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Bluestone Market Research

IN THE END, IT WAS JUST A HEALTH CARE BILL

“When we start to grow the economy at 4, 4.1 percent, it actually not only increases wages but it puts more money in Americans pockets each and every day.  And so tax reform and lowering taxes will create and generate more income, and so we’re looking at those, where the fine balance is. But does it have to be fully offset? My personal response is no.”

House Freedom Caucus Chairman, Rep. Mark Meadows, 3/26/17

FAST FACTS ABOUT TODAY’S ECONOMIC DATA:

  • Maybe the failure of the AHCA improves the odds of meaningful tax reform.
  • Dallas Fed survey joins other surveys in recent weakness.
  • German IFO index hits highest level since 2011.

IN THE END, IT WAS JUST A HEALTH CARE BILL:

So let’s assume the American Health Care Act actually passed the house on Friday by a measly single vote.  Now what would we be dealing with?  Well, first off, we’d be dealing with the U.S. Senate.  The U.S. Senate, and folks like Rand Paul, would have completely trashed this bill.  Democrats would be screaming about how the AHCA is going to hurt the poor, the elderly, and give a tax cut to the rich.  Senators would be getting called constantly to vote down the bill.  We’d be hearing today how there was no way the bill can get through the Senate.  And everyone would be worried that tax reform won’t happen for months to come, if ever.

Now back to reality, the bill failed so miserably in the House of Representatives that they wouldn’t even vote on it.  And everyone assumes that the failure of the AHCA lowers the odds of tax reform.  However, the GOP needs to save face.   The President needs to save face, Paul Ryan needs to save face, and the ideological lunatics in the House Freedom Caucus even need to save face.    Maybe the failure of the AHCA actually INCREASES the likelihood and immediacy of meaningful tax reform?  And that is why Mark Meadows is our quote of the day above.

DALLAS FED MANUFACTURING INDEX SLIPPED FROM 10-YEAR HIGH, SIMILAR TO OTHER SURVEYS:

Today, the Dallas Federal Reserve reported that the Current General Business Activity Index fell -7.6 points to +16.9 in the month of March.  Note that the prior month was the highest level since 2006 and this month marks the sixth consecutive month of growth in the region.  Certainly the decline in oil prices last month led back some growth.  In the month, there were improvements in Production (+1.9 points to 18.6), Growth Rate of New Orders (+1.2 points to +3.2), and Finish Goods Inventories (+0.8 points to -1.8).  However, there were declines in New Orders (-2.1 points to 9.5), Shipments (-5.7 points to 6.5), and Number of Employees (-1.2 points to 8.4).  Lastly, manufacturers had a slightly less positive business outlook, as the Forecast slipped -0.7 points to +36.3.

 

1

 

GERMAN IFO BUSINESS CLIMATE INDEX AT HIGHEST LEVEL SINCE 2011:

The German IFO Institute Business Climate Index increased +1.2 points to 112.3 in March, which is the highest level since July 2011. In the month, the Business Situations Index increased +0.9 points to 119.3 (highest level since July 2011) and the Business Expectations Index increased +1.5 points to 105.7.

 

2

 

AMERICAS:

U.S. GDP:  Our GDP model points toward stronger growth in 2H 2017 (+3.1% Real GDP) given improvements in workforce population growth and workforce participation.  Our official forecast for 2017 is 3.0%. 

 

3

 

U.S. Inflation:  Recent inflation data in the U.S. has been accelerating.  The Fed’s preferred inflation metric, the Core PCE Deflator continues to approach the Fed’s 2% inflation target (+1.74% in January).  Meanwhile, U.S. CPI has been trending higher, with headline CPI at 2.5% and Core CPI at 2.3%.  As we anniversary the drop in commodities prices, we expect headline inflation to peak within the next few months.

U.S. Federal Reserve:  Given our belief that U.S. inflation will peak within the next few months, we believe the FOMC will become increasingly more data-dependent in the coming months.  We believe the Fed will hike rates 1-2 more times in 2017.

U.S. Treasuries:  With headline CPI at 2.7% Y/Y and peaking, we continue to believe the U.S. 10-year yield will approach 3.0% in 2017, despite the recent rally in treasuries. 

U.S. Equities and Earnings:  S&P 500 operating earnings will rise materially in 2017 but with oil prices trading lower again, street expectations of +20% Y/Y earnings growth are unlikely.  We have a yearend S&P 500 target of 2400, which has already been attained.  We favor the Financials and Energy sectors, as well as the Homebuilding sub-sector, and are offsetting that against underweight views in Consumer Staples and Utilities, which are overvalued by historical measures.

Argentina:  In short, the economic data out of Argentina has been “less bad”.   Industrial Production was less negative at -1.1% Y/Y in January, which is an improvement from -8.0% Y/Y in October.  However, Consumer Confidence remains depressed in March and GDP is still negative.

Brazil:  Recent data in Brazil has been mixed, but heading in the direction of improvement.  Inflation has turned meaningfully lower – which has allowed for interest rate cuts, consumer/business confidence continues to improve, tax receipts are trending higher, and PMI is trending positively.  However, despite recent improvements in Brazilian data, Brazilian markets have rallied substantially since President Rousseff’s removal.  We feel Brazil’s current economic condition is mostly priced in at this time.

Canada: Recent economic data suggest improvement in Consumer Confidence, manufacturing, and Housing.  Canada’s monthly GDP has been remarkably steady at roughly 2.0% Y/Y over the past four months and Unemployment improved to 6.6% in February.  As the U.S. economy experiences liftoff, we are watching Canada for signs that it too may follow suit.  However, with oil prices trending down again, we remain neutral on Canada.

Mexico:

Inflation continues to rise, yet Consumer Confidence improved in February, following a sharp decline. Meanwhile, Manufacturing is slowing.  We’re neutral on Mexico given the political uncertainty, but certainly the fundamental backdrop has worsened.

EMEA:

United Kingdom:  The U.K. economy seems to be on decent footing post-BREXIT, as was evidenced in the release of Q4 GDP and retail sales data. With some modest economic deterioration and Article 50 set to be triggered on March 29th, we recently closed out our bullish view on GBP.    

European Union:  With far-right candidate, Wilders, losing the election in the Netherlands, and with polls showing anti-E.U. candidate, Le Pen, not making progress in the French election (first round: April 23), we feel the political situation is more certain in the coming months (at least until Germany’s election on Sept 24).  However, any further unrest or terrorism in Europe will undoubtedly push the European populace more towards protectionist positions, favoring anti-establishment (and anti-EU) candidates.  As politics are improving along with economic data in Europe, we recently removed our Euro short view and initiated a long view on the Euro STOXX 50 Index.

European Central Banks:  The ECB is doing exactly what we thought they would do by favoring asset purchases over furthering lowering rates into negative territory and now the ECB is facing rising inflation.  The ECB begins tapering its asset purchases next month and certainly a discussion will begin on the process of how/when to raise rates.  We will watch to see if ECB tapering has any meaningful impact on zero (or near-zero) interest rates throughout the continent.

Eastern Europe: We continue to believe risks remain for Eastern Europe given high Debt/GDP levels, most notably Cyprus (104%), Croatia (88%, up from 66% at the end of 2013), and Slovenia (81%).

South Africa:  Recent data show improvements in PMI, Business Confidence, mining production, and Vehicle Sales following weak Q4 data, which inflation data weakened in January.  Given South Africa’s commodity-driven exports, a stronger U.S. dollar could continue to hamper export growth.

ASIA / PACIFIC:

Australia: The RBA has cut rates twice in the past year and we may be seeing some of the fruits of the RBA’s dovish policy, as PMI’s have improved in recent months.  However, retail sales have slowed slightly and the unemployment rate recently ticked higher.  Recent trade data suggests that Australian trade with China has improved.  We are monitoring Australia for further improvement.  Note that the ASX 200 index trades at a P/E of 19.8x and yields 4.2% (when compared to other developed economies, the ASX is cheaper than its peers).  We remain neutral on Australia until further economic improvement is evidenced.

China:   Recently, we closed out our China equity market short view on the back of stronger trade data, and some subtle improvements in PMI’s.  It appears that China plans to continue to stabilize markets ahead of the National Communist Party Congress later this year, and we no longer believe a short China equities position offers compelling risk/reward at this time. 

India:  Money supply growth is beginning to recover following last year’s currency demonetization.  M1 growth has “improved” to -7.7% Y/Y (versus -18.7% Y/Y in December) and M3 has rebounded to +7.0% Y/Y (was +6.4% in January).  Manufacturing and Services PMI’s have improved in February, but inflation appears to be turning higher again.  As exports and imports in India are surging in Q1, it appears economic activity is rebounding.  However, the recovery may be priced in as the Sensex index is already up 10% this year and trades at an above-average P/E.

Indonesia:  Indonesia’s GDP and Private Consumption Expenditures have been stable at 5% Y/Y, but Consumer Confidence and inflation appear to be turning higher.  As a result, it is reasonable to assume that the central bank’s dovish policy stance (six rate cuts in 2016) may revert to a more neutral stance this year.

Japan:  Data from Japan in Q1 showed modest, positive improvements in Unemployment, CPI, PPI, retail sales, and manufacturing; however, Industrial Production and Exports have recently slipped. 

Russia: We are concerned about the recent unexpected drop in Industrial Production and a worsening in unemployment; however, Real Disposable Income and Wages have turned up.  Moreover, CPI slowed to +4.6% Y/Y in February, which allowed the Bank of Russia to cuts rates once again.  Also, Russian equities remain the cheapest in the industrialized world and we remain bullish, albeit now with greater concern given oil prices are breaking lower. 

Turkey:  Inflation is rising in Turkey (+10.1% Y/Y in February), consumer confidence continues to decline, and given political instability, Turkey hasn’t reported GDP since Q2.  Meanwhile, unemployment (last reported in November) has turned meaningfully higher at 12.7% and Turkey’s 10-year bond yield is +175 bps higher than it was in April.  Overall, Turkey’s economic situation appears to be in deterioration, but without timely data releases we will refrain from initiating a view.

GLOBAL CENTRAL BANK SCORECARD:

 

4

 

MACRO TRADING IDEAS:

 

5

 

WEEK IN REVIEW – BEST & WORST PERFORMERS:

S&P 500 SECTOR PERFORMANCE:

 

6

 

BEST/WORST PERFORMING WORLD BOND MARKETS:

 

7

 

BEST/WORST PERFORMING GLOBAL STOCK MARKETS:

 

8

 

BEST/WORST PERFORMING CURRENCIES:

 

9

 

COMMODITIES MARKET PERFORMANCE:

 

10MAJOR GLOBAL STOCK MARKETS:

 

11

 

MAJOR GLOBAL BOND MARKETS:

 

12

 

DISCLOSURE APPENDIX

This publication is for Institutional Investor use only and not for distribution to the general public. The comments herein are based on the author’s opinion at a particular point in time and February change at any time without notice. Merion Capital Group does not guarantee the accuracy or completeness of the information contained herein. Merion Capital Group is a FINRA-registered broker-dealer. Merion Capital Group shares in the commissions for trades that are executed through Tourmaline Partners, LLC, a FINRA-registered broker-dealer. This report is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. It does not constitute a general or personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors. Past performance is not a guarantee of future performance. All investments involve risk, including the loss of all of the original capital invested.

RUSSIA TURNS RED AGAIN

“I have been authorized by the Department of Justice to confirm that the FBI is investigating Russia’s interference in the US election.  [Including] whether there was any coordination between the campaign and Russian efforts.”

FBI Director, James Comey, 3/20/17

FAST FACTS ABOUT TODAY’S ECONOMIC DATA:

  • Russia Industrial Production falls unexpectedly.
  • PPI inflation turns higher in Germany.

RUSSIAN INDUSTRIAL PRODUCTION UNEXPECTEDLY FALLS:

According to data from the Russian Federation Federal State Statistics Service, industrial production declined -0.6% M/M in February (second consecutive decline) and now stands at -2.7% Y/Y (first Y/Y decline since January 2016).  Note that the market was expecting a gain of +1.3% Y/Y, so this is a notable deviation.

The decline in the month was led mostly by a drop in oil output (-7.6% M/M and now -0.7% Y/Y, versus +2.4% prior).  Meanwhile, Natural Gas output fell -11.8% M/M but actually accelerated to +12.1% Y/Y (+7.1% prior).  The monthly decline in oil and gas output pushed the overall “Mining and Quarrying Sector down -6.2% M/M, and flat Y/Y (+3.3% Y/Y prior).  Meanwhile, although manufacturing output increased +4.7% M/M, manufacturing is now down -5.1% Y/Y (versus +2.0% Y/Y prior).  As Russia remains one of our preferred geographies at this time, we will now monitor Russia more closely for other signs of weakness.

 

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GERMAN PPI ACCELERATES, BUT ENERGY WAS THE PRIMARY DRIVER:

According to the German Federal Statistics Office, German Producer Prices increased +0.2% M/M and accelerated to +3.1% Y/Y (+2.4% prior).   However, similar to U.S. inflationary data, the primary driver of the acceleration was energy prices (-0.2% M/M, but up +5.4% Y/Y).  Note that Heating Oil is up +61.9% Y/Y!  As for consumer goods prices, they increased to +2.2% Y/Y, versus +2.1% prior.

 

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CHICAGO FED NATIONAL ACTIVITY SLIPPED IN JANUARY:

According to the Federal Reserve Bank of Chicago, the Chicago Fed National Activity Index (CFNAI) improved +0.36 points to +0.34 in February.  The three-month average increased +0.18 points to 0.25.  In the month, Production & Income improved +0.05 points to +0.09, PCE & Housing improved +0.08 points to -0.03, Sales & Inventories increased +0.09 points to +0.08, and Employment & Hours increased +0.15 points to +0.21.

AMERICAS:

U.S. GDP:  Our GDP model points toward stronger growth in 2H 2017 (+3.1% Real GDP) given improvements in workforce population growth and workforce participation.  Our official forecast for 2017 is 3.0%. 

 

3

 

U.S. Inflation:  Recent inflation data in the U.S. has been accelerating.  The Fed’s preferred inflation metric, the Core PCE Deflator continues to approach the Fed’s 2% inflation target (+1.74% in January).  Meanwhile, U.S. CPI has been trending higher, with headline CPI at 2.5% and Core CPI at 2.3%.  As we anniversary the drop in commodities prices, we expect headline inflation to peak within the next few months.

U.S. Federal Reserve:  Given our belief that U.S. inflation will peak within the next few months, we believe the FOMC will become increasingly more data-dependent in the coming months.  We believe the Fed will hike rates 1-2 more times in 2017.

U.S. Treasuries:  With headline CPI at 2.7% Y/Y and peaking, we continue to believe the U.S. 10-year yield will approach 3.0% in 2017. 

U.S. Equities and Earnings:  S&P 500 operating earnings will rise materially in 2017 but with oil prices trading lower again, street expectations of +20% Y/Y earnings growth are unlikely.  We have a yearend S&P 500 target of 2400, which has already been attained.  We favor the Financials and Energy sectors, as well as the Homebuilding sub-sector, and are offsetting that against underweight views in Consumer Staples and Utilities, which are overvalued by historical measures.

Argentina:  In short, the economic data out of Argentina has been “less bad”.   Industrial Production was less negative at -1.1% Y/Y in January, which is an improvement from -8.0% Y/Y in October.  However, Consumer Confidence has worsened in February and GDP is still negative.

Brazil:  Recent data in Brazil has been mixed, but heading in the direction of improvement.  Inflation has turned meaningfully lower – which has allowed for interest rate cuts, consumer/business confidence continues to improve, tax receipts are trending higher, and PMI is trending positively.  However, despite recent improvements in Brazilian data, Brazilian markets have rallied substantially since President Rousseff’s removal.  We feel Brazil’s current economic condition is mostly priced in at this time.

Canada: Recent economic data suggest improvement in Consumer Confidence, manufacturing, and Housing.  Canada’s monthly GDP has been remarkably steady at roughly 2.0% Y/Y over the past four months and Unemployment improved to 6.6% in February.  CPI has accelerated to +2.1% Y/Y in January.  As the U.S. economy experiences liftoff, we are watching Canada for signs that it too may follow suit.  However, with oil prices trending down again, we remain neutral on Canada.

Mexico:

Inflation continues to rise, yet Consumer Confidence improved in February, following a sharp decline. Meanwhile, Manufacturing is slowing.  We’re neutral on Mexico given the political uncertainty, but certainly the fundamental backdrop has worsened.

EMEA:

United Kingdom:  The U.K. economy seems to be on decent footing post-BREXIT, as was evidenced in the release of Q4 GDP, however, retail sales and industrial production have slowed in 2017.  With some modest economic deterioration, and Article 50 set to be triggered on March 29th, we are closing out our bullish view on GBP at this time.   

European Union:  With far-right candidate, Wilders, losing the election in the Netherlands, and with polls showing anti-E.U. candidate, Le Pen, not making progress in the French election (first round: April 23), we feel the political situation is more certain in the coming months (at least until Germany’s election on Sept 24).  However, any further unrest or terrorism in Europe will undoubtedly push the European populace more towards protectionist positions, favoring anti-establishment (and anti-EU) candidates.  As politics are improving along with economic data in Europe, we recently removed our Euro short view and initiated a long view on the Euro STOXX 50 Index.

European Central Banks:  The ECB is doing exactly what we thought they would do by favoring asset purchases over furthering lowering rates into negative territory and now the ECB is facing rising inflation.  The ECB begins tapering its asset purchases next month and certainly a discussion will begin on the process of how/when to raise rates.  We will watch to see if ECB tapering has any meaningful impact on zero (or near-zero) interest rates throughout the continent.

Eastern Europe: We continue to believe risks remain for Eastern Europe given high Debt/GDP levels, most notably Cyprus (104%), Croatia (88%, up from 66% at the end of 2013), and Slovenia (81%).

South Africa:  Recent data show improvements in PMI, Business Confidence, mining production, and Vehicle Sales following weak Q4 data, which inflation data weakened in January.  Given South Africa’s commodity-driven exports, a stronger U.S. dollar could continue to hamper export growth.

ASIA / PACIFIC:

Australia: The RBA has cut rates twice in the past year and we may be seeing some of the fruits of the RBA’s dovish policy, as PMI’s have improved in recent months.  However, retail sales have slowed slightly and the unemployment rate recently ticked higher.  Recent trade data suggests that Australian trade with China has improved.  We are monitoring Australia for further improvement.  Note that the ASX 200 index trades at a P/E of 19.9x and yields 4.2% (when compared to other developed economies, the ASX is cheap-er than its peers).  We remain neutral on Australia until further economic improvement is evidenced.

China:   Recently, we closed out our China equity market short view on the back of stronger trade data, and some subtle improvements in PMI’s.  It appears that China plans to continue to stabilize markets ahead of the National Communist Party Congress later this year, and we no longer believe a short China equities position offers compelling risk/reward at this time. 

India:  Money supply growth is beginning to recover following last year’s currency demonetization.  M1 growth has “improved” to -7.7% Y/Y (versus -18.7% Y/Y in December) and M3 has rebounded to +7.0% Y/Y (was +6.4% in January).  Manufacturing and Services PMI’s have improved in February, but inflation appears to be turning higher again.  As imports in India are surging in Q1, it appears economic activity is rebounding.  However, the recovery may be priced in as the Sensex index is already up 11% this year and trades at an above-average P/E.

Indonesia:  Indonesia’s GDP and Private Consumption Expenditures have been stable at 5% Y/Y, but Consumer Confidence and inflation appear to be turning higher.  As a result, it is reasonable to assume that the central bank’s dovish policy stance (six rate cuts in 2016) may revert to a more neutral stance this year.

Japan:  Data from Japan in Q1 showed modest, positive improvements in Unemployment, CPI, PPI, retail sales, and manufacturing; however, Industrial Production and Exports have recently slipped. 

Russia: Russia may be the only place on Earth where retail sales can fall 25% in January, and that can actually be a material improvement (-2.3% Y/Y versus -5.9% Y/Y prior).  As mentioned above, we are concerned about the recent unexpected drop in Industrial Production and a worsening in unemployment, but Real Disposable Income and Wages have turned up.  Russian equities remain the cheapest in the industrialized world and we remain bullish, albeit now with greater concern given oil prices are breaking lower. 

Turkey:  Inflation is rising in Turkey (+10.1% Y/Y in February), consumer confidence continues to decline, and given political instability, Turkey hasn’t reported GDP since Q2.  Meanwhile, unemployment (last reported in November) has turned meaningfully higher at 12.7% and Turkey’s 10-year bond yield is +175 bps higher than it was in April.  Overall, Turkey’s economic situation appears to be in deterioration, but without timely data releases we will refrain from initiating a view.

GLOBAL CENTRAL BANK SCORECARD:

 

4

 

MACRO TRADING IDEAS:

 

5

 

WEEK IN REVIEW – BEST & WORST PERFORMERS:

S&P 500 SECTOR PERFORMANCE:

 

6

 

BEST/WORST PERFORMING WORLD BOND MARKETS:

 

7

 

BEST/WORST PERFORMING GLOBAL STOCK MARKETS:

 

8

 

BEST/WORST PERFORMING CURRENCIES:

 

9

 

COMMODITIES MARKET PERFORMANCE:

 

10

 

MAJOR GLOBAL STOCK MARKETS:

 

11

 

MAJOR GLOBAL BOND MARKETS:

 

12

DISCLOSURE APPENDIX

This publication is for Institutional Investor use only and not for distribution to the general public. The comments herein are based on the author’s opinion at a particular point in time and February change at any time without notice. Merion Capital Group does not guarantee the accuracy or completeness of the information contained herein. Merion Capital Group is a FINRA-registered broker-dealer. Merion Capital Group shares in the commissions for trades that are executed through Tourmaline Partners, LLC, a FINRA-registered broker-dealer. This report is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. It does not constitute a general or personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors. Past performance is not a guarantee of future performance. All investments involve risk, including the loss of all of the original capital invested.

S&P EPS RELIANT ON ENERGY (BUT LESS SO)

“I think the Federal Reserve has been doing a good job [in achieving its mandate]. The Fed will do what they need to do. And we respect the powers of the Fed.”

White House Chief Economic Advisor, Gary Cohn, 3/12/17

FAST FACTS ABOUT TODAY’S ECONOMIC DATA:

  • The Street is still banking on Energy to drive earnings, but less so.
  • So much for buying everything, Japan machinery orders fell in January.
  • Italian industrial production has worst monthly drop since January 2012.

STREET S&P EARNINGS FORECASTS ARE BECOMING LESS RELIANT ON ENERGY:

The S&P Energy Sector garners a lot of investor attention despite comprising only 6.5% of the S&P 500 Index.   For comparison purposes, the Energy Sector pales in significance to Technology (21.7% of the index), Financials (14.9%), and Health Care (14.1%).

However, despite the Energy Sector’s small size, swings in energy prices create significant deltas in S&P Operating Earnings.  The table below underscores the point.  In 2015, S&P Operating Earnings fell by $116 billion, of which $147 billion was due to energy (126%).  Last year, S&P Operating Earnings improved by $31 billion, of which $26 billion was energy (84%).   However, in 2017, S&P Operating Earnings are expected to increase by nearly $190 billion, of which $54 billion is expected to come from energy (29%).  The point being, barring another collapse in energy prices, S&P Operating Earnings will still show significant growth in 2017 and 2018. 

 

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So if the delta in energy earnings is only driving 29% of earnings growth in 2017, where are the earnings coming from?  According to recent data from S&P Index Services, the street is also placing its bets on Tech, Healthcare and Industrials to drive much of the earnings growth this year.

 

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Certainly, energy remains a major driver for 2017 earnings growth, but earnings growth expectations now appear to be more broadly-based.   We have a few observations, however. First of all, is the street already baking in health care and infrastructure reform, given large improvements in earnings expectations for these sectors in 2017?  Additionally, we are struck by how little the street is expecting in terms of earnings growth from the financial sector this year.   With a steeper yield curve and credit growth still on the rise, is the street too pessimistic about the prospects for the S&P’s second largest sector?  We believe so.

JAPAN CORE MACHINERY ORDERS DOWN -3.2% IN JANUARY:

According to the Japan Economic and Social Research Institute, Core Machinery Orders declined -3.24% M/M in the month of January (+2.15% M/M prior).  Furthermore, Core Machinery Orders are now down -8.2% Y/Y versus +6.7% Y/Y prior.  In the month, Total Machinery Orders declined -9.95% M/M to ¥2.237 trillion in January; however, Overseas Orders increased +3.25% M/M and Government Orders rebounded +20.39% M/M.

 

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ITALIAN INDUSTRIAL PRODUCTION DOWN -2.3% M/M IN JANUARY:

According to iStat, Italian Industrial Production declined -2.29% M/M in the month of January (+1.37% M/M prior).  In fact, this is the largest monthly decline since January 2012 Furthermore, total output is now down -0.45% Y/Y when adjusted for working days versus +6.76% Y/Y prior.  In the month, Energy Output increased +3.07% M/M and +15.35% Y/Y; however, Consumer Goods output fell -1.63% M/M, Intermediate Goods output fell -3.39% M/M, and Investment Goods output fell -5.25% M/M. 

 

4

 

AMERICAS:

U.S. GDP:  Our GDP model points toward stronger growth in 2H 2017 (+3.4% Real GDP) given improvements in workforce population growth and workforce participation.  Our official forecast for 2017 is 3.0%. 

 

5

 

U.S. Inflation:  Recent inflation data in the U.S. has been accelerating.  The Fed’s preferred inflation metric, the Core PCE Deflator continues to approach the Fed’s 2% inflation target (+1.74% in January).  Meanwhile, U.S. CPI has been trending higher, with headline CPI at 2.5% and Core CPI at 2.3%.  As we anniversary the drop in commodities prices, we expect headline inflation to eclipse Core inflation in 2017 and our base assumptions are for 2.5% headline CPI and 2.25% Core CPI by yearend.

U.S. Federal Reserve:  Given our belief that the U.S. economy continues to improve, and inflation will rise, we believe the FOMC will hike rates three or four times this year.  We are setting a yearend 2017 Fed Funds target of 1.5% as a result.

U.S. Treasuries:  On the heels of stronger growth in the U.S. and backup in yields throughout Europe, we recommended to short the U.S. 10-year Treasury bond.  Despite low inflation globally, we believe U.S. 10-year yields will approach 3.0% in 2017.  We believe that economic conditions will likely deteriorate above the 3% threshold, based on recent history in the housing sector. 

U.S. Equities and Earnings:  As discussed above, S&P 500 operating earnings will rise materially in 2017 (the street believes earnings will grow approximately +20% in 2017).  We have a yearend S&P 500 target of 2400.  Note that we have lowered our multiple slightly to 17.5x forward earnings (from 18.0x) given the rising rate environment, but if the White House continues its confrontational approach to trade negotiation, or if tax reform measures are delayed, we expect to lower that forward multiple further.   We continue to favor the Financials sector, as well as the Homebuilding sub-sector, and are offsetting that against underweight views in Consumer Staples and Utilities, which are overvalued by historical measures, particularly in light of more Fed rate hikes in 2017.

Argentina:  In short, the economic data out of Argentina has been “less bad”.   Industrial Production was less negative at -1.1% Y/Y in January, which is an improvement from -8.0% Y/Y in October.  However, Consumer Confidence has worsened in February.  All that being said, “less bad” isn’t exactly “good” and we believe the United States’ stronger dollar and tighter trade policies are a major negative for emerging market economies, particularly economies like Argentina, where GDP is still negative.

Brazil:  Recent data in Brazil has been mixed, but heading in the direction of improvement.  Inflation has turned meaningfully lower – which has allowed for interest rate cuts, consumer confidence continues to improve, and tax receipts are trending higher.  Meanwhile, retail sales remain negative, unemployment increased in January, personal loan default rates have not dropped, business confidence hasn’t improved, and PMI manufacturing contracted in February.  Given that Brazilian markets have rallied substantially since President Rousseff’s removal, we feel Brazil’s current economic condition is mostly priced in and believe downside risk remains for Brazilian equities, particularly when adjusted for currency.

Canada:

Despite a housing bubble that appears to be deflating in some areas, building permits and home prices improved in Q4.  Canada’s monthly GDP has been remarkably steady at 1.0-2.0% Y/Y.  Unemployment has improved to 6.6% in February.  CPI has accelerated to +2.1% Y/Y in January and Manufacturing PMI’s remain modestly expansionary.  As the U.S. economy experiences liftoff, we will be watching Canada for signs that it too may follow suit.  As oil prices rise, we are becoming less concerned about Canada’s exposure to oil prices and certainly a recovery in the energy patch would delay fallout from inflated housing prices.  At this time, we remain neutral on Canada.

Mexico:

Unemployment and Inflation are picking up, Confidence is declining, Manufacturing is slowing, and Trump and Mexican President Nieto are firing off shots at each other.  What’s not to like about this situation??  We’re neutral on Mexico because it’s impossible to assess what’s coming next here.  From an economic perspective, the trend appears to be continued weakness, although recent improvements in USDMXN are worth monitoring.

MIDDLE EAST/AFRICA:

Saudi Arabia:  Despite being a G-20 country, Saudi Arabia provides little timely data.  Real GDP was revised higher to +0.04% Q/Q in Q3 (previously -1.3% Q/Q), and PMI data continue to improve.  Deflationary pressure has found its way to Saudi, as CPI fell to -0.4% Y/Y in January (previously +1.7% Y/Y).  Money supply is growing slowly at +0.7% Y/Y, and non-oil exports remain negative.

South Africa:  Recent data show improvements in PMI, Business Confidence, mining production, and Vehicle Sales following weak Q4 data, which inflation data weakened in January.  Given South Africa’s commodity-driven exports, a stronger U.S. dollar could continue to hamper export growth.

EUROPE:

United Kingdom:  The U.K. economy seems to be on decent footing post-BREXIT, as was evidenced in the release of Q4 GDP, which revealed a spike in exports.  However, retail sales and industrial production slowed in January.  We still believe the odds rising for another rate hike in the next few years, we remain bullish on the GBP versus the Euro. 

European Union: 2017 will be a year of political uncertainty as Europe’s biggest economies are holding federal elections: the Netherlands (March 15), France (first round:  April 23), and Germany (Sept 24).  Any further unrest or terrorism in Europe will undoubtedly push the European populace more towards protectionist positions, favoring anti-establishment (and anti-EU) candidates.  Although economic data has improved in Europe (particularly Feb PMI data), Consumer Confidence recently fell, and the political landscape is currently filled with too many possible pitfalls.  We’ll remain short the Euro as a result.

European Central Banks:  The ECB is doing exactly what we thought they would do by favoring asset purchases over negative rates, although the ECB has now suggested that they will taper those purchases.  Additionally, TLTRO II is helping Europe to refi its debts and therefore blow the asset bubble ever bigger.  We will watch to see if ECB tapering expectations has any meaningful impact on zero (or near-zero) interest rates throughout the continent.

Eastern Europe: We continue to believe risks remain for Eastern Europe given high Debt/GDP levels, most notably Cyprus (104%), Croatia (88%, up from 66% at the end of 2013), and Slovenia (81%).

ASIA / PACIFIC:

Australia: Despite the fact that the RBA cut rates twice since April, Australian economic data has yet to achieve liftoff.  Despite the rebound in retail sales, Consumer Confidence is flattening out, building permits declined materially in Q4, PMI data weakened in January, inventories have increased, and recent employment data was mixed.  Although Australia recently experienced an improvement in trade with China, we believe the improvement will be short-lived.  With the ASX200 index up 12% Y/Y, we believe downside risk is elevated.  We remain neutral on Australia at this time.

China:   Recently, we closed out our China equity market short view on the back of stronger trade data, but remain short China’s currency given the likelihood of continued deficit spending.  It appears that China plans to continue to stabilize markets ahead of the National Communist Party Congress later this year, and we no longer believe a short China equities position offers compelling risk/reward at this time. 

India:  As part of our broader strategy shift away from emerging markets, we closed out our long India call in late 2016.  It’s hard to make an assessment of India’s economic situation given distortions from the recent demonetization.  Recent data suggests business conditions deteriorated in Q4 and early Q1, although imports surged on a Y/Y basis in January.

Indonesia:  Indonesia’s GDP and Private Consumption Expenditures have been stable at 5% Y/Y, and inflation has been stable at roughly a 3.5% Y/Y for nearly a year.  As a result, it is reasonable to assume that the central bank’s dovish policy stance may revert to a more neutral stance in 2017.  Consumer Confidence and domestic auto sales turned higher in Q4 and Manufacturing PMI moved back above 50 in January.

Japan:  Data from Japan in Q1 showed modest, positive improvements in Unemployment, CPI, PPI, retail sales, and manufacturing; however, Industrial Production and Exports have recently slipped.  For now, we will remain negative on the Yen given the BOJ’s ‘buy everything’ until inflation hits 2% policy.

Russia: Russia may be the only place on Earth where retail sales can fall 25% in January, and that can actually be a material improvement (-2.3% Y/Y versus -5.9% Y/Y prior).  So far, January economic data looks solid (Real Disposable Income and Wages turned up, Industrial Production is accelerating, but unemployment worsened).  Russian equities remain the cheapest in the industrialized world and we remain bullish.  With the Bank of Russia cutting rates, which could see further economic improvements as well.  We continue to believe that the Russian Ruble will rise, particularly versus the Euro, but we remain concerned about the impact of low-ish oil prices on the Russian economy.

Turkey:  Inflation is rising in Turkey (+10.1% Y/Y in February), consumer confidence continues to decline, and given political instability, Turkey hasn’t reported GDP since Q2.  Meanwhile, unemployment (last reported in November) has turned meaningfully higher at 12.1% and Turkey’s 10-year bond yield is +200 bps higher than it was in April, yet, home sales improved in January.  Overall, Turkey’s economic situation appears to be in deterioration, but without timely data releases we will refrain from forming any opinion.

GLOBAL CENTRAL BANK SCORECARD:

 

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MACRO TRADING IDEAS:

 

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BEST/WORST PERFORMING S&P 500 SECTORS:

 

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WEEK IN REVIEW – BEST & WORST PERFORMERS:

BEST/WORST PERFORMING WORLD BOND MARKETS:

 

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BEST/WORST PERFORMING GLOBAL STOCK MARKETS:

 

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BEST/WORST PERFORMING CURRENCIES:

 

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COMMODITIES MARKET PERFORMANCE:

 

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MAJOR GLOBAL STOCK MARKETS:

 

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MAJOR GLOBAL BOND MARKETS:

 

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DISCLOSURE APPENDIX

This publication is for Institutional Investor use only and not for distribution to the general public. The comments herein are based on the author’s opinion at a particular point in time and February change at any time without notice. Merion Capital Group does not guarantee the accuracy or completeness of the information contained herein. Merion Capital Group is a FINRA-registered broker-dealer. Merion Capital Group shares in the commissions for trades that are executed through Tourmaline Partners, LLC, a FINRA-registered broker-dealer. This report is distributed for informational purposes only and should not be construed as investment advice or a recommendation to sell or buy any security or other investment, or undertake any investment strategy. It does not constitute a general or personal recommendation or take into account the particular investment objectives, financial situations, or needs of individual investors. Past performance is not a guarantee of future performance. All investments involve risk, including the loss of all of the original capital invested.

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