Inflation Remains Below Target (excerpt)

So what is inflation doing? February’s inflation data released in yesterday’s personal income report show that the core PCED remains stuck about half a point below the Fed’s 2% target for this variable. It was up 1.4% y/y during February, and has been hovering around 1.5% for the past 10 months. However, over the past three months through February, the core PCED increased 0.9% (saar), the third consecutive reading below 1.0%. It may be hard for Fed officials to be reasonably confident that inflation is heading higher given the trend of the recent three-month inflation rates.

The persistence of the core inflation rate below 2% despite ultra-easy monetary policy in the US and elsewhere over the past six years is certainly puzzling Fed officials. Nevertheless, rather than reassessing their models of inflation, they continue to expect that a tightening labor market will boost wage inflation soon, which then will boost price inflation. In other words, they continue to bet on the Phillips Curve model.

I have argued on many occasions over the past couple of years that there may be structural forces at work (such as globalization, competition, and innovation) keeping a lid on inflation. If so, then maintaining ultra-easy monetary policy to boost wage and price inflation may instead boost asset inflation. Indeed, easy money actually may be deflationary by boosting supplies of goods and services more than the demand for them, as I’ve discussed before. Let’s have a closer look at the latest price inflation data:

(1) Inflating, disinflation, & deflating. The PCED is based on prices in the CPI, but with different weights that are more reflective of actual consumer spending. The core CPI inflation rate tends to exceed the core PCED inflation rate. The former was 1.7% y/y during February, while the latter was 1.4%.

The services components of the CPI and PCED rose 2.4% and 2.1% during February. Both have disinflated by about 50bps since early 2014. Nondurable goods prices including energy are deflating--down by about 4% y/y. Durable goods prices are also deflating--down 1.6% in the CPI and down 2.6% in the PCED.

(2) Devil in the details. One of the main reasons why services inflation is lower in the PCED than in the CPI is because medical care services inflation is lower in the former (currently 0.8%) than in the latter (currently 1.8%). Both have been disinflating in recent years. It’s not obvious to us why the Fed would want to see this component of inflation rise to achieve its 2% target.

On the other hand, rents have been rapidly inflating in recent years based on the CPI (3.5%) and PCED (3.4%), with both at the highest readings since November 2008. Again, would Fed officials cheer if they achieved their 2% inflation target by driving rent inflation still higher?

It’s not obvious how ultra-easy monetary policy is supposed to stop consumer durables prices from deflating. They’ve been doing so mostly as a result of globalization, which has lowered labor costs in manufacturing. Now automation and robotics is increasingly replacing labor in durable goods manufacturing. If the Fed’s policies succeed in boosting wage costs, manufacturers may simply replace labor with technology. This all begs the question: Why are higher durable goods prices a good thing anyway?

Today's Morning Briefing: Days of Wine & Rosés. (1) Les Misérables. (2) Rosé a day. (3) Setback for Socialists in France. (4) Six cylinders firing in Eurozone. (5) Slicing and dicing Yellen’s latest speech. (6) FOMC lowers new normal unemployment rate. (7) Waiting for Godot and Phillips? (8) From ZIRP to LIRP. (9) Liftoff coming, though it might be postponed, but will be gradual until further notice. (10) Fed puzzled by persistence of low inflation. (11) Slicing and dicing the inflation data. (12) Three-month annualized core PCED inflation rate falling below 1.0% rather than rising to 2.0%! (More for subscribers.)

Six Cylinders Firing in Eurozone (excerpt)

The ECB lowered its deposit rate for banks below zero last year to -0.1% on June 5 and to -0.2% on September 4. The result has been that banks seem to be starting to lend again. This past Friday, we learned that over the past three months through February, Eurozone loans rose €659.2 billion at an annual rate. Lending to households rose €112 billion at an annual rate, while lending to nonfinancial corporations rose €162 billion. Country data are available with more of a lag for lending, which is most likely picking up especially well in Spain and Italy, while continuing to expand in Germany and France.

In addition, there has been a significant upswing in the growth rates of the monetary aggregates in the Eurozone since early last year. M2 is up 4.0% y/y through February, the best pace since August 2013. Furthermore, in local currency terms, the EMU MSCI stock price index is up 17.8% ytd, besting all the other major MSCI indexes as follows: Japan (10.5%), UK (4.2), All-Country World (4.0), Emerging Markets (2.7), and US (0.5).

The Eurozone is benefitting from near-zero interest rates, QE, a weak euro, rising bank lending, soaring stock prices, and lower oil prices. If these six cylinders don’t revive the region’s economy, then nothing will. Of course, the possibility of a Grexit continues to hang over the Eurozone. However, the strong performance of stocks suggests that investors believe it won’t happen or it won’t matter much if it does. I tend to agree.

Today's Morning Briefing: Split Personality. (1) Catalonia and Provence. (2) Additional autonomy more likely than independence. (3) Busy pace in Spain. (4) Draghi more popular than Rajoy. (5) Bank loans starting to expand in Eurozone. (6) Monetary growth rising too. (7) Lots to fuel better growth in Eurozone. (8) Ups and downs for US economy. (9) Employment indicators are upbeat, while production-related ones are mixed. (10) Tale of four cities in Spain and in US. (11) Fed’s talking heads sending mixed message. (More for subscribers.)

Redistributing Income to Reduce Inequality (excerpt)

Income equality is easy to achieve by making nearly everyone poor. That has been and continues to be the modus operandi of totalitarian regimes. Capitalist systems are often infested with corrupt cronies, but true capitalists tend to prosper when their customers have more income to spend.

Meanwhile, the income inequality debate continues to rage on today. Progressives claim that it has worsened in recent years. They typically show a chart of real median household income, which has declined 9% from a record high of $56,900 during 1999 to $51,900 during 2013. In addition, they show that the share of income going to the top 1% is at a record high.

I’ve previously noted that the degree of income inequality may be exaggerated by demographic changes. For example, the percentage of singles in the adult population (i.e., aged 16 years and older) increased to 50% during February, up from 47% and 44% 10 and 20 years ago. Households composed of a single person tend to have lower incomes than those of a married couple. Young singles tend to be just starting their careers. Older singles tend to be retired and living on their savings, dividends, interest income, and government support. As the Baby Boomers age and their longevity increases, they could significantly distort the extent of income inequality.

Which raises an interesting question about the income inequality debate: What are we arguing about? The median household income data so frequently used to show that standards of living are stagnating for most Americans do not include government support payments. Could it be that the Progressives are right about worsening income inequality, but are ignoring the fact that the problem continues to be fixed by the very government programs that they implemented during their New Deal and Great Society heydays?

Exhibit A is the fact that government benefits now account for 17% of personal income, up from 14% 10 years ago and 12% in 2000. Labor compensation (i.e., wages, salaries, and supplements) was down to 60.7% of National Income during Q4-2014 from its recent high of 66.2% during Q4-2008 and its record-high 67.9% during Q2-1980. However, total personal income continues to hover between 95% and 100% of National Income, as it has since the start of the 1980s. That’s all because of government support payments, which increasingly have been deficit financed.

The conclusion is that Progressives who claim that income inequality has worsened have to prove that this is so after government support payments have been made, not before. If they are still right, then they will undoubtedly continue to press for even more income redistribution. However, before they do so, they should prove that the existing redistribution programs are not the cause of worsening income inequality. Conservatives argue that government benefits erode the work ethic and thereby exacerbate income inequality. I agree with that view. The debate will continue.

Today's Morning Briefing: Running of the Bond Bulls. (1) Granada & Barcelona. (2) Alcazar & Alhambra. (3) Ruling class always lives well. (4) Income inequality now and then. (5) Income inequality before and after government support. (6) Progressives need to prove that redistributing income isn’t worsening income inequality. (7) Bond bulls worrying about Pamplona scenario. (8) Yellen and Draghi want to be reasonably confident of inflation’s rebound. (9) Focus on market-weight-rated S&P 500 Industrials. (More for subscribers.)

More Signs of Life in Eurozone (excerpt)

The Eurozone’s economic indicators have perked up in recent months. The region’s flash Composite Output PMI rose to 54.1 during March, the best reading since May 2011. That’s mostly attributable to the success of ECB President Mario Draghi in dragging the euro down, which may be starting to boost Eurozone exports. He continues to do whatever it takes to hold the Eurozone together and talk the euro down.

On Monday, Draghi strongly reiterated that the ECB’s mandate is to boost inflation. In testimony before the European Parliament, he said that the central bank’s QE bond-buying program, which started earlier this month, is likely to continue for at least another 18 months until inflation stabilizes convincingly around 2%. Let’s review some of the recent Eurozone economic indicators:

(1) Orders. Manufacturing orders fell 3.2% during January in Spain, and have remained fairly flat and depressed since mid-2012. Eurozone orders show more of a recovery over this period, led by Germany.

(2) Production. The upturn in Eurozone orders has yet to be convincingly reflected in the region’s industrial production, which is up just 2.4% from the most recent low during November 2012 through January 2015. Here’s the performance derby for the major economies over this period: Germany (5.0%), Spain (2.9), France (0.9), and Italy (-1.6).

(3) Real GDP. Real GDP in the Eurozone rose 1.3% saar during Q4-2014. Here’s the performance derby for the major economies of the region from highest to lowest: Germany (2.8%), Spain (2.7), France (0.3), and Italy (-0.1).

Today's Morning Briefing: History Repeats Itself. (1) Madrid & Seville. (2) Anti-austerity protestors. (3) Hispania’s religious wars. (4) Ferdinand & Isabella and Columbus. (5) Are the Crusades making a comeback? (6) ISIS following a bloody millenarian script. (7) ISIS jihadists vs. Iran’s mullahs: Dueling apocalyptic visions. (8) Andalusian vote. (9) Rajoy’s challenge. (10) Draghi’s latest whatever-it-takes pledge. (11) Looking up in the Eurozone. (More for subscribers.)

Old Age Doesn’t Kill Bull Markets (excerpt)

A long expansion is a persuasive argument for buying stocks even though forward P/Es are historically high. Investors are likely to be willing to pay more for stocks if they perceive that the economic expansion could last, let’s say, another four years rather than another two years. The more time we have before the next recession, the more time that earnings can grow to justify currently high valuations.

If a recession is imminent, stocks should obviously be sold immediately, especially if they have historically high P/Es based on the erroneous assumption that the expansion’s longevity will be well above average. Bull markets don’t die of old age. They are killed by recessions.

Previously, I examined the Index of Coincident Indicators (CEI) for some historical guidance on the longevity of economic expansions. Let’s update the analysis:

(1) It has taken 68 months--from January 2008 through October 2013--for the CEI to fully recover from its severe decline during 2008 and early 2009. The previous five recovery periods averaged 26 months within a range of 19-33 months.

(2) The good news is that the average increase in the CEI following each of those recovery periods through the next peak was 18.6%, over an average period of 65 months within a range of 30-104 months. If we apply these averages to the current cycle, then the CEI would peak in 48 more months, during March 2019, with a substantial gain from here.

(3) For now, let’s just enjoy the fact that the CEI is at a record high, and 4.1% above its previous cyclical high during January 2008. All four components of the CEI (payroll employment, real personal income less transfer payments, industrial production, and real manufacturing and trade sales) are at record highs.

Today's Morning Briefing: Long Good Buy. (1) Stocks aren’t cheap. (2) Finding good reasons to buy them anyway. (3) Stock dividends trump bond coupons over time. (4) Abnormal monetary normalization. (5) Might this expansion last till March 2019? (6) Yellen ducks a valuation question on biotechs and social media stocks. (7) Valuations go from within historical norms to high side of them according to Yellen. (8) Forward P/Es pushing the outer limits. (9) Fisher’s warning. (More for subscribers.)

US Still Gushing Oil (excerpt)

Some of my best friends live in Texas. However, I’ve misjudged them so far. I didn’t expect that they would continue to pump more and more crude oil despite the plunge in oil prices and the freefall in the US oil rig count. Let’s drill down and see what we find:

(1) US production. US crude oil field production rose to another new high of 9.4mbd during the 3/13 week, with output still rising in both Texas (to 3.9mbd) and North Dakota (to 1.2mbd).

(2) US inventories and trade. US crude oil stocks rose 22% y/y to a record 458.5 million barrels during the week of March 13. There are mounting concerns that the US is running out of storage capacity, which could cause a further collapse in crude oil prices. US refineries are working overtime to convert crude oil--which the government bans from exporting--into refined products, which can be exported. During the 3/13 week, US exports of crude oil and petroleum products rose to a record 4.4mbd (with crude accounting for just 0.5mbd of this total), up 3.2mbd since the start of 2008.

(3) Global supply and demand. Data compiled by Oil Market Intelligence show that over the past 12 months through February, global oil supply is up 2.5% y/y, while demand is up 0.7%. I calculate a demand/supply ratio using these data. It has been highly correlated with the y/y percentage change in the price of a barrel of Brent crude oil since 2005. The ratio has been increasingly bearish since mid-2013, and was down last month to 1.01, the lowest since January 1999.

(4) Geopolitics. The Saudis triggered the latest price drop in early October of last year when they cut their oil prices rather than their production. That’s because North American frackers have flooded the world market with so much oil that the Saudis are aiming to shut them down with lower prices. It’s not working so far. The US and Canada produced 13.2mbd during February, up 4.0mbd since August 2012. That well exceeds the Saudi’s 9.6mbd.

Despite the invasion by ISIS forces, Iraqi oil production remained high at 3.4mbd during February, helping to offset the drop in Iranian output since early 2012, when sanctions were imposed on the country. The big concern is that if Iran agrees to a nuclear deal with the US, then the sanctions will be lifted. If so, there could be another 1.0mbd flooding the flooded global oil market.

Today's Morning Briefing: No Shortage of Gluts. (1) Easy money boosting supply more than demand. (2) Maxed out credit. (3) Disinflation with a whiff of deflation. (4) Flood of liquidity. (5) Yellen, Einstein, and the “insanity trade.” (6) June rate hike less certain. (7) Guidance of endless possibilities. (8) Fed funds forecast to three decimal points. (9) None- or one-and-done remain in play. (10) Texas still gushing oil. (11) Global oil demand/supply ratio still falling. (12) Trigger-happy Saudis have met their match in US frackers. (13) Iran deal would add to oil glut. (14) Natural gas analogy. (15) Lowering S&P 500 Energy to market weight while waiting for production to fall. (More for subscribers.)

Chinese Stocks Part Ways With Copper Price (excerpt)

Foreign investors were permitted to purchase shares of companies listed on the Shanghai Stock Exchange in mid-November of last year. Previously, only a select group of institutional investors who met certain qualifications had access to Shanghai's $2 trillion market. As the property market has cooled, more individual investors have turned to the stock market. The number of new stock accounts opened last week in China reached the highest level in five years. The result is that the Shanghai A-Share Index (in yuan) is up 44.4% since November 14.

Now imagine what might happen to stock prices if the Chinese authorities decided to devalue their currency. It has soared relative to the euro and the yen, and many other currencies. However, it has been edging down relative to the US dollar since early last year.

For now, China’s economy remains challenged, as growth seems to be slowing faster than expected. But that’s bullish since the monetary and fiscal authorities will respond by providing more stimulus. Interestingly, the price of copper was highly correlated with the China MSCI stock price index (in yuan) from 2009 to 2013. Since early last year, the divergence between the two has widened as the former has decreased and the latter has increased. That’s because bad news is good news for stocks, for now.

Today's Morning Briefing: Pete & Repeat. (1) Age-old riddle. (2) Abbott & Costello. (3) Seeing a pattern. (4) BOJ buying equities on dips. (5) Wage hikes in Japan. (6) Weak yen, strong Nikkei. (7) Weak euro, strong DAX. (8) Bad news in China is good news for stocks. (9) Why isn’t falling copper price depressing EM stock prices? (10) Fed remains implicitly patient. (11) Yellen sees more room for improvement before first rate hike. (12) Fed decision bullish for stocks, bonds, and commodities. Bearish for dollar. (13) Thank you, again, Godmother and Godfathers. (14) Raising odds of the Irrational Exuberance melt-up scenario. (More for subscribers.)

Ice Patch or Soft Patch? (excerpt)

Most economic indicators are seasonally adjusted. Nevertheless, the latest winter was unusually bad. It was brutally cold and pounded the Midwest and Northeast with one snowstorm after another. On Sunday, Boston received the two or so inches of snow it needed to break its all-time recorded snowfall mark for a single winter, previously set back in 1995-96 (107.9 inches). The new record, as of 7:00 p.m., March 15, 2015: 108.6 inches. Down South and Southwest, several severe ice storms disrupted travel and business.

That might explain why the Citigroup Economic Surprise Index plunged from its most recent peak of 40.0 on December 29 to -72.0 yesterday, the lowest reading since August 23, 2011. This index also fell sharply during the previous two winters from December through February. Economists face enough challenges forecasting seasonally adjusted data. So they leave weather forecasting up to meteorologists and groundhogs.

Manufacturing production seems to have hit an ice patch as well during the latest winter and the previous two. It was down 0.2% m/m during February. January's was revised down significantly from +0.2% to -0.3%. During the three months through February, factory output rose only 1.8% (saar), the weakest since March 2014. It was also weak during the previous two winters.

Today's Morning Briefing: Ice Patch or Soft Patch? (1) Chauncey Gardiner’s forecast. (2) Our forecast: Spring will start on Friday. (3) Citigroup Economic Surprise Index can be moody, and depressed during the winter. (4) Factory output slips on ice and oil. (5) Regional business surveys down, but not out. (6) Optimism should blossom in March and April. (7) Real retail sales not too bad really. (8) In the spring, there will be shopping. (9) More Texans collecting jobless insurance. (10) The downside of the dollar’s upside. (11) Fed depending on slippery data. (12) What’s the rush to normalize? (13) Focus on market-weight-rated S&P 500 housing-related industries. (More for subscribers.)

Hot Zone (excerpt)

Global investors are taking a European excursion. This year, European stocks are flying high. The EMU MSCI (in euros) is up 19.0% ytd, well ahead of the 1.5% gain in the US MSCI. Of course, this divergence has been fueled by the 12.6% ytd plunge in the euro.

The currency is down 24% from last year’s high of $1.39 to $1.06. In US dollars, the EMU MSCI is up only 4.1% ytd, and is actually down 6.8% y/y. As a result, there has been a rush to Eurozone ETFs that are hedged to the euro. There’s already chatter that the euro will fall below parity with the dollar and retest its record low since it was introduced on January 1, 1999 of $0.83 on October 25, 2000. Investors are clearly betting that currency devaluation will boost earnings and stock prices in the Eurozone as it has in Japan.

While the weaker euro is providing some lift to the region’s economy, the pace of economic expansion remains slow. Manufacturing orders rose 2.5% m/m (2.3% y/y) during December. Domestic orders remain relatively flat, as they have been since mid-2012. However, foreign orders to both Eurozone and non-Eurozone customers are robust, with the former rising to the best pace since April 2008 while the latter is at a record high. Industrial production fell 0.1% m/m during January. It was up only 1.2% y/y. It remains relatively flat, as it has been since mid-2012.

Today's Morning Briefing: European Excursion. (1) Hot zone. (2) Taking a Spanish break during a working vacation. (3) Rush to Eurozone euro-hedged ETFs. (4) Will devaluation boost earnings in Eurozone as it did in Japan? (5) Latest orders and production data still showing lackluster recovery in Eurozone. (6) P/E-led rally as earnings estimates remain depressed in Eurozone. (7) Greeks heading for a “Grexident?” (8) US production soft patch: The weather or the dollar? (9) Earnings soft patch: Oil and the dollar. (10) Forward earnings diverging a bit by market cap. (More for subscribers.)

Draghi’s Latest Pledge Pushes Yields Closer to Zero (excerpt)

Among the most breath-taking moves attributable to central bank intervention, of course, is the plunge in bond yields, especially in the Eurozone. The Spanish and Italian 10-year government bond yields are both down to 1.15% from peaks of 7.61% and 6.61% during July 24, 2012--just before ECB President Mario Draghi’s whatever-it-takes pledge two days later. Astonishingly, the German yield is down to 0.25%, which is below the Japanese yield of 0.37%.

Throughout Europe and Japan, the short and intermediate portions of yield curves are actually negative. That means that fiscal deficits can be funded with bonds that are worth less when they mature. It’s an extraordinary development. Draghi’s latest hat trick was to say the following at his 3/5 press conference: “We observe that almost half of the euro bonds are outside the euro area and we also observe that the average weighted price of bonds in the 2 to 30-year maturity is well above par. It’s exactly 124%. So how negative do we go? Until the deposit rate.” That rate was lowered to minus 0.2% from minus 0.1% on September 4, 2014.

In other words, the ECB as a buyer of bonds under its QE program won’t pay less than minus 0.2% for bonds! By saying so, Draghi in effect is pegging the entire yield curve to that sub-zero yield. The question has been raised about the necessity of QE in the Eurozone given how low bond yields are today. The answer is that Draghi wants to keep the euro down, and send it even lower. Of course, he would never admit that publicly since central bankers always deny charges of currency manipulation.

The obvious outlier is the US Treasury yield curve. That’s because US yields are torn between the gravitational pull of near zero (plus or minus) European and Japanese yields and the prospect of Fed rate hikes. If Fed officials signal that the strong dollar has become a major concern that might lead to a more patient pace of normalization, then the melt-up in US bond prices is likely to continue on a catch-up basis with comparable overseas securities.

Today's Morning Briefing: Global Melt-Ups & Meltdowns. (1) Investments 101. (2) Don’t fight them, join them. (3) Transmission mechanisms: wealth effect and currency depreciation. (4) Melt-ups in assets and meltdowns in currencies and commodities. (5) Soaring dollar is equivalent to Fed rate hike, and reduces odds of monetary normalization. (6) Will FOMC statement delete “patient” or change it to “patient pace”? (7) The Age of Central Banks. (8) Breath-taking moves in financial, currency, and commodity markets. (9) Draghi’s latest pledge. (10) If Fed goes for “one-and-done” due to soaring dollar, look for melt-ups in US stocks and bonds. (11) “Foxcatcher” (-). (More for subscribers.)

Chinese Stocks: Year of the Bull?

This is the Year of the Goat in China. This could be the year of the bull for stock investors given the big 32.8% gain in the Shanghai A-Share Index (in yuan) since November 14 of last year. However, the China MSCI stock index (also in yuan) is up only 3.2% over this period. Nevertheless, both are impressive gains given the concerns discussed above. Let’s have a closer look:

(1) Easy money. Global investors are on the prowl for another opportunity to win big as they did in Japan when Abenomics was introduced. They are looking for a weak economy that will force the central bank to ease. They’ve moved from Japan to the Eurozone over the past couple of years. Now they may be positioning for more gains in China.

Sure enough, the PBOC cut its official loan rate from 6.00% to 5.60% on November 21 last year, the first such move in two years. The one-year deposit rate was lowered from 3.00% to 2.75%. The central bank did it again on February 28, lowering by a quarter percentage point both the benchmark one-year loan rate, to 5.35%, and the one-year deposit rate, to 2.50%. At the beginning of February, the PBOC lowered bank reserve requirements.

(2) Foreign buying. Another reason why the Shanghai A-Share Index soared is the fact that foreign investors were permitted to purchase shares of companies listed on the Shanghai Stock Exchange in mid-November of last year. Previously, only a select group of institutional investors who met certain qualifications had access to Shanghai's $2 trillion market.

(3) Locals buying. As the property market has cooled, more individual investors have turned to the stock market. The number of new stock accounts opened last week in China reached the highest level in five years, while in February, 20 new accounts were opened under the Qualified Foreign Institutional Investor (QFII) scheme, a sign of growing interest by foreign investors, state media reported yesterday.

(4) Relatively cheap. I calculated the forward P/Es for the MSCI and Shanghai A-Shares indexes. The former (which has 139 companies) is at 10.0, while the latter (which has 591 companies) is at 11.8. Those are relatively cheap valuation multiples compared to the MSCIs for the US (17.5), Eurozone (15.4), UK (15.4), and Japan (14.9).

At the end of February, the forward profit margin of the Shanghai A-Share was at 7.9%, while it was 3.6% for the MSCI. The forward earnings for both indexes have been relatively flat for the past year. In other words, it’s hard to get excited about either index based on earnings.

Today's Morning Briefing: Under the Dome. (1) Chai and Spielberg. (2) Pollution is a major health hazard in China. (3) “Maternity tourism.” (4) Premier Li’s state-of-the-nation speech. (5) Struggling to rebalance away from infrastructure to more consumption. (6) PPI deflation signals excess capacity. (7) Debt, corruption, and pollution all linked together in China. (8) Insane increase in bank loans. (9) Hard to breathe in China’s version of Heaven on Earth. (10) Utopians can be dangerous. (11) The Year of the Goat or the Bull? (12) Easy money attracting global investors. (13) China is relatively cheap, but earnings are flat-lining. (More for subscribers.)

Almighty Dollar Risky for US (except)

There are risks for the US in a soaring dollar. It gives a competitive advantage to our trading partners. That means it stimulates our imports while depressing our exports. In addition, it depresses the dollar value of profits from overseas. Profits drive employment and capital spending. So weaker profits attributable to the strong dollar can slow the economy down.

There is a strong correlation between the y/y growth rates in S&P 500 forward earnings and aggregate weekly hours worked in private industry. The y/y growth rate of capital spending in real GDP is also driven by this profits cycle. Forward earnings was up just 1.4% y/y at the beginning of March, down from 8.2% at the end of September. That’s the lowest growth rate since December 2009. Before we get all panicky, keep in mind that this drop was mostly attributable to the S&P 500 Energy sector, which currently accounts for just 5.3% of S&P 500 forward earnings.

The bottom line is that the Fed has a problem. The FOMC rarely considers the impact of the dollar on the US economy. The subject is almost never discussed at the FOMC meetings. The members of the committee may need to give more weight to the soaring dollar in their deliberations. They have three options for the rest of this year. They can proceed to normalize monetary policy and raise interest rates a few times this year. “One-and-done” is another option. So is “none-and-done.” I still believe that the last two are more likely than normalization given that the dollar will continue to soar if the Fed doesn’t back off.

Today's Morning Briefing: Almighty Dollar. (1) Trade-weighted dollar started lift-off last summer and has achieved escape velocity. (2) ECB and BOJ adding rocket fuel to dollar. (3) Euro/dollar parity, here we come. (4) Yen down 36%. (5) Commodity producers jumping off currency cliff. (6) Break out in the dollar could break something. (7) Foreign earnings could depress the profits cycle which drives employment and capital spending. (8) Odds still favor “one-and-done” or “none-and-done” for Fed if dollar soars higher. (9) Searching for oil-drop winners and strong-dollar losers. (More for subscribers.)

Transportation Stocks Running Out of Steam? (excerpt)

S&P 500 Transportation stocks have been among the outperformers during the current bull market. I have recommended overweighting them for quite some time. I lowered my rating to market weight on February 17 because I simply don’t expect that they will continue to outperform. Indeed, the index is down 5% from its record high on January 22 despite the big drop in fuel costs since last summer.

Analysts’ consensus earnings expectations for 2015 and 2016 rose late last year to reflect the drop in fuel costs. They now expect earnings to grow 22.2% this year and 12.7% next year. The Net Earnings Revisions Index (NERI) dropped sharply last month to 1.7%, following eight months of double-digit NERIs, and the lowest since May 2014.

Today's Morning Briefing: Inconclusive Trade Stats. (1) Mixed picture. (2) World production and volume of exports growing at slow paces. (3) Strong Chinese exports bullish sign for global growth. (4) Weak Chinese imports not so bullish for China and global growth. (5) German data on weak side during January after gaining in December. (6) Eurozone exports also suggest good global economy, but imports signal bad regional one. (7) Yen is boosting Japanese exports. (8) US trade data suggest strong dollar may clip exports. (9) US trucking index rose to record high during January, while port strike might have weighed on railcar loadings. (10) Transportation stocks unlikely to continue outperforming. (11) Focus on market-weight-rated S&P 500 Transportation. (More for subscribers.)

An Inflection Point for Bonds? (excerpt)

The 2/27 WSJ reported that after Fed Chair Janet Yellen’s congressional testimony on February 24 and 25, Fed “officials fanned out to drive home the message that they are likely to start raising short-term interest rates later this year.” They included Fed Vice Chairman Stanley Fischer and the leaders of the Atlanta, St. Louis, and San Francisco Fed banks.

I’m sure we will shortly hear from many of them about their reaction to the latest stronger-than-expected employment report. In his Barron’s column this week, Randy Forsyth probably expressed the widespread consensus view: “When the Fed’s policy-setting panel gathers on March 17 and 18, there’s a good chance the ‘patient’ will be gone. That would leave the path open for the FOMC to lift its target for the federal-funds rate at the June 16-17 confab from the near-zero level that has prevailed since the crisis days of December 2008.”

That assessment was instantly discounted in the bond market on Friday, when the 10-year Treasury yield rose to 2.24%, the year’s high and the highest since December 26. Interestingly, the Merrill Lynch corporate junk bond yield edged up to 6.16% on Friday, but remains well below the recent high of 7.28% on December 16, when there were widespread fears of a significant global slowdown. The yield spread between Merrill’s composite and the 10-year Treasury is highly correlated with the S&P 500’s VIX, which remained low at 15.2 on Friday despite the selloff in the stock market.

By the way, in the 2/23 Morning Briefing, I listed eight reasons why bond yields were rebounding since the start of February. The bearish eight reasons mostly continued to drive yields higher since then. However, I’m still not convinced that the secular bull market in bonds is over yet. I will have second thoughts if the 10-year Treasury rises above 2.50%.

Today's Morning Briefing: New & Old Normals. (1) Lots of good news sends stock prices lower. (2) Fed diverging from central bank norm. (3) The strong dollar weakens earnings. (4) Sideways may be path of least resistance. (5) Time should be on the side of the bulls. (6) While Fed is normalizing, other centrals banks continue to abnormalize. (7) US bonds reverse course. (8) Draghi’s mission-almost-accomplished press conference. (9) BOJ still well below inflation target despite massive yen depreciation. (10) Chinese Premier sounds the alarm by sounding alarmed. (11) Earned Income Proxy at new high. (12) Why aren’t employment gains boosting wages? (13) Labor force dropouts at record high. (More for subscribers.)

Earnings: More or Less Erosion?

At the end of last year and early this year, I lowered my earnings forecasts for this year and next year by a total of $10 each to $120 per share in 2015 and $130 in 2016 for the S&P 500. I did so in response to the plunge in oil prices, which depressed earnings for the Energy sector, and the jump in the trade-weighted dollar, which depressed earnings for corporations with significant overseas earnings.

Industry analysts did the same. Their estimate for this year fell from $133.04 at the end of September to $120.58 currently. Their estimate for 2016 is down from $145.94 to $136.68 over this same period. As a result, S&P 500 forward earnings peaked at a record $129.57 during the week of October 10, and was down to $123.37 at the end of last month.

Is the worst over? It probably is if the price of oil is stabilizing, and if the same can be said for the dollar. The dollar could continue to strengthen if the Fed starts raising interest rates at mid-year, as widely expected. However, this move may be widely discounted. Let’s have a closer look at the latest analysts’ consensus earnings estimates:

(1) Forward earnings. Forward earnings rose last week for the first time since the week of January 2 as the estimate for 2016 stopped falling while the 2015 estimate fell at a slower pace. The estimates for all four quarters of this year continued to fall, but all did so at a slower pace last week. The y/y growth rates are still expected to be negative for Q1 (-3.4%) and Q2 (-1.9). However, buybacks could push those growth rates up to marginally positive readings.

(2) Sector earnings. I am now tracking 2015 and 2016 consensus earnings for the 10 sectors of the S&P 500. The Energy sector had the highest earnings per share of all of them until late last year, when it plunged below six of them for this year and four of them for next year. It fell again in mid-February, but at a slower pace as it started to reflect the recent rebound in the price of oil.

There has been some modest erosion recently in the 2015 earnings estimates for Industrials, Consumer Staples, and Materials. This is most likely attributable to the stronger dollar, though IT estimates are holding up well.

Today's Morning Briefing: Tank Tops. (1) Oil patch is less slippery slope. (2) Less unnerved about global economy. (3) Saudis giveth and taketh. (4) Record US crude oil inventories topping storage tanks. (5) US wells still gushing crude. (6) Rigs down for the count. (7) Usage rising. (8) Global economy looking up according to Eurozone retail sales and global PMI. (9) Asian central banks spiking the punch bowl. (10) Game of Thrones. (11) Churchill or bust. (12) Is the worst over for earnings? (13) Some sector erosion besides Energy. (More for subscribers.)

Bull Market in Buybacks (excerpt)

I was early in recognizing that the current bull market was driven by corporate share repurchases. During the first two to three years of the bull market, bearish strategists contended that stocks were on a “sugar high.” They couldn’t fathom why stock prices were rising when there were no obvious buyers among retail, institutional, and foreign buyers. They obviously missed corporate buyers.

Share repurchases by the S&P 500 corporations totaled a staggering $2.1 trillion from Q1-2009 through the latest available data, for Q3-2014. Over the same period through Q4-2014, these companies paid dividends of $1.6 trillion. Many investors tend to reinvest dividends in the stock market. The S&P 500 has been highly correlated with the sum of these two cash flows.

S&P 500 corporations have had an incentive to buy back their shares ever since 2004, when corporate bond yields consistently fell below the forward earnings yield of the composite. Today, Moody’s Seasoned Aaa corporate bond yield is down to an historical low of 3.8%, while the forward earnings yield is at 5.8%. In other words, the Fed’s Stock Valuation Model has been more relevant to corporate finance behavior than investor behavior in the equity market.

My friend Lazlo Birinyi reports that buyback authorizations for February 2015--of $118.32 billion--were the strongest for any February on record as well as for any month ever, in dollar terms. While analysts expect H1-2015 earnings growth to be negative y/y for the S&P 500, I think buybacks could help to turn S&P 500 earnings growth positive.

Today's Morning Briefing: Bull Market in Buybacks. (1) Early bulls. (2) Lots of buybacks and dividends. (3) Fed’s Stock Valuation Model really a model for corporate finance rather than asset allocation. (4) Interest margins and profits. (5) Gross vs. net corporate bond issuance. (6) Birinyi’s numbers. (7) Other inflows. (8) QE myth and fact. (9) The scary correlation. (10) Buybacks-led melt-up? (11) What will stop buybacks? (12) Focus on market-weight-rated S&P 500 auto-related industries. (More for subscribers.)

Consumers Spending Less on Gas, More on Health (excerpt)

Last week, I observed that while consumers are spending less of their budgets on gasoline, they are spending more on health care. The latest data through January show that the percentage of current-dollar consumption for gasoline plunged from last year’s high of 3.2% to 2.1% in January. Consumers saved $133 billion (saar) on gasoline over this period.

On the other hand, the percentage of their outlays for health care goods and services rose from last year’s low of 20.0% during March to 20.6% during January. I received lots of inquiries about this topic. Most readers want to know if this is attributable to Obamacare, which seems to have raised health insurance premiums, deductibles, and copays. I think so, but I don’t have the data to corroborate this conjecture.

Health care consumption includes spending paid for by both insurance and government programs, as well as out-of-pocket costs. Presumably and anecdotally, the latter have risen sharply. However, that wouldn’t necessarily bloat overall spending, though more out-of-pocket outlays would depress spending on other goods and services.

Today's Morning Briefing: Purchasing Power. (1) American consumers on dopamine. (2) Investors shopping for shoppers. (3) Few bargains left among Consumer Discretionary stocks. (4) Real wages and salaries and inflation-adjusted retail sales at new highs. (5) Rent inflation is a problem, but only for renters. (6) Did Obamacare boost health care spending at the expense of sales of other goods and services? (7) Out-of-pocket costs hard to measure. (8) Texans aren’t as depressed as they should be. (More for subscribers.)

Eurozone Turning the Corner? (excerpt)

The question is whether the economic fundamentals in the Eurozone are improving enough to boost earnings. Investors seem to think so, and we are coming around to the same opinion. Let’s review the latest relatively upbeat financial indicators:

(1) Bank lending. Over the past three months through January, private-sector lending by monetary financial institutions (MFIs) jumped to €612.8 billion at an annual rate, the best pace since October 2008. Unfortunately, €422.8 billion of that total was lending mostly to other financial institutions. Nevertheless, lending to nonfinancial corporations was €88.8 billion over this three-month period, the first positive reading since November 2011. Mortgage lending rose to €114.0 billion, the most since June 2011.

Last June, the ECB became the largest central bank to experiment with a negative rate on bank deposits at the central bank. Last September, it cut the rate on bank deposits deeper into negative territory, to -0.2% from -0.1%. This may be starting to have the desired effect of stimulating lending.

(2) Monetary aggregates. The growth rates of M1, M2, and M3 slowed significantly during 2013 through early 2014. They’ve rebounded since then. During January of this year, M1 is up 9.0% y/y, the highest since June 2010. M2 is 4.0% higher than a year ago, up from a recent low of 2.0% during April 2014. Negative money market rates in the Eurozone may be causing investors to park more of their liquid assets in bank deposits, providing more lendable funds to the banks.

Today's Morning Briefing: Game of Thrones. (1) Low-intensity vs. high-intensity crises. (2) Putin’s latest gambit aimed at provoking Israel to attack Iran? (3) Will the Iranian deal bomb or lead to a bomb? (4) The Prime Minister’s existential speech. (5) Eurozone is back in fashion. (6) Cheaper for a reason? (7) Will the fundamentals improve enough to boost earnings? (8) Several upbeat indicators in the Eurozone. (9) Most Eurozone sectors are cheaper than in the US. (10) Ice patch or soft patch? Business surveys were very weak in the US last month. (11) “Leviathan” (+ + +). (More for subscribers.)