Weekly Wrap 4.26.15

To spoof or not to spoof, that is the question…Spoofing, which sounds more like a 60’s hairstyle than it does a deceptive trading technique, is the rapid placing and cancelling of orders with the intention of skewing actual market depth. It is also one of the charges that a formerly unknown British chap by the name of Navinder Sarao was charged with by the US along with other securities trading related crimes. Nav, as his nickname goes, is also being blamed partially for the May 2010 flash crash. Since 2010 there have been many explanations for the crash ranging from a simple trading error to an algo driven selling frenzy with the truth probably laying somewhere in between. At first, I thought Nav was being scapegoated for our regulators inability to manage markets, but after further review that does not seem to be the case. In fact, having read the actual criminal complaint (see items 15,16 and 17 in the complaint) it appears that Nav may have been a bad boy and could be in some real trouble. The email evidence that the government puts forth, shows Nav developing and using trading software designed to create false market activity. That my friends, is a crime plain and simple. Anyways, it’ll be interesting to see how this case unfolds and if we get our first recorded criminal spoofer.

So with our compliance training completed, we can now dive into this weeks economic activity. Things didn’t really get started until Wednesday when we got the National Association of Realtors (NAR) Existing Home Sales data (EHS) and the FHFA Housing Price Index Report . Both prints came in on the high side with the FHFA index showing particular strength. When we look at EHS, it’s very important to look at how it is defined especialy in comparison to new home sales (NHS). EHS captures a sampling of closed transactions drawn from listing services across the country whereas NHS is based on only contracted sales derived from sample surveys. EHS also composes roughly 90% of overall home sales as per NAR. EHS data for March showed unit sales at a 6.1% seasonally adjusted annual pace and up nearly 10.5% year over year. As the graph below shows, we are well below the peak, but the peak is arguably something that should have never been reached if there was any prudence in lending during the housing boom. I think that with today’s rigorous mortage approval process, we are looking at much higher quality sales data. As for the FHFA price index in February, it was up .7% from the prior month, up +5.4% year over year and now sits just 2.9% off its 2007 all time high! Given the low quality transactions that fueled the 2007 peak in prices and the high quality tansactions driving todays prices, we are looking at a healthy housing market.


Thursday we got a weekly unemployment claims print that ticked higher by 1,000 to come in at 295,000 with the four week moving average at 284,500. These consistent sub 300,000 weekly prints bode well for the April employment report but then again so should have last months and we saw how that turned out. Of note are continuing claims numbers which continue to grind lower and are at a historically low level. I like to focus on weekly / continuing claims data because unemployment insurance (UI) is a great real time barometer for high turnover trades and services work. With that being said, we still have yet to see the fallout from the energy related layoffs which could show up any week. However, with oil having stabilized around the mid 50’s on the back of Saudi Arabia backing off of its no cuts stance, some oil rig workers may have just gotten new life. I guess only time will tell.


Also on Thursday was the Markit Flash Manufacturing PMI for April and new home sales data. The PMI data, which came in below expectations at 54.2, was still well in expansionary (>50) territory but had slowed since last month. The PMI flash reflects the downbeat manufacturing data we have gotten from several readings for March and April thus far. This ties into last weeks closing comments which touched on an economy that, in some sectors, is lacking the enthusiasm we would like to see. Wrapping up the housing data on Thursday were new home sales, which we had touched on a bit earlier. The print was down 11.4% from February but still up nearly 20% year over year.

Last but certainly not least for the week was another soft durable goods report for March. The headline print of +4% month over month was skewed from transportation and defense orders leaving the “core” areas in negative territory. We did see an uptick in the shipments components of the report, which I suspect may be a result of the end of the west coast port strike. It will still take a couple more months of data to get the port strike noise straightened out so we can get some clean readings from many different surveys. Even so, manufacturing data is still persistently lagging other data. Whether the weakness is due to the strong dollar, weak demand or a combination of both remains to be seen. We’ll just have to keep an eye on things and remain data dependent, as the Fed likes to say.

Weekly Wrap 4.19.2015

Well that’s another week in the books and a rather interesting one it was. The highlight of the week goes to Mario “The Bazooka” Draghi as he cowered in front of his confetti throwing thonged assailant. You just can’t make this stuff up…

Protestor Thong 4.17.15

It’s tough to follow an act like that but never the less I’ll trudge on. We had a pretty busy week on the economic front. The major data points were on retail sales, industrial production and inflation. On Tuesday we got PPI which actually firmed a bit since the last report thanks to a rise in energy prices. The indices for final demand in goods and services were up from February showing gains in gasoline, jet fuel, beef and veal. On the downside were pork, natural gas and plastic resins. Right along with the PPI release was also Retail Sales. I wrote about this earlier in the week so not much more to discuss on this one other than you can’t just take the headline number and go with it. When we look at the individual series that make up the report, we see that there is indeed strength in sales coupled with inflation. The inflation in some of the categories from the report were confirmed when we got CPI data on Friday. CPI registered gains in the energy, clothing, furniture and recreation categories, all of which were first presented in retail sales data.

Unfortunately we did get some disappointing data from the NFIB Small Business (personal favorite) and Industrial Production (IP) reports. Respondents in NFIB cited poor weather, the strong dollar and government regulations as the main constraints. Of note in the data was a reference to a shortage of skilled labor which has been a recurring theme in various labor reports. We then had the Industrial Production report, which was dragged down by energy related businesses. The massive drop in energy prices has definitely skewed data in many reports which is why it has become even more critical to sift through the line items to get a true read on the information. IP only showed a gain in business equipment for the month, but all major market groups are still up on a year over year basis.

On Wednesday afternoon we got the release of the Beige Book report. The Beige Book is one of these reports that many people don’t pay attention to, but really should. When you read the summary and all the actual reports from the individual regions, you get a very good feel for what is going on in the country, not to mention a sneak peek into following data points. For example, in this month’s report, the Philadelphia section spoke about manufacturing gains which were then confirmed on Thursday when we got the Philadelphia Fed survey that beat expectations. Again in the Beige Book was the reference to a lack of skilled labor. Several regions in the report cited an inability to find workers in areas ranging from construction all the way to Information technology positions. While this inability is good to see as it speaks to an increase in labor demand, it also brings up a very troubling aspect of our country which is a decline in relevant job training. Overall the Beige Book showed an economy that is growing, but is lacking real enthusiasm.

Thursday we got another sub 300,000 weekly unemployment claims number. The stretch of low claims data we are experiencing typically coincides with a boom time economy. This begs the question, what is different this time? The answer, I believe, is that we are in a kind of reset period. We have made the transition from a severe contraction into a period of growth, but because of the extent of the damage from the downturn it has taken much longer to recover. We are just now seeing wages rise on both a nominal and real level which is the key to fostering consumption and shifting our economy into high gear. Also on Thursday we got a below expectations housing starts and building permits report. While on the soft side, when you look at the data historically, it seems as if we are at the beginning of a growth period.

Claims 4.18.15*Shaded area indicates a recession as defined by the NBER.

Housing 4.18.15

Ah…TGIF. We got CPI, Consumer Sentiment and Leading Indicators. CPI, similar to PPI, showed some firmness because of the recent rebound in energy. So far in April, crude oil has rallied a bit and if it stays around these levels will certainly lead to a gain in next month’s inflation and retail sales data. Consumer Sentiment came in above expectations and is also at a historically high level. Ultimately it is the consumer which drives our economy and I expect that as things slowly improve we will get to that point where the economy accelerates and people will take notice. Leading Indicators were somewhat subdued in March and pointed to the reset period which I referred to earlier.

All in all it was mixed bag of data for the week. Points for both the bulls and the bears to support their arguments. Over the weekend I had lunch with a friend of mine who works in the leveraged loan business and he had some interesting observations. He is seeing demand, but what he is not seeing is the real fear of missing out that comes with a true bull market. His observations do seem to mesh with what we are seeing in the data recently which points to an economy that is moving, but just not as quickly as we would like. I have to admit that even as optimistic as I have been, I do have to agree with him. That being said, there are enough good points to the economy that I believe growth will pick up. As they say, you have to learn to walk before you can run.

Retail Sales – Always have to check under the hood!

Yesterday we had the release of advanced retail sales data for March which came across as disappointing at first look and downright miserable according some peoples reviews. On top of that, the “control group” which is a component of GDP and PCE calculations was also to the downside for the month. Just looking at what is excluded to form this “control group” doesn’t really make sense in my opinion because prices fluctuate in all areas, but purchases are still made. That being said, there are plenty of bones to pick with GDP calculations and government surveys so I’m just going to stick to the hard facts on this one. When you get inside this report and look around you will see several categories that are either near all-time series highs or close to the pre-crisis highs of 2005/2006. For example in Clothing and Clothing Accessories, the March print of $21.47 billion is the second highest in series history with the highest print of $21.69 billion having just come in November 2014. In the Furniture and Home Furnishings category, Q1 2015 sales averaged $8.62 billion which would be on pace to be the best year since 2007 when sales averaged $9.28 billion. Next up is the Building Material, Garden Equipment and Supplies Dealers group where Q1 2015 sales are running at the highest level in series history with the March print also being the highest amount since April 2006! Then in the Sporting Goods & Hobby category Q1 sales are also running at their best pace in series history. Last but certainly not least comes the Food Services and Drinking sector which continues to accelerate with a Q1 year over year growth rate of 8.8% with March also being the highest sales print in series history. So inflation does seem to be alive in the retail sales world just looking at these sales comps. Gasoline Stations were the obvious drag on the month with a roughly 23% decline in sales from Q1 2014. All in all, Q1 2015 had 11/13 categories show positive year over year growth and if we back out gasoline stations, we had nearly 4.5% growth across the board! As usual it’s easy for people to just say the report is generically weak, but when you look under the hood, you can see the engine is solid and humming along.

The New Conundrum – Deflation versus Consumption

As we head further into 2015 with the US economy on solid ground and building momentum, an interesting tug of war is taking place in economic circles. Economists and other market participants are debating whether or not declines in the prices of some goods and services, especially those in the energy sector, are good or bad for the economy. The argument is basically a debate on the ramifications of deflation. To begin, I’d like to get us all on the same page with how we are defining deflation which is a decline in the prices of goods and services. Now, in and of itself, this definition does not carry a negative connotation. Deflation does not become a negative occurrence until it’s viewed in what some economists see as a situation where consumption halts in anticipation of lower prices. While it is true that an economy would suffer as people postpone purchases, it’s unlikely to happen because of a natural human tendency to consume. This brings me to the crux of my disagreement with the deflationary economic collapse scenario which is that consumers, who find themselves with stable employment and discretionary income, will consume regardless of any potential future price declines. Furthermore, deflation when coupled with both steady employment and incomes can induce greater consumption of goods and services which will ultimately lead to rising prices as firms seek to maximize profits. The question now becomes, what drives consumer behavior?  The answer comes from three areas: basic human psychology, economics and common sense.

To frame the discussion in an academic sense for now so that we can address consumer behavior, we will begin with Maslow’s Hierarchy of Needs. The hierarchy acts as a psychological framework made of up of tiers which begins with the most basic necessities for life and then progresses up to the final level in which people have become essentially all that they want to be. The section which I will draw attention to is just before the final tier and is called the “Esteem” tier. It is in this “Esteem” tier that a person’s innate desire to consume lies. Maslow describes this tier as one that “is soundly based upon real capacity, achievement and respect from others.” Translation: A person will consume to fill personal desires and / or the desire for attention from others. Maslow also succinctly captured consumer behavior in his Theory when he stated, “Man is a perpetually wanting animal.” In general, if we believe in Maslow’s hierarchy or other types of motivation theory, we believe that people will always have a need to consume. It is this need to consume that will create greater utility for consumers as prices decline which in turn will create more consumption.

From an economics standpoint, there are a couple of concepts at work that also support rising demand from lower prices. While these concepts are some of the most basic and often first lessons learned in finance, it appears that they are also some of the first to be forgotten. If we go back to basic demand curves and elastic goods, economic principles dictate that as prices fall demand goes up, all things being equal. From a common sense standpoint, I’m pretty sure that as consumers we have all been in a store and bought more items because they were on sale, right? Going a step further, I have found myself more hesitant to make additional purchases of a discretionary item if the price has gone up.

Another economic concept at work was introduced by J.M. Keynes in his seminal work The General Theory of Employment, Interest and Money and is referred to as “propensity to consume” or PC. PC looks at changes in consumption as changes to income occurs. Interestingly enough, Keynes was kind of a predecessor to Maslow as Keynes also looked at the psychological factors of consumption which he referred to as the “subjective” factors. The primary and rather intuitive relationship Keynes established was that as incomes rise so does consumption. Keynes primarily focused on increases in income as a function of labor expended; however, that focus can be built upon to look at an increase in income as a function of expended labor as well as decreasing costs (deflation). Today, consumers’ incomes are rising through a combination of nominal wage raises, lower nominal prices in many goods and finally through savings from a drop in energy prices. All this being said, we can see PC manifesting itself in one of the most elastic/discretionary of goods categories which is the restaurant and food services sector (RFS). The year over year growth rate in RFS sales for the three month period ending February 2015 was 8.97%. The same metrics for 2014 and 2013 yielded an average growth rate of just 3.49%. The significant increase in sales is a function of a decline in energy prices (increase in income) and RFS being a readily available outlet for spending. I expect in 2015 that as energy prices stay muted and more companies follow the lead of retail giants like Wal-Mart and Target in increasing wages, we will see PC driving up consumption across the entire retail goods spectrum. The bottom line is that people want to consume, and consumption is the fuel that will drive our economy to new heights and achieve greater prosperity for all.

I’d like to now shift gears to a more market focused discussion in which we will look at the possible reasons behind falling prices. This is of great importance because if prices were falling because of a lack of demand, then we would actually be in a negative deflationary scenario. I would argue that we are in a natural period of deflation that is a result of dramatic advances in technology. These advances have had the knock on effect of suppressing prices. To be specific, there have been two key structural changes to the production of goods and services which have led to deflation. The first was a change to the labor force as a result of technology. This change has resulted in increased productivity and reduced costs at the firm level through a reduction and rebalancing of the labor force. A basic example of this would be software programs that have replaced almost entire human resource departments in large organizations. Then on a smaller scale we can look to “smart” technology in portable devices which have eliminated the need for sales support roles and other administrative positions throughout many businesses. This streamlining has allowed firms to be more competitive in pricing without harming margins and ultimately create more jobs through business growth. The second structural change comes from the renaissance in American energy production. America has gone from being the world’s largest consumer of oil to the world’s largest producer in less than a decade. This rapid change has completely altered the dynamics of international energy markets and reduced input and operating costs for many domestic companies. What used to be a massive transfer of wealth to foreign oil producers has now become a savings for domestic consumers on a retail and commercial level. In fact, based on 2014 gasoline consumption, consumers have saved roughly $148 billion from the drop in gas prices. To put this into perspective, the economic stimulus package of 2008 provided by the government and paid for by tax payers was $170 billion. The $148 billion in gas savings is essentially a no cost stimulus to US consumers. Of course this is just the savings on retail gasoline; one has to look across the entire energy complex to gauge the complete savings.

To conclude, depending on its context, deflation is not a bad thing. Deflation as a result of changes from supply side dynamics is just as natural an occurrence as changes in inflation from demand side factors. Every day we are bombarded with headlines from central bankers and economists about the perils of deflation and what the latest macroprudential policy rabbit out of the hat will be to stop it, when in fact all that is necessary is to let economic nature take its course. With that, I think when we look at the current unemployment rate of 5.5% and the structural changes temporarily suppressing inflation, I believe the economy has recovered. The reason people are having such a difficult time recognizing the recovery is because they are looking for this “break out” moment and are forgetting how far we have travelled from the financial abyss of 2007/2008. The new recovered state of the economy is not going to look like what we had before because of all the changes that have occurred. The sooner we come to this realization, the sooner we will be able to focus on the future and finally leave the great recession behind.