January was a rotten month for stock markets, but what is the action is telling us? Is the economy about to careen into a recession or did stocks get ahead of the broader economy and are now resetting lower, to a more reasonable level? My guess is that it's the later, but the answer will only be evident in hindsight. Here’s what we know: the economy slowed to a measly 0.7 percent annualized pace in the fourth quarter, dragged down by business investment (-1.8 percent) and net exports (-0.5 percent). Plunging energy prices was the culprit for the weak reading on business investment. Within the category, there was a 5.3 percent drop in structures investment, which was mainly due to the collapse in drilling activity. According to Capital Economics, “mining structures investment fell by 51 percent in 2015, subtracting 0.4 percentage points from overall GDP.”
Exports and inventories were down primarily due to a strong dollar. Although growth was only 2.4 percent for all of last year, essentially matching the slower than normal pace of the previous three years, U.S. GDP is better than other developed nations, like Europe and Japan. That’s why the dollar Index is up by more than 20 percent over the past two years. A strengthening greenback is great for consumers who are purchasing French cheese or Italian olive oil, but it also makes U.S. goods costlier overseas, which has put the manufacturing sector into a deep funk.
One bright spot in the GDP was consumer spending. Although consumption slowed to 2.2 percent in the fourth quarter, from 3 percent in the third, for all of 2015, consumption grew at the fastest pace in a decade, according to Joel Naroff of Naroff Economic Advisors. He notes, “given that the warm December meant a lot lower heating bills and very little reason to buy winter-related products such as sweaters or shovels, it [the 2.2 percent reading] was actually quite good.”
Americans may be spending, but they are not going crazy. Overall after-tax income increased by 3.2 percent at an annualized inflation-adjusted basis, but instead of blowing it, more people chose to bank those extra shekels. The personal savings rate jumped to 5.4 percent, the highest level since 2012 and a far cry from the negative rate seen in mid 2005.
Fed/Jobs Watch: The drop off in US growth kept the Fed on hold in January and investors think that the current economic uncertainty will clear up by the time of the next FOMC meeting in March. Futures markets anticipate only one additional quarter-point rate hike by the end of this year. It is important to underscore the US monetary policy remains accommodative—after all, the inflation-adjusted fed funds rate is still well below zero.
To determine whether or not to raise in March, the Fed will keep a close eye on economic data and the labor market. The January employment report, which is due on Friday, is expected to show that 200,000 jobs were created and the unemployment rate will remain at 5 percent. There may even be an upside surprise, as companies have recently been reporting that they are finding those job vacancies harder to fill and households say that jobs are plentiful.
Oil, Oil Everywhere: And finally, a word about oil…an old commodities trader once told me: “Honey (it was 1987), there are only two things to analyze with commodities: supply and demand.” The 2015/early 2016 oil selloff has been attributed to weak demand, reflecting fears of a slowdown in China’s economic growth and, consequently, its demand for oil.
But Capital Economics points out that the Energy Information Administration’ short- term outlook “shows that Chinese petroleum consumption has continued to rise at roughly the same pace as before. Instead, the slump in global oil prices appears to be predominantly due to the surge in supply that began in 2014 (a lot of it due to higher US shale output) rather than weaker world demand.”
MARKETS: Negative is a Positive for markets. Persistently weak growth in Japan and the rest of the world prompted the Japanese central bank to join other central banks (ECB, Sweden, Denmark, Switzerland) to push deposit interest rates for new reserves into negative territory. That means that a Japanese commercial bank will have to pay for the privilege of sitting on cash. The government hopes that the move will encourage banks to lend more, which would in turn create more spending. Investors saw the action as evidence that both Japan and Europe would like have to resort to more stimuluative measures in the future, which pushed stocks higher on Friday. It was not enough to save the dreadful month, but it coulda’ been worse!
- DJIA: 16,466 up 2.3% on week, down 5.5% MTD/YTD
- S&P 500: 1940 up 1.8% on week, down 5.1% YTD
- NASDAQ: 4613 up 0.5% on week, down 7.9% YTD
- Russell 2000: 1035, up 1.3% on week, down 8.8% YTD
- Shanghai Composite: down 23% in Jan, the largest monthly drop since 2008. The index has fallen by nearly 50% since its peak in June 2015, but remains 33% above its level in mid-2014, before the bubble began
- 10-Year Treasury yield: 1.93% (from 2.06% a week ago)
- Mar Crude: $33.62, up 4.4% on week, down 9.2% MTD/YTD and up 27% from Jan 20 low)
- Apr Gold: $1,116.40, up 1.8% on week, +5.3% MTD/YTD
- AAA Nat'l avg. for gallon of reg. gas: $1.80 (from $1.84 wk ago, $2.05 a year ago)
THE WEEK AHEAD:
Aetna, Alphabet (formerly known as Google)
8:30 Personal Income and Spending
9:45 PMI Manufacturing Index
10:00 ISM Manufacturing Index
10:00 Construction Spending
Exxon Mobil, Dow Chemical, UPS, Yahoo
Motor Vehicle Sales
GM, Merck, MetLife, Yum! Brands
8:15 ADP Private Employment Report
9:45 PMI Service Index
8:30 Productivity Costs
10:00 Factory Orders
8:30 Jan Employment Report
3:00 Consumer Credit