Good morning,

What’s in this week’s Report:

  • Two Key Questions For the Market, Following Last Week’s Rally.
  • Are there Green Chutes of an Economic Reflation?
  • Why Last Week’s CPI Report Was Important
  • Is Oil Breaking Out?
  • Weekly Market Preview
  • Weekly Economic Cheat Sheet

It’s green on the screen as futures and global markets are all modestly higher thanks to continued momentum from last week and following a quiet weekend.

Economically, the only notable number overnight was the August China Home Price Index, which declined to 8.3{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} from 9.7{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} in July.  But, it largely met analyst expectations.

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Politically, focus remains on tax cuts but there was no notable news over the weekend.  Next Monday (Sept 25th) is now a key day as a detailed “blueprint” is expected.

News Headlines:

Today there are no notable economic reports and no Fed speakers, so focus will remain on the “micro” economic.  If Treasury yields can move higher and bank stocks can rally, that can extend last week’s “reflation rebound” ahead of the Fed meeting later this week.





{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} Change

S&P 500 Futures




U.S. Dollar (DXY)












10 Year







This Week

The Fed is clearly the highlight this week, and while any surprise will move markets, the odds favor a potentially “hawkish” surprise.

The global flash PMIs (out Friday) also will be a market mover if they miss expectations.

Geopolitically, the UN General Assembly starts Wednesday, and while I don’t expect any decisions this week there’s a lot of “noise” regarding the Iran nuclear deal. If the US backs out that likely would be a short-term negative, but not a bearish game changer.

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

Stocks jumped to new record highs last week, claiming the 2500 level for the first time as reflationary money flows buoyed equities and bond yields while investors shrugged off renewed North Korean tensions. The S&P 500 finished the week up 1.58{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}.

Stocks surged 1{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} to record territory on Monday as the damage from Hurricane Irma was not as bad as feared, and North Korea chose to put a new ICBM launch on hold (until later last week, of course).

The rally continued on Tuesday as the S&P 500 extended the week’s gains by another 0.34{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} as a “reflation rebound” took hold in the markets in the wake of firmer inflation data in both China and Great Britain (and to a lesser extent, India).

Stocks were basically flat on Wednesday and Thursday after an in line, but “healthy” CPI report. The S&P 500 closed down just 0.11{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} on the day after staying contained in a 5-point trading range.

Friday, stocks opened cautiously thanks to a North Korean missile launch after the close on Thursday. Investors largely took the launch in stride relative to recent North Korean developments, but the latest uptick in geopolitical angst still created a headwind for stocks. A rebound in tech shares trumped soft economic data and stocks were able to close Friday with a slight gain on the day, but up solidly on the week.

Your Need to Know

It was a pretty standard reflation rally from an index and sector trading standpoint last week. Small caps and industrials both outperformed the S&P 500 (R2K and Dow both up over 2{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}).

On a sector level, “cyclical” sectors outperformed: Banks (BKX) rose 4{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}, semiconductors (SOXX) rose 4.8{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}, energy rose 2.2{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} (helped by higher oil) and basic materials also surged. Meanwhile, defensive sectors lagged, as utilities fell 1.1{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}, consumer staples (XLP) rose just 0.24{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}, and healthcare rose 0.06{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} (kept down by profit taking in biotech).

While that sector performance isn’t a surprise, there are two notable observations that, if they continue, could be meaningful for the remainder of the year.

First, while cyclical sectors outperformed, tech held in relatively well, and we didn’t see the declines like back in late-June/early July. FDN rose 1.4{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} on the week and if the cyclical rally doesn’t mean tech declines, that’s positive for the market.

Second, “value” handily outperformed “growth.” The Russell value index rose nearly 3{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} while the Russell growth index rose just 1.7{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}, again driven by financials (which due to underperformance are in the “value category”). If that trend continues (and to be fair, we’ve had several false starts this year), it will necessitate a rotation out of tech/growth and into financials/value.

Bottom Line

Stocks grinded to marginal new highs last week thanks to 1) Expectations of better economic growth/earnings and 2) Hopes of an economic “reflation.” But despite the optimism and higher prices, I’m sorry to say that the outlook for stocks didn’t really improve that much.

First, keep in mind that virtually all of last week’s gains came on Monday following the not-as-bad-as-feared Hurricane hit on Florida by Irma. That outcome does remove a potential economic headwind, but it’s not like it’s an absolute positive, either. So, the gains there were more trading/momentum oriented than anything else (point being, not-as-bad-as-feared hurricane hits aren’t going to power stocks higher).

Second, the uptick in global inflation via stronger-than-expected CPIs in China, Great Britain and the US is a potential positive, as we need stronger inflation to help fuel that reflation rebound and carry stocks materially higher. But, it breeds two key questions that remain unanswered.

First, can economic growth also accelerate? If not, then we’re talking about 1) Global central banks that have to raise rates despite lower growth, and 2) A potential stagflation. Neither of those outcomes are positive for stocks.

Second, do we need to rotate tactical sector exposure to cyclical sectors? The recipe for outperformance in 2017 has been defensive sector exposure (super-cap internet (FDN), healthcare (XLV), utilities (XLU)) and foreign exposure (Europe via HEDJ & EZU and emerging markets via IEMG). That’s been because of middling growth and low inflation. But, if inflation and growth accelerate, then we will need to switch to “reflation” exposed sectors, and that’s something I’ll be covering further this week.

Finally, positive rhetoric on tax cuts was an underappreciated positive on markets last week. Lots of “happy talk” from Republicans (including their promise to reveal details of the tax plan on Sept. 25) raised expectations that a deal will get done. However, if 2017 has shown us anything it’s that nothing is easily done in Washington.

Bottom line, it has paid to remain patient on two trends in 2017: Staying long stocks and staying long those sector outperformers. So, despite rising caution on this market over the medium and longer term, that’s what we will continue to do. From a new-money standpoint, from a 10,000-foot level I’d remain comfortable being “fully” allocated to stocks (meaning whatever your full equity allocation normally is). Tactically, I would continue to allocate new money to what’s “worked,” i.e. super-cap tech/internet, healthcare and defensive and international markets.

At some point, it may be time to rotate into more cyclical sectors and/or reduce equity exposure, but at this point I don’t think we are there yet—although we are watching very, very closely for signs of trouble.

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

Need to Know Econ from Last Week

Up until Friday, last week’s data looked like it was going to show “green shoots” of an economic reflation. But disappointing economic growth numbers on Friday offset better inflation readings from earlier in the week, and while Hurricane Harvey likely impacted the growth data, the bottom line is the data just isn’t good enough to spur a rising tide for stocks.

From a Fed standpoint, the higher inflation data did increase the likelihood that we will get a December rate hike, although the market expectation of that remains below 50{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}. As such, increased expectations of a rate hike in the coming weeks could be a headwind on stocks, especially if economic data doesn’t improve.

Looking at last week’s data, the most important takeaway was that inflation appears to be bottoming. Chinese, (1.8{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} yoy vs. (E) 1.7{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} yoy), British (2.7{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} vs. (E) 2.5{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}), and US CPI (0.4{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} m/m vs. (E) 0.3{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}) all firmed up and beat expectations, and while it’s just one month’s data, it’s still a break of a pretty consistent downtrend.

That turn in inflation potentially matters, a lot, because it’s making central banks become more hawkish. The ECB is going to taper QE, the Bank of England is going to raise rates sooner rather than later (more on that in Currencies), the Fed may hike again in December and the Bank of Canada was the first major central bank to give us a surprise rate hike in nearly a decade. The times, so it seems, they are a changin’.

That makes an acceleration in economic growth now even more important. Unfortunately, the growth data from last week was disappointing. July retail sales missed on the headline (-0.2{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} vs. (E) 0.1{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}) as did the more important “Control” group (retail sales minus autos, gas and building materials). The “control” group fell to -0.2{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} vs. (E) 0.3{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}. Additionally, Industrial Production also was a miss. Headline IP fell to -0.9{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} vs. (E) 0.1{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} while the manufacturing subcomponent declined to -0.3{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} vs. (E) 0.1{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}. Now, to be fair, Hurricane Harvey, which hit Southeast Texas, likely skewed the numbers negatively. But, the impact of that is unclear, and we can’t just dismiss these numbers because of the hurricane.

Bottom line, the unknown impact of Hurricane Harvey keeps this week’s data from eliciting a “stagflation” scare, given firm inflation and soft growth. But if this is the start of a trend, and it can’t be blamed on Harvey or Irma, then that’s a problem for stocks down the road. We need both inflation and growth to accelerate (and at the same time) to lift stocks to material new highs.

Important Economic Data This Week

The two key events for markets this week will be the Fed meeting on Wednesday, and the global flash PMIs on Friday.

Starting with the Fed, normally I’d assume this meeting will be anti-climactic, but it’s one of the meetings with the “dots” and economic projections, so there is the chance we get either a hawkish or dovish surprise. So, don’t be fooled into a false sense of security if people you read say this meeting is going to be a non-event. It very well could be, but there’s a better-than-expected chance for a surprise, too (and if I had to guess which way, I’d say it’d be a hawkish surprise… and that could hit stocks).

Turning then to the upcoming data, given the new-found incremental hawkishness of global central banks, strong growth data is more important than ever to avoid stagflation. We’ll want to see firm global manufacturing PMIs to keep stagflation concerns at bay. Looking more specifically at the US, Philly Fed comes Thursday and that will give us anecdotal insight into manufacturing activity, although the national flash PMI out the next day will effectively steal the thunder from the Philly report.

Commodities, Currencies & Bonds

In Commodities, the segment was mixed last week as gold pulled back with bonds while the copper pullback continued. Meanwhile, oil futures rallied amid shifting dynamics in the energy markets. The commodity ETF, DBC, rose 1.46{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}.

Oil was in focus last week as traders watched US inventory data closely to see if the adverse effects of Hurricane Harvey on the oil industry in the Gulf were short lived. On balance, they were, as 582K b/d of output came back online, a nearly 75{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} rebound from the previous week’s Harvey-related decline. If all things had stayed the same last week, this would have been bearish for prices, but there were other moving parts last week and US production took a back seat for the first time in months. WTI rallied 4.77{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} on the week.

OPEC chatter was back in the headlines last week as the de facto leader of the cartel, Saudi Arabia, was apparently in talks with other major oil producers as well as industry experts regarding “why” the oil production cuts have not yet been effective. The short answer was exports did not fall enough to support prices, which is exactly what the Saudis are now pursuing from a policy standpoint. Looking ahead, if OPEC members can align themselves and reduce exports that would likely be a material positive for oil markets, especially given the IEA’s positively revised oil demand growth forecasts released last week, which was also a bullish tailwind for the week. For now, the market remains in a sideways range between the mid-$40s and mid-$50s, and that is expected to continue. Still, the fundamental backdrop, at the very least, got less bearish last week.

Gold declined as a part of the reflation trade seen across assets last week, with futures falling 2.04{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}. The surge in equities reduced safe-haven demand and the swift rise in bond yields weighed on the real interest rate fundamentals (as real rates rise, demand for non-yielding gold declines). Bottom line, gold is in an uptrend right now with an upside target just shy of $1400, but if the reflation money flows continue, gold will decline and the rally will likely end.

Looking at Currencies and Bonds, there was a reflation rebound in the Treasury market last week, although the Dollar Index gave back early gains on North Korea concerns and lackluster growth data. The Dollar Index rose 0.6{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}.

The big moves last week were in the bond market, so I want to start there. The 10-year Treasury yield rose 15 basis points (which is a huge one-week move) to close at 2.21{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} (a one-month high) following stronger-than-expected inflation data from China, Great Britain and the US.

Before we get too positive on yields/negative on bonds, 10-year Treasury yields remain in a downtrend on a short- and medium-term basis. A few closes above 2.27{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} would break a multi-month downtrend while a close above 2.40{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} would imply a medium-term trend change. So, despite the impressive move, we’re still far away from a sustained short/medium-term uptrend in bond yields.

Turning to currencies, the Dollar Index was higher most of the week, but got hit on Thursday and Friday following the North Korea missile launch and soft Retail Sales and Industrial Production.

The pound was by far the biggest mover vs. the dollar as it surged 2.5{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} following a stronger-than-expected CPI report, and hawkish commentary from the Bank of England. The BOE kept rates unchanged, but acknowledged that a rate hike would likely be appropriate in the “coming months,” which is sooner than expected.

Looking elsewhere, the yen fell 2.5{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} vs. the dollar thanks to strong US CPI and a continuation of yen selling following an easing of global macro tensions (North Korea missile launches won’t boost the yen anymore unless it’s toward Guam).

Bottom line, the inflation data was better last week, but it’ll take a hawkish turn from the Fed or additional strong economic data to break the dollar downtrend.


Special Reports and Editorial

CPI Update and Takeaways

The “reflation rebound” got another boost last week as headline CPI rose the most since January, and beat expectations.

To boot, core CPI met expectations at 0.2{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}, but a closer look revealed a 2.485{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} rise, so 0.015{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} away from the number being rounded up to 0.3{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e}.

Point being, this was a firm inflation number. It wasn’t a hot inflation number (core CPI is still up 1.9{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} yoy, below the Fed 2.0{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} target), but it was a firm number and it should increase the chances of another rate hike in December (although it will not make it a consensus expectation). For that to happen, the Core PCE Price Index out later this month will need to also beat estimates.

From a market standpoint, this was a pretty “Goldilocks” CPI report. It was good enough to imply we may still see a reflationary expansion, but not so strong that it makes the Fed materially more hawkish.

From a short-term standpoint, clearly there was focus on the in-line “core” number meeting expectations, as there was a mild “sell-the-news” reaction as the dollar dipped slightly and Treasury yields were flat.

But, beyond the short term, make no mistake—this is a “reflationary” number, and while one CPI report won’t cause me to make wholesale sector allocation changes, it’s safe to say we should all be on “alert” that we may need to rotate out of defensives and into more cyclical sectors (but, not yet).

Are We Seeing “Green Shoots” of A Global Reflation?

Are there “green shoots” of inflation? I reference the Bernanke comments regarding economic growth here, because very quietly we’ve seen two better-than-expected inflation numbers in two big economies.

The Chinese CPI beat (1.8{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} yoy vs. (E) 1.7{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} yoy) and the big uptick in core British CPI (2.7{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} vs. (E) 2.5{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} yoy) helped the market jump on Monday and Tuesday.

So, the logical question given these two surprise beats is, “Will US CPI also surprise markets?” The inclination is to believe in the trend, but to be clear, higher Chinese and British CPIs have no real bearing on US CPI—so strong numbers in those two reports don’t increase the likelihood of a strong CPI number.

Looking at the effects of the strong Chinese and British CPI, the clear winner there is EUFN, the European financials ETF. With the ECB committed to tapering, and British CPI putting upward pressure on yields, EUFN stands to get a potential tailwind given rising yields.

So, if you’re looking for a way to play a global reflation, EUFN remains one of the best pure plays (we recommended EUFN several months ago, but have only sporadically mentioned it since because not much had changed). Yet with European bond yields potentially rising, this reinforces the opportunity in European banks/financials.

Bottom line, I continue to believe that an economic reflation (better growth, higher inflation) remains the key to a sustained US and global stock rally. And while two numbers don’t make a trend, they were the first positive surprises we’ve had on inflation in months, and we think that’s potentially very important (if it continues).

EIA Analysis and Oil Update

Last week’s EIA report was mixed, and the market’s reaction was a bit confusing at first glance, as WTI rallied despite a larger-than-expected supply build while RBOB gasoline futures fell on the day despite a larger-than-expected draw.

On the headlines, oil stocks rose +5.9M bbls last week vs. expectations of a +3.7M bbl rise (however, this was less than the API’s reported build of +6.2M bbls, which may have invited a slight bid). Meanwhile, the EIA reported that gasoline stocks fell -8.4M bbls vs. (E) -3.0M (and API: -7.9M) which should have been bullish; however, the extreme volatility related to Hurricane Harvey is still coming unwound from the market, and pressure remained on the products relative to oil prices.

Production was the focus of the release, as more than 94{96ddfe1ef385335ceff100e1336af509b2f9add6e53d7bce1dd31667fe2af45e} of the lower 48 production gains were reversed in the week that Harvey hit Texas, and the data swing yesterday was another sizeable one. Lower 48 production rebounded 582K b/d to 8.869M b/d, falling short of the psychological 9M b/d mark that had started to weigh on markets. The rebound was solid, but we will need to see a continued rebound back through 9M in the coming weeks for the “US output headwind” to return to its pre-Harvey strength.

Bottom line, attention is turning from the EIA data, which has been the leading reason for suppressed price action in the oil market this year, to overseas policy development and international data. First, the International Energy Agency (IEA) said in their monthly report released yesterday that demand growth for 2017 would edge up 100K b/d to 1.6M b/d. Additionally, the IEA said that global supply, as well as OPEC production, fell in August, both tailwinds for oil near term.

Second, the Saudis are back in the news as they are pressing not only for production cuts, but also export reduction from members. There are some hurdles to this concept, but if they were able to get oil exports down as much as they have lowered production among those countries that agreed to the global “cut,” that could be another oil-bullish development.

Bottom line, there has been a subtle but noticeable bullish shift in global oil market dynamics over the last week, and the potential for a breakout is rising (but that has not yet been confirmed on the charts). In the very near term, OPEC headlines and global production and supply data will be more closely watched, but we cannot ignore US production statistics either, as the post-Harvey rebound could pour cold water on the bulls.

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