Are Markets Rallying Themselves Into a Fed Rate Hike?

If a higher stock market is the Fed’s implied 3rd mandate, then are we rallying into a rate hike next week?

We’ll see but the 2 yr note yield this morning is up to .75%, up 4 bps this week and to the highest level since April ’11. In terms of market sentiment as a setting for the current action, II said Bears now exceed Bulls for the 1st time since October ’11 and this is certainly a good back drop for the rally seen yesterday and into today from a contrarian standpoint. Bulls fell to 25.7 from 27.8 while Bears rose to 27.9 from 26.8. The survey though is still dominated by those believing that all we’re seeing is a Correction as this component rose 1 pt to 46.4. As stated before, those expecting a Correction are bulls that want to buy the dip. Bottom line, while the sentiment shift is good in that “sentiment is a leading market indicator” according to II, Bears got as high as 46.3 in October ’11 while the Correction side was below 30. Also, while Bears exceed Bulls by 2.2 pts, the spread was almost 12 in October ’11, 20.8 in March ’09 and 32.2 in October ’08. Thus, buying on the dip is still the preferred strategy rather than the belief in hunkering down ahead of a bear market. I still believe that the odds are greater than 50% that the bear market has begun. The extent of the current rally and whether it ‘fails’ or not will be a great test of that belief.

After a sharp 17% jump in refi applications last week, they fell back by 10% but still remain 50.5% higher y/o/y. Purchase applications were down .9% w/o/w but are up 41.4% y/o/y. Existing home sales still dominate total home sales as new home sales remain 30% below its 30 year average.

Asian markets continued to bounce overnight with the Nikkei up an astonishing 7.7%, the largest one day rally on a percentage basis since October ’08. The Shanghai index was up by 2.2% and the H share index was up by 5.2%. Margin debt in China is down to the lowest level since mid December and lower by 57% off the insanity seen in mid June. It still though is more than double the level seen last July when the bull run got started. Japanese consumer confidence in August rose to 41.7 from 40.3 in July and above the estimate of 40.5. This matches the best since December ’13 but remains below the Abenomics peak of 45.3 in May ’13. The key Income Growth component was up a touch, by .3 to 39.9 and just off the recent peak of 40.3 in June. Employment rose by 2.6 pts but only after dropping by 3 pts in June.

On the issue of the Chinese yuan devaluation, Premier Li today said “we don’t want to devalue the yuan to boost the exports” and he doesn’t want to see a currency war. They are sticking to their thesis that this was a market liberalization move and one step closer to the yuan getting accepted as a reserve currency eligible one day for inclusion in the SDR basket of the IMF. Let’s realistically call the reason for the FX move a combination of both. The yuan was lower for a 3rd day overnight as the PBOC is learning that they can’t move to a more market based floating system at the same time intervene everyday because you don’t like which way the currency is going.

Copper is little changed after yesterday’s 5.3% spike in response to the large production cut from Glencore. I’ll say again that continued commodity supply cuts will be the ticket to higher inflation that central banks want as free money has been responsible up this point for much of the excess capacity. I’m taking this quote from yesterday’s FT from a research report from ICBC on copper, “With cutbacks in Zambia, El Nino related drought in Indonesia and Papua New Guinea that is affecting output, and industrial action in Chile, supply disruptions in 2015 have amounted to more than 1.5mm tons, exceeding the record figure in 2008, when 1.2mm tons of copper supplies were affected.” I still believe that the 2015 drop in commodity prices is the last leg of the 4 year bear market and it is this group that has provided the best investment opportunities for those looking out over the next 4 years.

The only data point of note in Europe was the UK July industrial production figure which fell .4% m/o/m, worse than expectations of up .1%. The miss was due to the manufacturing component which dropped by .8% instead of rising by .2% as expected. The index level for IP is at a 5 month low as UK companies are pressured by the strong pound vs the euro, a drop in oil/gas extraction and also the softness in Asia. The one caveat to the weakness was the scheduled summer auto shutdowns in July which I guess was not properly seasonally adjusted for. Also in the UK, exports in July fell a large 9.2% m/o/m but is very volatile month to month. Imports were up slightly. The pound is lower in response vs the US$ but is up vs the euro. The BoE meets on Thursday and will likely remain noncommittal until they see what the Fed does next week.

Peter Boockvar,
Chief Market Analyst
The Lindsey Group LLC
703-621-1170
peter -AT- thelindseygroup.com
www.thelindseygroup.com