Global Markets Follow US Lead

US equity markets charged higher for a third session out of four yesterday fueled by a resurgent energy sector and significant outperformance by financials. The Dow industrials (+0.81%) followed by the Nasdaq (+0.70%) and S&P 500 (+0.69%). Volume slipped on the Nasdaq (-8.92%) and rose on the NYSE (+6.89%).

This week’s economic data has provided confirmation that last week’s call on financials was timely. My interview with Fred Katayama of Reuters Insider on Wednesday, May 18th entitled “Why it’s time to buy financials” though rather rudimentary was, narratively speaking, on point. I also called for outperformance by energy and materials in the near term. Since the close on May 17th through yesterday, Select Sector SPDR Trust Financial ETF (XLF) has risen 4.02%, while the SPDR Trust Regional Banking ETF (KRE) has risen 7.77%. Much of that charge higher in the sector is due to the anticipated hike in rates.

Specifically the data this week, though not compelling, does suggest a degree of inflationary pressure in the economy.

PMI Manufacturing Index Flash 50.5, consensus 51
New Home Sales 619K, consensus 523K
FHFA House Price Index M/M 0.7%, consensus 0.5%
PMI Services Flash 51.2, prior 52.1

Importantly, the IEA Petroleum Status Report continued to reflect the impact of tightening supplies. Crude oil inventories (weekly change) was -4.2M barrels versus last weeks gain of 1.3M barrels. Gasoline inventories ticked up by a modest 2.0M barrels while distillates continue to reflect a draw down of 1.3M barrels.

Today we receive Durable Goods, Weekly Jobless Claims and Pending Home Sales. All of this narrative feeds in a frictionless manner into tomorrow’s talk by Fed Chair Janet Yellen. Our week to date gains by the financials and the broader market will likely pause heading into tomorrow’s talk. The interesting thing to observe for investors has been the manner in which several key factors have aligned to provide the context for the next move in rates.

We have discussed them on several occasions independently but now that we are apparently on the verge of a rate hike it is important to take a quick look back at the dynamics at play in our current cycle. Crude oil has obviously reversed course since trading to its cycle low last year. Tightening supply as a result of the sharp drop in rig counts coupled with increased demand have helped build a floor under crude – effectively providing some lift to prices and a healthy degree of long sought after inflation. New Homes supply which has been constrained since the great unwinding of the financial crisis, has seen prices climb at nearly 3X the rate of inflation and in the process adding another component to the inflation matrix for the Federal Reserve. Employment gains have been relentless averaging close to 200k/mo for six months, on top of solid gains for nearly three years. The expanding roles of the employed have provided for nearly full employment for the first time since the financial crisis. More people working chasing fewer jobs leads to one thing – wage inflation. Though clearly that last piece of the puzzle to materialize, is beginning to be reflected in the data. Energy, housing and employment provide support for a narrative that calls for higher rates. The only question is when.

Two important themes that emerged in the overnight worth highlighting; Brent crude traded above $50/bbl which will likely add some momentum to WTI’s trade higher today. Greek debt talks with the ECB and IMF moved one step closer to resolution and in the process may remove a hurdle for the Federal Reserve at it looks to further normalize rates. Still looming large as a variable for investors and the Fed is the Brexit narrative.

flickr photo: neilhinchley