The Set Up In Bonds As The FOMC Considers A Second Rate Increase

Summary: Bond yields usually rise as the FOMC raises rates. This is one of the mostly strongly held consensus views in the market right now. A year ago, investors also thought yields were set to rise; instead they fell over the next half year. Might investors be wrong now once again?

* * *

The FOMC will likely raise the target for the federal funds rates later today. We discussed the affect of rate increases on various asset classes a year ago when the FOMC enacted their first rate increase since 2006. The general conclusion was that equities, commodities and bond yields all rose in the subsequent months. That post is here.

Those conclusions were mostly right. The one exception was bond yields. On the day of the rate increase in December 2015, 10 year yields in the US hit 2.33% (arrow). That was the high until November 2016, 11 months later.  In the interim, yields fell 100 basis points over the next half year.

Fund Managers' Current Asset Allocation - December

Summary: Global equities are more than 20% higher than in February. A tailwind for this rally has been the bearish positioning of investors, with fund managers persistently shunning equities in exchange for holding cash. This was in stark contrast to 2013, 2014 and early 2015, during which fund managers were heavily overweight equities and underweight cash and bonds.

Fund managers have finally become bullish again. Optimism towards the economy has surged to a 19-month high. Cash remains in favor (although levels dropped significantly in the past two months) but global equity allocations are now back to neutral for the first time in a year.

Bearish sentiment had been a persistent tailwind for US equities in the past year and a half.  That's no longer the case. Another push higher and excessive bullish sentiment will become a headwind. Global equity allocations would already be excessively bullish if not for Europe, where sentiment has dropped. Emerging markets became the consensus long in October and the region has since been pummeled. Those markets are now in the process of resetting.

Findings in the bond market are of greatest interest. Fund managers' allocations to bonds are near prior capitulation lows. Moreover, inflation expectations have jumped to the highest level in 12-1/2 years and expectations that the yield curve will steepen are the highest in 3-1/4 years. When this has happened in the past, yields have been near a point of reversal lower, at least short-term.

The dollar is now considered the third most overvalued in the past 10 years. Under similar conditions, the dollar has fallen in value in the month(s) ahead.

* * *

Among the various ways of measuring investor sentiment, the BAML survey of global fund managers is one of the better as the results reflect how managers are allocated in various asset classes. These managers oversee a combined $500b in assets.

The data should be viewed mostly from a contrarian perspective; that is, when equities fall in price, allocations to cash go higher and allocations to equities go lower as investors become bearish, setting up a buy signal. When prices rise, the opposite occurs, setting up a sell signal. We did a recap of this pattern in December 2014 (post).

Let's review the highlights from the past month.

Cash: Fund managers' cash levels dropped from 5.8% in October to 4.8% in December. That is a big drop for two months, but recall that 5.8% was the highest cash level since November 2001. Cash has remained above 5% for all of 2016, the longest stretch of elevated cash in the survey's history. A good amount of the tailwind behind the rally is now gone but cash is still supportive of further gains in equities. A significant further drop in cash in the month ahead, however, would be bearish. Enlarge any image by clicking on it.

Market Watch: Top 50 Twitter Accounts for Investors to Follow in 2017

Many thanks to the people at Market Watch for including us on their list of the Top 50 Twitter Accounts for Investors to Follow in 2017. The full list is here.

Weekly Market Summary

Summary: US equities have made new all-time highs in the past week. Breadth is good. But there is a set-up for price gains to be limited (or negative) in the next 1-2 weeks.

* * *

In the past week, SPX, DJIA and RUT have all made new all-time highs (ATH). Each is within 1% of those highs today. All of their respective moving averages, from 5-d to 200-d, are rising. This is the definition of an uptrending equity market. Enlarge any chart by clicking on it.

December Macro Update: Employment Growth Is Decelerating

Summary: The macro data from the past month continues to mostly point to positive growth. On balance, the evidence suggests the imminent onset of a recession is unlikely.

That said, there are some signs of weakness creeping into the data. Most importantly, employment growth is decelerating, from over 2% last year to 1.6% now. Housing starts and permits have flattened over the past year. There is nothing alarming in any of this but it is noteworthy that expansions weaken before they end, and these are signs of some weakening that bear monitoring closely.

Overall, the main positives from the recent data are in employment, consumption growth and housing:

• Monthly employment gains have averaged 188,000 during the past year, with annual growth of 1.6% yoy.  Full-time employment is leading.
• Recent compensation growth is near the highest in 7 years: 2.5% yoy in November. 
• Most measures of demand show 3-4% nominal growth. Real personal consumption growth in October was 2.8%.  Retail sales reached a new all-time high in October, growing 2.6% yoy.
• Housing sales are near a 9 year high. Starts made a new 9 year high in October.
• The core inflation rate has remained near 2% since November 2015.

The main negatives are concentrated in the manufacturing sector (which accounts for less than 10% of employment):

• Core durable goods growth rose 1.0% yoy in October. It was weak during the winter of 2015 and it has not rebounded since. 
• Industrial production has also been weak, falling -1.0% yoy due to weakness in mining (oil and coal). The manufacturing component grew +0.1% yoy.

Prior macro posts from the past year are here.

* * *

Our key message over the past 3 years has been that (a) growth is positive but slow, in the range of ~3-4% (nominal), and; (b) current growth is lower than in prior periods of economic expansion and a return to 1980s or 1990s style growth does not appear likely.

Modest growth should not be a surprise. This is the typical pattern in the years following a financial crisis like the one experienced in 2008-09.

This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels. The saying that "the stock market is not the economy" is true on a day to day or even month to month basis, but over time these two move together. When they diverge, it is normally a function of emotion, whether measured in valuation premiums/discounts or sentiment extremes (enlarge any image by clicking on it).

A valuable post on using macro data to improve trend following investment strategies can be found here.

Let's review each of these points in turn. We'll focus on four macro categories: labor market, inflation, end-demand and housing.


Employment and Wages

The November non-farm payroll was 178,000 new employees less 2,000 in revisions.

In the past 12 months, the average monthly gain in employment was 188,000.

Monthly NFP prints are normally volatile. Since 2004, NFP prints near 300,000 have been followed by ones near or under 100,000. That has been a pattern during every bull market; NFP was negative in 1993, 1995, 1996 and 1997. The low prints of 84,000 in March 2015 and 24,000 in May 2016 fit the historical pattern. This is normal, not unusual or unexpected.

What Happened To The Earnings Recession?

Summary: A year ago, profits for companies in the S&P had declined 15% year over year (yoy). Sales were 3% lower. Margins had fallen more than 100 basis points. The consensus believed all of this signaled the start of a recession in the US.

How has that dire prognosis worked out? In a word: terrible. Jobless claims are at more than a 40 year low and retail sales are at an all-time high. The US economy continues to expand.

In the past year, S&P profits have grown 12% yoy. Sales are 2.4% higher. By some measures, profit margins are at new highs. Why were the critics wrong? They confused a collapse in one sector - energy, where sales dropped by 60% - with a general decline in all sectors. Energy was considered the same as financials in 2007-08; events since then show that it is nothing like financials.

Where critics have a valid point is valuation: even excluding energy, the S&P is highly valued. With economic growth of 3-4% (nominal), it will likely take exuberance among investors to propel S&P price appreciation at a significantly faster annual clip.

* * *

A year ago, profits for companies in the S&P had declined 15% year over year (yoy). Sales were 3% lower. Margins had fallen more than 100 basis points. The consensus believed all of this signaled the start of a recession in the US.

The chart below was from Barclays at the start of the 2016, who said that big drops in profitability like those last year have coincided with a recession 5 of the last 6 times since 1973 (read further here). Enlarge any chart by clicking on it.

Technology, Not Trade or Regulations, Killed Manufacturing Jobs

Summary: Manufacturing output is at an all-time high. Manufacturing employment is at a post-industrialization low. Deregulation, dollar devaluation and protectionist/isolationist policies will not resurrect manufacturing employment.

* * *

The Economist:

In the early postwar decades, the American economy grew at a healthy clip. Millions of Americans earned a middle class wage by working in manufacturing. In recent decades, rising inequality and the stagnation of middle class earnings have generated a wave of nostalgia for the postwar economy, and for manufacturing employment in particular. If only America hadn't lost its manufacturing edge, all would be well.

You might reasonably guess that manufacturing in the US is in a secular downtrend. It's not. Real output is at an all-time high (ATH). It has nearly doubled in the past 30 years.

Forecasting The Next Recession Based On The Calendar And The Presidency

Summary: The US economy will soon be in its 8th year of expansion. The US will also have a new president next year. So, is a recession a certainty in 2017? No. Economic expansions don't die at a predetermined definition of old age, and changes in the presidency have not been a useful predictor of a coming recession. The danger in forecasting based on these things is that it makes an imminent downturn appear to be a fait accompli. It's not, and believing that it is closes your mind to other possibilities. Maintaining a mind open to changes in the data and the opportunities they present is the essence of successful investing.

* * *

Will 2017 bring a recession? The calendar says it's likely.

The Great Recession officially ended in June 2009, 7-1/2 years ago. That is already a long time without a recession. Since 1900, the US has stayed out of a recession longer only two other times: the 1960s (9 years) and the 1990s (10 years).

There have been 23 recessions since 1900, and 21 of them have taken place within 8-1/2 years of the prior one's end. So, the historical odds based on the calendar say the next recession is likely to start in 2017 (21/23 = 91%).

Notably, the time between recessions has been expanding over time. At the turn of the 20th century, recessions took place very other year. They now take place nearly every other decade. Consider the following:

Between 1900 and 1928: a recession every 1 year and 10 months.

Between 1929 and 1949:  a recession every 3 years and 8 months.

Since 1950:  a recession every 5 years and 9 months. 

Since 1990: a recession every 8 years.  

Fund Managers' Current Asset Allocation - November

Summary: Throughout 2013, 2014 and early 2015, fund managers were heavily overweight equities and underweight cash and bonds. Those allocations entirely flipped in 2016, with investors persistently shunning equities in exchange for holding cash.

Global equities are more than 15% higher than in February. A tailwind for this rally has been the bearish positioning of investors. Cash remains in favor (although levels dropped significantly this month) and equity allocations are just slightly higher than in February. Overall, fund managers' defensive positioning supports higher equity prices in the month(s) ahead.

Bearish sentiment remains a tailwind for US equities. That is somewhat less true for European equities. Emerging markets became the consensus long last month and the region has since been pummeled. Those markets are now in the process of resetting.

Findings in the bond market are of greatest interest this month. Fund managers' inflation expectations have jumped to the highest level in 12-1/2 years. Similarly, their expectations that the yield curve will steepen are the highest in 3-1/4 years. When this has happened in the past, yields have been near a point of reversal lower, at least short-term.

The dollar is considered overvalued for the first time since April 2016. Under similar conditions, the dollar has fallen in value in the month(s) ahead.

* * *

Among the various ways of measuring investor sentiment, the BAML survey of global fund managers is one of the better as the results reflect how managers are allocated in various asset classes. These managers oversee a combined $600b in assets.

The data should be viewed mostly from a contrarian perspective; that is, when equities fall in price, allocations to cash go higher and allocations to equities go lower as investors become bearish, setting up a buy signal. When prices rise, the opposite occurs, setting up a sell signal. We did a recap of this pattern in December 2014 (post).

Let's review the highlights from the past month.

Cash: Fund managers' cash levels dropped from 5.8% in October to 5% in November. That is a big drop for one month but recall that 5.8% was the highest cash level since November 2001. Cash has remained above 5% for all of 2016, the longest stretch of elevated cash in the survey's history. Some of the wind behind the rally has faded but cash remains supportive of further gains in equities. A significant further drop in cash in the month ahead, however, would be bearish. Enlarge any image by clicking on it.

Small Caps Impulse Into A New All-Time High

Summary: The small cap index is at a new all-time high today, having gained more than 13% in the past 10 days. That type of price behavior has historically been very bullish. Add to that (a) positive seasonality and (b) bearish sentiment just a few weeks ago, and the odds favor further gains into year end. There's just one thing: strong gains like this usually take place during or right after a bear market low. This makes the current rally to new highs an anomaly, having the slight whiff of euphoric capitulation.

* * *

The Russell 2000 (RUT) index of small cap stocks is at a new all-time high today. This new high is coming after the index has risen more than 13% over the past 10 days.

We think of strong gains in a short period of time as the initiation of a new uptrend. In other words, stocks fall hard into a capitulatory low and then reverse. The strong "impulse" higher from the low means that investors are switching sides and chasing price higher. That momentum most often continues into the weeks ahead. This is how new uptrends typically begin.

That's not always the case; there are exceptions, but there are exceptions to every pattern in the markets. Still, the odds overwhelming favor further upside: according to Ryan Detrick, RUT has risen more than 13% in a 10 day period 21 times before. In all but one, the index was even higher a month later. Since 1991, the median gain was 3%.

Which makes the current rise over the past 10 days an historical anomaly. The chart below looks at prior gains of 13% over 10 days since 1991. All occurred during or after a bear market. In each case, the gain of 13% either started at a significant low or was within a just few weeks one. Enlarge any image by clicking on it.

Interview With Financial Sense on US Debt

We were interviewed by Cris Sheridan of Financial Sense on November 9, the day after the US presidential election. During the interview, we discuss fiscal spending, US debt at the federal and consumer level and the impact on all these with the election of Donald Trump.

Our thanks to Cris for the opportunity to speak with him and to his editor for making these disparate thoughts seem cogent.

Listen here.

If you find this post to be valuable, consider visiting a few of our sponsors who have offers that might be relevant to you.

Fund Flows, Investor Positioning And The "Secular Low in Yields"

Summary: In July, fund managers' had their highest exposure to bonds in 3-1/2 years. In other words, they expected yields to keep falling. Instead, yields reversed higher and have since risen so sharply that several smart money managers now say that a new secular uptrend in yields is taking place. That is a big call, given that the foregoing secular downtrend has lasted more than 35 years.

Over the past 18 months, investors' money has been flowing consistently out of equity funds. Where has that money gone? Mostly to bond funds. Money usually follows performance, so it's a good guess that fund flows might soon begin to favor equities. If past is prologue, then equities should gain and bond yields should continue to rise. Whether that will constitute the start to a new secular uptrend for yields it is far too early to say.

* * *

Perhaps the most prevalent storyline in the markets over the past several years has been the long term secular decline in interest rates. Not just in the United States, but worldwide, low economic growth and persistently weak inflation has contributed to falling sovereign yields.

Interest rates have historically moved in cycles. On a relative basis, yields were as low as they are now for most of the period between 1900 and 1960 (the 10 year is currently 2.2%). Rates rose for 20 years until 1920 and then fell for 30 years into the 1950s. Then came a long secular rise in rates until 1980. That 30 year period has been followed by one even longer, as rates have cycled down over the past 4 decades. Enlarge any image by clicking on it.

Demographics: The Boomers Have Already Been Overtaken By The Millennials

Summary: Demographics is a key driver of economic growth. Most people focus on the aging of the Boomer generation. But the working-age population in the US has been growing almost as fast as the retirement of Boomers. Millennials are now the largest living generation and will be in the working-age population until well past 2050. "By 2030 the top 11 birth cohorts will be the youngest 11 cohorts. The movement of these younger cohorts into the prime working age is a key economic story in coming years."

* * *

Nearly 20 years ago, investors started becoming concerned about the aging demographic profile in the United States. The concern was understandable: the largest birth cohort in the nation's history was close to entering retirement. Between 1940 and 1950, the number of births per year in the US increased by a massive 45%, and that group would begin retiring in 2005. Enlarge any chart by clicking on it (data from Doug Short).

Copper Prices And The Global Economy

Summary: The rising price of copper is probably a good sign that the global economy is non-recessionary. When copper has risen, so has GDP. But the converse is not true: falling copper prices have not signaled a slump in the economy.

* * *

Copper prices are surging. The metal's price is up over 20% in 2016. Current prices are the highest in about 18 months. Enlarge any image by clicking on it.

November Macro Update: Wage Growth Accelerates, But Some Signs of Weakness Creeping In

Summary: The macro data from the past month continues to mostly point to positive growth. On balance, the evidence suggests the imminent onset of a recession is unlikely.

That said, there are some signs of weakness creeping into the data. Retail sales are at a new all-time high, but overall growth is decelerating and less than 2% real. Employment growth is also decelerating, from over 2% last year to 1.7% now. Housing starts and permits have flattened over the past year. There is nothing alarming in any of this but it is noteworthy that expansions weaken before they end, and these are signs of some weakening that bear monitoring closely.

Overall, the main positives from the recent data are in employment, consumption growth and housing:

• Monthly employment gains have averaged 197,000 during the past year, with annual growth of 1.7% yoy.  Full-time employment is leading.
• Recent compensation growth is the highest in more than 7 years: 2.8% yoy in October. 
• Most measures of demand show 3-4% nominal growth. Real personal consumption growth in September was 2.4%.  Retail sales reached a new all-time high in September.
• Housing sales are near a 9 year high. Starts and permits in August remain near their 8 year highs, but growth has been flattening.
• The core inflation rate has remained near 2% since November 2015.

The main negatives are concentrated in the manufacturing sector (which accounts for just 10% of employment):

• Core durable goods growth fell 2.0% yoy in September. It was weak during the winter of 2015 and it has not rebounded since. 
• Industrial production has also been weak, falling -1.0% yoy due to weakness in mining (oil and coal). The manufacturing component grew +0.1% yoy.

Prior macro posts from the past year are here.

* * *

Our key message over the past 2 years has been that (a) growth is positive but slow, in the range of ~3-4% (nominal), and; (b) current growth is lower than in prior periods of economic expansion and a return to 1980s or 1990s style growth does not appear likely.

Modest growth should not be a surprise. This is the typical pattern in the years following a financial crisis like the one experienced in 2008-09.

This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels. The saying that "the stock market is not the economy" is true on a day to day or even month to month basis, but over time these two move together. When they diverge, it is normally a function of emotion, whether measured in valuation premiums/discounts or sentiment extremes (enlarge any image by clicking on it).

A valuable post on using macro data to improve trend following investment strategies can be found here.

Let's review each of these points in turn. We'll focus on four macro categories: labor market, inflation, end-demand and housing.


Employment and Wages

The October non-farm payroll was 161,000 new employees plus 44,000 in revisions.

In the past 12 months, the average monthly gain in employment was 197,000.

Monthly NFP prints are normally volatile. Since 2004, NFP prints near 300,000 have been followed by ones near or under 100,000. That has been a pattern during every bull market; NFP was negative in 1993, 1995, 1996 and 1997. The low prints of 84,000 in March 2015 and 24,000 in May 2016 fit the historical pattern. This is normal, not unusual or unexpected.

Has US Debt Reached A Tipping Point?

Summary: Investors have become very concerned about excessive debt in the US. The worry is that current leverage has risen so rapidly and become so extreme that the economy is at imminent risk of a crisis. Is this concern valid?

In this post, we break US debt into its main components: government, corporate and household. We compare each to their historical levels to determine whether current leverage levels have previously led to adversity. More importantly, we assess whether current leverage levels for each are sustainable.

The rise in US debt is primarily due to the federal government and corporates. Objectively, it is hard to see the case for either being a worrisome risk at present: their liabilities and interest expenses can be covered many times over by assets and income.

Moreover, households have deleveraged during the current cycle. This is quite unlike other periods of economic expansion. Given the importance of consumer spending to overall economic growth, current consumer debt levels are likely to be more of a tailwind for the economy than an impending risk.

* * *

There is a good chance that you have seen a picture of US debt like this one. It compares total US debt, held by the government, corporations and households, to the US economy. By this view, total US debt is very high by historical standards and has grown too rapidly. Enlarge any chart by clicking on it (chart from the Federal Reserve).

Fund Managers' Current Asset Allocation - October

Summary: Throughout 2013, 2014 and early 2015, fund managers were heavily overweight equities and underweight cash and bonds. Those allocations have entirely flipped in 2016, with investors persistently shunning equities in exchange for holding cash.

Global equities are more than 15% higher than in February. A tailwind for this rally has been the bearish positioning of investors, with fund managers' cash in October rising to the highest level since 2001. Similarly, their equity allocations are now like those in February, mid-2010 and mid-2012, periods which were notable lows for equity prices during this bull market. Overall, fund managers' defensive positioning supports higher equity prices in the month(s) ahead.

Allocations to US equities had been near 8-year lows over the past year and half, during which the US outperformed most of the world. After rising for two months during the summer, allocations fell again to underweight in both September and October. Bearish sentiment remains a tailwind for US equities.

European equity markets, which had been the consensus overweight and also the world's worst performing region, are now underweighted relative to their long term mean.  Investors are chasing the world's best performing region - emerging markets - which now have their highest overweight in 3 1/2 years. Emerging markets may rise further but note that the contrarian long trade is now over.

* * *

Among the various ways of measuring investor sentiment, the BAML survey of global fund managers is one of the better as the results reflect how managers are allocated in various asset classes. These managers oversee a combined $600b in assets.

The data should be viewed mostly from a contrarian perspective; that is, when equities fall in price, allocations to cash go higher and allocations to equities go lower as investors become bearish, setting up a buy signal. When prices rise, the opposite occurs, setting up a sell signal. We did a recap of this pattern in December 2014 (post).

Let's review the highlights from the past month.

Cash: Fund managers' cash levels at the equity low in February were 5.6%. Despite the rise in global equities since then, cash levels are now higher, at 5.8%. This is equal to the high after the Brexit vote in July, higher than at any time during the 2008-09 bear market and at the highest since November 2001. Even November 2001, which wasn't a bear market low, saw equities rise nearly 10% in the following 2 months.  High cash levels are supportive of further gains in equities in the month(s) ahead. Enlarge any image by clicking on it.

October Macro Update: Solid Wage Growth But Housing Construction Flattening

Summary: The macro data from the past month continues to mostly point to positive growth. On balance, the evidence suggests the imminent onset of a recession is unlikely.

Overall, the main positives from the recent data are in employment, consumption growth and housing:

• Monthly employment gains have averaged more than 200,000 during the past year, with annual growth of 1.7% yoy.  Full-time employment is leading.
• Recent compensation growth is the highest in 7 years: 2.7% yoy in July and 2.6% in September. 
• Most measures of demand show 3-4% nominal growth. Real personal consumption growth in August was 2.6%.  Retail sales reached a new all-time high in July.
• Housing sales are near a 9 year high. Starts and permits in August remain near their 8 year highs.
• The core inflation rate has remained above 2% since November 2015.

The main negatives are concentrated in the manufacturing sector (which accounts for just 10% of GDP):

• Core durable goods growth fell 3.7% yoy in August. It was weak during the winter of 2015 and it has not rebounded since. 
• Industrial production has also been weak, falling -1.1% yoy due to weakness in mining (oil and coal). The manufacturing component fell -0.2% yoy.

Prior macro posts from the past year are here.

* * *

Our key message over the past 2 years has been that (a) growth is positive but slow, in the range of ~3-4% (nominal), and; (b) current growth is lower than in prior periods of economic expansion and a return to 1980s or 1990s style growth does not appear likely.

Modest growth should not be a surprise. This is the typical pattern in the years following a financial crisis like the one experienced in 2008-09.

This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels. The saying that "the stock market is not the economy" is true on a day to day or even month to month basis, but over time these two move together. When they diverge, it is normally a function of emotion, whether measured in valuation premiums/discounts or sentiment extremes (enlarge any image by clicking on it).

A valuable post on using macro data to improve trend following investment strategies can be found here.

Let's review each of these points in turn. We'll focus on four macro categories: labor market, inflation, end-demand and housing.


Employment and Wages

The September non-farm payroll was 156,000 new employees less 7,000 in revisions.

In the past 12 months, the average monthly gain in employment was 204,000.

Monthly NFP prints are normally volatile. Since 2004, NFP prints near 300,000 have been followed by ones near or under 100,000. That has been a pattern during every bull market; NFP was negative in 1993, 1995, 1996 and 1997. The low prints of 84,000 in March 2015 and 24,000 in May 2016 fit the historical pattern. This is normal, not unusual or unexpected.

Has The Fed's Policy Decisions Propped Up Equities?

Summary: The stock market rises on days when the FOMC releases its policy statement, probably as a result of some uncertainty being removed for market participants. This pattern has existed for more than 30 years. The Fed's ability to "jawbone" the market higher is no more exceptional now than it was during any prior bull market.

* * *

Morgan Stanley's chief economist this week stated that the Fed's low rate policy and "jawboning" are responsible for most of the stock market's gains since 2009.  In doing so, Sharma is repeating the popular meme that the Fed's actions have been exceptional in pushing the market higher (from Market Watch). Enlarge any image by clicking on it.

Is this view accurate?

Sharma is correct in saying the stock market typically rallies on days when the FOMC announces its policy decisions. That's not terribly surprising: rate decisions represent some uncertainty which is resolved with the release of the policy statement. That investors are continually uncertain about Fed policy is a testament to its ability to keep complacency in check. This is remarkable, moreover, since Fed policy very rarely changes.

But where Sharma is wrong - and this is the key point - is in saying that the Fed's "aggressive monetary easing" and policy utterances have had an anomalous influence during the current bull market.  They haven't.

Quantifiable Edges (bookmark it here) has repeatedly looked at the performance of the S&P on days when the FOMC policy statement is released. From 1982 to mid-2009, the average FOMC day outperformed the average of all days by 7.5 times. Gains on FOMC days were common during the 1980s, the 1990s and became more exceptional during the 2000s, both during and after the 2003-07 bull market (chart below as of September 2009).

Interview with Financial Sense on US Macro and Equities

We were interviewed by Cris Sheridan of Financial Sense on September 21, the day of the FOMC rate decision. During the interview, we discuss the good and the not so good within the macro environment, the Fed, corporate fundamentals, investor positioning and what all of this means for US equities in the months ahead.

Our thanks to Cris for the opportunity to speak with him and to his editor for making these disparate thoughts seem cogent.

Listen here.

If you find this post to be valuable, consider visiting a few of our sponsors who have offers that might be relevant to you.

Live at Stocktoberfest on October 14

I'll be on a panel with Mark Dow, Jack Little and Eddy Elfenbein at Stocktoberfest in Coronado, CA on October 14. We'll be discussing global macro.

Mark is a former policy economist with the US Treasury and the IMF. Jack is the CEO of Mercenary Trader. The panel will be led by Eddy Elfenbein, editor of Crossing Wall Street.

Details are here.

Fund Managers' Current Asset Allocation - September

Summary: Even after the sell-off over the past week, global equities are more than 15% higher than in February. A tailwind for this rally has been the bearish positioning of investors, with fund managers' cash in February at the highest level since 2001. Similarly, their equity allocations in February had only been lower in mid-2011 and mid-2012, periods which were notable lows for equity prices during this bull market.

Remarkably, allocations to cash in September are as high as in February and allocations to equities are now even lower. Investors have jumped into the safety of bonds, with allocations rising to a 3 1/2 year high in June and July.  Overall, fund managers' defensive positioning supports higher equity prices in the month(s) ahead.

Allocations to US equities had been near 8-year lows over the past year and half, during which the US outperformed most of the world. After rising the past two months, allocations fell again to underweight in September. Bearish sentiment remains a tailwind for US equities. European equity markets, which had been the consensus overweight and also the world's worst performing region, are now underweighted relative to their long term mean.  Investors are chasing the world's best performing region - emerging markets - which now have their highest overweight in 3 1/2 years.

* * *

Among the various ways of measuring investor sentiment, the BAML survey of global fund managers is one of the better as the results reflect how managers are allocated in various asset classes. These managers oversee a combined $600b in assets.

The data should be viewed mostly from a contrarian perspective; that is, when equities fall in price, allocations to cash go higher and allocations to equities go lower as investors become bearish, setting up a buy signal. When prices rise, the opposite occurs, setting up a sell signal. We did a recap of this pattern in December 2014 (post).

Let's review the highlights from the past month.

Cash: Fund managers cash levels at the equity low in February were 5.6%, the highest since November 2001 and higher than at any time during the 2008-09 bear market. Cash has remained high ever since: it peaked at 5.8% in July and is only modestly lower in September at 5.5%. High cash levels are supportive of further gains in equities in the month(s) ahead. Enlarge any image by clicking on it.

September Macro Update: Consumption Growing 3% and Housing Sales at a 9 Year High

Summary: The macro data from the past month continues to mostly point to positive growth. On balance, the evidence suggests the imminent onset of a recession is unlikely.

Overall, the main positives from the recent data are in employment, consumption growth and housing:

• Monthly employment gains have averaged more than 200,000 during the past year, with annual growth of 1.7% yoy.  Full-time employment is leading.
• Recent compensation growth is the highest in 7 years: 2.7% yoy in July and 2.4% in August. 
• Most measures of demand show 3-4% nominal growth. Real personal consumption growth in July was 3.0%.  Retail sales reached a new all-time high in July.
• Housing sales are at a new 9 year high. Starts and permits in July remain near their 8 year highs.
• The core inflation rate has remained above 2% since November 2015.

The main negatives are concentrated in the manufacturing sector (which accounts for just 10% of GDP):

• Core durable goods growth grew 0.2% yoy in July, its first gain since April 2015. It was weak during the winter of 2015 and it has not rebounded since. 
• Industrial production has also been weak, falling -0.5% yoy due to weakness in mining (oil and coal). The manufacturing component grew +0.4% yoy.

Prior macro posts from the past year are here.

* * *

Our key message over the past 2 years has been that (a) growth is positive but slow, in the range of ~3-4% (nominal), and; (b) current growth is lower than in prior periods of economic expansion and a return to 1980s or 1990s style growth does not appear likely.

Modest growth should not be a surprise. This is the typical pattern in the years following a financial crisis like the one experienced in 2008-09.

This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels. The saying that "the stock market is not the economy" is true on a day to day or even month to month basis, but over time these two move together. When they diverge, it is normally a function of emotion, whether measured in valuation premiums/discounts or sentiment extremes (enlarge any image by clicking on it).

A valuable post on using macro data to improve trend following investment strategies can be found here.

Let's review each of these points in turn. We'll focus on four macro categories: labor market, inflation, end-demand and housing.


Employment and Wages

The August non-farm payroll was 151,000 new employees less 1,000 in revisions.

In the past 12 months, the average gain in employment was 204,000.

Monthly NFP prints are normally volatile. Since 2004, NFP prints near 300,000 have been followed by ones near or under 100,000. That has been a pattern during every bull market; NFP was negative in 1993, 1995, 1996 and 1997. The low prints of 84,000 in March 2015 and 24,000 in May 2016 fit the historical pattern. This is normal, not unusual or unexpected.

Weekly Market Summary

Summary: Resilient macro economic data as well as healthy consumer and corporate balance sheets provide a bullish longer term back drop for US equities. While the indices traded at new all-time highs this week, the pace of the advance has markedly slowed. The S&P has effectively reached the 2200 "round number" milestone and some shorter term measures of investor sentiment show bullishness at their highest level since the end of 2014. There's been no price trigger, but a set up for a retrace of some of gains since June is in place.

* * *

At our last market summary at the end of July, the S&P had closed at 2173. In the three weeks since, the index has gained just 10 points, or 0.5%. In the last two weeks, the index has gained exactly 1 point.

Almost all of the gains in the past three weeks came on August 5th, the day when non-farm payrolls were better than expected. The S&P gained nearly 1% that day and has done little since.

Our view has been that US equities are most likely in a final "wave 5" of their 7 year bull market, supported by solid breadth, skeptical long term sentiment and continued macro expansion. That view continues to be validated: SPX, NDX and DJIA all made new ATHs this week, and RUT made a new 1-year high. The trend remains higher. A recent post on this is here.

Strong gains in July are often partially retraced in August and September, months that are seasonally weak and also susceptible to increased volatility. That has so far not been the case: volatility has been persistently low and the indices continue to grind higher. This is why we always distinguish between a "set-up" for prices to move up or down and a "trigger" to indicate that the expected set-up has been activated.

The S&P remains above all its moving averages. With little gain over the past two weeks, it's not surprising that the 5-dma has flattened and the 13-ema is just below it. The likely "trigger" for a retrace will be the 13-ema inflecting lower. It's not perfect, but a when the MACD is declining (lower panel), RSI is under 50 (upper panel) and the 13-ema has inflected lower (lowest panel), a drop in the S&P is usually underway. Right now, only the MACD is weak; RSI and 13-ema are close to confirming, but haven't yet (enlarge any image by clicking on it).

Fund Managers' Current Asset Allocation - August

Summary: Since February, US equities have risen more than 20%. Equities outside the US have risen 16%. A tailwind for this rally has been the bearish positioning of investors, with fund managers' cash in February at the highest level since 2001. Similarly, their equity allocations in February had only been lower in mid-2011 and mid-2012, periods which were notable lows for equity prices during this bull market.

Remarkably, allocations to cash in July were even higher than in February, and fund managers became underweight equities for the first time in 4 years. Investors dove into the safety of bonds, with allocations rising to a 3 1/2 year high in June and July.

Now in August, cash allocations are only slightly lower than in February and allocations to equities only slightly higher. Both are about one standard deviation away from their long term mean. Overall, fund managers' defensive positioning supports higher equity prices in the month(s) ahead.

Allocations to US equities had been near 8-year lows over the past year and half, during which the US has outperformed most of the world. That has now changed: exposure to the US is at a 20-month high. There is room for exposure to move higher, but the tailwind for the US due to excessive bearish sentiment has mostly passed. That's also the case for emerging markets which have been the best performing equity region so far in 2016.  European equity markets, which have been the consensus overweight and also the world's worst performing region, are now the contrarian long trade within equities.

* * *

Among the various ways of measuring investor sentiment, the BAML survey of global fund managers is one of the better as the results reflect how managers are allocated in various asset classes. These managers oversee a combined $600b in assets.

The data should be viewed mostly from a contrarian perspective; that is, when equities fall in price, allocations to cash go higher and allocations to equities go lower as investors become bearish, setting up a buy signal. When prices rise, the opposite occurs, setting up a sell signal. We did a recap of this pattern in December 2014 (post).

Let's review the highlights from the past month.

Cash: Fund managers cash levels at the equity low in February were 5.6%, the highest since the post-9/11 panic in November 2001 and lower than at any time during the 2008-09 bear market. This was an extreme that has normally been very bullish for equities. Remarkably, with the SPX 20% higher, cash in July was even higher (5.8%) and at the highest level in 14 years (since November 2001).  That has moderated only slightly in August, falling to 5.4%. High cash levels are supportive of further gains in equities in the month(s) ahead (enlarge any image by clicking on it).

Be On Alert For A Pop Higher in Volatility

Summary: The trend in equities continues to be higher, even a very short term basis. As equity prices move higher, volatility is compressing. That, on its own, is not bearish, as volatility can stay low for months as equities grind higher. But it's noteworthy that volatility has popped higher in each of the past seven Augusts. Combined with an unusually tight trading range in SPX and an extreme in the volatility term structure, short term traders should be on alert for a pop higher in volatility. That may well correspond with SPX approaching its next "round number" milestone at 2200.

* * *

This week, the major US equity indices - SPX, NDX and COMPQ - all traded at new bull market highs. Moreover, RUT has traded at a new 12-month high. None of these, nor the DJIA, has closed below its 50-dma since late June. All are trading above their rising 5, 10, 20 and 50-dmas. The trend for US equities remains higher, even on a very short term basis.

As always, the first sign of a weakening trend will be consecutive closes below the 5-dma, which will then flatten or inflect downwards. As of today, that is not the case for any of the US equity indices.

In our last update, we shared several studies related to trend, breadth, sentiment, macro and corporate reports that supported higher equity prices in the month(s) ahead. That continues to be the case. Read that post here.

But there were also reasons to be on alert for a retracement of recent gains in August.  This post elaborates further on some of these reasons with a focus on volatility.

The CBOE volatility index, Vix, which measures implied volatility in the stock market over the next month, has been under 12 the last 4 days and also intermittently under 12 over the past month. This is unusually low volatility.

On its own, a very low Vix is not necessarily bearish: forward returns in the SPX are no different than when the Vix is above its median of 18.6 (data from Mark Hulbert).

August Macro Update: New Post-Crisis Highs in Employment, Wage Growth, Income, Consumption and Housing

Summary: The macro data from the past month continues to mostly point to positive growth. On balance, the evidence suggests the imminent onset of a recession is unlikely.

Overall, the main positives from the recent data are in employment, consumption growth and housing:

• Monthly employment gains have averaged more than 200,000 during the past year, with annual growth of 1.7% yoy.  Full-time employment is leading.
• Recent compensation growth is the highest in 7 years: 2.6% yoy in July. 
• Most measures of demand show 3-4% nominal growth. Real personal consumption growth in 2Q was 2.7%.  Retail sales reached a new all-time high in June.
• Housing sales are at a new 8 year high. Starts and permits in June remain near their 8 year highs.
• The core inflation rate has remained above 2% since November 2015.

The main negatives are concentrated in the manufacturing sector (which accounts for just 10% of GDP):

• Core durable goods growth fell -3.3% yoy in June. It was weak during the winter of 2015 and it has not rebounded since. 
• Industrial production has also been weak, falling -0.7% yoy due to weakness in mining (oil and coal). The manufacturing component grew +0.6% yoy.

Prior macro posts from the past year are here.

* * *

Our key message over the past 2 years has been that (a) growth is positive but slow, in the range of ~3-4% (nominal), and; (b) current growth is lower than in prior periods of economic expansion and a return to 1980s or 1990s style growth does not appear likely.

Modest growth should not be a surprise. This is the typical pattern in the years following a financial crisis like the one experienced in 2008-09.

This is germane to equity markets in that macro growth drives corporate revenue, profit expansion and valuation levels. The saying that "the stock market is not the economy" is true on a day to day or even month to month basis, but over time these two move together. When they diverge, it is normally a function of emotion, whether measured in valuation premiums/discounts or sentiment extremes.

A valuable post on using macro data to improve trend following investment strategies can be found here.

Let's review each of these points in turn. We'll focus on four macro categories: labor market, inflation, end-demand and housing.


Employment and Wages

The July non-farm payroll was 255,000 new employees plus 18,000 in revisions.

In the past 12 months, the average gain in employment was 205,000.

Monthly NFP prints are normally volatile. Since 2004, NFP prints near 300,000 have been followed by ones near or under 100,000. That has been a pattern during every bull market; NFP was negative in 1993, 1995, 1996 and 1997. The low print of 84,000 in March 2015 and 24,000 in May 2016 fit the historical pattern. This is normal, not unusual or unexpected.

Weekly Market Summary

Summary: US equities are trading at all-time highs. The trend is higher, supported by strong breadth, resilient economic data and improved corporate financials. Even after the strong advance, longer term measures of sentiment continue to show skepticism among investors. Together, this is a set up for higher equity prices in the month(s) ahead.

All of this said, there are reasons to be on the alert for a retracement of recent gains in August. The SPX consistently reacts negatively as it approaches each "round number" milestone (like 2200) for the first time. NDX has returned to its late 2015 resistance level. Some measures of shorter sentiment are heady. And August is seasonally weak and prone to a larger interim drawdown. Importantly, none of this is likely to be trend-ending.

* * *

In our last market summary at the end of June, the near term set-up was for higher equity prices in July (that post is here). For the month, SPX gained 3.5%. The leader has been NDX, which gained more than 7%. Outside the US, Europe gained 3.6% while emerging markets continued to outperform the rest of the world, gaining more than 5%.

Recall that the Brexit vote knocked 6% off US equity prices to close out the month of June. As we wrote then, non-economic shocks (like Brexit) tend to leave minimal damage to stock indices. In a study of 14 non-economic shocks since WWII, S&P Capital found that US indices bottomed within 6 days and had regained all of the losses within 2 weeks (read more here).