Well, the bulls certainly are emboldened, there isn’t any doubt about that. And this confidence, bordering on hubris, is proving very difficult to break. We are back to good news being good news and bad news also treated as good news.
The Dow’s nine-week winning streak barely came to an end but the Nasdaq did make it 10 in a row last week. The major averages are enjoying their fastest start to any year since 1991 (hmmm …which was still a recession year, folks). Amazingly, the S&P 500, after this 11 per cent January-February surge, is now within 4.3 per cent of reclaiming the cycle (all-time) highs. Virtually every commentator is bullish both on the market and macro outlook.
The safe-havens are now under pressure in this feel-good, risk-on environment. Gold has peeled back to a two-week low of US$1,286 per ounce after failing to pierce US$1,350 per ounce at the recent 10-month highs recorded on Feb. 20. The Treasury market has begun to trade quite defensively — the 10-year note yield is up 10 basis points in the worst week since last November to a five-week high of 2.76 per cent. The yield curve is re-steepening. The dollar is showing signs that it wants to break out again, as investors seem to be reassessing and revising up the U.S. economic landscape and pricing out the prospect that the Fed will be cutting rates this year, after all. Rate-cut odds by year-end have almost vanished to 2 per cent from 22 per cent a week ago, while market-based rate hike probabilities rose from just over 1 per cent to 7.7 per cent — ostensibly owing to what has been construed as some economic cheerleading during Jay Powell’s congressional testimony last week.
Let’s revisit the factors underpinning the relentless rally this year in risk assets, some of which came to further light this past week:
1. Trade tensions with China were already thawing out, but last week we did hear Robert Lighthizer say that the plan to raise tariffs from 10 per cent to 25 per cent was being postponed.
2. Theresa May kiboshed the risk of seeing a hard ‘no deal’ Brexit. We either see her plan get passed or we end up seeing Article 50 being extended. Against this backdrop, 10-year gilt yields soared 16 basis points in the steepest surge since September 2017. And within the FTSE, stocks that benefit from a soft Brexit (or no Brexit) outperformed the index by 300 basis points last week. And let’s not forget sterling’s test of a seven-month high of US$1.33 last week, before being hit by a round of profit-taking.
3. There is more and more talk of Modern Monetary Theory and this has caused investors to start pricing in fresh rounds of fiscal reflation, financed by the Federal Reserve, no less. MMT really should stand for Magical Money Tree (whoever heard of such nonsense, and yet this “theory” is gaining more adherents, and investors love it).
4. Richard Clarida of today’s Fed conjures up the memory of Ben Bernanke and his revolutionary ideas (non-conventional easings) back in 2002 when he was a newbie governor. Now Clarida, the No. 2 person at the Fed, is pushing for the central bank to aim for a period of inflation above the 2 per cent target. Bernanke was ahead of his time, and perhaps Clarida is too. One reason why the bond market has become a bit more jittery.
5. The corporate bond market is back open for business and spreads have tightened dramatically. The same is true in the EM debt space. Fear is back in the broom closet — and the investor stretch for yield is back in the kitchen (even as my old Merrill colleague, and bond guru, Marty Fridson is again warning of some froth entering back into the high-yield space).
6. While the oil price took a bit of a drubbing on Friday, the near-20 per cent surge this year has proven to have been a big surprise, thanks to Saudi-led OPEC compliance on the production curbs. The correlation between WTI and the S&P 500 is positive to the tune of 90 per cent, so the rebound in crude has helped out a lot with respect to the newly-found optimism in the stock market.
7. Earnings season was mixed and guidance poor overall, but was not an unmitigated disaster. The bar was lowered enough for most companies to beat their beaten-down estimates.
8. Everyone seems to have been emboldened by the Q4 real GDP data in the USA — a “solid” 2.6 per cent annual rate. I remember the days when a number like this was referred to as sluggish. No mention, I have to say, about the spurious run-up in business capital spending, which somehow escaped the monthly indicators but showed through in the GDP report. Outside of that, and GDP would have gripped a ‘1-handle’ in Q4. Now the data have been spotty, overall, but the mantra in the economics community is that we are in a 2016 type of ‘soft patch’ that will prove transitory.
9. The prevailing view in China is that the data are stabilizing and fiscal and monetary stimulus efforts are going to turn growth back into acceleration mode. And the equity market rally might lead one to believe that this is indeed the case (note that the Shanghai index led the world on the way down last year and led the way up last Fall … recall that the Chinese market had already bottomed prior to the late-year U.S. meltdown). The MSCI decision to quadruple the representation of Chinese shares in its flagship Emerging Market composite to 3.3 per cent (in line with Russia and Mexico) will undoubtedly add to the excitement created by the big rally in the Shanghai index this year. Well, there is no denying that it is a ‘cheap’ market, trading at a forward P/E multiple of 14, a 17 per cent discount to the historical (10-year) norm of 17.
10. There’s even some renewed enthusiasm in the euro area, which is brand spanking new. Even though Italy’s macro numbers have remained abysmal, confidence seems to have returned in both France and Germany. And the just-released data showed the eurozone jobless rate slipping to a 10-year low of 7.8 per cent and the headline inflation did the unthinkable and ticked up to 1.5 per cent from 1.4 per cent (though oil prices had a thing or two to do with that).
While these factors may be encouraging the bulls, it is nevertheless amazing that we could have a situation this past week where investors positively rerated the economic outlook and repriced the Federal Reserve for a renewed tightening in policy. After all, the Citigroup economic surprise index for the United States deteriorated to -43.4, which is the weakest it has been since August 2017; and the global index sagged to -32.4, a level we last saw in June 2013, which only begged for more monetary easing.
Americans should take note that their little brother north of the border saw real GDP growth throttle back to a mere +0.4% annual rate in Q4
The Atlanta Fed took its Q1 real GDP growth estimate to a microscopic +0.3 per cent annual rate and the NY Fed is down to +0.9 per cent. Even the usually bullish Macroeconomic Advisers cut its Q1 view to +1.2 per cent from an already puny +1.6 per cent the week before. Be that as it may, the consensus is adamant that this is all related to temporary factors like the weather, the government shutdown and trade/tariff tensions.
Even if true, the reality is that despite this broad consensus that the data softness is temporary, the numbers are coming in surprisingly weak. The economists knew that this so-called transitory malaise was going to result in an ISM decline in February — but why did the index fall so hard from 56.6 to 54.2 rather than to 55.9 as was widely expected? Why are the numbers surprising so much to the downside? This was, after all, the worst ISM reading since November 2016. New orders slipped to 55.5 from 58.2. Production sagged to 54.8 from 60.5. In the past six months the headline has receded 6.6 points, which has not happened since the credit rating downgrade in August 2011. Each of the past three recessions were presaged by such a dive, and the only other ‘head fake’ was in 1995. Note that in 1995 and 2011, the Fed was forced into easing action to lean against escalating downside economic risks. All the Powell Fed has done so far is talk.
Oh, and as for the latest backup in bond yields, this too looks temporary because the ISM data showed prices-paid declining for the fourth month in a row to 49.4 from 49.6 (nearby peak was over 80!) — the first time since January/February of 2016 that we have seen back-to-back sub-50 readings on the inflation metric. And keep in mind that back in early 2016, oil and commodity prices were sinking, not sharply rebounding as they have done this year. Tells you a thing or two about corporate pricing power …or perhaps a lack thereof.
Ignore forward-looking indicators at your peril
Then there was the consumer spending data for December — a 0.6 per cent slump in real terms doesn’t happen every day, that’s for sure (only one economist polled by Bloomberg was calling for such a decline). And we already know that auto sales plunged 5 per cent in January (16.6 million units) with no recovery at all in February (16.56 million units, which is the lowest tally since August 2017 — the consensus was looking for a rebound to 16.8 million but this was not forthcoming). The Friday data on PCE was a tell-tale that, no, sorry, the retail sales plunge that month was not due to any hasty reporting flaws. And while the consensus was looking for a decline, indeed, the slump was twice as much as what was generally expected. Real discretionary outlays fell 0.4 per cent in the sharpest decline since February of last year and before that, September 2009 when it wasn’t even clear yet that the Great Recession had run its course. Perhaps even more disconcerting was the extent to which ‘essentials’ are being cut from the family budget — ‘nondiscretionary spending’ contracted 1.1 per cent in December, which is a deeper slide than anything we ever saw in each of the past three recessions (having occurred just two other times in the past three decades).
The decline in real consumer spending was right across the board in December. The government shutdown happened too late to have any perceptible impact. The weather that month was just fine. The mantra by the experts was how great the holiday shopping season was going. The stock market decline had little to do with it because the ‘wealth effect’ on spending occurs with lags; it is not contemporaneous (I can’t believe how many times I’ve heard this as a reason). Volume spending on durable goods sagged 1.9 per cent in the worst month since September 2009; nondurables dropped 1.2 per cent in the largest decline since the month of the Lehman collapse in September 2008; and even spending on services, typically resilient to the forces of the business cycle, dipped 0.2 per cent, something we haven’t seen since August 2012.
Let’s not forget that the spending plan components of the latest Conference Board consumer confidence survey rolled over in a meaningful way in February — and this includes the effects of the stock market rebound — across autos, housing, major appliances and even vacations (by road and by air). Ignore forward-looking indicators at your peril.
And the next question is whether Canada is acting as a leading indicator, too. After all, look at the similarities — tensions with China, a national leader under pressure, an early-year stock market boom, a central bank that has been pushed to the sidelines after a rate-hiking cycle, signs of deleveraging in the household sector, and the benefits of the recovery in oil prices. Canada may be small for a country, but it’s economy is bigger than California’s and being so well integrated with the United States, it may be serving up a wake-up call here (keeping in mind that California has been known to have been a leading indicator at times in the past as well).
One can kiss goodbye to the Bank of Canada’s efforts to keep market-based rate hike expectations alive
So Americans should take note that their little brother north of the border saw real GDP growth throttle back to a mere +0.4 per cent annual rate in Q4, from +2 per cent in Q3 and +2.6 per cent in Q2 of last year. The bright spot in the report was actually dismal in its own right — a +0.7 per cent annualized increase in real consumer spending. Housing contracted at a 14.7 per cent annual rate and business spending plunged 10.9 per cent (-4.8 per cent for machinery and equipment and -15 per cent for nonresidential construction). The government sector didn’t help either (-0.6 per cent). If not for an inventory boost, curiously at the same time as imports declined, the headline would have been much worse. Indeed, real final domestic demand contracted at a 1.5 per cent annual rate in Q4 and that followed a 0.5 per cent drop in Q3. Back-to-back declines in this metric, virtually all the time, are associated with official recessions.
The monthly series showed a 0.1 per cent GDP dip in December, and that sets the stage for another flat quarterly reading, at best, for Q1. One can kiss goodbye to the Bank of Canada’s efforts to keep market-based rate hike expectations alive (all the more so with core inflation still modestly below target), and to the early-year rally in the Canadian dollar as well. The loonie should not be rallying in the face of a horrible 0.8 per cent rundown in industrial activity in December, the fourth setback in the past five months, contracting at a 2.3 per cent annual rate through the piece.
This all comes as a bit of a surprise given the alleged good news we have seen on the employment front. But the Household survey may have been flashing a false signal — the companion, though lagged, SEPH data showed a 20,000 net payroll slide in December. And even though the headline Household survey data appeared to have been decent, the workweek has shrunk 0.3 per cent, the second decline in a row (and flat or down in four of the past five months). Hours worked are a leading indicator for job creation, and the news here is not good. And keep in mind that the Q4 inventory bulge does not augur well for any near-term recovery in manufacturing activity.
The one thing Canada is showing us all is that: one, monetary policy does influence the economy with a lag … this receives scant attention from U.S. economists; and two, ballyhooed infrastructure spending sounds great from a political ‘feel good’ standpoint, but doesn’t do a very good job at affecting the business cycle. (But won’t stop the big government spenders south of the border from clamoring for a big package financed by money printing out of the Fed).
One final comment on the risk-on rally that has taken hold in the first two months of the year. I would hazard to say that if we hadn’t endured that Q4 meltdown, such a flashy rebound never would have occurred. As things stand, the stock market is still more than four per cent off the highs and actually, despite all the euphoria of late, has really made no headway at all for the past 14 months. It could be dangerous to extrapolate very good January-February stock market gains into the future, because if memory serves me correctly, the S&P in prior such years went on to post mediocre gains or outright declines in the ensuing 10 months. I am thinking of 1987, 1988, 1993, 2004, 2011 and 2012 when I say that.
Word to the wise.
David Rosenberg is chief economist and strategist at Gluskin Sheff + Associates Inc. and author of the daily economic report, Breakfast with Dave.
This Article Was Originally From *This Site*