With the end of the first half of the year in the books, we’re seeing an interesting divergence between the recent trading and the total results for the past 6 months. The Nasdaq had its best first half since 2009 as it was up 14.1%. At the same time, it also had a rough June as it broke a 7-month winning streak having its worst month since October. In the same token, the yield curve had been flattening this year, but in the past four days it has steepened to the rate it was at when June started as you can see in the chart below. There’s been a large selloff in the 10-year bond as yields increased from 2.137% to 2.2966% in the past four days.
There’s a few reasons for this recent move in bonds. Firstly, it’s a correction from the overbought levels in long bonds which caused the flattening of the yield curve to nearly breach the levels seen in 2016. Another thing to keep in mind was the positive surprise seen in Q1 GDP. The 1.4% growth rate is double the first reading which might mean bond investors realized they got too negative on U.S. growth. Remember, investors buy the long bond as a play on weak growth. Keeping with the theme of investors reversing some of the intermediate term trends, oil prices have increased about $3 to $46.15. With higher oil prices, inflation expectations increase and so do bond yields. Finally, there was a selloff in long European bonds. This selling bled into the American bond market. This selloff was in response to Draghi’s anticipated tapering. I’ve been on both sides of the coin with Draghi and so has the market. I can see the market changing its reaction back and forth until the final decision comes out in October.
Unlike the Bloomberg Consumer Comfort index, the University of Michigan’s consumer confidence showed weakness. While the indexes had different overall numbers, both saw their expectations index fall and current index rise. As you can see from the chart below, the Current Conditions index increased from 111.7 to 112.5 which is an increase of 0.7% month over month. The expectations index fell 4.3% month over month, pushing the overall index down 2.1% month over month (it was still up 1.7% year over year). This divergence doesn’t mean much. If you look at the long-term charts of both indexes, they seem to crash right before recessions. Neither metric leads the other. However, the current conditions index is higher than the expectations index relative to their historical past making the divergence not a new trend.
The most prominent economic report on Friday was the Chicago PMI which measures manufacturing activity in the Midwest. It was a mammoth beat over expectations. According to Zero Hedge, it was a 7 sigma beat. In theory, a 7-sigma event occurs once in 3 billion years. The headline number was 65.7 which beat expectations for 58.0. It was the highest reading since May 2014. As you can see from the chart below, the index is now near its cycle high. The new orders index increased 10.5 points to 71.9 which was the highest level since May 2014. The part of the report which makes it seem almost impossible to believe was the order backlog growth. Backlog orders went from contracting to seeing the fastest growth since July 1994. That was likely the segment of the report which caused analysts to wrongly predict the headline number.
The only indicator which fell was employment which was down from 57.1 to 56.6. The divergence between backlog growth and the employment growth, plus the fact that the manufacturing economy is likely not the strongest since 1994 makes me think this report isn’t properly reflecting the midwestern manufacturing economy. I take this as a positive report, but it doesn’t change my mind which has previously been set on the fact that manufacturing is weakening as is seen in the Philly Fed index among others.
In every report, the Chicago PMI has a special question. This time it asked if businesses thought new orders in Q3 would be higher than new orders in Q2. As you can see in the chart below, 53.2% said they expected new orders to increase. If the new orders actually do increase, it would mean the manufacturing industry is firing on all cylinders. I’m expecting a pull back in the optimism seen in this report when the next one comes out because it was too positive.
I’m not saying that the Chicago PMI report is too high because I’m bearish. I just don’t think activity is as robust as it shows. On the other side, the U.S. macro surprise index is likely too negative. As you can see from the chart below, the index is at -72.60 which is the worst since 2011. The index doesn’t do a great job at measuring where the economy is, but it gets a lot of coverage among the bears, so I think it’s worth discussing. When it moves higher in July like I expect, the bears will still be negative as they will find another metric to latch onto. Anyone who seriously uses this metric as a reason to be bearish either isn’t doing their research or is trying to support an opinion which doesn’t have much real evidence to back it. My prediction is once this index improves in the next few weeks, no one will discuss it.
Conclusion
The first half of trading has ended. It was a great period for the Nasdaq as tech earnings in Q1 were impressive. The yield curve had a trend reversal, but the long-term trend is towards flattening because the Fed is raising rates and economic growth isn’t going to accelerate, absent tax cuts. The Chicago PMI was a massive beat. It was so unexpected, it makes me question its veracity. While I’m uncertain about what the Chicago PMI means, I’m certain that the Citi Macro Surprise index is meaningless. The U.S. economy is not nearly as bad as it was in 2008 like this index suggests.
Recent Comments