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On revision second quarter U.S. GDP revised up to 3.7% from 2.3%–and U.S. stocks are off and running

posted on August 27, 2015 at 7:47 pm

Back on August 22 I posted that it looked like second quarter U.S. GDP growth would get revised upwards in a release scheduled for today, August 27. The initial estimate of 2.3% annualized growth could get revised upwards by as much as a full percentage point, I wrote.

Boy, was I wrong. Second quarter growth was revised upwards today to an 3.7% annualized rate, an increase of 1.4 percentage points from the prior estimate. None of the economists surveyed by Bloomberg forecast that big a revision. In addition, contracts to purchase previously owned homes climbed in July for the sixth time in the last seven months.

On the good news, U.S. stocks climbed with the Standard & Poor’s 500 up by 2.43 at the close and the Dow Jones Industrial Average ahead by 2.27%. (It didn’t hurt that China’s markets staged a big rally overnight, with the Shanghai Composite climbing 5.34%. That gave U.S. stocks plenty of upward momentum at the open.

So far, at least, I haven’t seen any comments suggesting that the higher than expected 3.7% growth rate might be strong enough to put a September interest rate increase back on the table. The consensus, which I don’t agree with, is that that ship has sailed.

One reason that I’m hearing today for thinking that this stronger than expected growth won’t lead the Fed to act in September is the fragility of the financial markets. Analysts raising that point aren’t gesturing at the Chinese equity markets but at the U.S. credit markets. The spread between the yields on high-yield bonds and Treasuries has expanded to 600 basis points (or 6 percentage points) as investors ramp up their anxiety about rising defaults, especially in the energy sector. Even taking out energy high yield bonds, also known as junk bonds, the spread to Treasuries is 100 basis points higher than a year ago. Does the Federal Reserve want to raise interest rates, they ask, when the debt markets are looking so shaky—at least in the high yield sector?

Volatility, which had spiked hard earlier in the weak, continued to fall with the Chicago Board Options Exchange Volatility Index, the VIX, declining today by another 9.2% to 27.52 after a 14% drop the day before. That’s quite a reversal from the charge in volatility that saw the VIX climb to its highest level since October 2011.

What is now a two-day rally in U.S. stocks put the S&P 500 on a path to its strongest back-to-back advance of the six-year bull market.

Is a September interest rate increase from the Fed really off the table? The consensus believes it is

posted on August 26, 2015 at 7:51 pm

The consensus now says that the Federal Reserve won’t raise interest rates—for the first time since 2006—when it’s Open Market Committee meets on September 17.

On August 18, the Fed funds futures market pointed to an almost 50/50 chance (48%) of a September move in interest rates off the current zero rate that has held since 2008.

On August 25, the odds had fallen to just 28%. And markets were giving an increase in 2015 at all just a 50/50 chance. That was down from 73% on August 18.

The consensus vote is now for an initial rate increase in March 2016 (72%).

That’s what a renewed bear market in Chinese equities, a continued meltdown in emerging market stocks and currencies, and the fall of U.S. indexes into a technical (10% decline) correction will do to sentiment.

The markets—and in this case I think that means the big players on Wall Street—have decided that the Fed won’t risk adding to market turmoil by increasing interest rates in September.

There are good reasons to think that the current consensus is wrong. Wall Street may be voting its own hopes rather than coolly calculating the odds.

Why do I think the consensus might be wrong?

  • The Chinese meltdown hasn’t significantly weakened the U.S. economy—and the strength of the U.S. economy, particularly the strength of the U.S. labor market—is the single biggest feature in the Fed’s calculations. Today government numbers showed, for example, that orders for capital goods, the stuff that companies use to make stuff, rose in July by the most in more than a year. Orders for all durable goods—that’s stuff that’s meant to last for more than three years–climbed by 2%. That was stronger than any forecast by any economist surveyed by Bloomberg. And there’s a very good chance that on next revision GDP growth for the second quarter will get a big upward revision.
  • The Fed would really like to disabuse the stock market of its belief that every time markets flag the central bank will ride to the rescue. A strong belief that the Fed (and other central banks) will shower the markets with cheap cash whenever they get into trouble is a key market belief from the years following the Global Financial Crisis. The Fed would like to eat away at that certainty—because the central bank sees it as a key element in creating asset bubbles.
  • If not now, when? It’s not like the problems in the Chinese economy and financial system or the weakness in emerging market economies and currencies will end in just a few weeks. What is supposed to change that will make raising interest rates “better” in March?
  • We’re only talking about 25 basis points (100 basis points equals one percentage point) in any initial interest rate increase. Much of that has already been anticipated by the markets. And an interest rate increase of that size off of a base near 0% isn’t going to change conditions very much
  • The Fed has so thoroughly signaled a September or at least a 2015 interest rate increase that Janet Yellen and crew at the Fed may well feel the central bank’s credibility is at stake.

That’s not to say there aren’t reasons to believe the Fed will stay its hand—at least for September. Emerging markets and their currencies are indeed very fragile after China’s devaluation of the yuan. Countries such as Brazil and Turkey and Russia don’t need even 25 basis points in extra inducement for money to flow into dollars and out of the real, lira, and ruble. And we know that the current global financial market is so nervous that even a minor move—like a 4.5% devaluation of the yuan versus the dollar—can have huge unexpected effects.

The best near-term indicator of the Fed’s intentions is likely to be Federal Reserve vice-chairman Stanley Fischer ‘s Saturday appearance on a panel at the Kansas City Fed’s annual Jackson Hole conference. (Fischer, as of the current schedule, will be the senior Fed figure present since chair Janet Yellen isn’t scheduled to attend. Speculate all you want about what that means. European Central Bank president Mario Draghi is, so far, scheduled to be absent as well.)

If Fischer focuses on the strength in the U.S. economy and, in particular, on the solid gains in the U.S. labor market, it will be read as an endorsement of a September increase. Comments that indicate the Fed sees current dollar strength and low oil prices as “transitory” will also be seen as signs that the Fed is leaning toward a September move.

In the current very sensitive market, Fischer comments that point to a September increase could well set off another round of losses in emerging markets and China in the days after the Jackson Hole conference. I remain convinced, however, that in the longer run putting in place the first interest rate increase of a very modest 25 basis points is likely to help stabilize global markets. Putting the increase in the books and observing that global markets and currencies haven’t collapsed would be a very positive step toward stabilizing these financial markets.

Worth following Fischer’s comments at Jackson Hole? You bet.

After Friday’s global stock debacle–where do we go from here?

posted on August 22, 2015 at 4:53 pm

The selling Friday started in China as fears of a slowdown in economic growth in that country intensified worries that the global economy was headed for a serious slump.

On a big picture level, the flash manufacturing purchasing managers index from Caixin/Markit economics dropped to 47.1 in August from 47.8 in July. (Anything below 50 indicates contraction.) The drop in the sector index was the fastest decline in six years and marks the lowest level since March 2009. On an industry/sector level market research Gartner reported that quarterly sales of smartphones had dropped for the first time ever.

The immediate result was a 4.3% drop in the Shanghai Composite Index. At Friday’s close of 3507.7 the index is again deep into bear market territory with a decline of 31.5% sine the June 11 high of 5121.6.

It didn’t take long for fears of slowing growth in China to ripple out across global markets in everything for oil (U.S. benchmark West Texas Intermediate fell another 2.17% at the close to $40.45 a barrel after trading a low as $39.86 a barrel in intraday trading) to technology. Apple (AAPL) let the U.S. technology sector lower with a 6.1% retreat (pushing the stock into bear market territory with a 20% decline.) The semiconductor sector fell into a bear market too. Technology momentum stocks, such a Netflix (NFLX) plunged. Shares of Netflix dropped 7.6% on Friday. Internet security high-flyer FireEye (FEYE) retreated 8.1%.

The Dow Jones Industrial Average fell into 10% correction territory from its May high. The Standard & Poor’s 500 stock index finished lower by 5.5% for the week.

That’s all history, of course—although it is very recent history. What you want to know now is where stocks go from here.

Start with a recognition that the drop of last week (and not just Friday) has done considerable damage to the structure of global stock markets. Sectors all across the U.S. market—biotech and media, as well as semiconductors–are in correction, which always raises fears that a 10% correction will turn into a 20% bear market drop. U.S. stocks have clearly broken out of the narrow 150-point trading range that has dominated the year—to the downside—and major markets are setting major lows. The NASDAQ Composite index, for example, made a six-month low. Individual U.S. stocks have fallen below support at 50-day or even 200-day moving averages and market leaders such as Apple are in bear markets. (I’d add in the huge bear market drop in Alibaba (BABA) on the New York market with shares down 42.8% from their November 10 peak and down 26.9% from the May 22 high.) Indicators such as the CBOE VIX volatility index soared last week with the VIX climbing 46% to 28.03 (a 118% gain for the week) as lots of investors and traders bought options to protect their portfolios. If nothing else that’s an indicator that traders are looking for continued high levels of volatility in the weeks ahead of the September 17 meeting of the Federal Reserve.

Add in a bear market in emerging markets that has continued to punish the usual suspects (Brazil and Malaysia) and that continues to suck in new victims. The Turkish lira, for example, finished the week at historic lows against the U.S. dollar.

Factor in what looks like a lengthy period of confusing signals about growth. It’s likely to be quarters before growth in China rebounds or at least settles down enough so that traders and investors stop worrying that this locomotive of the global economy isn’t about to suffer a train wreck. Most forecasts for the next few quarters point to China’s growth falling to 6.8% or less, significantly below the official target of 7%. There’s nothing wrong with 6.8% growth—except that once traders see the Chinese economy breach 7%, it’s going to take a few quarters of 6.8% or 6.6% growth to convince them that 6.8% isn’t a prelude to a descent to 6.4% or 6.2% or even lower. Fortunately, there’s a good chance that the next quarter or two will produce stronger growth data in the United States. Number crunchers who look study the way that later data moves preliminary reports of GDP growth up or down say there’s a reasonable chance that the 2.3% annual growth reported so far for the second quarter will get revised upward when more complete figures and a new GDP growth rate are reported on August 27. The upward revision, some economists say, could be as high as full percentage point. Investors and traders will get their first read on third quarter GDP growth On October 29. (After the Fed decides on interest rates in September, by the way.) On August 18 the Federal Reserve Bank of Atlanta released its latest forecast for third quarter GDP growth. The Atlanta Fed forecast just 1.3% growth—which certainly seems disappointing, until you realize that this forecast is up from 0.7% in the August 13 forecast. There is the possibility that the trend is running toward higher growth and that we’re looking at better than expected growth in the third quarter. Growth of better than 3% on revised numbers for the second quarter and something above 2% for the third quarter for the U.S. is going to look pretty good in a slow growth global economy and those also going to say that there’s another growth engine available besides China. Of course, we won’t actually have the data to dispel fears and back up hopes until the end of August and the end of October.

Finally, those two dates for more GDP data neatly bracket the September decision to raise interest rates of not by the Fed. It’s hard for me to see markets settling down until after that Fed decision. Until then worries about will the Fed, won’t the Fed will be, at the least, a significant amplifier for worries about global growth.

I can’t say that global markets are going lower from here with certainty. The trends—worry about growth in China and in emerging market economies, worry about a war of competitive currency devaluations, worry about U.S. economic growth, worry about a Federal Reserve interest rate move (and worry about the possibility of a lack of a Fed move)—all seem to point lower. (And I haven’t even mentioned the continued rout in commodities.) And don’t see any immediate upside trends until we get data in the fall or later on growth in the United States and China.

The prognosis, in my opinion, is continued volatility that nets out to a drift lower for global equities including the U.S. markets until the September Fed meeting.

Economy adds 215,000 jobs in July; market sees September interest rate increase from the Fed as more likely

posted on August 7, 2015 at 10:43 pm

Companies added 215,000 jobs in July and the unemployment rate held at a seven-year low of 5.3%, the U.S. government announced today, August 7.

That was slightly below the median forecast of 225,000 net new jobs among economists surveyed by Bloomberg, but it is certainly strong enough to support belief in a September schedule for the first interest rate increase by the Federal Reserve since 2006. Forecasts by economists surveyed had ranged from a low of 140,000 to a high of 310,000.

The financial markets are behaving today like this report confirms the growing consensus of a September increase—but a very modest increase that would be usher in a very slow flight path toward higher interest rates.

Oil, which is good proxy for market sentiment these days since the price sinks when it looks more likely that the Fed will raise rates, (which would lead to a stronger dollar and lower prices for dollar-denominated commodities such as oil) dropped again today. U.S. benchmark West Texas Intermediate fell another 1.86% to $43.83 a barrel and the Brent benchmark declined about 1.9% to $48.58 a barrel.

That takes the price of oil back to its January 2015 lows. On January 28 West Texas Intermediate hit $43.70 a barrel. And the drop sets up an “interesting” test of those lows next week. Traders looking to play a bounce might decide that a return to the January lows is in indicator that going long now is the more potentially profitable trade. On the other hand, the dollar could well strengthen further next week. That, combined with news of lackluster growth in global economies, might be enough to keep oil moving lower.

As I said, an “interesting” week.

The VIX (the Chicago Board Options Exchange SPX Volatility Index) has been moving upward over the last week in a reflection of the increasing uncertainties in the direction of the markets. The VIX, sometimes called the fear index, is still at an extraordinarily low level, showing that markets are a long way from fear. But the index is up from 12.13 on July 30 to 14.08 today, ahead another 2.25% for today’s session as traders and investors bid up the price of options on the S&P 500 in order to hedge risk in the market.

Wall Street looks for winners and losers in Round 2 of the Fed’s stress test next week

posted on March 21, 2014 at 6:46 pm

So what U.S. banks will be the winners—and which the losers—when the Federal Reserve releases Round 2 of its stress test data on March 26?

Yesterday’s Round 1 looked at 30 big U.S banks to see which met the Fed’s capital targets in the event of a U.S. financial and economic crisis. Only Zions Bancorp (ZION) railed to meet the Fed’s target. In the event of a crisis Zion’s capital ratio would fall to 3.5%. That’s below the 5% minimum set by the Fed.

Today Wall Street has moved on to look at next week’s test. On Wednesday the U.S. central bank will announce which of the 30 banks on the list have won approval for their capital plans for 2014. Banks winning approval will be able to go ahead with plans for share buybacks and increased dividend payouts. Banks that fail to win approval will have to put buybacks and dividend payouts (or at least increases in dividend payouts) on hold while they resubmit plans for raising capital and for distributing it to shareholders.

Zions Bancorp isn’t the only bank in danger of getting a “No” from the Fed next week. Bank of America (BAC), Morgan Stanley (MS), Goldman Sachs (GS), and JPMorgan Chase (JPM) all came in with capital ratios below 7% in the Fed’s test. That puts them relatively close to the 5% limit and might lead the Fed to veto their plans for buybacks and dividend increases. Last year the Fed gave an initial “No” to both Bank of America and Citigroup (C). (Citigroup is a member of my Jubak’s Picks portfolio http://jubakpicks.com/the-jubak-picks/ )

The capital ratio under the Fed’s stress test isn’t a straightforward indicator of how the Fed will rule. The central bank will also consider the capital distribution plans submitted by individual banks and how much capital buffer any plan would leave. For example, the consensus among Wall Street analysts is that the Fed will approve the plan from JPMorgan Chase because it projects distributing only about $10 billion from the bank’s $17 billion capital buffer above the Fed’s stress test minimum.

The consensus also points to Bank of America as the closest to a potential veto. Read more

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