On revision second quarter U.S. GDP revised up to 3.7% from 2.3%–and U.S. stocks are off and running
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.
I usually start these brief recaps of stuff I’ve posted on my paid site with the phrase “What I’m thinking about today besides…” But today I’m not really thinking about anything but the rout in global stocks.
So it’s more appropriate to slug this post with a head that begins “Other takes” on today’s market, besides the general market view that I’ve posted here today.
In my regular Saturday Night Quarterback look at the week ahead I noted that normally we’d expect a bounce on a Monday after a two-day rout like that which ended last week. A bounce wouldn’t signal that the coast was clear, but the lack of a bounce would tell us that traders and investors were so fearful that they weren’t the slightest bit interested in bargain hunting and that we had a way to go before we could think about a bottom. I think today’s reaction in global markets and even the U.S. indicates deep, deep fear.
You’ll find evidence for that view in the extraordinary performance of the VIX volatility index, sometimes called the fear index. The index closed Friday at 28.03 and then soared to an intraday high of 53.29–indicating a huge increase in fear since the index tracks the price that traders and investors are willing to pay for options providing protection against a drop in the S&P 500. The VIX closed at 40.74 today for an extraordinary move of 45.34%. On the JubakAM.com site I recommended closing the trade in VIX options that I’d suggested on July 21. VIX options purchased that day for 83 cents closed today at $6.60. I’m no options trader but I’ve been following the VIX closely this year. On July 21 the VIX closed at 12.69, an extremely low level of volatility. I didn’t think the VIX would stay so low with the Federal Reserve set to meet on interest rates on September 17. I certainly didn’t predict that the Chinese stock market would tank global stocks.
And also on JubakAM.com I noted that I thought this correction/bear/whatever had moved into a new stage where instead of just taking profits in momentum stocks that had climbed the most in 2015, traders and investors had started to sell on liquidity. Selling a stock like say Netflix (NFLX) that would be easy to sell because it traded in volume makes sense at this stage because it will also be easy to buy it back when the coast is clear. I suggested three other stocks in the technology sector that on the basis of today’s action seemed to be part of a liquidity trade. In passing I also noted Apple CEO Tim Cook’s extraordinary email to CNBC’s Jim Cramer telling Cramer that iPhone sales in China had picked up in recent weeks. That kind of email to someone who co-manages a portfolio would seem to be at best on the shaky edge of security rules–and testifies to Apple’s worry about iPhone sales in China this quarter..
Just thought I’d let you know what I’m working on at JubakAM.com–I think there’s some value to you in passing on the direction of my thinking about this market on that site. Hope so anyway.
And, of course, there’s an ulterior motive: If you decide that you’d like more detail on those posts, I’m hoping that you’ll subscribe to my site at JubakAM.com for $199 a year. (By the way, you can get a full refund during the first seven days if you change your mind for any reason.)
Today, August 24, has been like two days (maybe three) in one. (Yesterday in my Saturday Night Quarterback post on my paid JubakAM.com site I told readers to watch to see if Monday brought a bounce or a continued decline. Well… how about both?)
First, there was the continued global rout that began in Asia—with the Shanghai Composite index closing down 8.49% and even the Japanese Nikkei 225 index participating in the downturn with a loss of 4.6%.
U.S. stocks opened hugely lower with the Dow Jones Industrial Average plunging 1000 points at the open for a 6.6% loss and the Standard & Poor’s 500 tumbling to a 5.3% decline. But then U.S. stocks rallied into midday and held on to much of those gains so that at 2:30 p.m. New York time the Dow was “only” off by 363.5 points (2.21%) and the Standard & Poor’s was down “only 2.64%.
And then, as U.S.markets moved toward the close, U.S. stocks fell again with the Dow Jones Industrial Average down 3.57% at the close and the S&P 500 falling by 3.94%. The swing in the NASDAQ was even wilder with a 6.6% loss “rallying” to a 2.16% loss by 2:30 p.m and then falling to a 3.82% loss as of the close.
There is actually some logic to the day’s action. The big worry is slowing global growth with the epicenter for that potential financial earthquake in China’s economy. So it’s “logical” that Shanghai would take the worst of the hit and that economies that export a lot to China would fall in concert. Europe’s biggest export economy, Germany, saw its DAX stock index down 4.7% at the close.
On the other hand, once traders and investors had a chance to get over their early shock at yet another big down day in Shanghai, it was “logical” for U.S. stocks to take back much of their early losses. The U.S. economy looks to be growing at a better than expected—if still modest rate—in the second and third quarters and with its huge domestic market, the U.S. economy has proportionately less exposure to global export growth or decline. Certainly a 2.2% loss in the Dow Industrial Average is nothing to cheer about, but it is nonetheless a comparatively better performance.
Volatility on the S&P 500 as measured by the CBOE volatility index, the VIX, soared in the morning to 53.29 as of 9:55 a.m. from a prior close at 28.03 before moving up again to 35.13 as of 2:30. That’s still a 43% pop in what is known as the fear index but that’s still a lot better than the 90% jump in the index at its high. (A higher index number indicates that options on the S&P 500 have moved up in price as more traders and investors decide to buy in order to hedge against market volatility.)
The rally within a down day didn’t stem the commodity markets from turning in another dismal performance. U.S. benchmark West Texas Intermediate crude, which breached the psychologically important $40 a barrel price intraday on Friday fell another 3.73% as of 2:30 p.m. New York time to $38.94 a barrel. Brent benchmark crude fell 4.18% to $43.56 a barrel. That move and the continued closing of the price gap between the U.S and the Brent global benchmark also has its logic if the U.S. economy will turn in relatively better growth than the global economy.
The Bloomberg Commodity Index fell to its lowest level since August 1999. Copper prices, a key indicator of expectations for global growth, fell 4% to the lowest level since 2009 on the London Metal Exchange.
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
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.