Political Calculations
Unexpectedly Intriguing!
May 22, 2017

In Week 3 of May 2017, the S&P 500 provided a small demonstration of what can happen to stock prices whenever investors shift their focus from one point of time in the future to another.

Because we've already discussed that "almost interesting" event, where investors partially shifted their forward-looking attention from 2017-Q2 to 2017-Q3, we'll simply note that the S&P rebounded in the latter part of the week as investors had reason to shift their focus back toward 2017-Q2, with stock prices behaving accordingly.

Alternative Futures - S&P 500 - 2017Q2 - Standard Model - Snapshot on 19 May 2017

Stock prices aren't the only data that suggest that a partial shift in focus for how far forward in time investors are looking took place during Week 3 of May 2017. U.S. Treasury futures also communicated similar information, as Mike Shedlock observed:

The futures market is starting to question the June rate hike thesis. For its part, the bond market is behaving as if the Fed is hiking the economy into a recession. Here are some pictures.

June Rate Hike Odds

Mish Annotated: CME Group FedWatch June Rate Hike Odds

No Hike in June Odds

  • Month ago – 51%
  • Week Ago – 12.3%
  • Yesterday – 21.5%
  • Today – 35.4%

The CME Group provides this data through its FedWatch tool, which uses futures contracts for the Federal Funds Rate to divine the probability that the Fed will hike that particular interest rate by the various upcoming meeting dates of the Federal Reserve's Open Market Committee (FOMC). They've been providing that kind of insight from futures contracts since at least the last quarter of 2015.

We've been using dividend futures to do somewhat similar analysis, where the Fed has often had an outsized role in determining how far forward in time investors in the U.S. stock market focus their attention, where our dividend futures-based model can explain a good portion of why stock prices behave as they do whenever investors shift their forward looking attention.

At least, when that information is combined with the more significant market moving breaking news of the week....

Monday, 15 May 2017
Tuesday, 16 May 2017
Wednesday, 17 May 2017
Thursday, 18 May 2017
Friday, 19 May 2017

For the week's major economic data points, be sure to check out Barry Ritholtz' succinct summary of the week's positives and negatives.

Note: Following our confirmation of the CBOE's decision to terminate reporting its implied future DVS indicators at the end of April 2017, we switched to using the CME Group's S&P 500 Quarterly Dividend Index Futures quotes in their place for our analysis, with the changeover taking place on 11 May 2017. The change in data source accounts for the apparent volatility on that date for the alternative future trajectories that our model projects for the S&P 500 for when investors would be focused on either 2017-Q3 or 2018-Q1 in our chart above.

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May 19, 2017

Every three months, we take a snapshot of the expectations for future earnings in the S&P 500 at approximately the midpoint of the current quarter, shortly after most U.S. firms have announced their previous quarter's earnings. Today's snapshot of the trailing year earnings per share for the S&P 500 confirms that the stock market's earnings have continued to rebound off their 2016-Q3 bottom, where they will likely recover to their pre-earnings recession levels during the current quarter of 2017-Q2.

Forecasts for S&P 500 Trailing Twelve Month Earnings per Share, 2014-2019, Snapshot on 4 May 2017

The recovery in the S&P 500's earnings has been a significant factor in boosting the value of the S&P 500 since the index bottomed at 1829.08 on 12 February 2017. The index has since gone on to set its all time record closing value of 2402.67 earlier this week (on 15 May 2017).

Data Source

Silverblatt, Howard. S&P Indices Market Attribute Series. S&P 500 Monthly Performance Data. S&P 500 Earnings and Estimate Report. [Excel Spreadsheet]. Last Updated 4 May 2017. Accessed 18 May 2017.

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May 18, 2017

As a general rule, and as it happens, one backed up by statistics, we don't often get very excited about single day moves in the S&P 500 unless the value of the index changes by more than two percent of its previous day's closing value. We're making an exception for Wednesday, 17 May 2017, because we get to once again demonstrate how stock prices really work.

Let's revisit the stage we began setting in earnest just one week ago, which we described in greater detail earlier this week. We've emphasized the key takeaways in the following text.

In Week 1 of May 2017, the probability that investors expecting the Federal Reserve to next hike U.S. short term interest rates before the end of 2017-Q2 reached 90%. As a result of that strong focus by investors upon the current quarter of 2017-Q2, the S&P 500 (Index: INX) has developed a real potential to experience the "ticking clock" problem.

The ticking clock problem for the S&P 500 arises whenever investors become strongly focused on the current quarter as they make the investing decisions that affect the value of the S&P 500 index. Because the clock on the current quarter is ticking down, investors only have a limited amount of time during which they can maintain their attention on the current quarter before they will be forced to shift their forward-looking attention to another point of time in the future.

The potential for a problem as a consequence of that shift in focus arises because of the expectations associated with the next period of time in the future to which investors might next collectively target their attention. If those expectations include an acceleration in the rate of growth of the index' dividends per share, then the shift in attention will drive an increase in stock prices, which would not be considered to be much of a problem.

If however those expectations include a deceleration (or negative acceleration) of the expected growth rate for the S&P 500's dividends per share, then the shift in attention will drive a decrease in stock prices. How much they might potentially move would then be a factor of the magnitude of the difference in those future expectations between the quarter they are currently focused upon and the quarter to which they set their attention to next.

Our dividend futures-based model for projecting the alternative future trajectories for the S&P 500 allows us to show how stock prices will likely be set as investors might focus their attention on specific points of time in the near future.

Alternative Futures - S&P 500 - 2017Q2 - Standard Model - Snapshot on 11 May 2017

If investors shift their attention to focus upon 2017-Q3, say because Fed officials begin communicating that they'll next hike interest rates in that quarter, that shift in attention will likely produce as much as an 8-10% decline in stock prices with respect to its projected trajectory. If investors fully redirect their focus to the 2017-Q4, then stock prices may rise by as much as 5%. And if investors have reason to split their focus between the two quarters, stock prices will fall somewhere in between, weighted to whichever future quarter investors are more strongly directing their attention toward.

As for telling how far forward investors may be looking, that takes paying attention to the market's news to understand the context of the market's information environment....

  • Should investors redirect their attention to 2017-Q3, that shift in focus would represent why the "Sell in May" stock trading strategy might matter in 2017, even though we basically debunked the evidence to support the calendar effect as the result of statistical outliers last week! As we hinted in that post, it would be purely coincidental if it turns out to have any bearing this year!

On 17 May 2017, the S&P 500 declined by 1.84% to close at 2357.83, which is a bit shy of the 2% threshold that usually marks where we find the stock market doing something interesting. We're calling the day interesting however because the Nasdaq (Index: IXIC) slumped by 2.57% to close the day at 6011.24, which technically makes the day almost interesting.

Alternative Futures - S&P 500 - 2017Q2 - Standard Model - Snapshot on 17 May 2017

So do we find a shift in investor focus from the current quarter 2017-Q2 toward 2017-Q3? Why, yes, we do (after accounting for the mild echo from past stock price volatility that is slightly skewing the accuracy of our model's projections at this time)! Via ZeroHedge:

We warned last week that behind the scenes, professionals were increasingly speculating on a delay to the "baked in the cake" June rate hike.

The sudden surge in interest in Eurodollar calls (vs puts) suggests more than just a few prop bets are being placed on the fact that The Fed does not hike rates in June.

ZeroHedge: Eurodollar Futures - 20170517 - Source: http://www.zerohedge.com/sites/default/files/images/user3303/imageroot/2017/05/10/20170511_rates.jpg

Well the last few days have seen that started to be reflected in the primary markets... as US macro data collapses (and Trumptopia tumbles).

ZeroHedge: June 2017 Rate Hike Odds - 20170517 - Source: http://www.zerohedge.com/sites/default/files/images/user3303/imageroot/2017/05/14/20170517_hike_0.jpg

And we know how much The Fed hates surprising the market. However, by now it is becoming clear to even the most resentful permabulls - and even Goldman  - that the longer the Fed delays the day of reckoning out of pure fear of the unknown, the greater the chaos and loss in asset values when the Fed no longer has the luxury of picking when to pull the switch.

It wouldn't be ZeroHedge if their outlook weren't both gloomy and doomy. For our purposes however, there's no guarantee that stock prices will steadily travel all the way to where our model indicates that stock prices would be if investors were fully fixated on 2017-Q3. Instead, what's more immediately significant is the vertical distance between the trajectories indicated for investors focused on 2017-Q2 and investors focusing upon 2017-Q3 - that wide distance between them provides the space where the market's day-to-day volatility will have the real potential to be genuinely interesting, with the attention of investors perhaps swinging back and forth between those two points of time until things finally settle down.

Until that happens, it could make for some interesting times for the market in the very near term future.

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May 17, 2017

We're surprised that nobody has put this information together before now, but here's the quick tally of jobs gained and lost as a direct consequence of Philadelphia's controversial soda tax. First, here's the positive side of the jobs ledger:

Here's the negative side of the jobs ledger:

The following chart shows how the jobs gained compare with the minimum announced jobs that will be lost.

Number of Jobs Added and Lost Due to Philadelphia's Sweetened Beverage Tax, 1 January 2017 to 1 May 2017

Seems pretty good, right?

The problem is that at an average wage of $14.72 per hour, the jobs added to support Philadelphia's pre-K school program pay a lot less than the estimated average of $21.50 per hour that the city's bottling plants and distributors were paying the employees who will be losing their jobs as a result of the city's controversial soda tax (based on similar jobs in Indianapolis).

Plus, according to the city's Pre-K enrollment applications, the pre-K jobs only require work during the School District of Philadelphia’s 2017-2018 School Year Calendar, which only covers nine out of the twelve months of the year. The school schedule covers less than seven hours per day, four days a week, with a just over a half-day on Fridays.

By contrast, the job layoffs affecting the employees of Philadelphia's beverage producers and distributors are mostly hitting people who work 40 hours per week, all year round.

In the following chart, we'll estimate the aggregate annual incomes for the jobs being added and lost in Philadelphia due to the city's sweetened beverage tax.

We find that at a minimum, the city's economy is losing more income than it is gaining through this point in time. We should also note that the negative $743,000 gap in the annual incomes between jobs lost and jobs added is a low end estimate that is based on the minimum announced layoffs attributable to the soda tax to date, where if the Pepsi layoffs total up to 100 (rather than 80), it would represent another $894,000 worth of annual incomes being taken out of the city's economy.

These estimates do not yet extend to job losses or work hour reductions that might also be likely to occur at the city's bodegas, grocers and soft drink retailers, which would further increase the income gap between jobs added and jobs lost.

One factor that would reduce the gap would be the "extremely generous" increase in wages that were awarded to the city's unionized employees at the same time the soda tax was being passed, but since that increase in incomes wasn't the result of adding or losing jobs, we've omitted those incomes from this analysis. Similarly, we have also not considered lost incomes through reduced labor hours.

Finally, we should also note that focusing just on jobs represents just a portion of the lost economic activity that has resulted within Philadelphia as a result of the imposition of its sweetened beverage tax. We'll refine our estimates of the projected deadweight loss to Philadelphia's economy sometime in the near future as new and updated data becomes available.

Previously on Political Calculations

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May 16, 2017

According to foreign trade data released earlier this month by the U.S. Census Bureau, U.S. imports from China surged in March 2017, following a month in which they had plunged by a "record amount".

We're revisiting that account today because last month, we found ourselves in the rare position of contradicting news reports that suggested that the reason for February 2017's plunge in Chinese imports was caused by "slowing domestic demand". We argued instead that the primary culprit behind the decline in the amount of Chinese goods reaching America's shores in February was the timing of China's 2017 Spring Festival, a week long holiday that largely shuts down operations at Chinese ports, which greatly diminishes incoming traffic at U.S. ports two to three weeks later after accounting for the trans-Pacific transit time for the largely shipborne cargo.

Once the Chinese holiday ends, China's ports get back to business, which we can see in our calculation of the year over year growth rate of the volume of goods and services traded between the U.S. and China that the U.S. Census Bureau has reported for March 2017.

Year Over Year Growth Rate of Exchange Rate Adjusted U.S.-China Trade in Goods and Services, January 1986 - March 2017

Here, we can see that the value of goods imported into the U.S. from China has rebounded above their February 2017. Now, that's not saying very much, because that year-over-year increase of nearly 15% above is in part based upon a very low March 2016 level, which was itself depressed because of the timing of China's 2016 Spring Festival.

We can however compensate for that factor by switching up the growth rate math to instead look at the value of goods imported into the U.S. from China over combined two-month-long periods, which can absorb the pause in recorded trade resulting from the variable timing of China's Spring Festival. In doing that math, we find that the combined value of February and March 2017's imports from China shows a 1.4% increase over the combined months of February and March 2016, suggesting sluggish but positive growth for the U.S. economy during this time.

Considering the rate of influx of U.S. goods flowing into China, that year-over-year growth rate dipped in March 2017, but continued to be fairly robust. Taking the rate of growth of imports as an indicator of the relative health of China's economy suggests that it is continuing to grow somewhat more strongly than the U.S. economy at this time.

On a final note, that situation may be changing. Several months ago, we here at Political Calculations began seeing a notable uptick in site traffic from China to our tool for reckoning the odds of recession from the spread of the yields between long and short term treasury bonds.

Set up specifically to consider U.S. treasury yield spreads in era before the Federal Reserve began its Zero Interest Rate Policy (ZIRP), we believe it is drawing interest from China because that nation's bond yield curve has flattened and has recently begun to invert, which our tool would indicate as potential harbinger of a pending recession beginning sometime in the next 12 months.

We don't know if that's the scenario that will play out in China. Our tool is specifically based on pre-2006 U.S. treasury yield spread data, where we don't know how well that might translate to China's economic situation, so if you're reading this from China, please do take that factor into consideration.

And if you are reading this from China, you absolutely will want to pay attention to the year over year growth rate of China's imports from the United States, as measured by the U.S. Census Bureau as a comparatively high quality data source. If that growth rate turns negative outside of the months affected by the timing of China's annual Spring Festival, then that would be a near real-time indication that China's economy is indeed slowing down, which is very definitely something that we've directly observed in the past.

Data Sources

Board of Governors of the Federal Reserve System. China / U.S. Foreign Exchange Rate. G.5 Foreign Exchange Rates. Accessed 15 January 2017.

U.S. Census Bureau. Trade in Goods with China. Accessed 15 January 2017.

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