“Live and learn” is one of those succinct yet incredibly meaningful sayings that we often hear but don’t pay enough attention to. This past week in markets was certainly one of those times that we all could learn a lot from. In fact, if last Friday after the Brexit referendum vote, someone had told me that the S&P 500 would close over 2100 the following Friday, I would have questioned their sanity in a rather colorful way. As it turns out, it’s my sanity that should have been in question as the S&P went on a strong rally starting Tuesday all the way to the close on Friday to finish at 2102. While we didn’t have any official Brexit news from the EU or the U.K. to justify the rally, we did get a vote of confidence of sorts from the FX and equity markets. The GBP was able to regain its footing and stay flat against the dollar while the Euro managed to gain a little ground. This stability seemed to come from investors taking a more sanguine look at potential Brexit outcomes and their implications. This improved view allowed equities to rally across Europe and in the U.S. with some markets posting their best weekly gains in years. I would attribute some of this improved outlook to the points I touched on in last week’s writing and what other Wall Street analysts pointed out this week about the trade relationships between the U.K. and the rest of the EU (mainly Germany). These relationships are so significant that it behooves all parties to come to a cordial agreement. In terms of the actual Brexit campaign, there have been some changes as well. Since the referendum vote, the remain and pro-EU voices across the U.K. and Europe have become more vocal and made their presence more known. Attesting to this was a march in London this weekend which garnered lots of media attention in support of staying in the EU. If nothing else, the referendum has certainly sent a clear message to EU leadership that changes must be made to strengthen the union for the long term. While Brexit may eventually happen, I have a feeling that it will be a watered down version that allows all sides to save face and will end up being a positive for markets in general.
With the obligatory Brexit analysis out of the way, we can take a look at some good and rather interesting data we got about the U.S. economy this week and the big week coming up. As much in the rear view mirror as it is, the first quarter GDP final revision we got on Tuesday deserves a mention. Q1 GDP was revised up to a final 1.1% from its originally reported .5% on primarily stronger exports. This is significant because improving exports, which were nearly flat in 2015, would be a great addition to our current GDP that is being driven almost entirely by consumption. Building on Q1 GDP data is the export component of the national Manufacturing ISM® Report On Business® which ticked up a point to a healthy 53.5 as well as being its fourth month in a row of expansion. As it stands now, the overall ISM index which came in at 53.2, its highest since February 2015, would equate to a 3.2% GDP if annualized. Within the ISM index, all the components were in expansionary territory except for inventories which did still rise for the month but remained in contraction. Also of note in the report were the gains in new orders to a very healthy level of 57 and employment which pushed back into expansionary territory to 50.4. That said, I would not try and extrapolate gains in ISM employment to gains in the upcoming nonfarm payroll (NFP) report. We’ve seen enough NFP reports to have learned that it marches to its own drummer. The fact still remains that the U.S. is a services based economy, but the growth in exports are a welcome tailwind for the economy. Should export growth persist, this will certainly add to the top line of S&P industrials / exporters and result in significant earnings growth and greater shareholder wealth thanks to all the stock buybacks done over the last couple years. I think the CFO’s who implemented all these buybacks will be the last ones laughing after having been ridiculed for “manufacturing” earnings throughout this cycle.
Along with the solid ISM report came the Chicago PMI, which is a 60/40 services to manufacturing weighted index, at 56.8 from its previous contractionary level of 49.3. Even though the report is regional, it still gives good insight into a major business hub of the Midwest. The report showed strong growth in new orders and order backlogs with employment being the only component in contraction. Taking the June PMI report in context with the previous couple months of less robust reports, this could be a case of payback along with some outright improvement. We’ll have to wait till next month for confirmation. Still, when looking at this and the ISM report, the economy is in good shape as we head into the second half of the year. It’s important to keep in mind that we are well into this expansionary cycle and that steady levels of activity and employment are what we are looking for.
Heading into next week, we have two significant data points. First up is the services version of the ISM manufacturing report, the Non-Manufacturing ISM® Report On Business® or NMI. The NMI is the best gauge of the services sector available and warrants close attention. Last month’s report came in at 52.9, down from 55.7 which was a bit worrisome. Given what we have seen on the manufacturing side of things and the persistently low unemployment claims data, I am expecting a bounce back in the report. Next up, on Friday we have the almighty nonfarm payroll report. This report has truly become an enigma as of late with its completely unpredictable results. However, as statistically flawed the report may be, it still holds sway over the markets and the Fed. Personally, I’ll be more interested to see what the weekly unemployment claims data have to show on Thursday. So, having lived through and learned from the markets’ behavior last week, we are well prepared to deal with upcoming volatility. The fact is the game hasn’t changed, but it’s our mindset that does need to change. Therefore, stay focused on the actual data and try not to fall into the hysteria that financial media is so good at creating. Otherwise, we haven’t learned a thing.