This past week was chock full of smaller plots rather one large full blown storyline. Most weeks I do my best to pick a maximum of 2 themes to carry through my commentary but given the multitude of developments last week, this week’s commentary is going to be a bit different.
I’m channeling my inner Swedish chef this week with a smorgasbord of different topics including the US, Eurozone, the Land of the Rising Sun and finally, China.
US Divergence Continues
Last week was a full calendar of economic data points but just a few of those I want to highlight.
The most important of the week were the latest monthly labor market reports from ADP and non-farm payrolls. The ADP report showed a +230K gain in jobs during October. This makes the second straight month in which the APD year-over-year growth rate has accelerated higher, and is now sitting back to where it was in July.
The trend continued with October non-farm payrolls, which also showed a job gain of over 200K. This is the 9th month in a row that NFP has posted a gain of over 200K jobs, the longest such streak in 2 years. These larger reports were backed up by the more frequent, and more “noisy”, weekly unemployment claims.
Weekly claims declined 18.5% year over year, which marks the fourth straight week where claims have accelerated lower. Remember, falling claims are a positive development for the labor market. The 4-week moving average for claims is now at its lowest level since 2000 and is within spitting distance of its 40-year lows.
A couple of lower priority reports that can give us some insight into the health of the US are US ISM Manufacturing report and the US Services PMI. ISM manufacturing in October hit the highest level since March 2011 but as always, the devil is in the details. While hitting a 3.5 year high, the new orders and new export orders both fell month over month and construction spending fell for the third straight month.
There’s nothing detrimental here but when you see this type of divergence in headline numbers and critical sub-indices, its worth noting. Remember, what matters most in financial markets, happens at the margin. The US Services PMI dropped month over month and was the lowest such report since April.
That said, the 57.1 that was posted in October, is indicative of a GDP that runs around 2.5% annually. If this relationship holds, then we can expect GDP to accelerate a bit higher from Q3’s first look growth rate of 2.3%.
The divergence between economic growth here in the US and pretty much everywhere else on the planet is still in place. That’s a big reason why US equities gained on the week while China, the Eurozone and Japan’s equity markets all declined. Also, this divergence continues to be the main driver of the US Dollar’s amazing strength and the burning of the euro and Yen.
Economic data out of the Eurozone, as well as Draghi’s soundbites, continues to weigh heavily on both Eurozone equities and the Euro. For starters, the ECB began the week by slashing GDP growth forecasts for the full year 2014 and 2015.
The growth expectations for 2014 are now 0.8% versus the 1.2% growth rate that was forecasted this past spring. That’s a healthy 33% downward revision.
The 2015 forecast was revised lower from 1.7% to 1.1%, a 35% decline.
Those growth rates are just abysmal and now you can start to see why the US looks like a California dime at growth rates over 2%.
This news was followed by a mix of data which showed some improvement in the manufacturing sector, but the Eurozone’s growth engine, Germany, remains well below the levels we saw earlier this year.
That said, the German September Industrial Production report rose 1.4%. As a reminder it was the 4.0% August plunge in German industrial production that was one of the catalysts of the market decline in early October.
The week was capped off by the ECB’s Mario Draghi doing what he does best. Draghi stated explicitly that the ECB has unanimously agreed to target the return of its balance sheet back to early 2012 levels. It will be near impossible to reach such a target without the purchases of Government bonds so Draghi’s comments bring Government QE a step closer. This quote from Draghi somes it up, "The main message is ECB assets are set to expand as others contract." I sure am glad we are SHORT the Euro via FXE.
Land of the Rising Sun
In the space of the last 3 weeks, Japanese stocks (the TOPIX) have swung from the most overbought in 18 months to the most oversold in 36 months to the most overbought in 18 months again. This is the fastest and most violent swing in TOPIX on record.
This historic price moves comes on the heels of the BOJ amping its purchases of equities and exchange traded funds and Japan’s Government pension fund uping its allocation to the Japanese equity markets.
Let’s put this in perspective, in the last week, the TOPIX had a 2 day rally that pushed back towards 18 month highs, then in the following 4 days, it fell 5.5%. Who do you think bought the peak? Easy come, easy go.
Oh, I almost forgot, Japan’s manufacturing PMI declined for the 8th straight month and the Yen lost an additional 2% last week.
Another week, another set of data points showing a decline in both manufacturing and non-manufacturing growth rates. China’s manufacturing sector has now spent more time in contraction than expansion since 2011.
But the biggest driver of asset prices came later in the week with the release of the quarterly monetary policy report from the People’s Bank of China.
It’s becoming clear that stimulus, via cuts to system-wide required reserve ration (RRR) or the benchmark interest rates, is becoming less and less likely. The PBOC's introduction of a new facility called The People’s Bank of China confirmed it injected 769.5B Yuan ($126 billion) into the country’s lenders in the last two months through a newly-created Medium-term Lending Facility (MLF).
The MLF allows 'targeted' easing, and as one local economist noted, "it shows the central bank is very reluctant to loosen monetary policy.” All of the “injections” were for a 3-month term at 3.5%. It should be pointed out that while no direct stimulus is being considered, every $500B Yuan from the PBOC is similar to a 50 basis point cut to the required reserve ratio.
Things are constantly shifting in global markets. There are always a ton of data points and “news” stories each week. It can be difficult to sift through all of the noise to find the actual signals, which are few and far between. Look for the signals, avoid the noise.