September Quick Read on the US Economy

I interpreted last month’s economic releases as somewhat weaker.  Forward looking surveys were concerning though consumer spending in the US, the most important single component of GDP, seems to be stable.

Our latest reading for the Astor Economic Index® (“AEI”) is lower over the month, though I see no discernible trend over the last twelve months.  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. 

aei

 

The nowcasts produced by the Federal Reserve banks of Atlanta and New York are both still showing stronger growth in the third quarter than the first half of the year.  The Atlanta Fed is currently estimating a gaudy 3.3% SAAR and the New York Fed is currently forecasting 2.8%.  These are both significantly stronger than their final Q2 estimates and represent a significant increase from the poor Q2 release.  Both have been updated since the employment report.

Another month of solid job growth means that the we are adding more jobs than needed to absorb the natural increase in the labor force.  We can also see strength in the labor force from some less-often discussed numbers such as the quit-rate which has increased 9% over the last 12 months and the number of job offers, which is at a high for the recovery.  These series can be seen in the JOLTS report put out by the Bureau of Labor Statistics.  On the other hand, there are still signs of higher levels of labor market slack than we would normally expect late in the cycle. The chart below shows unemployment (the headline number) and underemployment.   While unemployment is fairly low and roughly at the level targeted by the FOMC, underemployment shows significant additional slack in the labor market.

unemp-rate

 

The latest purchasing managers surveys from the Institute for Supply Management (ISM) were disappointing. 

pmi

The manufacturing index gave up much of its gains for the year.  I hope this is not a harbinger of renewed manufacturing weakness such as we saw in the first quarter of this year.  Surprisingly, non-manufacturing survey was also quite weak in August and it’s at the lowest level of the recovery.  A diffusion index (such as these) is a bit challenging to interpret exactly and a glance at the chart will show many months spike up or down without signaling sustained shifts in growth.  Digging into the details of the reports we see that much of this month’s weakness was due to drops in new orders and non-manufacturing exports.  This will bear close watching in coming months.

The hawks at the Fed seem to be getting louder, and one month’s survey data is, in my opinion, unlikely to deter them.  See this speech by San Francisco Fed President John Williams who makes the argument that 1) because the unemployment rate is low the Fed will need to raise soon and 2) better to raise sooner by less rather than later my more.  I see both those assertions as questionable (see Tim Duy for an argument about why it might make sense to let the unemployment rate drift lower) but I think a hike is coming in September or December assuming growth stays on its current course. For what it’s worth, my interpretation of Fed Funds futures prices shows that the market places a low possibility of a September hike but a likely hood of December hike.

 Overall, the economy continues its pattern of positive but modest growth.  The ISM numbers make me a bit worried about the fall.  As always I will be monitoring developments in the US economy carefully in the weeks ahead.  Clients are welcome to get in touch for a detailed conversation.

 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.

 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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Breaking up is not that hard to do: Real Estate (RE) classification

Effective September 1, 2016, the Global Industry Classification Standard (GICS®) will undergo its first major change since its inception in 1999.

As a result of the evolving investment landscape, not to mention the global economy, real estate will be carved out of the financial sector. The new 11th sector will primarily contain equity REITs.

All Dow Jones and Russell indices will be unaffected by the change.

MSCI will make the change on Aug 31, but S&P 500 will change on Sept. 16, which is when most sector funds will rebalance.

The Break Up

The financial sector will be split into financials ex-real estate and real estate. After the change, we estimate that the S&P 500 will have a 14% weight in the “new” financials and 3.2% in real estate.

REITS and Real Estate Management & Development, which are currently sub-sectors under financials, will be renamed to form the new sector of “Equity REITS” composed of 28 companies in the S&P 500.

Mortgage REITs will remain within the financial sector given their greater similarity to traditional financial companies; however, they are a negligible percentage of the index.

From our calculations, specialized REITs (35%), retail REITs (22%), residential REITs (13%), and health care REITs (12%) will be the major components of the new real estate sector.

In making this change, we believe that both MSCI and S&P 500 recognize the increasing role of real estate in global equity markets and considerable growth in assets since 2009. In addition, the increasing specialization of real estate firms has made real estate the least correlated sub-group within financials.

Astor’s View

Volatility:  We expect that financials’ volatility will increase because the low correlation with REITs provided diversification.

Dividend Yield: REITs have a higher dividend yield (~3.5%) vs. 2.4% for the financial sector. So, taking out REITs will lower the dividend yield of financial ETFs to between 1.5-2%.

Performance: Financials ex-REITs will have a higher weighting of interest-rate sensitive sub-sectors such as banks, which will be negatively impacted by rate hikes.

Increased Demand: Most U.S. equity funds significantly underweight real estate, especially in value strategies.  Based on a December 2015 JP Morgan report (1), there is pent-up demand of $100 billion for real estate funds, as long-only mutual funds have an average real estate underweight of 2.1%. Plus, new tax incentives for foreign investors in U.S. REITS may drive demand.

Outlook for Banks and Financial Stocks: Banks and financial stocks have more than recovered from the temporary sentiment-driven sell-off led by the Brexit uncertainty as well as concerns about the Fed’s policy stance. Yet financial stocks remain undervalued relative to other sectors, based on estimated P/E 2016, price/book and long-term debt/capital.

Unless economic conditions deteriorate significantly in the next few months, we expect a stable to steeper yield curve and higher rates by early 2017.

 

 

 

(1) J.P. Morgan Research, 17 December 2015, “2016 REIT Outlook: Remain Constructive as Growth/Valuation Stack Up Well and GICX Change Could be Boon; Risk is Rates.”

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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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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