Wednesday, September 7, 2016

September-October 2016 Market Outlook: A Disaster in the Making September-October 2016 Outlook: A Disaster in the Making
Tue, 06 Sep 2016 23:22 PM EST

With US Presidential candidate Donald Trump labeling the economy a "disaster" and his billionaire advisor Carl Icahn calling for a "day of reckoning" for the stock market, we look ahead to the potential upsets and near misses that might occur in the next couple of months. Stocks continue to climb the wall of worry, pushing aside every adversity from the Brexit to anemic global growth. Government paper remains a crowded trade even as central banks keeping adding to their hoards, with the key 10-year US Treasury yield still compressed near 1.50% and the German and Japanese equivalents at negative yields. WTI crude futures have seen some stabilization in the $40's as OPEC edges toward a possible agreement on an oil freeze.

Brexit related worries have subsided for the time being, but may emerge again early next year when the UK invokes article 50 to start the succession process. The BOE and other central banks are poised to expand or extend their stimulus programs in the months ahead, notwithstanding the Fed looking to take rates in the other direction. Markets will probably be able to absorb a "one and done" rate hike from the Fed in September, or more likely December. Not incidentally, between now and then the US will elect a new President and OPEC may well retake some control of the oil market.

Fed Seas Rising

With global jitters in check, the Fed has resumed making noises about a rate hike this year, perhaps within the month. The one thing all Fed members can agree on is that monetary policy remains data dependent. Unfortunately, the latest data was inconclusive. The August Nonfarm Payrolls came in below expectations, and just weak enough to lower market expectations for a September rate hike. After the jobs report was released Fed Fund futures indicated the probability of a September raise dropped from 25% to less than 20%.

Some market luminaries, including Goldman's chief economist Jan Hatzius and Janus' Bill Gross believe that the pace of job gains was still strong enough to green-light a Fed hike this month. If they are right, then the Fed will have to do significant jawboning in the next few days to prepare the markets for a policy move. In the absence of strong verbal guidance from the Fed in the next week or so, it should be inferred that the FOMC will hold its fire until December.

A more hawkish Fed could prompt renewed volatility if economic conditions start to deteriorate again. On the other hand, if conditions continue to improve, the markets might finally admit that "good news is good news" and accept that another 25 basis point Fed rate hike is a show of confidence in the economy and not an act of sabotage.

And there are indeed some signs of rebounding economic health. The Job Openings and Labor Turnover Survey (JOLTS), one of Janet Yellen's favorite employment indicators, has reached record levels in recent months. New home sales and building permits continue to rise steadily, and auto sales remain strong. Another less prominent but still interesting signal of an improving economy was the recent industry-wide hike in containerboard prices. All signs of growth and inflation at work.

The Fed appears ready to execute its second rate hike of the cycle, though Fed officials are downplaying talk about the timing and stressing that "gradual" tightening is the key takeaway. Officials concur that every meeting is "live" and that overseas developments have been a big reason why the Fed has held off on more tightening this year.


September and October are seasonally bad months for the stock market, and there is election risk this year with two unpopular candidates. Clinton remains the odds on favorite and if she pulls out the victory it will probably be a negative for biotechs, against whom the Democratic nominee has been railing over hefty drug price increases. If Trump gets a late surge in the polls it is likely to elevate volatility on concerns about his protectionist rhetoric. Mr. Trump's political inexperience and over the top personality has led to a series of gaffs that have him down in the polls, and the Presidential debates (Sept 26, Oct 9, Oct 19) may be his last chance pull even. If Trump can score a knockout blow against Clinton during the debates - unlikely but not impossible - markets will have to recalibrate for a potential Trump Presidency. Alternatively, if Trump completely implodes, then Democrats will be salivating over the possibility that they might win enough down-ticket contests to retake the Senate and the House. Democrats would need to win at least four seats in the Senate to retake control of that body, but would need a daunting thirty seat net gain in the House to flip it back to Democratic control.

Despite assurances from Fed leaders that they will not let the Presidential race impact their monetary policy decisions, the political environment is forever intertwined with market calculus. Stock market analysts note that of the past 22 presidential elections, the direction of the S&P500 index has correctly predicted the outcome of 19 elections. That is to say, a run higher in stocks preceding the election portends a victory by the incumbent party, while a negative return usually leads to the other party taking control of the White House. Notably, the S&P500 fell about 10% in the months after the first rate hike last December, so a Fed rate hike in September could conceivably influence the election outcome, even if the Fed says its policy is divorced from politics.

The next earnings season in October will be presaged by a busy conference calendar in September. Given the mediocre quality of the just completed Q2 earning season and guidance, the bar is not set very high for Q3. That could give at least some individual companies the chance to shine in their Q3 releases, which could in turn add to the case that business and consumers are improving headed into the key holiday quarter.

Oil Spill

The energy market continues to hold out hope that OPEC will manage to agree to a production level freeze as soon as this month. Oil producers will meet at the International Energy Forum in Algeria on September 26, and could forge an agreement for a new production cap, as first proposed about a year ago. Efforts to reach a freeze deal earlier this year fell apart as Iran refused to participate before it had returned to full production and Saudi Arabia continued to vie with rivals for market share with no concern for pricing.

This time around Iran is approaching pre-sanction production levels of 4M bpd, and Saudi Arabia is pumping oil at record levels (10.48M bpd in July). Heading into the Algeria meeting, Saudi Arabia and Russia agreed to form a working group to cooperation on stabilizing the oil market, which might include a production freeze. The Russians and Saudis will meet in Moscow in October. Iranian President Rouhani also signaled he would support measures that would foster a recovery in oil prices, so the pieces could be in place for a deal. If no accord emerges from the September meeting, focus will turn to the November 30 semi-annual OPEC gathering in Vienna.

Helicopter Rescue

Outside of the US, it has been noted that global central-bank rate cuts haven't effectively weakened surging currencies despite the fact loosening monetary policy generally lowers a currency's value. Even with this frustrating dynamic in play, the ECB, BOJ and other central banks appear poised to consider ever more accommodation.

At the ECB, rates are already negative and the central bank is vacuuming up €80 billion per month in bonds for its QE program. Mr. Draghi's team has kept all options on the table including cutting rates further, or expanding the QE buying program even though it appears to already seems to be struggling to find enough worthy paper to purchase. The simplest path for the ECB appears to be the option of extending the QE program past the current tentative end date of March 2017. With the New Year coming up fast it would be prudent for the ECB to announce an extension sometime in the next few months, so that markets don't start to contemplate the QE program suddenly ending in March.

The Bank of England took measured steps to address the surprise Brexit vote. At its August meeting, the BOE followed through on an expected 25 basis point rate cut to 0.25%, and also threw in a £60 billion boost to the asset purchase facility (APF) for good measure. In the wake of the move, BOE chief economist Haldane warned that the central bank is not under any illusions that it can fully insulate against the long term effects of the Brexit vote, which will represents a structural shift in the UK economic and trading regime. Likewise, the new PM May has stated that the UK may face difficult times ahead, though she remains optimistic about the longer term.

Brexit related turmoil has calmed for the moment, so the BOE has the leeway to keep policy on hold in September. However, expectations are that the BOE is not done providing new stimulus, and that could come in November in the form of a 15 basis point cut in the bank rate, which would take it down to 0.10%.

Though Japanese officials have ruled out using "helicopter money" as stimulus, many market analysts still believe they will ultimate resort to this tactic. They point to the cozy relationship between the government and the BOJ, working closely together to beat deflation under the framework of 'Abenomics.' Even with this level of cooperation, Koichi Hamada, a key economic advisor to PM Abe has been verbally flogging officials to do more. Hamada recently asserted that the Ministry of Finance has lost credibility when it comes to intervention threats and that the MOF should "courageously" intervene in FX markets to stem the yen currency appreciation. It remains to be seen of the MOF will acquiesce, especially given that the USD/JPY has managed to hold above 100.

China remains under continued scrutiny after currency tinkering contributed to a market meltdown last August and again in January. Another shoe could drop at any time in China, but things have been quiet since the spring. Some industrial and growth data has been less than satisfactory, including a 7-year low in the Q2 GDP reading (at 6.7%, though that was one-tenth better than expected).

Earlier this year, there were concerns that China could execute another large devaluation, but speculation about such a move has died down. Instead the Chinese currency has devalued slowly to the tune of 2.5% year to date, obviating the need for another sudden one-off adjustment. But that still leaves concerns about poorly regulated and opaque investments could suddenly implode and threaten the financial system and jolt the economy.

1: UK Manufacturing PMI; US ISM Manufacturing PMI
2: UK Construction PMI; US Payrolls & Unemployment; US Trade Balance; US Factory Orders

4: China Caixin Services PMI
5: UK Services PMI; US ISM Non- Manufacturing PMI; US LABOR DAY HOLIDAY
7: UK Manufacturing Production; US Jolts Jobs Openings; Japan Final Q2 GDP; China Trade Balance (tentative)
8: ECB Policy Statement & Press Confernce; China CPI & PPI
9: UK Goods Trade Balance

12: China Industrial Production; Japan BSI Manufacturing Index
13: UK CPI & PPI; German Zew Economic Sentiment
14: UK Claimant Count & Unemployment
15: UK Retail Sales; Euro Zone Final CPI; BOE Policy Statement; US PPI; US Retail Sales; Philadelphia Fed Manufacturing; US Industrial Production & Capacity Utilization
16: US CPI; Preliminary University of Michigan Consumer Sentiment

19: BOJ Policy Statement
20: Various Euro Zone PMI readings; US Housing Starts & Building Permits
21: FOMC Policy Statement, Economic Projections & Press Conference
22: US Existing Home Sales

26: German Ifo Business Climate; US Durable Goods Orders; US New Home Sales; International Energy Forum in Algeria; 1st US Presidential Debate
27: UK Current Account; UK Final Q2 GDP; US Consumer Confidence
28: German Unemployment
29: US Final Q2 GDP; Japan Household Spending; Tokyo Core CPI; China Caixin Services PMI
30: German Retail Sales; Euro Zone Flash CPI; Chicago PMI; China Manufacturing & Non-Manufacturing PMIs

2: Japan Tankan Manufacturing & Non-Manufacturing Indices
3: UK Manufacturing PMI; US ISM Manufacturing PMI
4: UK Construction PMI; US Vice Presidential Debate
5: UK Manufacturing Production; UK Services PMI; US Trade Balance; US ISM Non-Manufacturing PMI; US Factory Orders
6: German Factory Orders; ECB Minutes
7: UK Goods Trade Balance; US Payrolls & Unemployment

9: 2nd US Presidential Debate
10: Japan Current Account
11: UK CPI & PPI; German Zew Economic Sentiment
12: JOLTS Job Openings; FOMC Minutes; China Trade Balance (tentative)
13: UK Retail Sales; BOE Policy Statement; China CPI & PPI
14: US Retail Sales; US PPI; Preliminary University of Michigan Consumer Sentiment

17: Euro Zone Final CPI; US Industrial Production & Capacity Utilization
18: US CPI; China Q3 GDP; China Industrial Production
19: UK Claimant Count & Unemployment; US Housing Starts & Building Permits; 3rd US Presidential Debate
20: ECB Policy Statement & Press Conference; Philadelphia Fed Manufacturing; US Existing Home Sales
21: Various Euro Zone PMIs

25: German Ifo Business Climate; UK Preliminary Q3 GDP; US Consumer Confidence
26: US Durable Goods Orders; US New Home Sales
27: German Unemployment; Japan Household Spending; Tokyo Core CPI
28: US Q3 Advance GDP

31: BOJ Policy Statement (tentative)
1: UK Manufacturing PMI; US ISM Manufacturing PMI; China Caixin Manufacturing PMI
2: UK Construction PMI; Euro Zone Economic Forecasts; FOMC Policy Statement
3: UK Services PMI; BOE Policy Statement; US ISM Non-Manufacturing PMI; US Factory Orders; China Caixin Services PMI
4: US Payrolls & Unemployment; US Trade Balance

7: German Factory Orders; China Trade Balance (tentative)