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Frank Fahey: Market News for the Prepared Mind: 3.20–3.27.2017

March 20, 2017


“Chance favors the Prepared Mind.” – Louis Pasteur

All generalizations are dangerous, even this one.” – Alexandre Dumas fils

“If you must hold yourself up to your children as an object lesson,
hold yourself up as a warning and not as an example.” – George Bernard Shaw

“History is a vast early warning system.” – Norman Cousins

Stocks finished higher for the week. The specter of a correction – major or minor -has been a constant topic of discussion in the financial media. Market participants are presented with a litany of reason the market is “due” for a correction – Fibonacci numbers, CBOE Skew Index, low VIX, consecutive days without a 1% move in the SPX, number of days between 5% corrections, the French election in April, and Korean nuclear intentions. Listening to these admonitions can be daunting.

I acknowledge the outlier risks. These risks are a small part of the risk/reward equation. One of the most important factor in successful trading is knowing one’s response to emergency trading situations will be. I constantly ask myself “What if, what if, what if.” I always know how and where I can shut down risk. I am my own emergency first responder.

Here is an overview of the US market behavior last week and for 2017:

Index 17-Mar Change % Weekly 2016 YTD Volatility of Index
Dow Jones Industrials (DJIA) 20,914.62 11.64 0.06% 5.83% 10.33% (VXD)
S&P 500 (SPX) 2,378.25 7.00 0.30% 6.25% 11.28% (VIX)
NASDAQ 100 (NDX) 5,408.76 35.28 0.66% 11.21% 10.57% (VXN)
Russell 2000 (RUT) 1,391.50 25.86 1.89% 2.53% 14.14% (RVX)
S&P 100 (OEX) 1055.34 0.10 0.01% 6.45% 9.15% (VXO)
Crude Oil (CLK7) 49.26 0.35 0.72% -8.59% 27.45%(OVX)
CBOE Volatility Index (VIX) 11.28 (0.38) -3.26% NA

Data Source: OptionVue8

The CBOE Skew Index closed on Friday at 154.34. This is the highest closing level for the SKEW in the history of the index. The CBOE Skew Index has hit closing all time high a number of times during the current bull market run. In a nut shell, the SKEW measures the implied volatility/market pricing of deep out-of-the-money options on the S&P 500. A SKEW level of 100 in an indicator of a normal distribution of index implied volatilities. A “high” SKEW value is a shows market pricing of a large market move to the downside. In other words, the probability of outlier returns increases as the SKEW reaches higher prices.

Russell Rhoads, CBOE VIX guru sums the calculation as follows: “SKEW is calculated starting with a ratio. This ratio consists of the numerator being lower strike SPX puts and the denominator being higher strike SPX puts. For instances if the IV of the lower strike puts is 30% and the higher strike puts is 20% then the first part of the calculation is 30/20 = 1.33. This figure is then multiplied by 100 to give us the SKEW index or 1.33 x 100 results in a SKEW of 133. There are two ways for SKEW to rise, either through a higher numerator or a lower denominator. High SKEW does indicate that out of the money puts are relatively expensive, but in a low volatility environment we may get excited about an all-time high, but keep that number in a bit of context.”

SKEW monthly chart for 2011 – 2017. (Chart courtesy of Thinkorswim).

Here is an overview of last week for the VIX and related products:

Indexes Ticker 17-Mar 10-Mar Change % Change
CBOE Volatility Index VIX 11.28 11.66 (0.38) -3.26%
VIX March Future (3/22/2017) VXH7 11.775 12.525 (0.75) -5.99%
VIX April Future (4/19/2017) VXJ7 13.270 14.200 (0.93) -6.55%
VIX May Future (5/17/2017) VXK7 14.225 15.125 (0.90) -5.95%
CBOE Short-term Volatility Index VXST 9.87 10.68 (0.81) -7.58%
CBOE 3 Month Volatility Index VXV 13.92 14.38 (0.46) -3.20%
CBOE Mid-term Volatility Index (6 month) VXMT 15.85 16.33 (0.48) -2.94%
VIX of VIX VVIX 78.66 80.27 (1.61) -2.01%
CBOE SKEW Index SKEW 154.34 138.99 15.35 11.04%
Long VIX ETP’s
ProShares Ultra VIX Short Term Futures ETF UVXY 16.32 18.90 (2.58) -13.65%
iPath S&P 500 VIX Short Term Futures ETN VXX 15.81 17.01 (1.20) -7.05%
ProShares VIX Short Term Futures ETF VIXY 13.19 14.18 (0.99) -6.98%
iPath S&P 500 VIX Mid-Term Futures ETN VXZ 27.53 28.45 (0.92) -3.23%
Inverse VIX ETP’s
ProShares Short VIX Short Term Future ETF SVXY 142.15 132.58 9.57 7.22%
Daily Inverse VIX Short Term ETN XIV 73.58 68.42 5.16 7.54%

Data Source: OptionVue8

The week opens with FBI Director James Comey testifying before a House committee investigating Russian activities during the 2016 presidential election. In addition, he is expected he will provide long-awaited answers and evidence on that issue and whether President Trump was indeed wiretapped. Other highlights for the week will be a litany of speeches – 12 in all – given by members of the Fed. Any of these talks have the potential to provide a market moving slip of the tongue. The House of Representatives is scheduled to vote on Thursday on an ACA replacement.

The coming week brings reports on new home sales, existing home sales, durable goods orders. The week’s highlight will be Friday’s durable goods report, offering the latest on the factory sector. Flash PMIs for the Eurozone and Japan will give a first look at data for March. Price data and all important retail sales will be released for February in the UK.

Fedex and Lennar are the only stocks announcing earnings this week which meet my criteria. For trading the announcement. This was the second straight ho-hum earnings season. It has been my experience that the post earnings behavior of individual stocks and the associated options usually show a remarkable consistency between individual earnings announcements in movement of the underlying and change in the implied volatility of the options. This consistency within individual stocks has not been apparent the past two earnings cycles. It is as if a “new normal” is being defined.

 

Advice to stimulate your imagination:

“I took a speed-reading course and read War and Peace in twenty minutes. It involves Russia.” – Woody Allen

“Man approaches the unattainable truth through a succession of errors.” – Aldous Huxley

“The sky is falling” – Chicken little

“Buy the ticket, take the ride.” – Hunter S. Thompson

 

Monday, March 20:

Economic: Chicago Fed National Activity Index – 8:30.

International Economic: Germany PPI – 3:00AM.

Other: Chicago Federal Reserve Bank President Charles Evans speaks about current economic conditions or monetary policy in live TV interview with Fox Business News’ Maria Bartiromo during “Mornings with Maria.” – 8:30AM, Chicago Federal Reserve Bank President Charles Evans will speak at New York National Association for Business Economics Luncheon followed by audience and then media Q&A in New York – 1:10PM.

 

Tuesday, March 21:

Economic: NFIB Small Business Optimism Index – 6:00, PPI – FD – 8:30, Redbook – 8:55.

International Economic: Great Britain CPI & PPI – 5:30AM, Great Britain CBI Industrial Trends Survey – 7:00, AM, Japan – Merchandise Trade – 7:50PM.

Other: Kansas City Federal Reserve Bank President Esther George speaks on the U.S. economy and the Fed at a Women in Housing and Finance event in Washington, D.C., with audience Q&A – 12:00PM, Federal Reserve Bank of Cleveland President Loretta Mester speaks on outlook and communications at the University of Richmond in Richmond, Va., with audience and media Q&A – 6:00PM, Bank of Japan Minutes – 7:50PM, Boston Federal Reserve Bank President Eric Rosengren addresses the Twelfth Asia-Pacific High Level Meeting on Banking Supervision in Bali, Indonesia –9:45PM.

 

Wednesday, March 22:

Economic: MBA Mortgage Applications – 7:00, FHFA House Price Index – 9:00, Existing Home Sales – 10:00, EIA Petroleum Status Report – 10:30.

International Economic: Japan All Industry Index – 12:30AM.

 

Thursday, March 23:

Economic: Jobless Claims – 8:30, Bloomberg Consumer Comfort Index – 9:45, New home Sales – 10:00, EIA Natural Gas Report – 10:30, Money Supply – 4;30.

International Economic: Great Britain Retail Sales – 5:30, Great Britain CBI Distributive Trades – 7:00AM.

Other: Federal Reserve Chairman Janet Yellen gives opening keynote at Federal Reserve System Community Development Research Conference in Washington – 8:00AM, Minneapolis Federal Reserve Bank President Neel Kashkari gives afternoon remarks at Federal Reserve System Community Development Research Conference in Washington – 12:00PM, Dallas Federal Reserve Bank President Robert Kaplan participates in a discussion on the economic outlook and monetary policy at the Chicago Council on Global Affairs in Chicago, with audience and media Q&A -7:00PM.

 

Friday, March 24:

Economic: Durable Goods Orders – 8:30, PMI Composite Flash – 9:45, Baker-Hughes Rig Count – 1:00PM.

International Economic: France GDP – 3:45AM, Eurozone PMI Composite Flash – 5:00AM.

Other: Federal Reserve Bank of Chicago President Charles Evans gives opening remarks at Federal Reserve System Community Development Research Conference in Washington – 8:00AM, St. Louis Federal Reserve Bank President James Bullard speaks at a Economic Club of Memphis Economic Briefing in Memphis, Tenn., with audience and media Q&A – 8:05AM, San Francisco Federal Reserve Bank President John Williams discusses a paper titled “Safety, Liquidity, and the Natural Rate of Interest” at the Brookings Institution’s Papers on Economic Activity spring conference – 8:30AM.

 

Monday, March 27:

Economic: Dallas Fed Manufacturing Survey

International Economic: Eurozone M3 Money Supply – 5:00AM.

Other: San Francisco Federal Reserve Bank President John Williams discusses a paper titled “Safety, Liquidity, and the Natural Rate of Interest” at the Brookings Institution’s Papers on Economic Activity spring conference – 1:15PM.

 

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Hal Snarr: Supply-side or Something-d-o-o Economics? Anyone?

March 17, 2017


The way that macroeconomics is politically applied today produces a rift that separates it into demand-siders and supply-siders. Demand-siders advocate for temporary changes like tax cuts, higher government expenditures, and lower interest rates to stimulate aggregate demand when the economy is in a high-unemployment rut. The former pair of policies, however, produce budget deficits. To pay them off, demand-side economics proposes temporary changes in fiscal policy like higher tax rates or cuts in government expenditures. Although these policies pay down deficits, they are politically unpopular and have little chance of being enacted. Oddly, this is not the case with temporary interest rates hikes by the demand-siders at the Fed. In fact, most expect it since overstimulated aggregated demand needs to be pushed back down to head off the inflation that economic stimulus creates.

Supply-siders, like Robert Mundell and Art Laffer, focus on stimulating aggregate supply by setting marginal tax rates low and reducing government regulations. These policies reduce the costs of production and regulation compliance. The increase in the supply of goods and services that results lowers prices, which puts more money in the pockets of consumers. The increase in product supply also raises the demand for labor. More people working results in greater product demand. In total, as economic activity swells, tax receipts rise at lower tax rates.

The Laffer curve is the relationship between a tax rate and the revenue it generates. It is a core principle of supply-side economics. It got its name during a 1974 dinner attended by Jude Wanniski, Art Laffer, Donald Rumsfeld, and Dick Cheney. Although a 14th-century Muslim philosopher, Ibn Khaldun, discussed the relationship in The Muqaddimah, Wanniski dubbed it the Laffer curve after Laffer drew it on a napkin to show why President Ford’s tax increase would not raise tax revenue. (For the complete story, go to LafferCenter.com.)

The Laffer curve was the topic of discussion in Ferris’ economics class while he was ditching high school in the classic 1986 movie, Ferris Bueller’s Day Off. According to Ferris’ Economics Teacher, played brilliantly by Ben Stein, the Laffer curve explains why the Hawley-Smoot Tariff Act of 1930 did not work as intended:

In 1930, the Republican-controlled House of Representatives, in an effort to alleviate the effects of the… Anyone? Anyone?… the Great Depression, passed the… Anyone? Anyone? The tariff bill? The Hawley-Smoot Tariff Act? Which, anyone? Raised or lowered?… raised tariffs, in an effort to collect more revenue for the federal government. Did it work? Anyone? Anyone know the effects? It did not work…

The Laffer curve indicated by the arrow in the above picture suggests that tax receipts max out at the green dot. Tax revenue is zero at the red dot because a 100% tax rate drives all economic activity underground. Tax revenue is zero at the yellow dot since the tax rate is 0%. Raising the tax rate along the curve from the yellow dot to the green dot raises tax receipts as it reduces legitimate economic activity. Raising the tax rate from the green dot to the red dot reduces tax receipts because it drives increasingly more economic activity underground.

The Laffer curve does not imply what the “optimal tax” rate is for a given year. In the figure below, tax receipts peak at a 20% tax rate on the red Laffer curve, but at 50% and 80% on the black and blue Laffer curves. These curves simply say that tax receipts rise when the tax rate is raised from a very low level or is lowered from a very high level.

The Laffer curve also suggests there is a limit to the amount of money that government can seize from the public via taxation. Thus, elected officials interested in balancing the fiscal budget can only spend up to the tax revenue that the optimal tax rate generates. At any other tax rate, a budget deficit occurs.

The figure above can also be used to demonstrate how the optimal tax rate for a given country evolves over time. If people and capital are free to move across borders, the tax rates in other nations will affect a country’s optimal tax rate. Suppose all governments had their tax rates set at 80% at one point. If all but the government of nation A reduced their tax rates to 50%, and then to 20%, firms and citizens in nation A will eventually move to other countries to avoid paying an 80% tax rate. This implies that a country’s optimal tax rate can fall as other nations reduce their tax rates.

A temporary reduction in the tax rate has no effect on an economy’s long-run productive capacity. However, since it temporarily reduces production costs and raises disposable incomes, aggregate demand and short run aggregate supply shift outward. With long run aggregate supply unchanged, the economy ends up in an inflationary gap, the situation where unemployment is below its natural rate. Since this creates a bidding war for labor, aggregate supply falls back before the tax-rate cuts sunset. Aggregate demand retreats after the tax-rate cuts sunset.

For supply-side economics to work, low tax rates must be permanent. This is so because it creates certainty, which is important to firms as they adjust their long run plans. Instead of moving operations overseas, they expand domestically. This shifts long run and short run aggregate supply outward at a pace higher than what would have prevailed otherwise. Aggregate demand increases too after the lower tax rate boosts disposable incomes. In theory, supply-side economic policy results in no inflation over the long run and ever-expanding GDP. In practice, however, low tax rates are never permanent since Congress cannot bind future Congresses to the policies it enacts.

The above suggests that it is difficult to evaluate supply-side economics. The curve below is a crude estimate of the U.S. Laffer curve. The horizontal axis is the top marginal income tax rate (from TaxPolicyCenter.org). The vertical axis is real per capita tax revenue. It equals individual income tax receipts (from Table 2.1 of the OMB’s Historical Tables) divided by population and by the GDP Implicit Price Deflator. Since real per-capita tax receipts are in log-scale, the red line in the graph implies that per-capita tax revenue falls by 1.8% if the top marginal tax rate is raised from 39.6% to 40.6%. With 2015 income tax receipts of $1.5 trillion, or $4,785 for each of the 322 million Americans, this estimate implies that a 1-point increase in the top marginal tax rate will lower annual federal income tax receipts by $28 billion.

The graph on the left in the figure below supports the Laffer effect. After accounting for the effects of the 2001 and 2009 recessions, the trends in this graph show that people in the upper half of the income distribution generally paid an increasingly greater share of all income taxes collected as the top marginal tax rate was lowered to 39.1% in 2001, 38.6% in 2002, and 35% in 2003.

The graph above on the right shows the relationship between the growth rates in real GDP and federal tax receipts. The red line in this graph implies that each percentage point increase in economic growth increases the growth rate of tax receipts by 1.8 percentage points. This suggests that pro-growth policies push the Laffer curve upward. Thus, those who advocate for a large welfare state should perhaps become supply-siders or embrace their pro-growth policies.

Supply-side economics has its critics. Does it even exist if Congress cannot bind future Congresses to a low tax rate that it enacts? Austrian Economics regards it with the same esteem as it regards monetarism. Monetarists legitimized the Fed when they concluded that it was here to stay. Supply-siders legitimize expenditures on welfare and warfare programs and theft via income taxation when it supports the tax rate that maximizes tax receipts. When these pragmatists accepted a little government intervention, they left open the door to the creeping tyranny of the State that Murray Rothbard warns of in chapter 12 of his 1962 book, Man, Economy, and State.

The solution to the new normal, anemic economic and wage growth, that mainstream economics seems to be embracing is not more demand-side or supply-side tinkering. The solution is a restoration of the economic and personal liberty that we once cherished. In our heart of hearts, we know this to be true. The long run evidence is everywhere. Prices fall and quality rises in markets that are relatively free of government ownership, management, or subsidization. Prices rise, quality stagnates, or moral hazard is rampant in enterprises owned, regulated, managed, or subsidized by government.

 

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Frank Fahey: Market News for the Prepared Mind: 3.13-3.20.2017

March 13, 2017


“Chance favors the Prepared Mind.” -Louis Pasteur

“I had nothing to offer anybody except my own confusion.” -Jack Kerouac

“Experience is not what happens to a man; it is what a man does with what happens to him.” -Aldous Huxley

“When buying and selling are controlled by legislation, the first things to be bought and sold are legislators.” -PJ O’Rourke

The S&P 500 Index recorded its first weekly loss after six consecutive weeks of gains. A strong jobs report and the glimmerings of inflation all but guarantee a rate hike at this week’s FOMC meeting. It should be noted that job numbers which Trump described as phony, when reported by the previous administration, are now described by the current administrations as “very real,” “great again”, and “great news for American workers.” The Bureau of Labor Statistics has not changed the methodology for computing the employment numbers. As Mike Ditka once famously replied, “Who ya crappin?”

This rosy outlook is threatened by the Trump administration’s impending renegotiation of trade agreements Grumbling by fiscal hawks in the House could throw a wrench in implementation of the president’s legislative agenda. This uncertainty led to a market searching for a trend. The lack of a short-term trend has made it difficult for traders. I ignored one my of my tried and true trading maxims last week – “Doing nothing is a viable trading strategy.” I chose to flail around rather than doing nothing. The comings week’s mantra will be “Do not force trades.”

Here is an overview of the US market behavior last week and for 2017:

Index 10-Mar Change % Weekly 2016 YTD Volatility of Index
Dow Jones Industrials (DJIA) 20,902.98 (102.73) -0.49% 5.77% 11.3% (VXD)
S&P 500 (SPX) 2,371.25 (9.25) -0.39% 5.94% 11.66% (VIX)
NASDAQ 100 (NDX) 5,373.48 0.00 0.00% 10.48% 12.20% (VXN)
Russell 2000 (RUT) 1,365.64 (28.48) -2.04% 0.63% 16.33% (RVX)
S&P 100 (OEX) 1055.24 (1.60) -0.15% 6.44% 10.50% (VXO)
Crude Oil (CLJ7) 48.39 (4.81) -9.04% -10.21% 33.45%(OVX)
CBOE Volatility Index (VIX) 11.66 0.70 6.39% NA

Data Source: OptionVue8

The 2017 high for the CBOE Volatility Index is 13.28. As of Friday March 10, the VIX has gone 46 consecutive session without going above 13.50. This is the longest stretch below 13.5 since the 2008 financial crisis. The longest all time streak of 68 days below 13.50 took place from September 2006 to February. These low VIX levels are indicative of the fact the S&P 500 has gone 103 days without a 1% drop. Beware of complacency.

Here is an overview of last week for the VIX and related products:

Indexes Ticker 10-Mar 3-Mar Change % Change
CBOE Volatility Index VIX 11.66 10.96 0.70 6.39%
VIX March Future (3/22/2017) VXH7 12.525 12.825 (0.30) -2.34%
VIX April Future (4/19/2017) VXJ7 14.200 14.575 (0.38) -2.57%
VIX May Future (5/17/2017) VXK7 15.125 15.425 (0.30) -1.94%
CBOE Short-term Volatility Index VXST 10.68 8.56 2.12 24.77%
CBOE 3 Month Volatility Index VXV 14.38 14.26 0.12 0.84%
CBOE Mid-term Volatility Index (6 month) VXMT 16.33 16.25 0.08 0.49%
VIX of VIX VVIX 80.27 81.19 (0.92) -1.13%
CBOE SKEW Index SKEW 138.99 136.10 2.89 2.12%
Long VIX ETP’s
ProShares Ultra VIX Short Term Futures ETF UVXY 18.90 20.13 (1.23) -6.11%
iPath S&P 500 VIX Short Term Futures ETN VXX 17.01 17.54 (0.53) -3.02%
ProShares VIX Short Term Futures ETF VIXY 14.18 14.61 (0.43) -2.94%
iPath S&P 500 VIX Mid-Term Futures ETN VXZ 28.45 28.96 (0.51) -1.76%
Inverse VIX ETP’s
ProShares Short VIX Short Term Future ETF SVXY 132.58 128.79 3.79 2.94%
Daily Inverse VIX Short Term ETN XIV 68.42 66.42 2.00 3.01%

Data Source: OptionVue8

The week of March 13 is all about the Federal Reserve. The Federal Reserve will meet ab March 14 and March 5. It will and announce its monetary policy on Wednesday. Release of the FOMC report will be followed by a Janet Yellen press conference. Other national banks in the news this week. The Banks of Japan and England will also meet along with the Swiss National Bank. The Group of 20 (G20) will meet in Baden-Baden on March 17 and 18. China will release industrial production and retail sales data for the first two months of the year.

The earnings season has entered the quiet time. Adobe and Dollar General are the only stocks announcing earnings this week which meet my criteria. For trading the announcement. This was the second straight ho-hum earnings season. It has been my experience that the post earnings behavior of individual stocks and the associated options usually show a remarkable consistency between individual earnings announcements in movement of the underlying and change in the implied volatility of the options. This consistency within individual stocks has not been apparent the past two earnings cycles. It is as if a “new normal” is being defined.

 

Advice to stimulate your imagination:

“I took a speed-reading course and read War and Peace in twenty minutes. It involves Russia.” -Woody Allen

“I don’t mind going back to daylight saving time.”

With inflation, the hour will be the only thing I’ve saved all year.” –Victor Borge

“Buy the ticket, take the ride.” –Hunter S. Thompson

 

Monday, March 13:

Economic: Labor Market Conditions Index – 10:00.

International Economic: Japan Tertiary Index – 1:30AM, China Industrial Production and Retail Sales – 10:00PM.

 

Tuesday, March 14:

Economic: NFIB Small Business Optimism Index – 6:00, PPI – FD – 8:30, Redbook – 8:55.

International Economic: Germany CPI – 3:00AM, Eurozone Industrial Production – 6:00.

Other: FOMC meeting begins.

 

Wednesday, March 15:

Economic: MBA Mortgage Applications – 7:00, CPI – 8:30, Retail Sales – 8:30, Empire State Manufacturing Survey = 8:30, Business Inventories – 10:00, Housing Market Index 0 10:00, EIA Petroleum Status Report – 10:30.

International Economic: France CPI – 3:45AM, Great Britain Labour Market Report – 5:30AM.

Other: FOMC Meeting Announcement – 2:00, Fed Chair Press Conference – 2:30.

 

Thursday, March 16:

Economic: Housing Starts – 8:30, Jobless Claims – 8:30, Philadelphia Fed Business Outlook Survey – 8:30, Bloomberg Consumer Comfort Index – 9:45, JOLTS – 10:00, EIA Natural Gas Report – 10:30, Money Supply – 4;30.

International Economic: Eurozone HICP – 6:Am.

Other: European Central Bank (ECB) Announcement – 7:45 AM

 

Friday, March 17:

Quadruple Witching – expiration for stock index futures, stock index options, stock options and single stock futures.

Economic: Industrial Production – 9:15, Atlanta Fed Business Inflation Expectations – 10:00, Consumer Sentiment – 10:00, Leading Indicators – 10:00, Baker-Hughes Rig Count – 1:00PM.

International Economic: Eurozone Merchandise Trade – 6:00AM.

 

Monday, March 20:

Economic: Chicago Fed National Activity Index – 8:30.

International Economic: Germany PPI = 3:00AM.

Other: Chicago Federal Reserve Bank President Charles Evans will speak at New York National Association for Business Economics Luncheon followed by audience and then media Q&A in New York – 1:10PM.

 

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Hal Snarr: The end, when falling unemployment starts to bend and ascend

March 10, 2017


Recent labor market news is being hailed as the beginning of the recovery that should have been. Commentators on CNBC and the Fox Business Network are glowing over this week’s ADP report. It showed employment surging by nearly 300 thousand over the previous month. It also showed that goods producers were responsible for over a third of those new jobs. The chart below shows initial jobless claims touching a 44-year low, and unemployment dropping to its lowest rate since before the Great Recession.

Source: Federal Reserve Economic Data

Celebrating the recent labor market news is like appreciating a Monet painting from two inches away. Both are myopic views that mask the real picture. Backing away from a Monet reveals that the dots of many colors become an increasingly beautiful Victorian scene. Backing up in time from today’s lows in jobless claims and unemployment reveals that recession is around the bend when labor market news cannot get much better.

Mainstream economists embrace such news as the ideal time for the Fed to return the federal funds rate to a more normal level. Doing this heads off the inflation produced from monetary stimulus. The chart below shows how setting rates near zero for eight years and counting has put upward pressure on inflation, which is heading north after touching zero in 2015.

Source: Federal Reserve Economic Data

The recent acceleration in inflation coincides with the S&P 500’s post-election burst. After the election triggered a short-lived sell off between October 24th and Election Day, which is highlighted inside the green circle in the chart below, an epic rally followed. This rally could be from traders pricing in Trump’s pro-business policies. However, it could also be a result of bottled up inflation, in the form of the trillions of dollars in excess reserves that the Fed digitized into existence, finally being unleashed on the economy.

Source: Yahoo Finance

The problem with the mainstream view regarding rate normalization is that the Fed usually goes too far when implementing restrictive monetary policy. Why? For one, it relies on flawed aggregated data that is months, quarters, and years old. Second, the Fed seems to fear low unemployment something fierce. The chart below shows the Fed hiking the federal funds rate substantially after unemployment gets too low. In about a year’s time, the Fed hiked the rate by 50% after unemployment got too low for comfort in 1988. After unemployment dipped to 4.3% in January 1999, it hiked the rate 41% over the next couple of years. It hiked the rate by 430% in the two years following unemployment dropping to 5.6% in May 2004. Each of these hikes preceded recession, the vertical gray bars in the graph.

Source: Federal Reserve Economic Data

Whether or not excessive monetary expansion is driving the recent stock market rally, if history is correct, the Fed will respond to it and the acceleration in CPI and PCE inflation by hiking the federal funds rate. Just this week the Bloomberg World Interest Rate Probability hit 100%. That implies traders are all but certain that the Fed will hike rates.

To normalize rates, the Fed abandons its bubble inflating policy of keeping interest rates too low for far too long. Austrian Business Cycle Theory says the switch to higher rates and slowed money growth busts easy-credit booms. The 5-year and 10-year TIPS spreads, graphed below, suggest that markets could be pricing in this possibility. The recent flattening out of both graphs is suggesting that expected rate hikes are going to slow aggregate demand in the future.

Source: Federal Reserve Economic Data

The graph of excess reserves below shows the expansion may be coming to an end as well. In the aftermath of the 2008 financial crisis, the Fed raises the federal funds rate by setting interest on reserves at a higher rate. When this price floor is increased, banks are more likely to lend to the Fed (in the form of holding more reserves) than to consumers and firms. So perhaps the recent uptick in excess reserves is from banks pricing in recession that rate hikes usher in.

Source: Federal Reserve Economic Data

Low jobless claims, low unemployment, and strong job growth are signaling the Fed’s historic monetary party is coming to an end. If The Doors were still touring today, they might be singing: This is the end, my only friend, the end of the Fed’s elaborate plans, the end.

 

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Frank Fahey: Market News for the Prepared Mind: 3.6-3.13.2017

March 6, 2017


“Chance favors the Prepared Mind.” – Louis Pasteur

“Sometimes paranoia’s just having all the facts.” – William S. Burroughs

“Facts do not cease to exist because they are ignored.” – Aldous Huxley

“The market can remain irrational longer than you can remain solvent.” John Keynes

The Dow Jones Industrials and the S&P 500 are up over 6% since New Year’s Day. The tech-laden NASDAQ 100 is up nearly 10.5% for the same period. The 2009-2017 bull market is the second longest in in history, surpassed on by the bull market running from 1987-2000. In absolute terms this bull market is the third strongest in history. The market rose 582% from 1987-2000 and 267% from 1949 to 1956. This long-term movement leaves the investor in the quandary of “What to do.”

After any major market move, it is a good idea to reassess your financial goals based on age, need, and risk tolerance.
Do not be afraid to adjust and re-balance.

Here is an overview of the US market behavior last week and for 2017:

Data Source: OptionVue8

Concerns about Trump’s speech before Congress led to a Tuesday close of 12.92. The VIX ended the week closing down at 4.45% or 0.51. This was the lowest closing low since February 14. The VXST – CBOE Short-term Volatility Index – show the largest decrease, 9.03%, among the various S&P 500 volatility indexes. Fears of March 15 parliamentary elections in the Netherlands and the April 21 beginning of the French Presidential election process were not reflected in pricing of VIX futures or related products. This could change at any moment. The ephemeral nature of fear and VIX pricing guarantee this.

Here is an overview of last week for the VIX and related products:

Data Source: OptionVue8

There are just a few economic reports that will be released next week, but they do include one of the biggest – the U.S. Employment Situation report on Friday. Monday starts with Factory Orders followed by the Tuesday release of trade numbers. The focus changes to employment on Wednesday with the release of the ADP Employment Report. Employment remains the focus through Friday when February’s Employment Situation Report is released. The ECB will also release a statement after its regularly scheduled meeting on Thursday. January merchandise trade and industrial output will be released this coming week by a number of countries.

The wild card remains the US political climate. Google Trump and read the tweets from Donald Trump (@realDonaldTrump). His tweets have the capability of setting the tenor for an entire trading day.

The earnings season has entered the quiet time. This was the second straight ho-hum earnings season. It has been my experience that the post earnings behavior of individual stocks and the associated options usually show a remarkable consistency between individual earnings announcements in movement of the underlying and change in the implied volatility of the options. This consistency within individual stocks has not been apparent the past two earnings cycles. It is as if a “new normal” is being defined.

Earnings announcements are predictable volatility events providing trading opportunity. It is important to reduce the number of surprises which may occur in any trading campaign. Confirm the date and time of any company’s earnings announcement before trading any earnings announcement strategy. The most accurate source of this information is the company’s investor relations website.

I have added a scan of stocks with earnings announcements to the calendar for each day in the coming week. The scan criteria are: Closing price> $20, Implied Volatility > 25, Average daily option volume > 800 contracts. Liquidity, as determined by width of option markets and individual option contract volume, is a crucial component in successfully trading any option strategy. One of the most frustrating experiences is an inability to adjust or exit a strategy due to lack of liquidity in the market. The market uncertainty associated with the election has impacted liquidity. I found it difficult to enter earning trades last week. The bid/ask spreads seemed much larger than usual. Do not force trades in illiquid markets. Data Source for earnings: OptionVue8

Earnings Scan:   March 6 through March 17

Advice to stimulate your imagination:

“I took a speed-reading course and read War and Peace in twenty minutes. It involves Russia.” – Woody Allen

“Nobody should have any illusion about the possibility of gaining military superiority over Russia. We will never allow this to happen.” – Vladimir Putin

“If you do not actively attack the risks, they will actively attack you.” – Tom Gib

Monday March 6:

Economic: Gallup US Spending Measure – 8:30, Factory Orders – 10:00, TD-Ameritrade IMX – 12:30, Durable Goods Orders – 8:30, Dallas Fed Manufacturing Survey – 10:30.

International Economic: No major announcements.

Orders: Minneapolis Federal Reserve Bank President Neel Kashkari speaks at NABE conference in panel titled “A View from the FRB Minneapolis,” in Washington, D.C – 3:00PM.

 

Tuesday March 7:

Economic: International Trade in Goods – 8:30, Gallup US ECI – 8:30. Redbook – 8:55, EIA Petroleum Status Report – 10:30.

International Economic: Germany Manufacturers’ Orders – 2:00AM, Eurozone GDP – 5:00AM.
Other:

 

Wednesday March 8:

Economic: MBA Mortgage Applications – 7:00 ADP Employment Report – 8:15, Productivity and Costs
8:30, Wholesale Trade – 10:00, EIA Natural Gas Report – 10:30.

International Economic: Germany Industrial Production – 2:00AM, France Merchandise Trade – 2:45. China CPI & PPI – 8:30PM,

 

Thursday March 9:

Economic: Challenger Job-Cut Report – 7:30, Jobless Claims – 8:30, Gallup Good Jobs Rate – 8:30, Import and Export Prices – 8:30, Bloomberg Consumer Comfort Index – 9:45, Quarterly Services Survey – 10:00.

International Economic: No major announcements.

Other: European Central Bank (ECB) Announcement – 7:45 AM

 

Friday March 10:

Economic: February Employment Situation – 8:30, Baker-Hughes Rig Count – 1:00PM.

International Economic: Germany Merchandise Trade – 2:00AM, France Industrial Production – 3:45AM, Italy Unemployment Rate – 4:00AM, Great Britain Industrial Production – 5:30AM, Great Britain Merchandise Trade – 5:30AM.

 

Monday March 13:

Economic: Labor Market Situation – 10:00.

International Economic: Japan Tertiary Index – 1:30AM, China Industrial Production and Retail Sales – 10:00PM

 

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