"The extreme limit of wisdom, that's what the public calls madness." -- Jean Cocteau
The Madness of It All
San Francisco Fed President John Williams warned against slowing the trajectory of intent on tightening monetary policy in the U.S. earlier this morning from Australia. Williams said: "Raising interest rates to bring monetary policy back to normal helps us keep the economy growing at a rate that can be sustained for a long time". He added: "If we delay too long, the economy will eventually overheat." Williams has been hawkish and his support for the central bank's public stance is not surprising, but economic data have been inconsistent of late, particularly data on consumer inflation. Those decision makers at the Fed obviously believe that with full employment comes headline level inflation. The FOMC in aggregate appear to believe as a group that full employment in an economy comes after the official unemployment rate drops below 5%. Maybe that's true for job fulfillment, but job fulfillment and the full employment of an economy are two very different things. Economics 101.
Hence, the problem. That concept for the uninitiated, is what is referred to as the Phillips Curve. There are reasons why the Phillips Curve has not unfolded in reality the way that it does in the textbooks. Those reasons seem obvious to traders and investors, but somehow not to our esteemed economists at the central bank. For one, the individual in this economy is not at full employment. Due to current healthcare laws, many hourly workers are held to less than 30 hours a week. Some of those folks are then forced into part-time positions, or multiple jobs. Many of these folks are working at income levels well below where they had been earlier in their lives, due to drops in national productivity levels or technological advance. My point is not to fight about healthcare or against progress here, just to point out that John or Jane Doe might be working their tail off, but they do not feel as though they are fully employed at the individual level. They are functioning below their potential, due to external forces. That hurts morale. Without a higher level of comfort or satisfaction at the individual level, Mr. and Ms. Doe are not going to open their wallets.
Then there's commodity prices. Seen the price of oil lately? I bet you have. Usually, in periods of low unemployment and sustained economic growth, commodity prices rise, which supports headline level consumer inflation. Commodities in general have seen their priced contract this year -- oil is just the leader -- heading into a bear market very publicly last week. Anyone else notice headline CPI drop from a height of 2.7% year over year to where it is now, 1.8%? That should be your focus right there, and the Fed's too. Obviously, this is a component ignored by their Phillips curve, yet crucial to the nation's success in getting inflation back to target, and maintaining said target. A weaker dollar would help in this regard. The clearly announced intent to wrestle the balance sheet down, while continuing to raise the target for the fed funds rate is obviously supportive of a stronger dollar, and could be the one thing, if implemented congruently, that sparks the next recession.
Last week's trade was exciting, and at times scary. The S&P 500 bumped its head on the 2,441 level seven times between Thursday and Friday. Oil rolled off a cliff. Several truly positive earnings results strayed in from the tech space. Think Adobe Systems (ADBE - Get Report) , Red Hat (RHT - Get Report) , and Oracle (ORCL - Get Report) . Did last week's moves halt a rotation? Was there ever really more than some profit taking among the front runners that others took as a nod that was not there? Those are tough questions to answer for those of us that have to try to answer them.
The truth is that last week, the top two performing sectors were information technology and healthcare. The health care sector was supported by the reform bill being negotiated around the U.S. Senate. Right? Right? Well, the top two sectors over the last 90 days are ... tech and healthcare. How about year to date? Tech and healthcare. Five years back? Still, tech and healthcare. You can go even further back if you want, the story does not change all that much. Even more interesting, the two worst performing sectors over one week, 90 days, year to date, and five years out? Energy and telecom, at every checkpoint. Now, there is obviously some rotation within these sectors, as different industry groups themselves are hit with innovation, and/or react to policy changes (and expectations), but performance among sector groups has been remarkably consistent over a long stretch of time.
The Earnings Dance
JP Morgan (JPM - Get Report) , as well as Action Alerts PLUS charity portfolio holdings Citigroup (C - Get Report) and Wells Fargo (WFC - Get Report) will all report quarterly earnings on July 14. That's two weeks from this Friday. A three-quarter winning streak, including a real dandy for the first quarter, has supported equity markets, in my opinion as much, if not more than anything else. Well, earnings for the second quarter are starting to be ratcheted downward ahead of the results, which -- do not be alarmed -- is quite normal. The calendar second quarter ends this week, and aggregate earnings projections for the S&P 500 now stand at year-over-year growth of 6.6%. Much of that growth is, or has been, expected to come from the energy space. Even if the yearly comparisons are rather easy for that sector, with both crude and natural gas deep in the hole, how much can solid earnings numbers help turn the sector's momentum? That group has already behaved poorly, despite projections that show more than 390% year-on-year growth for the second quarter of 2017.
On top of that, earnings growth may have to go it completely alone this quarter. Most traders have completely priced out gains that would have been made this year, if tax reform or an infrastructure build had been implemented. Yes, I know that the administration insists that these things are still coming sooner, rather than later. But we have become Missouri as far as that is concerned. You are going to have to show me. Progress on those fronts would have to be priced back in, were it to be realized prior to 2018. Keep in mind that the whisper number for earnings growth is generally 2% to 3% higher than the "official" (there is no such thing) expectations, because corporate expectations can often appear to be managed downward intentionally. 9%?? Tough nut to crack.
01:10 - Fed Speaker: San Francisco Fed Pres. John Williams spoke this morning from New South Wales in Australia. This is the first of three consecutive mornings that we will wake up to comments made by Williams who does not vote on policy this year. As he has been all year long, Williams, who is seen as close to the Fed Chair, took a hawkish tone.
08:30 - Durable Goods Orders (May): Expecting -0.5%, April -0.7% m/m.
08:30 - ex-Transportation (May): Expecting 0.5%, April -0.4% m/m.
08:30 - ex-Defense (May): Expecting 0.5%, April -0.8% m/m.
08:30 - Core Capital Goods (May): Expecting 0.5%, April 0.0% m/m. Expectations are that the military ordered fewer aircraft in May. Hence why we are looking for growth ex-transportation and ex-defense. This could actually be taken as a positive, if there were to be growth in the "real" economy. Keep an eye on core capital goods as well; as the general economy has sputtered in recent months, so has business spending. The first significant growth for this line all year is expected for today, and will be watched for closely by traders. This data-point within the data may just be your macro item of the day.
10:30 - Dallas Fed Manufacturing Survey (June): Expecting 18.5, May 17.2. The district is expected to show headline growth today for an eighth consecutive month. That will not change as long as production levels are maintained for crude in the Permian Basin. Though rigs in production across the U.S. have grown for 23 straight weeks, those operating in the Permian have only seen a net gain of one rig over two weeks. Dallas, this is your focus.
Sarge's Trading Levels
These are my levels to watch today for where I think that the S&P 500, and the Russell 2000 might either pause or turn.
SPX: 2462, 2448, 2441, 2432, 2421, 2411
RUT: 1433, 1426, 1419, 1410, 1403, 1397
Today's Earnings Highlights (Consensus EPS Expectations)
What's Hot On TheStreet
Unusual to hear these words: Under Armour's (UAA - Get Report) founder Kevin Plank has never been one to sound weak in a public setting. Plank is known for his motivational speeches to employees and desire to crush all competition. So, it was odd to hear Plank say rival Nike (NKE - Get Report) "isn't playing fair" on the Today Show on Sunday -- it sounded like a CEO who after several below plan quarters is finally realizing how challenging it will be to dethrone Nike.
Hat tip to Ford: A noted supporter of recycling, auto legend Henry Ford would be proud to know his spirit of conservation is still alive and well in the company that bears his name.
And in fact, as TheStreet learned on a recent trip to Ford's (F - Get Report) Dearborn, MI. headquarters, the founder's recycling efforts have been taken to a whole other level. Within Ford's Plastics and Materials Sustainability Research Department, which is tasked with finding ways to create auto parts from things found in the Earth such as soybeans and agave plants, senior technical leader Deborah Mielewski showed off a new coin tray made from shredded cash.
It took about $400 of cash to make the coin tray, said Mielewski.
Shout out to the 1990s: It may be time to cash in those Tesla (TSLA - Get Report) stock gains and go out and buy one of these new classic cars, TheStreet reports. There are several models from 1992, including the early version of the Dodge Viper, that are starting to take off in value.
Nestle rips to a high: Shares of chocolate maker Nestle touched an all-time high Monday after activist investor Third Point, led by Dan Loeb, revealed it had built a stake in the group and pressed for asset sales and increased buybacks. The stake is worth more than $3.5 billion, making Third Point one of Nestle's top 10 shareholders. For Loeb, this is one of his boldest bets yet as he tries to shake up the staid consumer packaged goods giant.
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