What’s in Today’s Report:

  • Two Keys to a Continued Rally
  • Why The Credit Impulse Matters to You
  • Key Levels for Two Key Tech ETFs
  • Oil Analysis – How Low Can It Go?
  • Weekly Market Preview
  • Weekly Economic Cheat Sheet


Futures and global markets are modestly higher thanks to continued momentum from Friday’s rally and following an uneventful weekend.

Economically the only notable number was the German IFO Survey, which beat estimates (Business Expectations rose to 106.8 vs. (E) 106.4). 

Politically, the weekend was focused on the Senate healthcare bill.  Passage in not expected but that’s actually a potential positive as focus will shift back to tax cuts. 

Today there are no Fed speakers (Williams spoke at 1:10 a.m. and reiterated the recent slightly hawkish tone from the Fed) and only notable economic number is Durable Goods Orders (E: -0.4%).

So, barring any major surprises from Durable Goods, oil and the 10-year Treasury yield will again lead markets.  Oil/yields are slightly higher this morning and that’s helping to push stock futures higher, and if oil/yields extend those gains throughout today, so will stocks. 






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This Week

This week won’t be the busiest, but there are still some potentially market-moving events to watch. First, Friday’s Core PCE Price Index will give us more color on inflation, and could cause further declines in bond yields (ultimately bad for stocks). Second, part two of the annual stress tests come Wednesday after the close. We’ll likely see a sell-the-news reaction to this, although if there are some unexpected positive capital return announcements that will be a positive.

Finally, turning to politics, the Senate healthcare vote comes later in the week, and right now passage is not expected. Bottom line, the inflation stats Friday are the most important event of this week, as it’ll give us more color on expected Fed policy. Again, if inflation underwhelms that could be a headwind on stocks as bond yields fall.  

Last Week (Needed Context as We Start a New Week)

Stocks hit new all-time highs early last week thanks to momentum, although a plunge in oil saw some of those early gains roll back by week’s end. The S&P 500 was up 0.21% on the week, and is up 8.91% year to date.

Monday was the best day of last week, as the S&P 500 surged to an all-time high, rising 0.83%. There wasn’t any reason for the rally, just continued momentum thanks to a rebound in tech and bank shares.

However, lower oil rained on the bullish parade Tuesday, as a plunge in oil saw the S&P 500 give back most of Monday’s gains, as it fell 0.63%.

Tuesday and Wednesday stocks were flat, as another drop in oil offset positive earnings from FDX, ADBE and RHT while a bounce in oil helped support stocks on Thursday. Still, a late-day sell-off saw the averages dip slightly into the close.

Friday saw stocks dip initially following a disappointing June flash PMI, but as has been the case for seemingly every Friday in 2017, buyers stepped into the weakness (despite any real positive catalyst). By lunch time stocks were modestly positive in typical quite summer trade, and they closed the week with small gains.  

Your Need to Know

There were two notable trends from an internals standpoint (healthcare/tech outperformance, oil underperformance) but neither had macro implications. Broadly speaking, markets are looking for either tech or financial to reassume a leadership role to push things higher.

Starting with the latter, healthcare exploded as all three of our recommended ETFs (IHF/XLV/IBB) rose to 52-week highs. Lack of Republican consensus on healthcare combined with not-as-bad-as-feared drug pricing policies from the Trump administration helped power the sector higher. Healthcare is overbought and due for a dip, but we remain bullish and would buy that dip.

Turning to tech, the Nasdaq outperformed handily last week (up 1.8%) thanks to healthcare (especially biotech) and super-cap internet. FDN surged nearly 3% on dip buying, but it still remains below the recent all-time high at 98.08. If FDN and SOXX can hit new highs this week, that will be a bullish signal, as those sectors will have resumed market leadership. Finally, energy continues to be a disaster. Lower oil is the reason for the weakness, as XLE plunged 3% and that weighed on industrial as well. XLI fell 2% on energy-related concerns (less oil field revenue).

Bottom Line

The market remained broadly unchanged last week as stocks continue to generally ignore historically worrisome signs from 1) The bond market, 2) The oil market, 3) Economic data (Citi Economic Surprise Index and 4) The Fed (hiking rates, and potentially more hawkish than expected).

The reasons stocks have been able to ignore these multiplying caution signs are twofold. First, the “TINA” trade, i.e. (There Is No Alternative) to stocks in the capital markets. Second, earnings growth.

The former is best viewed through the lens of momentum sectors/indicators, and as we’ve covered recently, all the major momentum indicators we watch are still positive (SOXX, FDN, NYSE A/D Line, Investor Sentiment). So, the fact that there isn’t a viable alternative for capital out there (bonds are doing well, but I think you’ll be hard pressed to find a compelling long-term bull argument that doesn’t involved a recession forecast) continues to help stocks grind higher.

As for earnings growth, this is a very underappreciated tailwind on the markets. Expectations are 2018 S&P 500 EPS will rise conservatively to $137/$138 from the current $130-$132, without any help from tax cuts (if we get them). If we do get tax cuts, then 2018 S&P 500 earnings expectations shoot higher to $140-$142.

In this calm macro environment, and taken in the context of no other compelling destinations for risk capital, that earnings growth justifies buying a market at nearly 18X 2018 earnings… because the expectation is that earnings will continue to rise, and so will stocks (as they have for the last year).

So, there are two practical takeaways from this: Stay cautiously long, as long as momentum is positive (which it is) and earnings growth is still expected. That means that the upcoming Q2 earnings season (in early July) will be very, very important for stocks. If earnings are strong, we could see a breakout, and if earnings are soft, well, that could result in the first real pullback in stocks in over 18 months.

Bottom line, the music keeps playing in our game of market musical chairs, but I am still content to hold current broad equity allocations. And, we continue to think the key to outperforming in 2017 is sector selection, and we remain bullish on Europe (HEDJ, EZU), healthcare (on a dip XLV, IHF, IBB), super-cap Internet (FDN), emerging markets (IEMG) and cyber security (HACK). These sectors should continue to outperform until the market dynamic changes (we’re watching for that change, very, very closely).


Economic Data (What You Need to Know in Plain English)

Need to Know Econ from Last Week

For a second-straight week, we got underwhelming data and a more-hawkish-than-expected Fed. And for a second-straight week, stocks ignored it. Yet as we keep saying, unless this changes it can only be ignored for so long.

Starting with the former, there was only one material economic report last week, and it came Friday via the June Flash Manufacturing PMIs. Underscoring yet again that the regional surveys (which have been strong in June) apparently have no bearing on the actual national manufacturing PMI, the June composite flash PMI missed estimates at 53.0 vs. (E) 53.6. To boot, both the manufacturing PMI (52.1 vs. (E) 52.7) and the service sector PMI (53.0 vs. (E) 53.7) also missed estimates.

So, at least according to this flash PMI, manufacturing and service sector activity decelerated in June. Now, to be fair, all three numbers (the composite, manufacturing and service PMI) remain in positive territory above 50, so it’s not like activity is outright slowing. However, the level of acceleration continued to decrease in June.

Bigger picture, Friday’s numbers certainly aren’t damning for the economy, but again they are not going in the right direction. And with stocks extended (and a lot of good news priced in), and the Fed apparently more hawkish than we thought, the lack of economic acceleration so far in 2017 is going to become a problem if it doesn’t change.

Speaking of the Fed, last Monday Fed Vice Chair Dudley reiterated that he expected economic growth to continue, and was again dismissive of the disappointing inflation numbers. And, he clearly meant to imply that the Fed remains on course to 1) Begin to reduce the balance sheet in 2017 and 2) Hike rates again.

As with the slightly hawkish Fed meeting of two weeks ago, markets largely ignored the comments. But the bottom line is that the Fed is trying to communicate a more hawkish message to the markets, and the markets aren’t listening, yet. So, the chances of a hawkish “shock” from the Fed are rising (they aren’t high yet, but they are rising).

To end on a positive note, however, housing data bounced back nicely last week. Existing Home Sales and the FHFA Housing Price Index both beat estimates, and countered a very soft New Home Sales report.

Bottom line, over the past two weeks the data has continued to underwhelm while the Fed appears to be more hawkish than most thought. So, one of two things will happen if this continues: 1) Bonds will be right, and the economic data will get worse, which obviously isn’t good for stocks, or 2) Bonds will stop ignoring the Fed’s hawkish message and rates will rise. Either way, it will resolve itself with an uptick in volatility for stocks. 

Important Economic Data This Week

This week is similar to last week in so much as the important economic data points comes Friday, although on an absolute basis we do get more data this week.

The most important report coming this week is Friday’s Personal Income and Outlays Report, because it contains the PCE Price Index (the Fed’s preferred measure of inflation). If that number is soft, you will likely see the 10-year Treasury yield drop to new 2017 lows (likely below 2.10%, and the bond market’s warning on future economic growth will get louder).

The second most important number this week is the official Chinese June Manufacturing PMI, which comes Thursday night. If this number drops below 50 (which it shouldn’t, but there’s a chance) people will get nervous again about Chinese growth, and that will become a headwind on markets.

Looking elsewhere, Durable Goods will be reported and it will be yet another opportunity for “hard” economic data to show some acceleration and close the gap between strong “soft” sentiment surveys and hard economic data. Bottom line, next week is truly the key week for economic data, but this week’s inflation numbers (in the US and Europe) and Chinese PMIs will move markets, and give us further color into the state of growth and inflation. If the numbers disappoint, I’d expect lower bond yields… and lower stocks.


Commodities, Currencies & Bonds

In Commodities, the segment dropped sharply last week thanks to a plunge in oil to seven-month lows. That weighed on the commodity index ETF, DBC, which fell 2.1%.

Oil was the story in the commodity markets last week, as continued supply concerns and technical trading caused a rout early in the week. Oil plunged more than 5% through Thursday, and hit seven-month lows. There wasn’t any specific catalyst for the decline, just the unrelenting reality that supply is growing, and OPEC/NOPEC does not have the same ability to constrain supply like they used to thanks to growing US production.

Oil did manage to bounce slightly on Thursday/Friday, but it was mostly an oversold bounce. OPEC members jawboned about offsetting rising Libyan and Nigerian production, but the likelihood of deeper cuts from OPEC remains unlikely. Bottom line, oil is oversold and due for a bounce, but as long as US shale continues to rise the market will have a supply problem, and that reinforces our lower-for-longer stance.

Turning to the metals, gold was weak initially last week thanks mainly to a stronger dollar. The Dollar Index bounced early last week after the hawkish Dudley comments, but the rally didn’t continue throughout the week, and gold held support at $1240. A modest decline in the dollar Friday helped gold rally, and actually close flat on the week and well off the lows.

Barring a correction/pullback in stocks, gold needs either 1) Better inflation stats or 2) A weaker dollar to mount a rally back towards $1300. Until we get one of those two catalysts, the near-term outlook remains neutral.

Looking at commodities more broadly, the complex remains under pressure. Oversupply in many commodities remains a problem, and while global economic growth is accelerating, it hasn’t caused a requisite uptick in demand. Commodities as an asset class remain unattractive to us from an allocation standpoint.


Looking at Currencies and Bonds, despite the hawkish comments from Fed Vice Chair Dudley last Monday, the Dollar Index was unable to mount a decent rally, and rose just 0.1% on the week. At least according to the currency and bond markets, investors simply don’t believe the Fed is serious about hiking rates further and reducing the balance sheet. That’s the only conclusion from the price action last week, as Dudley’s comments and the flash manufacturing PMI were really the only two catalysts. Clearly, the market is paying more attention to the data than it is the Fed speak.

Looking internationally, outside of Great Britain it was a pretty quiet week, as most other currencies traded off the dollar. The euro rose 0.4% with most of the gains coming Friday in reaction to the lower dollar while the yen was basically flat on the week as dollar/yen remains very comfortable around 110.

The pound was the only currency that showed any real volatility last week, as conflicting messages from BOE officials caused a whipsaw early in the week. First, the BOE’s Carney said there would be no impending rate hikes. Then the next day the BOE Chief Economist said he could see rate hikes this year. The pound finished the week flat thanks to a Friday rally, but confusing rhetoric aside, Brexit and political uncertainty remain headwinds. We expect the pound to drift into the mid-1.20s over the medium term, barring a slowdown in the US economy.

Turning to bonds, it was more of the same. The yield curve flattened further (the 10’s-2’s Treasury spread hit a new 2017 low at 79 basis points) while the 10-year yield rose 1 basis point. Broadly, the bond market continues to signal slower economic growth and inflation in the future. That signal remains a large and increasingly significant caution sign for stocks that are trading at 18X next year’s expected earnings (a very high historical multiple), and ultimately, something will have to give.  

Special Reports and Editorial

Why “Credit Impulse” Matters to You

There are many analysts and investors who believe that the entire ’09-’17 stock rally is nothing more than the result of a historic, globally coordinated credit creation event from the world’s major central banks. Put in layman’s terms, every major central bank in the world has done QE at some stage over the past eight years, and pumped the world full of cash. So, all they’ve done is create massive asset inflation in bonds, stocks and real estate.

First, the theory goes, it was China’s central bank (the PBOC) and the Fed unleashing the initial wave of QE following the financial crisis in ’08/’09. Both central banks kept their foot on the accelerators over the next several years (remember QE1, QE2, Operation Twist, and then QE Infinity?). In 2013, the Bank of Japan joined the Fed, PBOC and Bank of England at the QE party, only they came to really party, and upped the ante by creating a huge QE program.

Then, as the US and Chinese economies showed signs of life (finally) in 2015, the Fed and PBOC paused their QE/credit creation programs. And, whether causally or coincidentally, 2015 turned out to be one of the more volatile years in the markets in the last decade… and US stocks largely traded sideways until early 2016.

But by that point, the ECB had joined the QE party, and the PBOC restarted its credit creation machine following the economic scare of 2H 2015. So, even while the Fed has stopped QE, on a global basis the total amount of QE and credit in the system resumed a steep acceleration, as now the PBOC, BOJ and ECB were doing QE.

Again, coincidentally or causally, stocks broke out in February 2016, and they literally haven’t taken a break in 19 months (excluding two one-night scares with Brexit and the US election).

So, again, while there is no hard proof that this global expansion of credit has powered US (and now global) stocks higher, there certainly is at least a relationship if we look at history.

The reason I am pointing this out is simple: There are growing signs that the near-decade-long global credit creation/QE cycle appears to be nearing the end. First, there are the central bank actions. The Fed is hiking rates, and likely taking steps to reduce its balance sheet, draining liquidity from the system.

Second, the ECB appears to be on the verge of tapering its QE program, and while that will still result in a net credit increase for the next year, the pace of credit creation will slow. Finally, and perhaps most importantly, China continues to aggressively reduce credit in its economy, and I’ll again remind everyone the last time they did that, we got the volatility in 2H ’15.

This is where the “Credit Impulse” comes in.

Credit Impulse is a term used by various research firms that measures the “Rate of Change of Change” of global credit creation/QE. Put simply, while the global amount of credit may still be rising, the pace of the increase has not only slowed… it’s turned negative. Similar to taking your foot off the gas while you’re still going forward. It’s just a matter of time until you stop.

Getting more granular, UBS has been out front on this issue, and in February noted that Credit Impulse turned negative. In a much-anticipated report out last week, the firm said that the decline over the past three-to-four months has accelerated, with Credit Impulse dropping to -0.6% annualized over the past three months.

Now, Credit Impulse is a composite of various measures of credit, including loans, loan demand and other metrics, so this is not a hard-and-fast number. And the fact that it has turned negative doesn’t mean we’re looking at an impending collapse in stocks.

But if we look at the entire picture, negative Credit Impulse; a more-hawkish-than-expected Fed that’s apparently committed to reducing its balance sheet, a Chinese central bank that is apparently committed to reducing credit in that economy, and an ECB that will begin tapering QE in 2018… the fact is we appear to be nearing the end of the post-financial-crisis credit expansion, and with economic growth where it is, I cannot see how that will be positive for stocks longer term.

Bottom line, I’m not turning into ZeroHedge (although they are all over this), but the fact is that I sense a lot of complacence regarding the end of this global credit creation cycle.

People seem to think that because the Fed ended QE and hiked rates, and then nothing “bad” happened, that this means things will be ok. The only problem is they fail to consider that at the exact time the Fed stopped QE, the BOJ, ECB and PBOC all ramped up their QE programs. That means global liquidity continued to expand, and stocks and Treasuries have been the massive beneficiary.

So, there’s what keeps me up at night, i.e., what happens in 12 months if the only central bank still doing QE is the BOJ? Maybe nothing, but I can’t be sure, especially considering current economic growth.

We will continue to watch the tectonic movements in the global economy for signs of stress, because while we enjoy quiet markets and low volatility now, we appear to be on the cusp of an unknown period where the global punch bowl slowly gets removed from the party. And, I’m bound and determined to make sure we don’t get stuck with the proverbial bill. Food for thought.

One additional element of Credit Impulse here is China. Specifically, one of the reasons I and other macro analysts watch China so closely is because for the last decade, every time China has had an economic scare it’s given the rest of the world’s markets a scare. The most recent examples were Aug/Sept ’15 and Jan/Feb ’16.

More specifically, those two bouts of volatility ended at the same time as China massively re-engaged its credit creation machine. If you look at the chart here, Chinese credit creation declined in ’13-’14 and was flat through ’15. But when the Chinese economy started to stall, officials massively ramped up the credit creation machine again. Maybe it’s just coincidence, but the US stock market hasn’t had a correction since.


Now, China is once again trying to shrink its massive credit “bubble.” And, they’re removing liquidity from the system. The question for us is: “Will it cause another scare in global markets?”

It hasn’t so far, but that doesn’t mean it won’t.

So, while it might seem odd that I consistently bring up China even when it’s not in the news, this is why—because events are occurring that in the past have led to market disruption. And as they say, history in markets doesn’t repeat… but it does rhyme.

Tech Update: Key Levels for Important ETFs

Stepping back a moment, the tech sector still has not recouped all of the losses from the collapse two Friday’s ago, and again we view that as important for the broad market because tech has pulled this market higher all year, and without that outperformance we have a market devoid of sector leadership.

That said, tech did trade better over the past few days. Bottom line, as tech has gone, so has the broad market, so we continue to watch two key levels in SOXX and FDN.

In the former, the low of 142.81 in mid-June is key support while the previous high of 155.95 is key resistance. For FDN, the number is 92.00 (key support) and 98.08 (the old high). We will take whichever levels are broken first as an important signal about the current direction of the broad markets.

EIA Analysis and Oil Update

Last week’s EIA report was again mixed, as headlines were mildly bullish with larger-than-expected draws in oil and gasoline stockpiles while US production bearishly hit new 2017 highs. Commercial crude oil stocks fell -2.5M bbls last week, which was more than analysts had expected (-2.0M) but less than the -2.72M bbl draw reported by the API. Ultimately, the oil print was a bit of a wash with regard to market influence.

Meanwhile, gasoline stockpiles fell -600K bbls vs. analyst expectations of -100K. The API reported a 346K bbl increase, so the EIA draw was bullish and the subsequent rally in RBOB gasoline futures supported gains across the space immediately after the release.

Contrary to the somewhat optimistic headlines, the details of the report were still decidedly bearish. Lower 48 production rose 25K b/d last week to a new 2017 high of 8.865M b/d. Production in the continental US (which excludes the more volatile Alaskan data) has now risen 624K b/d this year, which is offsetting more than half of the pledged cuts by OPEC (1.2M b/d).

While the initial reaction to the EIA report was a spike higher, the data continues to favor the bears. US production is averaging gains of +26K b/d each week so far in 2017, which is clearly the most significant headwind on the oil market right now. Furthermore, the US continues to take market share from global producers, specifically OPEC members. That’s bad for the production cut deal, as the odds rise that producers will begin to cheat on their quotas (especially with prices falling).

Some analysts have pointed to the recent declines in US oil stockpiles as a potential bullish development, but inventories remain more than 6% higher on the year. That trend, however, is something to watch. If it accelerates or at least continues, it could eventually become a supportive factor. Bottom line, the oil market remains in a lower-for-longer phase, and until there is some sort of fundamental shift such as a reversal in US oil output, the path of least resistance will be lower for energy prices in the near-to-medium term.

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