Friday, September 25, 2015

Your Weekly Update AND The Confusing/Confused Fed AND On The 3 Risks That Have Everyone Up In Arms

If  you listened closely to Janet Yellen during her last two public appearances (the past two Thursdays) you just might be a little confused. The Janet Yellen of the post-September Fed Meeting press conference did not associate herself with her fellow members who thought that raising rates by year-end would be a fine idea. The Janet Yellen of last Thursday’s University of Massachusetts, Amherst speech, however, had shuffled over to the let’s-raise-the-rate-this-year side of the boat. So---merely a week later---what gives? Clearly, the stock market (the S&P 500 is off 3.5% since the Fed meeting) is calling the shots on this one.

But does it matter? Well, if your time horizon takes you beyond the few days, weeks or months following the next Fed meeting or two, certainly not! In which case you’re not concerned with how the market finishes up 2015, but rather with at what point you might begin tweaking your sector allocation to something a bit more defensive due to heightened recession-risk.

While I’m tempted to fill a dozen pages with recession indicator charts (the majority of which presently point to little foreseeable risk), I thought we’d consider the odds of a prolonged economic slowdown against the 3 risks that seem to have everyone up in arms these days:

  1. The Fed raising interest rates.

  2. The presumed signal from low commodities prices.

  3. The threat from a slowing Chinese economy.


As for the Fed, you’ll notice in the chart below that, indeed, Fed rate hikes tend to precede recessions. However, historically-speaking, only after a series of hikes. Since the early 70s the average period between the first hike and the onset of recession was 32 months (the shortest being 15 [between the back-to-back early-80s recessions], the longest was 50). And that’s ignoring the instances when the Fed raised rates only to reduce them before raising them once again (with no recession in between).     click to enlarge

 Recessions and the Fed Funds Rate


A very confident money manager appearing on CNBC last week cited the present bear market in commodities as proof positive that we’re about to enter a global recession---and he reported that, consequently, he’s gone 100% cash.

I get that the freefall in commodities prices speaks to reduced demand from China, etc., but what if developed nation economies begin to accelerate and, thus, maybe offset some of that lost demand from Asia. What if the green and blue lines (copper demand in Europe and North America) below continue in the direction they’ve been heading of late (Asia demand in yellow):     click to enlarge

 World Copper Demand

And what does it mean for the future price of, say, copper, when shipments of copper mining equipment are dropping precipitously while developed nation demand is picking up? I.e., less equipment shipments means less future production, which means less future supply, which means future prices rise when demand picks up:     click to enlarge

 Copper Mining Equipment Shipments

What happens to the commodities-dropping-spells-recession theory if commodities begin to rebound before the next recession? Like they did during the 80s:     click to enlarge

 Commodities During the 80s

And the 90s:     click to enlarge

 Commodities During the 90s



Yes, China, the world’s second largest economy, has issues. Its fantastic early-21st Century growth has been fueled by an amassment of private sector debt which will be no small feat to unwind. The folks who cite China’s economy as the ultimate headwind to future global growth point to the visible slowdown in its all-important manufacturing sector. As I suggested in a recent audio, never forget, publicly-exposed "experts" tend to speak their book---whether it's literally a "book" they've written, or their books of business (their portfolios, essentially). Of course they believe what they preach, it's just that they generally have skin in the game and, therefore, a desperate need to be right, and to convince the rest of the world---book buyers and stock-price-moving investors alike---of the same. With regard to China, in my view, there just seems to be too much passion and commitment coming from those who believe some great implosion in the east is imminent.

I spent the better part of last weekend engrossed in John Mauldin and Worth Wray's latest A Great Leap Forward?: Making Sense of China's Cooling Credit Boom, Technical Transformation, High Stakes Rebalancing, Geopolitical Rise & Currency Dream. The authors assembled a wide array of opinions from some of the world's most respected experts in global trends, economics and investing. The brainpower was divided essentially into two camps: those who bent toward a world-shaking hard landing for China and those who believe the odds favor a long, soft landing. While my bent favors the latter, I can't help but wonder if the most likely scenario doesn't lie somewhere in between.

Given the unreliability of economic reports coming from China's government, we have to rely on the data compiled by private sector players who've, surprisingly perhaps, been allowed in to gather a real world assessment of what the planet's largest population is truly up to. And, arguably, the best source is Leland Miller's China Beige Book (CBB)---literally, the world's largest private data base!

In 2012, Mr. Miller warned that his organization's 21,000 Chinese company survey told a story vastly different than the then consensus view: While the world saw China's rapid growth continuing unabated, the CBB was suggesting that China's economy was already slowing, and was likely to continue its descent in the coming years. As is now painfully apparent, the CBB had it right! However, today, ironically, while the world panics over the looming demise of the once great Red Dragon, Mr. Leland says not so fast. Here's from his Bloomberg Radio interview last week:
If you look back at what happened in June, in July and particularly in August, with the stock market collapse, with the surprise currency move, all of this with the Fed uncertainty hanging over it---people were really worried about China. And I think if you look at the August global market selloff, people mostly attributed that to this sudden fragility of the Chinese economy; why would the Chinese leadership do something so drastically with the currency unless they're seeing something we don't? So, something terrible has to be happening. And what our data show is, no, we had a mild slowdown this quarter---but the most remarkable thing about it was that there was nothing remarkable happening.

What I think is most important is that manufacturing, as we've been talking about for years now, is assumed to be the Chinese economy writ large. You look at people's reaction to the PMI, and it's visceral! So, people wake up, they check the Flash PMI---if it looks good they think China's in good shape, if it's looking bad they think it's in bad shape, but the Chinese economy is so much more than just manufacturing.

So all the data, public and private, is indicating that the manufacturing sector is going through some significant weakness, but I think our point there is that China is not just manufacturing. If you look at the economy through our multi-sector data, you see a much more mixed picture---you see what is a mild slowdown, but not this cataclysmic result that most people are assuming.

Services is a very important part of the economy, one of the leading, growing parts of the economy, and it had a very good quarter. So, you can have manufacturing have a down quarter, you can have services have an up quarter, you can have a very mix of the rest of the sectors and what you're left with is a very mixed picture of growth overall. But it's a lot more optimistic than what the current views on China are.

As I've described many times of late, China is evolving, rebalancing if you will. As was the case with every developed economy; in the beginning there was industry---smoke stacks and grimy faces. In the middle there was the transition---a rising middle class, growing consumption and a blossoming service sector. In the end a predominantly service-driven economy. 

Here's a visual:     click to enlarge

China GDP Evolution by Sector

And the trend continues: As of last year according to the CIA World Fact Book: Industry: 42.6% Services: 48.2% Agriculture: 9.2%

A CNBC regular last week sought to downplay Nike's earnings report (yesterday) that showed it blowing past estimates---based, yes, on stellar sales out of China---by stating that for every Nike and Apple (another company showing great results in China), there's a Caterpillar (laying off at least 5,000 workers over the next couple of years due to challenges related to China's manufacturing slowdown) and United Technologies (suffering recent share price decline based on concerns over its Otis Elevator prospects in China and other emerging markets).

Well, yeah, given China's economic evolution/transformation, that makes sense!

While China---suffering through its growing pains---will no doubt be a source of volatility (extreme at times) well into the future, it's far too soon to call it down for the count.


All things considered, for now anyway, the present downdraft in stocks looks more like a long-overdue correction to me, as opposed to the beginning of the next great bear market. Although, anything can happen---I make no guarantees.

The Stock Market:

After last week's pummeling of Europe (thanks in no small part to the VW scandal and Mario Draghi's somewhat hawkish tone) I can no longer say that non-US developed markets (EFA and FEZ below) have outperformed the U.S. major averages year-to-date. But I do maintain that, given many foreign markets’ cheaper valuations, early-stage recoveries and, yes, accommodative central banks, I remain very constructive on non-U.S.. That said, there are a number of potential international hot buttons (as we've recently experienced) that could easily delay the narrowing of the gap between the valuations of U.S. and non-U.S. securities (particularly emerging markets [VWO below]). That’s why we think long-term and stay diversified!

Here’s 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:  -8.46%

S&P 500:  -6.20%

NASDAQ Comp:  -1.05

EFA (Europe, Australia and Far East):  -5.56%

FEZ (Eurozone):  -9.28%

VWO (Emerging Markets):  -17.04%

Sector ETFs:

Here’s a look at the year-to-date results for a number of U.S. sector ETFs:



IYH (HEATHCARE):  +1.64%


XLK (TECH):  -3.72%


XLU (UTILITIES):  -9.51%


IYT (TRANSP):  -14.07%

XLB (MATERIALS):  -17.25%

XLE (ENERGY):  -21.21%

The Bond Market:

As I type, the yield on the 10-year treasury bond sits at 2.17%.

TLT, an ETF that tracks an index of long-dated U.S. treasury bonds, saw  its share price decline a 0.46%  over the past 5 trading days (down 3.48% 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.

On Volatility and Timing:

Each week I share with you the very short-term (year-to-date) results for major indexes 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). While my beginning of the year optimism over non-US (developed markets that is) and the housing sector, and my pessimism over utilities, appears to be justified by recent results, I need to strongly (very strongly!) emphasize that I was not predicting what we’ve experienced thus far in 2015. Plus, while we maintained our healthcare exposure I in no way expected the gains that sector has experienced this year. Same goes for energy and materials, only in the other direction.

My optimism or concerns over a given sector or region are based on factors such as valuations, trends, supply and demand, monetary policy and cyclicality—and my comfort in making allocation recommendations rests on the view that our clients are not short-minded investors 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.


SEPTEMBER 21, 2015

EXISTING HOME SALES, per Econoday below, softened a bit in August:
Though slowing in August, existing home sales are still healthy and trending higher. Existing home sales came in at a lower-than-expected 5.31 million annual rate in August which is the lowest since April. July was revised down just slightly but is still an 8-year high at 5.58 million. At 6.2 percent, growth in year-on-year sales is the lowest since February. The year-on-year median price, up only 4.7 percent to $228,700, is the lowest since August 2014. The report cites no special reasons behind August's softness, but notes that it follows prior strength, in fact six months of strength. 

With the in dip sales, supply relative to sales is less tight, at 5.2 months from 4.9 months in the prior two months. But there's still a lack of homes on the market, evidenced by a comparison with the year-ago supply at 5.6 months.

SEPTEMBER 22, 2015:

THE JOHNSON REDBOOK RETAIL REPORT came in very soft last week, +0.9%. The report blames the wind-down after back to school season.

THE ICSC RETAIL REPORT came in soft as well, +1.03% last week.

THE FHFA HOUSE PRICE INDEX showed strength in July’s number. Here’s Econoday:
Home prices cooled late in the second quarter but began to pick up in July based on FHFA's house price index which rose a higher-than-expected 0.6 percent with the year-on-year rate at plus 5.8 percent. This is the largest monthly gain since February this year and the largest year-on-year gain since April last year.

The strongest gains were in the West led by the Mountain region at 1.6 percent in the month. Only two of nine regions declined in the month with New England at a steep minus 1.2 percent. Year-on-year, Mountain is out in front at a very strong plus 9.4 percent with New England bringing up the tail end but still in positive ground at plus 2.1 percent.

THE RICHMOND FED MANUFACTURING INDEX confirms the weakness reported in other recent manufacturingsector data. Coming in at -5.

SEPTEMBER 23, 2015

NEW PURCHASE MORTGAGE APPS surged last week by 9.0%. REFIS even more so, up 18%. The 30-year mortgage rate averaged 4.09%... This is good near-term news for the housing market…

CRUDE OIL INVENTORIES declined by 1.9 million barrels last week. GASOLINE rose by 1.4 mbs, DISTILLATES declined 2.1 mbs…

MARKIT’S FLASH MANUFACTURING PMI came in an expansionary 53 for September. While above 50 denotes expansion, 53 is as slow as its been since October 2013…

SEPTEMBER 24, 2015

DURABLE GOODS ORDERS FOR AUGUST came in inline with the consensus estimate, -2.0%. Aircraft orders are once again skewing the number. Ex-transportation, orders were unchanged. Captial goods slipped .2% after posting two months of very sold growth.

WEEKLY JOBLESS CLAIMS remain unrellentingly below the all-important 300k market, coming in last week at 267k. Clearly, the U.S. labor market is strong!

THE CHICAGO FED NATIONAL ACTIVITY INDEX points to a weak August for the economy, coming in at -0.41. Manufacturing is largely to blame for August's weakness.

THE BLOOMBERG CONSUMER COMFORT INDEX surprisingly rose last week, to 41.9, from 40.2. I'm surprised given recent stock market volatility.

NEW HOME SALES surged in August, to 552k, vs the consensus estimate of 515k. Here's Econoday:
Because of a small sample, new home sales can be very volatile month-to-month as they are in the August report where, at 552,000, the annual rate came in far above the high-end estimate. This is the highest rate since February 2008. Adding to the momentum is a 15,000 upward revision to July. 

In especially welcome news for builders, the sales strength pulled supply relative to sales even lower, to 4.7 months from 4.9 months. Still, low supply is a constraint on sales in contrast to pricing which remains favorable, at a median $292,700 for a 0.5 percent gain on the month but at a paltry year-on-year gain of only 0.3 percent. By comparison, the year-on-year sales gain is 22 percent.

NAT GAS INVENTORIES continue to climb, up 106 bcf last week.

THE KANSAS CITY FED MANUFACTURING INDEX came in weak, -8, as the sector continues to struggle under the weight of a strong dollar and weak commodities prices.

THE FED BALANCE SHEET grew by $9.7 billion last week. RESERVE BANK CREDIT grew by $10.9 billion.

M2 MONEY SUPPLY posted yet another gain last week, by $36.7 billion.

SEPTEMBER 25, 2015

Q2 GDP'S FINAL REVISION came in at a very strong 3.9% annual pace. Thanks to consumer spending!

THE SEPTEMBER SERVICES FLASH PMI came in at a nicely-expansionary 55.6. Consumer services providers report solid domestic conditions. Hiring has been "robust" and the respondents are optimistic going forward. New orders, however, slowed for a second month.

THE UNIVERSITY OF MICHIGAN'S CONSUMER SENTIMENT INDEX for September rose to 87.2. While it's an improvement over the prior reading, it's the weakest number since October of last year.

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