August Quick Read on the US Economy

My view on the economy is little changed over the month.  I still see the US in an environment of modest economic growth.  A second strong payroll number should quiet the concerns that a period of weakness is beginning.

Our latest reading for the Astor Economic Index® (“AEI”) is still near the highest level posted this year.  I still see the US as currently growing above average. 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.

usei.long

The payroll number beat expectations for a second month in a row, relieving concerns that any decline in growth is imminent.  There are no obvious signs of weakness hiding in the details and even real earnings are above where they have been in this long, tepid recovery.  Nevertheless, economists do expect payroll growth to moderate as the economy nears full employment, where many believe it is today, so don’t be surprised if average jobs growth in the next year is lower than the last few years.

The “nowcasts”(1) produced by the Federal Reserve banks of Atlanta and New York continue to show stronger growth in the third quarter than in the first half of the year.  The Atlanta Fed is currently forecasting a 3.7% SAAR (seasonally adjusted annual rate) for Q3 2016.  The New York Fed forecast for Q3 is 2.6%.

These forecasts are significantly higher than not only their own respective final Q2 estimates,  but also higher than the BEA’s (Bureau of Economic Analysis) recent release of their preliminary Q2 GDP estimate of 1.2%.

The combination of our proprietary AEI and the “nowcasts” cited above make me somewhat confident that today the US economy is doing fine and would require a shock of some kind to tip us into recession.

How will the Fed react to the passing of the Brexit vote and the bounce from payrolls?

Former Fed Chair Ben Bernanke had a very useful (though a bit wonky) post explaining how the FOMC in aggregate seems to have adjusted its expectations for the near future of the US economy.  The positive news is that the Fed has become more permissive in what counts as “full employment”, meaning the Fed should not be in as much of a hurry to choke off growth because of inflation fears.  On the disappointing side of the ledger, the FOMC seems to think that the US will grow more slowly in the future with GDP growth around 1.8-2% per year where they were hoping for 2.3-2.5% just a few years ago.

The low rate of growth and the continued low level of realized inflation suggest that The Fed sees the natural rate of interest (the level we might expect the Fed Funds rate to gravitate toward over time) to be lower than they calculated it to be before.

The bottom line is that the Fed should see the need to do less tightening to get to a neutral interest rate which may make the Fed more comfortable deferring its next hike.  In other words, lower for longer once again.

Nevertheless, I expect a few Fed speakers to try to remind the markets that they can hike in September, although I still expect a December hike.  To be clear, I do not think that another 25bp would have significant effects on the economy.

Overall, the economy seems to be holding to the same positive but low growth groove it has been in for the last several months.

 

 

(1) “Nowcast” is the GDPNow forecasting model of the Federal Reserve Bank of Atlanta and  “nowcast” is the Nowcasting report of the New York Fed. 

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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STAR Gazing

We see several themes playing out this year for US domestic sectors, with regards to sector fundamentals, factor selection and the overall direction of the US economy. In our STAR mid-year update, we seek to answer following questions:

  • How have the sector economic fundamentals evolved and how does that guide allocation?
  • So far this year, why are sectors not performing in line with fundamentals?
  • Why is value still underperforming growth & is the reversal expected to continue? Is this related to small caps underperforming large/mega caps?
  • What are the implications of market uncertainty from Brexit, monetary policy, elections etc. for domestic equity?

The Stock Market appears to be placing value on the following sectors in particular; Energy, Materials, Utilities and Industrials – laggards from last year as well as ones projected to perform well in a risk off environment. However, given that we are fundamentally driven, our analysis believes that Economic indicators are pointing toward a weaker growth environment in these particular sectors compared to others such as healthcare, financials and technology.

Our view is that there is a disconnect between the fundamentals and sector performance, implying that the rally is being driven by expanding price multiples rather than economic outlook

Star Gazing Chart 1

Sectors ranked by Composite Valuation Indicators as of June 30, 2016. The ranking shows average of ranks for Estimated P/E 2016, Projected 5-year Earnings Growth, Price/Book and Long Term Debt/Capital. (Source: Bloomberg, Factset) Past performance is no guarantee of future results. See definitions and disclosures here for additional information

 

We believe that as political and economic uncertainty dissipates, the risk-off trades will unwind bringing market performance in line with fundamentals, which could help the following;

  • Value converges in performance to historical patterns versus growth stocks
  • Large caps give way to small and mid-cap leadership
  • Defensive sectors flows subside & market corrects to reflect relative economic strength.

However, as long as the external headwinds remain, being able to pare down overall exposure to equities, in our opinion, reduces volatility and drawdowns in the long run.

StarGazing Chart 2

Sector Economic Index used in STAR for July 2016 compared to July 2015 and July 2014. (Source: Astor Calculations) Past performance is no guarantee of future results. See definitions and disclosures here for additional information

READ MORE HERE

 

 

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 Sector Tactical Asset Rotation Composite is a tactical strategy focused on the generation of returns through shifts in domestic equity sector allocations. The Composite exclusively uses exchange-traded funds (ETFs) and focuses on investing in domestic equities during economic expansions while reducing equity exposure for fixed income and cash in weak economic periods. Prior to May 2014, the Composite previously invested in various other asset classes, including commodities, international equity, and currencies. The Composite includes a minimum 15% domestic equity allocation and does not invest in inverse funds. The benchmark is the 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.

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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

The Answer to the Question on Investors’ Minds: Stay the Course

For much of the year, beginning in January when the stock market had its worst start of a new year in history, we’ve been asked periodically why our portfolios haven’t been materially more defensive. The question has arisen at other times during the year, such as in aftermath of the UK’s “Brexit” vote, an event that temporarily took the market lower because of fear and uncertainty, but did not change the fundamentals. Now, some are wondering if the economic expansion could be getting long in the tooth.

Add to that the cable news chorus that, from time to time, warns investors that the next bear market is right around the corner (cable news pundits have called about five of the last two recessions).

And yet, here we sit, at or near all-time highs in equities.

For us, it’s a pretty straightforward proposition, thanks to the Astor Economic Index®, our proprietary, data-driven guidepost that allows us to determine, in real time, the direction and strength of the U.S. economy. Thanks to this “now-cast,” we are able to aggregate a variety of data into a single value, which we compare to historical levels and historical averages to determine whether we believe the economy is expanding or contracting and to what degree of strength or weakness.

The AEI is our answer to “the” question we believe is foremost on investors’ minds: What is the current state of the economy and its implications for exposure to risk assets?

As a robust aggregation of what is occurring across the $17 trillion U.S. economy, the AEI is our guide for determining risk asset allocation. Research shows that when the economy is growing, it is productive to hold risk assets (i.e. equities); when the economy is contracting, risk assets should be reduced. This is not prognostication—it’s now-casting, to capture the current state of the economy.

AEISource:  Astor Calculations

Since the economy turned the corner after the last recession—whether measured by the National Bureau of Economic Research (NBER), the Astor Economic Index®, or even your own “gut feel” of when things got better after the 2008-2009 financial crisis—the economy has been growing. As the AEI chart (above) illustrates, there have been points during this recovery when economic growth has been faster or slower. But at no time since the recovery has the AEI suggested that the expected return on risk assets was negative.

Not that there haven’t been some times of concern, when caution seemed prudent, such as the 2011 debt ceiling crisis and fears of a U.S. government default. But once those clouds cleared, downturns proved temporary and the financial news media’s repeated calls for a bear market were only head fakes.

The caveat, of course, is that some times are riskier than others; from time to time some assets and sectors do better than others. For example, earlier this year a slower pace of economic growth (but growth, nonetheless) suggested that we reduce beta somewhat in our portfolios, which we did.

Nonetheless, as the AEI chart shows from 2012 to the present, generally speaking risk exposure to risk assets (equities) has paid off, with the exception of a quarter or two. Our data-driven, fundamental approach, however, doesn’t attempt to capture short-term moves, quarter to quarter. As we tell clients, our goal is to generate solid, long-term returns, but our discipline is focused mainly on mitigating risk and protecting the downside. We attempt to give investors what we call “a smoother ride” through the cycles. Interestingly, this theme was featured in a recent Wall Street Journal’s report on the desire of investors for “peace of mind” by controlling volatility. When investors know what they want they can pursue their investment goals accordingly. A fundamentally-driven, macroeconomics-based approach, we believe, is the key to staying disciplined in the pursuit of those investment objectives.

For now, the AEI tells us to stay the course with exposure to risk assets. One day, presumably, that will change—and when it does, we will act accordingly.

 

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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U.S. Manufacturing Update

The report on Durable Goods today:

  • New orders for Durable goods decreased 4% in June making this the biggest drop since August 2014. The core measure of new orders for non-defense capital goods excluding aircrafts is up 0.2% in June but still down -3.7% YoY.
  • While the overall new orders decline of 4% looks bad, we believe it is not as meaningful as a measure of manufacturing activity. The reported decline is attributable to a -59% change in commercial aircraft orders.
  • The core capital goods number is used by economists as sign of business investment activity. It has been negative since Dec 2015 but the pace of decline has been slowing.
  • This measure tracks private fixed non-residential investment, a measure of business investment which declined for two consecutive quarters (Q4 2015 & Q1 2016) for the first time since 2009.
  • It can be seen as leading indicator, but revisions & volatility may make it less reliable.
  • These numbers don’t fully take into account the uncertainty and the strengthening dollar post-Brexit and we expect next month’s release to reflect further deterioration in business investment activity.

Astor’s View

Since 2014, there has been ongoing weakness in manufacturing sector and US PMIs, led by the domestic energy sector & a strong US $.  We have been seeing gradual recovery in 2016- the July Markit Flash Manufacturing PMI released last week was highest since October 2015.  But, we expect headwinds to remain from political & global markets uncertainty.

Durable goods

Data Source:  Bloomberg

 

 

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/Q2 Recap: Beyond Market-Rattling Events, the Data Prevail

If you were to look only at where the market closed out June, with the S&P (SPX) at just under 2100 (2098.87 SPX) and compare that to month-end for May (2096.96), you’d see that little had changed. Quarter-to-quarter, the rise from the Q1 close of roughly 2060 to the Q2-end is nearly a 2% gain.  Q1 followed a similar pattern ending the quarter within 1% of where it began.

What that view fails to acknowledge, of course, is another quick, market-rattling event—this one known as “Brexit,” which caused a spike in fear and uncertainty again. Volatility increased and the major averages were sent swinging in 5-10% ranges. At its lows, SPX traded below 2000, declining nearly 5% in a matter of days.

But, here we are again, right back to previous levels (sound familiar?).  As I noted in my previous post about Brexit being an event, the UK’s departure from the EU had little short-term impact on the current state of the economy, and markets will eventually reflect that reality.

Speaking of the U.S. economy, there have been some hopeful signs. The Chicago Business Barometer (also known as the Chicago Purchasing Manager Index) rose 7.5 points to 56.8 in June, the highest level since January 2015. The rise was attributed to strong gains in new orders and production. Further, the rebound in June offset the previous two months of weakness. The Chicago Barometer average for Q2 was 52.2, virtually unchanged from 52.3 in Q1.

Also widely anticipated was the June ISM Manufacturing Survey (released July 1), which came in at 53.2—beating estimates and posting a fourth consecutive month of growth.

That’s why, market “events” aside, Astor focuses intently on the economic fundamentals—especially through the lens of our proprietary Astor Economic Index® (AEI). Based on our reading of the current state of the economy we allocate assets accordingly. Although the AEI has declined over the past several months and our beta (exposure to risk assets) was adjusted accordingly, the Brexit “event” and aftermath of the past week did not change our overall view of the economy, or our outlook for the equity markets over the next few quarters.

To be clear, if fundamentals change we will adjust our asset allocation and our weighting of risk assets. But as of this writing, fundamentals are about the same as they were a few months ago. In fact, Q1 GDP was revised higher to 1.1%, compared to the initial reading of 0.5% and the second estimate of 0.8%. (Whether GDP has accelerated from the economy’s slowed pace of earlier this year will put the spotlight on the Q2 advance report, due to be released July 29.)

The conclusion we draw from all this further supports our thesis from earlier in the year:  we are in a low-return environment. Low-risk assets such as 10-year treasuries are yielding less than 2%, and risk assets such as equities are on track for single-digit returns with double-digit volatility.

Given that outlook, we believe our portfolios are positioned to capitalize on this environment, while we remain prepared to make adjustments to become defensive should risks increase. At the same time, if economic fundamentals improve and risk assets appear likely to generate greater returns for the same risk, we will adjust to that accordingly as well.

Through whatever “events” might rattle the market from time to time, we continue to keep our eye on what really matters—the economy.

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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