Consumer and Trade Deficit
The market stalled a bit yesterday, but we are still holding strong. If we look back over the month of July it seemed that the rally stalled out; however, with the recent Labor Report we received another reprieve and a leg higher. There are still some big earnings, but for the most part we are at the close of an earnings season in which we have seen weak top line revenues and some concerns heading into the 2nd half of the year. The concern is not about a crashing economy or market, but rather stagnation and the pain of weaning off government stimulus and FED QE and relying on the private sector. A quick retreat of government and Federal Reserve intervention would certainly bring volatility to the market, but now we are seeing elevated concern just with the Fed hinting at a slight reduction in QE. Also, there is uncertainty in the near future and while that doesn’t necessarily spell good or bad news for the economy or market, it does bring continued businesses and consumer trepidation. Obamacare implementation, the next Federal Reserve Chairman choice, Fed tapering, the debt ceiling and budget deficit (that was just kicked down the road to year-end), and a host of other government and regulated issues have not yet been resolved. The concern for many is that market has made a strong climb in the first half of the year, on the back of Fed QE efforts, despite warnings from the retail sector and slowing/contracting top line revenues. Some are starting to expect a slight contraction in the market, perhaps 5-10% in the second half of the year. However, that would only seem possible if there is nowhere else to invest or if the general conclusion is that cash is better than being exposed to pending political and Fed decisions. Remember, bonds remain unattractive, so the equity market seems to be the only game in town.
While we are wrapped up in domestic politics and economic uncertainty, the rest of the world also is dealing with their own dilemmas. Their sovereign debt issues of Greece, Spain, and the rest of Europe have not graced the headlines in sometime, but let’s not forget “out of sight, out of mind” should not apply. Any day now we could see a return of Europe’s woes in the headlines. They have managed, like our nation, to kick-the-can down the road again by extending some loan packages and bailouts, but for the most part nothing has changed. Germany did take the ECB to court on the bailout and the rules of the EU and Germany were correct, but the rules have been bent to such an extent they are broken. Germany just wanted to draw a legal line in the sand, perhaps to give them an “out” when the next rounds of bailouts come.
China and the emerging markets, which have been carrying the West since the Great Recession, have also slowed down. Sure, they are still growing at very strong levels, but those levels are declining. In and of itself, I don’t see it as a problem. I still believe that the emerging markets remain the strongest sectors of consumer growth as we see net incomes increase annually by over 10% and consumer spending continue to rise in double digits. The problem with their growth decline had more to do with the global growth. If the US and the rest of the West continue to face consumer spending contraction and stagnation, the reliance on the emerging markets becomes more burdensome for the multi/international brands.
Earnings clearly spell out this conundrum. We see that the continued growth in top-line revenue of the S&P 500 companies comes from the emerging markets, while the top-line revenue in the Western nations, on a whole, continue to contract. Companies will eventually have to decide which of their consumers they wish to be most loyal to; I suspect it will be the ones that can pay.
I am certainly not predicting the demise of the US or European consumer, but I do believe it can take years for the middle and lower income class to rebound in their consumption levels. The problem is simple, access to credit. The boom from the 1990′s and early 2000′s came strictly from the access to credit spending and the accumulation of debt. The emerging markets have not faced this problem yet, but the US and Europe continues to struggle with jump starting an economy that for so long relied on the credit/debit class of society, which happened to be the biggest spenders.
The silver lining, which will certainly upset many of my Democrat/Socialist friends, is that the top 10% of income earners have seen a rather strong rebound in spending. During the Great Recession, they certainly saw unrealized losses, but not being subject to and dictated by debt, they were able to hunker down, save and reduce spending. Now we are seeing that, in some areas, the only real growth in the West is coming from the top 10%. One only has to look at record home and apartment prices in NY and other locales, while at the same time foreclosure rates and MBS debt accumulation on the low end remains very high. However, the top 10%, much like the emerging markets, can’t continue to carry the load entirely or indefinitely. It is not until the 90% are able to get back to work, reduce debt, save, and get access to credit that we will see a strong rebound in the private sector that would lead to a REAL economic recovery, rather than a government stimulated one.
Courtesy of wikipedia
This morning the Commerce Department released data on the U.S. trade deficit, which narrowed sharply. On the face of it, it is very good news and I am sure one that many talking heads will embrace as another data point hailing an economic recovery. However, I think it wise to ask, HOW did it narrow? Did it narrow because imports fell or did exports rise, predominately? The Commerce Department said the trade gap fell 22.4% to $34.2 billion, the lowest levels since the end of 2009. Economists expected a decline from $44.1 billion to $43.5 billion, so it did come as a surprise. Trade subtracted 0.8 percentage points from the 2nd quarter GDP growth, thus stepping up to an annual 1.7% from a 1.1% pace. However, adjusted for inflation, the gap narrowed to $43.2 billion, but the government is also using the adjusted CPI model for inflation as well. Once we peer into the numbers we see another issue, imports for goods and services fell 2.5%, which was greater than net exports, which rose 2.2%. While net exports to Europe rose 1.5%, for the first half of the year they are down 5.5%. Ironically, China has been one of the U.S.’s biggest saviors being one of the fast growing importers of U.S. goods. I wonder if in China they will start a campaign to support their local economy with slogans like “Buy Chinese!” Meanwhile, Chinese imports fell 2.2%, part of that has been reflected with recent retail trends in the U.S. as same store sales for domestic consumers has slowed and in some cases contracted.
Overall the Trade Deficit reflects a stagnant domestic consumer and a slight rebound from a depressing first half of the year. The market didn’t seem to get too excited by the shocking drop in the pre-market, but I am sure that politicians and talking heads will try to make hay with the data.
For now, nothing is definitive and the markets wait at these levels. Is it time to get into the market? Is there certainty and confidence? Does it build on optimism? We all wish that it would, but I think we are in for six long months of government, political, and Federal Reserve uncertainty. Continue to hedge long positions.
Support / Resistance
I have a feeling we may visit and test the 15,500 level in the near-term. Earnings season is coming to a close and while there have been a few great surprises, over all top-line revenue growth has been a concern. We also have some big unknowns heading into the 2nd half of the year.
This is the general support area for the index. We have seen a gap up from 3000 and then a stall, with a good rally in the last few days. Apple (AAPL) has rebounded and that has been a huge driver in the index. Apple had been at $400 and now it has retraced more than 50% of the sharp drop from $500. We could get back to $500, but I would expect some resistance. Apple is going to release their new iPhone and finally a new iOS, which has become dated. Ironically, I just switched, as many have, over to Android and the new HTC One phone. I have to say it is an impressive piece of kit, all metal, full 1080p HD screen, very fast with a processor you would find in a laptop. I loved my iPhone and have been with it for a long time; however, I think the new Android phones, like the HTC One, have caught up with the quality of build that iPhone once dominated. The release of the new iPhone will certainly boost Apple’s stock and pump up the fan base; however, I wonder how the fans will take to the new iOS – I am sure many will not be happy; people don’t like change. Take a look at the HTC ONE side-by-side with the iPhone 5. Perhaps the new movie about Steve Jobs will also give the stock a boost, I am a big fan of Jobs, but unfortunately Ashton Kutcher playing Jobs may not go over that well and I am sure it will Hollywood-ize the true Jobs. Luckily Oliver Stone is not directing it, so it should remain somewhat in the realm of reality.
I think we might be in for a little fight at 1700. We could be in for a stall or short pull back in the near term. I also don’t like seeing the VIX below 12, which for me is warning sign that we are getting a little too complacent about this rally. Look for 1680 as a support level in any near-term sell off.
This is the RUT’s support area. The RUT has been going strong for a while and reflects general order flow continues to head into equities rather than cash or bonds. Remember, the bond market continues to be propped up by the Federal Reserve, so it is not necessarily the best gauge of order flow. Don’t get too concerned about the volatility in the other narrower indices, unless you see the RUT also start coming off sharply. For now it looks strong and I would continue to watch the 1040 level for short term support.
President Obama will be in Phoenix discussing the housing market and primarily speaking about Freddie and Fannie. They are two nationalized behemoths that received well over $300 billion of government bailout and continue to enjoy very slack accounting and margin standards while operating in full force. Together, with the FHA, 90% of all mortgages run through these entities. The private sector is not interested in mortgages; primarily because they don’t want to take the risk when the Fed artificially keeps interest rates ultra-low. Right now the Federal Reserve buys 90% of all gross issuance of Mortgage Backed Securities (MBS) because no one else will take them.
Ending Freddie and Fannie sure has bi-partisan support and should. These two entities are at the core of the entire housing problem and crisis. While not solely to blame, their risk margin, accounting shenanigans, and willingness to assume any/all risk was the drug dealer and main supplier to the greed of home buyers (many of which could not afford a home).
However, I am not sure HOW the government can wind down these companies that represent 90% of the market. The private sector will not assume the risk with ultra-low interest or would be willing to lend to those not qualified. So what will take its place?
I can only hope that President Obama does not create a NEW entity, a national mortgage company, and socialize mortgages much like Obamacare. We will wait to hear his general idea today; so far it does seem promising.
Meanwhile, Chicago looks like it might emulate Detroit’s recent failure. There are rumors that Chicago is on the hook and it is only a matter of time. Are the domino’s falling in the state/city debt problem? Is Meredith Whitney’s’ prediction finally coming true?