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 Good morning! Here's what you need to know. Russia invades Ukraine. Russia has taken over airspaces, airports, highways, and the regional government of the Ukrainian peninsula of Crimea, and troops are reportedly telling Ukrainians to give up arms and support the area's pro-Moscow leaders. The move earned a rebuke from President Obama, who spoke with Russia's Vladimir Putin on the phone over the weekend. Then Russia pays the economic price. The Russian Central Bank hiked interest rates from 5.5% to 7% to help save its plunging currency. Meanwhile, the country's stock market has crashed. The MICEX index is down 10%, and the country just saw its fourth straight month of manufacturing contraction. "Direct costs of war to Russia could reach at least 3% of GDP, which consists of nearly half (or about $30 billion) of gas exports from Russia to Europe, which is carried out through Ukraine and which would most likely be disrupted in case of a war," said Vladimir Osakovskiy, an economist at BofA Merrill Lynch. Gold rallied in the wake of the Ukraine crisis, and is up 11% since the end of December. Problems in China. The country suffered a deadly terrorist attack when a knife-wielding group of militants killed 27 and injured 109 in a Kunming train station. On the economic side, the Chinese manufacturing sector slumped. According to Markit/HSBC, China's PMI reading came in at 48.5, with both output and new orders falling for the first time since July 2013. China's official PMI reading was 50.2, down from 50.5 and marking an eight-month low. Other Asian economies also contracted in their PMI reports. Check out the full recap here. Australia contracts, Europe looking stronger. Australia's AIG-performance of manufacturing grew to 48.6 in February, but the below-50 print means the sector is still contracting. The pivotal exports sub-index collapsed to 25.8 from 34.1. In Europe, U.K. manufacturing employment hit a 33-month high, with PMI growing to 56.9 from 56.6 in January. Eurozone PMI ticked down to 53.2, still above that 50-mark threshold. It's a packed day of economic data, with U.S. automakers reporting sales throughout the day. Analysts predict the annualized pace of sales grew to 15.4 million in February. "Mid-month industry reports in January saw sales rising to near a 15.8 million unit annual pace from 15.3 million in December, but instead bad late month weather resulted in a slight decline to 15.2 million," Morgan Stanley's Ted Wieseman wrote clients. "Weather disruptions continued into the first part of February, but improvement moving into Presidents Day weekend helped stabilize retail sales, and a rebound in fleet sales that were disrupted by weather in January is expected to provide a boost to the overall selling rate." At 8:30 a.m. ET, personal income and outlays will be released. Economists expect income climbed 0.2% and spending grew by 0.1% in January. "Personal income growth should rebound in January," Wells Fargo's John Silvia wrote. "The average workweek remained unchanged, but average hourly earnings rose 0.2 percent over the month, along with the addition of 113,000 new jobs to the economy. Spending growth likely was more modest. After outpacing income gains the past three months, spending likely ticked up 0.1 percent in January as cold weather kept many shoppers at home." We'll also get a batch of manufacturing data. At 8:58 a.m., Markit PMI will be released. Economists believe PMI came in at 56.7 in February (anything above 50 signals expansion. Then at 10:00 a.m., we'll get ISM manufacturing. Economists are looking for this index to climb to 52.0 in February from 51.3 the month prior. "Regional manufacturing surveys point to a slower pace of manufacturing activity in February," wrote Nomura economists. "For example, the headline indexes in the Empire State and Philly Fed manufacturing surveys both declined in February, with the latter turning negative." Finally, construction spending will be released at 10:00 a.m. Economists think this declined by 0.5% in January. "Severe weather likely substantially disrupted construction in January," said Morgan Stanley's Wieseman."The 16% plunge in housing starts points to a large drop in homebuilding, and we’re assuming sizable declines in private nonresidential and government spending as well." Introducing "5 Questions," a new daily feature where we interview top strategists and economists about their thoughts on the market. Today's interview is with High Frequency Economics' Jim O'Sullivan. BUSINESS INSIDER: To what extent do you think poor weather has impacted this winter’s economic data?
JIM O'SULLIVAN: The weather probably explains most—not necessarily all, but most—of the sudden weakening. More generally, big swings in the raw data make seasonal adjustment challenging at this time of year. The seasonal factors allow for about a 3 million drop in payrolls and a 19% drop in retail sales in January. Meanwhile, the relative stability in jobless claims and confidence suggests that underlying trends have not changed significantly. At 338K, the 4-week average in claims is down slightly from 343K in all of 2013, when payrolls gains averaged 194K per month. Of course, that does not preclude the weather from causing payrolls to be weak again in the February report; the weather was particularly harsh during the sample week.
BI: What’s the big story that is not being told now?
JO: I think there is still an under-appreciation of the degree to which the downtrend in the unemployment rate has represented a genuine reduction in slack—in large part because of an under-appreciation of the degree to which the drop in the participation rate has been due to secular and structural forces. The economy is not tight in any absolute sense, but it is moving in that direction, with the downtrend in unemployment corroborated by consumer and business surveys. Does this mean the Fed will be tightening this year? No, but it does suggest that the forward guidance for the next few years is too dovish. The bond market will start to look ahead again if and when weather-related weakness is reversed.
BI: Are you optimistic about Janet Yellen as Fed chair?
JO: I suspect she is under-appreciating the degree to which the downtrend in the unemployment rate has represented genuine tightening of the labor market but I also think she will ultimately respond appropriately when wage pressures become more apparent. She is widely viewed as a dove, but, more accurately, I think she is a big believer in the importance of the unemployment rate in determining inflation. Part of her dovishness now appears to be the view that the unemployment rate has overstated labor market tightening.
BI: The stock market is roaring back to all time highs. Do issues in EM not have as big an impact on U.S. markets as people argued a few weeks ago?
JO: No, certainly if EM issues are more country-specific than systemic. Indeed, the near-30% rise in the S&P 500 last year was despite a 5% decline in overall EM equities. The late-1990s Asian crisis was a more extreme example, with U.S. equities surging as EM equities collapsed.
BI: What’s something you’ll be watching this week and next?
JO: A few things. Will the manufacturing ISM index reverse some of last month's plunge? Does the non-manufacturing index hold on to last month's gain? Do claims come back down after the higher weekly reading last week? If payrolls are weak again, do the details suggest weather effects? Is winter over yet? And now back to 10 Things... Global markets were lower in overnight trading. Japan's Nikkei fell 1.27% while Korea's KOSPI dropped 0.77%. In Europe, stocks are decidedly lower, and U.S. futures pointed to a negative open. Warren Buffett releases his annual letter. Over the weekend, Buffett put out his letter to Berkshire Hathaway shareholders. "Over the last 49 years (that is, since present management took over), book value has grown from $19 to $134,973, a rate of 19.7% compounded annually," wrote Buffett. In 2014, book value grew 18.2% — but still didn't beat out the S&P 500. Buffett also warned about public pensions plans, writing that "local and state financial problems are accelerating, in large part because public entities promised pensions they couldn’t afford." Oppenheimer's John Stoltzfus sums up how the situation in Ukraine may affect markets: For all the attention the violence in the streets of Kiev and the Russian troop deployment to Crimea garnered last week through the weekend, it appears that the markets -- at least for now -- are recognizing that problems in Ukraine provide significantly greater geopolitical risk than economic and market risk to the U.S. at this time. The announcement that Secretary of State John Kerry was on his way to meetings in Kiev on Monday could well serve to add balm to any near-term market concerns. Even as European stocks showed resilience last week, the region’s greater proximity to Ukraine and that country’s role as a main conduit for Russian gas to consumers in Europe could become a near-term negative overhang for stocks. |
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