Bond Market Volatility – It’s Greek to Us.
No discussion of today’s securities markets is complete without prefacing Greece and the volatility in the bond markets. For Greece’s new government there is little room for an agreement. In fact on Saturday morning the news from Greece was that Prime Minister Alexis Tsipras stated he is “willing to accept unpalatable compromises to secure a deal with international creditors.” Sounded like he has finally realized Greece has no further leverage, either accept what is offered or default. Not so, talks in Brussels on Sunday ended with “large gaps” in the negotiations. The next attempt will be on Thursday but EU leaders are becoming annoyed at the Greek stonewalling. By Thursday both sides could possibly reach an agreement keeping Greece in the euro but not solving the longer term problems. In actuality, Greece should not matter except to traders and a few European banks, most everyone else owning Greek debt and related securities has had three years to insulate themselves. Even if an agreement is not reached and Greece defaults, so what!
The volatility in the bond market is no less meaningful to US equities than Grexit. As Central Banks implement their customized version of QE their purchases limit liquidity in Long-Term bonds. This attracts traders using leverage seeking to profit from short-term moves based on market internals, rather than on fundamentals. There is no economic rationale for these almost daily fluctuations. Incorporating potential negatives of Fed interest rate policy and Greek default into the short-term outlook results in more volatility in a leveraged illiquid market - - a traders Utopia. The prospect of any clarity on Fed interest rate increases from the meeting will dominate discussion early in the week and without any agreement with Greece, be prepared for continued instability. All of this with technicians bantering about a ten year chart of the 10-year Treasury showing a “big, inverted head and shoulders bottom pattern,” WOW!
Since the completion of QE3, the US economy has gradually moved toward self-sustainability. However, without a viable consumer, growth has been erratic and more influenced by external events, such as weather, falling energy prices, and the strengthening dollar. Both retail spending and housing are showing clear signs of a consumer returning from hibernation. Consumer sentiment has improved as employment rises and wages begin to reflect some labor tightening, but also a new segment of non-savers having additional purchasing power are entering the market.
While one month does not make a trend, the data for May retail sales certainly was welcome. The comparison with the prior month shows an increase of 1.2%, but comparing month-to-month with year-over-year data gives a clearer picture, as the effect of declining gas prices is included, and the inadequacies of seasonal adjustments is limited in the twelve month data.
Source: US Census Bureau
The Table shows an interesting trend over the past year as the lower-end consumer remains reluctant or unable to spend. On a 12-month basis, Merchandise Stores, including department stores and discount retailers, remain flat despite a savings reduction of up to 40% from gasoline. Auto sales are the largest contributor to rising total retail sales as they have been during the past few years. In May, dealers reported auto sales at an annual rate of 17.7 million, the highest level in nine years. Hard to fathom the savings at the pump is a determinate of auto sales, but it is in an unconventional way. Looking at Auto Sales year-to-date through May 2015 shows total new car sales, both domestic and imported, down 3.1% from the same period in 2014. Total truck sales (which includes SUVs) are up 10% with SUV sales +13.9%, led by luxury SUVs +25.7%, followed by mid-sized SUVs +16.9%. The all-important pickup category rose 9.9% over the past five months. Of the top 20 vehicles sold in May, the more reasonably priced cars show a distinctive downtrend, less reflective of cheaper gasoline mileage than the lower-end purchaser, Chevy Cruz (-26.7%), Honda Accord (-18.3%), and Toyota Camry (-11.6%) show the largest declines. The higher-end consumer remains the bulwark of retail sales.
While most analysts have been awaiting the consumer to turn gasoline savings into spending, we have stated that the savings to the average consumer will result only in a marginal increase in spending. A recent report by the New York Federal Reserve Bank modeling supply and demand oil shocks back through the 1980’s concludes that the “expansionary oil supply shock of late-2014 and early-2015 will have a relatively modest stimulative impact on economic activity, which will peak around mid-2015, and the effect should dissipate significantly by early-2016.” Aside from looking for increased consumer spending from energy savings, the most recent employment data offer an insight into where consumer spending may begin to make a meaningful impact on economic growth. In May 2015, labor force participation rate rose to 62.9% but only slightly above its March 2015 all-time low of 62.7% and well-below the 66.4% high in December 2006. What is interesting is the under-25 age category accounted for 96% of the 392,000 net new entrants into the labor force. According to the Household Survey, of the 272,000 net employed last month, 76% were in this demographic. The hiring of these new employees is an indicator of labor market tightening. With a record 5.38 million available jobs a full employment level in 2H2015 at 5.0% seems attainable. We anticipate some wage pressure at these levels and with job openings at record highs a further increase in participation rates.
As retail sales await rising employment and a tighter labor market to ignite purchases by a more financially sound consumer, the housing market in April 2015 is picking up where it left off in 2013. The transition away from foreign and investment purchasers to the traditional first-time buyer and existing homeowner upgrade is slowly evolving.
• Housing Starts – At 31.6% increase in April over March to 103,600 starts is the highest monthly total going back to October 2007. Also permits were up 15% month-over-month, the best level since June 2008. Multi-family starts remain about 33% of the total as the rental market for many potential first-time homebuyers is the only alternative. Also, Millennial’s are moving into cities where they are working, and without family commitments, savor convenience over home ownership. This trend in multi-family building should remain intact as permits rose 21% month-over-month in April.
• Existing Home Sales – Once again, existing home sales came in below expectations. Although up 6.4% above April 2014, mortgage restrictions, low inventory levels, higher prices and limited equity for existing home owners have all impacted current sales. This is the category most affected by the withdrawal of investors and foreign purchasers.
• New Home Sales - Month-over-month April 2014 new home sales were 8.9% above March and for the first five months 21.4% above 2014. However, these levels remain 45% lower than the early 2000’s. Builders have shunned this market moving instead to multi-family or building single family homes above the level of affordability for many first-time homebuyers. Overall inventory remains low, but the level of housing starts indicates a current level of housing starts that availability will increase. Also, the proposed easing of mortgage restrictions will draw first-time buyers even as rates rise.
Markets remain vulnerable as investors and traders assess the effects of lowered earnings amid fluctuating oil prices, a stronger dollar, and rising interest rates. In the short-term, there is potential for a definable technical correction which will offer a tactical buying opportunity. Once the Fed raises rates, stocks should perform well during the rate normalization process. Longer term we believe that moderate economic growth, accompanied by slow rising real interest rates and low inflation, will result in increased earnings and limited multiple expansion with continued upside for equities. Our investment policy remains optimistic on selective Large-Cap domestic corporate equities.