Caution still warranted as we book a big win with Chipotle

Caution still warranted as we book a big win with Chipotle

Key points in this issue

  • Despite the market’s improved mood over the last few trading days, we are not out of the proverbial woods just yet. As such, we are sticking with our current plan of sitting on the sidelines until calmer market waters emerge.
  • We are booking another win with our Chipotle Mexican Grill (CMG) Jan 2018 450.00 calls (CMG190118C00450000) that closed last night at 34.76, up almost 73% from our 20.10 buy-in in mid-October.

Last night we closed the books on the month of October, and what a month it was for the stock market. In today’s short-term focused society some will focus on the rebound over the last few days in the major domestic stock market indices, but even those cannot hide the fact that October was one of the most challenging months for stocks in recent memory. All told, the Dow Jones Industrial Average fell 5.1% for the month, making it the best performer of the major market indices. By comparison, the S&P 500 fell 6.9% in October while the technology-heavy Nasdaq Composite Index dropped 9.2% and the small-cap focused Russell 2000 plummeted 10.9%. In short, the month of October wiped out most the market’s year to date gains.

As I write this, we are just over halfway through the September quarter earnings season, which means there are ample companies left to report and issue updated guidance. Candidly, those reports could push or pull the market either higher or continue the October pain. Some may be tempted to put on some short-the-market positions as we did in late September, which paid off handsomely for us, but that was when there was a clear risk to the downside. Today, that downside view is far less compelling. Don’t misunderstand, there are still ample risks in the market to be had as the current earnings season winds down. These include the mid-term elections; Italy’s next round of budget talks with Brussels; upcoming Trump-China trade talks, which have led to another round of tariff preparations; and Fed rate hikes vs. the slowing speed of the global economy.

Most of those factors will unfold over the coming weeks and then we’ll be in the thick of the holiday shopping period. As we navigate these must-watch events, I’ll be watching option plays in companies like Amazon (AMZN) and United Parcel Service that are riding our Digital Lifestyle theme in the upcoming holiday shopping season.


Exiting our Chipotle calls with a hefty win

Last week I cautioned patience with our Chipotle Mexican Grill (CMG) January 2018 450 calls (CMG190118C00450000) and that coupled with the market rebound these last few days drove those calls higher. With last night’s close, the underlying CMG shares hit 460.33, well above our 450.00 strike price and that share price rebound led our CMG calls to close at 34.76 – up just shy of 73%. Not bad for a position that was added just two weeks ago.

Given my comments above, I’m taking the quick win on this trade and putting the returned capital and profits into the war chest as we wait for a calmer market to emerge.

  • We are booking another win with our Chipotle Mexican Grill (CMG) Jan 2018 450.00 calls (CMG190118C00450000) that closed last night at 34.76, up almost 73% from our 20.10 buy-in in mid-October.
Surprises From Market Breadth with Record Margin Debt

Surprises From Market Breadth with Record Margin Debt

As we discussed earlier, heading into the third quarter earnings season, we have above average level of positive guidance in terms of both top line sales and earnings as well as lower-than-average negative earnings guidance. We  pointed out yesterday, however, that an uncomfortable portion of that guidance is driven by gains from a weak dollar and we are seeing signs that may be reversing course.


In the last quarter, companies that delivered on or beat expectations didn’t get much of a reward for their efforts. We looked at the current market conditions to get a feel for what the earnings reactions could be this reporting season.


Margin Debt

Margin debt has reached $550.9 billion, a record high for the second consecutive month and the sixth record high in the past eight months.  Anyone who recalls just a tad bit of market history can see that rapidly rising margin debt has preceded the beginnings of both the March 2000 and July 2007 bear markets. However, nearly one in four monthly margin debt readings since 1959 have been record highs, so to assume that a pullback is imminent based on a record high is folly at best. Instead, we like to look at the rate of change over a 12-month period. Here we can see that the rate of change recently hasn’t been nearly as dramatic as the wild moves we saw around the 2000 and 2007 crashes. This metric does not indicate a market that has been wildly laying on the leverage, despite reaching yet another record high.

Market Breadth

Another measure of the health of the market is the Advance/Decline line which has been well above its 50-day and 200-day moving average. This indicator is showing a market that appears rather robust, but the value of this indicator may lessened by the rapidly rising use of ETFs. When an investor puts money into an ETF, those funds are used to buy all the companies in the ETF indiscriminately, which can give the appearance of greater robustness than would otherwise exist.


To further assess breadth, we look at the ratio of equal weight versus market cap weighted for the major market indices. What we found is the S&P 500 and the Russell 2000 equal weight indices underperformed their market cap weighted indices by a material amount year-to-date. This metric indicates that the indices upward moves have been driving by larger cap high-flyers, which indicates weaker breadth than we’d like to see.


High Fliers Losing Some Altitude

Amazon (AMZN) tried to carve out a head and shoulders pattern this week, down by over 2% during the week, but closed the week back in the black by Friday. If it moves below the neckline where it is currently perched rather precariously, the shorts will go for the jugular and this is one of those mega cap stock that has been helping to keep the indices up. Another high flier that has driven a good portion of the market’s gains, Apple (APPL), has dropped below both its 50-day and 100-day moving averages and is now down in 13 of the last 18 days as the new product line doesn’t exactly have consumers busting down the doors.


Facebook (FB) is also feeling the pain with all the bad press surrounding is ad platform that Ivan and his Russian buddies have been abusing to stir up domestic strife here in the U.S. Who knew Putin’s team may not play fair! The stock suffered its worst day this week since last November, falling over 5% at one point during the week and closing below its 50-day moving average for the first time since July 6th. By week’s end the shares had moved back to neutral territory in this Teflon market, but the warning flares have been fired. Netflix (NFLX) joined in falling as much as 5.5% this week to waver right arounds its 50-day moving average.


With the performance of the equal weight indices below that of the market cap weighted, weakness in the big guys are cause for concern. The end of the week saw a rebound in most, such as Alphabet (GOOGL) but we’ll be watching to see if the rebound holds.


Another Breadth Indicator

We then looked at the percent of companies above their 50-day moving average in the S&P 500, Nasdaq and the NYSE Composite. We found that the number of stocks trading above their 50-day moving averages has been rising, so from this metric, the markets are looking to have decent breadth, which limits the damage from those high fliers weakening.


When assessing either the markets or a stock we always want to find confirming or discordant data points to increase our confidence. While we have conflicting indicators here, our assessment leans more towards a bullish view based on this data for the near term.




What about that wacky VIX that appears to be on a IV drip of some sort of powerful sedative? No matter what gets thrown at it, the index continues to be like Fonzi. The recent Commitments of Traders report from the CFTC revealed that the net speculative short position on the VIX has once again reached a new record high at 171,187 futures and options contractions, taking out the prior 158,114 peak in early August. This is a 63% increase! Talk about the calm before the storm. Yeah, we know, been saying that for a while. This has been a seriously impressive run!


Of all the days the VIX has been below 10 since its inception, 70% those have been in 2017. We can’t help but shake our heads, (and remember to stock up on Alka Seltzer) when we consider the likely impact on the markets when the reversion to the mean rule kicks in.


Given the lack of volatility, investors seem to be going all in. The last week’s Market Vane report found that the bullish share has reached the highest level in the current bull market. The last time it was this high was in June 2007.


The bottom line is while equities are clearly expensive at these levels, the market breadth looks decent and volatility is still hitting the snooze button. The disconnect between fundamentals, historical norms and the current market is likely to at some point result in some seriously dramatic moves.  However, we’ve all seen that expensive stocks can get even more expensive and for at least the near term, we are not seeing any clear catalyst for a pullback that would get the attention of this seemingly Teflon market.

Safety & Security as Markets Wobble

Safety & Security as Markets Wobble

The major equity indices are struggling.Today the Nasdaq posted its third consecutive down

Today the Nasdaq posted its third consecutive down day after last Friday’s close marked the fourth consecutive down week for the index. This is now its longest losing streak since May 2016 with only one-third of Nasdaq stocks trading above their 50-day moving averages – not exactly great breadth. The Dow Jones Industrial Average posted its second consecutive weekly decline as well with last Friday’s close.

The Russell 2000 has now experienced its third worst performance in its history relative to the S&P 500 for the first 160 trading days in a year and is now in the red for 2017 while the S&P 500 is up 8.5%. The S&P 500 today has only around 40 percent of its stocks trading above their 50-day moving average, the lowest percentage since early November – any poor breadth indicator.

Over the past 2 months, since June 22nd, the Utilities sector has been the strongest performer – not exactly an indicator of a bull market.

XLY Chart

XLY data by YCharts

Nor is the iShares 20+ Year Treasury Bond ETF (TLT) rising during the year to above its 50-day and 200-day moving averages a bullish sign for equities nor for an accelerating economy.

TLT Chart

TLT data by YCharts

Despite the wobbly markets, today’s report on University of Michigan’s Consumer Sentiment found that the mean expected probability of higher stock prices rose to the second-highest level on record at 62.9% from June and July’s 59.2%. The last time it was this high was in June 2015, when the markets experienced at 10% correction within two months – all that confidence comes with a price.

On top of all that we are experiencing rising geopolitical tensions as the U.S. and South Korea engage in military exercises right next to that bastion of stability and calm diplomacy, North Korea. This evening, President Trump will speak to the nation about his plans for Afghanistan, now the now longest running war in American history. Good times.

Amidst the rising tensions, both geopolitical and domestic, one good hedge against those global tensions may be found in Defense and Aerospace stocks, some of which are included in our Safety and Security investing thematic. Over the weekend Barron’s discussed a company that they found particularly attractive.

Large-cap defense stocks have had 20%-plus total returns over the past year, outpacing the Standard & Poor’s 500 index by more than 10 points. And more gains could be ahead for shares of the No. 1 U.S. defense contractor, Lockheed Martin.

Source: In a World of Danger, Lockheed Looks Like a Safe Bet – Barron’s

Washington’s Attack on Online Advertising Revenues Disguised as Tax Reform

Washington’s Attack on Online Advertising Revenues Disguised as Tax Reform

When we look at the creative destruction associated with our Connected Society investing theme, on the positive side we see new technologies transforming how people communicate, transact, shop and consume content. That change in how people consume TV, movies, music, books, and newspapers has led to a sea change in where companies are spending their advertising dollars given the consumer’s growing preference for mobile consumption on smartphones, tablets and even laptops over fixed location consumption in the home. This has spurred cord cutters and arguably is one of the reasons why AT&T (T) is looking to merge with Time Warner (TWX).

Data from eMarketer puts digital media advertising at $129.2 billion in 2021, up from $83 billion this year with big gains from over the air radio as well as TV advertising. As a result, eMarketer sees, “TV’s share of total spend will decline from 35.2% in 2017 to 30.8% by 2021.”

That shift in advertising dollars to digital and mobile platforms away from radio, print and increasingly TV has created a windfall for companies like Facebook (FB) and Alphabet (GOOGL) as companies re-allocate their advertising dollars. With our Connected Society investing theme expanding from smartphones and tablets into other markets like the Connected Car and Connected Home, odds are companies will look to advertising related business models to help keep service costs down. We’ve seen this already at Content is King contenders Pandora (P) as well as Spotify, both of which use advertising to allow free, but limited streaming music to listeners. Outside the digital lifestyle, other companies have embraced this practice such as movie theater companies like Regal Cinema Group (RGC) that use pre-movie advertising on the big screen to help defray costs.

As we point out, however, in Cocktail Investing, investors need to keep tabs on developments in Washington for they can potentially be disruptive to business models and that could lead to revisions to both revenue and earnings expectations. Case in point, current Ways and Means Committee Chairman Kevin Brady recently acknowledged that there “may be a need” to look at some of the revenue raisers to complete his 2017 tax reform proposal. One item was revisiting the idea to convert advertising from being a fully deductible business expense – as it has been for over a century – to just half deductible, with the rest being amortized over the course of a decade.

The sounds you just heard was jaws dropping at the thought that this might happen and what it could mean to revenue and earnings expectations for Facebook, Alphabet, Twitter (TWTR), Snap (SNAP), Disney (DIS), CBS (CBS), The New York Times (NYT) and all the other companies for which advertising is a key part of their business model.

Other jaws dropping were those had by economists remembering the 2014 IHS study that showed the country’s $297 billion in advertising spending generated $5.5 trillion in sales, or 16% of the nation’s total economic activity, and created 20 million jobs, roughly 14% of total US employment at the time. Those same economists are likely doing some quick math as to what the added headwind would be to an economy that grew less than 1 percent in 1Q 2017 and how it would impact future job creation should an advertising tax be initiated. It’s hard to imagine such an initiative going over well with a president that is looking to streamline and simplify the tax code, especially when one of his key campaign promises was to lower tax rates.

As we talked on the last several Cocktail Investing Podcasts, there are several headwinds that will restrain the speed of the domestic economy – the demographic shift and subsequent change in spending associated with our Aging of the Population investing theme and the wide skill set disparity noted in the monthly JOLTs report that bodes well for our Tooling & Retooling investment theme are just two examples. Our view is incremental taxes like those that could be placed on advertising would be a net contributor to the downside of our Economic Acceleration/Deceleration investing theme.

That’s how we see it, but investors in some of the high-flying stocks that have driven the Nasdaq Composite Index more than 17 percent higher year to date should ponder what this could mean to not only the market, but the shares of Facebook, Alphabet, and others. In our experience, one of the quickest ways to torpedo a stock price is big earnings revisions to the downside. With the S&P 500 trading at more than 18x expected 2017 earnings, a skittish market faced with a summer slowdown and pushed out presidential policies could be looking for an excuse to move lower and taking the wind out of this aspect of the technology sails could be it.

Earnings not boosting Trump Trade, yet markets continue to rise

Just a little over two weeks ago Donald Trump took the oath of office. Since then, nary a day goes by without President Trump dominating the pages of most every major publication. Love him or hate him, the man certainly knows how to command attention.

Yesterday both the Dow and the Nasdaq hit new interday highs, but on valuations that remain stretched as earnings reported so far have been beating less than normal and caution over policial volatility holds the “C” suite back.

Fourth-quarter results have so far eclipsed Wall Street expectations, with 65 per cent of companies beating earnings projections and 52 per cent topping forecasts for sales — both below the five-year average. Corporate America’s guidance for the current year is already coming up light, with BofA noting that twice as many companies have forecast earnings below projections than above.


“[Companies] are clearly excited about lower taxes, a lower regulatory environment and more pro-growth policies, but that is offset by the trade policy and immigration,” says Grant Bowers, a portfolio manager with Franklin Templeton. “There was some built-up hype after the election but we have seen a lot of conservative guidance as companies face an uncertain outlook.”


At Tematica we suspect that investor expectations, which translate into higher share prices, are getting way ahead of themselves. According to a recent Gallup poll, 53% of American’s disapprove of the job he is doing with only 42% approving. That is the lowest level of any president in history after two weeks in office. So whether you love or hate the job he is doing, he is likely to face significant headwinds pushing through legislation, which means these changes that investors are so optimistic about are likely to come later rather than sooner and may not deliver quite the level of change anticipated.

What has us even more concerned are all the global events that would otherwise be receiving front-page treatment that are relegated to lining hamster cages, without much attention. Greece… still a potentially big problem. Italian banks … still seriously troubled. French elections… one of the front runners is hell bent on exiting the European Union. Were that to happen, the Eurozone would collapse and its currency with it – a very big deal.

We will have a lot more on this in the coming days and weeks, so stay tuned!

Source: Corporate America fails to add gas to Trump rally

Pricey markets with rising default rates

Pricey markets with rising default rates

As of Friday’s close, the S&P 500 was 1.9% away from all-time highs with trailing P/E ratio around 19x and forward P/E ratio at 17x, rather pricey market by historical standards.

Early last week the Russell 2000 closed above its 200-day moving average for the first time since last August, making for a total of 167 consecutive days below the 200-day moving average, the fourth longest streak in the index’s history. The three prior times is had running streaks longer, the index gained an average of 37.7% over the next six months.

Tech stocks experienced their worst day since the February lows on Friday and momentum for the NASDAQ is now decidedly negative with the MACD and the 14-day RSI in downtrends.

2016-04-25 NASDAQ

But if we look just under the surface, much is still being driven by short-coverings, with S&P 500 shorts cut in half recently and at 2016 lows – still some 17,000 options out there though so there is more room to go.

More importantly, where are the fundamentals? Price and value often diverge, but when they diverge a lot in either direction, it is either a selling or a buying opportunity. 

The 24% of the S&P 500 non-energy companies that have already reported for 2016’s first quarter show revenue that is basically flat, up just 0.6% with operating income coming in a dismal decline of -6.6%.

The top-line revenue beat rate is currently at 54.4% , which is well below the bottom line beat rate of 63% and is so far better than we’ve seen in the prior four earnings season, but is still below the long-term trend.

I’ve talked a lot in the past about the lack of wage growth being a headwind to the economy. With unemployment rates getting so low, we are seeing wage pressures now with the wages and salaries rising an estimated 4.6% in Q2. But that is at a time when revenue is flat! Not good. Tough for companies to increase costs when their revenues are flat or declining.

In fact we are seeing an absolutely unprecedented imbalance between the growth rates of top line sales and private-sector payrolls. Going back to 1994, we’ve never seen such a diversion during the mature phase of a business cycle which means there is a heightened risk of a sudden and material jump in layoffs that would likely stall consumer spending. With an economy in stall speed, (GDP growth for Q1 expected to be less than 1%) this is something to watch.

Meanwhile the number of companies defaulting on their debt is hitting levels not seen since the financial crisis with 46 so far this year amidst projected corporate earnings that are projected to have declined 18.5% from their peak in late 2014, as measured by GAAP accounting.

2016-04-25 Corporate Defaults

In fact, so far in 2016, downgrades have supplied 82% of all US high yield credit rating revisions. Even after excluding those downgrades having exposure to the oil and gas sector, downgrades still account for 72%.  This is the highest ratio of downgrades since Q1 2009.

With P/E ratios at historically high levels combined with high default rates, non-existent sales growth and rising wage costs, S&P 500 stocks look to be platinum pricing for a tin ring.

Last week also painted a less than rosy picture for the housing sector.

Monday the National Association of Home Builders/Wells Fargo builder sentiment was released, showing the index was unchanged at 58 versus expectations for 59, staying at the same level for the past three months. Builders outlook for sales over the next six months edged higher but view of current conditions fell.

On Tuesday we learned that US housing starts fell -8.8% versus expectations for -1.1%, with declines in both single-family (down -9.2%) and multi-family units (down -7.9%). Permits also dropping to a one-year low, down -7.7% versus expectations for a gain of +2%, making for the second biggest month-over-month fall since January 2011 and the biggest miss versus expectations since 2002.  Looking at the longer-range trends, housing starts remain in the middle of the range they’ve been in since early 2015, but permits have been making lower highs and now lower lows.

The decline in housing market activity mirrors the slowing we have seen in business spending, trade and retail sales

This week we’ll get two very important releases, the Fed’s rate hike decision and the first estimate for Q1 2016 GDP.  Late Monday Boston Fed President Eric Rosengren told Reuters that the Federal Reserve is set to hike rates more rapidly than is currently priced into futures market, which see only one modest rate hike in each of the next few years. I still think it is highly unlikely that the Fed will decide to raise rates this week, but when a bunch of economist get into a room, you can never be 100% sure.

This week we’ll hear about

  • New home sales
  • Durable goods orders (important for forward look on economy)
  • Markit services PMI (service sector has been stronger than manufacturing – will see if that continues)
  • Consumer confidence (typically a lagging indictor, but still useful)
  • Personal Income and Spending (people making a bit more, but where is that money going?)
  • Dallas, Richmond, Kansas City Fed activity index reports
Volatility – It's here!

Volatility – It's here!

In my firm’s newsletter last month I pointed out that the S&P 500 had been showing some technical signs of weakness, with the index falling below its 50-day moving average and with the 50-day moving average plateauing at that time.  I also pointed out the lack of breadth, with the number of stocks making new 52-week highs declining while the number making 52-week lows was rising, all while the index continued to move up, which makes for an unstable market.  I’ve frequently commented on the unusually low levels of volatility, which is likely due to actions taken by central bankers, but can’t last forever and typically leads to heightened future volatility – it’s here!

The technical breakdowns and suppressed volatility came to a head over the past few weeks.  On August 25, the 3-day sum of the prices of the S&P 500’s distance from its 50-day moving average, (which is a measure of just how much recent prices differ from the recent past averages) almost beat its biggest day in history – May 15th, 1940.

On that day in 1940 the German Blitzkrieg moved into northern France, German troops occupied Amsterdam with General Winkelman surrendering, General Dutch Persbureau was captured by the Nazis and the Dutch troops surrendered to the Nazi’s, beginning what was to be 5 years of occupation for that nation.  So yeah, last time around it was a pretty bad day.  The chart below illustrates just how dramatic the moves were relative to norms!

2015-08-28 Rolling 3 Day SD from 50DMA


On Monday 8/24 the markets experienced their biggest two and three day declines since the start of this bull  market. Tuesday 8/25 was the worst four day rate of change since the start of the bull market. There wasn’t a Mylanta, Zantac, Pepto or Tums to be found on shelves in Manhattan, with the Dow Jones Industrial Average getting hit the hardest, down 12.1% since the start of the year while the S&P 500 was down 9.29% and the NASDAQ was down 4.85%.

2015-08-25 US Indices

Just when all seemed lost, on Wednesday things started to turn around, with the S&P gaining more than on 99.3%  of all days in its history! So, yeah, it was a pretty good day. Thursday the S&P 500 was up the most over any two-day period during the recent bull market and was up more over the past five days than in 98.7% of all days in its history! By Friday the Dow Jones Industrial Average closed the week down 6.6% since the start of the year while the S&P 500 was down 3.4% and the NASDAQ was actually up 1.95%.

2015-08-28 US Indices

The market movement was so wild that the CBOE Volatility Index (VIX), a popular measure of implied volatility of the S&P 500 index options, rose 217% from August 14th to August 24thLast week alone it rose by 120%, which is the biggest rise in history! This was even more dramatic that what we experienced during the financial crisis! 


Market volatility has been like a 5-year old, locked in a tiny room, furiously chowing down on last year’s Halloween booty. The lock finally gave way and all you could do was let him have his tantrum!

One reason for the wild swings has been the absence of liquidity, which in a downward moving market simply means sellers can’t find a buyer… at any price.  This was in no small part due to the unintended consequences of Dodd-Frank a situation that many have been warning about for years to no avail.  While it became popular to malign proprietary trading by the banks post-financial crisis, that same proprietary trading has in the past provided the market with willing buyers, the banks, during times of market turmoil, which helped provide a price floor.  The new rules in Dodd-Frank prohibit much of such activity, so when folks panic, there is no one available on the bank trading desks to buy what investors are desperate to sell – the floor is no longer there. This time, it really is different.

All that got investors seriously nervous, with the daily outflows from equity funds hitting their highest levels since 2007 as folks panicked and sold, sold, sold.  For the entire week ending August 28th, nearly $30 billion left the equity markets which is the worst since Band of America Merrill Lynch has been recording data back in 2002.

All those that sold though, missed out on the turnaround in the second half of the week. The mid-week ThisWayThatWayturnaround was likely induced by a combination of New York Fed President Dudley’s comments that a September rate hike was “less compelling” than it was a few weeks prior, the actions taken by China to reflate its markets, and overall investor selling fatigue – markets never go straight down. We continue to be amazed at the continued contradictory statements coming out from the various Fed officials!   We still think that more volatility is more likely than not and suspect that the current shake out isn’t over quite just yet, but remember investing is always about probability, there are no certainties.

So, is this is just a correction within an ongoing bull market or has a new cyclical bear market begun? Only time will tell which is truly the case.  What we can say with a high level of confidence is that the initial decline in either case, will typically lead to a subsequent bounce and ultimately retest previous lows.  The big question is whether, with economic growth rates slowing and deflationary pressures building, will the Fed again intervene by postponing rate hikes and possibly even injecting liquidity as it has done for every prior market downturn during this cycle?  More on that later!

What caused such a rapid and large decline? 

Most people are pointing to the correction in China, both the economy and stocks, as the cause of the recent rout, but we think that is too simplistic. While we think it may have been the catalyst, the proverbial straw that broke the camel’s back, there are other realities that have been making a correction increasingly likely:

  • The discrepancy between earnings and top line revenue that has been going on for quite some time
  • Slowing global growth
Strong Economy, Really?

Strong Economy, Really?

Last week I pointed out that the data coming in wasn’t exactly painting a picture of an increasingly robust economy that would warrant the Fed tightening rates.

Last Thursday we learned that initial jobless claims rose again the last week of February to 320,000, significantly above expectations of 295,000. We also learned that US Factory orders fell 0.2% versus an expected increase of 0.2%. Friday we received impressive headline jobs data, but it didn’t exactly jive with much of the rest of what we are seeing in the economy and upon a closer look, the fall in the unemployment rate was driven more by people leaving the workforce than by new jobs, and those newly filled jobs were skewed towards lower paying industries.

Today we learned that retail sales fell for the third consecutive month in February as a mix of bad weather and consumer caution outweighed an improving labor market and cheap gasoline prices.  Sales at retailers and restaurants decreased 0.6% last month to a seasonally adjusted $437 billion, the Commerce Department said Thursday. Retail sales fell 0.8% in January and 0.9% in December.  We also learned that business inventories growth was flat in January versus expectations for 0.1% increase… but what is even more concerning is the sales to inventory ratio, which is back to where it was back in the depths of the financial crisis!

Inventory to Sales

So much for the economy getting back on track.

In fact, Tuesday the Wall Street Journal ran an article entitled “Recession’s Impact Lingers for Many States,” which pointed out that 30 states are still below their peak, pre-recession tax revenue receipts. The states that are actually above their last peak include North Dakota and Texas, which are likely to suffer going forward with the impact of plummeting oil prices. We’ve also seen US GDP expectations for Q1 tanking, (today’s retail numbers reinforcing this) with many forecasting in the 1.5% range, which given the increasingly soft data coming in, seems wise. Prior forecasts were north of 2% at the beginning of the year.

Additionally, inflation expectations remain firmly muted with yields indicating that investors expect US consumer prices to rise in the neighborhood of 1.7% a year for the next 10 years, dropping from 1.9% just last week – more of that dropping price thing. In addition, consumer credit growth is moderating, auto sales appear to be topping out and the Case-Shiller 20 city price index shows home price inflation has slowed to 4.5% year-over-year from 13.4% last year. So far, nothing screams out a need for tightening, particularly in light of the defacto tightening resulting from the rising dollar. In fact, if the Fed did tighten in June, it would be the first time in the past 30 years that it has done so with a rising dollar. We do see tightening also occurring on the fiscal side where the federal deficit is shrinking significantly.

The Euro has now dropped below $1.05 for the first time in about 12 years and is down around 33% from its highs against the dollar, last seen in April 2008 and down around 12% since the beginning of the year.


Tale of QE


As the ECB gets cranking on its 10-year sovereign debt purchases, yields have once again hit record lows yesterday in Germany, Belgium, the Netherlands, Italy, Ireland and Spain. The 10-year US Treasury rate at 2.2% is over 9.5x the 10-year bund, a phenomenon never before seen. With the US one of the few places to get any kind of yield on sovereign debt, it is unlikely that dollar strengthening will cease. So not only do foreign investors get better yields in the US, the dollar is most likely strengthening against your currency, jacking up returns even more.


Diverging monetary policies are continuing to affect domestic equity markets as we see the US materially underperforming Europe and Japan in 2015, which is a complete reversal from 2014. Monetary policy clearly continues to dominate equity markets post-financial crisis. We believe this is likely to continue further into 2015, making international market indices more attractive. Investors can access these market easily through ETFs such as the relatively new Recon Capital DAX Germany (DAX), iShares MSCI France Index (EWQ) or MAXIS Nikkei 225 Index ETF (NKY).




Just what data is the Fed seeing?

Just what data is the Fed seeing?

Funny-Images-33On Monday March 3rd, the NASDAQ closed above 5,000 for the first time since 2000, while the S&P 500 and the Dow Jones Industrial Average also reached new record highs, which would lead one to think that things are going pretty darn well. According to Chris Verrone of Strategas Research Partners, 70% of US stocks are currently in an uptrend. In comparison, at the NASDAQ’s previous March 2000 peak only 25% of stocks were in an uptrend.

Unfortunately outside of the US, central bankers don’t look like they are feeling quite as rosy as American equity investors. So far in 2015 at least 21 central banks have lowered their key interest rates in an attempt to strengthen their economies. China surprised the markets with a rate cut last weekend, after having early in February made a system-wide cut to bank reserves. India cut its main interest rates just last week for the second time in less than two months followed by Poland, which cut rates March 4th. So much for a growing global economy, and our view is if the guys in the center of it all think the punch bowl needs to be spiked, perhaps we need to look deeper.

Just what data is the Fed seeing?

Last week Janet-I’m-not-tellin-Yellen reported the domestic economy is looking better, not great, but better. We’re wondering just what data she was looking at because so far this week alone we’ve seen the following:

  • Monday we learned that Personal Income rose less than expected, (0.3% vs. expectations of 0.4%) while Personal Spending came in below expectations, (-0.2% vs. expectations of -0.1%) in January. That’s two in a row for spending whiffing it.
  • Markit Manufacturing PMI beat expectations, up from 53.9 to 55.1 vs. expectations of 54.3.
  • ISM manufacturing index fell in February to 52.9 from 53.5, for the fourth consecutive monthly decline
  • ISM non-manufacturing index beat expectations at 56.9 in February vs. 56.5 estimates.
  • Construction spending unexpectedly fell1% in January.
  • Six of the top seven auto manufacturers on Tuesday reported year-over-year sales increases in February, but all fell short of expectations.
  • This morning we learned private-sector job creation for February was below expectations with companies adding 212,000 positions versus expectations of 220,000 while also dropping from the 250,000 in January.
  • U.S. crude oil supplies rose to yet another record high last week, with crude-oil stocks at their highest level since 1982 on a weekly basis. Stockpiles rose by 46,000 barrels during the week versus expectations of a 1.8 million drop; keep in mind we’ve already seen operational oil rigs drop by about 1/3.

Well what about prior reports? From the economic data released during the month of February, forty-two were below expectations, (the aforementioned personal spending, construction spending, factory orders, retail sales, business inventories, housing starts, building permits, industrial production, and capacity utilization) while only six beat expectations, (including nonfarm payrolls, Case-Shiller Home prices and Markit Manufacturing PMI). Kinda makes one wonder exactly what Yellen was looking at let alone feeling good about.

Oh wait, there’s the love! Turns out there is no lack of (at least) self-love in the markets as companies last month announced a record $104.3 billion in planned repurchases, which is the most since TrimTabs Investment Research began tracking the data in 1995 and nearly twice the $55 billion from last year. To put that number in context, buybacks will amount to about $5 billion in purchases every day, which is about 2% of the value of all shares traded on U.S. exchanges, according to Bloomberg, which also estimates that earnings from S&P500 members will decline by at least 3.2% this quarter and next, with full year growth at 2.3% versus 5% in 2014.   With executive pay often linked to share price, it shouldn’t come as a surprise that companies in the S&P 500 spent about 95% of their earnings on repurchases and dividends in 2014… oh did we just say that out loud?

In the bond market, negative bond yields currently account for about $2 trillion of debt issued across Europe. Just this week Germany sold five-year bonds at a negative rate for the first time ever. Why would anyone buy bonds with negative yields? The ECB is set to begin rather large purchases of sovereign bonds in the coming months, which will likely push yields even lower. That could allow a negative yielding bond to actually experience a capital gain as bond prices are pushed lower. The ECBs move is also likely to push the euro even lower against the dollar, and as we discussed at the opening of this piece, central banks around the world are lowering their rates, which devalue their currencies… at least relative to currencies that aren’t lowering rates, which right now is basically the dollar. All this is a surreptitiousness form of monetary tightening, of which we are sure the Fed is well aware.

But what about last Friday’s (March 7th release) February Employment report.  The headline for the jobs report boasted 295,000 jobs being created during February, a big beat relative to the 240,000 jobs economist forecasted. The second headline pointed to a drop in the Unemployment Rate to 5.5%. That got everyone in an excited tizzy that the economy is finally really going strong and oh goody-goody-goody we can’t wait to see the next retail sales report!

As always, it pays to dig a bit deeper.  When we do, we find a lot of people continued to drop out of the labor force in February and that was the real driver behind the drop in the unemployment rate. Tough to argue that the jobs situation is all champagne and roses when lots of people decide it just isn’t worth it.  The chart below says it all – unemployment rate falling right along with those who simply leave the workforce.

umeployment and participation

Additionally, wage growth was once again modest in February with a pittance 0.1% increase. Hours worked during February declined, which could be thanks to the snowy weather and port disruptions – we continue to hear from companies like Macy’s (M), Gap (GPS) and others that both will weigh on growth in the current quarter.  The number of construction jobs created in February fell 40% month-over-month.

Most importantly the quality of jobs created remains problematic as leisure & hospitality was the big winner in February, continuing the trend we’ve been watching for some time as a good portion of the post-crisis job creation has been of lower quality than the jobs that were lost. For example, mining/logging lost 8,000 jobs, (which tend to be higher paying) while retailers (which tend to be lower paying) contributed 32,000 jobs. Makes you think about just how many “Do you have this in a small” jobs it takes to replace one highly skilled mining job. On that note, if the job situation is so rosy, why has personal spending declined for two months in a row?