Pent-Up Demand or Return to Frugality?

Key economic indicators and capital market events for November 2013 by Joe Terranova, Chief Market Strategist
Markets are at elevated levels with two months to go in the year, including only 20 trading days in November. This months big question: What is the state of the consumer? Does there continue to be pent-up demand, or do we start to see a return to frugality? To this point, strong growth in home prices and equity markets has moved consumers to spend. However, did this falls D.C. dysfunction have a negative impact on spending, particularly by the afuent consumer? During November, which happens to include the most important shopping day of the year, Black Friday, well start to get a sense of that answer from key economic data, as well as the earnings from many consumer discretionary companies reporting this month.

November 2013
Sunday Monday Tuesday Wednesday Thursday Friday
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Saturday
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U.S. ISM Manufacturing Market Reaction to China PMI U.S. Motor Vehicle Sales
3 10:00 AM: 4 10:00 AM: 5 6 7 8 8:30 AM: 9

U.S. Factory Orders (Aug./Sept.)

U.S. ISM NonManufacturing

ECB Monetary Policy Meeting China Trade Balance

U.S. Labor Report

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Veterans Day Bond Market Closed Stock Market Reaction to Key China Data
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U.S. NFIB Small Business Optimism

U.S. CPI

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U.S. Retail Sales

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U.S. Philly Fed Manufacturing

FOMC Minutes
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U.S. Housing Starts (Sept./Oct.)

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Thanksgiving Markets Closed

U.S. Black Friday

U.S. S&P Case-Shiller HPI

Times shown are Eastern Time.

November indicators / events of note:

U.S. ISM Manufacturing Issued by the Institute of Supply Management, this report provides an inuential monthly measure of the health of U.S. manufacturing based on an in-depth survey of 300 manufacturing rms. An index value of 50 is the dividing line between an expanding or slowing economy. Data released is for the previous month.

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Consistent with my Q4 playbook message, Two Plus Two Equals Four, were at the point where future market direction will be determined by pure numbers, not the words of central bankers, scal policy makers, or corporate CEOs. Data and statistics are whats most important. Applying that to manufacturing, Q3 ISM data (September 56.2, August 55.7, July 55.4) showed dramatic improvement over Q2 (June 50.9, May 49.0, April 50.7), which decelerated signicantly from Q1 (March 51.3, February 54.2, January 53.1). The Q3 improvement conrms that the Q2 decline was, in fact, transitory and due to the sequester. Year to date, average monthly ISM stands at 52.9. Markets get the opportunity to react to China PMI on Friday, November 1, following release of this data the night before. China PMI for August and September was 51.0 and 51.1, and we have not had two consecutive readings of 51 or higher since March and April 2012. Prior to August, China PMI had been between 49.2 and 50.9 for 15 consecutive months. With Octobers PMI, well be looking to see if China is showing signs of a modest resurrection in manufacturing growth. If there is a reversal in the current positive trend, the market will most likely react unfavorably to the news. Year to date, pent-up demand has been fueling strong vehicle sales. In September, total sales were 15.21 million, coming off a very strong August gure of 16.02 million, the highest level since the 16.19 million reported for October 2007. Was the September data nothing more than moderation? Vehicle sales havent dropped below 15 million since October 2012, so a print below that number would be concerning. Due to the government shutdown which delayed release of last months factory orders report, August and September data will be reported together. Because this report tends to be volatile, you get a better read by looking at data for consecutive months, and well have that advantage this month. In essence, this report is a preview of the durable goods report that will be released on the 27th. In particular, well want to look at new orders, shipments, and inventories. Inventories is an important metric to watch because that will tell us if demand is shrinking. In the last report, July factory orders showed a slight slip, down 2.4%.
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Market Reaction to China PMI China PMI (purchasing managers index) provides a monthly gauge of Chinas manufacturing sector which, when combined with the monthly U.S. ISM Manufacturing Index value, gives a clear picture of global manufacturing health. A PMI value above 50 indicates growth, below 50 contraction.

U.S. Motor Vehicle Sales Motor vehicle sales are an important component of consumer spending and a measure of economic health. This report provides prior month sales data for domestically produced cars and light duty trucks.

U.S. Factory Orders This monthly report from the U.S. Census Bureau gives a sense of the overall health of the U.S. manufacturing sector and includes data for durable and non-durable goods, including new factory orders, inventories, total shipments, and unlled orders.

November indicators / events of note:

U.S. ISM Non-Manufacturing The index is based on surveys of nearly 400 rms from 60 sectors across the U.S., including agriculture, mining, construction, transportation, communications, wholesale trade, and retail trade. The index provides the economic backdrop for the various markets, and consists of data on business activity, new orders, employment, and supplier deliveries.

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This report on the services side of the economy will give us more data on the consumer. Augusts reading came in at 58.6, one of the highest levels since 2005, following a 56.0 in July. In September, the reading was 55.4, still higher than the readings during the sequester-driven slowdown in Q2 (June 52.8, May 53.7, April53.1). Will Octobers reading go back down to Q2 levels, or was Septembers reading a one-month moderation? This will be the most relevant ECB meeting since February when ECB President Mario Draghi used verbal intervention to walk the euro currency down from 1.3711 to between 1.2750 and 1.3450 for the better part of March to late August. This depreciation was largely benecial to helping Europes export economy and the recovery were seeing in core and periphery countries. However, we now have the euro challenging 1.38, getting back to levels last seen in late 2011 and thats concerning. The euro is acting as the anti-dollar as the Street recognizes that Fed tapering, which was expected in September, has now been pushed back to March 2014 at the earliest. Once again, Draghi will have to use verbal intervention, and potentially more, to arrest the euros advance. The release of Chinas trade balance report is not as important as the ECB meeting that day but is still worth keeping an eye on. Last months exports data caused concern, however, some of that reaction may have been related to the D.C. dysfunction going on at the time. Last month, China exports contracted 0.3%, and there was a trade balance surplus of $15.21 billion. This month well want to see an uptick in exports and at least $10 billion in surplus. As I wrote in my blog about last months report, exports to India fell 10.7%, exports to Brazil fell 5%, exports to the U.S. moderated, and there was signicant moderation in exports to Southeast Asia. I would argue that this months report is less about China than it is about its trading partners. Last months government shutdown pushed back the release of the October jobs report to November 8. In the September report, unemployment dropped to 7.2%, and both the headline and private payroll numbers were very disappointing. The rolling 12-month average for headline jobs added is at its weakest point, dropping to 185,000, with the 6-month average down to 162,000, and the 3-month average down to 143,000. Labor challenges remain the biggest conundrum for the economy but I expect that this is a secular issue more than anything else.
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ECB Monetary Policy Meeting The European Central Bank (ECB) releases its monetary policy announcement on November 7.

China Trade Balance Chinas monthly trade report provides important import, export, and interest rate data on the Chinese economy.

U.S. Labor Report Private payroll data is part of the Labor Departments monthly U.S. Employment Situation report. This data gives the true employment story, is the best gauge of the economys direction, and has the power to move markets.

November indicators / events of note:

Stock Market Reaction to Key China Data (Released the Prior Weekend) China releases key data the weekend of November 9-10 including CPI, PPI, retail sales, and industrial production.

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On Monday, November 11, well get the markets reaction to the data released by China over the weekend. I am particularly interested in the ination (CPI) reading. Last month, China CPI jumped to 3.1% from 2.6% in August. Food was a critical piece of the jump, rising 6.1% after a 4.7% rise in August, while non-food CPI was only up 1.6%. Much of the increase was the result of regional ooding which decimated food supplies and elevated pricing. I still expect and want to see the Peoples Bank of Chinas 3.5% target ination rate achieved. I also believe were nowhere near the point of seeing any impact from changing scal and monetary policy. During earlier bouts of D.C. dysfunction in 2011 and 2012, these index readings were highly successful at identifying the overall sentiment of the small business community. For instance, the index was at 94.5 in February 2011, but moderated to 88.1 in August that year during the heated debt ceiling debate. In October 2012, the reading had risen back to 93.1, but as the scal cliff neared, it went to 87.5 in November, 88.0 in December, and 88.9 in January 2013. Its important to monitor this index this month to see if theres a similar dynamic because past contractions have also forecast a moderation in GDP growth. The last three months have been really solid (September 93.9, August 94.0, July 94.1), but if we see a slip this month, Im concerned the growth acceleration Ive been expecting is not looking as good. We can only hope for an uptick in U.S. CPI. While we have seen better readings and the Federal Reserve has acknowledged that we are nowhere near moving out of the somewhat deationary environment. CPI touched 2% in July and 1.5% in August, on a year-on-year basis. Those gures are uncomfortably low, and we havent been able to get better than a 2% print over the last 11 months. Just like the small business optimism index, if we see a slip in the CPI, Ill be concerned about economic growth. Retail sales gained 0.4% in July and 0.2% in August, month on month. While not robust, retail sales continue to suggest consumers are choosing to spend over frugality. There was only one negative print in the last 14 months in March of this year when sales declined 0.3% following an incredibly strong 1.1% gain in February.

U.S. NFIB Small Business Optimism Index This index offers insight on the health of the small business sector and is based on a survey conducted by the National Federation of Independent Business (NFIB) of its members. Results are for the previous month.

U.S. Consumer Pricing Index (CPI) The Consumer Price Index measures the price of goods and services paid by consumers and is therefore considered to be a key indicator of ination.

U.S. Retail Sales Retail sales data are released monthly by the U.S. Department of Commerce, providing total sales receipts for durable and nondurable goods. Consumer spending accounts for two-thirds of GDP and is therefore a key element in economic growth. Each report is based on the previous months data.

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November indicators / events of note:

FOMC Minutes The Federal Open Market Committee (FOMC) releases the minutes from its October meeting.

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I dont expect the October FOMC minutes to provide anything highly insightful in terms of the economy. However, the dialogue of the minutes may hint at a change in Fed tone in light of the upcoming change in leadership. With Janet Yellen seen as more of a dove than the current chair, will the dovish argument be emboldened as Dr. Bernanke prepares to step back? There has been a very high correlation between the Philly Fed and the S&P 500 Index in the last few months. In June, the Philly Fed was 12.5, then jumped to 19.8 in July, and the S&P 500 rallied. Then, when the Philly Fed was at 9.3 in August, the S&P 500 moderated. In September, the Philly Fed was 22.3, and the equity market rallied again. The Philly Fed remained strong in October, coming in at 19.8. The last week of November might be the most important in the month as housing data delayed by the government shutdown gets released. On the 26th, well get housing starts for both September and October, as well as home prices for September. Housing starts were 891,000 in August and 883,000 in July. Monthly housing starts have averaged 970,000 in 2013, compared to 783,000 in 2012. S&P Case-Shiller home price data remains an important component of the wealth effect. Consumers are more inclined to spend money when the value of their homes and investments rise. Home prices have been growing at an average of 10.08% on a year-on-year basis. Throughout 2013, a consistent theme and a favorable tailwind has been the clear shift in consumer spending from apparel to larger ticket items, such as appliances and electronics. On his earnings call in October, eBay CEO John Donahoe initially said he expected e-commerce sales to be somewhat challenged for the upcoming holiday season, only to quickly reverse his comments in the days that followed. Other retailers with a large e-commerce presence have said they are expecting strong seasonal demand. New electronics are being launched by Apple, such as the iPad Air, as well as by Microsoft and Google, and based on the evidence I am seeing, I expect the consumer continues to lean toward pent-up demand and doesnt shift to frugality. If there is a pullback in spending, the blame will fall entirely on the D.C. dysfunction.
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U.S. Philly Fed Manufacturing This monthly survey provides useful intelligence on manufacturing conditions within the Philadelphia Federal Reserve district and is useful as an indicator of broad manufacturing sector trends.

U.S. Housing Indicators >H  ousing Starts The most closely followed report on the housing sector discloses the number of new residential buildings under construction in the U.S. in the prior month. >S  &P Case-Shiller Home Price Index (HPI) This index, released on a two-month lag, tracks changes in the value of residential real estate in 20 metropolitan regions across the U.S.

Black Friday The ofcial start of the holiday shopping season starts the Friday after Thanksgiving when retailers begin to turn a prot and be in the black.

JOSEPH M. TERRANOVA, Chief Market Strategist, Virtus Investment Partners Joe Terranova is chief market strategist for Virtus Investment Partners. He was elevated to that position in June 2009, having started with the company in the role of chief alternatives strategist. In his current role, Mr. Terranova works with Virtus regional sales teams and the nancial advisors who sell the companys investment products, providing insight into the domestic and global investing landscape and has represented Virtus as a keynote speaker for several nancial institutions. He is a member of the Virtus Investment Oversight Committee. Prior to joining Virtus in 2008, Mr. Terranova spent 18 years at MBF Clearing Corp., rising to the position of director of trading for the company and its subsidiaries. In this capacity, he managed more than 300 traders and support staff for MBF, one of the New York Mercantile Exchanges largest rms. His work was highlighted as the feature story in the June 2004 issue of Futures magazine. Mr. Terranova is perhaps best known for his risk management skills, honed while overseeing MBFs proprietary trading operations during some of the most calamitous times for the U.S. markets, including the rst Gulf War, the 1998 Asian Crisis, 9/11, and the collapse of Amaranth Advisors. In 2003, he was one of the rst Wall Street professionals to make an early call for higher energy, natural resources, and commodity prices. In June 2008, he cautioned investors to move to the sidelines in commodities and, in March 2009, he encouraged investors to ignore the global embracement of pessimism and overweight equities. Before joining MBF, Mr. Terranova held positions at both Swiss Banking Corp. and JP Morgan Securities. Mr. Terranova has been an ensemble member of the CNBC Fast Money franchise since 2008. He also frequently contributes exclusively to CNBCs other business programs. He is the author of Buy High, Sell Higher (Business Plus, 2012), a book about the new rules of investing based on his years as a professional trader. In 2007, Mr. Terranova and Hockey Hall of Fame player Mike Bossy established Bossys Bunch, a program that rewards excellence in the classroom for elementary school students. Mr. Terranova earned a bachelors degree in nance from the Peter J. Tobin College of Business at St. Johns University in New York.

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This commentary is the opinion of Joe Terranova. Virtus Investment Partners provides this communication as a matter of general information. The opinions stated herein are those of the author and not necessarily the opinions of Virtus, its affiliates, or its subadvisers. Portfolio managers at Virtus make investment decisions in accordance with specific client guidelines and restrictions. As a result, client accounts may differ in strategy and composition from the information presented herein. Any facts and statistics quoted are from sources believed to be reliable, but they may be incomplete or condensed and we do not guarantee their accuracy. This communication is not an offer or solicitation to purchase or sell any security, and it is not a research report. Individuals should consult with a qualified financial professional before making any investment decisions.
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