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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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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Watching Risk-Reward Ratios: Economic Data Still Positive – But Rate is Slowing

Risk-reward ratios are on our radar screen these days as we review the most recent economic data against the backdrop of recent market movement. This is not to say that we are in any way suggesting a top, a bear market, or even that a correction is on the horizon, even taking into account this past week’s movement and volatility—although each of these scenarios remains a possibility. At this point, though, we do have some minor concerns about risk-reward in the markets going forward, suggesting that a slight adjustment in beta or equity exposure from current levels is prudent.

Our investment philosophy is to adjust equity exposure based on the velocity of economic fundamental data, combined with analysis of correlations between assets. Our objective is to adjust asset exposures to create the most efficient portfolio.

To be clear economic data is still positive, but the rate of increase in the positive data has not been accelerating with the market—and in some segments is slowing. For example the three-month trend of employment growth as measured by the jobs report has gone from 208,000/month at yearend, to 209,000/month as of April, which includes a large outlier of 332,000 in February, over half the total.

The ISM Manufacturing Index measured 50.7 in April, up very slightly from the 50.2 at yearend. The four-quarter average GDP growth rate was 1.85% as of Q1 2013, down from the 2.6% at the end of Q3 2012.

Much of the emerging market economic activity data is below expansion levels, and indices in many countries are down for the year. At the same time the U.S. broad market averages are up nearly 24% from the low in November. Simply stated, the last six months appear somewhat out of step with fundamentals.

Many economists forecast that 2013 would be back-loaded. However, I am concerned that it might be front-loaded.

As we have discussed previously, we have gone from uncertainty to visible risk; as a result, investment dollars have flowed into U.S. equities. To be sure, some of the visible risk is uncomfortable and even unpalatable at times, but financial destruction appears to be off the table. Accommodative global central bank activity has gone a long way to alleviate many of those structural concerns for now, while also making financial risk assets look more attractive. Recent outlooks from Fed Chairman Bernanke and members of the FOMC have varied in terms of continued duration and level of QE, but the Fed has nonetheless provided investors transparency into their views, and thus the ability to make calculations to the risk of exiting QE.

Hopefully, we’re just in for some garden-variety economic hiccups that can be managed with only a little indigestion for investors. However, if the data softens from here, and things get really distasteful or start to look queasy, we’ll get more defensive. And, if the Fed alters course and the loose negative-rate environment changes, we will also adjust fixed-income holdings accordingly.

For now, as always, we’ve got a close eye on the economy to see how things are shaping up.

For more insight into Astor’s philosophy, my latest publication, the 2013 edition of “Finding the Bull Inside the Bear” is available. To request a free copy, please email info@astorllc.com.

– Rob Stein

Risk: A Four-Letter Word. That’s Good for the Market

The stock market has posted a solid start to the year, with the S&P 500 up some 6.5% in January and February. The reason (at least in part) is—risk.

That four-letter word is good news for a market that, since the financial crisis, has been beleaguered by “complete uncertainty”—which left many investors with the sinking feeling that the proverbial shoe was always ready to drop. To counter the undercurrent of impending doom (real or imagined), the Fed, the Treasury, and central banks around the world essentially propped up the market.

When risk is visible, it can be measured, evaluated, mitigated, managed, and hedged (at least to some degree). And where there is risk of the visible variety, there is also the potential for reward.

Let’s take a simplified example. Say you have $20,000 to invest. If, based on visible risk, you determine that the most you stand to lose is 10% or even 20%—whatever the potential downside might be—then you can make an investment decision accordingly. You might decide to invest all of it and risk $2,000 or $4,000 (depending upon the magnitude of risk that you foresee), or you may decide to invest a portion—say, $10,000 and risk a potential loss based on your analysis of $1,000 or $2,000. (Hopefully, the potential on the upside more than offsets that risk, of course.)

The point is, with a better handle on the potential downside, and being able to tie actual reason to what’s behind potential risk, investors have been committing more to the market, as we’ve seen with the Dow hovering at all-time highs over the 14,000-mark.

The one caveat on visible risk is that it is—well, risk. Without the Fed-administered training wheels to guide the market through the bumps, now when risks are detected the market will react—for real. Therefore, should there be a significant change in the economic picture, there could potentially be a 20-25% correction lasting two to four quarters. This is not a prediction—just a potentiality.

With visible risk, we also expect the market to be more responsive to economic fundamentals than it has in recent years when intervention basically clipped the tails. This is a far healthier environment, at least from a fundamental, tactical asset management approach.

The dominant reality for 2013 is all about whether we will see a pickup in demand. Since the financial crisis, demand has been crimped as consumers dealt with hangovers caused by pre-crisis overindulgence. The good news, we believe, is that there is pentup demand, particularly for capital spending. A revision in Q4 2012 GDP brought the reading to +0.1% from -0.1%. The ISM’s manufacturing purchasing managers’ index increased to 54.2 in February from 53.1 in January. Thus far, sequestration has had less impact on the market than many people thought because of drama fatigue. In housing, some improvements point to potential good buying opportunities on corrections in the right sectors. At the same time, investors should be cautious when it comes to oil and other commodities.

Not all the economic data, however, has been promising. The Philadelphia Fed Business Index worsened and fell into contraction territory in January, while construction spending posted an unexpected decline in January. The point being we’re not pushing the envelope on growth right now. Whatever occurs—an accelerating economy or a sudden contraction—the market will react accordingly, based on visible risk. (Beware that just because the return of visible risk was hailed by a market that moved higher, don’t expect that to always be the case.)

Risk is back, with its potential to move the market in either direction. After the past few years of complete uncertainty and market intervention, this is a welcome sign, indeed.

– Rob Stein