Market action continues to disappoint and it is our belief
that the lows hit in August and possibly last October could be retested. The
S&P 500 is probably headed for a level of 1820 to 1865 for an additional
decline of 3.5% to 6.0% in the near term. Relative performance on Friday sent a
signal that the opening rally was weak when the Nasdaq Composite and the
Russell 2000 were unable to hold early gains. Both indices are relative
laggards to the S&P 500 and that typically doesn’t support the “buy the dip”
thesis. Biotech’s and Pharmaceuticals are weighing on the Nasdaq, automobile
stocks are taking it in the chin mostly due to the VW scandal, and money continues
to rotate into safe haven investments such as treasuries and gold. The Vix
continues to hold support at the $20 range.
The question will present itself once we get to those levels
of whether we are in a correction phase with the likelihood of a market rally
into the end of the year or a bear market with further downside risk. We
probably won’t know the answer to that question until after it happens but
remain cognizant of the risks and diligent in the implementation of our
investment thesis.
We continue to believe that this downturn will be a
correction and not a bear market. We don’t believe the U.S. economy is heading
for a correction. In a recent Bank of America (via Business
Insider) points out, “In a note to
clients on Thursday, Bank of America's Michael Hartnett writes that while
global earnings have declined and manufacturing activity around the world has
slowed this year, we're a long way from levels that would get us thinking about
a recession. So far, global earnings are down 9.6% peak-to-trough, but in
Hartnett's view a 15% decline is needed for a "true recession-shock"
to earnings. Global manufacturing PMIs are even further away from recession-type
levels. This year global PMI — or purchasing managers index — is down 3.4% over
the prior year, but still hanging in around the 50-52 range, indicating
expansion in global manufacturing and nowhere near the 15% decline Hartnett
thinks would more seriously indicate a recession.”
The Atlanta Federal Reserve’s GDPNow
indicator has been an exceptionally accurate gauge of economic growth and
currently reads, “The GDPNow model
forecast for real GDP growth (seasonally adjusted annual rate) in the third
quarter of 2015 is 1.4 percent on September 24, down slightly from 1.5 percent
on September 17. The decline occurred on Monday when the model's forecast for
third-quarter real residential investment growth fell in response to the
existing home sales release from the National Association of Realtors.”
Further evidence according to Scott
Grannis that we are not heading into a recession is as follows, “As the chart [below] shows, the past three
recessions have been preceded by a significant rise in 2-yr swap spreads. Swap
spreads, as I explain here, are essentially barometers of systemic risk. When
they are as low as they are today—which is quite low, in fact—they tell us that
financial markets are extremely liquid and it is very easy for those who are
nervous to lay off risk on others. It's almost the opposite of the "don't
shout fire in a crowded theater" phenomenon, because those who these days
are worried and want to get out have almost no problem doing so. The problems
happen when everyone wants to get out at once, which is what leads to high swap
spreads. If everyone is feeling scared, if everyone is worried about the
ability of others to survive, if money is scarce, then the underlying
fundamentals have deteriorated significantly and there is something very wrong
out there. Today, swap spreads are telling us that the economic and financial
fundamentals are very sound; thus there is a very low probability of a
recession.”
Chemical Activity
Barometer (CAB)
We are active in the precious metals recycling space, working
with companies that extract platinum, palladium and rhodium from spent auto
catalysts. We assist in the aggregation, hedging and ultimate sale of metals to
those manufacturers that create new auto catalysts for new automobiles. One of
our biggest customers has been BASF, the chemical company so I have been
tracking various stats within the industry. I came across an index created by
the American Chemistry Council called the Chemical
Activity Barometer that has proven to be quite useful, especially in a
market environment such as the one we are in today.
Taken from their website, “American chemistry is essential to the U.S. economy. Chemistry’s early
position in the supply chain gives the American Chemistry Council (ACC) the
ability to identify emerging trends in the U.S. economy and specific sectors
outside of, but closely linked to, the business of chemistry.
The Chemical Activity
Barometer (CAB), the ACC’s first-of-its kind, leading macroeconomic indicator
will highlight the peaks and troughs in the overall U.S. economy and illuminate
potential trends in market sectors outside of chemistry. The barometer is a
critical tool for evaluating the direction of the U.S. economy.
The index provides a
longer lead (performs better) than the National Bureau of Economic Research
(NBER). The CAB leads by two to fourteen months, with an average lead of eight
months.”
How the Chemical
Activity Barometer is Created
The CAB is a composite
index which comprises indicators drawn from a range of chemicals and sectors,
including chlorine and other alkalies, pigments, plastic resins and other
selected basic industrial chemicals. It first originated through a study of the
relationship between the business cycles in the production of selected
chemicals and cycles in the larger economy during the period from 1947 to 2011.
Other specific indicators used include:
• Hours worked in
chemicals;
• Chemical company
stock data; publicly sourced, chemical price information;
• End-use (or
customer) industry sales-to-inventories; and
• Several broader
leading economic measures (building permits and ISM PMI new orders).
The CAB is constructed
using a five-step procedure similar to that used by the Conference Board to
calculate composite indexes:
1. Calculate
month-to-month changes in the component indices;
2. Adjust
month-to-month changes by multiplying them by the component’s weighting;
3. Sum the adjusted
month-to-month changes (across the components for each month);
4. Compute preliminary
levels of the composite index; and
5. Rebase the
composite index to reflect the average lead (in months) of an average 100 in
the base year (the year 2007 was used) of a reference time series (the Federal
Reserve’s Industrial Production index was used).
To update the CAB from
month to month, steps 1 through 4 are followed to incorporate the most recent
six months of data. The revisions to the base year (step 5) are made when the
Federal Reserve changes its base year for the industrial production (IP) index.
WASHINGTON (September
22, 2015) – The Chemical Activity Barometer (CAB), a leading economic indicator
created by the American Chemistry Council (ACC), dropped 0.4 percent in September,
following a revised 0.2 percent decline in August. The pattern shows a marked
deceleration, even reversal, over second quarter activity. Data is measured on
a three-month moving average (3MMA). Accounting for adjustments, the CAB
remains up 1.2 percent over this time last year, also a deceleration of annual
growth. In September 2014, the CAB logged a 4.1 percent annual gain over
September 2013. It is unlikely that growth will pick up through early 2016.
The Chemical Activity
Barometer has four primary components, each consisting of a variety of
indicators: 1) production; 2) equity prices; 3) product prices; and 4)
inventories and other indicators. During September chemical equity and product
prices were down, production was flat, and inventories moderated.
The Chemical Activity
Barometer is a leading economic indicator derived from a composite index of
chemical industry activity. The chemical industry has been found to
consistently lead the U.S. economy’s business cycle given its early position in
the supply chain, and this barometer can be used to determine turning points
and likely trends in the wider economy. Month-to-month movements can be
volatile so a three-month moving average of the barometer is provided. This
provides a more consistent and illustrative picture of national economic
trends.
Applying the CAB back
to 1919, it has been shown to provide a lead of two to 14 months, with an
average lead of eight months at cycle peaks as determined by the National
Bureau of Economic Research. The median lead was also eight months. At business
cycle troughs, the CAB leads by one to seven months, with an average lead of
four months. The median lead was three months. The CAB is rebased to the
average lead (in months) of an average 100 in the base year (the year 2012 was
used) of a reference time series. The latter is the Federal Reserve’s
Industrial Production Index.
“Business activity
cooled off in September,” said ACC Chief Economist Kevin Swift. “Chemical,
other equity, and product prices all continued to suffer, signaling a likely
slowdown in broader economic activity,” he added. “One bright spot continues to
be plastic resins, particularly those used in light vehicles. Sales of light
vehicles are on track to record a banner year, the best since 2000,” he said.
Light vehicles are a key end use market for chemistry, containing nearly $3,500
of chemistry per vehicle.
Also at play is the
ongoing decline in U.S. exports. According to Swift, global trade is lagging
behind both global industrial production and broader economic activity with
deflationary forces at play. With this month’s data, the CAB is signaling
slower gains in U.S. business activity into early 2016.
We’ll be watching the CAB for negative growth readings going
forward as another tool to assist in determining future investment strategy.
More Market Uncertainty
It’s bad enough to get confusing messages from our leaders
on Monetary Policy but on Friday with announcement of Speaker Boehner stepping down
as Speaker of the House next month adds a level of anxiety as it relates to
Fiscal Policy. While his leadership has come under scrutiny from conservatives
within his own party, his embattled position was still largely considered safe.
From the Washington
Post, “John Boehner's decision to step
down as House speaker next month almost certainly means the government won't
shut down in the days ahead. It also could -- depending on how Boehner times
his departure -- throw a big pile of chaos onto the U.S. economy. It puts the
debt ceiling back in play. Sometime late this fall, Treasury Department
officials have warned, Congress has to raise the limit on how much debt the
federal government can hold. Debt ceiling clashes have been separate and very
difficult fights from the battles over spending bills. And in this case, it's a
much bigger deal for the economy than a short-lived shut down would have been.”
“The bigger threat in
Washington's fiscal showdowns has always been the possibility that the
government could exhaust its ability to borrow money before lawmakers reach a
deal to lift the limit on national debt. If that actually happened, either the
United States would default on debt -- roiling markets worldwide -- or it would
start prioritizing who gets paid and who doesn't, from a group including Social
Security beneficiaries, government employees and contractors and active duty
members of the military. The only other option would be to pass a budget that
balances immediately - a wild improbability, in a time when even the
congressional Republican budget takes ten years to balance. "If you
actually hit the debt ceiling, that's a disaster," said Joel Prakken, who
founded the private research firm Macroeconomic Advisers.
Either default or
large, sudden spending cuts would cut deeply into growth, at a time when the
global economy still looks fairly weak. Even if Congress avoids the crisis, the
possibility can discourage people from making important economic decisions in the
meantime, until after lawmakers have made a deal and the danger has passed. As
a result, economic activity slows.
Reaching the debt
ceiling was always a risk, but Boehner's decision to step down raises new
questions for investors, businesses and workers. With Boehner holding the
gavel, at least they knew what to expect. "Changing leadership in the
middle of the process is sure to be an extra complication," Prakken said.
"We're watching it very carefully." If Boehner cuts a deal to raise
the debt limit before he goes, as some Democrats are privately hoping, those
fears go away. If he doesn't - and if his replacement comes to power vowing no
more debt limit increases ever -- there's suddenly a lot to worry about.”
This turn of events will provide additional uncertainty for a
stock market that can ill afford it at the moment. While House Majority Leader
Kevin McCarthy (R-Calif.) is largely expected to fill the role, leaders
from the Freedom Caucus have said point blank that they will not rubber stamp a
new leader into power unless the members of that caucus are convinced of the
new leaders commitment to conservative principles so important to the Tea Party
movement.
From The
Hill, “A co-founder of the
conservative Freedom Caucus has a warning for any Republican hoping to replace
outgoing Speaker John Boehner (R-Ohio): No one will get the promotion without
our blessing.
Rep. Tim Huelskamp
(R-Kan.), a sharp critic of Boehner, said Friday that there are roughly 40
members of the group — and another 20 conservatives outside of it — who won't
back any new Speaker who fails their litmus test for conservative purity. And
the group's leadership endorsements, he warned, will be “a collective,
corporate decision.”
“We have enough votes
in the House Freedom Caucus to prevent anybody from being Speaker. We will be a
voting bloc,” Huelskamp said.”
Bottom Line: Market
bias continues to be negative. We believe the market will retest the lows of
August and quite possibly October of last year. We continue to incorporate a
negative bias in our trading strategy looking for overbought situations in a down
trending market. We do not believe at this point that we are heading for a full
bear market and assume this to be a correction within the bull market. We will
be watching and planning as such but are prepared to reconfigure should our
assumptions turn out to be incorrect.
Joseph S. Kalinowski, CFA
Additional Reading
Furious
Boehner allies lash out – The Hill
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