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From WSJ:
The pace of job creation remained robust in February, with payrolls rising by a seasonally adjusted 235,000 new jobs, the Labor Department said.
Evidence of continued health in the U.S. labor market likely cleared the way for the Federal Reserve to raise short-term interest rates next week. The unemployment rate ticked down to 4.7%, as both workforce participation and employment rose….
Source: Robust Job Growth, Higher Wages Show Solid Labor Market – WSJ
From WSJ:
Federal Reserve Chairwoman Janet Yellen signaled the central bank is likely to raise short-term interest rates at its March meeting and suggested more increases are likely this year if the economy performs as expected.
“At our meeting later this month, the [Federal Open Market] Committee will evaluate whether employment and inflation are continuing to evolve in line with our expectations, in which case a further adjustment of the federal funds rate would likely be appropriate,” Ms. Yellen said in remarks prepared for delivery at the Executives’ Club of Chicago.
The Dollar Index rally continues to meet resistance, with tall shadows on the last three weekly candles signaling selling pressure. Rising interest rates would strengthen the advance, with bearish consequences for gold.
Spot Gold hesitated at $1250/ounce. Rising interest rates also increase the opportunity cost of holding precious metals. Reversal below $1200 would warn of another decline but recovery above $1250 remains more likely and would signal an advance to $1300.
Retail sales are surging, with Retail & Food (ex-Motor Vehicles) growing above 5% a year for the first time since 2012.
Light vehicles sales are back at their 2000-2006 norm of 17.5 million units a year, reflecting consumer confidence.
Housing remains soft but growth in new starts and building permits continues.
Durable goods orders are also soft but unlikely to remain so if retail sales growth continues.
Inflationary pressures are likely to rise. Which is why the Fed expects to increase the pace of interest rate hikes in 2017.
Dow Jones Industrial Average closed the week above 21000 for the first time. Twelve months ago the index was at 17000, an increase of 23.5 percent. Shallow retracements since then signal buying pressure, highlighted by Twiggs Money Flow troughs above zero. The latest trough, higher than zero, reflects growing enthusiasm from investors.
Prices are rising faster than earnings in expectation of future growth. Clearly the Dow is in Phase III of a Bull Market. As I pointed out in December, this could last for several years.
Two interesting graphs on inflation from Niels Jensen at Absolute Return Partners:
….similarities between the story unfolding in the UK and the one in the US. Core inflation in both countries is significantly higher than it is in the Eurozone – just above 2% in the US and just below 2% in the UK whereas, in the Eurozone, it is only 0.9%. Furthermore, services are very much the engine that drives core inflation in both the UK and the US (exhibit 6).
Exhibit 6: The drivers of core inflation (US only)Source: The Daily Shot, BEA, Bureau of Labor Statistics, Haver Analytics, February 2017. Data as of December 2016
To a very significant degree that is down to rising medical care costs (exhibit 7). As the populace ages, this can only get worse – at least in the US, where almost all healthcare is provided privately and paid for by insurance companies.
Exhibit 7: US personal consumption expenditures by component (%)
Source: The Daily Shot, BEA, Haver Analytics, February 2017
Source: A Note on Inflation: Is it here or isn’t it? – The Absolute Return Letter
Dow Jones Industrial Average continues to climb, heading for a target of 21000. Rising troughs on Twiggs Money Flow signal strong buying pressure.
The S&P 500 follows a similar path.
With the CBOE Volatility Index (VIX) close to historic lows around 10 percent.
However, at least one investment manager, Bob Doll, is growing more cautious:
“…we think the easy gains for equities are in the rearview mirror and we are growing less positive toward the stock market. We do not believe the current bull market has ended, but the pace and magnitude of the gains we have seen over the past year are unlikely to persist.”
Bob Doll’s view is reinforced by recent developments with the S&P 500 Forward Price-Earnings Ratio. I remarked at the beginning of February that the Forward P/E had dropped below 20, signaling a time to invest.
Actual earnings results, however, have come in below earlier estimates — shown by the difference between the first of the purple (latest estimate) and orange bars (04Feb2017) on the chart below.
In the mean time the S&P 500 index has continued to climb, driving the Forward P/E up towards 20.
This is not yet cause for alarm. We are only one month away from the end of the quarter, when Forward P/E is again expected to dip as the next quarter’s earnings (Q1 2018) are taken into account.
But there are two events that would be cause for concern:
Either of the above could cause Forward P/E to rise above 20, reflecting over-priced stocks.
Be fearful when others are greedy and greedy only when others are fearful.
~ Warren Buffett
10-Year Treasury Yields are testing support at 2.30%. Expect this to hold. Breach of the rising trendline would warn of a correction but this seems unlikely with the Fed intent on normalizing interest rates. Breakout above 2.50% would offer a target of 3.0%.
The Dollar Index rally remains muted since finding support at 100. Rising long-term yields would fuel the advance, with bearish consequences for gold.
China’s Yuan is consolidating. Resistance on USDCNY at 7 Yuan is likely to be tested soon.
The PBOC has been burning through its foreign reserves to slow the rate of depreciation against the Dollar, to create a soft landing. A sharp fall would destabilize global financial markets and fuel capital flight from China.
Spot Gold broke through resistance at $1250, signaling an advance to $1300.
RBA governor Phil Lowe recently made a speech comparing the experiences of Australia and Canada over the last decade. Both have undergone a resources and housing boom. Four charts highlight the differences and similarities between the two countries.
Australia’s spike in mining investment during the resources boom did serious damage to non-mining investment while Canada’s smaller boom had no impact.
Immigration fueled a spike in population growth in Australia, adding pressure on infrastructure and housing.
Both countries are experiencing a housing bubble, fueled by low interest rates and lately by export of China’s property bubble, with capital fleeing China and driving up house prices in the two countries.
Record levels of household debt make the situation more precarious and vulnerable to a correction.
Hat tip to David Llewellyn-Smith at Macrobusiness
Great headline from Bob Doll (Nuveen Investments) latest newsletter.
“….we think the easy gains for equities are in the rearview mirror and we are growing less positive toward the stock market. We do not believe the current bull market has ended, but the pace and magnitude of the gains we have seen over the past year are unlikely to persist.”
His key points:
We believe investors are overly complacent about the state of the global economy and the political backdrop.
We remain cautiously optimistic toward equities, but think the pace of recent gains is unlikely to persist and that risks will rise this year.
Still positive on the economy but wary of the political backdrop seems a common theme among investment managers. The timing of any reversal (Doll: 2018) will largely be determined by inflation and interest rates.
The yield curve is one of the best predictors of US economic recessions. Every time the yield curve has turned negative in the last fifty years, a recession has followed.
First of all, what is a yield curve? It is the plot of yields on bonds, normally Treasuries, against their maturities. Long maturity bonds are expected to have higher yields than short-term bills, to compensate for the increased risk (primarily of interest rate changes). If you tie your money up for longer, you would expect a higher return. Hence a rising yield curve.
A rising yield curve is a major source of profit to the banks as their funding is mostly short-term while they charge long-term rates to borrowers, pocketing a healthy interest margin.
When the Fed steps into the market, however, restricting the flow of money into the economy, then short-term rates rise faster than long-term rates and the yield curve can invert (referred to as a negative yield curve).
Bank interest margins are squeezed — it is no longer profitable to borrow short and lend long — and they restrict the flow of new credit.
Credit is the lifeblood of the economy and activity slows.
The chart below compares US recessions to the yield differential: the difference between 10-year Treasury yields and the yield on 3-month T-bills. The yield differential falls below zero when 3-month T-bills yield more than 10-year T-notes.
You can see that every time the yield differential dips below zero it is followed by a gray bar indicating a recession. There is one exception: the phantom recession of 1966 when the S&P 500 fell 22%. This was originally certified as a recession by the NBER but they later changed their mind and airbrushed it out of history.
You can also see that the yield differential is declining at present but, at 2.0%, it is a long way from a flat or negative yield curve. This supports my argument last week that current Fed rate hikes are more about normalizing interest rates than about monetary tightening.
That could change in the future but at present the bull market still appears to have plenty in the tank.
Corporate bond spreads — the yield difference between high-grade corporate bonds and the risk-free Treasury rate — are another useful indicator of the state of the economy.
Wide bond spreads indicate increased risk of corporate default. Investors are concerned about the state of the economy and demand a higher premium for taking credit risk.
Narrow spreads suggest that credit premiums are low and confidence in the economy is good.
If we examine the chart below, bond spreads are declining, indicating confidence in the US economy, with even the lowest investment grade BBB dipping below 150 basis points (or 1.50%). This is synonymous with a bull market.
Australian corporate bond spreads are higher than the US, with BBB still at 200 bps. They have also declined over the last year but seem to be trending upward from their 2013 low. This is not conclusive as the current trough is not yet complete, but a higher low would warn that credit risk is rising.
Only when the tide goes out do you discover who’s been swimming naked.
~ Warren Buffett
