Deflation Shadows Bulls with Disequilibrium in Capital Markets

View from the Hill 17 November 2014

by J. Clinton Hill

Deflation is casting a larger shadow over the U.S. equity bull market and I believe that the Fed may be forced to defer raising rates if the U.S. Dollar continues its upward trajectory while weaker G-8 members (Japan, China, and Europe) maintain highly accommodative policies. As the last man standing, the USA is winning by default, but is this sustainable? Meanwhile, some market pundits regard the drop in oil prices as a long term positive influence for the economy.

Perhaps, but I am inclined to disagree as the trifecta of a stronger dollar, oil supply glut and falling demand for energy are actually the consequences of a global deflationary feedback loop. Agriculture and other export prices are declining and our booming energy sector could very well become a pocket of employment weakness. Continually lower energy prices do not benefit the global economy or its geopolitical stability (i.e. Russia or ISIS). Something has to give to restore equilibrium in the capital markets before things get ugly. Global economic growth or a truce between Shale Producers and OPEC?

Market Summary: November 10th – 14th, 2014

Market Condition

Despite the economic backdrop mentioned above, price trends for major U.S. equity indexes remain bullish. However, this week’s trading volume was @ 40% to 50% less than average weekly volume for the SP-500 (SPY), Nasdaq 100 (QQQ) and Russell 2k (IWM). Market momentum is robustly positive, but if our benchmark SPY is to be regarded as a reliable indicator for the broader markets, it is showing signs of deceleration, besides being overbought. Regardless of any of the above, the trend is our most respected friend and deserving of reverence by both traders and investors.

Bullish Events

Consumer

• USA / Retail Sales Oct-2014: By now, everyone who is anyone should know that oil and gasoline prices have decreased dramatically and are impacting the consumer sector of the economy in a positive manner. Retail Sales (excluding autos and gasoline) were up 0.6% m/m vs. estimates @ 0.5% and prior revised @ 0.1%.

Economic Growth

• Eurozone / GDP Q3-2014: GDP in the EU accelerated faster than estimated @ 0.2% qtr/qtr and 0.8% yr/yr (NSA) vs. estimates @ 0.1% qtr/qtr and 0.7% yr/yr. Germany also reported slightly better than expected GDP Flash @ 0.1% qtr/qtr and 1.2% yr/yr vs. estimates @ 0.1% qtr/qtr and 1.0% yr/yr (NSA). France’s GDP Flash came in @ 0.3% qtr/qtr vs. estimates @ 02% and prior @ 0.0% and its yr/yr growth ticked up to 0.4% vs. estimates @ 0.4% and prior @ 0.3%.

Energy

• USA / Petroleum Status Report for week of Nov-7-2014: Crude Oil Inventories dipped t0 -1.7mm barrels vs. prior @ 0.5mm barrels. With refineries operating @ 90% capacity and having recently completed their maintenance period, they stand ready to increase production. Gasoline supplies increased to 1.8mm barrels vs. prior @ -1.4mm barrels. Of course, shadowing this bullish news of higher drawdowns in crude is this existing supply gut on the market.

Industrial Activity

• India / Industrial Production Sept-2014: India’s economy displayed resiliency with a surprising report @ 2.5% vs. estimates @ 0.6% and prior revised @ 0.5%.

• Japan / Machine Orders Sept-2014: Month-over-month Machine Orders increased 2.9% vs. estimates @ -2.0% and prior @ 4.7%.

Mergers & Acquisitions

• Energy Sector: Baker Hughes (BHI) has confirmed that it is discussing a potential business combination with Haliburton (HAL).

Monetary & Fiscal Policies

• Japanese Yen / Japanese Equities: Continued weakness in the Yen, which is at a 7-year low vs. the U.S. Dollar, is boosting the outlook for its exporters. The iShares Japan ETF (EWJ) has increased 7.8% over the past 5 weeks to $11.57 from its low of $10.73. Further aiding their performance is speculation that Japan’s Prime Minister Abe Shinzo may defer the announcement of his intended national sales tax and instead call for a dissolution of parliament and new elections.

Bearish Events

Credit Markets

• China / Lending: October-2014 data for new Yuan loans disappointed with results @ 548.3bn yuan vs. estimates @ 626.4bn yuan, while its aggregate financing increased by 662.7bn yuan vs. estimates @ 887.5bn yuan.

Economic Growth

• Italy / GDP Flash Q3-2014: The recession in Europe’s major economies continues with Italy reporting quarterly growth @ -0.1% vs. estimates @ -0.1% and prior @ -0.2% while annual growth dipped to -0.4% vs. estimates @ -0.4% and prior @ -0.3%.

Employment

• USA / Jobless Claims for week of Nov-8-2014: New claims rose to 290k vs. estimates @ 280k and prior revised @ 278k. The 4-week moving average also increased to 285k vs. prior revised @ 279k.

Industrial Activity

• Italy / Industrial Production Sept-2014: Italy’s Industrial Production contracted to -0.9% m/m and -2.9% yr/yr vs. estimates @ -0.2% m/m and -0.8% yr/yr and prior @ 0.3% m/m and -0.7% yr/yr.
• Japan / Tertiary Index Sept-2014: Despite being in line with monthly expectations @ 1.0% vs. estimates @ 0.9% and prior @ -0.1%, annualized activity remains weak @ -1.5% yr/yr vs. prior @ -2.4% yr/yr.
• China / Industrial Production Oct-2014: Industrial Production only rose 0.52% vs. prior @ 0.91% on a monthly basis. The annual rate of change for October increased 7.7% vs. estimates @ 8.0% and prior @ 8.0%. Overall, the trend for the last 4 years shows a steady deceleration in positive output.

Inflation

• Japan / PPI Oct-2014: Producer Price Inflation declined -0.8% m/m vs. estimates @ -0.5% m/m and prior @ -0.1% m/m, while they rose 2.9% yr/yr vs. estimates @ 3.2% yr/yr and prior @ 3.5% yr/yr. Deflation remains a problem for the Japanese economy as prices continue to drift lower and the pace of the decline steadily increases.
• Eurozone / HCIP (Harmonized Index of Consumer Prices) Oct-2014: Monthly prices declined -0.1% vs. estimates @ 0.0% and prior @ 0.4%. Annual prices rose 0.4%, still below desired levels for satisfactory growth, vs. estimates 0.4% and prior @ 0.3%.
• Germany / CPI Oct-2014: Consumer Price Inflation declined -0.3% m/m vs. estimates @ -0.3% and prior @ -0.3%. Annually, prices rose 0.8% vs. estimates @ 0.8% and prior @ .8%. Anyone looking for Germany to fan the flames of inflationary growth throughout the EU should reconsider.
• France / CPI Oct-2014: Monthly consumer price changes remained flat @ 0.0% vs. estimates @ 0.0% and prior @ -0.4%. Annually, things were slightly better with an increase @ 0.5% vs. estimates @ 0.4% and prior @ 0.3%.
• Italy / CPI Oct-2014: Consumer prices increased 0.1% m/m vs. 0.1% estimates and prior @ 0.1%. Annually, they only rose 0.1% yr/yr vs. estimates @ .1% and prior @ 0.1%.

Real Estate

• Great Britain / Construction Sept-2014: Construction Output was @ 1.8% m/m and 3.5% yr/yr vs. estimates @ 4.0% m/m and 4.3% yr/yr.
• Canada / Housing Starts (AR) Oct-2014: While Canada’s residential real estate market is strong, it could be beginning to show some signs of weakness. Housing Starts were @ 183.6k vs. estimates @ 200k and prior revised @ 197.3k.

Neutral Events

Consumer

• China / Retail Sales Oct-2014: Retail sales are steadily declining on the mainland. This month’s report was more or less in line with estimates. Yr/yr, they were up 11.% vs. consensus @ 11.6% and prior @ 11.6%. Month/month sales were up 0.98% vs. prior @ 0.85%.

Employment

• USA / JOLTS (Jobs Openings and Labor Turnover Survey) Sept-2014: Job Openings were @ 4.73mm vs. estimates @ 4.8mm and prior revised @ 4.853mm.

• Great Britain / Labor Market Report Oct-2014: Claimant Counts decreased to -20.4k vs .estimates @ -21.7k and prior revised @ -18.4k.However, the percent of claimant count was unchanged @ 2.8% as well as ILO Unemployment @ 6.0%. Average Earnings Yr/Yr improved slightly to 1.0% vs. estimates @ 0.9% and prior @ 0.7%.

Industrial Activity

• Eurozone / Industrial Production Sept-2014: Monthly results for Industrial Production within the EU were just slightly below consensus @ 0.6% vs. estimates @ 0.7% and prior revised @ -1.4%. Annually, results were @ 0.6% vs. estimates @ 0.3% and prior revised @ -0.5%.

Real Estate

• Australia / Residential Property Prices for Q3-2014: Australia’s quarterly residential property prices came in line with consensus @ 1.5% q/q vs. estimates @ 1.5% q/q and prior @ 1.8% q/q. Annualized, prices were up 9.1% yr/yr vs. prior @ 10.1% yr/yr.

ETF Weekly Summary of Capital Markets

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