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By HaleStewart May 22, 2016 7:38 am
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US Equity and Economic Review: Just Not Feeling the the Warm Fuzzies From the Macro Data

     On Friday, the Conference Board released the latest leading and coincident indicators.  The LEIs increased .6% while the CEIs rose .3%.  The report's internals were strong: 9/10 LEIs were higher while all 4 CEIs advanced – even industrial production, which declined in 4 of the last 6 months.  And the LEIs 6-month rate of change was up .2% to .6%.  Overall, this was the best LEI report of the year.     

     This week’s housing news was positive: building permits increased 3.6% M/M while housing starts rose 6.6% M/M.  But both figures declined Y/Y (5.3% and 1.7%, respectively).  More importantly, both data series are moving sideways:

Housing starts (red line) fluctuated between ~ 1.1 and 1.2 million for the last 12 months.  Building permits’ (blue line) overall range has been a wider 200,000, with figures moving between ~1.1 and ~1.3 million.  But both are contracting on a Y/Y basis, which is a bit concerning.  Rounding out the good news, existing home sales were up 1.7% M/M and 6% Y/Y.  It’s important to remember that at the macro level, residential investment is one of the strongest areas of GDP growth:

     Industrial production finally increased, rising .7%.  But the longer-term trend is still lower:

And the index’s components are not encouraging:

Mining consistently dropped for a half-year and utilities declined in 4 of the last 6 months.  Only manufacturing rose more than half the time since November – hardly an encouraging sign.  We’re beyond the point where we can argue temporary factors are to blame.  Instead, this key economic sector is slowing, portending future weakness.    

     The Federal Reserve hinted that a June rate hike was a strong possibility, sending the markets lower.  The weekly bond market review covers this development in depth.

     The Atlanta Fed’s GDP now model is predicting 2Q growth of 2.5%, down slightly from the earlier 2.8% prediction.  Still, the forecast remains sunnier than the 1Q number.

     Economic Conclusion: this week’s news was positive.  Housing numbers provided reassurance that a recession was not on the horizon.  The .7% increase in industrial production was a welcome development for this recently underperforming statistic.  But the LEIs were the best news, largely due to the breadth of the index’s components increase.      

     Market Analysis: The current and forward PEs of the SPYs/QQQs are 23.49/21.69 and 18.29/17.51, respectively.  The current level is expensive while the future levels are high.  To continue rallying, an expensive market needs top line revenue growth.  But weak domestic and international growth have led to declining corporate earnings in 4 of the last 5 quarters.  Just as importantly, the primary reasons for weak growth continue:

  1. Chinese growth is slowing.  This not only impacts China proper, but also any country that provides raw materials to the Chinese manufacturing plant.  The Chinese slowdown is a primary reason for weak growth in emerging market economies, which is slowing multinational’s international sales.
  2. Developed economies (Japan, Canada, UK, and the EU) continue growing at a slow pace, also negatively impacting US multi-nationals international sales.
  3. The pace of U.S. consumer spending, which is responsible for 70% of U.S. GDP growth, is weakening.  Personal consumption expenditures decreased from 3.5% Q/Q growth in 2Q15 to .5% in 1Q16.  However, this data point is still positive.  And, low unemployment, rising asset values, and the recent 1.3% M/M increase in retail sales could point to an upcoming rebound.
  4. Corporate capital expenditures are slowing.  Gross private investment contracted for the last three quarters.  While the oil patch’s slowdown started the trend, a widening malaise may be developing.  Commercial real estate investment dropped in 6 of the last 9 quarters while intellectual property investment declined in the last 2.  U.S. business is clearly concerned enough about the macro environment to contain their spending. 

And now we have an added issue:

  1. The latest Meeting Minutes from the Federal Reserve indicate a June rate hike is definitely on the table.  Just as Fed dovishness earlier in the year prompted the most recent rally, so too is their current intent to raise rates lowering equity prices. 

Until these points reverse, there is little reason to argue for a meaningful rally above previous highs.

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