Divergent, convergent or a bit of both? Analysts and investors appear to have crept up too close to the forest to see the trees. The talk this last year and a half that has been burning up the wires and airwaves centered around monetary policy and Federal Reserve speeches (Fed speak). We’ve fretted over the divergent policies of global monetary policy as the Federal Reserve went rogue and hiked rates a full one quarter of one percent while the European Central Bank and Bank of Japan went nearly nuclear option and cut rates into negative territory. Whoa! The markets shuttered while investors confused and fearful sold resulting in a -10%+ correction in US equities. The way we view this the Fed sensing the skittishness of investors and impact of the rate hike on the strengthening US greenback and in turn US exports put a cease and desist on their planned one percent of additional rate increases for the current year.  In fact it was that convergence of implied easing not priced into the markets that set off the 12%+ rally off those lows leaving market indices back into positive territory exiting the first quarter. We’ll get into the Feds real goal here later.  

Where We’re At:

Jobs - Non-Farm Payrolls gained +215,000 jobs. Importantly construction and healthcare added seventy four thousand jobs collectively which tend to be good payers. Hourly earnings ticked up +.03 while the participation rate inched up to 63%. This tick up in the participation rate suggests the strengthening labor market is pulling more people into the workforce. More work needs to be done here but the uptick is welcomed and long anticipated.

ISM Manufacturing-ISMM. ISMM as we anticipated in our March report continued its healing and moved back into expansionary mode clocking in +2.3% to +51.8%. There were signs of strength across the report. The New Orders Index snapped up +6.8% to +58.3%. The Prices Paid Index was up a whopping +13% to +51% largely due to the surge in energy prices. Of the Manufacturing Industries 67% reported growth. Commentary remains positive and potentially bullish.  Plastics and Rubber “ Hard to find workers and running lots of overtime”. Chemical Products “Business in telecom is booming”. Machinery “Requests for proposals for new equipment are very strong”. A few more months like this and we’ll likely see economists revising up estimates for US GDI and GDP. 

ISM Non-Manufacturing-ISMNM.ISMNM came in up +.5% to +54.5%. Again this report on an important sector of the economy appeared solid across the board. Business Activity Index +2% to +59.8%. The Employment Index +.6% to +50.3% and the forward looking New Orders Index was up a respectable +1.2% to +56.7%. Respondents pointed to a continued expansion at a steady pace with no visible signs of weakness but caution flags were raised about a potential slowing China and strong US dollar hurting our competitiveness. Again a very nice reports that should ease fears of a pending US recession. 

Leading Economic Indicators-LEI. March LEI ticked up +.1%. This report follows two prior months of decline. There remains soft spots here which may have be explained by the volatility and huge swings in the equity and bond markets alike. Even so this forward looking index points to continued economic expansion. If anything we would anticipate further improvements in the LEI as fears of recession recede and market volatility throttles back. 

Housing. Housing continues to be an area of strength in this extended economic expansion. New Homes sales inched up 2% month over month to a seasonally adjusted annual run rate of 512,000. Further progress appears restrained by lack of supply. The lack of supply in turn seems directly tied to recent home-builder CEO commentary relating to their inability to hire skilled workers or they’d build more homes. A problem, but a good problem as this lack of both supply and labor should restrain any potential bubble formations  allowing for this market to continue unabated for quite some time at current pace just to sate current and future demand. 

Where We’re Going:

There seems to be a never ending parade of Fed Governors taking to the podium nowadays. The thing is there doesn’t appear to be any consistency to the viewpoints offered.Governors who just weeks prior were espousing easy money policies and the need to be deliberate and pragmatic with any interest rate hikes now see the need to be more proactive. I believe this inconsistency is purposeful and here’s why. We take a look back to the Greenspan era at the Federal Reserve. Chairman Greenspan was correct in identifying the tech bubble along with lofty equity valuations at the time capped off with his famous “Irrational Exuberance” speech. The thing is he did not do enough to deflate the ensuing bubble that preceded the crash which took over a decade to repair. Our view at GSA is the current deluge of Fed Speak is in fact an attempt to jawbone down any bubblicious valuations or bubbles before the inflate since hiking interest rates in this divergent/convergent environment doesn’t seem an option.So far, so good from our vantage point. Oh, and if we’re incorrect about the intention of all this Fed chatter, it’s having the desired effect anyway. 

We are entering earning season. The bar has been set low enough where even Woody Harrelson could clear it. The consensus is for a decline of -8% due in no small part to two large sectors, banking and commodities. The key for market direction will not be surpassing current expectations but the guidance CEO’s give about the prospects for the next few quarters. We look for a bit more positive outlooks due to continued gains in labor markets, the weakened dollar helping our exports and early signs of a bottoming and rebound in China and India. Should these views be shared by corporate leadership Chair Yellen’s Tris Prior moment may be pulled forward, “I am selfish, I am Brave, I am divergent!”

For now we remained committed to the market patiently deploying our cash.   

Note: We believe we were incorrect in our conclusion the Euro-zone was two years behind the US in regards to repairing their financial institutions and ensuing rebound in economic growth. That hypothesis was predicated on monetary policy being the salve to allow the financials to heal. We underestimated the Euro Centric banks unwillingness to write down or write off bad assets, loans and recapitalize. Italy has finally taken this “bold” step and established a “bad bank” which will act as a depositary for toxic assets and non-performing (defaulted) loans. Note here in the states Citibank took there medicine back in 2009 setting up Citi Holdings. We now look at the EU as being a laggard of closer to five years behind the US. The Eurozone Money Center Banks have finally taken notice as major financial institutions are recapitalizing while simultaneously selling down assets and cutting costs. Without a healthy banking system the economy cannot function efficiently. Delaying the inevitable would allow for the Eurozone to continue to sputter along propped up only by a savvy Central banker that has and is willing to do “whatever it takes”. This reinforces our belief that globally interest rates will remain lower for longer supporting an extension of albeit subpar economic expansion along with the current bull market in equities.