reasonably strong growth in the economy. We would need to see employment growth falter or sustained contraction in the manufacturing sector to begin to get nervous about the economy.

 

The global manufacturing environment continues to be a source of concern. The chart below averages the PMIs of the g-20 group of countries, weighted by GDP.

 

Source: Bloomberg, Markit, Astor calculations

Source: Bloomberg, Markit, Astor calculations

Despite noticeable improvement in Europe, this measure continues to decline dragged recently by China and to a lesser extent, Asia broadly. The heatmap below gives the details, click for a clearer view.

Source: Bloomberg, Markit, Astor calculations

Source: Bloomberg, Markit, Astor calculations