With all the angst generated by elevated anxiety from a potential .25% basis point (1/4% of 1%) rate hike we at GSA have to wonder have investors been captured or corralled into the Federal Reserve’s Habitrail? Have investors been abandoning all common sense and reason, trading kneejerk style at every and any Federal Reserve headline, statement or missives. Unfortunately, we believe the recent trading activity suggests too many investors are getting caught doing just that.  We were all in one global easing mode module content to take on risk and invest across a broad spectrum of assets of varying quality. Then, the Federal Reserve added on a tube and module, baits it with some tightening talk and many investors go stampeding through exiting their home base and core investment principals fearing they might miss out or there might be something better on the other side.  I’ve found out over the years those who stay true to their long term disciplines, in times like these tend to have a lot less competition picking through the scraps tossed aside during panic selling leading to successful outcomes.  

Where We Are.

Gross Domestic Product(GDP). The US economy clearly regained its footing in the second quarter as GDP was revised up to +3.7% coming off the first quarters +.6% showing. The third quarter currently appears to be trending towards +3% rate of growth helped by strong demand for housing, auto’s, aerospace, retail sales along with a resilient level of consumer confidence.  Estimates for the fourth quarter stand close to +3.5-+4% which would see us exit 2015 at a +2.7-+2.8% level. Good not great but a solid foundation heading into 2016 where GDP is targeted to expand at greater than 3% barring another polar blast or government shutdown. 

Leading Economic Indicators (LEI). LEI in July registered -.2% after a fairly robust June reading of +.6% and May’s +.6%. This minor setback against the fallback of the prior two months strong readings would suggest we remain in a Goldilocks environment, not too hot not too cold and steady as she goes mode.

Purchasing Managers Manufacturing Index (PMMI).  PMMI came in down 1.6% to +51.1%.  Across the board respondents were positive. Food and Beverage noted the positive impact from falling oil prices. Transportation pointed to the strong demand but a bit of softening. Computers and electronic pointed to the headwinds created by the stronger dollar which has since stabilized from the reporting period.  Machinery saw heavy demand from the automotive industry upgrades to equipment.  Lastly Furniture and related products pointed to strong business (see impacts from housing) while finding labor remains a challenge. So, we may be seeing a bit of softness in the headline figure but the underlying businesses appear on solid footing and well above the 50% break even level. 

Purchasing Managers Non-Manufacturing Index(PMNMI).  PMNMI rang in at a very strong +59%.  Arguably since non-manufacturing or services accounts for 90% of the economy this should have a heavier weighting in our view. We saw strength across the board here. Business activity index +63.9%. New Orders Index +63.4%. Employment Index +56%.   By sector. Healthcare noted “overall business is increasing”. Construction seeing business as “good and no signs of any slowdown”. Retail trade stated “ business and our market sector continue to be strong with continued growth and stability”. Again a very solid showing. 

Industrial Production (IP).  IP popped to a +.6% the highest level since November. Again here we see how the strength in autos contributed +.8% in manufacturing. Capacity Utilization rang in at +78% up +.3%. This improved level still leaves an ample 2.1% below its historic average of unutilized capacity to act as an inflationary buffer. 

Inflation.  No matter which indices or indicator utilized as a proxy all remain in favorable territory. All remain below the Feds stated 2% target rate.  Many remain fairly stable, that is ex-energy. Energy costs are down substantially.So, we look to the core or figures ex-food and energy which tend to be the more volatile components. Core PCE is up a very tame 1.2% year over year. So, again I ask what is the rush by the Fed hawks to hike rates?

Housing. Housing starts ticked up +.2% to a 1.206 million annual run rate in July. On a year over year basis starts have increased +10.1% and permits are also up strongly +7.5% which bodes well for the upcoming quarters. 

Where We’re Going:

In order to assess where we’re going we need to understand how we got to where we currently are. The recent market sell-off has many investors confused, was it due to a potential Fed rate hike?  Was it the well telegraphed slowing of the Chinese economy?  Is there an end to Global Central Bank QE? I would say the following; 1 Overblown.  2. Well known. 3. A resounding NO. I would also add to this great debate. Could causation be, as opposed to the Amaranth Advisors collapse ($10 billion Hedge Funds bet large on an increase in natural gas prices) in which one firm bet big, bet wrong and lost/collapsed that currently far too many Hedge Funds with hundreds of billions  have entered into the same commodity related bets and are getting decimated? This would help explain large unexplained selling as redemptions requests pour in along with margin calls being executed. A few recent casualties. A Carlyle Group(considered some of the more savvy investors by many) related fund saw assets fall from $2 billion to $50 million. Another $650 million Hedge Fund Armajaro Holdings closed down after values fell precipitously in the first seven months of the year. These are just two of the most recent that closed but the list of closures is long and the dollar amounts large, at least they were at one point. 

Taking a view from ten thousand feet above we see China’s economy is slowing to a targeted 7% rate of growth +/-. This slowing also pressures the exports of their trading partners mainly its Asian neighbors and markets of Japan, Taiwan, Australia and Korea among others. But, as we broaden our view we have to factor in the effects of the rebounding economies of India +7%+, a rebounding UK and Euro Zone that may finally break above a 2% growth rate in 2016.  Honing our focus over to the US, still the largest economy in the world, we see 2015 growth accelerating 3%+ into 2016 relying primarily on the domestic consumer which still accounts for 70% of demand.

I believe we experienced the recent sell off for the following reasons.

1. Seasonality. Many professional trades/investors take vacations at this time of year before sending kids off to school. 

2. The markets were fairly valued, not cheap not expensive at 18x earnings awaiting a catalyst to drive direction. Energy’s volatility and collapse provided one catalyst. 

3. China devalued the Yuan. 

4. Crowded commodities related trades gone wrong experiencing forced liquidations. 

If correct we should see a continuation of the ongoing bottoming process the markets are attempting succeed. This should be followed by investor refocusing on corporate and economic fundamentals. The US is creating 200,000+ jobs a month or close to 2 ½ million annually. Inflation is benign.   Global economic growth is slowing incrementally but is stable and could resume to faster growth as we look into 2016 an 2017.  Global Central banks even if the Fed hikes rates by the ¼% are incredibly stimulative and show no signs of abruptly ending QE or hiking rates. This backdrop would pose US and European equities in a very attractive light. The current market gyrations may be with us for a bit longer but when the time come to move we won’t be with the crowd wondering “who took my cheese”  and we won’t get caught on any tread wheels either.  We’re looking for our next opportunities now so we’ll capture the next leg higher when it comes. For now we maintain our aggressive posture to the markets remaining open to the next catalyst to dictate market direction. 

Side note: Someone much brighter and more clever than myself once stated “the bear market enthusiasts have correctly predicted 30 of the last 11 bear markets”. Always keep this handy as we never can tell when one of those experts may find a podium or platform so they can take a shot at their fifteen minutes of fame, again. 

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