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By HaleStewart August 20, 2017 7:13 am
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US Equity and Economic Week in Review: Solid Economic Fundamentals Provide Support For a Correcting Market

            This week saw the release of several key statistics: building permits and housing starts (which, depending on your interpretation, are either long-leading or leading indicators), along with two coincident indicators: industrial production and retail sales.  It seems appropriate to fold these releases into a broader analysis of the long-leading leading and coincident indicators in order to gauge the current growth potential of the economy.

Long Leading Indicators

            Due to oil’s price decline that started in mid-2014, corporate profits contracted for five consecutive months, starting in the 3Q15:

They have since rebounded, rising the last two quarters.  Factset.com and Zacks.com are both projecting increasing earnings in the third quarter.

            The long-leading indicators contain two monetary statistics:  BBB yields document the bond market’s risk appetite while M2 shows available liquidity:

BBB yields are tame while M2 is growing sufficiently to lubricate the economy.  Both readings point to future growth. 

 

Leading indicators

 

            For each of the last 6 months, the Conference Board’s Leading Indicator Index has risen 0.2%-0.6%.  The index’s financial components (the treasury market spread and S&P 500) along with the four-week moving average of first-time unemployment claims have consistently made positive contributions.  The latest housing permits and starts numbers were released on Wednesday; the results were mixed.  Permits were off 4.1% from June but they increased 4.6% Y/Y.  A 12.1% drop in multi-family units was the primary cause for the decline.  Housing starts were also weak, dropping 4.8% M/M and 5.6% Y/Y.  Once again, multi-family units (which account for 20% of the market) caused the decline: they were down 17% M/M and 35% Y/Y.  Starts of single family homes were down marginally M/M (-0.5%) but were up 10.9% Y/Y.  The following graph places these numbers into a longer-term context:

Both have trended sideways for about the 12 months.  Sideways movement could indicate the market has topped.  But, it could also indicate supply and demand are fairly-evenly balanced.

      

Coincident Indicators

 

            Earlier this week, the Federal Reserve released the latest industrial production numbers, which increased .2%.  The following charts show the last 5 years for the index and its Y/Y percentage increase:

Oil’s price drop caused a decline in mining investment, which is the primary reason for weakness from 2014-2016.  But this indicator is currently in an upswing. 

            More importantly, the Census Bureau released the latest retail sales figures this week, which were very strong: they rose .6% M/M and 4.2% Y/Y.  Growth was widespread among the various sub-components.  This was welcome news.  As I wrote last week, this statistic has been weak over the last 7 months and needed a bullish report.  That’s exactly what happened this week.

             The following chart show the other main coincident numbers, all converted to base 100 at the end of the last recession:

Real manufacturing and trade industry sales are the only indicator moving sideways; the others are increasing. 

Economic Conclusion

            The combined analysis of these indicators is for continued modest expansion.  There is ample liquidity to lubricate the economy while rising corporate income indicates people are purchasing goods and services.  This will also support business investment.  The LEIs are supported by broad-based participation of its constituent members and the CEIs are mostly positive. 

 

Markets Overview

 

This week the treasury market moved higher while equities were off.  The magnitude of the decline isn’t concerning; it could easily be reversed with a positive week.  But the 30-minute charts reveal a deteriorating technical environment:

The SPYs (top chart), IYTs (middle chart) and QQQs (bottom chart) are trading right at their 30-day support.

         

And the IWMs – which are a proxy for risk sentiment – are now testing new lows. 

            And several daily charts are starting to break down:

 

The QQQs (top chart) are doing their best to roll over while the DIAs (bottom chart) have broken a trend lin.  The IWMs (bottom chart) broke their 200-day EMA earlier this week and are now only slightly above that level.

            At this juncture, it’s important to remember that technical analysis is akin to a wind sock at an airport: it tells us the markets current direction.  It gives an idea where the market might be going, but only if we carefully and neutrally weigh the evidence.  The weight of the above information is the market is moving down, buy in a disciplined way, largely due to it being expensive.  But, the overall condition of the economy will provide a floor to any correction.  

              Hale Stewart is a tax attorney in Houston, Texas and a Registered Investment Advisor with Thompson Creek Wealth Advisors.  

 

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