October 3, 2016

Stocks opened lower this morning (Dow -72 pts; SPX -.5%). All eleven major sectors are lower in early trading. Utilities (-1.9%) and real estate (-1.6%) investment trusts (REITs) are really taking it on the chin. Cyclical sectors are down less. Emerging markets funds are modestly higher and Asian markets were higher overnight. But most everything else is in the red. The dollar is a bit stronger; WTI crude is hanging on to a modest gain at $48.50/barrel. Bonds are lower as yields move upward. The 5- and 10-year Treasury yields are back up to 1.17% and 1.61%, respectively. 

The ISM Manufacturing Index rebounded to 51.5 in August vs. 49.4 in the prior month. This is important since 50.0 is the dividing line between contracting and expanding business activity and that July reading was really disappointing. Factories reported that production levels and new product orders rebounded in August. In fact, new orders, a forward-looking indicator, popped to 55.1 vs. 49.1 in the prior month. That’s probably one reason why bonds are selling off today.  

I’d like to summarize two very different viewpoints on the economy and stock market that are representative of the main camps on Wall Street. First, economist Mohamed El-Erian:  “The principal issue today is that we continue to operate well below potential. Remember, you cannot run a complex economy at low speed forever and not expect things to break.” He says the least likely scenario is continued low but stable growth with sideways markets. This is an “artificial period.”  Low growth could easily become recession. Alternatively, governments could step up with fiscal policy to stimulate growth. On the other hand, hedge Fund manager Jim Paulsen sees a “global bounce.” He says, “We’ve had pretty good PMI reports now in the United States, in Germany…in China.” Earnings momentum is finally turning positive and “this month could be big” in terms of earnings reports and economic data. Mr. Paulsen expects the second half of this stock market & economic recovery to begin shortly. He believes that “this may be a slow recovery, but it’s long-lasting; it’s got multiple years ahead…”

By the way, China’s manufacturing PMI has been in recovery mode since February. And investors are beginning to notice improvement in the economy. In China, industrials company profits are up 11% y/y, turning around from negative growth in 2015. Wholesale inflation bottomed out at -6% y/y in late 2015 but has recovered back to flat. And some recent earnings reports (from Starbucks & Nike) suggest consumer spending in China is healthy. 

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