Mixed Economic Reports

This stock market never quits. Even though there were concerns about President Trump’s major policy speech Tuesday, all four major indices rose. The Russell 2000 rose 0.96% and the Dow rose to a new record high for the 12th consecutive day which ties a record long streak. While equities were blissful, some investors must’ve been skittish because the VIX rose 5.41%. We’ve seen this weird phenomenon of a rising VIX and stock market a few times this year. Therefore, I say the stock market is acting like it’s broken. The chart below is one day old, so the record string of days without an intraday move of 1% has reached 49. It’s odd to see the VIX rising with this trend still in place. It started from a low level, but this trend cannot continue. Either the streak will end or the VIX will fall.

Because equities were mostly quiet, the biggest news of the day was the large increase in the chance of a rate hike in March. The CME Fedwatch tool has the chances of a Fed rate hike increasing from 26.6% to 33.2%. As you can see in the chart below, Bloomberg has the odds increasing from the high 30s to 50%. The news that caused this was Dallas Fed President Robert Kaplan telling journalists that “sooner rather than later, means in the near future.” When he says “the near future”, some are suggesting he means a rate hike will be coming in March. The Fed must’ve been unhappy with the market. It wanted March to be a ‘live’ meeting, but the market ignored its statements. Finally, it is getting its wishes. It’s still a long shot that the Fed hikes rates, but now the situation has gotten more interesting.

What I find interesting is even with the Fed increasing its hawkish tone, the stock market rallying, and inflation increasing, the 10-year bond yield has fallen since December 15th, as you can see in the chart below. There’s a few reasons for this. The first is that there was a big trade which unwound. Investors who were bullish on the reflation trade were betting that the entire multi-decade move lower in yields was coming to an end based on the promises made by Trump. This was overzealous, so the treasury short trade is unwinding. Another point is that German yields are declining so some investors are moving to the U.S. in search of yield. The German 10-year bund yield has fallen from 0.484% in late January to 0.198% today. Going into French bonds is a non-starter because of the political risk. The U.S. has the benefit of higher yields and less political risk because its election already happened. The final possibility is some bond investors don’t believe in the Trump trade so they want to hedge their equity risk and buy some treasuries.

One reason investors may not believe in the reflation trade is because some data hasn’t improved as much as expected. There were two economic reports Monday which gave opposite indications about the health of the economy. The two I will discuss below are the Monthly Advance Report on Manufacturers’ Shipments, Inventories, and Orders and the Texas Manufacturing Outlook Survey.

The Monthly Advanced Manufacturers Report for January showed an increase of 1.8% in new orders. However, this increase was caused by an increase in contracts for commercial jets and military planes There was a 70% increase in orders for passenger planes and a 60% increase in bookings for fighter jets and related military goods. Orders for new cars and trucks increased 0.2%. This represents the likely end to positive results from the auto industry as the bubble begins to unwind. As you can see from the chart below, GM’s 61+ day delinquencies on loans is at the highest point since 2009. If you take out autos and airplanes, there was a 0.2% decline in new orders which is the first decline in six months. Core capital goods orders fell 0.4% which was a big miss from the 0.5% growth expected and the 1.1% growth last month.

The Dallas Fed’s Manufacturing Outlook Survey for February was much better than expected. It was expected to fall 19.4 points, but it rose 24.5 points. Many of the subcomponents of the survey showed deceleration, but they all showed underlying improvement. For example, the general business activity index fell from 43.7 in January to 37.0 in February, but still showed a reading which means it is improving. The worst subcomponent was the company outlook index which fell from 48.8 in January to 35.6 in February. The best subcomponent was capital expenditures which went up from 26.6 last month to 33.0 this month.

The main reason why businesses are optimistic is because of the proposals by the Trump administration. An interesting comment came from a fabricated metal producer. The firm said the global and American economy are weak and uncertain. The reason the firm is optimistic in this tough situation is because of proposed tax cuts, regulatory reforms, and a repeal and replace of the Affordable Care Act. This shows how important Trump’s speech tomorrow is for the stock market. I tend to favor the soft data over the hard data now because I believe Trump will execute on those policies. He already has issued two executive orders on regulation reform which is a good indicator to me that the other plans will get put into action.

Conclusion

            The Dallas Fed report was much better than expected, but showed some signs of deceleration. The optimism about the Trump administration’s reforms has waned moderately. That’s not a surprise since most of the proposals haven’t gone into law yet. However, this doesn’t mean action won’t be happening soon. On the other hand, the manufacturers survey was worse than expected. The situation will only get worse when the auto market begins to falter. On the bright side, autos aren’t counted into the all-important core durable goods orders. This weak report doesn’t mean the economy is in decline, but it should give the bulls something to be concerned about.

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