The purpose of this page is to display key macro points that we observe and learn on our journey in pursuit of truth in finance and economics.

Keep in mind, this does not replace the need to read the articles which contain much more details, graphics and explanations. 

To read in-depth, click on the hyperlinked article title corresponding to each note.


12/14/18 – Is Current Stock Market Sentiment A Contrarian Indicator?

  • The latest jobless claims report switched the narrative from wondering about a potential recession, to wondering if the metric will hit a new cycle low. 
  • There are a lot of seasonal adjustments around holidays like Thanksgiving. One way to avoid mistaking a signal for noise is determining if there is a one time event which affected claims.
  • The latest jobless claims report fell to 206,000 which is just 4,000 above the September low.
  • The 27,000 weekly decline in initial claims was the largest since the week of April 25th, 2015 when it fell 28,000.
  • The record low jobless claims in relation to the size of the labor market suggests the labor market is full. That and the lowest unemployment rate since December 1969 support the Fed’s rate hikes.
  • The prime age employment to population ratio which doesn’t signal the labor market is full.
  • The percentage of people unemployed for longer than 27 weeks is much higher than the past 2 cycle troughs. Currently it is at 20.8%. It troughed at 15.9% in October 2006 and 10% in May 2000 which was during the 2001 recession.
  • This metric and the prime age employment to population ratio suggest there is still labor supply left in the labor market’s pool of workers.
  • If the yield curve is correct, the next recession could be over 1.5 years away.
  • Retail investors are getting worried as 48.9% of traders think the S&P 500 is going to fall in the next 6 months. That’s up 18.4% from the previous week’s reading. It is the highest reading since April 11th, 2013.
  • In the survey, cash allocations hit a 33 month high, which is a bullish sign. However, only 13% see a recession in the next year.
  • We say this is a unique point in the cycle because the correction is happening fairly early.
  • Even knowing where the economy is headed, doesn’t mean you can time the market perfectly.
  • PE ratio has already fallen even though EBDITA profit margins are still high.
  • There has been severe multiple compression in 2018. If stocks keep falling, they will eventually price in a recession which might make them a buy even if the economy weakens.
  • Consumer discretionary stocks underperform the S&P 500 a few years before recessions. Currently consumer discretionary stocks have traded on par with the S&P 500.
  • The real 2 year treasury yield increased a few years before the past 3 recessions, similar to what’s happening now.
  • The difference between America’s 10 year real yield and international 10 year real yields is at a record high.

12/13/18 – November Core Inflation: Impact On Fed Guidance & Yield Curve

  • The decline in oil prices pushed headline inflation lower, but the Fed sets policy mainly based on core inflation, which excludes oil, so this won’t affect policy.
  • Core inflation contributed a high percentage of headline CPI.
  • The Fed believes the next rate hike in December will only get it to the low end of the range of the estimates of the neutral rate.
  • Fed doesn’t believe further hikes in 2019 is hawkish policy because it looks at the neutral rate rather than the yield curve as a guide.
  • The weakness in the housing market this year hasn’t affected shelter inflation enough to push down core CPI.
  • The Fed looks at the November NFIB small business report, which says firms are prepared to raise wages. Additionally, the average hourly wage growth for retail trade workers is the highest of this cycle.
  • There is a correlation between the yield curve in relation to other nations and the dollar index.
  • Specifically, it has been bad for the dollar when the curve is relatively flat compared to other countries, implying the Fed needs to cut rates in relation to other countries.
  • The oil price decline might be over soon since global oil inventory has gone from a huge surplus to a small deficit.
  • When the 10 year yield and the 2 year yield are the same, there is a 91.9% chance of a recession.

12/12/18 – Housing Starts & Permits Near Cycle Troughs?

  • The housing market isn’t as important to GDP growth as it was last cycle.
  • The housing market is like the energy sector in that energy and mining capex as a percentage of the economy didn’t get as large in 2018 as it was in 2014. As a result, the oil price crash in 2018 didn’t damage the economy as much as it did in 2015.
  • Single family residential investment is less than 1.5% of GDP, while it was almost 3.5% of GDP in 2006. That level in 2006 was the highest since at least 1959.
  • Housing starts and permits as a percentage of the population shows very interesting trends. The peak in the previous cycle was relatively normal while this current expansion is abnormal as it is near the previous cycles’ troughs even though this expansion is about to be the longest since the 1800s.
  • Housing starts in the previous cycle were higher than the demographic demand for homes and housing formation.
  • In this cycle, the 4 quarter average housing starts are in between household formation and the demographic demand for homes.
  • Household equity growth in Q3/2018 was up the least in 2 years.
  • The share of home owners with negative equity fell 16% to 4.1%. That’s a decline of 416,000 homes.

12/11/18 –  Multiple Ways To Review Wage Growth

  • Monthly labor market report – on the negative side, hours worked missed last month’s report and the consensus of 34.5 hours, coming in at 34.4 hours.
  • Weekly pay is all that matters. Working less and getting paid more per hour doesn’t drive retail spending (which is a majority of GDP in the US).
  • Average weekly wage growth fell from 3.4% to 2.8%.
  • The 3.4% wage growth was the highest since October 2010.
  • One big reason for this weakness is the tough comparison.
  • However, it’s not ideal to have decelerating wage growth even if it’s because of strong comparisons.
  • This decline in weekly wage growth supports the notion that the Fed shouldn’t be hawkish.
  • Wage growth for private production and non-supervisory workers increased to 3.2% which is the highest growth rate of this expansion – the best reading since April 2009 when the economy was in a recession.
  • The labor market isn’t currently full because 208,000 jobs have been created per month this year which is above the past 2 years and about double the additions needed to keep up with population growth.
  • Your determination of the fullness of the labor market depends on which data you look at making it both interesting and difficult to analyze.
  • The labor force participation ratio for women 25 to 34 years old is higher than the previous cycle’s peak and just below the 2000 peak.
  • On the other hand, men’s participation rate from 25-34 is in a secular decline as it has fallen from about 95% in 1990 to about 89% now.
  • The less educated the group is, the wider the vacillations in the unemployment rate. 
  • One indicator suggests that the labor market is close to full because the unemployment rate for those with only a high school diploma is 3.5% which is the lowest rate since 2000. 
  • The S&P 500’s forward PE multiple is the lowest since early 2016 which was a great buying opportunity.
  • S&P 500 EPS growth of 5% to 7% next year translates to 2019 EPS of $168. Current estimates are for $173.
  • Even if inflation falls in November, real weekly earnings growth won’t be great. 
  • With no recession on the immediate horizon, a dovish Fed could help stocks avoid a bear market in 2019.

12/10/18 – Yield Curve Inversion Can Cause A Crisis Through Reflexivity

  • Instead of using the indicator to forecast a recession, investors are selling before the curve even inverts (10 year – 2 year) because they think they know what will happen next.
  • The number of Google searches for the yield curve has exploded recently.
  • The yield curve is usually a leading indicator, but its new-found popularity has made it a concurrent indicator due to reflexivity.
  • Adding fuel to the reflexivity issue with the yield curve is banks have stated they will tighten lending standards if the curve inverts.
  • Since banks lend long and borrow short, their margins are hurt by a flattening yield curve.
  • The year over year change in the unemployment rate shows us the momentum of the economy.
  • When the unemployment rate increases year over year, it’s a good indicator the economy is headed into a recession.
  • The unemployment rate YoY indicator moved positive 3 months before the last recession, 2 months before the 2001 recession, and 8 months before the 1990-1991 recession.
  • There were two false warnings of YoY unemployment rate increases since the mid-1970s and the double dip recession in the early 1980s never gave off the warning.
  • Historically, individually, a high CAPE ratio and low unemployment rate are bad for returns. Therefore, it’s not surprising that when you combine them, the returns are terrible.
  • The current CAPE ratio is 29.37. When the CAPE is above 25 and the unemployment rate is in between 2.5% and 4.4%, 2 year annualized returns are -9.8%. The returns are negative every period up until 5 years. Even 7 year returns are only 2% per year.
  • There were 155,000 jobs created in November which means job creation was above the population growth.
  • The average job creation of 208,000 per month in 2018 is about double the population growth rate.
  • The prime age employment to population ratio is 79.7%.
  • On average, in the past 3 cycles prime age employment to population ratio has peaked at 80.8% which means it is 1.1% away from reaching full employment.

12/7/18 – China & America Not On The Same Page In Trade Negotiations

  • In the past 2 cycles, the Fed has finished off its rate hikes after the difference between the 5 year yield and 2 year yield inverted.
  • The Fed wants to hike rates because the labor market is strong and nominal wage growth has accelerated this year. That could be a mistake because wage growth isn’t causing inflation to increase.
  • The labor market is near full employment – that is driving real consumption growth which helps GDP growth
  • The percentage of prime aged men who aren’t working full time, but want to work full time is very close to the low from the year 2000 & 2006.
  • This cycle is different because the ISM reports are strong even as the yield curve is near inverting.
  • Current growth rates don’t make it seem like a recession is coming in 1-2 years. Maybe this signals a recession isn’t coming or maybe it just signals business sentiment is too high in relation to real growth.
  • MBA Applications Composite Index – 30 year fixed mortgage rate fell 4 basis points to 5.8% and that the average loan size for purchase applications fell from $313,000 to $298,000 which is the lowest since December 2017.
  • University of Michigan Survey – New home inventory has spiked to 7.1 months like when the housing market started to weaken in 2006. 
  • Unlike 2006 existing home inventories are low at 4.3 months. Existing homes are a bigger percentage of the market than new homes.
  • University of Michigan Survey – Buying conditions in relation to selling conditions are worse than the previous cycle. This implies mortgage rates falling a few basis points won’t be enough to bring back buyers.

 


12/6/18 – Does Current Yield Curve Inversion Signal Crash For Stocks?

  • Our goal is to present the best bullish and bearish cases for markets and the economy. We try to improve your and our own understanding of markets to make the smartest decisions.
  • If you expected this cycle to be average, you would have overestimated the average annual GDP growth rate and underestimated the length of this expansion.
  • The yield curve could be wrong as it doesn’t have as good of a track record in international economies such as Japan.
  • Data suggests that yield curve inversions such as when the 2 and 3 year bond yields recently moved higher than the 5 year bond yield are irrelevant. What’s more important is the whole curve, not parts of it. 
  • Look for 80% of the yield curve to invert before expecting a recession.
  • ISM is a good predictor of stock returns. 
  • Stock returns based on the ISM manufacturing index and changes to the market’s prior year change in PE multiple suggests that when the ISM is above 53, every scenario has positive returns for stocks.
  • The ISM is above 53 and the prior 12 month change in the PE multiple is between -3 and -2, suggesting 11.6% returns in the next 12 months.
  • The returns are much different if the ISM PMI is below 53. In that scenario, the best performance occurs when the prior year PE multiple increases.
  • The themes from the quotes in the new orders index report were that there are labor shortages, tariffs are increasing metals prices, growth is strong, and oil prices fell.
  • Q4 and 2019 full year earnings estimates are falling, but they are still outperforming the historical average. In other words, the positive difference between current revisions and the long run average of revisions is shrinking.
  • The tax cuts boosted 2018 earnings estimates in the beginning of the year; then GDP growth beating estimates helped boost earnings revisions later in the year.
  • The stock volatility in the fall is about 2019 results. Anyone who claims stocks should rally because 2018 earnings growth was solid is looking in the rear-view mirror. 
  • Even with some of the negative economic catalysts being priced in, the decline in earnings estimates is better (less) than average.
  • Recessionary indicators (yield curve, inflation trends, job creation, credit performance, ISM, earnings quality, housing market) point to limited downside risk in equities.
  • Good earnings quality means the gap between pro-forma and GAAP earnings isn’t increasing and write-offs as a percentage of pro-forma earnings aren’t high.
  • When earnings are weak, firms can use accounting tricks to put lipstick on the pig that is GAAP earnings to make pro-forma earnings look good.
  • The ISM composite and manufacturing indexes signal the economy is growing.

12/5/18 – Can Widely Followed Indicators Make You Money?

  • There is a spike in S&P 500 volatility right before and after inversions.
  • The average lag time in the past 5 cycles from when the 10/2 year curve inverts until the next recession is 22 months. 
  • As of November, the Cleveland Fed’s recession indicator states there is a 20.3% chance of a recession in the next year.
  • The lag time from yield curve inversion until the stock market peaks is 13.1 months.
  • Average stock market returns are 21.8% after inversions.
  • Fed rate cuts don’t cause recessions; they signal the economy is weak enough to need monetary support.
  • In every cycle since he Fed was created the yield curve has inverted.
  • The Fed has a long history of ignoring yield curve inversions.
  • Powell stated the low term premium could mean the yield curve flatness doesn’t matter. With that mindset, the Fed will invert the curve because it thinks where the Fed funds rate is in relation to the neutral rate is more important that the treasury curve.
  • The housing market surprise index is showing its worst reading on record with the weakness being led by new home sales, NAHB, and pending home sales.
  • To be clear, the housing market isn’t worse than the last cycle just because the index is at a record low.
  • Keep in mind, surprise indexes don’t signal overall weakness. They signal weakness relative to expectations. 
  • If the Fed doesn’t change guidance for 2019 hikes, the 10/2 year curve will invert, signaling a stock market peak sometime in early 2020 and a recession sometime in late 2020, if we are to estimate based on lead time averages.

12/4/18 – The Fed Has Justification To Pause Rate Hikes

  • There has also been weakness in housing price growth which should negatively impact both core and headline PCE.
  • Inflation has never been able to stay above the Fed’s 2% target this cycle. This is because of cyclicality and the inability to surpass tough comparisons without falling.
  • Inflation is falling because commodity prices are falling, comparisons are tough, economic growth is slowing, and housing price growth is slowing
  • High nominal wage growth hasn’t translated to higher inflation which is great news for workers as they will see real wage growth gains due to this decline in inflation and tight labor market.
  • The October core PCE reading is important because it’s the last reading before the December 19th Fed meeting.
  • With the Fed’s favorite inflation reading falling below its target, the Fed can easily turn dovish.
  • 2019 is different from 2017 as growth has been slowing (in 2017 it was accelerating).
  • Nominal wage growth has been strong in other reports, but it wasn’t amazing in the PCE report as interest payments and sole proprietorship growth catalyzed the month over month acceleration in income growth
  • Keep in mind, this year there is an extra week between Thanksgiving and Christmas which means year over year spending growth might be even stronger than what has been implied by Black Friday and Cyber Monday sales growth.

12/3/18 – Passive Investing Won’t End The World

  • Index funds are diversified, inexpensive, tax efficient, have a lot of capacity, have performed well over the long run, and have been used well by investors.
  • The big fear about index funds is that when enough investment capital goes into them, firms will be able to do whatever they want because the managers are passive.
  • Voting for directors and changes to firms’ charters is actually more critical to passive funds than active ones because passive ones can’t sell their shares.
  • Whereas, when active investors want the firm to do well then they own it, but if the situation goes awry, they can just sell it and buy a different stock.
  • Passive firms aren’t voting in lockstep with each other and are becoming more engaged.
  • Firms also have the motivation to stay in the index to gain investment from passive funds.
  • The jobless claims report is a leading indicator for the economy.
  • Initial jobless claims are the most accurate forecaster of recessions as they have the lowest error rate.
  • On average, the 3 month moving average of the 6 month growth rate of initial jobless claims is up 10.8% prior to recessions.
  • Many believe when the claims rise above 300,000, the metric raises a red flag.
  • Economists often predict that when economic growth slows, there will be a soft landing which is slow growth at the long run potential.
  • The labor market is rarely creating the amount of jobs consistent with population growth – either the labor market is growing faster or slower than the population.
  • The housing market is a great leading indicator of economic growth. Pending home sales lead existing home sales by 1-2 months.

11/30/18 – Negative 5 Year Annualized Real Returns For S&P 500

  • The most interesting discussion in economics is about whether the increasing jobless claims mean the labor market is weakening and the expansion is near its end
  • The bulls claim this is just noise since the change in jobless claims is very small in relation to the total labor market
  • Increasing jobless claims are a bad sign for stocks since claims increase before and during recessions.
  • Jobless claims don’t give us much lead time in predicting stock market moves.
  • Key to monitor 4 week moving average of jobless claims rising above 300,000 for indication of economic trouble. 
  • Cycle trough of jobless claims had the lowest jobless claims in relation to the labor market in history.
  • Continuing claims experienced a trough in October at 1.635 million which was a 45 year low.
  • When the unemployment rate starts increasing year over year, it has historically been a strong sell signal.
  • Johnson Redbook same store sales report showed 7.9% year over year growth in the week of November 24th which included Black Friday which is the most important shopping day of the year. marking the fastest growth rate in at least 12 years. 
  • The Evercore ISI retail sales survey confirms the great news from the Redbook metric.
  • If this expansion continues, it will be the longest one since the 1800s in June 2019.
  • The economy is in the longest stretch where nominal GDP growth is above the Fed funds rate, namely because the Fed has been so dovish.
  • S&P 500 5 Year Annualized Real Returns vs Nominal GDP minus the Fed funds rate which has a 5 year lead, signals negative 5 year annualized real returns for the S&P 500 in the next 5 years.

11/29/18 – Stock Market Rallies, But Powell Didn’t Blink

  • The Fed fund futures market increased its confidence in a December rate hike, but lowered the odds of hikes next year.
  • Fed removed the “accomodative” language because it “doesn’t want to suggest it has a precise understanding of where accommodative stops.
  • The broad range of neutral estimates by the FOMC is from 2.5% to 3.5%.
  • The Fed is 1 hike away from low end, 3 hikes away from the middle of the range and 5 hikes from the top of neutral range.
  • Fed fund futures are great at predicting short term policy changes, but aren’t accurate in the intermediate term.
  • There is a 0.92 correlation between oil prices and forward 12 month energy sector EPS estimates.
  • Morgan Stanley leading earnings indicator, which has a great track record of predicting actual EPS growth, expects year over year earnings growth to crater in 2019. 
  • Just because the Fed thinks the neutral rate is between 2.5% and 3.5% doesn’t mean it is. 

11/28/2018 – This Is A Leading Indicator Of S&P 500 Peaks

  • This report includes data already seen in inflation metrics
  • Housing will become less of a boost to inflation in the next few reports.
  • Higher priced homes are more at risk of falling with new home sales, pending home sales, and the sale pair count all weakening.
  • The sale pair count tracks the changes in home prices between sales. There needs to be 2 sales for the data to be calculated.
  • Homebuilder stocks have been leading indicators of peaks in the S&P 500. 
  • In the past 5 cycles, housing has led the stock market 4 times.
  • If you average the past 5 cycles, housing leads the stock market by 9.6 months. 
  • November Conference Board consumer confidence index is the most important reading of the year since it’s the holiday shopping season.
  • The difference between the present situation index and the expectations index is a great metric to predict recessions.
  • The gap widened as the present situation index increased 0.8 to 172.7 and the expectations index fell 4.1 points to 111, which is a bad news.
  • The difference between the ‘jobs plentiful’ index and the present situation’s ‘jobs hard to get’ suggests that this is one of the best labor markets ever as only the 1990s peak had a higher reading, which peaks generally a few quarters before a recession. 
  • Main reason for weakness in world trade outlook is cyclicality, however this slowdown will rival the 2016 weakness.
  • Export orders index is at 96.6 which is near the trough from 2012 during the EU crisis.

 


11/27/2018 – How Many More Rate Hikes?

  • Best housing markets (Dallas, Denver, Seattle, and San Francisco) are showing signs of weakness with year over year inventories in these cities up much more than the national average.
  • Housing is a leading indicator, with the primary catalysts for current weakness caused by a lack of affordability and rising interest rates.
  • Despite sequential (MoM) improvement in existing home sales, this did not reverse the negative trend (YoY).
  • Sometimes the headline reading of the durable goods report isn’t in tune with the underlying trend which is what matters. 
  • Year over year non-defense capital goods orders and shipments excluding aircrafts were up only 3.4% and 4.3% – indicating the economy is slowing down and implying that slow growth in non-residential business investment in Q3 will continue into Q4.
  • The Fed fund futures market combines the market’s expectation for the economy with Fed statements to predict rates
  • The market only expects 2 more hikes this cycle including the anticipated December hike with a 79.2% chance of happening.
  • The middle of the 2020 dot plot has the Fed funds rate between 3.25% and 3.5%. The Fed sees 2 to 3 more hikes than the market. 
  • However the Fed funds futures market has a bad track record of predicting intermediate term policy.
  • Predicting policy is the combination of predicting economic results and how the Fed will react to them.
  • Financial conditions are constricting giving us an idea of where policy is. Further rate hikes will be a drag on economic growth in 2019.
  • The Fed is hiking into this slowdown making it different than the last 2 slowdowns in this expansion.
    • In the first slowdown, the Fed was doing QE and had zero percent interest rates.
    • In the second slowdown, the Fed hiked once which was its first hike. Now the Fed is much deeper into its hike cycle and is unwinding its balance sheet.
    • The hawkish Fed increases the odds that this slowdown turns into a recession.

11/26/2018 – 2019 Economic Setup Looks Unfavorable

  • Median age of homeowners has increased from 50 in 2002 to 56 in 2015. In that time, the median age of adults in America increased from 43 to 47.
  • Housing starts during current cycle looks more like a recession than an expansion, which has contributed to a lack of starter homes for millennials. 
  • Jobless claims have a great record of indicating recessions and bear markets, which moves in concert with stocks since both are leading indicators.
  • If the weakness in jobless claims isn’t caused by a one-time event, it’s a negative sign for the labor market and stocks.
  • Conference Board Leading Index has led recessions by 6.7 months on average in the past 7 cycles with two false alarms since the 1960s.
  • Leading indicators don’t suggest a recession is coming in the next few months, but there are a few negative catalysts in 2019 which will slow growth.
  • Financial conditions will be a drag on GDP growth in 2019 and the fiscal stimulus will provide less of a benefit as the year goes on.
  • High yield spread is the highest since December 2016.

11/21/2018 – Late Cycle Oil Price Decline & Effect On Consumer

  • In the past 5 recessions, on average total consumption growth didn’t turn negative until after the recession started.
  • Emerging market industrial production growth is below US industrial production growth for the first time since the Asian crisis in 2002.
  • The capacity to utilization rate fell from 78.5% to 78.4%. The cycle peak was 79.6% which means there’s still headroom for capacity to grow without reaching constraints.
  • About 70% of industrial production growth was due to oil related line items this cycle, but some think the decline in oil won’t hurt industrial production as much as the last crash in late 2014 and 2015.
  • Mining and oilfield machinery as a percentage of nonresidential investment in equipment is lower than the peak in 2012.
  • Mining capex as a percentage of total capex peaked at about 10% last cycle, while it is only at about 6% now.

11/20/2018 – Cash Outperforms Stocks & Bonds First Time Since 1992

  • The housing market index was down 13% year over year which is the biggest year over year decline since 2011.
  • The housing and real estate surprise index has the lowest z-score since the calculation began in 2000, despite the data being obviously worse during the financial crisis.
  • Housing market index reached an 18 year high of 74 in December 2017.
  • In the last 3 cycles, the average housing market index peak was 73.6, which after a decline signals the end of the business cycle.
  • Goldman Sachs has recently become relatively bearish on growth as it only expects GDP to grow at a 1.75% pace by the end of 2019.
  • The HMI: Traffic of Prospective Buyers of New Homes index fell sharply from 53 to 45, marking the lowest reading since August 2016, and on a year over year basis, experiencing the largest decline in traffic since February 2014.
  • Future sales index was the worst component of the HMI falling 10 points to 65 which was the worst reading since May 2016.
  • Usually, in sentiment surveys, future estimates are highly correlated with current results. However, it’s bad for future expectations to underperform current results.
  • Unusual recession indicator – 1 quarter average spread between the 10 year yield and the 3 month yield paired with the 1 quarter average of the Fed funds rate. It gives a 1.85% chance of a recession in the next year.
  • The 30 year yields of 11 countries are below the Fed funds rate. The caveat here is these comparisons aren’t apples to apples as the Fed funds rate is much lower than the U.S. 30 year treasury yield.


11/19/2018 – Who Didn’t Learn From 2008 Housing Crash?

  • Economic growth is slowing according to GDP estimates, earnings estimates, housing loan demand weakness and the ECRI leading index
  • Average debt-to-income ratio of FHA loan borrowers has deteriorated. 2% above 2009 peak at 43.09%.
  • 25% of FHA borrowers have a debt to income ratio of 50% or higher which is a record high since 2000.
  • In 2007, which was the height of the housing bubble, only about 10% of borrowers had a debt to income ratio of 50% or higher.
  • Over 20% of borrowers had a credit score less than 579 in 2007 and now close to 1% have those low scores
  • The good news is that private mortgages look pristine with the prevalent credit score range of borrowers being 760+.
  • Total household debt hit a record high of $13.51 trillion.
  • Housing debt is $9.56 trillion which is still below last cycle’s peak of $9.99 trillion