Financial Review

Go Figure

..Stocks move higher again. PPI shows inflation at the wholesale level. Why the markets seemed to stop worrying about inflation.

Financial Review by Sinclair Noe for 02-15-2018


DOW + 306 = 25,200
SPX + 32 = 2731
NAS + 112 = 7256
RUT + 15 = 1537
10 Y – .02 = 2.89%
OIL + .89 = 61.49
GOLD + 3.10 = 1354.30


Stocks moved higher for a fifth consecutive session. Go figure


Wholesale prices shot up 0.4% in January, another sign that inflation is perking up. The 12-month rate of wholesale inflation rose a tick to 2.7% in January. The biggest culprit: higher oil prices. Yet a more stable measure known as core Producer Price Index, or core PPI, also rose 0.4%, suggesting price pressures are more widespread. The core rate strips out food, energy and trade margins — volatile categories that can distort the report from month to month. The yearly rate of core inflation edged up to 2.5%.


The National Association of Home Builders/Wells Fargo housing market index stayed at 72 in February. That’s a very strong reading, and just slightly below December’s cycle-high reading of 74, as any reading over 50 indicates “good” performance. The component on sales expectations in the next six months rose two points to 80, the index measuring buyer traffic held steady at 54, and the component gauging current sales conditions dropped one point to 78. Over the last year, the SPDR S&P Homebuilders ETF (ticker XHB) has gained nearly 22%, outpacing the S&P 500’s 17.7% advance.


Mortgage rates have climbed to the highest level in close to four years, according to data released Thursday. The 30-year fixed-rate mortgage averaged 4.38% in the week ending Feb. 15, up from 4.32%


Initial U.S. jobless claims increased by 7,000 to 230,000 in the seven days ended Feb 10. Jobless claims have now been under the key 300,000 threshold that signals a strong labor market for 154 straight weeks.


The Federal Reserve reports industrial production slipped 0.1% in January, the first decline after four straight gains. December’s initial report of a large 0.9% increase was cut in half to a 0.4% rise. Manufacturing output was unchanged in January for the second straight month. Mining output fell 1%. Utility output rose 0.6% after a sharp 4.6% gain in the prior month. Auto production rose 0.6% in January, down from a 1.1% gain in the prior month. Capacity utilization edged down to 77.5% in January from 77.7% in the prior month. The capacity utilization rate reflects the limits to operating the nation’s factories, mines and utilities. It’s still well below prerecession levels, above 80%, that could fan production costs and prices.


The Philadelphia Fed manufacturing index rose to a reading of 25.8 in February from 22.2 in January. Economists had expected a slight retreat to 21. The Empire State Index, meanwhile slowed to a reading of 13.1 in February from 17.7 in January, the New York Fed said. Economists had expected a reading of 17.5. This is the fourth straight drop after the index hit 28.1 in October. Both gauges are well above zero indicating improving conditions.


The real question as we started this week was how the market would react to the CPI and PPI numbers and it seems to have taken higher inflation in stride. Given that the blame for this month’s market turmoil was the above-consensus read on average hourly earnings that accompanied the January jobs report and given that the fiscal outlook worsened materially with the budget deal, everyone was terrified that Wednesday’s CPI number would come in ahead of consensus and exacerbate the bond sell-off. And it did. Yield on the 10-year Treasury note popped above 2.9% yesterday; and 3% yields now seem inevitable. Remember, the bond sell-off was what triggered the market turmoil this month. And before stocks opened on Wednesday morning, Dow futures tumbled 500 points on the CPI news; but after falling off the cliff, futures started climbing; the Dow opened down but soon climbed into positive territory. Inflation. What inflation?


Meanwhile, the dollar tried to rally on Wednesday with the CPI print but that ultimately failed miserably and the bottom fell out. The dollar has dropped to its 2017 low against the Japanese yen, on the way to nobody quite knows where. A weak dollar might be good for exports, but it doesn’t attract foreign investment in financial assets.


So, anyway, stocks started going higher, and continued higher today on news of inflation at the wholesale level. Volatility eased; the VIX is back down below 20, we’ve already seen more 1% SPX moves in 2018 than we saw in all of 2017. Maybe traders are expecting the Federal Reserve will just keep a lid on any craziness. The bet is that Jerome Powell is the incarnation of Janet Yellen. Fed policy is still on track – at least that seems to be the prevailing bet. The thinking is that rates can go higher from here without doing much damage – the trick is that the increases are gradual. Five years ago, yields surged after Federal Reserve chair Ben Bernanke said the central bank might slow asset purchases as the U.S. economy found its footing. The Fed’s bond purchases were a holdover from the financial crisis, when quantitative easing was implemented to spur economic growth. The 10-year bond yield began May 2013 at 1.63 percent before spiking above 2 percent when Bernanke announced the Fed’s intention. In 1987, during the “Black Monday” stock market crash in October, yields spiked. The yield on the 30-year Treasury bond spiked to 10.25 percent in October after hitting the year’s low of 7.29 percent in January. If the Fed can make rate increases as boring as watching paint dry, the markets can adjust.


And now the narrative is that rising rates are not so bad, might actually be a good thing; that is stocks can go higher as interest rates rise. It sort of makes sense, rates typically go up in the latter stages of an economic cycle, at a time when companies still have fairly solid fundamentals, earnings still look good enough to keep the party going, at least for a while. As inflation picks up, stocks can benefit from overall appreciating asset values. Small-cap stocks have typically fared the best during periods of rising rates, gaining 7.3 percent for every 100-basis point increase. Meanwhile, mid-caps have added 5.9 percent and large caps have advanced 2.5 percent.


The problem with this kind of strong bounce is that people get over-confident. There is still a strong chance of a re-test. Typically, recoveries from sharp sell-offs require reassurances. In other words, investors will need proof that the bounce was for real. The most likely source of reassurance could come from the Federal Reserve, which has another policy meeting in about one month. Another reason to expect a re-test is that a stock bottom is rarely a V pattern. Any pullback might also represent another buying opportunity, provided the retest doesn’t result in a breakdown. And quite simply, the economy is in pretty good shape right now – not just in the US but globally. Today, Asian stocks and European stocks were all moving higher. There was a lot of money in the market with no conviction behind it, for example, buying index funds and ETFs just “to be part of the party” which was an element of “hot money.” Last week was most probably the preview to the bigger event that we’ll see this year.


Following many forecast increases by corporations in recent weeks, analysts on average now expect S&P 500 companies to increase their earnings per share in 2018 by 18.9 percent, according to Thomson Reuters I/B/E/S.


Apple jumped 3.36 percent and contributed more than any other stock to gains on the S&P 500 after Warren Buffett’s Berkshire Hathaway made Apple its top investment.


Cisco surged 4.73 percent following upbeat results and a strong forecast, as the network gear maker’s years-long efforts to transform into a software-focused company began to pay off.


CBS reported fourth-quarter earnings and revenue that beat analysts’ expectations. The stock gained about 2 percent in after-hours trade following the report. Chairman and CEO Les Moonves said that the company’s “total subscriber base continues to grow at an accelerated pace.” He said that streaming services CBS All Access and Showtime OTT now have nearly 5 million subscribers combined. The broadcast media company’s results come amid a flurry of consolidation in its industry, including chatter about CBS’ potential reunion with Viacom.


FANG stocks are getting their bite back, but there’s one name that sat out the rally today – Facebook. While shares of Amazon, Netflix, and Alphabet were sharply in the green today, Facebook shares were struggling to stay afloat. Facebook has fallen more than 7 percent from all-time highs the stock hit on Feb. 1. It is currently up just 1 percent year to date.


Swiss drugmaker Roche Holding said it would buy the rest of the privately held U.S. cancer data company Flatiron Health for $1.9 billion to speed up development and delivery of breakthrough medicines for cancer patients.


Federal regulators hit U.S. Bancorp, the nation’s biggest regional bank, with more than $800 million in fines for deficient anti-money laundering practices. The Justice Department announced a deferred prosecution with U.S. Bancorp related to the Bank Secrecy Act. Separately, the Federal Reserve ordered the Minneapolis-based bank to improve compliance with anti-money laundering laws. According to the Financial Crimes Enforcement Network, U.S. Bank, instead of addressing apparent risks, capped the number of alerts its automated transaction monitoring system would generate to identify only a predetermined number of transactions for further investigation, without regard for the legitimate alerts that would be lost due to the cap. The actual amount of the fines totaled $613 million, reflecting credits from certain regulators for remediation work that has already been completed.

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