It's common thought that the recent collapse in commodities' prices reflects concern over weakness in the global economy, particularly in China. And that that could very well spell bad news for global equities going forward. Make sense? Well of course!
But here's the thing, as the chart below displays, lower commodities prices---while surely reflecting light demand relative to supply (and, btw, a very strong U.S. dollar)---aren't generally harbingers of recessions, quite the contrary in fact. As you can see, it's typically a prolonged rise in commodities prices that precedes recessions---declines tend to presage expansions. Which flies in the face of much of today's commentary. But it makes perfect sense: Higher input prices, whether it's gas in your car or copper wire in your house, can eventually choke consumption and investment. Lower input prices, on the other hand, ultimately mean more capital left over with which to spend if you're a consumer or to ultimately invest if you're a producer, leading ultimately to a growing global economy.
Recessions are outlined in red, the oil price is dark yellow, and the mountain is the JOC-ECRI Industrial Price Index: click charts to enlarge...
THE GLOBAL FLOW OF CAPITAL
I here confess, I am a free trade freak! Long-time readers have been inundated with why I believe ("know" in fact) that free trade is the absolute worthiest of pursuits if the world is to continue to grow more prosperous (across all nations), and more peaceful in the years ahead. If you're new to the blog, and interested, shoot me an email and I'll effort mightily to convert you to my way of thinking. Although, being that I'm guessing that all recent subscribers are Americans, I should expect that they're already free trade fanatics. Right? I mean "freedom" and America are synonymous! Right?
Have you ever noticed what typically happens to a stock when it's discovered that Warren Buffet is pouring money into it? That's right, it typically rises in price, often dramatically. As it should, for Mr. Buffet is renowned as a savvy, patient, very long-term investor.
As an allocator of globally-diversified portfolios, I am keenly interested in what goes on throughout the world. In terms of investment destinations, among other things, I want to know to what extent capital is flowing to, or away from, the targets of my attention. I.e., I want to know to what extent---and to where---the world's big money is making big investments beyond its own borders---for perhaps we should consider following its lead.
The Bank for International Settlements (BIS) is considered the central bank of central banks, and is the best source of information when it comes to cross-border money flow. Sadly, however, the data is reported with a six-month lag.
For today we'll focus on emerging markets.
Here's a look at cross border claims on emerging countries during the course of 2014:
As you can see, in the aggregate, there was a souring of sentiment toward emerging markets during the second half of last year. As you might guess, given Russia/Ukraine and Greece, emerging Europe was not on big money's list of attractive destinations.
Here's a look at Russia, Poland and Ukraine:
Of course we can't have a discussion about emerging markets without featuring China, which, as you can see, saw a tapering of cross border flow late in the year---but nothing like what we saw in emerging Europe.
So where in the major emerging economies, if anywhere, did capital flow actually increase late last year? Well, for one, there was India, which is where we'll focus from here:
India is undergoing major, and truly landmark, market reforms:
India's Prime Minister Narendra Modi's goal
...to lift India to glory by cleaning up the country, clearing the way for business and preparing its young citizens to be the work force of an aging world.
According to the IMF:
Within the next 15 years, India will have the largest, and among the youngest, workforces in the world, and will need to create jobs for the roughly one hundred million young Indians who will enter the job market in the coming decade.
While it appears that most countries are what you'd call demand constrained (as suggested by low commodities prices), India is clearly supply constrained. With per capita income of only $1,600 annually, any increase in income will translate immediately into consumption, and production will have to catch up in a hurry!
Here's from Bloomberg last Wednesday:
Prime Minister Narendra Modi has loosened government purse strings, swelling cash piles at Indian banks and driving short-term borrowing costs for local companies to a five-year low.
One-year commercial-paper rates fell to 8.54% last week, the lowest level since October 2010, and the overnight interbank rate has averaged the least in four years this month. Lenders, which borrowed an averageRs.1,80,000 crore daily from the Reserve Bank of India last quarter to meet fund shortages, are now parking money with the central bank.
Modi has pledged to build roads, ports and airports as he seeks to reverse an investment slowdown in Asias third-largest economy saddled with bad loans and stalled projects. The so- called plan spending in April-May, including that on infrastructure, was 13.4% of the amount budgeted for the year ending March 2016, compared with 10.4% in the same period last year.
While there's much to report in terms of reforms that are currently underway---as well as those that are yet to get off the ground---suffice it to say that the world has taken notice (as we see in cross border flow) and that India will be an interesting (and of course volatile) investment proposition for the patient long-term investor.
Over the next few days we'll be reviewing each of your portfolios' emerging markets exposure and, consistent with your asset allocation strategy and your risk tolerance, we'll be looking for opportunities to add a little, or increase your, exposure to India. For those of you who've given us discretionary authority we'll proceed with making the adjustments, if any, as we deem fit (unless we hear from you otherwise). For the few of you whom we need to chat with first, we'll reach out to you if we believe any adjustments would fit with your personal strategy.
The Stock Market:
Non-US developed marketseven after their recent pummelinghave outperformed the U.S. major averages (save for the NASDAQ Composite Index) year-to-date. Given many foreign markets cheaper valuations, early-stage recoveries and, yes, accommodative central banks, I remain constructive on non-U.S.. That said, there are a number of potential international hot buttons (as were presently experiencing) that could easily delay the narrowing of the gap between the valuations of U.S. and non-U.S. securities. Thats why we think long-term and stay diversified!
Heres a look at the year-to-date price changes (according to CNBC) for the major U.S. indices---and for non-U.S. indices and U.S. sectors---using index ETFs as our non-U.S. and sector proxies:
Dow Jones Industrials: +1.67%
S&P 500: +3.18%
NASDAQ Comp: +9.02%
EFA (Europe, Australia and Far East): +7.50%
FEZ (Eurozone): +4.99%
VWO (Emerging Markets): +0.10%
Heres a look at the year-to-date results for a number of U.S. sector ETFs:
IYH (HEATHCARE): +13.95%
XLY (DISCRETIONARY): +9.90%
XHB (HOMEBUILDERS): +8.29%
XLK (TECH): +3.46%
XLP (CONS STAPLES): +3.32%
XLF (FINANCIALS): +2.95%
XLB (MATERIALS): -1.21%
XLI (INDUSTRIALS): -2.90%
XLE (ENERGY): -7.49%
XLU (UTILITIES): -8.64%
IYT (TRANSP): -10.14%
The Bond Market:
As I type, the yield on the 10-year treasury bond sits at 2.35%. Which is 5 basis points lower than where it was when I penned last week's update.
TLT, an ETF that tracks an index of long-dated U.S. treasury bonds, saw its share rise 2.30% over the past 5 trading days (down 6.20% year-to-date). As I keep repeating, I see bonds in general sporting a risk/return trade-off that makes going out on the yield curve not worth the risk.
Once again, here's the reminder on volatility I posted earlier in the year:
In last weekends commentary I attempted to put a rough January into proper perspective by urging you to view the stock market as an antifragile (benefits from stress) entity. Again, periodic market downturns are an essential aspect of the long-term investing process. As I stated in our year-end letter, and several commentaries since, I expect financial markets in 2015 to exhibit the kind of volatility that will challenge the resolve of many a short-term investor. Good thing you and I think long-term!
One additional note on volatility: The past couple of weeks Ive shared with you the very short-term results for markets and sectors. I do this with a bit of hesitation, as I in no way want to give the impression that you, nor I for that matter, should base our long-term investment decisions on short-term movements in markets or their sectors. It can, however, serve as a reference point for how the markets are, or are not, responding to the data (which is why I, as a professional, track the short-term). As you may have noticed, my beginning of the year optimism over non-US and the housing sector (to name two), and pessimism over utilities, appears to be justified by recent results. I need to strongly (very strongly!) emphasize that I was not predicting what weve experienced these few short weeks into 2015. My optimism or concerns are based on factors such as valuations, trends, monetary policy and cyclicalityand my comfort in making allocation recommendations rests on the view that our clients are not short-minded investors (it can take awhile, if at all, for the market to reward what I believe to be good fundamental logic) who mistakenly believe that any human being possesses a capacity for market timing. Some people get lucky from time to time, but without exception, market timers are wrong far more often than they are right. The path to long-term investment success is fraught with bumps and potholes. The ones who successfully make the journey take it slow and never over-compensate when steering through and around the inevitable obstacles along the way.
Here are last weeks U.S. economic highlights:
JULY 16, 2015
WEEKLY JOBLESS CLAIMS fell 15k last week to 281k. Remaining below the 300k mark for yet another week. The 4-week average rose 3.25k to 282.5k. Continuing claims, which report with a one-week lag, plunged 112k to 2.215 million, the 4-week average dropped 3k to 2.264 million.
THE BLOOMBERG CONSUMER COMFORT INDEX came in barely changed, down .3, over the prior week. Mixed to negative results are reported in Bloomberg's release below:
U.S. Consumer Comfort Little Changed as Financial Optimism Fades
By Erin Roman
(Bloomberg) -- Consumer confidence in the U.S. was little changed last week as Americans views about their finances retreated for the first time since May.
The Bloomberg Consumer Comfort Index cooled to 43.2 in the period ended July 12 from 43.5 in the prior week. A monthly measure tracking the economic outlook declined in July for fourth time in the past five months.
The comfort measure stood pat this week, stuck on pause after only a partial recovery from its springtime slowdown, Gary Langer, president of Langer Research Associates LLC in New York, which produces the data for Bloomberg, said in a statement. In June, the gauge recouped half of its 7.8 point decline from Aprils eight-year high.
Stable sentiment coincides with little change in the prices consumers are paying at the gas pump. At the same time, volatility in the stock market on the heels of the Greek financial crisis may have led to dimmer views of personal finances and less optimism among upper-income earners.
A smaller share of households said the economy was getting better and more indicated it was worsening, leaving the monthly expectations index at 45.5, down from 47.5 in June.
Among the three components of the weekly report, the index of personal finances declined to 58 from 59.3 the prior week. The buying climate gauge, which measures whether now is a good time to purchase goods and services, improved to 38.2 from 37.7.
The weekly measure of consumers current views of the national economy was little changed at 33.3 after 33.4.
Less ebullient attitudes were reflected in a report earlier this week showing an unexpected decline in June retail sales. Purchases fell 0.3 percent after a 1 percent May advance, according to the Commerce Department.
Sentiment waned in four of the seven major income groups last week. Confidence among those making more than $50,000 a year reached a one-month low, while the measure for those earning less rose to a two-month high, probably buoyed by more employment opportunities and lower prices at the gas pump.
Employers added 223,000 jobs in June after a 254,000 increase in May, the strongest two months since January/December, while the jobless rate fell to a seven-year low of 5.3 percent.
The nationwide average price of a gallon of gasoline has been holding below $2.80 since mid-June, based on data from the auto group AAA.
By region, comfort declined to a one-month low in the South and rose in the West to a nine-week high.
JULY 13, 2015
THE TREASURY BUDGET came in at a surplus of $51.8 billion in June. Now, nine months into the government's fiscal year, the budget deficit stands at $313.4 billion. Which is 14.3% below this time last year. Total receipts are up 8.3%, with tax receipts up a very strong 11.6% for individuals and 8.7% for corporations. Which speaks volumes about the improving U.S. economy. Spending, however, is up 5.1% with Medicare up 8% and defense down 1.7%.
JULY 14, 2105
THE NFIB SMALL BUSINESS OPTIMISM INDEX retreated notably in June, down 4.2 points to 94.1. While the survey results don't point to recession, they are nonetheless dismal, with the exception of credit demand. This is in sharp contrasts to May's optimistic report. It'll be interesting to see the trend for the remainder of the year. On balance, I'm seeing a reasonably good economy and I, therefore, expect this survey to read more optimistically as the second half unfolds. Here's the release's opening paragraph:
The Small Business Optimism Index fell 4.2 points to 94.1, likely in response to five months of lousy growth. The 42 year Index average is 98.0, while the pre-recession average is 99.5 (1974-2007). This leaves the current reading 4 points below the overall average, a deficiency of 40 net positive percentage point responses to the Indexs 10 component questions. While this is not a recession signal, it is a clear sign that economic growth on Main Street is not set for a strong second half. Nine of the 10 Index components fell and 1 was unchanged from last month. Declines in spending plans accounted for 30 percent of the Index decline, and weaker expectations for real sales and business conditions another 20 percent. The deterioration in earnings trends accounted for about a quarter of the decline.
RETAIL SALES ACCORDING TO THE CENSUS BUREAU were weak in June. Gasoline stations were the one bright spot as gas prices rose during the month. Electronic and appliance stores also showed good growth, up 1%. Here's Econoday:
The second-quarter suddenly doesn't look very strong as retail sales for June, showing broad weakness, came in way below expectations, at minus 0.3 percent. Motor vehicles were part of the reason, excluding which sales came in at only minus 0.1 percent. But excluding both autos and gasoline, core sales fell 0.2 percent.
The bounce back for gasoline prices has given gas station sales a lift the last couple of months, up 0.8 percent in June following May's 3.7 percent surge. And there's also two strong gains for the key general merchandise category which is up 0.7 percent and 1.4 percent the last two months. Electronic & appliance stores also show a solid gain, up 1.0 percent in June.
But that's where the good news stops. Auto sales, though still at strong levels, fell 1.1 percent against an unusually strong May. Furniture sales fell 1.6 percent, apparel fell 1.5 percent, building materials fell 1.3 percent, and restaurants fell 0.2 percent.
The fall in restaurant sales doesn't speak to the strong levels of consumer confidence that are being reported, readings that the Fed has been pointing to as a future indicator of strength for consumer spending. A look at year-on-year sales underscores the complete lack of consumer punch, at only plus 1.4 percent for total retail sales and only plus 2.7 percent for the core. This is a very disappointing report that will cut second-quarter GDP estimates and that will likely push back the outlook for the Fed's rate hike from September to December, at least for now.
IMPORT AND EXPORT PRICES are in no way suggesting the Fed has inflation to worry about anytime soon, down .2% month-on-month and down 5.7% year-on-year. In terms of imports, this would speak volumes about the higher dollar. In terms of export prices, their decline points to a lack of any global price pressure.
THE JOHNSON REDBOOK RETAIL REPORT for last week jibes with this morning's CB retail results for June, up only 1.4% year-on-year.
BUSINESS INVENTORIES were up .3% in May, which is okay given that sales were up .4%. The inventory to sales ratio sits at 1.36%. While inventory builds are positive in terms of the GDP calculation, better to have stable to reducing inventories from a forward production standpoint
JULY 15, 2015
NEW PURCHASE MORTGAGE APPS tanked 8.0% last week, after surging 7.0% the week prior. Refinances rose 4.0% after rising 3.0% the week prior. While the weekly numbers are noisy, the housing market is showing solid results of late. The 30-year fixed rate averaged 4.23% last week.
PRODUCER PRICES FOR JUNE contradicted the import/export price readings. Up .4% after rising .5% in May. Here's Econoday:
Producer prices showed slightly more pressure than expected, at plus 0.4 percent in June vs Econoday expectations for plus 0.3 percent. Ex-food and energy, producer prices rose 0.3 percent vs expectations for plus 0.1 percent with the core rate for this series, which excludes food, energy as well as services, also up 0.3 percent vs expectations for plus 0.1 percent.
Showing pressure were electric power, pharmaceuticals and cigarettes. Gasoline and food, specifically eggs, contributed to the overall increase.
The gains in this series will be welcome by Federal Reserve officials who are hoping inflation will move to its 2 percent year-on-year target. But there's a ways to go with the overall year-on-year rate far into the negative column at minus 0.7 percent and the ex-food and energy reading at only plus 0.8 percent with the preferred core that also excludes services at plus 0.7 percent. Watch Friday for the consumer price report.
THE EMPIRE STATE MANUFACTURING SURVEY came in with uninspiring results, at 3.86. Weak exports are clearly doing a number on the manufacturing numbers this year.
INDUSTRIAL PRODUTION, while stronger this month, up .3%, is coming off of two months of contraction. There's little in this report that would give one optimism with regard to manufacturing in the near future.
CAPACITY UTILIZATION came in at an inflationary-benign 78.4%.
CRUDE OIL INVENTORIES declined by 4.3 million barrels last month, which speaks to very strong refining activity---refiners are running at 95.3% of capacity. Interestingly, the decline did not bolster the price. I remain bearish on the price of oil going forward. GASOLINE stocks rose .1 mbs and DISTILLATES rose 3.8mbs
JULY 16, 2015
THE PHILADELPHIA FED BUSINESS OUTLOOK SURVEY for July shows June's jump to not be the beginning of a robust forward trend. Up 5.7 after rising 15.2 in June.
THE NAHB HOUSING MARKET INDEX for July showed its strongest reading in nearly 10 years! This signals significant strength in the new home market going forward. Supporting the optimistic view I've maintained since late last year. Here's Econoday:
The housing market index, unchanged in July at 60, is signaling substantial strength for the new home market. This is the strongest reading since November 2005.
Future sales, at 71, lead the report with present sales right behind at 66. Still lagging is traffic, down 1 point in the month to 43 and reflecting a lack of first-time buyers in the market.
All regions are showing growth led by the West at a composite 63 followed by the South at 62. The Midwest is at 59 and the Northeast, which had been under 50 for a long run, is now at 52.
The new home market is accelerating and is in place to be the best surprise of the 2015 economy. Housing starts & permit data, which have been volatile but very strong, will be posted tomorrow.
NATURAL GAS INVENTORIES increased for yet another week, up 99 bcf.
THE FED BALANCE SHEET increased $12.3 billion last week to $4.494 trillion. RESERVE BANK CREDIT increased $7 billion.
M2 MONEY SUPPLY rose again last week, by $12.6 billion.
TREASURY INTERNATIONAL CAPITAL shows capital flowing mightily into U.S. treasuries and corporate bonds---that speaks to the strong dollar and I maybe a flight to quality given Greece's turmoil. While foreigners were big buyers of U.S. debt, they were net sellers of U.S equities in May. U.S. accounts did the opposite; bought foreign equities while selling foreign bonds.
We've been buyers of foreign equities all year..
JULY 17, 2015
CPI FOR JUNE came in right at expectations, 0.3%. The core number came in as expected also, 02%, which is up from May's 0.1%. While there have indeed been mixed signals of late, I do believe the Fed has a green light for a September rate increase. Here's Econoday:
Consumer inflation, up an as-expected 0.3 percent in June, isn't soaring but, as Federal Reserve policy makers are predicting, underlying pressures are beginning to inch higher. The core also came in as expected at plus 0.2 percent which is up from 0.1 percent in May and with two-thirds of the gain tied to a 0.4 percent rise for owners' equivalent rent in another indication of rising demand in the housing sector. Looking at year-on-year rates, total consumer inflation is up 0.1 percent which doesn't like much at all but is the first positive reading of the year. The core is up 1.8 percent, on the rise from 1.7 percent in May and closer to the Fed's general 2 percent inflation target.
The gain in the overall rate was driven higher by a 1.7 percent rise for energy within which gasoline rose 3.4 percent in the month. This is exactly what the Fed has been pointing to, that is easing downward pull from energy prices. Food rose 0.3 percent in the month with egg prices a concern, up 18.3 percent in the month. Other gains include airfares at plus 2.0 percent and tobacco at plus 0.8 percent.
Pulling down the CPI was a record decline of 1.1 percent in hospital services that drove the medical care component to minus 0.2 percent in the month. Year-on-year, medical care is still on the high side compared to other prices, at plus 2.5 percent. Other readings on the negative side include apparel, down 0.1 percent in the month for a minus 1.8 percent year-on-year rate.
But the key story in this report is the incremental rise in the core rate with the rise in owners' equivalent rent, the highest since way back in October 2006, a special concern. Today's report is line with expectations for a rate liftoff sometime later this year.
HOUSING STARTS FOR JUNE were huge. Which is yet more support for my continued optimism over the U.S. housing market. As we might expect, given today's tight rental market, multi family construction is soaring, up 29.4%. PERMITS for new construction jumped well above expectations, at 7.4%.
THE UNIVERSITY OF MICHIGAN CONSUMER SENTIMENT INDEX FOR JULY slipped to 93.3, from June's 96.1. I suspect June's volatile stock market, and general global unrest (Greece in particular) that was so vividly portrayed in the media, helped put a bit of a damper on sentiment. At present, I expect an improvement in next month's reading.