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.

2/15/19 – Disastrous December 2018 Retail Sales Report

  • The December retail sales report was so terrible that it implies a recession is coming soon if the data is accurate. 
  • November report was strong, so the month over month comparison was tough. 
  • The reflexivity effect could have been in play whereby stocks cause the economy to weaken instead of predicting weakness (or both).
  • Overall monthly retail sales growth was -1.2% which missed estimates for 0.1% and November’s growth of 0.1%. That was the worst decline since September 2009.
  • GDP forecasts are acting like this retail sales report means more doom for Q1, while the stock market is acting like December is the ancient past that is irrelevant to the future.
  • Stocks don’t do well when retail sales less food service are down 1.5% or more.
  • There have been 3 other instances of this since 1992. They occurred right before the top in 2000, during the 2001 recession, and during the last recession. The average S&P 500 return in the next year is -11.03%.
  • Every category in this report was negative on a monthly basis besides auto dealers, vehicles and parts, and building materials

2/14/19 – Similar Set Up To 2000 & 2008 Or 2016?

  • 89.8% of S&P 500 stocks are above their 50 day moving average which is 4.4% away from the highest level of this expansion (2016) and the highest level since at least 2003. 
  • 4 of the past 6 earnings recessions didn’t coincide with an economic recession.
  • These earnings recessions not in economic recessions occurred during slowdowns. There have been more mid-cycle slowdowns lately because expansions have gotten longer.
  • It’s possible globalization has played a role in the decoupling of earnings growth and the economy. From 1948 to 1984 there was only one earnings recession without an economic recession.
  • Since international earnings are catalyzing the 2019 weakness, this is a candidate for another earnings recession without an economic recession.
  • The headlines on the January small business confidence index are horrid as the index fell for the 5th straight month for the first time since 1998.
  • Consumers’ and small business’ economic projections don’t mean much because they often express optimism right before recessions. We’d rather know how their individual finances and businesses are doing. 
  • The expectations for the economy to improve were down 10 points while plans to make capital outlays were up 1 point.
  • The net percentage of fund managers that said they were overweight cash was the highest since January 2009. That was the end of the 2007-2009 bear market, so that’s not a bad situation to be compared with.
  • We are at a 10 year high in profit and macroeconomic pessimism, a 2.5 year high in bond allocation, and a 16 year high in dollar overvaluation.
  • Fund managers have the smallest overweight global equity allocation since September 2016.
  • Bearish investors should be worried that a high percentage of fund managers are on their side. That doesn’t provide much upside for the short trade as bear markets are built on euphoria, not skepticism.  

2/13/19 – Impact of Household Debt & Key Labor Market Indicator

  • The most transparent way to misrepresent the NY Fed’s Household Debt and Credit report is to obsess about how much debt consumers have without contextualizing the results. 
  • Household debt to income is low compared to the last cycle because consumers deleveraged.
  • Just because debt has increased doesn’t mean leverage has.
  • This cycle has been dominated by non-housing debt, namely student and auto loans. 
  • Aggregate 90+ day delinquencies were steady at 4.7%.
  • Consumers might be getting smarter about credit cards as the number of accounts closed has been increasing, albeit to a similar level in the previous cycle.
  • The number of credit card inquiries in the past 6 months fell to near the level it troughed at right after the last recession.
  • Student loans have grown from $260 billion in Q1 2004 to $1.46 trillion now.
  • The best way to determine if the labor market is filling up is to look at the flow of unemployed people getting jobs.
  • Prime age people getting jobs in each stage of being unemployed has increased cyclically because the labor market is strong.
  • Categories of labor supply in the labor market for the prime age population. Currently, being involuntarily part time is the largest percentage of slack. That means workers filling full time jobs will come from working part time the most.

2/12/19 – 2019 International Earnings Recession

  • The good news is Q1 estimates will likely be beat. The bad news is they still have room to fall before earnings season starts.
  • Q1 2019 earnings estimates are unusual in the sense that tech is the laggard as its earnings are expected to fall 9.7%, while utilities is the only sector with positive earnings revisions as growth estimates increased from 4.6% at the end of last year to 5.2% today.
  • Tech has the largest percentage of profits that come from foreign countries while utilities are domestically oriented.
  • Usually international firms have quicker EPS growth than domestic firms, but that’s unlikely to occur this year based on current estimates.   
  • Currently, 37% of S&P 500 revenues come from international markets and 63% come from the US. If you want more American exposure, look at small caps.  
  • In Q1 only 4 sectors are expected to have earnings growth, while 10 out of 11 sectors are expected to have revenue growth. 
  • So far, this potential earnings recession doesn’t look as bad as the one from 2014 to 2016. Stocks fell more when pricing in this weakness than they did during the corrections in that period.
  • The ECRI leading index’s yearly growth rate has improved and
    the comparisons are going to get easier in the next few months which suggests the possibility that this index could have positive growth soon.
  • Oxford Economics global risk survey states that about 70% of respondents stated the probability of sharp slowing in global growth has increased in the past 3 months.
  • The economic surprise index measures how economic reports look compared to the consensus, not the rate of change in growth.

2/11/19 – Bank Tightening Lending & Recession Risk

  • Fed’s January Senior Loan Survey showed that the net percentage of banks tightening commercial and industrial loans became positive in January. It went briefly positive in 2012 and 2016, which were the other two slowdowns in this expansion.
  • The net percentage of banks increasingly willing to make consumer loans fell to near zero.
  • In the mid-1960s and the mid-1990s, this percentage was negative without a recession, but there is usually one near or ongoing when this goes negative.
  • Financial conditions became very stressed in late 2018 before recently recovering.
  • The consumer is in good shape as the unemployment rate is 4%, and in Q4 2018 real median usual wage growth was 2.9% which was the strongest growth since the start of the cycle. 
  • Household debt service payments as a percentage of disposable personal income was 9.82% in Q3 2018 which was the lowest percentage since at least 1980.
  • The consumer deleveraged during and right after the financial crisis and hasn’t taken out more leverage since then.
  • Total consumer credit reached above $4 trillion for the first time in December.
  • Quarter over quarter annualized consumer credit growth increased to 6.6% which is one of the faster growth rates of this cycle besides the extreme growth after the recession which had very easy comparisons.
  • The median credit score for private bank loans is about 705 for autos and about 760 for mortgages. The banks have been very risk averse this cycle.
  • In December, the consumer credit impulse hit a 4 year high.
  • Consumer confidence fell in January because of the government shutdown and stock market volatility.
  • The Redbook survey showed same store sales growth was strong in December. 

2/8/19 – Eliminating Buybacks Isn’t A Free Lunch

  • If you have an agenda in macroeconomics or investing, your return of/on capital will suffer. 
  • Let us say upfront that there are issues with buybacks, such as when companies leverage themselves using debt so that management can take out lofty bonuses instead of investing capital back into the business.
  • But in finance you cannot paint everything with a broad brush. There are nuances that are important to review. The distinction is that some, not all, companies sending capital back to shareholders in the form of buybacks are misappropriating capital.
  • If the goal of eliminating buybacks is to tax the rich and corporations, it won’t work well.
  • The best way to get businesses to hire more workers is to lower the regulations that make it expensive to hire and fire people.
  • Full time median real usual earnings growth was 2.9% in Q4 2018. That’s the highest growth rate since Q3 2009.
  • Less than 15% of buybacks are funded with debt.
  • If you see a firm borrowing money to buyback stock and using the shares to reward management so that the share count doesn’t fall, consider selling the stock. 
  • There’s no need to complain about bad treatment of shareholders because in the free market, these firms won’t get away with it. There share prices will fall. More importantly, in the long-term their competitiveness will too, since they are not investing in innovation.
  • The average 30 year mortgage rate fell 7 basis points to 4.69%.
  • Housing demand is being helped by price cuts. This is simple supply and demand dynamics which appears to have been lost on some investors who have been panicking. The reason it works is the consumer is still strong. 
  • Fannie Mae Home Purchase Sentiment Index showed improvement in January.

2/7/19 – Stocks Respond The Best To Earnings Since 2009 Despite Crashing Estimates

  • S&P 500 firms are up more than 1% on average the day after reporting earnings which is the best performance since 2009.
  • There is faulty analysis done when analysts look at earnings beats versus misses instead of changes to guidance.
  • We’ve seen strong growth in Q4 as we will review, but estimates are dropping rapidly.
  • The 2 year growth stack hasn’t fallen much as this quarter is dealing with tougher comparisons. The 2 year growth stack was 39.39% last quarter and it is 34.37% this quarter.
  • Sales growth similarly fell as it has a 6 handle now unlike the double digit growth of the last 3 quarters. The 2 year stack has fallen from 17.46% to 16.65%. That’s a relatively minor slowdown.
  • Q1 EPS estimates have fallen from 5.54% at the start of the year to just 1.8%. Even if estimates call for a slight decline in 2019, growth would be positive because most firms beat estimates.
  • Stocks can easily rally while estimates fall, but when estimates fall so much that growth is negative, it’s not good for stocks. Multiples will soar if stocks keep rallying while earnings growth is nonexistent.  
  • On Christmas Eve 2018 there were only 1.2% of stocks in the S&P 500 above their 50 day moving average. That’s tied with two points in October 2008, which was the worst month of the financial crisis.
  • It’s quite amazing to see stocks as oversold as October 2008 considering there is no evidence the economy was in a recession in late 2018. 
  • America’s Markit services PMI in January was better than every country on this list except Russia, Spain, and Switzerland.
  • The PMI fell from 54.4 to 54.2, meeting estimates. It was weaker than the manufacturing PMI, but still showed growth consistent with 2.5% GDP growth.
  • The Markit services report, the prices paid index hit a 22 month low. 
  • The 3 month average of net businesses reporting that commodity prices were up in the ISM services and manufacturing reports
    suggests CPI growth may have also fallen in January.

2/6/19 – Fast Food Worker Wages Compared To Labor Market

  • Just because retail investors aren’t euphoric, doesn’t mean stocks can’t pull back. 
  • Wage growth for production and non-supervisory workers, which make up 82% of the work force, was 3.5% in December which was the highest of this cycle.
  • Workers at the bottom rung of companies are the easiest to fire because they are the easiest to replace. That makes their unemployment rate and wage growth the most volatile.
  • Limited service (fast food) restaurant wage growth compared to national average hourly pay – the ratio is above 49% which means these workers get slightly less than half the national average. That’s historically great as wages haven’t been this high in relation to national wages in over 19 years at least.
  • There has been a spike in terminations of Social Security disability benefits due to gainful employment from 2013 to 2017.
  • Q1 2019 had the largest decline in bottom up estimates in the first month of the quarter since Q1 2016, the epicenter of the last earnings recession.
  • Q1 2019 estimates fell 4.3% in January and Q1 2016 estimates fell 5.5% in January 2016. 

2/5/19 – Labor Market Running Out Of Supply?

  • Discussing the 6 month moving average of the standard deviations in the surprise rates of payrolls, core CPI, and average hourly earnings.
  • The recent payrolls beats have been exceptional, implying the potential for a mean reversion (lower).
  • Core CPI growth has recently been limited by the stabilization of shelter inflation. Shelter inflation still drives core CPI growth, but no longer at an accelerated rate.
  • Ignore the increases in the U3 and U6 unemployment rates and look at the overall labor participation rate which increased to 63.2% from 63.1% which is the highest rate since September 2013.
  • Discouraged workers increasing the labor market supply may have limited wage growth. 
  • Weekly earnings growth increased from 3.34% to 3.48%. The cycle high was 3.63% in October 2018.
  • One of the reasons this expansion has been so long is the 2008 financial crisis was so deep it created a huge amount of unemployed and discouraged workers.
  • Low slack in the labor market makes employers more willing to train workers who have limited experience or have been out of the labor market for a long time.
  • Because the labor force participation rate is dragged down by demographics, the best way to compare this cycle to previous ones is to adjust for demographics. The demographically adjusted labor force participation rate is near the 2006-2007 average.
  • There is still room for the demographically adjusted labor force participation rate to increase to get to the 1999-2000 average.
  • Specifically, the prime age labor force participation rate was 82.6% in January which was a 0.3% increase from December. That’s a huge increase considering how close it’s getting to the last 3 cycle peaks. It peaked at 83.4% in the prior cycle, 84.6% in the late 1990s, and 83.8% in the early 1990s.
  • Limited inflation, a dovish Fed, and a strong labor market is a recipe for a great consumer and an outperforming American economy.
  • The combination of jobs, hours worked, and hourly earnings for production and non-supervisory workers is up 0.3% monthly and 5.9% yearly. That’s the quickest yearly growth this cycle signifying little sign of recession for 2019.
  • For most of this cycle rent inflation has been above average hourly earnings growth.
  • The upward revision in hourly wage growth in December caused the rate to be above rent inflation for the first time in nearly 8 years
  • January construction jobs added of 52,000, which was almost double the 27,000 average job creation in the previous 12 months may be unsustainable.

2/4/19 – Is US Economic Growth Actually Slowing?

  • The NDR Sentiment Composite is at 66.67 which signals the market is exhibiting excessive optimism.
  • When this index is above 62.5, the returns per year are -8.84% since 1994 and -2.07% since 2014. 
  • In January 304,000 jobs were added which beat estimates for 158,000 jobs.
  • Great December reading was partially taken away as the report showed 222,000 jobs were created instead of 312,000 jobs.
  • November reading was revised higher by 20,000 jobs.
  • The U6 unemployment rate, which includes the underemployed, was up from 7.6% to 8.1% because the government shutdown caused some people to look for part time work.
  • Labor force participation rate increased from 63.1% to 63.2% which broke out of the range from 62.7% to 63.1% that it was in from 2014-2018. 
  • Discouraged workers continue to come off the sidelines which is boosting the supply of labor. 
  • Yearly growth and the average work week met estimates for 3.2% and 34.5 hours.
  • For all those wondering if the government will pass an infrastructure bill aimed to stimulate the economy, you may be interested to know public construction spending growth has been great. Spending on transportation, educational buildings, and highways and streets were up 7.6%, 8.5%, and 5.8% yearly.
  • The American manufacturing PMI vastly outperformed the PMIs of Europe, Japan, and China in January as U.S. growth accelerated, while those countries/regions all saw multi-year lows. Both the IHS Markit PMI and the ISM manufacturing PMI were strong for America. The American Markit PMI was 54.9 which was up from 53.8.
  • Global manufacturing PMI fell from 51.4 to 50.7. This was a 31 month low.
  • Without America, the index would have been 50 which indicates no growth. The Euro area hit a 50 month low (50.5) and Japan hit a 29 month low (50.3). Italy was the worst in Europe as its PMI fell to 47.8 which is the lowest in 68 months. China is in rough shape as its PMI was 48.3 which is the lowest since February 2016. 
  • American manufacturing’s relative strength versus European manufacturing is near previous peaks according to the ISM PMI.
  • The Markit PMI was consistent with 2.5% GDP growth and the ISM report is consistent with 4% GDP growth. Economists saw a slowdown, but growth accelerated.
  • Even the very bearish ECRI leading index’s growth improved. The leading index was down 1.8 points, but the year over year growth rate was up 1% to -4.3%. This index’s growth rate has been improving in the past few weeks. The comparisons will be getting easier. The growth rate never fell to levels consistent with the prior 3 recessions. 

2/1/19 – Is The Economy Telling Us Something New?

  • Most of the housing data from November and December was terrible, so the weak December pending home sales index shouldn’t be a surprise
  • The big issue with the housing market in December is lower interest rates didn’t drive demand.
  • One critical bullish thesis in 2018 was that the housing market was only weak because of rising rates.
  • If that’s not true, either affordability is a problem (rates aside), or the economy is weaker than we thought. 
  • The MBA applications index showed home buyers at the top of the funnel became interested in buying a house.
  • The pending home sales data is more accurate than that information as it measures signed contracts; it is also a leading indicator for the housing market. 
  • 80% of pending home sales close. They close an average of between 4-8 weeks, meaning existing home sales should be weak in the first two months of 2019.
  • 49% of new home sales were under $300,000. That’s the most since February 2017. 
  • The housing market is a huge negative for Q4 GDP growth. That’s why a housing rebound can power an economic growth acceleration in 2019.
  • The average number of months from the last hike of the cycle to the first cut is 4.75.
  • However, the Fed could easily pause for 9 months and hike again if the economy and stock market improve.
  • The ECI shows compensation growth is coming in the form of wages and salaries more than benefits.
  • Everyone is speculating that the cycle has ended because the Fed is pausing hikes.
  • The Fed paused hikes from December 2015 to December 2016 and there wasn’t a recession or string of rate cuts that followed.

1/31/19 – Biggest Shift Since 2016

  • Fed formalized its dovish turn, that it started making after its rate hike in December, in its January statement and press conference.
  • In shifting guidance and policy in the dovish direction, the Fed resumed its dependency on the stock market that it exhibited under Bernanke and Yellen.
  • In 2018, investors thought Powell was different because stocks fell on FOMC days 7 straight times. 
  • The interesting aspect to the Fed’s January statements and press conference is that the S&P 500 had rallied sharply in 2019.
  • If you assumed the Fed would react to stock market action, you may have considered the possibility that the Fed would be neutral since the sentiment tide has turned.
  • The market has a bad track record at predicting policy outside of the near-term meetings.
  • The Fed won’t update its dot plot and economic forecasts until March, but the statement implies zero hikes in 2019.
  • The Fed reacted to the stock market volatility last year, it didn’t really need much data. You can say the Fed had a delayed reaction to the slowdown and the stabilization of inflation.
  • Despite rising wages, the Fed is now less concerned with inflation.
  • The Fed has been getting help from moderating shelter inflation due to the slowing housing market
  • This statement was so dovish that it would take several meetings for the Fed to start talking about rate hikes again
  • Assuming economic growth is stable along the average of this cycle, it’s important to point out that this shift in Fed policy does not mark the end of the business cycle, and does not mean that QE4 is coming next nor that the balance sheet unwind is completed, nor that there are no more hikes on the table this cycle.

1/30/19 – Student Loans Impact On Millennials’ Homeownership Rate

  • The Case Shiller Home Price Index (non-seasonally adjusted 20 city index) experienced weakest growth since January 2015. Growth has been steady in the mid-single digits ever since growth decelerated in the 2nd half of 2014
  • If the unemployment rate increases (other than because more people entered the labor market or the one time increase caused by the shutdown) all bets are off for the housing market improving.
  • A $1,000 increase in student debt causes a 1-2% drop in the homeownership rate for student loan borrowers in their late 20s and early 30s.
  • Homeownership rate of those ages 24-32 has fallen 8.8% from 2005 to 2014.
  • The Conference Board’s consumer confidence reading fell from 128.1 in December to 120.2 in January. The 17.7 point decline since October is the worst string of losses since October 2011.
  • Historically, the difference between the present situation index and the expectations index has forecasted recessions. However, gov shutdown may have been a one time negative impact on sentiment.
  • The Redbook same store sales growth report from the week of January 26th was 5.8% which fell from 7% in the prior week. That’s down from 9% late last year.
  • The good news is in the weak consumer confidence report, the 6 month buying plans for houses increased 1.9% to 7.8%. The MBA mortgage applications index strength earlier in January has been confirmed by this reading

1/29/19 – Emerging Markets Show Strength Despite Chinese Weakness

  • It’s important to avoid the failed assumption that emerging markets are underperforming and will continue to do poorly because China’s economy is slowing.
  • The global economic slowdown is being driven by developed markets and China, not emerging markets ex-China
  • It’s no surprise China is acting like a developed market because it faces similar demographic issues.
  • Recently improving emerging markets’ leading activity index in relation to that of developed markets, implies the dollar should start to underperform emerging market currencies.
  • IMF’s forecasts are in tune with the current results because its forecasts are usually a reflection of the present not the future.
  • Emerging market revisions are now outperforming developed market revisions, suggesting a bullish undertone for emerging market equities.
  • Current data is suggesting that US technology or any firms with Chinese exposure may underperform 

1/28/19 – Leading Indicators & Recession Risk

  • Many S&P 500 2019 targets have already been surpassed in the first 3 weeks of the year. 
  • While earnings estimates have cratered, and many economic reports have been delayed because of the government. 
  • The first 112 firms to report have had a sequential decline in EPS and sales growth as well as weak guidance which has pushed earnings estimates lower.
  • If earnings growth is in the low single digits, it doesn’t justify a bear market. 
  • ECRI is a weekly leading index that is proprietary, so we don’t know what’s in it, but it has a great track record of predicting economic slowdowns and corrections.
  • ECRI states it is supposed to forecast cycle turning points 2-3 quarters in advance.
  • ECRI still suggests growth will slow in the next 2-3 quarters.
  • The more growth improves, the greater likelihood a recession isn’t coming in late 2019/early 2020.  
  • The leading indicators report is a monthly reading which has 10 known indicators. When it has negative year over year growth a recession usually follows.
  • If the number of 16 or older people per household falls to where it was between 2000 and 2003 on average, almost 3 million new households would be created.
  • Rent’s increase as percentage of median income for 25-34 year olds has correlated with more millennials living at home.

01/26/19 – QE & QT Effects On Markets

  • If you sold stocks because earnings estimates were falling, it could be a mistake because earnings estimates usually fall.
  • There have even been years were earnings fell and stocks rallied and the reverse of that.
  • It’s only a problem when estimates fall more than average and growth is negative. 
  • The stock market and Fed balance sheet rose in tandem at the start of the bull market.
  • The Fed’s balance sheet stopped increasing in 2014. Since the stock market didn’t do well in 2015 and early 2016 because of the economic slowdown, the cynics rejoiced that their thesis was true
  • The correlation between Fed balance sheet and stock market was 0.865 since 2010 and -0.275 since 2014.
  • The argument by cynics then changed to include all central bank balance sheets. That’s moving the goal post. 
  • The simple reality is stocks tend to move up over time in nominal terms because earnings increase
  • U.S. stocks have had great returns historically, way before QE was enacted. 
  • The conclusion here is that the Fed’s balance sheet shrinkage shouldn’t make you bearish. Look at earnings and economic momentum to determine your positioning.
  • ECB isn’t in a good situation because it hasn’t raised rates this cycle and a few economies such as Italy are facing a recession
  • The Fed’s balance sheet is declining while the banks’ holdings of government securities are increasing. The banks were forced to hold more government securities because of regulations, so the supply has been sopped up.
  • Even if you believe QE (quantitative easing) created an asset bubble and QT will prick the bubble, this shows there isn’t much of an effect from QT. This eliminates the bearish thesis.
  • Jobless claims are 199,000 which is the lowest since November 1969
  • When you consider the growth in the labor market, the jobless claims are by far the lowest in history.
  • That doesn’t make sense because the prime age labor force participation rate isn’t as high as it was last cycle let alone during the 1990s when the labor market was the fullest.
  • That difference is because the jobless claims are being suppressed. It’s tougher to file unemployment claims than in past decades because the laws have changed.
  • The percentage of continuing unemployment claims as a share of the unemployed has fallen in the past few decades. That’s not to say that the labor market isn’t strong; it’s just not the strongest ever . You can still use this metric to review the labor market. However, comparing it to past decades is comparing apples to oranges.
  • Regarding housing market – You would think that weakness in price growth and sales declines would be caused by too much supply and not enough demand. However, there actually isn’t enough supply of entry level housing.
  • In the 2000s, new homes cost about $20,000 more than existing homes. During this cycle, the difference has increased. It has been above $70,000 for the past few years as homebuilders focused on high end market.
  • Housing starts have been low this cycle. 
  • As it relates to the US, QE and QT hasn’t created a massive bubble that’s about to implode.
  • While there may certainly be negative effects from both QE and QT on markets and economies, these effects are more nuanced and unclear in real time.
  • This doesn’t mean that mistakes in monetary policy weren’t made. For instance, holding short-term interest rates lower for longer skewed economies to a much greater degree than the effects of QE and QT.
  • QE in Europe on the other hand, which was used to purchase corporate bonds, had a significant impact in creating zombie companies as we discussed in the past. 

1/24/19 – U.S. Stocks At 70 Year High Versus Global Stocks

  • Respondents were asked if jobs were difficult to find in their neighborhood or if there were plenty of jobs available.
  • 60% said there were plenty of jobs which is the highest percentage since the survey started in 2001. 
  • 33% said jobs were difficult to find which is the lowest since at least 2001
  • We wish this survey would have captured the end of the 1990s cycle to better compare the fullness of the labor market with that one.
  • The end of the 1990s was when the labor market was the fullest in history in terms of prime age labor participation. 
  • All we can tell from this survey is the labor market is much stronger than it was at the peak of last cycle.
  • Since the 1980s, it has been a good time to buy the S&P 500 when policy uncertainty was high and a good time to sell when uncertainty was low. That might be because stocks get too expensive when uncertainty is low and stocks get too cheap when uncertainty is high.
  • The key point is to stay within a range of expectations. If America were to shift from a mixed economy into a socialist one, uncertainty probably wouldn’t successfully work as a buying opportunity.
  • However, if fears of socialist policies become high even though they are unlikely to get enacted, then it would be a huge buying opportunity.  
  • American stocks are at a 70 year high versus other developed markets.
  • Q1, Q2, and Q3 are all expected to have EPS growth with a 3 handle. That’s not enough to send stocks in a bear market, but the recent trend signals the decline in estimates won’t stop here.

1/23/19 – Less Than Half Of S&P 500 Firms Beat Sales Estimates

  • The media is making the government shutdown and trade war appear as a bigger issue than it is to the recent economic deceleration.
  • While these issues are not helping the economy, they are not the core reasons behind deceleration in rate of change terms.
  • In rate of change terms, we are seeing economic deceleration in 2019 of which both the government shutdown and trade war are tiny components.
  • The weakness in housing buying conditions in 2018 helped forecast the 10.3% decline in existing home sales in December.
  • Soft data reports always come out before the hard data, so they give an earlier look at the economy
  • In 2017, bearish investors loved to discuss how hard data was much weaker than soft data because it fit their narrative. Now that the roles have reversed, they like discussing the soft data more.
  • The hard data is what gets entered into GDP calculations, which is what matters in the end.
  • Only 49% of S&P 500 firms have beaten sales estimates.
  • Sales results are tougher to beat than EPS estimates which makes them closer to reality. 
  • Even during the disastrous 2008 financial crisis, more firms beat EPS estimates than missed them.
  • The fact that estimates are declining isn’t a problem. It’s that the decline is worse than average. 
  • The 3 worst sectors have been energy, technology, and materials in terms of EPS estimates falling. Those 3 sectors are in the top 4 of international exposure which supports the narrative that international growth is slowing. 
  • If earnings fall in 2019, stock multiples will need to increase for stocks to have a positive year.

1/22/19 – Will Housing & Economy Recover In 2019?

  • The stock market, a leading indicator, began pricing in the risk of a recession in late 2018
  • It would be easier to say for certain a recession didn’t start in late 2018 if we had the economic data that has been delayed because of the government shutdown, but there’s still enough information to say it’s highly unlikely
  • Jobless claims were 213,000 which is only 11,000 above the cycle trough.
  • 60% of fund managers expected profits and growth to slow in the next year. That’s worse than the trough in 2001 when there was a recession. It’s the worst reading since July 2008 which means it’s worse than the prior 2 slowdowns.
  • The percentage of fund managers expecting a steeper yield curve has started to increase. Either this is another example of investors expecting a stronger economy like in 2017 or this is the end of the cycle where the curve inverts and then there is a recession as the curve steepens. 
  • This could be like in 2006 where fund managers got too bearish and were simply too early.
  • Median home prices grew 1.2% to $289,800.
  • Home builder index was weak, but it showed modest improvement sequentially.
  • A weak report at the cycle bottom which shows improvement is the best possible report in rate of change terms.
  • The current weakness in housing could lead to consumer spending weakness
  • The housing market can recover in 2019 because 30 year mortgage rates have fallen from 4.94% in November to 4.45%.
  • Since there wasn’t a recession, slowing price growth, strong wage growth, and declining interest rates could be enough to turn housing around.
  • December existing home sales fell 6.4% monthly and 10.3% yearly. 
  • Median home prices fell 1.4% monthly to $253,600 and were up 2.9% yearly.
  • It’s important to keep in mind the existing home market is much bigger than new home sales.

1/21/19 – Hard & Soft Data Show Divergence

  • It’s quite interesting to be in the information era where data is shared instantly, yet have little information on the economy due to the shutdown.
  • The Atlanta Fed GDP Nowcast is usually very accurate at predicting the initial GDP growth report at this stage in the quarter. However, now that’s not the case due to lack of data.
  • The S&P 500 started the year with a 13.93 forward PE multiple and now has a 15.11 PE
  • It’s important to clarify that while both hard and soft data are collected through surveys, hard data is representative of the past whereas soft data exemplifies forward looking expectations.
  • Industrial production growth was 4% on a year over year basis.
  • Manufacturing was very strong as monthly growth was 1.1% which was the quickest growth since February 2018.
  • Capacity to utilization increased from 78.6% to 78.7%. It peaked for the cycle at 79.6% in November 2014.
  • While reaching the peak for capacity to utilization would signal there is less room to grow, that’s a much better problem to have than a sharp growth slowdown which the ISM and Empire Fed reports implied.
  • Manufacturing production was up 3.2% year over year.
  • The weighted share of manufacturing sub-sectors that are contracting is the lowest since November 2010.
  • The soft data is suggesting that manufacturing is near a recession, but the hard data shows there is across the board strength. 
  • Stock market corrections don’t have long term impacts on the economy. The government shutdown has an even smaller effect on the growth trend. 
  • The University of Michigan consumer sentiment index fell from 98.3 to 90.7. It missed expectations by the most since at least 2000
  • If stocks fall, the odds of hikes fall which is bullish. If stocks rally, the odds of hikes increases, which is bearish. 

1/18/19 – Sectors Impacted Most By Wage Growth

  • Young people are far less likely to work now than in prior business cycles because college diploma is a prerequisite for a much higher percentage of jobs.
  • The labor force participation ratio for Americans ages 16 to 19 is 35.6%. That is in the middle of this cycle’s range which has varied from 32.5% to 37.7%. 
  • From 1972 to 2001, this participation rate never fell below 50%.
  • Going back to 1948, before this cycle the record low was 43% in 1965.
  • Participation rate for workers between 20 and 24 years old is similar, but less pronounced. The current participation rate is 70.6%. 
  • To understand how young workers are doing look at the wage growth for production and non-supervisory workers
  • Nominal growth for non-supervisory workers hit 3.3% in December which is the cycle high.
  • Median weekly earnings of young people has hit the highest level since 2002 relative to their older counterparts
  • Food service jobs are low skilled jobs that have accelerated wage growth at the end of the cycle.
  • This cycle has been great to workers without a high school diploma as their employment to population ratio hit a record high.
  • In 2018 people with incomes below $20,000 per year had the highest retail sales growth excluding autos and gas.
  • Most people planned to use the extra money from the tax cut to save or pay down their debt
  • Consumer discretionary firms employ 4.1 people per million dollars in sales. That means their costs increase the most because of wage growth.  Their gross margins are at a record high as well.
  • Real sales in relation to employees has grown in the past few decades. 

1/17/19 – Next Move For The Dollar

  • Because of the government shutdown, the business inventories and retail sales reports didn’t get released.
  • The retail sales report was from December which is very important because it includes holiday sales. 
  • Alternative data from private companies – the Redbook same store sales report signaled retail sales growth was strong in December. 
  • Bank of America “internal data” is plotted against retail sales ex autos which seem to move in tune with each other.
  • The Fed’s Beige Book showed the Fed finally sees economic growth slowing. It didn’t see the slowdown back in October which is partially why the S&P 500 fell 14% in Q4.
  • When the Fed sees economic strength, it implies hawkish policy is coming. The current slowdown means dovish policy is coming which is good for stocks and bad for the dollar.
  • The Fed has started using the words “weak” or “slow” more often.
  • If the core CPI reading were to increase sharply, it would put the Fed in a more nuanced position of suggesting a hike. However, the more likely slight increase probably won’t change anything.
  • Merrill Lynch surveyed fund managers believe the dollar is overvalued. This is the highest percentage that believe the dollar is overvalued since 2002. This survey has been historically accurate when paired with dollar index.

1/16/19 – Stocks Rally, But Fundamentals Get Worse

  • When the S&P 500 increases at least 4% in the first 10 trading days, the rest of the year is up 7 out of 8 times and the full year returns are positive every year. 
  • However, the stock market started the year very oversold. Usually, January tells us how the year will go, but this January only tells us December was terrible.
  • One example of a non-government created economic report that has a lot of value to macro investors is the Cass Freight Shipment index. The Cass Freight index measures freight volumes. The index is made up of 400 different companies and manufacturers.
  • The index shows economic growth this cycle peaked in January 2018
  • GDP growth peaked in Q2 2018. Growth has slowed every quarter since then.
  • The Empire Fed manufacturing survey (soft data) measures how manufacturing is doing in the New York Fed district. 
  • The Empire Fed’s general business conditions index fell from 11.5 to only 3.9. This was way below the consensus for 12 and the low end of the estimate range which was 8.9.
  • If you use the Empire Fed index as a model for the ISM manufacturing reading, the PMI report will be about 50. 
  • Services is outperforming manufacturing.
  • Manufacturing is probably underperforming because it is more influenced by the international economy which is slowing rapidly.
  • Germany just barely missed a recession as Q4 GDP growth was 0.1%.
  • In the US – Monthly headline inflation fell 0.2%. That missed expectations for no growth and 0.1% growth in November. This was the first decline since February 2017 and the largest decline since August 2016.
  • Merrill Lynch fund manager survey shows managers are very bearish – a similar reading coincided with the last recession.
  • Fund  managers want firms to improve their balance sheets, and they don’t want them to increase capex or return cash to shareholders
  • Small cap firms are the most vulnerable to widening yield spreads. They should take fund manager advice even if there isn’t a recession in 2019. The problem is they can’t improve their balance sheets because so many aren’t profitable.

1/15/19 – Expected Median S&P 500 Return In 2019

  • The most negative data points on the stock market and the US economy are Q4 earnings guidance and the ECRI leading index.
  • After the first 20 firms reported Q4 earnings 75% of them had their estimates lowered by an average of 6.63%. That’s the worst data The Earnings Scout has ever measured in 8 years of collecting data.
  • The ECRI leading index is down 6.5% year over year, which is the worst year over year decline in 363 weeks.
  • The median return after one year is only 1.8% with half of the instances positive and half of them negative. Knowing there’s only a 50% chance stocks will increase in the next year is a huge advantage.
  • The Tax Freedom Day represents theoretically how long Americans as a whole have to work in order to pay the nation’s tax burden.
  • The supposed gigantic tax cut of 2018 only pushed the Tax Freedom Day 3 days earlier. 
  • Americans will pay $5.2 trillion in taxes in 2018 which is 30% of the national income.
  • US exporters into China are seeing the most weakness on a rate of change basis out of China’s top trading partners. 
  • Chinese car sales are down over 4% in the past 3 months (on a 12 month rolling basis). This could be the weakest data in 4 decades.
  • China’s surplus with America was up 17% in 2018 to $323.3 billion. This was the highest surplus on record, going back to 2006.
  • The trade war has been named the biggest tail risk every month since March except in May.
  • Whether these are primary reasons for the recent decline in asset prices or secondary, we will leave up to you to determine. In our view, at best these factors suggest secondary reasons with the primary reason for the decline in stocks being the slower economic growth in the US in rate of change terms.

1/14/19 – US Real Wages Soar As Germany On Brink Of Recession

  • The decline in oil caused yearly CPI to fall from 2.2% to 1.9% which is below the Fed’s 2% target (the Fed looks at PCE closer than CPI).
  • Since wage growth is deflated by headline CPI and not core CPI, this divergence is great for real wage growth.
  • Even though it seems like the cycle might be near its end, inflation isn’t running out of control, so the Fed doesn’t have to hike rates. 
  • If core inflation falls below 2%, it will allow the Fed to not hike rates at all in 2019 (guidance is for 2 hikes).
  • Some economists believe a tight labor market causes the economy to overheat because wage growth causes inflation. This is why the Fed hikes rates when the unemployment rate is low. 
  • However, even with the latest spike in wage growth, inflation is still low. The two metrics haven’t had a strong relationship this cycle.
  • One industry which has seen a strong correlation between higher wages and increased inflation are “personal care services”.
  • Combined, housing and medical costs are over half of CPI.
  • Core CPI has been above core CPI excluding shelter for much of this cycle because shelter inflation has outperformed core CPI.
  • Italy and Germany are likely headed for a recession. Latest month over month industrial production growth – France was -1.3%, Germany was -1.9%, Italy was -1.6%, and Spain was -1.5%.
  • German stocks are at a 50 year low relative to American stocks.

1/11/19 – Impact on Stocks: QT, Shutdown & EPS Estimates

  • Opinions on the Fed’s balance sheet and QE have a huge variance.
  • Some investors blame the entire bull market on QE even though stocks rose after QE 3 ended. These investors tend to think the Fed will go through with QE 4 at the first sign of trouble in the economy.
  • On the other side, some investors think QE is an asset swap that has little effect on the economy or stocks.
  • The discussion about when the balance reduction will end will likely gain traction in 2020 which is when the balance sheet will decline below $3 trillion. This assumes there is at most a slowdown in 2019, and not a recession, which could potentially cause the Fed to shift its stance.
  • Stocks have had the best performance during a government shutdown ever in the past couple of weeks.
  • JP Morgan stated the government shutdown hurts GDP growth by between 0.1% and 0.2% every week.
  • Because of this, JP Morgan lowered its Q1 2019 GDP growth estimate from 2.25% to 2%. 
  • Analysts’ profit cuts are exceeding upgrades by the most since 2009.
  • Everyone knew Q3 2018 would be the last quarter with over 20% earnings growth, but the size of the slowdown in growth is an unknown.
  • That is the biggest risk that is hardest to anticipate, the rate of change of earnings. This, in large part, is what determines the likelihood of a recession versus a simple economic slowdown. 
  • The rate of change of quarterly bottom up estimates has worsened in each of the past 3 quarters.
  • The 3.8% decline in Q4 quarterly bottom up earning estimates is worse than the 5 year average which is 3.1%, but better than the 10 year and 15 year averages which are 4.5% and 3.9%. The first 3 quarters of 2018 were significantly above average. Q4 is simply a return to normalcy.  
  • 2019 estimates fell 2.3% in Q4 2018. That’s the worst performance since 2016. This decline is worse than the 5 year average which is -1.8%, but is better than the 10 year, 15 year, and 20 year average declines in estimates which are 3.6%, 2.4%, and 3.1%. 

1/10/19 – 70% Of Q1 2019 Earnings Estimates Cut

  • Your outlook on stocks should be based on macroeconomics and valuations, not narratives.
  • Even with great Q4 results, 70% of firms had their Q1 estimates cut by an average of -5.62%. 
  • It’s important to note that the slower sales and earnings growth in 2019 aren’t the problem. The problem is the rate of change of estimates.
  • Average hourly earnings from leisure and hospitality jobs as a percentage of total non-supervisory jobs is increasing.
  • Since 2015, the percentage has increased from about 58% to 62%. This is impressive because non-supervisory wage growth has been accelerating.
  • Leisure and hospitality industry makes the least per hour on average as workers make $14.18 per hour, indicating that the industry with lowest pay is doing well.
  • German industrial output fell 1.9% in November. In order for the index to be positive for Q4, it would need to rise 5.5% in December.  This turnaround has occurred once in the past 57 years.
  • When industrial output falls, GDP contracts 80% of the time.
  • German industrial production was down 4.7% year over year in November which was the biggest decline since December 2009.
  • China is the world’s largest car market. Chinese car sales fell 6% to 22.7 million in 2018. That was the first decline in over 20 years.
  • China’s contribution to global GDP growth is expected to fall to 32.4% in 2019; it peaked at 36.3% in 2016.

1/9/19 – Earnings Estimates Fell With Stocks

  • The rate of change of future earnings estimates tells us where stocks are headed.
  • Estimates cratered whether you exclude energy, financials, or tech.
  • The ex-tech segment started at the lowest growth rate and ended at the highest growth rate which shows us tech was a major reason overall estimates fell as tech growth was revised lower. 
  • Q4 EPS growth is still expected to be 10.51%, but Q1 2019 earnings growth is expected to be 5.02%, a decline from 6.26% on December 1st
  • These estimate declines are either going to make it easier for firms to beat estimates or are an accurate representation of the current economic slowdown.
  • The good news is if S&P 500 earnings growth is in the mid-single digits, it doesn’t justify a bear market unless investors are pricing in a recession next year.
  • If stocks were to fall on mid-single digit earnings growth, multiples would be very low.
  • The top internet firms control most of the S&P 500’s sales growth.
  • The expectation is for 20% and 15% sales growth for the FAAMG names in 2018 and 2019. If these firms falter, the overall market’s sales growth will too as excluding FAAMG, S&P 500 sales growth is only expected to be 4% in both years.
  • Cyclicals are cheaper than the overall market than at any time since at least 1980.
  • Cyclicals being this cheap implies traders are extremely fearful of a recession. That might not be fair yet because the economic data isn’t recessionary. 
  • Cyclicals are a buy when they are expensive and a sell when they are cheap.
  • It’s best to come up with a normalized PE when valuing cyclicals for the long run.
  • Forward earnings estimates are useless at the top and bottom of the cycle.
  • The manufacturing ISM weakened more than services probably because the global economy is seeing weakness; manufacturing is more internationally focused.
  • The odds of a German GDP contraction when industrial output falls are 80%.
  • Business activity – new orders don’t rise in a recession.
  • NFIB small business survey is biased towards Republicans and the Democrats won the House, it’s no surprise that the December small business index fell.

1/8/2019 – December Labor Report – Positive or Negative Signal?

  • There was a panic at the end of 2018 as investors feared a recession because of the flattening yield curve, hawkish Fed, trade war with China, global economic slowdown, and negative surprises from domestic economic data
  • It’s possible for stocks to fall into a bear market without a recession, and very unlikely for them to not fall into a bear market when there is a recession.
  • 38% of the U.S. treasury curve has inverted and 62% of the overnight indexed swap curve has inverted
  • Historically, more of U.S. treasury curve has inverted before recessions. However, the percentage of the curve that is inverted usually spikes quickly.
  • 312,000 jobs were added which beat estimates for 184,000.
  • This was the biggest beat since the May 2009 report which is when the economy was first exiting the recession. 
  • This was the 6th biggest jobs beat since 1999.
  • The labor market is considered a lagging indicator, but when there are huge prints with 300,000 or more jobs created, it usually means a recession isn’t coming in the near term
  • The last 300,000 jobs print in the past 5 cycles averaged being 12 months before the next recession.
  • The unemployment rate increased from 3.7% to 3.9%. Usually it means the cycle is ending when the unemployment rate bottoms, but this increase was good news because people came back to the labor force.
  • If the Fed realizes there is still labor supply (slack) left, it won’t hike rates as sharply as it otherwise would since one of it’s mandates is “maximum employment” and the labor market seems to be suggesting continued supply of labor.
  • Labor force participation hasn’t improved this cycle because of aging demographics, which is why we look at the prime age labor force participation rate to measure the slack in the labor market, which increased to 82.3% which is still below the previous cycle peak of 83.4% .
  • Wage growth experienced the cycle peak in October which had 3.17% growth.
  • The change in the length of the work week tells us if the growth in hourly pay translated into take home pay growth.
  • The average work week was 34.5 hours which was up from 34.4 hours, indicating worker pay was up meaningfully.  
  • Average production non-supervisory wage growth was 3.3% which was the highest since April 2009 with the previous cycle peak of 4.2% .
  • The latest increase in prime age employment is coming for those not in the labor force who don’t want a job.
  • People may get a job when they don’t want one because of wage growth or because training is being offered to those without skills because the labor market is tight.

12/19/18 – The Most Crowded Trade + Consumer Expectations Signal Recession

  • The long FAANG trade was considered the most crowded trade in the summer and fall of this year.
  • Now the most crowded trade is long the U.S. dollar.
  • Only about 10% of respondents think there will be a global economic recession in 2019.
  • The lowest net percentage of fund managers since 2008 think real global growth will improve in the next 12 months. 
  • Just because fewer fund managers expect growth to be stronger than when the survey was issued in 2008, that doesn’t mean this global recession will be worse than the previous one.
  • The consumer expectations index minus the current situation index in the consumer confidence report is signaling a recession is coming.
  • Differential between expectations and the current situation is worse than the last cycle, but still higher than the 1990s cycle.
  • Recessions generally come after this differential indicator bottoms, and there isn’t much room for it to fall further.
  • Single family current sales index fell from 67 to 61, the weakest reading since May 2015.
  • The index of single family sales for the next 6 months fell from 65 to 61 which was the worst reading since March 2016.
  • The traffic of prospective buyers index fell from 45 to 43, the weakest reading since March 2016. Since it is below 50, that means it is contracting.
  • The home builder sentiment reading leads the 3 month moving average of year over year consumer spending growth.
  • The bad news for GDP growth is that single family housing starts boost residential investment more than multi family starts.
  • New ownership costs are only 20.69% of pre-tax median family income, however, same  indicator shows the housing bubble peak didn’t have a very high unaffordability rate, which is a dubious claim.
  • If a new home down payment is 70% of median family income, the percent people can put as a down payment has fallen.

12/18/18 – Rate Hike In December Would Be Unprecedented

  • The Fed had zero percent rates during the weakness in 2011-2012 caused by the European debt crisis.
  • During the late 2015 to early 2016 economic weakness the Fed hiked rates for the first time. 
  • This time is different as the Fed is approaching the neutral rate, has hiked rates 3 times this year already, and economic growth is slowing.
  • A hawkish Fed paired with an economic slowdown can lead to a recession.
  • This hike would put the Fed funds rate at the low end of the estimate range for the neutral rate.
  • The Fed hiked rates in 1994-1995, but there wasn’t a recession until 2001. Modest cuts occurred until 1999 followed by rate hikes which ultimately led to a recession. 
  • The key with timing cycles is to avoid falling into the trap where investors assume this cycle will be just like the last one or just like the average.
  • “Negative stock returns realized between FOMC meetings are a more powerful predictor of subsequent federal funds target rate changes than almost all macroeconomic news releases.” – “The Economics of the Fed Put”
  • The Michigan survey, which measures consumer attention to negative stock market news, is correlated with the negative stock market mentions in FOMC statements.
  • The backdrop of the S&P 500 being down in the past 3 months, 6 months, and 1 year, has only accompanied 2 of the 76 rate hikes since 1990. That applies in this meeting because stocks are down in all 3 scenarios. The Fed would be going against the norm by hiking.
  • There is a 74% chance the Fed will hike rates on Wednesday. When the percentage is above 70%, the Fed usually goes with the market. 
  • The Fed funds futures market doesn’t expect any hikes in 2019 even though the Fed previously guided for 3.
  • The Fed will probably reduce its 2019 hike guidance, but the big question is by how much. It will be interesting to see how markets react if the Fed guides for 2 hikes.
  • A hawkish hike (with suggestion of further hikes) will likely invert the yield curve.
  • The T.V. news’ discussions of a policy mistake negatively correlates with the yield curve.
  • One problem with expecting the Fed to make the easy decision, which is to lower 2019 hike guidance and possibly not even hike rates in 2019, is Powell has claimed the relationship between the Fed funds rate and the neutral rate is more important than the yield curve.
  • Since 2011, the S&P 500’s year over year returns and the 10 year yield have been highly correlated.
  • The Fed used the tax cuts as an opportunity to hike rates, normalizing monetary policy.
  • As the effect of the tax cuts comes to an end, it appears the 10 year yield and the S&P 500’s returns are re-coupling. 
  • The Fed’s window to hike rates is closing.

12/17/18 – Chinese Economy, Transports & Housing Weak

  • China’s growth has been slowing for years, with only a slight uptick in 2017.
  • In China, both industrial production and retail activity growth has been slowing in the past few years.
  • Private firms only generate 52% of industrial output with the market share of government enterprises growing in China.
  • China needs further liberalization to regain the growth rate it achieved earlier in the 21st century.
  • China’s growth from 2007 to 2012 was worse than in the USSR before it collapsed. 
  • Additionally, as a result in part to the one-child policy, China doesn’t have great demographics. 
  • China has been relying on bringing its poor into the middle class to expand, however, in rate of change terms this becomes much harder to continue without further liberalization of its markets.
  • Dow theory suggests that when the transports are weak, the economy is weak. 
  • Cass Freight index’s growth is still above the 2015-2016 slowdown.
  • The other notable underperformer has been regional banks due to slowing economic growth, falling interest rates, a flattening yield curve, and a weakening housing market.
  • The percentage of houses sold with multiple offers, calculated by Redfin, shows the national rate has fallen to 32% which is the lowest since 2011.
  • Housing starts haven’t recovered this cycle.
  • The homeownership rate has finally started to normalize.
  • Private mortgages are mainly being originated by people with great credit scores.
  • The percentage of 25-34 year olds living with their parents has increased from about 7% in 1970 to about 16% now.
  • The percentage of 25-34 year olds who are heads of households has fallen from over 50% in 1980 to about 45% now.

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