Today’s Henny Penny’s continue to cry “the sky is falling, the sky is falling” or more rightly the Euro’s falling, The Shanghai Index is Falling, “let’s go tell the king” or in our case Janet Yellen.  So, should we perk up our ears and bolt our doors every time these modern day Chicken Little’s find a podium, soapbox or blog to bloviate from? Here’s an alternative thought let’s look to our economic indicators we follow at GSA to see if there really is any indication of an imminent economic contraction portending a recession. 

The discussion ongoing among analysts, economists and traders on Wall Street surrounds interest rate policy. I must admit in the past I’ve fallen victim to group think, specifically around when must the Federal Reserve hike and begin to normalize rates. This should introduce to the discussion why the Federal Reserve hikes interest rates. Put very simply, interest rates are a reflection of money supply. Better known as M1, M2 and M3.  The Federal Reserve eases or lowers rates by pushing more money into the system, lowering rates making it cheaper for consumers and corporations to borrow, expand and possibly stimulate employment. The Federal Reserve will raise rates or extract funding from the system when the economy seems to be running hot or above trend and inflationary pressures appear to be coming to a boil. This is the ultimate simplistic explanation of what drives Federal Reserve Monetary policy. It does not enter into the discussion the exponential effects it can have on currencies strengthening or devaluations. It does not take into account the Federal Reserve being the lender of last resort and periodically needing to break out “the bazooka” (a Treasury Secretary Paulson term) to stave off catastrophe when our fearless elected officials are incapable of legislating fiscal policy. The bad news, we’ve been stuck in the latter for the last seven years. Thank you President Obama, Congresspersons Boehner and Pelosi along with Senators Reid and McConnell and basically any incumbent that’s had their snout in the trough feasting on the public during this time frame.  Job undone.   

The reason this discussion arises now is the “experts” are all fretting about when the Fed will begin hiking rates and the ensuing demise of the US economy taking the markets with them. The conventional discussions conclude the Fed must hike immediately so they have some flexibility to ease should the economy lose its footing and slip back closer to recession at some future point.  This is the growing thought majeure on the street.  My experience is succumbing to group think and pressure tends to lead to bad outcomes. At GSA, contrary to the street view, we do not anticipate any aggressive shift in Federal Reserve policy for the remaining quarters of 2015.  Here’s why:

1. The US economy is in a good, not great growth trajectory. 

2. The EU is in early recovery mode whose economy is anticipated to expand at a 1 ¾%-1.9% rate. 

3. China’s economy is in transition from one being export driven to one more reliant on domestic consumption with estimates of growth at 6 ¾%-7%. 

4. Japan is clawing its way back from near twenty years of stagnation and may finally have found it’s footing while also registering a good not great growth rate of 1 ½%-2%. At a time of obviously modest but improving growth, cheap labor along with an explosion of cheap energy supplies, in GSA’s opinion, one needs to question conventional wisdom on the necessity to hike rates both soon or aggressively.

Before we get too deep though, let’s check those stats for the real story:

Jobs: The Non-Farm payroll figures released last Thursday tallied +223,000 new jobs in June with the unemployment rate falling to 5.3%. There were negative revisions to the prior two months shaving off 62,000. Also released Thursday was the real time labor indicator the weekly unemployment claims which came in at 281,000 an increase of 10,000 from the prior week but still solidly below 300,000. The four week moving average was also camped comfortably below 300,000 at 274,750. These levels seem to coordinate well to continued monthly job gains of 200,000+ and +2,400,000 annually. 

Leading Economic Indicators(LEI). LEI jumped +.7% last month.  This was the second monthly +.7% gain in a row.  The strength  was broad based with Building Permits a standout for future indications of growth. 

Purchasing Managers Manufacturing Index (PMMI). PMI for June expanded to +53.5% for the seventy third consecutive month.  This was an increase of +.7% over May’s +52.8%.  Strength was reflected in the New Orders Index, The Production Index and Inventories. Front and center the Employment Index came in at +55.5% up +3.8% from the prior reading of +51.7%.  Solid reading.

Purchasing Managers Services Index (PMSI). PMSI registered in at +56% an increase of +.3%.  We saw firming in the Business Activity Index at 61.5% a full 2% rise and the New Orders Index at +58.3% up +.4%. On the flip side the Employment Index slipped but stayed in expansion mode at +52.7% well above the 50% line. 

Housing.  Another bright spot on a slightly overcast market. New Homes sales were up +20% to the best levels since 2008. Pending Home Sales ticked up +.9% the best levels since 2006.  Lastly Existing Homes sales jumped as well +9.2% year over year.  Solid all around.

Gross Domestic Product (GDP).  We received the final first quarter GDP reading and while still negative was generally well received. First quarter GDP was revised up to -.2% from the prior -.7% reading. The first quarter was negatively impacted by another severe arctic blast coupled with a union sponsored shut in of the West Coast docs choking off any imports as well as exports. Those clouds appear to have dissipated as the just closed second quarter appears to be tracking +2 ¾%-+3 1/4%.  Another nice bounce back but not great in the bigger picture. 

Where We Are Going:

Frankie Valli penned today's mood perfectly, “Greece is the time is the place is the motion and Greece is the way we are feeling”. The markets behavior flip flops on the great unknown. Namely, what happens if Greece throws in the towel  or is kicked out of the Euro-zone and Euro Currency.  The dotted line, I’m sure originated from Greece sources point to a Lehman-like catastrophe. Hardly. Lehman’s cataclysmic effects ruptured our financial system due to exposure to counter-party risk related to Lehman’s equity, bonds, options, repo lines, swap lines, credit default swaps etc.  The largest institutions with exposure to Greece aside from Germany ($95 billion) are the European Central Bank, Sovereign Central Banks, and the International Monetary Fund (who’s largest contributor happens to be the US). So, while those socialist leaning talking heads congratulate the Greeks on being “bold” and “courageous”, know it is the US taxpayer paying for the Greek reckless overspending and social policies. Interestingly, this comes at a time the US is finally acknowledging our own inability to afford our Social Security Insurance and Medicare programs. Courageous is certainly not the work I’d have chosen.   

The global economy remains in an uneven recovery or stabilization mode. The US, India, Japan and the EU are in recovery mode searching for firmer footing most likely to be found in thus far elusive fiscal policy. While China, Russia and Brazil are finding that talking about growth policies and strategies are as useful as a bottle of Beam, a rock glass and one ice cube in Hades. It’s just not enough. In this environment of stagnant and below trend growth an argument to raise rates in 2015 is just a harder one to make. There is little doubt the global rally in equities, real estate and fixed income is built upon the unprecedented stimuli or liquidity provided by global Central Banks. The immediate risks lie with pulling away the punch bowl too early and choking off the economic and asset recovery. Doing so may cause a backslide into a recession and a plunge in asset prices mirroring Japan’s 20 year slog. Clearly when it comes to any adjustments to monetary policy, for now anyway, less is more and Chairwoman Yellen seems to agree. So, the next time you hear those talking heads prognosticating about the end of this bull run, think like those Cows posted on the highway billboards and “Eat Mor Chiken”. 

We are cautiously optimistic as we enter earnings season.  Should earnings and guidance not meet our lowered expectations we’ll look to move to a more defensive posture and raise our cash allocations.

Thank you again for your patience and confidence in these very challenging times. 

Yours in pursuit of the KWAN.