Have We Been Here Before? The Story of the Fed Increase that Did Not Occur….. Thoughts and Commenta
- Howard Isaacson
- Oct 5, 2015
- 6 min read
Have We Been Here Before? The Story of the Fed Increase that Did Not Occur…..Or…. What a Difference a Day Makes?
Thoughts and Commentary
September 30th brought the close of the WORST quarterly performance in the US stock markets in four years. The S&P 500 was down 6.9% for the quarter, versus 14.3% during 2011. The quarter was particularly painful for energy, materials, health care and pharmaceutical companies’ stocks. The last weeks of September seemed particularly painful, especially after the chaos of August 24th (down 1,000 Dow points on the Dow at the open day).
On the flip side of the emotional rollercoaster, including September 30th’s 2% rally, the market has now had its LONGEST RALLY since December, lasting 5 days, running from 1878 on the S&P 500 to 1,987 at today’s close, for a gain of 5.8% over the five days. Since the start of October, the S&P 500 has climbed 3.5%, recouping half of the losses of the index for the past quarter.
The 10 Year Treasury Rate has hit recent lows over this past week. Why? Because evidence continues to emerge indicating that the US economy is solid, but not strong enough to warrant the Fed raising their target rate.
The latest futures rates indicate that the likelihood for an increase in October is approximately 6%, December 31%, January 43%, and March 54%. http://www.cmegroup.com/trading/interest-rates/fed-funds-flash.html These odds are wildly different than those from late August, when there was a 55% likelihood of an increase in the target rate in September.
What we have seen in the markets over the past few days has likely been repricing of equities utilizing lower short term risk free rates, which has the direct impact of increasing market valuations (as long as institutions are buying the security and paying the increased price.)
Crude Oil pricing does seem to have stabilized to some degree since the last week in September, as indicated by the chart below. This, then, has the effect of boosting confidence in oil and gas companies, which were badly beaten down in the 3rd Quarter.
Source of all charts above: Marketwatch.com
So what is going on with the US economy? Does anyone know?
Yes. We have a good sense that the US economy is continuing to grow at a pace better than 2% for the balance of the year. Though this is not stellar and it is below past averages, it none-the-less is growth, rather than recession. Yes, there are pockets of the economy that are now in recession, including the oil and gas exploration and production sectors, and certain geographic areas that had concentrated exposure. Overall, things are okay. See the actual news a releases from the past week:
The Institute of Supply Management released their September Non-Manufacturing ISM report this morning. The index came in at 56.9 percent, indicating growth, but at a slower rate from prior month. They note that the rate of growth has “cooled”, but that there is definitely growth. One small surprise was that prices decreased from prior month.
The Gallup Consumer Spending Measure was reported at $88 for September, and it has been range bound between 88 and 90 since April. This is good news as it indicates that the market’s noise from August did not have any major impact on spending in September.
The Markit US Services Purchasing Managers’ Index was reported this afternoon. The index came in at 55.1 for September, lower than the 56.1 from August, but still significantly stronger than a flat no-growth environment of 50.0. Their Chief Economist estimates that the US economy grew by 2.2% in the 3nd quarter. They also noted that prices for goods and services are dropping at the fastest rate in five years. This does not demonstrate an environment for the Fed to boost rates in.
Payroll numbers were reported this past Friday. The figures certainly indicated some weakness in the hiring of new employees. New jobs for September was expected to increase by 203k, but came in only at 142k. To make matters worse, August figures were revised downward to 136k from 173k. Average hourly earnings was flat, versus expectations of a small increase. Private payrolls came in at 118k versus expectations of 195k. The participation rate declined to 62.4% in September, down from 62.6% for the prior three months.
The value of Manufacturers Shipments for August were reported to be down 0.7% from July, pulled down by metals, non-farm machinery, computers, transportation equipment, and petroleum products. These figures reflect dollar values and not units of production….
Motor Vehicle Sales – Up again!
Consumer Confidence for September increased to 103.0 from 101.3 for August. Their Present Situation Index is now sitting at an eight year high (last at this level was in September 2007). Overall consumer optimism was little changes in September, which indicates the market chaos of August had little effect on Main Street.
Pending Home Sales from the National Association of Realtors showed a 1.4% decline for August but remains 6.1% higher than at the same time last year. Part of the slight decline month over month may be attributable to the limited inventory available in much of the country.
Challenger Job Cut Report showed 58,877 cuts in September, up from 41k in August, but down from the 109k in July. The 30k announced cuts by HP on September 15 had significant impact on the Sept. numbers. https://www.challengergray.com/tags/job-cut-report
Construction Spending for August increased by 0.7% over July and is up 13.7% over the prior year. Multifamily construction is up 25% y/y. Single family home construction is up 14% y/y. Non-residential construction is up 17% y/y with strong gains in manufacturing. https://www.census.gov/construction/c30/pdf/release.pdf
Corporate Earnings:
Only 19 of the 500 companies in the S&P 500 have reported through this past Friday for the 3rd Q. Earnings for 17 of the 19 came in above the mean estimates of earnings and 13 had revenues above the respective mean estimate. So earnings season is off to a good start. With the pull back through September, the market price has declined to levels not seen since April 2014.
There has been much talk of weak earnings and analyst downgrades of estimates, but in looking at the actual guidance issued by companies, the percentage of companies issuing negative guidance is slightly below its 5 year average. (This is a good thing.) www.factset.com
Per Factset.com, if the Energy sector were excluded from the S&P 500, revenue growth for the S&P would be approx. 2.3%, rather than -3.4%.
Oil:
Though the number of rigs in operation have declined by more than half over the past year, US Crude oil production is up 7% y/y in July and up 1% July over June. Production in the Gulf of Mexico is up 10% m/m and y/y. North Dakota is down 0.3% m/m but up 7.4% y/y.
http://www.eia.gov/petroleum/production/
Debt service has risen to more than 80% of operating cash flows for US onshore oil producers, versus 55% in the 1st Q 2014. http://www.eia.gov/todayinenergy/detail.cfm?id=22992
Here is an interesting chart of the components of the price you pay at the pump for gasoline:
In looking at Natural gas, total supply is up 3.78% y/y thru 9/30, with imports from Canada down 5.6%. Demand has increased by 5.5% y/y with demand for power production up 13.7% y/y. http://www.eia.gov/naturalgas/weekly
Trade levels through the port of LA: August Loaded Inbound container counts were up 6.3% over August 2014. Loaded outbound was down 14.4% for the month versus the prior year’s August. https://www.portoflosangeles.org/maritime/stats.asp
Thoughts and Conclusions:
It has not been a fun ride. Year to date, the S&P 500 is down 3.49%. The S&P 500 1 year change is +0.97%. Earlier this year, if we can remember that far back, the S&P 500 hit new all-time highs 10 times since January 1, 2015! The old saying “take a picture of it” definitely applies as it seems those days were “but a dream” …
Here is a piece of good news: “The S&P 500 has had a positive return 73% of the time in the 12 months following a new “all-time high”. http://www.bloomberg.com/news/articles/2015-07-20/the-lowdown-on-new-highs-s-p-500-gets-to-record-in-53-of-years So the odds are in our favor for a very solid 4th Q 2015 and 1st Q 2016 based on this.
The US economy continues to be the most sound in the US. The Fed likely will defer any increases to the Fed Target Rate until the new year. This deferral will likely support a continued rally in the US equity markets, as the continued low rates get repriced back in.
Corporations have been announcing restructurings, layoffs, acquisitions, stock repurchases, etc. all in an effort to boost profitability per share. This should support continued appreciation.
Corporations (non-financial) have a record amount of cash on their balance sheets, $1.43 trillion. So they, on average, have excellent cash for financial stability and to weather any storms. http://money.cnn.com/2015/09/25/investing/us-companies-cash-hoard/
There are many pundits who are warning of great risk as we move forward. We are not in that camp. The Fed is wise and has demonstrated that they are not up for increasing risk to the US economy. Corporate profits, in general, should stabilize. Energy will be slow to rebound. Semiconductors should rebound much quicker, with the worst in terms of pricing behind them. Reduced raw materials will enhance (to a small degree) the profit margins of the companies using the materials.
So, overall we are confident as we move forward. The 4th Q and 1st Q are typically the best of the year, and we are optimistic that this will be the case as we move forward this year and into 2016.
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