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By HaleStewart April 3, 2016 8:23 am
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US Equity and Economic Review: Could We Rally From Here? Edition

    On Monday, the BEA reported income and consumption expenditures:

Personal income increased $23.7 billion, or 0.2 percent, and disposable personal income (DPI) increased $23.7 billion, or 0.2 percent, in February, according to the Bureau of Economic Analysis.  Personal consumption expenditures (PCE) increased $11.0 billion, or 0.1 percent.  In January, personal income increased $72.7 billion, or 0.5 percent, DPI increased $57.2 billion, or 0.4 percent, and PCE increased $10.7 billion, or 0.1 percent, based on revised estimates.

Real PCE -- PCE adjusted to remove price changes -- increased 0.2 percent in February, in contrast to a decrease of less than 0.1 percent in January.  Purchases of durable goods increased 0.3 percent, in contrast to a decrease of 0.8 percent.  Purchases of motor vehicles and parts accounted for about half of the increase. Purchases of nondurable goods decreased 0.3 percent in February, compared with a decrease of 0.1 percent in January.  Purchases of services increased 0.3 percent, compared with an increase of 0.1 percent.

The NBER uses personal income less transfer payments to date recessions.  The number continues increasing:

The following table shows the monthly change in real PCEs:

Goods purchases contracted for the last three months, with two negative months each from durable and non-durable purchases.  Service expenditures continue at a moderate pace.

     The ISM manufacturing index was bullish.  The headline number increased 2.3 points to 51.8.  The best news was the surge in new orders, which rose a strong 6.8, printing at 58.3.  The production number increased 2.5 points to 55.3.  Perhaps most importantly, the anecdotal comments were very strong:

  • "Unemployment rate is low in our county, making it hard to find workers. We are understaffed and running lots of overtime." (Plastics & Rubber Products)
  • "Business in telecom is booming. Fiber plant is at capacity." (Chemical Products)
  • "Current trends remain steady. No issues with delivery or costs." (Computer & Electronic Products)
  • "Capital equipment sales are steady." (Fabricated Metal Products)
  • "Requests for proposals for new equipment [are] very strong." (Machinery)
  • "Government is spending again. Have received delivery orders." (Transportation Equipment)
  • "Things are starting to pick up. Our business is seasonal and it is that time of year." (Printing & Related Support Activities)
  • "Business conditions are stable, little change from last month." (Miscellaneous Manufacturing)
  • "Incoming sales are improving." (Furniture & Related Products)
  • "Our business is still going strong." (Primary Metals)

There is no bearish statement. 

     Auto sales were positive.  From Yahoo.news:

Ford, Nissan and Fiat Chrysler each reported big U.S. sales gains in March as the auto industry appeared to be headed for its best month in more than a decade.


Nissan sales were up 13 percent, hitting a record for any month in its history. At Fiat Chrysler and Ford, sales were up 8 percent, while they grew 0.9 percent at General Motors. Ford and Fiat Chrysler posted their best March numbers in a decade.

Auto sales dipped a bit the last few months, making this announcement that much more important.

     And finally, there was Friday’s jobs report, which continued the trend of headline numbers slightly above 200,000 with a 215,000 rate.  Unemployment was 5%; both the employment/population ratio and labor force participation rate inched higher.  Previous months were barely revised while earnings increased modestly.  We discussed it in more detail here.

     Economic Conclusion: This week’s news was positive.

  1. The ISM index was the most welcome news of the week, indicating the industrial recession may be coming to an end.  We shouldn’t read too much into it because it's only one data point.  However, the surge in new orders and strong rise in overall production are encouraging.
  2. The increase in auto sales reverses two months of strong, but slightly lower, sales.
  3. The jobs release continues the string of positive reports.
  4. Personal spending continues to increase, albeit it at a slightly weaker pace.  And
  5. Personal income less transfer payments continues to climb.

     Market outlook: I’ve been slightly bearish on the market for 2H15 and 1Q16.  Today, however, I’m going to engage in a thought experiment, arguing that the market is slightly undervalued and therefore somewhat attractive.  A recent Morningstar article provides the basis for this, where they argued the following:

  • We view the overall market as slightly undervalued, based on our fair value estimates for approximately 1,500 global companies.
  • The financial services, consumer cyclical, and healthcare sectors are the most undervalued, while the basic materials sector is our only overvalued sector.
  • Oil price concerns are hurting the financial services sector, while divergent paths for China's future fixed asset investment growth and consumption inform our thinking in the basic materials and consumer cyclical sectors.

A macro level argument could be made for a continued rally.  Recent US economic weakness emanates from the business sector, where the strong dollar, weaker emerging economies and declining oil market have all contributed to weak investment.  However, let’s assume that this week’s surge in manufacturing – which is supported by several recent regional Fed manufacturing surveys -- is the beginning of a manufacturing rebound.  A more dovish Fed would lead to a lower dollar, adding support.  Let’s take a look at the P&F charts to see what would be needed for a new, bullish market to develop.

     As these two P&F charts show, the SPYs (top chart) and QQQs (bottom chart) are both only a few points away from breaking out to the upside:

     The transports and IWMs are each only a few points below key resistance as well:

The initial phases of this rally would be anticipatory – traders taking positions hoping for an increased round of economic growth that would translate into higher earnings.  A big key to that would be a decreasing dollar.  As this chart show, that isn’t far away:

While this scenario may seem far-fetched, it's actually in-line with the market's historical experience during periods of rate increases, as explained by Chris Civacco in this excellent article at seeitmarket.com






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