April 16, 2014

Closing Comment

The topsy-turvy world of equity activity continued again today, although stocks didn’t have to endure a selloff in the process. Equities opened in the green zone and remained well-bid right into the close. At day’s end we see the Dow up +162 points (+1.0%), the S&P up +0.92% and the NASDAQ higher by +1.29%. Another day of this sort of price action and all of the bleak memories from last week will have been erased.

European equities led the way this morning and these also closed near their highs. I would be surprised if Asian markets don’t keep the uptick intact tonight.

Bond prices opened to the down side but spent most of the day trying to decide on a direction. The middle part of the yield curve saw prices decline while the long end saw a bid. (Curve flattening trades coming back in favor?)

The 2-year closed at 0.37% (unchanged), the 5-year was 1.65% (lower by -4/32 in price), while the 10-year closed at 2.63% (also unchanged).

The 30-year tacked on a gain of +9/32, leaving its yield at 3.44%. This is the lowest yield on the 30-year bond for all of 2014; in fact, you have to look back to late June 2013 (in the middle of the taper tantrum) to see yields this low. The 30-year bond is just a few basis points away from retracing 50% of the rate bounce that started in May 2013. The rest of the curve is nowhere near echoing this performance. I guess bond traders have given up on inflation.

The Fed’s Beige Book, prepared for the upcoming April 29-30 FOMC meeting, was generally upbeat, albeit no district is really firing on all cylinders. Price pressures were generally subdued with beef and pork prices most notably under upward pressure. Wages are not growing in any significant way. This is the one area that has to be constraining most Americans’ spending at this point. We are beyond the fear of recession-induced layoffs, but are not yet seeing wage growth in our paychecks. My guru, David Rosenberg, continues to feel that wage growth is around the corner. He cites the smallish pool of skilled labor being in much demand from employers who would hire more people if they could just find qualified ones. It just hasn’t happened yet.

Fed Chair Yellen’s speech today broke no new ground. She continues to point to slack in the labor market as the reason for the Fed to remain in an accommodative stance. (I don’t disagree with this generally, but I do feel that the Fed’s current policies are more consistent with a deep recession, and we are nowhere near that.) What she didn’t do is roil the markets like she has on previous occasions. However, when asked what the Fed would do if inflation were to move above their current target of 2%, Yellen replied that she had a “two-sided” view of the Fed’s job on inflation. Just as the Fed doesn’t like inflation below 2%, they would resist upward price pressures above 2%. We’ll see about that. The Fed certainly abandoned the 6.5% unemployment rate threshold when we approached it. I don’t see how we can take the Fed’s word for what they plan to do against future benchmarks. I suppose that her insistence that any sort of tightening is a long way off might account for the late bid in stocks. That wouldn’t explain the uptick in yields in the middle part of the curve, however.

Morning Comment

Housing starts for March did rebound from the softer levels seen in January and February, but with less brio than had been forecast. Permits showed the same pattern. Yesterday we saw that the April sentiment reading from the National Association of Home Builders remains in neutral. The polar vortex may be receding (well not in Minnesota and Montana today), but the oomph in housing activity is not yet back to a go-go phase. Constraints include lack of available lots to develop, a shortage of carpenters to actually hammer a nail, tighter credit requirements for mortgages, and a general nervousness about where the economy is headed. It looks like we’re going to need another month to see if housing can pick up more traction.

Yesterday stocks seesawed in a rather erratic fashion, but at the close prices were higher for a second straight day. Asia continued the rally last night, with Japan leading the charge with a gain of +3.0%. Europe has taken the baton as all markets across Europe are well-bid. This appears to be feeding back into the U.S. with our equity futures pointing to another gain when stocks start trading today. The surge in Japan arises from a rumor that an official Japanese agency will downgrade its assessment of Japanese growth when that agency issues its report later this month. Normally, that would not be bullish for stocks, but in this topsy-turvy world the Nikkei rallied on hopes that the downbeat assessment would bring on more central bank stimulus. In Europe we are seeing more pressure developing on the ECB to take more overt steps to counter the momentum of lower prices in that region. Core inflation for Europe slipped to 0.7% from 1.0% in February. Once again the world is being carried along on the backs of its central bankers.

The upward price action in global equities is putting downward pressure on bond prices, but once again bond price movements have been constrained as bonds are understandably suspicious of reacting too much to what those crazy equities are doing.

The 2-year is opening at 0.37%, the 5-year is 1.64%, and the 10-year is 2.65%. Today is the last full day of trading this week as we have an early close to the market tomorrow and Friday is shuttered completely in recognition of Good Friday. Whatever investing you want to do should be done today while liquidity is still ample.

The Fed will be in the headlines today. Fed Chair Yellen addresses the Economics Club of New York at midday, so analysts will be looking for market-moving comments. Yellen didn’t say anything controversial in her remarks yesterday, but she was just talking about risks to the system embodied in banks “too big to fail.” Today her comments will focus on the economy. We will also hear from Lockhart and Fisher. There is always the potential for turmoil when any of these members are out there trumpeting their own opinions.

In late-breaking news, March industrial production came in at +0.7% (compared to a +0.5% forecast) and more impressively, February’s report of +0.6% was revised higher to show a gain of +1.7%! Capacity utilization for March was 79.2%! We haven’t been that tight on capacity since the start of the Great Recession. Capacity use declined to the low of 66.9% in June 2009 (which ironically was the official start of the recovery). Squeezing additional activity out of our plants and utilities is going to get more expensive, as you’re now talking running extra shifts and overtime for the work force. America’s corporations are sitting on a pile of cash. Rather than spend it on new plant and equipment these last years, our companies have used the money to buy back shares (thus increasing the price of the stock) and paying fat bonuses to the bosses who run the business. This money is not finding its way into the paychecks of the poor souls who labor in the bowels of the enterprise. The gap between what the top people make and what the average worker takes home is growing exponentially. However, if we are running at close to the top of our capacity in an economy that is growing at a pace less than 2% per year, and no new capacity is coming online, then what will happen if demand grows? Increases in marginal production are going to be very costly.

So you can ignore everything I wrote before the news on industrial production was released.

Jeff Smith
Director of Investment Sales

Jeff's comments and insights, based on his professional expertise and the knowledge he has acquired observing the U.S. economy and global markets, are offered as his own personal observations and opinions, and not necessarily reflective of those held by SunCorp, our board or member credit unions. Please do not respond to this message as this e-mail address is un-monitored.


March 2014

Worries of a third straight disappointing non-farm payroll report did not actualize, and for now the topic of pausing the quantitative easing (QE) taper appears to be off the table. Total non-farm payrolls added on the month were 175 thousand......Read More

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