Good morning,
What’s in this week’s Report:
- Was last week’s commodity crash a warning sign?
- Updated Fed Outlook
- Another Oil Plunge – When Will It Stop?
- Weekly Economic Cheat Sheet
Futures are slightly lower after more disappointing Chinese economic data and an as expected French election.
Chinese April exports and imports both missed estimates, adding to the soft data from last week. Exports rose 8% vs. (E) 11.3% and Imports rose 11.9% vs. (E) 18%. These numbers are the biggest reason for lower futures this morning.
Politically, Macron won the French Presidency in a landslide, but it was already priced in so markets didn’t react.
The economic calendar is quiet today and there are two Fed Speakers, Bullard (8:35 a.m. ET) and Mester (8:45 a.m. ET), but neither are members of Fed leadership so they won’t move markets.
So, focus will be on whether more soft Chinese economic data can delay another run at 2400 in the S&P 500 (I’d be surprised if we don’t hit new highs today given momentum and the quiet calendar. The key remains yields and oil, as long as both are higher, stocks can rally).
|
|
Level |
Change |
% Change |
|
S&P 500 Futures |
2,394.50 |
-2.25 |
-0.09% |
|
U.S. Dollar (DXY) |
98.825 |
0.2970 |
0.30% |
|
Gold |
1,234.30 |
7.40 |
0.60% |
|
WTI |
46.22 |
0.00 |
0.00% |
|
10 Year |
2.35% |
-0.001 |
-0.01% |
Stocks
This Week
China and the performance of commodities (oil, copper, iron ore) will be the focus of markets this week, as the macro calendar is relatively quiet.
Outside of the Chinese data and commodity price action, there are some April quarter-end companies that are reporting, with a specific focus on the retailers (which is one of the most-hated market sectors right now).
Last Week (Needed Context as We Start a New Week)
The S&P 500 was fractionally higher last week as better-than-expected economic data and political progress on the health care law failed to spur much of a rally. The S&P 500 rose 0.63% and is up 7.17% year to date.
Last Monday would end up being the most volatile day of last week, as the S&P 500 rose 0.17% on some potentially positive political headlines. The fact that Monday was the biggest move of the week, and the S&P 500 rose just 0.17%, tells you how exciting the remainder of the week was.
Tuesday, stocks moved slightly higher again on good European PMIs and progress on an Obamacare repeal/replace vote, although those gains were given back on Wednesday following some disappointing earnings (AAPL) and a slightly hawkish Fed meeting. The S&P 500 dipped 0.13% on Wednesday.
Thursday and Friday stocks drifted sideways in quiet trade. A plunge in oil prices combined with digestion of the Fed statement and looming jobs report kept prices flat on Thursday. Stocks spent most of Friday trading sideways before sprinting into the bell in quiet action to finish at new closing highs after the “Goldilocks” jobs report.
Your Need to Know
There were a few notable trends internally in markets last week, but performance is best described as “mixed,” and there was no definitive trend or event that was bullish or bearish. To that point, small caps lagged the market, and declined 0.25% on the week, while Nasdaq outperformed thanks to earnings and rose almost 0.90%.
Looking at sector trade, the big movers were the banks (positive) and energy (negative). Banks rallied nicely on the back of higher bond yields. Still, more progress is needed in the absolute level of yields, and in the yield curve, before we get bullish banks again. Energy (XLE) hit a nine-month low on the drop in oil, and that serves as an anecdotal warning sign on stocks (more on that later, but a broad stock rally accompanied by collapsing oil/energy stocks is very rare).
Adding to that was another month of disappointing auto sales, although the numbers were higher compared to March. Regardless, auto stocks underperformed (Ford (F) hit a 52-week low).
In sum, it was a week of gives and takes, and did not provide anything that will give us a better idea of the next 20-50 points in the S&P 500.
Bottom line, last week’s price action can be summed up as two steps forward, one step back. Stocks accurately reflected that reality as there was a modest rally on the week, but stocks weren’t quite able to breakout to new highs. Bigger picture, there was fundamental progress, but still not enough to get markets into the “clear” and ignite a sustainable rally.
Looking at the positives, there were actually three small steps forward, as each of the three “gaps” between market expectations and fundamental reality—gaps which have kept the S&P 500 stuck for two-plus months, narrowed last week (although to be clear, the gaps weren’t closed).
First, the House of Representatives passed their Obamacare replacement, and while it still has virtually no chance of passing the Senate it is a moral victory for the pro-growth agenda. Second, economic data last week bounced back a bit, especially the ISM Non-Manufacturing PMI and jobs report. So, the gap between strong sentiment surveys and hard economic did close slightly last week, although clearly work remains to be done there. Finally, the 10-year Treasury yield rose into the mid-2.30% range, a multi-week high. And while it didn’t break resistance at 2.40%, there was still progress in closing the large gap between near-record stock prices and bond yields at multi-month lows (which should not be happening in reflation). Given those modest positives, stocks should have rallied and they did.
However, while we had improvement in the closing of those three gaps, very quietly a new risk has potentially emerged. Last week, Chinese economic data universally missed expectations; base metals’ prices (copper, iron ore, steel) all collapsed (iron ore was down limit last Wednesday in overseas markets); oil broke down badly and hit multi-month lows, and the commodity currencies (Aussie and loonie) both hit lows for the year. All of those markets are anecdotal proxies for global economic growth, and they have served as important canaries in the coal mine for global growth scares that have caused sharp, surprising pullbacks in stocks (Sept. 2015, Jan. 2016).
It’s just one week of price action, but if it continues we are again faced with a situation where something isn’t adding up. If we are in a global reflation that will carry stocks higher, the leading edge of economic growth should not be in correction mode.
Perma-bulls will say last week’s commodity price action was due to oversupply, and to a point that’s true (especially in oil). Yet the bottom line is if we get protracted weakness in the aforementioned macro indicators, then that will be another caution sign on markets. We now are officially watching these assets much more closely for you going forward.
That said, for now the path of least resistance remains higher, although until we see more closing of the three gaps in the market we will remain cautiously long and will not chase stocks here.
However, if we do get a material breakout, we believe it will be cyclically led by IWM (small caps), SOXX (semiconductors), XLI (industrials) and KRE (banks). In the event of a breakout, we will rotate capital out of other domestic sectors and into those cyclical sectors (or in the case of banks, add to current longs)—although just to be crystal clear, we are not doing that yet!
Bottom line, it was two steps forward, one step back last week, and we are not in the clear yet. We remain cautiously long, and Europe (HEDJ) remains our overall best idea for new capital (i.e. we would allocate there before anywhere in the US).
Economic Data (What You Need to Know in Plain English)
Need to Know Econ from Last Week
Economic data last week, highlighted by the strong jobs report, helped to somewhat narrow the gap between soft sentiment surveys and hard economic data… although it’s fair to say that gap remains open and is still a headwind on stocks, just a slightly less strong one. It was not all positive last week, though, as we got several signs of potential loss of momentum in China, which was an underreported but potentially important development last week. Finally, the Fed meeting proved to be a non-event, except in that it reaffirmed a June rate hike is likely (but that’s already mostly expected from the markets).
Starting with the jobs report, it what we call the “just right” scenario. The overall job adds were strong at 211k vs. (E) 185k, but revisions to the March report were negative 19k, so the net number was more in line. The unemployment rate dropped to 4.4%, but that was in part due to a decline in the participation rate. Meanwhile, year-over-year wage increases declined to 2.5% from 2.7%. Bottom line, this number was “fine,” but it wasn’t massively reflationary (in part due to the wage number) and that’s why we didn’t see the strong headline jobs report ignite an immediate reflation rally in stocks (again, the wage number undermined the strong job adds).
Looking at other economic data last week, there were more positives than negatives, highlighted by the ISM Non-Manufacturing PMI, which hit 57.5 vs. (E) 55.8. That strong Non-Manufacturing PMI helped to offset the soft April Manufacturing PMI, which dipped to 54.8 vs. (E) 56.5 while the New Order component dropped below 60 for the first time in five months. While disappointing vs. expectations, it’s important to remember that the absolute level activity remains strong.
Turning to the Fed, the key takeaway from last week’s Fed meeting was that the Fed viewed the loss of economic momentum in Q1 as “transitory,” and still said risks to growth were “roughly balanced.” Both terms are Fed speak for, “We’re going to hike in June despite the soft Q1 GDP.” The market largely expects that (Fed Fund futures have a hike priced at 83% (which is close to a universal conclusion).
Finally, I want to take a moment and focus on Chinese economic data from last week, as the numbers were universally disappointing. Official April Manufacturing PMI dropped to 51.2 vs. (E) 51.7 while composite PMI declined to 51.2 vs. previous 52.1. Additionally, iron ore went into quasi freefall this week, as iron ore futures ended limit down on the Dalian Commodities Exchange on Wednesday night. The drop came after the Chinese steel industry PMI dropped below 50, signaling contraction. Oversupply has something to do with the price drop as well (exports are surging out of Australia) but the bottom line is that base metal prices are a coincident indicator of economic activity. The declines in iron ore, steel and copper last week, combined with the underwhelming Chinese data, definitely caught our attention. We now are officially watching this closely for everyone, and will keep you updated.
Important Economic Data This Week
This week, April CPI and April Retail Sales (both Friday) are the important reports to watch. The latter is more important for markets at this point than the former, as we need to see a rebound from Q1’s paltry consumer spending. If retail sales fail to show progress and beat expectations, it’ll widen the gap between soft data and hard economic numbers. With CPI, we should see some mild cooling of the recent uptick in inflation, but overall inflation pressures continue to slowly build.
Outside of those two numbers, focus will be on the Chinese CPI and PPI, as again data there suddenly turned lower last week. Bottom line, it should be a quiet week, but retail sales and CPI are important as the “gap” between soft sentiment surveys and hard economic data remains… and it needs to close further if we are going to see a breakout in stocks.
Commodities, Currencies & Bonds
In Commodities, the segment traded deep in the red last week, with both industrial and precious metals coming down hard. Oil and the refined products suffered the steepest losses on the week. The commodity ETF, DBC, sank 2.35% to a six-month low.
Oil had its worst one week peak-to-trough sell-off since the beginning of 2016, as futures fell from a high of $49.32/bbl to $43.76. Futures ended the week down 5.53%, and at a six-month low. Traders have been focused on two things of late—OPEC rhetoric, and US production (and the relationship between the two).
Last week, EIA data showed a continuation higher in US production, and no real sign of moderation yet. Lower 48 output now is up 526K b/d so far in 2017, a weekly average climb of 31K b/d. Meanwhile, the energy trading community has been hoping that OPEC would deepen their cuts to production to further support prices, but leadership from the cartel came out on Thursday and basically squashed that idea.
Bottom line, with OPEC only maintaining policy and not cutting further, and the trend in US production still decidedly higher, the outlook for oil remains bearish. Moreover, lower prices will be a headwind for stocks, and supportive of Treasury prices.
In the metals, gold plunged as much as $45/oz. (3.24%) last week as bond yields moved up to multi-week highs and inflation data disappointed, triggering a rebound in real interest rates. That is a contra move to the recent trend of real interest rates moving lower (supportive of gold prices). Bottom line, the trend of lower real rates has not entirely reversed, but rather just moderated, and last week there was a sizeable unwind in spec longs.
The 2017 uptrend is not dead yet, but it has certainly weakened and now $1195 is a “line in the sand” for the bulls. Meanwhile, copper fell a substantial 2.83% last week as LME warehouse supply rose sharply, and demand estimates for Chinese consumption underwhelmed vs. expectations. The softness in the copper market remains a warning sign for other risk assets as a lot of the post-election rally is based on the expectation of an acceleration in economic growth.
Looking at Currencies, the Dollar Index dropped to a seven-month low last week thanks to a strong euro, as currency markets largely ignored the decent US data and marginally hawkish Fed. The Dollar Index declined 0.47%.
Despite the declines, performance of the dollar vs. the major currencies was very mixed, with the euro being the standout. The euro rallied to seven-month highs following universally strong economic data (Manufacturing and Composite PMIs, and Retail Sales). Despite the multi-month highs, we do not think material euro strength can continue unless we get further soft US economic data, as the Fed remains on target to hike three times this year.
As mentioned, performance of the dollar was different against most currencies. The dollar was basically flat vs. the pound, rallied 1% vs. the yen, and gained sharply vs. the commodity currencies. The loonie fell 0.5% on lower oil while Aussie plunged more than 1% on the collapse in iron ore, and on soft Chinese data.
But because of the weight of the euro in the Dollar Index, the net effect was a decline to fresh lows. We do not think this is the start of a move in the dollar back to the mid 90s unless we get more soft data.
Turning to bonds, the yield on the 10-year Treasury rose 8 basis points to a two-week high, as bonds somewhat closed the gap between high stock prices and low yields. The rally in bond yields was due to the better-than-expected economic data.
However, the 10-year yield remains below 2.40%, and as such the near-term trend remains lower. Markets need that yield to make that “higher high” above 2.40% to help validate stocks prices at these levels.
Special Reports and Editorial
Fed Decision
The Fed made no changes to interest rates, as expected. The FOMC statement acknowledged the slight loss of economic momentum since March, but stated it viewed the slowing as only temporary, and left the door firmly open for a rate hike in June.
Looking specifically at the statement, the Fed said that economic activity had “slowed” compared to “expanded at a moderate pace” in March. But, in the second paragraph, the Fed said the loss of economic momentum appears to be “transitory,” and signaled the recent underwhelming data won’t make the Fed deviate from future rate hikes.
Underscoring that point was the fact that the Fed said risks to the near-term economic outlook continue to be “roughly balanced,” which is Fed speak for “we can hike rates at any meeting going forward.” Bottom line, the Fed was not spooked by the recent soft data and it is not deterring them from any future rate hikes… yet.
From a market standpoint, there was a mild “hawkish” reaction, not so much because the statement was hawkish, but instead because there was nothing dovish in the statement. That’s what markets have become conditioned to expect. The Dollar Index drifted to the highs of the day 30 minutes after the statement while the 30-year Treasury erased small gains and closed fractionally lower. Stocks drifted slightly lower, but selling was mild. Overall, the Fed statement was not a market mover.
Another Oil Plunge
Oil futures sank 2.74% last Tuesday, with a large portion of the losses coming in the final hour. The catalyst for the decline was a collection of analysts’ estimates for the next morning’s EIA report that started to come in showing more substantial builds in product inventories even though oil stocks are supposed to fall.
RBOB gasoline futures have been leading the way lower since they topped out on April 12. In fact, leading up to last week’s trade, futures had only notched one single gain (that is three weeks with just one positive trading day).
Oil futures came within 1% of their 2017 lows last Tuesday, and the momentum is clearly with the bears. That day’s move was amplified by a “stop run” as futures broke through the March lows in the June contract. But in an encouraging sign of weakness, futures were unable to rebound.
On the charts, futures broke through a longstanding technical uptrend line that dated back to early August. That is another sign of technical weakness in the market.
In doing some cross-asset analysis last week, there was evidence that the inverse correlation between oil prices and long bond prices is resurfacing. As a reminder, back in early 2016 long bond futures were trading almost exclusively off of the price of oil (specifically when WTI had a $20 handle). The reasons were twofold.
First, low oil prices are a drag on inflation readings, which would have dovish implications for Fed policy (long bond positive). Second, long bonds benefited from a safe-haven/fear bid as lower oil prices increased the risk of small producers defaulting on loans, many of which were issued by southern and central regional banks. Ultimately, contagion fears weighed on regional banks and the broader financial sector collectively. Now, it is not clear whether this is happening again as it was only one day of trading so far, but it is something to keep in mind going forward. If oil declines cause a sharp break lower in longer-term interest rates, that will weigh on stocks.
Bottom line, the fundamentals (rising US production and still-overflowing global stockpiles), technicals (new five-week lows), and market internals (bearish term structure) all continue to favor the oil bears right now, and the idea that we are in a “lower for longer” price environment still stands.
Oil and the rest of the energy complex is, however, near-term oversold, and we could see a volatile short-covering rally given the right catalyst. Such a move would likely be short-lived, and if we were to see a continued move into the low $40s or even high $30s that would have serious implications for all asset classes (as in early 2016).
EIA Analysis
One day after that big Tuesday oil price decline, the EIA report came in mixed on the headline with oil inventories at -900K bbls vs. (E) -1.8M (bearish). That print also was substantially smaller than the draw reported by the API late Tuesday (-4.2M bbls), which had been partially priced into the market ahead of the release–so it was received as even more bearish. Product stockpiles were both slightly bullish vs. (E) as RBOB gasoline supply was +200K vs. (E) +700K and Distillate supply unexpectedly came in at -600K bbls vs. (E) +600K. The RBOB number was notably above the API figure of -1.9M bbls, and that helped the complex bottom and finish slightly higher, but not before hitting a five-week low. RBOB futures led the way higher, rebounding 1.15% while WTI managed a gain of 0.31%.
In the details of the report, US production accelerated in the prior week, albeit only slightly. US output was +28K b/d and lower 48 production accounted for +25K b/d of that (versus +13K b/d and +20K b/d the prior week, respectively). The 2017 average weekly rise in L48 output (the smoother figure without Alaskan numbers) is currently +31K b/d, amounting to +526K b/d. For perspective, that is just shy of half the total output cuts by OPEC.
Rising US oil output remains the single-biggest headwind for global petroleum prices. Until either OPEC slashes production further (very unlikely, but possible outcome of the May 25 summit), or US production levels off and potentially pulls back (no sign of that in the data yet), then the path of least resistance remains lower for oil.
source http://capitalisthq.com/markets-losing-momentum-capitalisthq-5-8-17/
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