The Two-Themed Market
It was a rather eventful day on an otherwise unexciting trading day as investors debated whether the tax-cliff deal is enough to bid prices higher still or if the impending spending-cliff will curb enthusiasm for risk. Underlying themes still remain: that of an improving China and an improving housing market. I’d like to delve into these themes a little more and how today’s market news has helped those themes continue to develop and perform.
To start off the day, China’s non-manufacturing PMI data was released. It rose month over month to 56.1 in December versus 55.6 in November. Readings above 50 are expansionary. I’ve been covering the turnaround in China’s economy for a couple months now and the beneficial effect doesn’t stop at the Chinese Shanghai Stock Exchange Composite’s stellar performance in December, leading the foreign markets. Basic material stocks and industrial stocks in the U.S. have been a beneficiary of the recovery. The chart below shows the relative performance (to the S&P 500) of each of the Spyder sector funds since the market bottomed in November. Financials, industrials, and basic materials have shown the best performance over the period thanks to the recovery story in housing and China.
If you combine the recovery story in China with more inflationary pressure from the Federal Reserve Bank, announced at the September and December meeting, you have the recipe for a recovery in commodities. It was announced that Operation Twist would end (the sterilization of long-term Treasury purchases with short-term Treasury sales). Instead, the Fed will maintain purchases and remove the sales, thereby increasing QE. The Fed is shifting the printing presses into overdrive as the Fed’s balance sheet expands on all cylinders, just like in 2010. The end result should be a return of inflationary pressures in financial assets and commodities and the return of a weak dollar.
The Fed minutes from the December meeting were released today and they threw a slight curve ball on the day’s events and on inflationary expectations (no doubt by design). It appears that the voting members are equally divided between those who would like to see QE end in 2013 and those that want to see it continue beyond 2013 – what happened to data dependent? Obviously not all of the members have been happy with QE’s implementation since September, and would have preferred QE was never again implemented. It was written in the minutes that several participants wanted an end to all asset purchases at the end of 2012 when the maturity extension program (Operation Twist) was completed.
Looking at the projections in detail within the minutes, you’ll note that none of the participants believe the unemployment rate will reach the 6.5% target discussed in December within 2013. The majority of participants don’t believe unemployment will hit the Fed’s target levels until 2015. If you look at participant projections for interest rates, they remain at rock-bottom levels until 2015 at which point the projections are all over the map. Looking at the inflation projections (the other half of the Fed’s dual mandate), you’ll note they remain low out to 2015 at which point the participants begin to cluster around 2%; however, reading the minutes they expressed a high degree of uncertainty surrounding all projections, especially regarding inflationary projections.
The market used the FOMC minutes as an excuse to let off a little excess steam from the 2-day rally on the tax-cliff resolution and closed slightly negative on the day. All in all though, I think the FOMC minutes weren’t the major negative catalyst that the media made it out to be.
Besides the small correction in stocks courtesy of the FOMC minutes, there was also a correction in Treasury bond prices and yields spiked to levels we haven’t seen since September. That makes sense if:
- The Tax cliff has become a Tax bump, and the full effect of the austerity measures have been muted and
- If the Fed considers removing its current purchase plans of Treasuries and mortgage-backed securities.
Now if Treasury yields breakout, there’s the possibility we get the next bullish catalyst for this cyclical bull market. Mutual fund flow data over the past few years has shown a mass exodus from stock funds and into bonds as investors have continuously shifted to conservative portfolio allocation models in the wake of the 2007-2009 Bear Market. If bond performance ends and reverses, signaled by a rise in yields, we could see that paradigm shift as investors chase stocks. There has been a lot of talk of the next bubble in Treasury Bonds and I agree with the notion. It is the next bubble to burst, but timing is everything in this business. Bond bears have been wrong up until now.
The question is whether the economy can get back up to speed prompted by the full effect of QE, and the sobering thought that eventually that accommodation will need to be removed. Those two catalysts, which should feed on each other, will eventually be the cause of the Treasury Bond’s demise. While that may be the case, the jury is still out on another debt downgrade according to Moody’s yesterday.
We’ll just have to see as the story develops on the spending cliff this quarter when Washington will again go to war with itself to decide the outcome of sequestration and spending reform. The debt downgrade in 2011 did little to ignite a bear market in Treasuries as the Fed began Operation Twist at the same time foreign investors were exiting the European sovereign debt markets and flocking into U.S. Treasuries.
An improving housing market is bullish for homebuilders, consumer stocks (the wealth effect), construction materials, and financials. Homebuilding stocks and financials really found market favor in 2012, when home sales bottomed in late 2011 and home prices bottomed in early 2012. Yesterday’s construction spending details showed continued strength in residential construction spending and that has spilled over into today’s performance for the group. Not to mention that the House will be voting on a $9 billion flood insurance measure followed by a $51 billion aid bill on January 15. Those measures are a positive catalyst for infrastructure and construction material stocks.
It also helps that same-store-sales announcements today on the December month data from a number of retailers have helped to bolster the consumer discretionary sector where the homebuilders and construction material companies are found. It was today’s number one performing sector. There were a lot of fears built up around the holiday shopping month of December, but these were alleviated in part thanks to a number of reports today. ROST, TJX, JWN, and ZUMZ were some of better highlights in the sector. In addition to some of the same-store-sales news, auto sales were a big win as reported by F, GM, and Chrysler.
Lots of Jobs
Finally, the ADP National Employment report of private sector employers added 215,000 jobs in December, which is the fastest pace of job growth since February 2012. This last bit of information is helping to revise tomorrow’s BLS jobs report projections, upward. Oddly enough, the data suggests that companies were already brushing their shoulders off of fiscal cliff concerns with noticeably accelerated hiring in medium and large businesses, while small-business job growth slowed.
There was even talk today from Bank of America (BAC) they plan to ramp up mortgage and corporate lending after spending the last few years reigning in capital spending and cutting costs.
Today was a major day for news catalysts in the market, but none were enough to change its direction. We took a pause today based on good economics and retail sales beating expectations. Once the FOMC minutes came in, a chance to sell was signaled, but in the end it was much ado about nothing. The projections show that voting members do not anticipate a big improvement in the economy for a couple more years. Note that QE is open-ended without a final date. It’s likely we’ll get more (F)ederal (O)pen (M)outh comments from the Fed to “manage” inflationary expectations, but I say just keep an eye on unemployment and inflation. The Fed is data dependent and we’ll get another “tip” from the market tomorrow with the BLS employment situation.
I do expect another battle on Capitol Hill over spending cuts and sequestration will dampen bullish appetites ahead, but we have a few catalysts around the corner before that may happen, starting off with earnings next week and the jobs data tomorrow. The ECB will meet next week and the euro has started to sell off in anticipation of policy accommodation. Speaking of central banks, there’s a lot of anticipation leading up to the Bank of Japan’s meeting on the 22nd. If I hear more, I’ll be sure to mention it in the weeks ahead.
In conclusion, some of the themes that have been ongoing remain: China improving and the continued rally in housing-related industry groups. While precious metals have been through the volatility grinder over the past few months, when the onset of QE should be propelling prices much higher, the prospects of global economic recovery starting in China are the background for a major rally in 2013. A Financial Times article on December 28th discussed how iron prices have risen 60% in four months, prompting Fortescue Metals Group to resume its multibillion-dollar expansion. Commodity prices topped as a group in April of 2011 when China’s equity market topped. Now that China’s stocks are on the run and expectations are runing high that their economy is turning around, we’re bullish on commodities for 2013 and stocks. It should be bumpy in the first quarter, but if the printing presses are allowed to keep running globally, then we feel confident the market is in store for higher prices, especially if the air is deflated from the Treasury Bond bubble.
About Ryan Puplava CMT
Ryan Puplava CMT Archive
|03/07/2014||Enter the Inter||story|
|02/27/2014||What Tale Can Retail Tell?||story|
|02/20/2014||Rotation Comes and Goes||story|
|02/13/2014||What a Relief (for Gold)||story|
|01/30/2014||Technical Damage With Silver Lining||story|
|01/23/2014||China: Steady as She Goes||story|
|01/09/2014||Macro Priority Deferral||story|
|01/03/2014||Making Friends With the U.S. Dollar (Cont.)||story|
|12/26/2013||Making Friends with the U.S. Dollar||story|