U.S. Economy Surprising To The Upside?

Stocks Mostly Flat On Thursday

S&P 500 opened up, increased in the morning, and fell throughout the afternoon on Thursday. It closed the day almost exactly where it started. We need to wait another day for the S&P 500 to hit a new record high. It will likely happen soon. Stocks haven’t reacted much to the amazing housing market reports. Either traders anticipated them or are more focused on the Fed, earnings season, and the trade war. 

Economists certainly didn’t anticipate such great results because the reports beat estimates. It seems like homebuilder stocks predicted these solid results because the XHB index is up 32.09% year to date, but it’s slightly down this week despite the great MBA applications report, housing market index, housing starts and permits, and existing home sales report which I haven’t reviewed yet.

Nasdaq was up 7 basis points and the Russell 2000 fell 0.44%. After having a great run earlier this month, Russell 2000 has recently underperformed. It has followed the treasury market. Regional bank ETF KBW fell 0.88%. Even though the S&P 500 was flat, the CNN fear and greed index fell 3 points to 63. Best sectors were healthcare and utilities which increased 0.47% and 0.36%. Worst ones were the financials and industrials which fell 0.4% and 0.49%.

Rates Continue To Fall

A selloff in treasuries in the beginning of September is being taken back which is great news for the housing market, but is a bad signal for the overall economy. The 10 year yield does a great job of forecasting nominal yearly GDP growth. If the decline in rates continues, yearly GDP growth will fall in the 2nd half of this year. 

10 year yield is now only at 1.76% which is 14 basis points below its recent high. It’s still 33 basis points above its recent trough. I’d be surprised if the 10 year yield makes a new 2019 low, which would also potentially be a new record low. That’s because investors don’t see economic growth being that weak. 

After having huge swings in the past few weeks, I think yields will stabilize for the next few weeks. Specifically until we get clarification that the economy is ending this slowdown. Right now, that’s just speculation. There is far from complete evidence that growth will improve in 2020.

2 year yield is only at 1.73% which is 7 basis points below its recent peak. As you can tell, the Fed’s hawkishness has flattened the curve. Fewer rate cuts being expected has prevented the 2 year yield from falling more. Currently, there is a 49.2% chance the Fed cuts rates one more time this year. There is a 78.1% chance the Fed cuts at least once by January. Next rate cut might be the last one for a few meetings. It depends on the economic data and how the trade negotiations go next month.

Economic Surprise Index Takes A Turn

This week was loaded with housing data, but it’s not just housing that has beaten estimates. As you can see from the chart below, the U.S. Citi economic surprise index has exploded higher from about -70 to above 40. 

Economists see the slowdown, allowing reports to finally beat the lowered estimates. The economy isn’t necessarily turning a corner, but this is an early sign things aren’t getting as bad as they have been. Weakening in rate of change terms has lessened.

Yet Another Great Jobless Claims Report

Jobless claims in the week of September 14th showed claims rose 2,000 to 208,000 which is near the cycle low. It was 7,000 below the consensus. For those who think consumer confidence will fall with business confidence and that retail sales growth will weaken, recognize that the consumer will keep spending if there are jobs and positive real wage growth. 

Declines in business confidence, which is partially because of the trade war, hasn’t led to layoffs. Personally, I’m very interested in seeing the results of Q3 earnings season because the global economy has been weak. Can guidance be strong enough to keep estimates for Q4 earnings growth in the mid single digits.? Weak guidance could signal the resilient labor market will hit a snag soon.

4 week moving average of jobless claims fell 1,000 to 212,250. There’s nothing doing here, which is a great sign for consumers. Continuing claims in the week of September 7th fell 13,000 and the 4 week moving average fell 3,750 to 1.678 million.

Fed Attempts To Save The Repo Market

As Powell mentioned in his press conference on Wednesday, the Fed is undergoing Open Market Operations to stop the bleeding in the repo market. Think of this as the Fed fixing the plumbing of the financial system. Fed’s balance sheet will expand organically indefinitely. The balance sheet used to increase organically until QE was implemented. During QE, it obviously expanded rapidly. Then in the unwind, the balance sheet was wound down to a more normalized level.

As you can see from the top chart below, the Fed’s balance sheet expanded rapidly this past week. The 2nd chart explains one reason why it increased as repurchase agreements increased. Once this issue is fixed, that type of response by the Fed won’t be warranted. It’s very important to note this isn’t another round of QE. The Fed will have ammo to implement QE in to combat a future recession.


S&P 500 is stuck right near its record high. There isn’t technical resistance in my opinion. I think this is about the market needing more positive news to rally since it is already fairly valued. Few would argue this market is cheap after its 20% rally this year. 

We either need to see an interim trade deal or a great Q3 earnings season to see stocks rally another 5%. Trade negotiations and earnings season start next month. October will be very interesting for markets. I see the negotiations going well. I don’t think tech firms will issue great guidance because the global economy is still weak. 

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