Brexit, the markets & what to expect

“Brexit will never happen” is what a prominent fund manager told me while we exchanged bullish market views a couple weeks ago at a social gathering. I was a bit surprised at how emphatic the person was about Brexit, but it was understandable. I responded with my favorite behavioral finance quip about investors’ tendency to be overly fearful and risk averse at times when in fact probability favored a rising market. We both chuckled and seemed to have it all figured out. Well, as we all watched events unfold Thursday and into Friday, Brexit did happen and the market did go down. Much to my chagrin, I was faced with the difficult thought of having to reassess my bullish position. But, as investors, this is a painful but necessary exercise if we hope to survive inevitable bear markets. So, the question is, what does Brexit mean? The answer is, no one knows. Could it be the end of the European Union and the beginning of years of financial and political chaos in Europe which would undoubtedly wreak havoc with global markets? Or is it the event that forces the EU to reorganize itself and take serious measures to ensure fairness among its members? Again, the truth is that we simply don’t know yet. What we do know is that financial markets responded swiftly on Friday by knocking down the equity markets of all parties involved and dropping the value of the British Pound a staggering 8% versus the dollar. So while the U.K. has decided to head into the unknown in search of better arrangements and perhaps to find its former self, financial markets have already made some of its future known. And that future is not bright.

It is the financial realities that markets have delivered already that I believe will force the U.K. and EU to come to some sort of amicable agreement. Until the situation fully plays out, all we can do is to take a look at how market reactions may affect the principal participants’ (U.K. and Germany) motives. For the U.K., which is a consumption based economy like the U.S., a depreciating currency is like a tax on its citizens as imports become more expensive. Then, from the Bank of England’s perspective, a rapidly depreciating GBP could theoretically create hyperinflation, a situation in which the BoE would have to aggressively hike rates to thwart capital outflows and inflation. So Friday’s dramatic FX losses against its major trading partners will certainly have everyone’s attention. In terms of trade so far this year, Germany and the U.S. were the U.K.’s top trading partners to which the U.K. is running a 6.4 billion GBP deficit. A deficit that will get more expensive the further the pound drops. Now from Germany’s perspective, in 2015, the U.K. was their third largest export destination behind the U.S. and France. So we can see how it would behoove Germany, the de facto leader of the EU, to keep communications open and friendly with the U.K.

As the realities of the vote start to reveal themselves, it seems there are many in Britain who are experiencing, if you will, a kind of voters’ remorse. For example, Cornwall, a county in the south of England whose economy is based primarily on fishing and agriculture, received roughly 60 million GBP yearly in financial aid from the EU. Prior to the vote, the Leave campaign promised that funding would still be in place post a leave vote one way or another. Now that the vote has happened, Cornwall finds itself looking at a possible interruption of these funds as the transition takes place. It’s all fun and games until the bill comes. All this said, Brexit remains an extremely fluid situation as the idea of a new referendum is already being passed around and gaining momentum. Given the economic realities of what has happened so far, I would expect a softening of rhetoric from the Leave campaign and for the remaining political leaders in the U.K. to work with the EU in making as smooth a transition (if any) as possible to the benefit all parties. Translation: Now that real damage has been done on all sides, cooler heads should prevail and market volatility should subside.

Now moving to situations on this side of the pond, let’s look at a significant data point we got in the midst of all the Brexit hysteria last week, which was weekly unemployment benefits claims. Last Thursday’s initial claims print came in at a very low 259,000 with continuing claims getting close to their cycle low at 2.142 million. While labor market health has been under some scrutiny since last month’s “weak” nonfarm payroll (NFP) print of 38,000, I’m taking issue with both the scrutiny and the “weak” description. Since the labor market has essentially reached full employment and the economy is in a slow but steady growth mode, it is incorrect to expect 200,000 monthly job growth into perpetuity.  An excellent assessment of the “weak” payroll report and the labor market is given here by Stephen Williamson of the St. Louis Federal Reserve Bank. In short, Williamson says the labor market is doing just fine.

What I would like to focus on here is how well the weekly claims data does in capturing the cyclical nature and health of the labor market. Unlike NFP data which is based on statistical sampling, weekly claims data is based on the actual total numbers of people seeking unemployment benefits. While NFP data still does a great job in describing the composition of the labor force, claims data is the most accurate and timely gauge for judging true labor market health. The reason for preferring weekly claims data is that when cyclical industries hit slowdowns and lay people off, those layoffs show up almost immediately in the initial claims data. For people in cyclical and / or high turnover industries like construction, leisure & hospitality, unemployment benefits act as a lifeline until new work can be found. The Bureau of Labor Statistics also put out a report which shows that within initial claims data you have not just cyclically unemployed persons, but also workers who may be intentionally filing claims once they meet minimum work requirements. Depending on how much of the latter group is true, the labor market could be even tighter than the data suggests.

To illustrate how strong today’s labor market is, I have taken the initial claims data series and adjusted it for the size of the labor force. While the labor force has grown over time, the percentage of claimants to the total labor force has been fairly consistent through prior periods of higher labor force growth as is seen in the first two ovals. As we move forward to today, labor force growth has been fairly flat while the claimant number has dropped. This is indicative of a healthy / tight labor market.

IC LF 6.26.16

The key takeaway here is that regardless of nonfarm payroll growth, we know that cyclical industries are keeping people employed and that employment is the backbone to a healthy job market and, in turn, a healthy economy.

A market update would not be complete without a look at some recent services sector data, which we also got last week. On Tuesday, the Federal Reserve Bank of Philadelphia released its Nonmanufacturing Business Outlook Survey for June which is the services version of its highly regarded manufacturing report. Unfortunately, most people missed the release because it was not on the economic calendars of any of the major news sources. This is truly a shame because the report is one of the few metrics provided on the services sector by a regional Fed bank and deserves to be followed. As I’ve written before, services data just doesn’t get the coverage it deserves in financial media. That said, the report showed solid gains in employment and modest growth in sales and new orders, which is in line with our steady economy.

The above is all well and good, but the real issue is where are we headed now? Unfortunately, like back in February when we were tied to oil, we are now tied to Brexit. Given the news over the weekend, it seems that the Leave campaign has bitten off more than it can chew and is scrambling to control an unexpected victory. Already there is enough of a backlash from the Remain campaign that it may be able to thwart an actual Brexit. I think the fact that so many people in England, Northern Ireland and Scotland want to be a part of the EU and believe in a united Europe that it bodes well for the survival of the EU. Ultimately, I believe agreements will be reached and the bull market will continue. Otherwise, I would certainly hate to run into my fund manager friend again and have to share some humble pie.


Get long America!

This article was submitted for the Sohn Conference investment idea contest on April 22,2016. It was not selected as a finalist. The first half contains some of my earlier services work while the second half focuses on Darden Restaurants (DRI). I will be putting out more work on DRI and other names in the future. To be clear, this was written prior to the strong ISM NMI (services) data released on May 4,2016. #Sohn2016



Before looking at DRI, I feel it’s important to analyze the current economic backdrop and how it plays into the success of DRI. My thesis for DRI being undervalued is based on the belief that the long term strength of the consumer and the economy in general has been underestimated by the investment community. This underestimation is a function of many investor’s conservatism bias towards recognizing and accepting the strength of a services based economy. In short, conservatism bias is a term used in behavioral finance which describes why people cling to prior views and fail to update those views when presented with new information. This failure is mostly driven by the mental discomfort, or cognitive dissonance, that comes with processing new information that conflicts with an existing belief. Then compounding this bias, we have financial media constantly associating services based employment with that of “burger flippers” or low skilled and low paid positions. This association, quite frankly, is not only derogatory to a whole group of people that work very hard, but it’s also untrue. Most people don’t realize that the services jobs spectrum includes computer hardware designers, programmers, electrical and mechanical engineers, medical professionals, scientists, accountants, lawyers, architects, advertising agents, commercial drivers, CEOs, custodial arts professionals and even those very special folks that toil in financial markets. Not only are services jobs primarily high-skilled positions, they also have high earnings. Using data from the most recent nonfarm payrolls report, the table below shows how many people are employed in various goods producing and services sectors, and how much in earnings they generate.

total earnings 4.16.16


Much to the chagrin of those in financial media, you can see that four of the top five earning industries are all in the services sector and do not include the leisure and hospitality industry.

The U.S. economy used to be a manufacturing and exporting powerhouse, which is what many people still think the economy is about today. In reality, the economy has been transitioning from a manufacturing/export base to a services/consumption base since the mid 1900’s. This transition has had significant effects not only on the composition of the workforce, but also on business cycle length. Because a services/consumption based economy is highly self-sustaining and less susceptible to exogenous shocks, the length of the average business cycle has increased. In the table below, I have adjusted NBER business cycles to include the transition from a manufacturing/exports based economy to a services/consumption based one.

Biz Cycles 3.26.16.jpg

The current expansion is in its 83rd month, and I would argue we have more than a year to go.

In addition to having a longer business cycle, the services based economy also has a labor force that is more resilient to recessions and is able to recover more quickly from them as the charts below demonstrate. In the charts, I have drawn a comparison between Manufacturing, Professional and business services (PBS) and Total private employment. All three data series are titled and defined by The Bureau of Labor Statistics which is the source of all data used in the charts. I chose PBS because it best represents a broad range of service industries. The charts include every recession that has occurred since 1945 as defined by the NBER. 1945 is the earliest starting point for which data was available for all three series.

The first chart shows the average number of jobs lost on a monthly basis as a percentage of its total industry. For example, in the recession of 2001, manufacturing lost an average of .81% of its workforce on a monthly basis while PBS lost just .43%. Then in the Great Recession, they lost .83% and .47% respectively.

recession 3.27.16


As you can see, PBS has been more resilient to downturns than manufacturing.

The second chart shows the monthly average number of jobs recovered (or decline in job loss) in the first six months after a recession has ended.

postrecession 3.27.16


The takeaway from these charts is that PBS has outperformed manufacturing in terms of losing fewer jobs during a recession and then recovering them more quickly after a recession. This outperformance is a function of the self-sustaining nature of services labor and suggests that a longer than average expansionary cycle is possible. It is these changes in the nature of the economy and the labor force that I believe will keep this expansion alive and take equities along with it. It’s a bull market!

Now that I’ve covered my reasons for believing why the economy will continue to provide a bullish atmosphere for equities in general, let’s take a look at DRI. Darden Restaurants is the largest full service restaurant chain in America with 1,534 domestic locations and just 39 restaurants internationally. DRI finds itself in a great position to capture consumer discretionary dollars because of its excellent brand reputation and the wide spectrum of consumers that it appeals to. Unlike typical retailers that target a specific demographic, DRI has restaurants that appeal to all income levels and provides a range of atmospheres. The table below demonstrates the brand diversification that is offered to customers:

dri menu 4.19.16



DRI restaurants themselves are often situated in the main social structure of the locality they serve. These prime locations are what allows DRI to capture maximum consumer dollars during cycle upswings, but also allows DRI to capture dollars in a downturn by being part of the focal point of the community. The fact is, even in bad times, people still find a way to go out to eat and DRI will be there.

The greatest challenges that DRI faces come from managing its food and labor costs. While food costs can be extremely volatile, DRI is able to manage its suppliers by leveraging its significant scale. DRI has become a Walmart of the restaurant industry in its ability to manage costs through its dominant position over suppliers. As for labor, costs have risen as the economy has strengthened. To address this, in 2014 / 2015, DRI reviewed its operating structure and reduced its workforce for which it did incur termination expenses but has made the organization more long-term efficient. This leads us to the first aspect of “disruptive” technology that DRI may be able to take advantage of. Technology is currently being developed that could revolutionize labor intensive kitchen processes such as food preparation, basic cooking and cleaning. Spyce Kitchens, for example, is a company formed by MIT students which has made an entirely robotic kitchen service. Once this kind of technology is fully proven and brought up to scale, it could be an absolute windfall for DRI. Labor is roughly 30% of COGS, so just a 20% drop in labor costs would give a 50% increase to operating income. A reduction in labor costs will also allow DRI to redirect capital towards dining experience enhancing projects, thus making them that much more appealing to consumers in the long-term.

In terms of its finances, DRI is an investment grade credit with a fairly transparent balance sheet. Its long term debt is rated BBB- by S&P and Ba1 by Moody’s. While this is just barely IG, I would expect upgrades in the future as DRI has significantly reduced its leverage and continues to generate strong free cash flow. During the second and third quarters of fiscal 2016, DRI retired $1.01 billion of loans and notes, leaving just $450 million outstanding of long-term debt with overall leverage at just .5x on TTM EBITDA. The debt retirement was funded by the sale-leaseback of 64 restaurant properties and its corporate headquarters. After the sale-leasebacks, DRI still has significant real estate assets that can be used for future financing needs. The one issue on the B/S that there is, is the $1.44 billion in goodwill and trademarks that could be a problem should they incur an aggressive write down. That said, given that DRI has significant assets and minimal debt, tapping capital markets for future financing should not be an issue. This brings me to the second “disruptive” aspect of DRI which is that it operates in a nearly “disruptor” proof business. Given that the dining out experience is essentially irreplaceable and a timeless one, DRI future cash flows can be counted on. Obviously DRI’s business is still subject to normal competition, at least the risk of being “disrupted” can be almost entirely eliminated. In today’s technology driven and “disruptable” environment, the safety that DRI offers is sure to command a premium in its valuation.

While the food services industry has a history of being volatile and highly susceptible to the business cycle, I feel that DRI has built a business that will be able to rise above these risks and come out ahead. In conclusion, I think the economy is in good shape and has reached a critical mass where the expansion can keep going until we inevitably run into some kind of turbulence. That said, a great way to take advantage of this expansion is to get long DRI and in general, get long America!


(See below for ratios)

Ratios 4.21.61




Manufacturing rebounds while jobs abound!!

“Unemployment rate is low in our county, making it hard to find workers. We are understaffed and running lots of overtime.” That’s a survey response from a person in the Plastics & Rubber Products industry in the ISM Report on Business (ROB) that we got this past Friday. That quote pretty much sums up the renewed strength in manufacturing and the tightening of the labor market that we are seeing today. Normally after a payroll Friday, I feel compelled to write about the job gains we are seeing and what impact they have on the overall economy. However, I think it’s the manufacturing data that deserves the spotlight this time. It’s the recent rebound in manufacturing activity that could be the catalyst that drives this economy to a whole new level of performance in 2016. So let’s take a look at the data we got this week and its implications going forward.

As I touched on in last week’s writing, regional Fed manufacturing surveys had all been showing significant gains. We got an extension of that this week, with a better than expected report from the beaten down Dallas Fed which showed solid gains in its production and new orders components. Aside from the Dallas Fed report, we also got encouraging reports from the Milwaukee ISM Manufacturing report and the Chicago PMI. The Milwaukee index went from 55.22 to 57.78 with the production component going from 52.59 all the way to 68.81. The Milwaukee ISM is somewhat of a C-list indicator based on its area of coverage, but it still verifies what we are seeing in the larger and better known regional surveys. For example, the Chicago PMI that we got on Thursday jumped well back into expansionary territory to 53.6 from 47.6. The gain was primarily driven by increases in the employment and new orders components. All these regional reports from the last couple of weeks were like a crescendo to the ISM Report on Business on Friday. Fortunately, this time the music ended with a smooth finish instead of being off-key as the report came in ahead of expectations and back into expansionary territory at 51.8 from 49.5.

The ROB is essentially the most comprehensive and oldest report on manufacturing data available. The report began in 1931 and is based on the following industries which are weighted by their input to GDP: Food, Beverage & Tobacco Products; Textile Mills; Apparel, Leather & Allied Products; Wood Products; Paper Products; Printing & Related Support Activities; Petroleum & Coal Products; Chemical Products; Plastics & Rubber Products; Nonmetallic Mineral Products; Primary Metals; Fabricated Metal Products; Machinery; Computer & Electronic Products; Electrical Equipment, Appliances & Components; Transportation Equipment; Furniture & Related Products; and Miscellaneous Manufacturing (products such as medical equipment and supplies, jewelry, sporting goods, toys and office supplies). As you can see, the list is quite exhaustive.

When we take a look at the internal components of the report, there isn’t much not to like. Aside from the employment segment still being in contraction, the rest is good. Specifically, new orders went from 51.5 to 58.3 while production climbed from 52.8 to 55.3. I encourage the reader to go through the full report because the comments from the survey respondents paint a fairly bullish picture, especially when you consider how poorly performing manufacturing has been. That said, if manufacturing continues to get help from a softer dollar, we could really add some extra zip to this economy.

Now without further ado, we go to everyone’s favorite labor data point, the nonfarm payrolls report. Friday gave us another month of 200,000 plus job growth with the added bonus of strong average hourly wage gains. March saw 215,000 new jobs created along with a .3% month over month gain in average hourly earnings. For me, the best part of this report was the 33,000 jobs created in Professional and business services (PBS). Within PBS, we saw gains in computer systems design, management and technical consulting services and administrative and support services. While some people will discount the gains in administrative and support jobs as being low pay and inferior, this is a critical mistake. Support jobs grow because the underlying business has grown. In some cases there are regulatory needs for more support people, but that’s fairly centralized in financial services. That said, businesses don’t hire non-revenue generating positions unless growth in the business warrants it.

Now within PBS, it’s important to look at the growth in one of its sub-sectors, Professional and technical services (PTS). PTS is comprised of lawyers, accountants, computer programmers, other IT services, biotechnology research, and advertisers to name a few occupations. With the exception of advertisers, those are all occupations that have fairly non-cyclically dependent demand, i.e. sustainable. Since 1991, PTS has had an average year over year growth rate of 2.6% with the most recent reading at 3.4%.

(click to enlarge)

As you can see above, since 1991, PTS has had a higher growth rate than food services. So please don’t be fooled when the financial media bears say that all the job growth has been in baristas and the like. The opposite is true. Our labor force is showing higher growth in the more skilled and significantly higher paid areas. As time goes on, the labor force is literally generating greater earnings while simultaneously becoming more sustainable.

The growth in Food services and drinking places (FSD) employment is another area where economic bears go awry. I’m happy to see growth in FSD as it shows that people feel comfortable enough with their disposable incomes to go out and spend money dining out. Not to mention, it also shows an overall positive feeling in consumers as well. Families and friends going out to eat more often is a good thing. A great example of this is Darden Restaurants who already raised their earnings guidance back on March 9. DRI will report Q3 earnings on Tuesday and a strong number there will verify consumer confidence.

Now we head into another week where we have a smattering of data points covering manufacturing, services, and labor markets. I think the most important item will be the Non-Manufacturing ISM  (NMI) report on Tuesday. Like its manufacturing counterpart, the ROB, the NMI is our best services industry metric. I would expect to see the NMI to have picked up in March. Given the services job gains we had in March, that should drive the employment component of the NMI back into expansionary territory. Assuming a reading of 51 for employment and with the other components staying flat, we would get an NMI of 53.7, up just 3/10ths from February. However, we should be able to do better than that- I hope. Then, we also get another JOLT report next week. Given some of the comments made recently from employers, it seems we are having a skills mismatch in our labor force which is allowing positions to remain unfilled. A discussion on this topic goes beyond the scope of this writing, so I’ll just leave it with America needing to bring back trade schools with a focus on technology. On that note, let’s hope oil can hold its head up this week until earnings start to roll out and have a chance to drive up market multiples with a stronger E in P/E.


This time just might be different

“This time is different” has come to be known as the kiss of death phrase when regarding the future prospects of a particular asset or economic situation. Rightfully so, as we’ve seen bubbles like tech stocks and real estate blow up and burst while the majority of investors try to figure out where it all went wrong. Well, here we are today with the U.S. economy at a point that has many financial pundits warning of a recession or some type of crash. While I would not be so brash as to say such warnings have no basis, I would say that we need to look at what has happened to the economy that could actually make things different this time.

This past week we got several data points covering the services and manufacturing sides of the economy along with some employment data. It’s the employment data which I believe holds the key to understanding what is different this time around. While recessions can be triggered by many different things, what they all have in common is a rise in unemployment. The most recent weekly initial unemployment claims print came in at 265,000 which is a historically low number.

claims 3.27.16

As I have stated before, until this number starts to rise consistently over 300,000 the labor market is strong which translates to a strong economy. That said, let’s take a look at what has changed in labor market dynamics.

According to the NBER, whose data begins in 1854, the economy has had 33 cycles (recessions). During that time, the economy has evolved from being manufacturing / export based to services / consumption based. This evolution has allowed the economy to be more self-sustaining as it is driven by domestic consumption versus being dependent on foreign demand. This evolution has in turn led to an extension of the average length of economic expansions. If we adjust the NBER business cycles to reflect the evolution of the economy, we get a good metric for average expansion lengths.

Biz Cycles 3.26.16

The current cycle stands at 81 months and can arguably go on considerably longer when we factor in the changes to the labor market. It’s been the shift from manufacturing based labor force to one of services that makes all the difference.

Services based jobs have a much more sustainable quality to them than export based ones. For example, healthcare and education services in the U.S. and most developed markets are nearly perpetual in nature. Then we have Professional and business services which includes computer code writers and other dynamic technology oriented professionals. Essentially, industries for which there is always demand. In the charts below, I have drawn a comparison between Manufacturing, Professional and business services (PBS) and Total private employment. All three categories are titled and defined by The Bureau of Labor Statistics which is the source of all data used in the charts. I chose PBS because it best represents a broad range of service industries. The below charts are based on every recession that has occurred since 1945 as defined by the NBER. 1945 is the earliest starting point for which data was available for all three series.

The first chart shows the average number of jobs lost on a monthly basis as a percentage of its total industry. For example, in the recession of 2001, manufacturing lost an average of .81% of its workforce on a monthly basis while PBS lost just .43%. Then in the Great Recession, they lost .83% and .47% respectively.

recession 3.27.16

As you can see, throughout history, PBS has always been more resilient to downturns than manufacturing.

The second chart shows the monthly average number of jobs recovered (or decline in job loss) in the first six months after a recession has ended.

postrecession 3.27.16

The takeaway from these charts is that PBS has outperformed manufacturing in terms of losing fewer jobs during a recession and then recovering them more quickly after a recession. This outperformance is a function of the self-sustaining nature of services labor and suggests that a longer than average expansionary cycle is possible. Furthermore, as the workforce becomes more services based, future recessions should be shorter lived as employment is able to recover more quickly. The great news here is that not only are we building a more sustainable workforce, but we are also building a workforce that earns more as PBS earns 18.6% more than manufacturing on an hourly basis. The table below puts the earnings significance of services in perspective. The top three service sectors account for 58% of total earnings and employs 57% of total private payrolls.

total earnings 3.27.16

As for the actual manufacturing and services data received this past week, it was a fairly mixed bag. On the one hand, we actually got some strong manufacturing data from the Richmond Fed which goes along with other solid regional Fed data from New York and Philadelphia. Even the Kansas City Fed report, which had been abysmal, managed to come in less negative. Along with the regional Fed data, we got the Markit Flash Manufacturing PMI which came in at 51.4, up literally a tic from the previous month’s 51.3. A gain is a gain though. The Markit report also showed that employers increased their hiring.

Then, on the other hand, we got a very weak durable goods report on Thursday that took some of the steam out of the manufacturing recovery narrative. It’s still too early to tell what is going on in manufacturing, but it does look like activity is picking up overall. This is a welcome improvement from 2015 when manufacturing was basically missing in action all year.

On the services side of things, we got the Markit Flash U.S. Services PMI which moved back into expansionary territory at 51 from last month’s 49.7. While the Markit report had a pretty downbeat commentary, it did say “service providers signaled another solid increase in payroll numbers during March.” I look at employment as a leading indicator, so comments like that tell me business must be picking up. We also got a very favorable services report from the Richmond Fed which unfortunately went essentially unmentioned in the media. The report cited rising activity, wages and employment. So between general employment data and the various manufacturing and services reports, we have an economy that keeps chugging along.

To sum it all up, the economy remains on solid ground and is positioned to continue to grow. We have a significant amount of economic data due out this week which ends with the ever important nonfarm payroll report on Friday. A payroll report with both strong job creation and wage growth could be enough to push the Fed’s hand to raise in April. While such a move would most likely be rough for equities at the onset, a healthy economy will take them higher in the long run. While I would be surprised to see a rate hike next month, it is still possible. All this said, don’t be surprised if this expansion keeps on going and equities get to new highs. As history has proven, things change…It’s called evolution.





This bull market has plenty of room to run

originally published on 3/14/16

There was a lot of talk in financial media last week about the seventh birthday of the current bull market and if we may be approaching the end of it this year or next. While I was glad to hear people acknowledge that we are in a bull market, I don’t so much agree with the age and certainly not the proposed longevity of it.

While you can call March 2009 a bottom and start the meter running from there, I think that gives too much credit to the early years when the economy was still struggling and then discounts the later years. For instance, S&P 500 operating earnings didn’t regain pre-crisis (2006) levels until 2011. Also, we were still having negative nonfarm payroll prints through September 2010 when we lost 52,000 jobs. Looking at the chart of the S&P 500 below, we didn’t really start a sustained upward move until 2012, which would be a more fitting starting point since the turbulence of late 2011 is excluded.

All that being said, I find it tough to associate 2009-10 with a period like 2013-14 when companies had much stronger earnings and the economy was creating jobs. Saying this bull market is seven years old seems to make it easier for people to say it’s about to end. For me, a bull market encompasses not only rising stock prices but also a positive economic backdrop.

Now, for the longevity of this bull market, it really depends on one’s view of the U.S. economy and the global macro situation. Based on that view, a person can look at the chart above and say the S&P is either at a top or a bottom. (For the record, it’s a bottom to me.) In terms of the U.S. economy, we know for a fact that the labor market is strong and arguably at full employment. The most recent weekly initial claims data showed a drop down to 259,000, which is so low, you’d actually have to go back to the week of Aug. 18, 1973, to find a lower print. The reason why the initial claims series is so important is because it’s as close to a real-time indicator of job losses in high turnover/cyclical industries as is possible. Then, when we look at claims data in comparison to job openings, we see there is still room for claims to go even lower. (In the chart below, weekly claims data have been aggregated to monthly periods to match the job openings data.)

The point here is that the labor market is strong and still has room to tighten. Hence, consumption is set up to be strong.

As a result of a strong labor market, and not to mention cheap gas, we’ve gotten some great news on the retail front. On Wednesday, Darden Restaurants (DRI) raised its third-quarter earnings estimates because of stronger-than-anticipated sales. The DRI news really ties in well with the data on increased gasoline demand and record driving amounts that we have gotten recently. Literally, people are going out to eat more often.

Then on Thursday, we got reports from a couple of true consumer discretionary names. Ulta Salon (ULTA) posted 11.8% year-over-year comparable sales (stores open 14 months including online sales), which helped send the stock up 17% the next day. Then we had the parent company of Zara (global fashion retailer Inditex) report 15.4% year-over-year growth in sales and 15% year-over-year growth in net profits for 2015, with Zara being a strong performer for the group. So we can add these names to the likes of Under Armour (UA), Foot Locker (FL) and Home Depot (HD) to see that strong consumer demand is there. In the case of the retailers that are missing earnings, it’s more from offering the wrong products and not from weak overall demand. (Under Armour is part of TheStreet’s Growth Seeker portfolio. Foot Locker is part of the Trifecta Stocks portfolio.)

On the global macro front, we’ve gotten some very encouraging news over the last few weeks. It pretty much all starts with oil and then finishes with the ECB seeming to have finally come up with the correct combination of QE tools to get things going in Europe. In the last month, oil has gone from roughly $26 to just over $38 a barrel, which has allowed U.S. and emerging markets as represented by the iShares MSCI Emerging Markets ETF (EEM) to rally along with it. Reasons abound for the rally in oil, but I suspect that the producers, namely Saudi Arabia, looked into the abyss that $26 oil was bringing and didn’t like what they saw.

Along with oil, there has also been a nice rally in the metals complex ranging from iron ore to copper. This has taken pressure off emerging markets and then, by default, the U.S. Even though the rallies are mostly being driven by an expected reduction in supply and not increases in demand, whatever gets the global deflationary death spiral off the table works.

As for Europe, it’s still very early to tell how all the policy tweaks announced by the ECB on Thursday will work out, but markets have reacted positively so far. Having read various sell-side reports and other private investor opinions, it seems the ECB’s shift to focus on credit growth vs. negative rates is the right approach. The reaction to the ECB so far in F/X could become a major tailwind for U.S. companies doing business in Europe. Since the announcement, the euro has rallied significantly vs. the U.S. dollar. If this trend holds up, we can hopefully eliminate the strong dollar roadblock to better corporate sales and earnings.

Coming up this week, we have several major data points along with the Fed meeting. The only thing really missing from the lineup is nonfarm payrolls. As for the Fed, I’m not expecting it to raise rates. Given the turbulence we just got over and the near-zero expectations in the fed funds market, it will hold for now. However, I would expect some hawkish language given the strength in labor and recent inflation readings.

As for the economic data, there are several interesting items. Retail sales on Tuesday could show a large gain. The only issue here is if the extra volatility we had in February somehow spills over into the sampling data. Considering the company reports I have listed in this article and the others we’ve gotten, we should get a strong print. That said, if we don’t get a strong number now, I would expect next month’s to be that much better, assuming we don’t go back down the oil rabbit hole.

Then we have industrial production (IP) and the Philly Fed Manufacturing Survey, which go somewhat hand in hand. IP was up nicely in its last report and Philly Fed came in less negative. If manufacturing is showing some reversion to the mean, then maybe we get some reasonably OK prints here. Again, I don’t expect much out of manufacturing in general.

On Thursday we get the JOLT survey, which measures job openings and quit rates. This is one of Janet Yellen’s favorite indicators about the health of the labor market. The last report had openings near an all-time high, and it would be great to see them go up again. However, it would be discouraging if the rise is from a lack of skilled workers. What we would really like to see in the report is an increase in the quits rate, which is indicative of workers’ confidence in moving between jobs for what we hope are better opportunities.

It’s going to be an action-packed week for sure, but all in all, I’d say this bull market has plenty of room to run and the legs to do it.

Fortunately for the Economy, Consumers Are on the Road Again

The past week was one of those weeks where people who casually follow markets might say, ”Oh that’s nice, stocks were up a little bit this week.” However, for those of us that work in them daily, this was a week where both bulls and bears went from feelings of rage to those of elation. Wednesday was the turnaround point for the week when the S&P 500 broke below 1900 in the morning only to go on a monumental, if not miraculous (for some) rally running 38 points off the lows to close at 1929. Considering all the recession talk lately, 1929 is a rather fitting number to have closed on since that’s the year the U.S. entered the Great Depression. Also playing into the recession narrative on Wednesday was the Markit Flash Services PMI that dropped into contractionary territory going from 53.2 to 49.8 (more on that later). The Markit release was at 9:45 am when things were looking rather bleak. Then at 10:30am, we got an EIA report that showed stronger than expected gasoline demand which turned everything around. As we’ve seen time and time again, this market takes its orders from oil, and when oil turned around and ran higher, it took stocks right along with it. Hey, a rally is still a rally.

The EIA report is especially interesting because it lends itself to the fact that Americans have been driving record amounts. In fact, the Federal Highway Association just released a report showing that December alone set a record for the most miles traveled in a month while 2015 was the highest driving mileage year on record (going back to 1990). Clearly, that’s a manifestation of consumers taking advantage of lower gas prices. Unless you think people are just driving around in circles the whole time, all those miles are being driven for a reason. Whether it’s work, for a trip to an out of the way restaurant or to go see some relatives, it’s all a form of consumption. Which brings me to my next topic, the excellent PCE data we got.

On Friday, we got January PCE readings which showed a very healthy .5% monthly gain in both income and consumption. The prior six months had run at just .3% and .2% average monthly gains respectively for the two series. Also in the report was the Feds preferred inflation gauge, core PCE, which rose .2% to 1.7% year over year. This jump in inflation is just another reflection of strong demand across goods and services. The main story driving this data is that a strong labor market coupled with the extra disposable income from low gas prices is giving people additional means to consume. Just this past week, we saw fantastic earnings from the likes of Home Depot, Target, TJX and Foot Locker. Clearly HD is benefiting from the strength in housing as evidenced by the strong existing home sales (EHS) print we got on Tuesday. EHS, which account for roughly 90% of total home sales, are also running at a six month high. Then we have TGT, TJX, and FL all showing that consumption is strong outside of the housing market as well.

Unfortunately, we did get some weak readings this week from the Markit Flash Services PMI and the Conference Board Consumer Confidence Index . These two reports are also known as “soft” data points. “Soft” means that they are metrics derived from participant responses to questionnaires rather than “hard” metrics that are derived from actual quantifiable inputs. From reading both reports, you can see the impact that February’s stock market sell off had on people’s temperaments. The equity selloff from Asia to Europe to here had respondents doubting current and future financial stability. This doubt also fed through into business decisions as presented by the Markit PMI report. However, it is interesting to note that even in the decline of the Markit PMI, the employment component in the index still picked up, highlighting the strong labor market narrative that has been in place the last few months. So clearly all is not bad. In terms of hard data, we got the January Durable Goods report that showed a very strong 3.9% gain for the month in core goods. This report verifies the nice pick-up we saw in another hard data point we got for January, Industrial Production. In 2015, the trend was hard data coming in on the weak side while soft data was running strong. Perhaps that was a reflection of the relatively stable stock market (ex-Grexit part of summer) we had for 2015 and that manufacturing was indeed struggling. Now, assuming equities stabilize from this point, we could be entering a period where both hard and soft data show strength and that would be quite remarkable.

Now we are heading into my favorite week of the month, which is jobs week. On Wednesday we get the ADP employment report as a warmup to the most important labor indicator we have, the nonfarm payrolls report on Friday morning. Also this week, we have both ISM manufacturing and services reports along with a smattering of other manufacturing and housing related data. I’m expecting the ISM services report to show softness for February given the other “soft” data results we’ve seen so far. That being said, in times of uncertainty, it helps to take a step back and look at what the economy really is. The economy is the people who go to work every day in this country and consume goods and services. As long as employment remains healthy, the rest takes care of itself. Based on the latest JOLT survey which showed job openings being near an all-time high, it certainly seems like the labor market will be healthy for the near future.

jolts 2.28.16

So remember, when you go out to dinner, take a road trip, or even buy flowers for that special someone, you are strengthening the economy because you are the economy!

Retail sales and JOLTS

**originally published on 2.15.16 on

A three day weekend is just what the market needed after one of the most volatile weeks that I can remember. It’d be nice to think that stocks rallied on Friday in observance of Presidents Day on Monday, but I’m afraid there are only economic forces at work here. Friday saw the S&P 500 close at its highs for the day with a near 2% gain on decent volume. Considering all of the carnage that occurred Thursday on high volume, it’s safe to say the sellers were exhausted. At least they are for the time being it seems. Up until Friday, the “U.S. is in recession” narrative was building steam in financial media. Even with weekly unemployment claims resuming their downward trend to historically low levels and the Atlanta Fed GDPNow forecast for Q1 GDP going to 2.5% from 2.2% on Tuesday, the recession narrative kept on trucking. Then came Friday morning and much to the chagrin of the recessionistas, the January advance retail sales data came in much better than expected. Core sales came in up .6% for the month versus .3% expectations. To put that in perspective, for all of 2015, core sales averaged just .2% monthly gains. This is not the kind of data that recessions are made of. At the end of the day, its consumption that drives the U.S. economy and people are consuming. One of my favorite line items in the retail report is Nonstore retailers, or online shopping as we all know it. Nonstore retail was up 1.6% for the month and 8.7% year over year. As you can see below, it’s tough to get a better looking chart.

nonstore 2.13.16

But people will no doubt continue on with the recession talk. As they say, that’s what makes markets.

On Tuesday, we got one of Yellen’s favorite labor indicators, the Job Openings and Labor Turnover Survey (JOLTS). As I discussed in last week’s Real Money article, I was expecting to see a pick up in the quits rate to go along with the rise in average hourly earnings we got in the December and January nonfarm payroll reports (remember JOLTS is a month behind). Sure enough, the JOLTS report showed a sharp increase in quits for December along with a near record amount of job openings. When we look at the relationship between job openings and quit rates, it’s hard to be anything but optimistic about future earnings gains as employers will compete to keep employees. This is what happens in a tight labor market.


jolts 2.13.16

Then looking at the historical relationship between job openings and continuing claims data, we could very well see a further drop in the claims level. This is what makes keeping an eye on weekly claims data so important. Claims data is based on actual people entering and leaving the workforce, not like the sampling done with surveys. Claims data is a real time gauge of the labor market.

claims 2.14.16

Right now we have some very smart people in financial media pointing to the flat shape of the treasury yield curve and saying that the curve predicting a recession. My problem with this theory is that it assigns an omniscient ability to an indicator that is ultimately driven by people. Unless the people trading these markets do indeed have deity like abilities, I’m afraid it’s no more predictive than a magic eight ball. While in the years prior to QE, the yield curve did provide good insight into current inflation and rate expectations, it has since been stripped of that insight. The advent of massive worldwide central bank interventions, especially ZIRP and NIRP, has made the curve hollow shell of its former self. Taking this a step further, I don’t believe that any financial or commodity market is “smarter” than any other market. Asset prices take their cue from supply and demand which is ultimately driven by future economic expectations. This is why I believe a correct assessment of the macro economic situation is the key to being on the right side of a trade. That said, looking at the charts I have provided, the only market investors should trust for predictive powers, is the job market. Yes, I believe employment is a leading and not a lagging indicator.

Coming up this week we have some A-list economic data points including housing starts, industrial production, Philadelphia Fed Manufacturing, PPI and CPI. Given the uptick in both ISM and Markit manufacturing data, we could see a bounce back in industrial production and the Philly Fed. Again, I don’t expect much from the manufacturing side of things other than perhaps some slight reversion to a lowered mean. The good news is, so far the week seems to be off to a good start with Asia trading up. The bad news is, its only Tuesday.