Monthly Archives: September 2016

Buy, buy, buy… a lot of investors were pushing the buy button last week as risk assets, safe haven assets and inflation-sensitive assets (precious metals and commodities) all increased in price. Perhaps it was the generally supportive message from central bankers…. Whatever the reason, investors were ebullient last week. Global equities rose better than 2%, while large cap domestic equities increased by 1.2% and small cap stocks by 2.5%.  Investors also snapped up US Treasuries (moving the yield on the UST 10-year down to 1.62%, yields move inversely with bond prices) which even at 1.6% offer a substantially juicier yield than most other developed market fixed income instruments offering a yield of near, or less than, zero. The price of crude oil also moved higher as rumors circulated that OPEC members might agree to limit production at today’s meeting in Algeria. We’ve seen this movie before, so OPEC will remain guilty until proven otherwise about supporting a higher price for oil. At about $45 per barrel, WTI Crude is smack in the middle of the $40 – $50 trading range it has maintained over the last three months.

For a more detailed view of weekly, month-to-date and year-to-date asset class performance, please click here.


A tale of two banks: Last Wednesday was a central bank doubleheader as both the Bank of Japan (BOJ) and the Federal Reserve Open Market Committee (FOMC) held meetings on the same day. Neither bank did much on the surface, but looking deeper one can deduce that the central bankers are beginning to bump up against the limits that monetary policy can have on engendering real economic growth.

As you likely know the FOMC did not raise interest rates last week. However, the accompanying FOMC statement was rather hawkish, indicating the committee would like to increase interest rates in the near term. If the economic data holds up, odds favor the Fed moving rates higher by 0.25% at their December meeting. What may be of more importance is that the FOMC’s forward guidance on interest rates is falling faster than ever now, which is in effect a form of monetary policy easing relative to previous forecasts. The chart below compares the FOMC’s projection of the path of the Fed Funds Rate from June of this year and then updated as of their meeting last week.



Source: BCA Research

The first observation to make in this chart is that the FOMC continues to move their forward expectations lower, the downward shift in the forecasts from June (blue dotted line) to September (black solid line) is just the latest example. The second observation is that the market has continually forecast a Fed Funds rate anchored at much lower levels than the FOMC’s forecast. Incidentally, the market’s forecast of lower interest rates is a tacit forecast of slower economic growth because the market is seeing that the Fed will not need to raise rates to slow an overheating economy. As it turns out, the market has been far more accurate in forecasting future interest rates (and economic growth) than the FOMC. If past is prologue, which we currently believe to be the case, the FOMC’s interest rate forecasts will continue to converge with the market forecasts and the theme of “lower for longer” will remain intact, even if the Fed does move rates up at their December confab.

The Bank of Japan left its short-term target rate unchanged at -0.1%, but committed to target a 0% interest rate for its 10-year bond (which is currently trading with a slightly negative yield) and to allow inflation to exceed 2%. The BOJ’s goal is to create a positive yield in longer dated 30-year and 40-year bonds, which will incent banks to lend and increase overall economic activity. A positive sloping yield curve will also provide pensions and insurance companies with investment opportunities to fund their obligations. The BOJ is clearly struggling to pull Japan’s economy out of its multi-decade slump, having experimented with zero interest rates, quantitative easing, qualitative easing (verbally setting interest rate targets), and negative interest rates.

Bottom Line: The Fed is likely to raise rates in the short term, but rates will be lower in the long term and Japan will target higher rates to increase economic growth (typically higher rates act as a governor to growth). If you are still with me here, but you are confused, welcome to the club. The most powerful bankers in the world are sending conflicting messages, experimenting with novel monetary policies and have little economic growth to show for it. This series of events and unsatisfactory outcomes have not been lost on the market, which is assigning ever lower credibility to central bank forecasts.


Economic Wrap-up: Housing starts declined by 5.8% in August (vs. expectations of -1.7%), but not too much should be read into this number. Heavy rains in the southern states had a negative impact on starts, while other regions saw gains in both permits and starts. Moreover, the NAHB homebuilder sentiment index rose from 59 to 65 in September, indicating confidence amongst homebuilders heading into the Fall. Existing home sales also declined in August (by -0.9%), but here again this is not an indication of a lack of demand for housing. Rather a low supply level of existing homes (which fell from 4.7 months to 4.6 months of housing) are constraining turnover of the housing inventory.


Be well and Godspeed,


Following a rough end to the previous week (when equity markets declined by more than 2% on Friday, Sep 9th) risk assets staged a strong recovery on Monday, but ended the week mixed. Domestic equities rose by 0.6%, while developed international markets declined by 1.8% and emerging markets fell 2.6%. Month-to-date, broad equity indices are in the red, down an average of 1.5%, though the oft watched NASDAQ is up 0.6% after its largest constituent Apple gained more than 11% last week. The yield on US Treasury bonds, ended the week relatively unchanged. Precious metals declined (gold: -1.3%, silver: -1.4%) and crude oil fell 5.8% to $43.24 per barrel as a report from the Energy Information Administration showed a rise in crude inventories. The US Dollar rose by 0.7% (against a basket of its major international trade partners), while the VIX Index (a measure of expected S&P volatility) fell 12% to 15.37.

For a more detailed view of weekly, month-to-date and year-to-date asset class performance, please click here.

Rock and a Hard Place: This week the Federal Open Market Committee (aka FOMC and loosely referred to as “the Fed”) will meet to determine whether to raise interest rates. There are three FOMC meetings remaining this year, but with the next one falling only one week before the Presidential Election in November, most believe that if no action is taken this week then the most likely timing of the next potential interest rate hike would be December. Odds are that the Fed will not raise rates this week (Bloomberg data indicates a 20% probability). Although we believe that based on the available economic data there is not an economic reason for increasing interest rates, the Fed is concerned about normalizing rates as quickly as practicable so they have the ability to reduce rates to stimulate growth in the next recession. The Fed is in a Catch-22 with massive implications as raising rates now threatens to choke-off the modicum of growth that the economy is experiencing (over the last three quarters the economy has expanded at an annualized real rate of only 0.9%, 0.8% and 1.1%). A move to increase rates this week would represent a departure from the Fed’s policy over the last 20+ years of increased transparency, including telegraphing interest rate changes well in advance. The market reaction to such a move this week would be dramatic. Less than 10 days ago equity markets declined by more than 2% when rumors circulated that a dovish member of the FOMC might give a hawkish speech. The market is clearly on edge as low interest rates are supporting lofty stock valuations. Although the Fed is unlikely to raise rates this week, should they draw a line in the sand and announce a 0.25% increase on Wednesday, look for markets to react extremely negatively (unless the Fed softens the blow by announcing that they will not raise rates again for another three to six months). Being a FOMC member is never easy, but in this environment, the job is about as thankless as it gets.

Income, a step in the right direction: The median household inflation-adjusted income for U.S. families rose by 5.2% in 2015, the largest single-year increase since records began in 1967. The increase now puts the median annual income at $56,516. While a welcome change from years of declining earnings, it is worth noting that real median incomes are still 2.4% below the all-time high reached way back in 1999 (see the green line in the chart below). In other words, more than 50% of Americans have less income than they did 16 years ago. This unfortunate data point is surely influencing the rise of political populism because after nearly two decades average Joe’s and Jane’s have lost faith in the ability of traditional politicians to improve their standard of living.


Sources: Census Bureau and FTN Financial.                  * Dotted line reflects change in survey methodology in 2013.

Economic Wrap-up: In general it was not a good week for economic data. Retail Sales fell 0.3% in August (vs. expectations of -0.1%). The “control group” of products sold (which is the figure that goes into the GDP calculation) declined by 0.1%, versus an expected 0.4% increase. Industrial Production also declined by 0.4% (vs expectations of -0.2%). The core Producer Price Index (PPI) increased by 1.2% in August, which was above expectations, but the underlying data indicate the inflation increase may be short-lived and does not appear to be the beginning of a higher inflationary trend in the supply chain. That being said, the core Consumer Price Index (CPI), ex-food and energy, rose 0.3% (vs. expectations of +0.2%), primarily related to increases in medical care and housing costs. However, the Fed focuses on a different inflation measurement called Personal Consumption Expenditures (PCE). Medical care and housing costs have lower weightings in the PCE calculation and on this measure inflation is running closer to 1.5% year-over-year (well below the Fed’s 2% target).

Be well and Godspeed,


“Is this the big one?” The question was asked around trading desks, office water coolers, and at dinner tables on Friday evening as equity markets woke from their protracted slumber (the S&P 500 had not moved 1% in either direction for 44 consecutive days), got out of bed and tripped on the dog, cat or goat that was sleeping nearby. Most developed market equity indices fell more than 2% on Friday, emerging markets declined more than 3% and the long dormant VIX Index (a measure of market volatility) jumped nearly 40% to 17.5. What was particularly interesting about Friday’s selloff was that traditional ‘safe haven’ assets like US Treasuries were also being sold, causing yields to push higher.

As of this morning, the selling is continuing though not with as much vigor (at least not yet). And it is too early to tell if those putting new money to work right now will be rewarded – ‘buying the dips’ has been a wonderful strategy over the last couple of years with central bankers providing a liquidity backstop that has supported markets pushing asset valuations ever higher. However, last week’s selloff was precipitated by growing concern that central bankers might be tapping the brakes on their largess (the ECB did not expand their quantitative easing program and members of the FOMC made comments in support of raising rates this year). Several members of the FOMC are speaking today and, given the market backdrop, their comments will be closely scrutinized. 

For what it’s worth, thus far this selloff does not appear to be the “big one” as various financial market stress indicators, like swap spreads between banks, remain contained.  That being said most rational people acknowledge that risky assets (equities and bonds) are expensive based on fundamentals, finding value only in relative comparisons to low interest rate levels. In some respects, the markets have come to exhibit the great fool theory with asset prices rising based on the belief that someone (i.e. a fool) will pay a higher price in the future. Similar to musical chairs, everyone knows that there are not enough seats in the game, but all the players believe/hope there will be one for them when the music stops.  We’ll see if Friday was just another skip in the juke box record (like August ’15 and Jan/Feb ’16), or if the music is really stopping.  There have been so many false breakouts it’s difficult to call, especially when the whisper from a central banker can start the juke box again just like The Fonz in “Happy Days”.

Please click here to view detailed asset class performance.


What wages giveth, hours taketh away:  Although the recent Nonfarm Payrolls (aka the “Jobs Number”) showed a reasonably healthy 151,000 jobs were added in August, the average hours worked data belies that strength. The workweek declined from 34.4 hours to 34.3 hours in August – no big deal right? Actually it is a big deal because when that 0.1 hour per week reduction is multiplied by millions of jobs it results in the equivalent of losing 230,000 jobs in August. On an hours-adjusted basis, the six-month moving average of jobs created is only 91,000, having peaked in August 2014 (see chart below).


Sources: Labor Department and Covenant Investment Research.

While the market had its mind primarily on the hourly wage, ignoring hours actually worked leads to an incomplete and inaccurate picture.  Furthermore, looking deeper into the details reveals that some of the highest paid occupations (manufacturing and construction) are seeing the bulk of the reduced hours. (Source: Foleynomics).


Beige Book Blues: The Fed’s “Summary of Commentary on Current Economic Conditions by Federal Reserve District” is commonly (and thankfully, because that is a mouthful) known as the “Beige Book”. The Beige Book is published eight times per year and contains anecdotal information (collected through interviews with key business contacts, economists, market experts, and other sources) on current economic conditions in each of the twelve Federal Reserve Bank districts. The contents of the report generally offer little guidance on the direction of the economy because the varied data sources and breadth of the survey generate a lot of conflicting signals. However, that was not the case in last week’s Beige Book release which First Tennessee Bank (FTN) characterized as “awful” and Bloomberg’s Richard Yamarone wrote, “Sitting on the sidelines would be the most prudent move given the lackluster details of this Fed report.” FTN summarized the report as follows: “According to the survey, consumer spending ranged from ‘modest gains’ to ‘slowed noticeably.’ Prices ranged from ‘unchanged’ to ‘modestly higher.’ The most telling result, however, was the perception of overall growth in the twelve districts, which was ‘unchanged,’ ‘flat’, and ‘little changed’ from the last period, when the economy grew just 1.1%.” Just another reason for the Fed not to raise rates in spite of their stated desire to do so.


Bottom Line: We don’t believe that the Fed needs to raise rates because the economy is overheating. That’s not to say they won’t raise rates this year, but their reason for doing so would have more to do with putting bullets in their gun for the next recession than the current economic conditions.


Economic Data Wrap-Up: The August ISM Nonmanufacturing Index whiffed, recording a six-year low of 51.4. Though still in expansion territory (i.e. above 50), the combination of a slowing services sector (which along with housing was one of the very few areas of growth in the economy) and a manufacturing sector in contraction (last week the August ISM Manufacturing Index was 49.4) raised more than a few eyebrows. The combined reading of these two indices is now at its lowest level since 2010. Then again, these index readings represent a point in time and given that the survey came during the middle of the Louisiana floods, the readings may be an anomaly that the September data will shed additional light upon. The July Job Opening Labor Turnover (JOLT) report was very strong across the board, consistent with the strong payroll growth in July (+275k). The report did however provide further evidence that the labor market is, or has already peaked, as Job Openings (while still at very high levels) are plateauing on a 12-month moving average basis.

Be well and Godspeed,


Last week included the end of August, so a quick rundown of asset class performance for the month:

Equities (including dividends): S&P 500 (+0.1%), NASDAQ (+1.2%), Global Equities (+0.4%), Europe (+0.6%), Emerging Markets (+2.5%)

Fixed Income (yield change): UST-2 Year (+0.15%), UST-10 Year (+0.13%), UST-30 Year (+0.05%). Note the yield on the short duration instruments moved higher than the yield on the longer duration instruments, which is why you may have read/heard about the yield curve flattening.

Commodities: Gold (-3.1%), Copper (-6.8%), WTI Crude (+7.5% / $44.70 per barrel)

Please click here to view detailed asset class performance.


Negative Rates in the U.S.? Fed Vice Chairman Stanley Fischer raised a lot of eyebrows last week Tuesday when he made favorable comments about negative interest rates, although he said negative interest rates “are not on the table in the US”. I’m not looking to cross swords with Mr. Fischer, but the actual data from Japan and Europe simply doesn’t support his claim: consumers are saving more (instead of increasing spending) and the currencies for each of those countries have risen (not fallen as was expected before the adoption of negative interest rate policies). Although Mr. Fischer’s comments sounded crazy, perhaps he is crazy like a fox and was intentionally preparing investors for a worst case scenario should the Fed not be able to raise interest rates sufficiently before the next recession. That seems to be the case as reflected in the notes below from a conference call last week hosted by First Tennessee Bank’s Chief Economist Chris Low).

Mr. Low thinks the recession probability is ~50% in 2017 and ~65% in 2018.  We are seeing a slowdown in consumer spending, ongoing weakness in fixed investment….pent up demand is gradually being exhausted (autos as an example).  Corporate profit growth is one of the best leading indicators [and it has been negative for five consecutive quarters].

The next recession will probably be a bad one and will likely precipitate negative rates. There will likely be a significant liquidity squeeze and credit spreads will widen a la 2007/8. We could see another 50% drop in equities in the next recession whenever it comes because investors have been conditioned to flee.

So, if the Fed Funds rate is still close to zero, we could see negative rates as a last resort. But what we have seen is that negative rates do more harm than good because instead of encouraging spending, households save more. This is one good reason that the Fed wants the fed funds rate higher. 


Food Deflation – The price of meat, eggs and dairy products has been steadily declining, though I can’t say I’ve noticed it as the prices of most everything else my family consumes seems to be going up. But it’s true and a good study of Economics 101: supply and demand, with an international twist. As the U.S. dollar has strengthened over the last year, particularly against the Chinese Renminbi, international demand for these products has fallen leaving excess supply. Farmers and grocery stores are forced to cut prices to stimulate demand and in some, extreme cases, destroy product so as to reduce the level of excess supply. For example, in some places dairy farmers have reportedly dumped millions of gallons of excess milk onto their fields.



While cheaper food is great for the consumer, it makes for a difficult situation further up the value chain with grocery stores and farmers. Grocery stores, which already operate on thin profit margins, are cutting prices and large national food retailers such as Costco, Whole Foods, and Sysco, reported a negative impact to margins in the second quarter. Farmers are largely in a worse situation and the government reportedly purchased $20mm worth of cheese from one hard-hit dairy farmer (the cheese was donated to food banks and other organizations through the USDA nutrition-assistance programs). This is an example of imported deflation – namely that slow economic growth, especially outside of the U.S., and a strong US dollar are reducing demand for certain US products leading to lower prices. (Data source: WSJ)

Economic Data Wrap-Up: Personal Income rose by 0.4% month-over-month (m/m) in July and Consumption increased by 0.3% m/m. Core Personal Consumption Expenditures (PCE), which excludes food and energy, increased by 0.1% in July, leaving the annual rate unchanged at 1.6% (the Fed’s target is 2%). The ISM Manufacturing Index report unexpectedly fell to 49.4 in August, the first reading below 50 in six months. In reality there is not much difference between a reading of 49.4 and 50.4, other than the optics of being below or above the contraction/expansion threshold reading of 50. Of greater concern is that the report was weak across the board, indicating the manufacturing sector may be stagnating again. The August labor report missed expectations on most fronts: unemployment rate, hourly earnings, workweek hours, and Nonfarm payrolls (+151k vs. expectations of +180k). The market took this as a signal that Fed will not raise rates at their next meeting in September, but the report wasn’t really that weak when looking at longer term trends.

Hope everyone has a great Labor Day,