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.

This page is updated once a week.

11/15/19 – Largest Decline In Consumer Comfort Index Since 2008

  • Quarterly NY Fed Household Debt & Credit report 
  • financial obligations as a share of disposable income is only 15%. Besides a blip in 2012, this is the lowest reading since at least 1980.
  • This ratio increased prior to the last three recessions. It has decreased this time. 
  • You can’t look at student loan debt in terms of cycles because it’s the one type of debt that didn’t fall during the recession when the greatest amount of deleveraging occurred. 
  • CHART – overall household delinquency rate

11/14/19 – Have Inflation & Growth Peaked?

  • CHART – In Q3 almost 60% of global central banks were cutting rates. That’s the highest percentage since the end of the last recession. 
  • CHART – percentage of economies growing above trend has risen from about 10% to 33%.
  • It’s interesting to see that at the recent bottom fewer economies were growing above trend than in the depths of the 2008 financial crisis. This percentage includes 52 total economies
  • CHART – UIG & growth suggest US inflation pressures have peaked for the foreseeable future.
  • The core and headline CPI inflation data points make it seem like there weren’t many changes in this report, but there actually were. Firstly, the difference between core and headline CPI fell from 0.7% to 0.5%.
  • Health insurance inflation increased from 18.8% to 20.1% which is the highest reading since at least 2008.  

11/13/19 – Will Stocks Underperform In 2020?

  •  NFIB small business index is significantly off its cycle peak, but it’s still relatively strong. 
  • Small business confidence isn’t a leading index. It coincides with the weakness in the economy. It didn’t really fall much in the 2001 recession, but was hit hard in the recessions in the early 1990s and the late 2000s
  • The NFIB index tends to do better under Republicans. 
  • 25% of small businesses mentioned labor quality as their most important problem. This is one of the highest readings since the survey was started in 1974.
  • CHART – According to the NFIB’s Small Business Employment Trends Index, 34% of firms had one or more hard-to-fill jobs in October, the smallest percentage in 11 months and showing no increase in three months. Similar future developments will have negative impact on U-3 unemployment rate.
  • Sometimes fund managers in the Bank of America poll accurately predict changes to the economy. This is one investor sentiment survey which shouldn’t be approached from a contrarian mindset most of the time. Often times, assets listed as the most crowded trade underperform after being named. 
  •  All these funds going bullish limits the upside potential for the market because there are fewer bearish investors to turn bullish. When the bulls win, they really lose because stocks climb the wall of worry, not the wall of confidence.
  • Fund managers lowered their cash position from 5% to 4.2% which is the biggest monthly decline in cash since Trump’s 2016 election.
  • The net percentage expecting a stronger real global economy in the next year rose from -37% to 6% which is the biggest monthly increase ever.  This implies the ISM PMI will rise to 56.

11/12/19 – Is Consumer Confidence For Personal Finances A Contrarian Indicator?

  • Chart – US Business Activity Expectations Next 12 months
  • The net percentage seeing an increase in hiring in the next year fell to 5% which is the lowest reading since February 2016.

11/11/19 – Is The Cyclical Recovery Already Priced In By Stock Market?

  • 70% of S&P 600 stocks and 66% of S&P 500 stocks are above their 50 day moving average.
  • CHART – the 50 day rate of change in the 10 year 3 month curve is the 4th highest of this cycle.
  • CHART – Surging semiconductor prices implies ISM mfg index >55 next 3-months
  • The issue for bulls is even if the ISM increases to 55, it only confirms the rally. That doesn’t leave much room for a further increase on a yearly basis
  • Despite some global indicators rising at start of Q4, there are signs that labor markets in several major economies are weakening. Indeed, weaker jobs growth has already begun to drag on consumer confidence.
  • CHART – The OECD global leading indicator, the output index in the global autos PMI, and the new export orders index in the global manufacturing PMI all appear to be bottoming near where they did in early 2016.
  • the semiconductor index was down year over year in early 2016. The 2016 turnaround wasn’t priced in yet and the 2019/2020 one is already priced in.
  • Those who focus on the difference between the current and expectations indexes saw a nice positive as the expectations index increased from 84.2 to 85.9 and the current index fell from 113.2 to 110.9. The theory is that higher current conditions than expected conditions means a recession is coming. The problem with that logic is that the expectations index is near its cycle high of 91.

11/8/19 – Is The Entire Yield Curve Wrong?

  • The yield curve is now normal again across all maturities. If it wasn’t for the way the curve inverted, this would be a recessionary warning. 
  • The Fannie Mae Home Purchase Sentiment index 

11/7/19 – Are US Stock Market Investors Exhibiting Extreme Greed?

  • The MSCI All Country World Index 
  • If you have been waiting for an all clear sign in the economy, you would have missed a lot of gains in markets. You don’t want to wait for the economy to be perfect to buy stocks.
  • In Q3, productivity growth fell sharply and unit labor costs rose sharply. That’s good for workers, at least for now, and terrible for corporate profit margins
  • Currently, we are in the longest margin contraction in post war history as it has lasted 4.5 years
  •  It’s unusual for margins to fall this much for this long without a recession. There haven’t been mass layoffs yet. 
  • first drop in productivity in 15 quarters.
  • The last five years have seen productivity growth in the bottom 10% of all periods since 1947.
  • capital per worker growth is very weak. It has been correlated with the 5 year average of private sector real productivity growth. Usually when the unemployment rate falls this low, there is higher net capital spending as a percentage of capital stock.

11/6/19 – Service Sector PMIs Diverge

  • We look at hirings over openings when reviewing the JOLTS report.
  • job openings are meaningless if they don’t lead to hirings. 
  • Both the Markit and ISM manufacturing PMIs improved slightly. However, the Markit services PMI fell slightly and the ISM non-manufacturing PMI improved decently. The two diverged.

11/5/19 – Consumers Plan For Record Holiday Spending

  • Healthcare is the biggest sector in the S&P 500
  • There is low inflation, a low unemployment rate, positive real wage growth, cheap gas, and less uncertainty surrounding trade. These are all great signs for the consumer. 
  • Homeowners are living in their houses longer. Homeowners live in their houses 13 years which is 5 years more than they did in 2010.  which suppresses the inventory of houses for sales.

11/4/19 – Was This A Positive October Jobs Report?

  • Both the Markit manufacturing PMI and the ISM manufacturing PMI had weak October readings, but they improved. When these indexes go from weak to okay, that’s a great signal for stocks.
  • The unemployment rate rose from 3.5% to 3.6%. The underemployment rate rose from 6.9% to 7%. 
  • The prime age labor force participation rate rose from 82.6% to 82.8% which is the highest rate since August 2009. 
  • the demographically adjusted employment to population ratio has reached the 1999-2000 average. ( That means that holding the age & sex distribution of the population constant ) This implies the labor force is near full employment.

11/1/19 – Big Difference In 2 Inflation Metrics

  • Since income growth improved and the savings rate increased, there’s room for the consumer to increase spending growth further in the all-important holiday shopping season.
  • The consumer is saving more as the savings rate improved to 8.3% from 8.1%
  • If the consumer becomes more confident, there could be a huge burst in spending because there’s room to lower the savings rate. T

10/31/19 – 0.92% Q4 GDP Growth?

  • very small business yearly job growth fell to just 8 basis points. That’s the weakest reading since February 2011.
  • CHART – Total NFP Job Growth vs Small Business ADP Job Growth
  • The last 2 mid-cycle adjustments were three 25 basis point cuts in 1995-1996 and 1998. As more data comes in, we will see if this is wishful thinking by the market.
  • CHART – based on 29 macro and market factors, there is an 11% chance of a recession.
  • CHART – Contributions To Real GDP
  • Without the consumer, there would be no growth.

10/30/19 – Biggest Improvement In Homeownership Rate Since 1998

  • Case shiller home price index –  20 city seasonally adjusted monthly growth rate was negative for the 2nd time since March 2012. 
  • It’s important to seasonal adjust results when dealing with sequential data. 
  • Homeownership rate fell from 67.6% in Q3 2009 to 62.9% in Q2 2016. That was the weakest reading since Q3 1965.
  • In Q3 2019, the rate increased from 64.1% to 64.8% which is tied for the highest rate since Q1 2014 back when the rate was still falling. 
  • Regarding homeownership rate – It’s tough to say what is normal, but the current rate is near the long term average excluding the housing bubble.
  • biggest quarterly increase in the homeownership rate since it increased 0.8% in Q3 1998.
  •  the homeowner vacancy rate fell to the lowest level since 2002.
  • CHART pending home sales lead existing home sales by 1 month which means we should expect another good existing home sales report in September.

10/29/19 – 1.2% GDP Growth Coming

  • Barron’s does a survey of money managers each spring and fall.
  • The results from the poll in late September in which 134 money managers participated were surprisingly bearish. This is in line with how individual investors expressed themselves in the AAII poll earlier this fall.
  • According to the survey 31% of money managers were bearish and only 27% were bullish
  • It’s common to see the goalpost moved after big changes in stocks. People don’t want to be caught with a non-consensus position or an opinion that’s too one sided. 
  • It’s common for people to predict a recession in about 2-3 years and then move the goalpost further when it doesn’t happen. Recession calls are getting more aggressive because the economy is weak and this expansion is very old
  • CHART US economic activity slowed in September, based on the 3-month avg of the Chicago Fed Nat’l Activity Index:
  • While many debate if we are in an $SPY #earnings recession or not, they are missing what really drives stock prices – the direction & magnitude of EPS estimate changes. Stock prices follow the rate of change of expectations!

10/28/19 – Secular Stagnation In Housing Market?

  • With the unemployment rate the lowest since December 1969, the treasury budget should be in great shape, but it isn’t.
  • CHART – US cyclically adjusted primary deficit/ (surplus). Federal deficit less interest adjust for business cycle effects % of gdp.
  • Because the deficit is so large this late in the cycle, the current deficit blows away any previous cyclically adjusted deficit since at least 1960.
  • In theory, there should be a cyclically high percentage of people and businesses paying taxes and a cyclically low percentage of people taking money from the system because they don’t have a job or are in poverty. 
  • We’ve recently seen some subpar housing reports which was slightly disconcerting given the momentum housing appeared to have and how low rates are
  • In September, new home sales were 701,000 which beat estimates by 3,000. The 3 month average fell from 700,000 to 691,000. Those are the highest 3 month average and the 2nd highest average of this cycle.
  • CHART –  tightened the price gap between new and existing home prices as the difference is now $27,300.
  • CHART – the decline in prices was driven by a huge swing away from new homes costing $400,000 to $499,999.
  • CHART – new home sales are at a cycle high, on a population adjusted basis, they have been below the long term range for this entire cycle.
  • In the past few months, the Bloomberg Consumer Comfort index has been showing the most optimism out of the three major consumer confidence reports (Conference Board & University of Michigan).
  • The Bloomberg Consumer Comfort index was very strong and the buying climate index hit a record high.

10/25/19 – Durable Goods Orders Growth Could Get Worse In Q4 2019

  • jobless claims is one of the metrics in the current activity indicator which is consistent with 2.25% GDP growth.
  • This claims report measures the 3rd week of the month which means it’s the survey week for the BLS report. The decline in claims might mean the BLS report will be good.

10/24/19 – Is The Economy The Weakest Of This Expansion?

10/23/19 – Does It Matter That Labor Market Is Less Cyclical?

  • The U.S. economy is becoming less cyclical which means it needs a greater decline in its cyclical part to generate a recession. 
  • The fact that the U.S. consumer has deleveraged in this cycle is probably the most important reason the economy is in its longest expansion since the 1800s.
  • The secondary reason is the rise of acylical sectors like healthcare. These healthcare jobs are replacing the old manufacturing jobs of previous decades. 
  • If the U.S. labor market relied more on the oil and gas industry, there would have been a recession in 2016. 
  • Interestingly, even though the US is producing the most oil and gas ever, the industry doesn’t employ as many workers as it did in the 1980s.
  • As of September, the oil and gas industry employed 161,300 workers. The peak was 200,800 in 2014 which is still way less than 1% of the labor market. That’s nothing compared to the peak in 1982 at 267,000 when the overall labor market was much smaller.
  •  in 1990, 6.7% of American workers were in healthcare and now the percentage is 10.4%.
  • With healthcare being so important, it helps stabilize the labor market in cyclical slowdowns.
  • Philly Fed Index Shows Improved Optimism and capex expectations index rose from 25.9 to 36.4. This is one of the best readings in the past 19 years.
  • Richmond Fed Index Sharply Improves – The Richmond Fed manufacturing index is the 3rd of 5 regional Fed manufacturing reports. There is no expectations index, but it would have increased if it had the same weightings as the general index
  • Single family starts pack a more powerful punch than multi-family starts in the GDP report
  • housing starts are correlated with permits pushed forward by 6 months. This implies starts will continue to improve modestly later this year and into next year. 
  • The regional Fed manufacturing reports imply the manufacturing ISM will rise above 50 again which would be big news. It would probably send stocks higher, depending on where the consensus is. The ISM report comes out on November 1st

10/22/19 – What Causes Zombie Firms?

  • A zombie firm is a company that shouldn’t exist based on its business fundamentals (P&L), but does because of very easy credit conditions and low interest rates.
  • Low interest rates help valuations and help some firms stay in business. The theory that central bank suppressed low rates have unintentionally created many zombies can be argued that demographics and some other factors are pushing down rates, increasing firms’ ages, and mitigating startup rates.
  • There has been a slowdown in nominal growth in developed economies because of their slowing/declining population growth rates. These populations are also aging.
  • Older people don’t create new companies as often as middle aged people. The wave of ‘boomer’ created start-ups is mostly over.
  • It’s important to emphasize that while central banks do have an impact, it is not accurate to attribute all market responses on them, at least in the US.
  • For instance, in places like Europe and Japan where there has been a higher level of central bank involvement with corporate equities and debt, this has contributed to the creation of zombie companies.
  • the percentage of global central banks whose last rate change was a cut shifted from 38% to 82.4% in the past year. 
  • he U.S. economy is less cyclical as we have pointed out when discussing the employment gains in the healthcare sector. 
  • 19.1% of final domestic demand came from the cyclical sector in Q2 2019.
  • Cyclical sectors are a much smaller share of the economy or S&P than they used to be in the past
  • The economy would be at a standstill if it wasn’t for the non-cyclicals which have a negative correlation with cyclicals. 
  • There can still be recessions, but there needs to be a big imbalance to cause one, which we don’t see.
  • CHART – ratio of leading to coincident indicators.

10/21/19 – How Low Will GDP Growth Be In Q3 2019?

  • Excluding autos and gas, retail sales growth was 0% which missed estimates for 0.3%. The reading and the consensus were the same for the control group which goes right into the GDP report.
  • The weakness in control group growth was expected because of the ridiculously high growth earlier this summer.
  • Month over month annualized growth has been 10%, 3.9%, and 0.5% in the past 3 months.
  • quarter over quarter annualized growth fell to 6.8%. That’s similar to the recent decline in PCE growth.
  • This retail sales report caused Bank of America’s Q3 GDP growth tracking estimate to fall to just 1.5%
  • Oxford Economics’ estimate for consumption growth fell from 2.5% to 2.3% and its GDP growth estimate fell from 1.5% to 1.3%.
  • RSM US’s estimate for consumption growth is 2.5% and it’s GDP growth estimate is 1.4%
  • Consumption growth needs to be solid just for GDP growth to be in the mid 1% range (the median estimate is for 1.5% GDP growth).
  • Similar to August, the September retail sales report had bad breadth. The percentage of the 13 categories with a negative monthly growth rate rose from 54% to 62%. This was the highest rate since the terrible December 2018 reading which was hurt by the government shutdown and stock market decline.
  • disappointing retail sales growth report caused the odds of a rate cut in October to increase from 73.8% to 89.8%.
  • Cornerstone Macro’s model predicts core CPI will fall to 2.1% by Q4 2020 probably because of the cyclical slowdown.  The model’s inputs are unit labor costs, nominal GDP, and M2 growth. It has a 76% R^2.
  • The Fed’s Beige book from September and early October told us mostly what we expected, namely that growth is weakening because of the cyclical slowdown and the trade war.
  • CHART – NAHB index’s yearly growth in relation to the yearly change in mortgage rates pushed forward by six months.

10/16/19 – Global Growth Projections For 2020

  • 40% of respondents stated the trade war is the new normal.
  • 2019 world GDP growth was expected to be about 3.9% in early 2018 and now it’s expected to be 3%. – by IMF
  • In the long term, India will be driven by it’s amazing demographics, unlike China which will potentially see its population peak in 2023.
  • the proxy for Chinese household savings is rallying higher as it has risen from below 6% to above 10%
  • When consumers save more, it signals there will be weak profits, weak auto sales, and weak retail sales growth. Consumers don’t start saving more because they are confident in the economy. 
  • China’s goal has been to become more reliant on services like the US and other developed economies. A country can only do that by improving its GDP per capita (with a low Gini coefficient) and having consumers spend.  
  • credit impulse growth in China is at a 13 month high which might moderate the growth decline in 2020.

10/15/19 – Stocks Do Better With A Weak Manufacturing PMI

  • As the yield curve steepens, calls for a recession are growing because usually after yield curve inversions, steepening is coincident with recessions. 
  • However, this can be a bullish steepening.
  • It’s not great to see CEOs very bearish on the economy since they impact capex plans, but at the same time the ratio between the leading and coincident indexes isn’t signaling a recession, jobless claims are low, and consumers are confident.
  • CEOs are often bearish at the bottom in stocks. CEOs aren’t alone as investors are currently also bearish
  • It’s counter intuitive for bearishness among CEOs to be a positive for stocks.
  • Similarly, when the ISM manufacturing PMI is below 50, it’s a good sign for future S&P 500 returns.
  • The 1 year return is 13.29% with a PMI between 29.4 and 50, while returns are 6.97% with the PMI from 50 to 77.5.
  • The logic behind this is stocks price in the weakness before this report shows contraction. For example, if the PMI starts at 60 and bottoms at 45, most of the decline has already occurred by the time it falls below 50.
  • the expected inflation rate in the next 5-10 years fell 0.2% to 2.2% which is the lowest rate since at least 1989.
  • shows only 1 indicator out of 20 is signaling danger. At the last 3 market peaks, there were 8/20, 9/19, and 6/16 indicators signaling danger.
  • One of the most bullish indicators in this table is the relationship between the 10 year yield and the S&P 500’s dividend yield. 
  • Cass Freight Shipments – September, yearly growth was -3.4%. That follows yearly growth of -3% and -5.9% in the prior 2 months.
  • Cass Information Systems continues to warn about negative yearly real GDP growth later this year. That’s similar to the soft data, but different from the hard data.
  • Cass Freight Shipments – The comps get much easier in the next 2 months as yearly growth in 2018 went from 8.2% in September to 6.2% and 0.6%.

10/14/19 – Third Biggest Consumer Surprise In 21st Century

  • The August University of Michigan consumer confidence report was highly discussed because it showed a big decline in confidence.
  • We now have the benefit of hindsight which tells us retail sales growth improved, but PCE growth didn’t.
  • Very few economists saw an increase in consumer confidence coming in October. this was the largest positive surprise since 2013. It appears to be the 3rd biggest surprise in the 21st century.    
  • Inflation is expected to be low and nominal wage growth is expected to be high leading to the net percentage of consumers expecting their real incomes to rise in the next year reached the highest point in 20 years.
  • Just like during the prior two recessions, the gap between discount same store sales growth and department store sales store sales growth is increasing.
  • The key difference is discount store sales growth is extremely high and department store sales growth is only slightly negative.
  • The economy isn’t in a recession, but it’s worth watching to see if yearly growth in department store sales falls further.
  • Evercore Weekly activity index consistent with around 2 1/4 real growth
  • Because comparisons got easier, the ECRI leading index’s growth rate improved from 0.8% to 1.1% even though the index fell from 146.1 to 145.4

10/11/19 – Does Terrible Soft Data Indicate Recession?

  • Considering how close the stock market is to its record high, it’s surprising how bearish investors are.
  • the CNN fear and greed index (October 10th) is at 36 which is fear. 
  • Flows into money markets are among the highest in decades and are almost at the March 2009 panic high. 
  • The NDR daily trading sentiment survey is at 28.89 (October 9th) which is in the extreme pessimism category (below 41.5). Since the end of 1994, the S&P 500’s annualized returns in this category are 29.82%.
  • The AAII investor sentiment survey published on October 9th shows the percentage of bulls is at an extreme low.
  • CHART Cornerstone Macro’s GDP barometer has Q3 year over year real GDP growth coming in at 2.1%. The soft data pushed ahead by two quarters shows growth at just 0.8%. If it acts as a leading index, growth will be very weak in 1H 2020 since it is negative.
  • jobless claims are already the lowest in relation to the population ever. 
  • CPI Misses Estimates & Falls
  • Shelter inflation always drives core price growth because it is a large component (rent of shelter is 33% of CPI).

10/10/19 – Hiring Growth & Job Openings Fall

  • since 1950 stocks have fallen in this period (pre-election fall season) (Oct-Nov).
  • The Fed funds futures market sees an 85% chance of a rate cut in October and a 45.2% chance of another cut in December.
  •  If the Fed can’t influence the futures market because it is in disagreement, it will be beholden to the market.
  • CHART – Total job openings compared with US unemployment number
  • more workers quit their jobs as the labor market tightens

10/9/19 – Small Businesses Are Still More Optimistic Than CEOs

  • This decline in inflation is exactly in line with the cyclical slowdown. Inflation bottomed in 2016 along with economic growth and it topped in 2018 with economic growth. It’s easier for the Fed to cut rates if inflation falls, but it’s falling because of the economic slowdown which is the reason for cuts in the first place.
  • PPI CHART – Continue to foresee an inflation undershoot into 2020 on combination of international & domestic headwinds
  • we look for clues about how PCE will turn out in this PPI report. These clues explain why PCE inflation rarely misses/beats estimates by much.
  • While producer prices unexpectedly tumbled, consumer prices (PCE) will rise. Healthcare services PPI rose 0.4% in September, the strongest monthly gain since October 2017. This is especially important for core PCE, where healthcare services have a very large weight (~20%).
  • 7 categories in the NFIB sentiment report showed declines and 3 showed no change from last month.
  • 11% of firms named cost of labor as the biggest problem for them which is the highest reading since at least 1986.
  • we’d rather see hiring weakness because the high cost of labor and a limited supply of workers than because of sales weakness.

10/8/19 – Are CEO Expectations A Leading Indicator For Recession?

  •  it took 366 days from the start of the last recession for the NBER to recognize it
  • Just because recession announcements are delayed and GDP can be adjusted lower, doesn’t mean you can throw out all the data and claim a recession is ongoing
  •  the CEO confidence index as measured by Conference Board is the lowest since Q4 2008 and its yearly growth rate is the lowest since Q2 1979.
  • CEOs aren’t optimistic about the next 6 months for the economy. 
  • The economy is in a cyclical slowdown, but CEO confidence is acting like it’s potentially in a recession.
  • Chart – excess bond premium shows there’s low risk of a recession in the next year – the excess bond premium measures risk taking in corporate credit. The EBP measures the variations in the pricing of corporate credit risk instead of the changes in the probability of default by the issuer. The model built by Gilchrist and Zakrajšek uses secondary prices of unsecured bonds. A synthetic security was created to measure the bonds’ cash flows to avoid duration mismatch.

10/7/19 – Was The September Labor Report Positive or Negative?

  • September labor report wasn’t weak enough to signal a recession and it wasn’t strong enough for the Fed to consider canceling future potential rate cuts this year.
  • The BLS report wasn’t as bad as the Markit and ISM PMIs projected. 
  • Goldman Sachs’ current activity indicator shows 0.4% growth using survey data and 2.5% growth using hard data. We’d rather see hard data outperform
  • The 38,000 positive revision in August was actually below the average of 59,000 in the last 10 Augusts
  • The BLS has revised the September report positively 9 of the last 10 years. The average upward revision in those years was 55,000
  • the 12 month change in job growth by sector.
  • The less-cyclical healthcare sector has had the highest growth. The more jobs in this sector, the less cyclical the labor market will be.
  • Lowest Unemployment Rate Since December 1969
  • CHART –  the gap between the 3 month average of the unemployment rate and the 1 year low of the 3 month average signals there is a 0% chance of a recession.
  • the U6 underemployment rate fell from 7.2% to 6.9% which is the lowest rate since December 2000 (very close to record low of 6.8).
  •  changes in average hourly earnings growth are impacted by which day the 12th of the month falls.
  • September had one of the strongest production and non-supervisory wage growth rates of the cycle.
  • Chart – YOY Wage Growth By Worker Type

10/4/19 – The Market Begins Pricing In More Rate Cuts

  • Unlike the reaction to the disappointing manufacturing PMI, stocks recovered quickly because the odds of rate cuts increased. 
  • There is now a 79.6% chance of a rate cut at the October 30th meeting. One week prior there was a 49.2% chance of a cut. Usually, the market locks in rate decisions a couple weeks before the decision; over a 70% chance means the decision is very likely.
  • The Fed’s blackout window, which is when members can’t discuss policy publicly anymore, starts on October 19th.
  • The September ISM services PMI fell even more than the manufacturing PMI
  • Since the service sector employs most workers, its employment reading is critical.
  • At the end of the previous two recessions, the manufacturing Markit PMI was above the ISM PMI. The Markit services PMI has been consistently below its ISM counterpart.

10/3/19 – Does The Market Finally See The Slowdown?

  • Of all the news events in October, whether it be about politics, monetary policy, or earnings, it’s surprising that the cause of volatility was the ISM manufacturing report since it told us what we already knew.
  • It’s as if the market slept through the weak Cass Freight index and the other subpar manufacturing reports, and woke up to realize there is a trade war and a cyclical slowdown.
  • This supports a point we’ve made previously which is that you never can be sure what the market has priced in. Sometimes the market moves on something you thought was already known for weeks.
  • this is the 1st start to a Q4 where the S&P 500 has been down more than 1% on consecutive days.
  • Stocks usually don’t fall at the start of the quarter because it’s when new money comes in
  • As of October 2nd, the equity only put to call ratio signaled the market was oversold.
  • However, if the cyclical slowdown gets worse, no matter how easy the comps are, earnings growth will be weak and potentially negative.
  • Auto Sales fell the most since 2008 but current sales are almost double that of 2008 and they didn’t plummet nearly as much as in 2008 on a percentage basis.
  • Because of an inventory glut, auto makers gave out record discounts of $4,100. That’s a signal demand is weak. 
  • Weak ADP Report Signals Trouble For BLS
  • in the past eight years, in September, the ADP report averaged being above the BLS report by 55,125.
  • The housing market is far from a recession signal. 
  • best home sales data have all come in fall in this cycle!

10/2/19 – What Is The Manufacturing Sector Doing? Making Sense Of Mixed Data

  • There was a big divergence in the September manufacturing PMIs from Markit and ISM.
  • It’s not surprising that the market followed the ISM PMI closer because that’s what it has historically done. However, that doesn’t mean it’s more accurate. 
  • The Markit PMI actually has about twice the sample size as the ISM PMI. The ISM report has a small sample size which means you shouldn’t change your macro view based on one reading. It was probably too optimistic in 2018 and now it’s more pessimistic than the Markit report and the average of the regional Fed readings.
  • The ISM reading is an average of its 5 components which are new orders, production, deliveries, inventories, and employment. Markit gives a higher weighting to production and new orders and a smaller weight to inventories and deliveries. 
  • Just like the ISM report, input buying fell for the 3rd straight month because weak demand is causing firms to buy less inventory. The only difference here is Markit gives this change less of a weighting in its overall index.
  • the ISM manufacturing PMI was weak and disappointing. It went from an okay reading to a weak one. The next step is terrible, i.e. recessionary.
  • based on the ISM PMI there is a 23% chance of a recession. That’s the highest of this expansion by a slight amount.
  • CHART – the weakness was widespread as there were 15 sectors in decline and 3 sectors growing. That’s a net -12 which is the weakest reading by far since the financial crisis.
  • One positive – At least the manufacturing sector isn’t a big job creator. Healthcare has been driving job creation lately.  
  • New Export Index craters – The part of this report that drew the most attention is the new export orders index which fell 2.3 points to 41. This index usually is ahead of the overall index which means it will plummet if export orders are correct.
  • CHART – export orders aren’t in line with global PMIs as the percentage of global PMIs in expansion increased
  • the 3.7 point increase in the prices paid index to 49.7 was rare in relation to the decline in the overall PMI index. Don’t be concerned with stagflation as the PMI is still below 50. It’s just an odd monthly change.

10/1/19 – If This Continues Stocks Will Fall In October

  • In August real retail sales growth and real PCE growth were inversely correlated.
  • Real retail sales showed the strongest growth since August 2018, while real PCE showed the weakest growth since December. 
  • real PCE includes more data; it is all encompassing. The categories in PCE that aren’t in the retail sales report stopped pushing real PCE growth higher.
  • PCE is the value of all goods and services purchased by or for U.S. residents as calculated by the BEA.  The August PCE report showed $14.658 trillion in nominal sales. Retail sales measures the U.S. retail industry. The U.S. Census Bureau surveys 4,900 firms each month to collect the data in this report. In August, there were $526 billion in nominal retail sales.
  • Examples of consumption included in PCE, that are not in retail sales are services like utilities, healthcare, going to the movies, and gambling.
  • in the last recession, real retail sales growth fell much further than real PCE growth.
  • CHART – advanced real retail and food services sales – real personal consumption expenditures
  • Real retail sales growth is more volatile than real PCE growth
  •  While real PCE growth encompasses more data, it appears, cyclically, the economy shows more strength when real retail sales growth is higher.
  • The track record of rate cuts leading to improvement in the global manufacturing PMI is solid.
  • the global manufacturing PMI is correlated with the net number of global central banks cutting rates when the number of central banks cutting is pushed forward by 8 months. 
  •  the global manufacturing PMI’s decline in new orders could lead to renewed weakness in the output index. (Since that statement, the September release showed the new orders index improved from 49 to 49.4.) 
  •  firms usually beat EPS growth by around 3%.
  •  The consensus for Q4 growth, which we must follow the closest, is 6.01%. This estimate will fall in the next 3 months. The velocity of this decline during Q3 earnings season is pivotal.
  • the first 14 firms to report Q3 results have had big declines in their Q4 EPS estimates. Q4 estimates are higher than Q3 estimates were which means they have further to fall.
  • Q4 also faces much easier comps. We will be watching to see if weak economic growth leads to weak guidance. If estimates continue falling this much, stocks will fall in October and November.
  • Supporting the thesis that there is an economic backdrop for weak earnings is the Chicago business barometer index. The overall barometer is below some of the readings in the last recession.
  • Given the deleveraging in China and the trade war, it’s surprising that the manufacturing PMI improved from 50.4 to 51.4 in September which was the highest reading since February 2018

9/30/19 – Terrible Combination Of Weak Consumption & Business Investment Growth

  • The disappointing August real consumption and core capital goods orders growth caused many Q3 GDP growth estimates to plummet.
  • the U.S. consumer is slightly larger than the entire Chinese economy. 
  • The weak August University of Michigan consumer confidence index was wrong about retail sales growth which was solid, but was correct in predicting weak real consumption growth.
  • If there is going to be weak consumption growth, we’d rather see income growth be stronger than consumption growth and the savings rate go up because when confidence improves, spending growth can improve.
  • At least real income growth wasn’t terrible, leading the savings rate to increase.
  • August core CPI increased from 2.3% to 2.4% which caused many to fear inflation and criticize the Fed’s rate cuts.
  • It seems like those saying inflation is a problem are also bearish on economic growth.  You can’t have it both ways with criticizing the Fed’s rate cuts. 
  • Core PCE inflation could be a problem in early 2020 because the comps get much easier. 
  • Inflation depends on cyclical growth. It would be a high quality problem for core PCE to be modestly above 2% because economic growth is improving.
  • core capital goods orders growth is the best representative of business investment.
  • core capital goods shipments growth has been highly correlated with non-residential business investment growth.
  • Shipments, not orders, get put into GDP since they are the result of production
  • Weak business investment combined with weak consumption growth is *not good* for Q3 GDP growth. 
  • Core Capital Goods Orders Weakness

9/27/19 – Many Possible October Surprises

  • The stock market is in a weird situation where it has had a great year and is near its record high, yet individual investors aren’t very bullish. That’s a good sign for the bulls. 
  • The rolling 52-week average of bullish sentiment has basically been trending lower this entire bull market.
  • Investors aren’t that positive compared to the past 30 years. You wouldn’t think the market had amazing performance in the past 10 years by looking at sentiment. Can stocks climb the wall of worry again?
  • Existing home sales, the housing market index, new home sales, MBA purchase applications, housing starts, and permits have all been heading in a positive direction
  • Contract signing usually lead sales by 45 to 60 days.
  • Pending home sales signal new home sales will be strong this fall and new home sales signal starts will be strong in Q4. 
  • Real residential investment growth could go from hurting GDP growth for 6 straight quarters to helping it significantly in the 2nd half of 2019. 
  • A model uses median income and mortgage rates to predict new and pending home sales growth.
  • There’s a misnomer that profit margins are extremely high because people only look at the S&P 500. The situation isn’t as great for small firms which are being hurt by rising labor costs. 
  • NIPA corporate profit margins have been declining for 4.5 years which is the longest run of declines in post-war history.
  • Previous declines have ended with a recession. So far, this decline in margins hasn’t led to a burst in layoffs as jobless claims in the week of September 21st were 213,000.
  • Profit margins have fallen in the past 4.5 years and the percentage of the national income going to workers has increased.
  • To be fair to those claiming income inequality is still large, the current percentage is below most of the troughs in the past few decades according to Rich’s Ratio (percentage of national income going to labor).
  • Furthermore, the Gini coefficient, which measures inequality (higher is less equal & 1 is the highest possible) has increased from 0.43 in 1990 to 0.49 in 2018.
  • the odds of Warren winning the nomination have been inversely correlated with UnitedHealth Group’s stock.
  • The term “October surprise” is overused, but we thought it was apt here because of all the news events coming out in mid-October.
  • Politics, trade negotiations, earnings, economic reports, and Fed policy will make news next month

9/26/19 – New Cycle High In 3 Month Average New Home Sales

  • When we have positive headlines, less people are interested in the content than if the headline was negative. That’s unfortunate, but regardless of whether the data is positive or negative, our goal is understanding reality.
  • The housing data in the past couple of weeks has almost been all good. 
  • The new home sales report was a continuation of the other great housing reports this summer. The July reading was revised up from 635,000 to 666,000. The June reading still is a cycle high which makes a recession highly unlikely in the next few quarters. 
  • there were 713,000 new homes sold in August which beat estimates for 662,000 and the high end of the consensus range for 685,000.
  • The average (mean) price of a new home sold in the U.S. in August was $404.2k, highest on record. The 6.1% annual price appreciation was the strongest in 21 months. The median price ($328.4k) was only the highest since April and up only 2.2% y/y.
  • The 3 month average new home sales was the highest since October 2007 which was before the subprime crisis. Before you get worried, new home sales peaked in July 2005 which was over 2 years before the recession started.
  • New home sales usually run about 70% of single family housing starts. The percentage is now 77.5%. That signals housing starts will increase soon.
  • The other signal that a construction boom is coming, which will boost real residential investment growth, is the decline in new single family home inventories.
  • The inventory glut that built up in 2H 2018 because of affordability issues has been removed. 
  • The main reason housing isn’t affordable is down payments
  •  it only takes nonsupervisory and production workers 51.7 hours of work per month to pay for the median new home assuming they put 20% down. In reality – most people buy existing homes which are cheaper. 
  • Obviously, buyers don’t need to put 20% down. First time buyers put 6% down on average. That increases monthly payments.
  • The Atlanta Fed report suggests cyclical weakness is a bigger issue than the trade war. The uncertainty index fell from 97.4 to 90.2 which means there is less uncertainty – allowing the capex index to hit a record high    This report showed sales growth and capex growth divergence which is odd.
  • Warren has a 24.7% chance of being elected president in 2020

9/25/19 – Huge Drop In Consumers Saying Jobs Are Plentiful

  • In the week of September 21st, the Redbook same store sales growth rate fell from 5.4% to 5.2%. That’s still very strong growth; the tariffs haven’t slowed spending – will face very tough comparisons in December. Notably, it strayed far from retail sales growth in that month as December is when yearly retail sales growth bottomed.
  • Generally, the more up to the minute data is, the less reliable it is.  The longer it takes for data to come out, including revisions, the more reliable it is
  • This is just like how the regional Fed manufacturing reports tell us about the manufacturing sector before the ISM PMI and way before the industrial production report.
  • You probably shouldn’t change your macro thesis because of Redbook or regional Fed readings, but they can support a trend you’ve already noticed.
  • In August, the University of Michigan consumer confidence index fell sharply from the prior month while the Conference Board index was very strong. The working thesis was that the University of Michigan report was impacted by financial markets, while the Conference Board index was impacted by the labor market. 
  • The University of Michigan index increased slightly in September and the Conference Board index plummeted the most this year.
  • The reality is both reports were driven lower by the same thing, the trade war. 
  • Weakness In Business Conditions & Labor Market
  • US. The key factor on confidence slump this morning was expectations of business conditions, which fell but remain in positive territory and far away from levels seen ahead of recession.
  • The most important part of the report is sentiment on the labor market since that’s what consumers are the most knowledgeable about. The situation worsened considerably although it’s still positive. Those saying jobs are “plentiful” fell from 50.3% to 44.8%. Those saying jobs are “hard to get” fell 0.4% to 11.6%. 
  • the monthly decline in those saying jobs are plentiful was the largest since 2001.
  • This is in tune with the decline in payroll growth, but not in line with the very low jobless claims
  • The FHFA home price index and the Case Shiller price index’s growth rates went in opposite directions as FHFA yearly growth in July rose from 4.8% to 5% and Case Shiller price growth fell 7 basis points to 3.2% which was once again the weakest growth since September 2012. 
  • On the one hand, the Case Shiller growth rate faced easier comparisons in July. On the other hand, comps are about to get much easier. There might even be a bottom in price growth soon as mortgage rates are near their record low.

9/24/19 – Will Covenant Lite Loans Be An Issue?

  • cov-lite loans are about 80% of leveraged U.S. debt.
  • It takes high confidence to claim all these loans given out by lenders are a mistake. Obviously, lenders don’t see it that way. There is an argument to be made that they won’t be problematic.
  • Cov-lite loans had lower default rates and higher recovery rates in the last recession. Specifically, in November 2009 the overall default rate on levered loans was 10.81% and the cov-lite default rate was 5.19%.
  • Cov-lite loans have also had high recovery rates. From 1987-2017, the average recovery rate was 71%.
  • For first lien loans it was 73%, for 2nd lien loans it was 53%, and for senior unsecured loans it was 47%. 
  • In the last recession, default rates were lower because only the best borrowers received cov-lite loans. This cycle, cov-lite loans will look like the average since they dominate the market. 
  • the average spread between cov-lite loans and treasuries has been lower than that of full covenant loans.  That implies cov-lite loans on average were considered less risky.
  • Chicago Fed National Activity Index Improves but economy is still in a slowdown
  • There was broad modest weakness. That’s a great summary of this slowdown as it’s not driven by one sector like the slowdown of 2015-2016 was driven by energy.
  • In the Chicago Fed National Activity Index manufacturing was pulled to the positive side by the industrial production report and to the negative side by the ISM report. 
  • U.S. manufacturing PMI vastly outperformed that of Europe and Germany
  • The beta of German equity returns to world trade growth is 3.1 which is much more than the S&P 500 which is at 2.3.
  • The details of the US flash Markit report weren’t pretty as the composite PMI is consistent with just 1.5% GDP growth which is below the consensus of 2%
  • the sector payroll numbers dropped for the first time since January 2010 which is why Markit sees less than 100,000 monthly payrolls growth in September
  • Overall private sector new business growth was the weakest since at least October 2009.
  • Service sector input costs fell the most since late 2009.
  •  India should drive global growth in 2020 because it is adding in a fiscal stimulus through tax cuts.

9/23/19 – This Doesn’t Happen During A Recession

  • the long yield fell below the short yield instead of the short yield rising above the long yield like usually happens.
  • This big decline in long rates helped the housing market. That might mean this yield curve inversion won’t lead to a recession.
  • it’s the steepening after the inversion that coincides with recessions, not the inversion itself
  • Usually, the curve steepens very quickly during recessions as the Fed cuts rates. We aren’t talking about a few basis points. We’re talking about a couple percentage points of steepening.
  • At about the 3 month mark after the first rate cut, the inversions that preceded recessions saw the curve steepen significantly. 
  • If the curve stays flat over the next couple months, it increases the odds that there won’t be a recession soon. 
  • this analysis might not even matter. The 10 year yield has been correlated with nominal growth. A low yield means lower growth is coming. If the yield spikes, it would steepen the curve, but also imply nominal growth will improve.
  • the coincident ECRI index is growing quicker than the leading index
  • the ECRI leading index includes data from September. It was also below the coincident index in August.
  • The ECRI coincident index’s growth rate fell from 2% to 1.8%. It’s very interesting to see this compared to the last slowdown where growth bottomed at about 1% in 1H 2016. 
  • In Q4, the comparisons will get easier. It will be important to review the sequential change in the index to see if economic growth is really accelerating.
  •  It’s better to have high estimates GDP estimates later in the quarter like now because they include more data.
  • Suddenly, this slowdown doesn’t look close to recessionary. You don’t see cycle high housing starts and permits in recessions. 
  • GS calculated a trade war barometer using markets to suggest there is a 40% chance of a trade deal. The barometer showed there was about an 80% chance of a deal this spring.
  • It’s good to see the market less hopeful now as there is less room for it to be disappointed.
  • The tariffs almost completely counteract the fiscal stimulus in 2019.
  • The University of Michigan consumer confidence index is in the penalty box because it fell in August, even though retail sales were strong.
  • Regarding University of Michigan consumer confidence survey – Historically, drops of more than 20 have signaled all previous recessions going back to 1979.  Currently has fallen 15.9 points (not taken into account recent rise).
  • Chart – the average of the Philly and Empire Fed indexes has been higher than the ISM PMI. (showing continued expansion)

9/20/19 – Can Stocks Fall Without A Recession?

  • The cycle high new home sales reading in June, the solid MBA purchase applications growth (15% growth in the week of September 13th), and the strong improvement in current sales in the September housing market index were all confirmed by the strong August housing starts report.
  • Most of the data is headed in the right direction and this is even before the yearly comps get much easier in Q4. 
  • The decline in mortgage rates is doing wonders for demand. The excess inventory was worked through. Many blamed this cycle’s low housing starts on supply, but it has always been a demand issue.
  • If the labor market stays strong, demographics should take hold of housing and drive it higher. A large number of millennials are entering their early 30s which is when people buy their first home.
  • Real residential investment growth has hurt GDP for 6 straight quarters. the increase in housing starts in August to the highest level since June 2007 might be enough to push real residential investment growth above 0%.
  • the improvement in existing home sales was catalyzed by the decline in the average 30 year fixed rate.
  • The median existing home price was $278,200 which was down from July, but up 4.7% from last year. That’s higher than the growth shown in the July Case Shiller index, but lower than the growth seen in the FHFA index. 
  • The leading indicators index – The positive contributions were from permits, the Leading Credit Index, and manufacturing hours worked. The index was hurt by the manufacturing components and the yield curve. Essentially, the treasury market helped and hurt the index since low rates helped permits. 
  • Rather than drop sharply as it has prior to past recessions, the Leading/Coincident indicator ratio is moving sideways. ( the ratio between the leading index and the coincident index has been flattening )
  • Since the leading index is at a record high, it’s not giving off a recession signal. In the past three cycles, it peaked 17 months, 10 months, and 20 months before recessions.
  • The conference board leading index – the 6 month moving average of the 6 month rate of change is just above giving off a recession signal
  • about 45% of bear markets since 1900 had no relationship with a recession.
  • You don’t need to call for a recession to call for a bear market. Expansions don’t guarantee great stock performance.

9/19/19 – Forward Guidance Doesn’t Meet Reality

  • Even though in the few days leading up to the September Fed meeting, the CME Group FedWatch tool showed a declining chance of a rate cut (it fell to near 50%), the Fed did exactly what was expected by cutting rates on Wednesday. 
  • The effective Fed funds rate spiked from 2.13% on September 12th to 2.3% on the 17th. Therefore, the Fed lowered the IOER (interest rate on excess reserves) by 30 basis points, authorized temporary Open Market Operations, and allowed organic balance sheet expansion.
  • There were 3 dissents which is the highest since 2013.
  • You probably shouldn’t take 2021 policy estimates very seriously since the Fed didn’t guide for any cuts this year back in June.
  • There’s not much visibility into December 2019 let alone 2021. To be clear, the CME Group FedWatch tool shows there is a 49.2% chance of a cut by the end of this year.
  • If you think steepening after an inversion signals a recession like it has in recent cycles, flattening is actually good news.
  • The key reason this was a hawkish presser is that Powell didn’t support further easing. He left it open 
  • The Fed’s guidance doesn’t make much sense because in June the Fed saw 2.1% real GDP growth in 2019 and 2% growth in 2020. Now it sees 2.2% growth in 2019 and 2% in 2020. Somehow, slightly improved growth was in tune with 2 cuts, which the Fed didn’t see coming as late as June. 
  • The August housing starts report signals the economy isn’t close to a recession.
  • just based on permits, the 2 year cumulative recession probability is near 0%. This model uses the distance from the two year rolling average max in permits. Permits are at a 12 year high.
  • the permits data signals starts will improve in the next 6 months.

9/18/19 – The End Of The Manufacturing Recession?

  • After the very weak ISM and Markit August manufacturing PMIs, it seemed clear the economy was destined for a terrible August industrial production report. That didn’t end up happening, although, manufacturing production was still down from last year. 
  • Some economists are saying the ISM report was way off because it asks firms how business is doing compared to the previous month and monthly production growth was great in this hard data report.
  •  the ISM PMI is still highly correlated with yearly manufacturing production growth, so it’s not as if the report is a complete waste of time to review.
  • The yearly growth trough in the last manufacturing recession was -2% in late 2015. There is broader weakness in this slowdown, but the depth isn’t there yet.
  • The big difference between this manufacturing slowdown and the last manufacturing recession is mining production won’t get as bad because oil prices didn’t crater.
  • the 3 month change in the 3 month average of industrial production was with energy versus without it in the 2015-2016 recession.
  •  If there is a cyclical upturn in 2020 and a trade deal this fall, the deal will be given the credit for the cyclical change just like the trade war was given all the blame for the cyclical downturn.
  • the movement in rates was large at the start of September as the long bond index had its worst 10 day start to a month since at least 1987 and the average 30 year mortgage rate increased 36 basis points from the trough on September 4th.
  • The NAHB stated the shortage of skilled labor, lack of affordable building lots, and rising costs hurt affordability.
  • The September fund manager survey asked investors about the most bullish possible policies for risk assets. The German fiscal stimulus was the top answer. The 2nd most prominent was a 50 basis point Fed rate cut. 
  • the net percentage of fund managers expecting a global recession in the next year hit -21%
  • 59% see a recession as unlikely and 38% see a recession as likely. That’s the highest net percentage since August 2009

9/17/19 – Potential US GDP Contraction Predicted In Late 2019

  • as treasuries were selling off, they were considered the most crowded trade. To be fair, long treasuries was also considered crowded in August. 
  • Obviously, it’s way easier to point out an overcrowded trade than it is to get in the trenches and bet against it because betting against a trend takes great timing.
  • Expecting A Trade Deal Is Non-Consensus
  • over 35% of managers think the U.S. China trade war is the new normal which won’t be resolved. 
  • Only less than 5% see it being resolved this year. 25% say a deal will be made before the US presidential election in 2020.
  •  allocation to US stocks among fund managers increased 15 points to a net 17% overweight. That’s the biggest jump since June 2018.
  • When the net percentage of fund managers overweight US stocks is above 15%, US stocks fall 25.2% annually.
  • The Cass Freight index was weak again in August.  This was the 9th straight negative yearly volume growth reading 
  • Chinese Rhetoric & Expectations Don’t Match PMI
  • It’s ironic to see China blame the global slowdown since China is one of the main drivers of said slowdown
  • The Empire Fed manufacturing report showed big weakness in 6 month expectations
  • Cap Ex plans in the September Empire Manufacturing report saw its third largest monthly drop on record (since 2001).
  • Fund managers were right about treasuries and growth stocks being overcrowded as treasuries have sold off and value has outperformed growth recently.
  • Fund managers have been chasing U.S. equities, but they aren’t optimistic about a trade deal soon. 
  •  The Cass Freight index shows the level of economic weakness is getting closer to the 2015 to 2016 slowdown.
  • Cass Information Systems already sees the possibility of negative GDP growth later this year. 

9/16/19 – Do Restaurant Sales Lead The Economy?

  • The August retail sales report ended up being very strong because of motor vehicle and parts sales and online sales. 
  • Positive revisions make it tougher to beat monthly growth estimates, but this report did so anyway.
  • This great retail sales report signals the consumer isn’t pulling back because of tariff worries. It is buying more items because real wage growth is strong.
  • The control group measures retail sales excluding food services, car dealers, building materials stores, and gasoline stores. This reading goes directly into the GDP report
  •  This is back to back reports where yearly online sales growth has been the highest since December 2000 when the internet was in its infancy.
  • If you divide non-store sales by total sales, online had a 6% weighting back then and has a 12.8% weighting now.
  • This retail sales report had bad breadth. Most categories declined monthly. 
  •  yearly restaurant sales growth fell from 3.33% to 1.1%. That’s the weakest growth rate since February 2010 when the economy was just exiting the last recession.
  • It’s a misnomer that restaurant sales growth leads the economy. 
  • To be clear, weakness in restaurant sales growth isn’t good. It just isn’t a leading indicator for more weakness.
  • The University of Michigan index is in the doghouse in terms of indicators because it cratered in August, but the retail sales report was great as we just reviewed. This index is correlated with financial markets which were stressed in August. 
  • The net percentage of consumers expecting a decline in interest rates was the highest since February 2009.
  • the TLT, which measures the long bond, ended its record long streak of 100 days above its 50 day moving average.

9/13/19 – Core CPI Hits Cycle High: An Explanation Of Why Fed Won’t Stop Cutting

  • Headline CPI missed estimates and core CPI beat estimates. 
  • If you deflate wage growth by CPI, it means real wage growth improved again
  • CPI is usually above PCE inflation.
  • The best way to get the Fed to stop cutting would be to have a trade deal. 
  • highest core CPI since September 2008. 
  • The improvement in yearly core CPI was mainly due to an easier comparison. However, even easier comps are coming, so maybe that’s not a reason to doubt core inflation.
  • Energy inflation will be a drag on headline inflation for the next 2 months if oil prices stay around where they are now. Oil prices peaked in early October 2018. 
  • the 5 year compound annual growth rate of food away from home inflation divided by food at home inflation is near the highest it has been in the past 60 years. That’s because of labor costs as the labor market is tight.
  • The quirk in the data pertains to medical care services inflation. This spike in medical care inflation gave it the highest reading since September 2016 (one of the highest rates of the cycle), but there might not have actually been a big change in healthcare services prices. .
  • healthcare insurance inflation was 18.6% which is the highest rate since at least 2005.
  • CPI only measures out of pocket payments.  Conceptually, it’s measured similarly to a hedonic adjustment
  • When measuring health insurance inflation, the BLS tries to measure what consumers pay into insurance versus what they get out of it. That means if consumers pay the same amount into insurance, but receive less benefits, the CPI reading increases. Therefore, a rise in health insurers’ profits relates to higher inflation.
  • The 2nd quirk is that CPI collects data on health insurance inflation annually and spreads inflation out monthly unlike the other goods and services in the report which are measured monthly. 
  • The BLS changed its data provider on premiums and benefits in September 2018 which is right before this big run in prices making it somewhat dubious
  •  services inflation without medical care services inflation is falling
  • The Fed won’t change policy because of this CPI reading because core PCE inflation is very likely to stay below 2% in August
  • The PCE inflation report covers health insurance payments made on your behalf.  The PCE report uses data from the PPI report which is why the PPI’s selected healthcare industries reading is highly correlated with the PCE’s healthcare services measurement.
  • Without the burst in healthcare services inflation, we don’t see core PCE inflation hitting a cycle high.

9/12/19 – Why Investors Might Not Want Rate Cuts

  • The Fed would rather PPI be modest because it is about to cut rates in September, but ultimately the Fed follows PCE inflation the closest, so an increase in PPI won’t be a deal breaker for coming rate cuts
  • The Fed is hoping for a trade deal. If a deal is made soon and it improves business/consumer sentiment, the Fed can easily be done with rate cuts this fall.
  • The odd situation as far as how the Fed affects the yield curve is that a few months ago before the curve inverted, the bulls were begging the Fed to cut rates to steepen the curve, but now a steepening after an inversion would be a recession signal, based on past cycles.
  • However, it’s also important to point out that the inversion in the yield curve was primarily driven by different factors unlike previous cycles, so this relationship may not necessarily hold this cycle.
  • on average in the past 7 inversions, the short end of the curve has increased above the long end. Now it’s the opposite as the long end fell below the short end. Dovish guidance at the September meeting would steepen the curve. The bulls are trying to avoid what they wanted a few months ago.
  • demand declines are overcoming price increases which is making for a continuation of modest inflation.
  • Trade war – very small changes, but they indicate the momentum is in favor of some sort of compromise.
  • The working theory on the divergence between the University of Michigan survey and the Conference Board survey is the former is correlated with stocks and the latter is correlated with the labor market CB = labor market and Umich = stocks
  • Conference Board survey has a high correlation with Thomson Reuters / Ipsos Primary Consumer Sentiment Index which has recently fallen.
  • The weakness in sentiment correlates perfectly with the reading that 60% of Americans see a recession in the next year as somewhat likely or very likely. That also relates to the increase in Google searches for the term “recession.” However, this exact survey shows 56% of Americans view the economy as excellent or good.
  • It’s ironic that the consumer sees a recession because strong consumer spending growth is what is keeping the economy out of a recession. 
  • The spread between ISM Services & Manufacturing is currently 7.3pts, the highest since Oct ‘15.
  • it’s not a good sign for manufacturing to crater much more than services. 
  • On average since 1998 whenever the services PMI has been 6 or more points above the manufacturing PMI, the services PMI has fallen 2.13 points in the next 6 months. Such a drop wouldn’t be recessionary, but would be consistent with a slowdown.
  • It’s interesting that small cap earnings estimates are cratering as the group is rallying significantly (mainly driven by yield increases and bank stocks rallying). S&P 600 earnings estimates have been declining to negative yearly growth.

9/11/19 – Does Weakness In Job Openings Foreshadow Recession?

  • Same store sales growth has been strong in the past 3 readings. Keep in mind, we are still awaiting the government’s August retail sales report.
  • We’re most interested in how the control group does because it has been incredibly strong in the past couple of months. 
  • Let’s see if the University of Michigan survey’s decline in consumer confidence is correlated with a drop in spending.
  • It’s not necessarily a big problem for small businesses to become less positive on the economy. Actual sales, hiring, and profits as well expectations for those results matter more. We’re not looking for macro analysis from small businesses.
  • the yearly change in small businesses’ capex intentions is correlated with business equipment investment growth.
  • if the Fed didn’t cut in July and guide for further cuts, there would be tighter credit conditions. Tightening conditions, a global slowdown, and a trade war is a recipe for a sharp slowdown in activity.
  • the 3 month moving average of plans to increase pay is correlated with average hourly earnings growth lagged 15 months. That means any decreases in hiring plans will show up in hourly wage growth next year.
  • The JOLTS report was good because hiring increased from 5.716 million to 5.953 million which is the 2nd highest reading ever (highest was in April).
  • We’ve seen the gap between openings and hires increase in the past few years making openings less relevant.
  • There’s no benefit to the economy if companies have job openings, but never hire workers to fill these positions. 
  • This report lowered the spread between openings and hires to 1.264 million which is the lowest since May 2018. We’ve seen this gap fall in the past 2 recessions, but that occurred when hiring fell. There won’t be a recession if hiring is strong. 
  • Further supporting the narrative that this was a very good JOLTS report is that quits increased from 2.3% to 2.4% which is a cycle high. This means workers see opportunity elsewhere. Switching jobs leads to higher wage growth.

9/10/19 – This Usually Happens Right Before Recessions

  • Changes to weekly aggregate hours worked includes the changes to the length of the workweek and the growth in payrolls. It gives a more detailed picture of the changes to the labor market than headline job creation.
  • Manufacturing is the only sector where we have data on overtime. For all manufacturing employees, overtime hours worked per week fell from 3.3 to 3.2 hours which is the lowest since April 2017
  • yearly growth in private sector aggregate weekly hours worked for production and nonsupervisory workers – growth rate improved from 0.7% to 0.8%  –  there is usually a recession soon after growth gets this low. The notable exception was in 1967.
  • That’s not to say production and nonsupervisory workers are doing terribly. They had hourly wage growth of 3.5% in August which is tied for the cycle high.
  • (  US Markit sector PMI  ) the US industrials output index was barely above 50 as it had its lowest reading since April 2016.
  • Global service sector business sentiment was the worst since the calculation started in October 2009. 
  •  Similar to the US, the global service sector PMI played catch up with the weakness in manufacturing.
  • In Germany the pace of manufacturing job cuts hit the fastest rate since July 2012. 
  • Usually, there is a stimulus towards the end of recessions and right after them because governments are late to the game. 
  • 2018 and 2019 included oddly timed smaller stimuli. The expansion didn’t require a tax cut and spending bump. 2020 won’t have as large of a benefit (only from fiscal spending though).
  • Aggregate hours worked growth is mostly weak for manufacturing, production and nonsupervisory workers, and the entire private sector. Usually, such weakness occurs before a recession.

9/9/19 – What The August BLS Headline Miss Didn’t Tell You

  • The August BLS report was a positive, all things considered. Headline job creation missed estimates and private sector job creation missed by even more. However, the labor force participation rate and weekly wage growth improved. 
  • At this point in the cycle, we can’t expect amazing job creation growth because the labor market is nearly full. 
  • Since the labor market is nearly full, a wide swath of workers is seeing solid wage growth.
  • With headline inflation low, real wage growth continues to be positive.
  • Many bearish investors point out the low single digit real wage growth, but it’s solid relative to the past few decades of data
  • the 12 month average of monthly job creation fell to 173,000 and the 3 month average rose to 156,000. Both totals are above the number needed to keep up with population growth. That’s why we say the labor market is nearing full employment rather than at full employment.
  • if the labor market reaches full employment and there is no increase in inflation, that’s one less reason for there to be a recession.
  • It’s not a surprise manufacturing job creation was weak because manufacturing production is contracting
  • The good news for manufacturing is aggregate hours worked increased 0.5% monthly which was the largest increase since June 2018.
  • The overall labor force participation rate increased from 63% to 63.2% which is a big deal because the rate rarely increases due to demographics
  •  Just to give you an idea of the size of this increase, in the past 10 years, the rate has only increased 0.3% from the previous month twice.
  • the prime age labor force participation rate increased 0.6% to 82.6% which matched the highest rate of this cycle  – this is the largest monthly increase since April 1960.
  • A bigger group of workers is getting a raise than earlier in the cycle when the unemployment rate was higher. 
  • The good news is in the past 10 Augusts, the payroll revisions have been positive 9 times. 
  • Now let’s look at the bad news. As you can see from the chart below, the payroll diffusion index hit the lowest level since May 2016. This means job growth is being spread across fewer industries.

9/6/19 – Are These Indicators Forecasting An End To Economic Weakness?

  • The BLS report is followed the most, but some question its validity because of its sometimes massive revisions which can occur in the following months or years.
  • Jobless claims were steadily low again as they increased 1,000 to 217,000 in the week of August 31st. That’s the 100th straight week of claims being below 250,000 which is a new record long streak.
  • Claims historically have one of the highest correlations with stock market performance out of any economic metric, so follow them closely.  
  • The ADP private sector job creation report showed 195,000 jobs added in August which beat the high end of the estimate range . The key takeaway from this report is that small business job creation was solid
  • As usual, education and healthcare drove job creation as it added 58,000 jobs. This isn’t a cyclical group, which is important.
  • The labor market isn’t being driven by cyclical industries which might make it somewhat resistant to a downturn in growth
  • The one negative report was the increase in job cuts in the Challenger Job Cut report
  • The spikes in job cut growth recently haven’t been as bad as the spikes earlier in the year. Therefore, the 6 month moving average of yearly growth fell again. Since it forecasted the slowdown, maybe this is forecasting an end to the economic weakness.
  • improvement in ISM non-manufacturing PMI more than counteracts the weakness in manufacturing because the service sector is much larger. 
  • Regarding ISM non-manu PMI – an 80% services weighting and a 20% manufacturing weighting is correlated with yearly GDP growth. These latest reports imply yearly GDP growth of 2%-2.5%.
  • Regarding ISM non-manufacturing PMI – The past two times the difference between services new orders and manufacturing new orders was this large, the economy was either about to enter a recession or in a recession.
  • Manufacturing weakness led services weakness in the past two recessions. It’s more cyclical so it leads recessions. However, it also gives off false recession signals
  • In the US, the ISM PMI gets much more coverage than the Markit report. However, don’t ignore it. 
  • the Markit services PMI had a sharp decline unlike the sharp increase in the ISM report.
  • Regarding Markit PMI – Business expectations fell to the lowest in history. 
  • We’ve seen some bearish investors claim a great non-manufacturing ISM report doesn’t matter because the manufacturing ISM PMI was weak. A far better argument is to review the Markit PMI which almost indicates a recession. 

9/5/19 – Fed Projects A Decline In GDP Growth With Its Rhetoric

  • It wouldn’t be a big surprise if consumer spending growth is solid in September as well despite the new tariffs. That’s because retailers are taking margin declines rather than raising prices.
  • It’s easy to pick out somewhat optimistic phrases in the Fed’s Beige Book, but the totality of the August report was pessimistic which implies dovishness. That’s what you’d expect from a report that precedes a rate cut.
  • the Beige Book diffusion index shows the Fed pivoted in late 2018 as the stock market was cratering.
  • Interestingly, the BLS projects the labor force will grow 0.54% per year over the next 10 years which is 68,000 jobs added per month in the payroll reading. Obviously, that will vacillate cyclically. Current average job creation is still above that even with the unemployment rate low.
  • Oddly, the use of “tariffs” has predicted how many times the Fed will use the root word “slow.”
  • When the number of times “slow” is used is lagged by 2 months, its correlation with the use of “tariffs” is high. If the correlation stays the same, then the Fed won’t mention “slow” as much in the October Beige Book.
  • Bespoke’s Beige Book index compared to yearly GDP growth with the GDP report lagged 9 months. This correlation is high which means the latest Beige Book diffusion indexes portend a further slowdown in yearly GDP growth
  • It’s interesting to see this great track record because the Fed has been given a bad reputation for missing the last 2 recessions especially the 2008 financial crisis. 
  • Even if you see a crisis as a Fed member, should you yell fire in a crowded theater? It’s a difficult position to be in.
  • The Fed’s bearish Beige Book reports look correct because Q3 GDP growth is expected to be weak based on the current data. 
  • The consumer needs to be strong in Q3 if GDP growth is going to be above 2%
  • We prefer to look at real growth and productivity growth to determine the health of the overall economy, not inflation. If there is real expansion without inflation, that’s not a problem.
  • Consumers aren’t reacting to tariffs just yet because retailers aren’t passing down the price increases fully.

9/4/19 – Is The Narrative On Worker Pay Accurate?

  • Based on the regional Fed reports, the PMI could have been higher, but not enough to reverse the downtrend. In short, investors were braced for this weakness; they didn’t ignore it.
  • while the manufacturing economy is contracting, it still is above 42.9 which is the breakeven line for overall growth.
  • The drop below 50 in ISM manufacturing over August has accompanied a drop in the new orders-to-inventories ratio to below 1 (in 3mma terms)
  • The 2016 slowdown was deeper and narrower because it was driven by the weakness related to the massive crash in oil prices. Oil prices have been stable this year. 
  • Just under 60% of U.S. manufacturing industries are showing year over year declines in production. In the last slowdown, that percentage reached the low 60s. It should surpass that peak in the next few months.
  • The Markit manufacturing PMI was pretty much in line with the ISM PMI.
  • The Markit manufacturing PMI report is still consistent with annualized manufacturing output growth of -3%. New export orders fell at the fastest rate in 10 years. 
  • The output expectations index hit its lowest reading ever.
  • 63.16% of national income in the past 5 years has gone to wages which is a historically high percentage. This increase might be related to the hikes in state minimum wages. To be clear, the national income is the total value of a country’s output in the year. It includes all new goods and services.
  • This is about to be the second manufacturing recession of this expansion.   The difference is this one is broader and shallower. 
  • There have been huge gains in financial assets in this cycle. That’s a problem for those who don’t own any. About 50% of Americans don’t own stocks.

9/3/19 – Where Is The Economy Headed In The Next 6 Months?

  • The concept of being due for a recession only works if there is excessive leverage. 
  • Many investors have a bias towards expecting a recession soon because this cycle has been long.
  • Investing experience can be a good thing, but it can also be a hindrance.
  • The timing of your investment career can cause biases.
  • Even though this cycle is 2 months longer than the longest one since the 1800s (and still going), cumulative real growth is the 4th highest since 1945. It has the lowest annualized real GDP growth rate.
  • Uncertainty is difficult to quantify, but is very important. Every new investment a business makes is a risk. 
  • Monthly global economic policy uncertainty index shows that uncertainty has been high this year.
  • The ECRI leading index did a great job of predicting the current slowdown in nominal GDP growth. 
  • in late 2018 and early 2019, the ECRI leading index’s yearly growth was very low. It predicts economic growth 2-3 quarters ahead of time.
  • The ECRI coincident index has slowly seen a decline in yearly growth as it has gone from 2.4% in April to 1.9% in July. We’re interested to see if it falls below 1% which was about the trough in the 2015-2016 slowdown.
  • The Conference Board leading economic indicators index was relatively solid in July, but the moving average still shows weak growth.
  • There hasn’t been a recession with the conference board leading index at its record high since at least 1959. The last 3 cycles had peaks an average of 15.7 months before recessions. The 12 month moving average of the 12 month rate of change fell to 3.6% growth. The prior 2 slowdowns had growth fall below 2%.
  • The 6 month moving average of the 6 month rate of change of the conference board leading index has just 0.4% growth. It’s not the cycle low, but it’s very close. The false recession indicators showed mild declines. When the indicator has been correct, it has led recessions by an average of 6.7 months in the past 7 cycles. The recession warning could be triggered in the next few months.
  • We mentioned the negative revision to GDP growth from 2018 to 2019 which has transformed our thinking of the benefits of the tax cuts
  • U.S. corporate profits haven’t surpassed their Q3 2014 peak. The revision has dramatically changed the data.  
  • The profit margin of 9.9% in Q2 2019 is just above the long run average.
  •  there was 2.7% yearly growth in Q2 2019. Of the $106 billion in profit growth, $58 billion was from international business. That could be a problem because the global economy looks weak. 
  •  just 30% of global PMIs are above 50. That implies MSCI AC world earnings will fall.

9/2/19 – How Core PCE Could Impact Rate Cuts

  • Income growth is everything because it drives consumption growth in a healthy manner. If consumption growth is quicker than income growth, debt increases.
  • even though yearly consumption growth was below income growth, the savings rate fell from 8% to 7.7% which is the lowest reading since November 2018.
  • core inflation has been contained for over 20 years.
  • Even though everything seems great, there might be a modest issue in the next few months with core inflation.
  • In this report, core inflation dealt with the toughest comparisons of this mini-cycle.
  • In July 2018, core PCE was 2.11% which was the highest rate since January 2012.
  • Comps will get easier in the next few months, potentially pushing core PCE closer to 2%.
  • Because trade war situation can change quickly, the Fed may once again be cautious with rate cuts. 
  • the final reading of the August University of Michigan survey was worse than the preliminary reading experiencing the worst monthly decline since December 2012 when consumers feared the fiscal cliff. 
  • The divergence between the current and expectations indexes increased. This divergence is the largest when expansions are old.
  • This survey is not just different from the Conference Board index, it also widely differs from the Bloomberg Consumer Comfort index.
  • The only thing that matters is if this leads to weakness in consumption growth in September. 
  • Earlier in Trump’s presidency, 35% of consumers made positive comments on the news they heard about government economic policy. That percentage has cratered closer to the long term average (low single digits) as it is 7%. 
  • The Chicago Fed business barometer index increased sharply in August – this report measures the whole economy, so it’s a good sign for the non-manufacturing and manufacturing PMIs.

8/30/19 – A Surprise In Q2 GDP Data Revision

  • With the recent terrible revisions to older economic data, Q2 GDP’s first revision is a welcome surprise 
  • Non-residential fixed investment fell 6.1%. That is in line with the weakness in manufacturing, global growth, the Markit PMIs, and the other negative business sentiment surveys. 
  • Residential fixed investment fell for the 6th straight quarter as it was down 2.9%. With the latest decline in interest rates helping the housing market, this streak should end soon.
  • yearly GDP growth was 2.3%. Its recent peak was 3.2% in Q2 2018. 
  • It’s a big mistake to look at the July pending home sales report and claim the housing market is in trouble. Look at the trend, not one month of data.
  • Pending home sales lead existing home sales by 1-2 months, so expect a weak reading in August or September unless this pending home sales report is revised higher.
  • Based on the new export orders segment of the ISM report, corporate profit growth from the rest of the world is set to fall (highly correlated).
  • The strong dollar and global weakness support this estimate. This could be bad for tech earnings which rely the most on the rest of the world. the regional Fed manufacturing reports imply the manufacturing ISM PMI will improve in August, so this is subject to change. 

8/29/19 – Will The Trade War Escalate In 2020?

  • In this cycle, states have made it more difficult to qualify for unemployment benefits and have lowered benefits. You can say that in itself is a signal of a strong economy because there would be national outrage if the unemployment rate was high. 
  • Remember, early in this expansion the length of unemployment benefits was extended to 99 weeks because people had such a tough time getting a job. The social safety net needed to be strong.
  • This change means jobless claims are probably signaling the labor market is stronger than it is. 
  • The ratio of jobless claims to the population is at a record low
  • Jobless claims data is one of the best recession forecasting indicators. 
  • It’s worth double checking it’s accuracy though because new laws mean historic comparisons aren’t ‘apples to apples.’ 
  • Google searches for “unemployment benefits” are very low. This supports the strong indication the current low claims give.
  • Atlanta Fed’s survey of business uncertainty is elevated, but not as much as you’d expect.
  • Capex was surprisingly strong; you’d think the trade war was preventing investment.   It increased from 106.3 to 112 which was the best reading since July 2018. 
  • The US can’t stop firms from doing business in China, but China can if the trade war gets that far.
  • The Case Shiller national price index’s yearly growth rate fell from 3.4% to just 3.1%. That’s the weakest growth since September 2012. (latest data from June). The yearly growth comps will get easier in the next few months. 
  •  That along with the decline in rates should prevent growth from falling much further in the next few months. By September the yearly growth comp will fall to 5.5%.
  • Home affordability is up because interest rates have fallen significantly. That’s even though weekly wage growth is still below home price growth since wage growth has fallen in recent months. 
  • Big cities did worse than the national index as the 20 city index’s yearly growth rate fell 
  • The trade war could move from economics to geopolitics in 2020 if it escalates further. 

8/28/19 – Record Dislocations In Sentiment & Economy

  • At 1.93% the 30 year US treasury yield is below the S&P 500’s dividend yield for the first time since March 2009
  • If the Fed cut rates to zero and then there is a trade deal this fall, the Fed would likely need to raise rates again. There’s a case to be made to not overreact to the planed tariffs and the huge rally in the long bond. 
  • This example of the 30 year yield being below the S&P 500’s dividend yield isn’t like in 2008 and 2009 because stocks haven’t cratered.
  • The XLU ETF was up 19.8% year to date as of August 27th. The S&P 500 was up 14.45%.
  • When global financial conditions tighten, the utilities sector outperforms the S&P 500. When the ISM manufacturing index falls, utilities outperform the S&P 500. Finally, when the 10 year bond yield falls, utilities outperform the S&P 500
  • Another Oddity: Wage Growth Is Higher Than The 10 Year Yield
  • Since 1972 there has only been one other month when production and non-supervisory wages rose quicker than the 10 year yield. 
  • December 2008 wage growth doesn’t mean nearly as much as the current wage growth because the unemployment rate was much higher then. Now the labor market is strong as real wage growth is positive and the unemployment rate is low. 
  • Businesses Are Pessimistic & Consumers Are Optimistic
  • The consumer is preventing the global economy from falling into a recession.
  • Global business sentiment has cratered, while global consumer sentiment is at a record high.
  • The August Conference Board consumer confidence index was very strong, unlike the preliminary University of Michigan report.  that divergence is actually an indicator.
  • The later in the expansion, the more the Conference Board index rises above the University of Michigan survey. The divergence just hit a record high.
  • Regarding Conference Board index – The divergence between the Present and Expectations index increased like usually happens the longer the cycle goes
  • Consumers were confident about the current labor market, but not as optimistic about the future labor market.

8/27/19 – There Isn’t A Recession In The Data

  • July monthly headline durable goods orders growth was very strong.
  • Because aircraft orders are so volatile, they are excluded from calculations of cyclical changes to the economy. For that we look at core capital goods orders and ex-transportation orders. 
  • The true test of the durable goods report came up way short as monthly ex-transportation orders growth missed estimates for no growth, coming it at -0.4%
  • Shipments of core capital goods goes directly into the calculation of non-residential fixed investment growth in the GDP report
  •  Another bad sign is inventories were up 0.4% while total shipments fell 1.1%.  Eventually, that means orders will decline if that situation keeps up
  • That’s different from the Q2 GDP report in which inventory investment hurt GDP growth, while consumption growth was strong.
  • Another Negative Chicago Fed National Activity Index
  • There doesn’t seem to be a very good understanding of the difference between weak and recessionary data in the financial media and on FinTwit
  •  The Chicago Fed national activity index is a great example of this because it was negative for the 7th time in 8 months, but there is still not even close to a recession signal being given.
  • The 3 month moving average needs to fall below -0.7 for there to be a recession.
  • In July the 3 month average rose from -0.3 to -0.14 because the terrible April reading of -0.83, which was the worst reading since early 2014, was lapped out of the average.
  • Growth is below average across the board in the main categories, but the economy is far from a recession.
  • Very Strong Dallas Fed Manufacturing Index
  • Heading into the August Dallas Fed manufacturing report, 2 of the 3 regional Fed indexes had fallen from July.
  • Because the Dallas Fed index improved by much more than those reports fell, it pulled the entire average higher.
  • By just looking at the average of 4 of the 5 reports, the manufacturing ISM PMI should improve slightly.
  •  the regional Fed indexes has the PMI coming in at 54.1 which would be a solid improvement from July’s reading of 51.2.
  • However, it’s interesting to see that this report, which had its production index increase from 9.3 to 17.9 and its general activity index increase from -6.3 to 2.7, had every category in the expectations index decline except for delivery time.
  • The 15% tax on $300 billion in imports (a lot of consumer goods) goes into effect in 2 parts on September 1st and December 15th. The tax rate on $250 billion goods increases from 25% to 30% on October 1st. By December 15th, 98.6% of imports from China will be taxed at a 24.3% rate
  • Just like how Trump is trying to make deals with the rest of the world (a trade deal with Japan was just announced) to alienate China, China has lowered tariffs on the rest of the world and raised them on America.
  • Since the start of 2018, the tax rate on the rest of the word’s goods in China fell from 8% to 6.7%. The rate on US goods increased from 8% to 20.7%. It’s set to increase to 25.9% on December 15th.

8/26/19 – Best Sector Heading Into 2020?

  • Nordea’s Fed sentiment score shows the Fed only became a little more hawkish recently.
  • The most likely scenario is one cut in September and then one cut in either October or December.
  • University of Michigan consumer sentiment report showed consumers were more cautious because of the July rate cut
  • If that makes them worried, two more cuts this year will make them even more concerned.
  • The latest German flash August Markit PMI actually showed improvement (driven higher by manufacturing).
  • Since the American composite flash PMI fell from 52.6 to 50.9, Germany is now looking stronger than America
  • Hong Kong is by far the most unaffordable city with at least 1 million people in the world.
  • China is putting another 5% tax on American soybean and oil imports beginning in September. China will resume its 25% additional tariff on American cars on December 15th. 
  • With general duties included, the total tax on U.S. cars can reach 50%.
  • Starting on October 1st, the $250 billion in goods taxed will be taxed at a 30% rate instead of a 25% rate. That will hit manufacturing firms. The $300 billion in goods that were going to be taxed starting on September 1st at a 10% rate will now be taxed at a 15% rate. 
  • the June new home sales report was revised up substantially, putting it at a new cycle high. 
  • Some were worried if a recession was coming because the previous peak was back in November 2017. 
  •  it’s better to see a strong revision than a strong initial reading since it’s subject to one less revision.
  • Supply of new homes was up 1.2% to 337,000. The supply is now 6.4 months.
  • With such improvement in June new home sales, the real residential investment growth component in Q2 could turn positive. 
  • Housing might have momentum heading into 2020 partially because of low rates.  

8/23/19 – New Business Growth Weakest Since 2009

  • the most recession stories were run in the press since 2011.
  • Regardless of whether there will be a recession, this number of stories might hurt consumer sentiment. 
  • Manufacturing output has fallen as a percentage of nominal GDP in the past few decades. Also, the manufacturing and non-manufacturing sectors have become less correlated.
  • US Markit Services PMI Falls – particularly services
  • New business growth was the weakest ever (dating back to October 2009)
  • Job creation was the weakest since February 2010
  • 1 year business confidence fell for the 7th straight month and hit a record low (since July 2012).
  • Prices paid fell for the first time since at least October 2009 and prices received fell for the first time in 3.5 years.
  • Service sector business expectations were the worst in at least almost 10 years.
  • New work fell the most since March 2016. Manufacturing was also weak. New business and export sales fell the most in 10 years as firms blamed the weak global economy and the auto industry.
  • In Europe, versus services, manufacturing was the worst since the financial crisis. 
  •  The European PMI actually improved. 

8/22/19 – Largest Negative Employment Revision Since 2009

  • the steadiness of GDP growth, inflation, and unemployment has been amazing in since the 90s.
  • the Fed funds rate is expected to be 60 basis points lower by the December meeting.
  • Since the curve already gave off the recession warning earlier this week, any flattening should be thought of as good news because it means the curve is far from the steepening that typically occurs during recessions.
  • Existing home sales don’t affect GDP growth.  However, this report is the most important measurement of the housing market (much larger than new home sales)
  •  It’s one of the few recent positive hard data housing reports
  • There are often sharp employment revisions which is why the first reading can’t be fully relied upon. The latest revision was horrible. 
  • Job creation was revised lower by 501,000 making this the worst revision since 2009 .
  • This March 2019 jobs preliminary benchmark will get its final revisions published in January 2020. It takes that long to see how the labor market really did.

8/21/19 – How Many Indicators See A Recession?

  • global real GDP growth doesn’t need to fall to the negatives for the economy to be in a recession. real growth below 2.5% is recessionary according to this study.
  • This study expects Q4 growth to fall to a new cycle low but then rebound in early 2020 allowing the economy to avoid a recession. 
  •  The service sector is keeping the global economy out of a recession.
  • According to this study the term structure of the yield curve is pricing in over a 70% chance of a recession.
  • On the other hand, this model based on the yield curve, cyclical stocks versus defensives, the copper to gold ratio, crude oil prices, high yield prices, the libor spread, and bank stocks shows there is only about a 15% chance of a recession.
  • Based on another model – which includes the yield curve, inflation trends, job creation, credit performance, the ISM manufacturing PMI, earnings quality, and the housing market, only the yield curve is recessionary. – Prior to 5 of the past 6 recessions, there were zero indicators showing expansionary readings. Now there are 4
  • on average in the past 7 inversions, the short end of the curve has increased above the long end. Now it’s the opposite as the long end fell below the short end.
  • even though the economy isn’t in a recession, the market expects more rate cuts in the next 2 years than it did before and during the financial crisis.
  • Fed funds futures market sees another 4 rate cuts in the next 2 years.

8/20/19 – How Much Of US Housing Is Overvalued?

  • It’s ironic to see negative rates being given out on a 10 year mortgage since such low rates encourage borrowing for longer.
  • in July mortgage applications for new homes increased 31.2% yearly because of the decline in rates. Applications were up 11% sequentially. 
  • The August housing market index increased 1 point to 66 which matched estimates. That’s tied with May for the highest reading of 2019
  • prospective buyers traffic index which increased from 48 to 50 which means traffic isn’t declining for the first time since October 2018. This index is a great measurement of first time buyers.
  • The July housing starts report was mixed because permits and completions were strong, while starts were weak.
  • Strong permits imply improved starts 6 months from now. 
  • CoreLogic Market Conditions indicators, which categorize current prices versus the prices sustainable by local market fundamentals such as disposable income, show 32.4% of metro areas were overvalued as of May 2019.

8/19/19 – The 2019 Manufacturing Recession

  • Based on the Thursday’s hard data reports, it looks like the manufacturing sector is heading into a recession, while the consumer is doing well.
  • In an economy driven by consumer spending, that’s a recipe for a modest economic slowdown, unlike 2008, perhaps closer to 2015. 
  • Manufacturing has shrunk as a percentage of the labor market because of automation.
  • Real Value Added To Select Industries to GDP (% of Private Sector) – Manufacturing has declined since 2010. Healthcare/Info/Tech has increased.
  • [N]o single industry adds more real net value to the economy than manufacturing.
  • Manufacturing still matters to the economy; it just doesn’t matter as much to the labor market. 
  • It’s also notable that the cyclical nature of manufacturing means it leads services. 
  • China only had 4.8% industrial production growth in July. It’s terrible in relative terms as it was the weakest growth rate since February 2002. 
  • Regarding Industrial Production In US – July 2018’s growth was 3.9% which was near the recent mini-cycle’s peak. The next 2 months will have harder comparisons as their growth rates were 5.3% and 5.4%. 
  • September 2018’s growth rate was the highest since December 2010. Therefore, it wouldn’t be shocking to see negative yearly growth in the next 2 months.
  • Manufacturing followed a very solid monthly reading of 0.6% growth in June with a poor reading of -0.4% in July which missed estimates by 3 tenths. It’s yearly growth of -0.5% in July was just above April’s reading. This negative yearly growth is why we’ve referred to this being the start of a manufacturing recession. 
  • mining was hurt by the oil crash in the last manufacturing recession. Current yearly growth is 5.5%. It bottomed at -12.4% in April 2016. That was actually worse growth than the 2007-09 recession. 
  • overall industrial production capacity to utilization rate fell from 77.8% to 77.5% which was below the consensus of 77.8%. This stat isn’t that useful at this point in the cycle because capacity is nowhere near full utilization.
  •  the net percentage of fund managers who see a global recession coming in the next year is the highest in 8 years.
  • To be clear, there doesn’t need to be negative global GDP growth for there to be a recession. Negative global growth is rare. Since 1961, it only went negative on a full year basis once. 

8/16/19 – Can Consumers Save Economy From Recession?

  • Besides looking at monthly inflation data, the Fed looks to see if inflation expectations are well anchored. This is the likelihood inflation expectations will stay where they are.
  • The new concern is whether inflation can stay low as the Fed cuts rates.
  • Those criticizing the Fed’s rate cut because they think the economy isn’t doing poorly are worried about the Fed running out of room to cut rates in the next recession and about inflation rising (potentially into an economic slowdown).
  • The two determining factors as to whether the Fed will have enough room to cut rates are how bad the next recession gets and whether the Fed can cut rates below 0%.
  • The criticism that inflation might spike higher also might not have value even though core CPI recently rose to 2.2% in July.
  • the cost of protection against inflation averaging above 2% over the next 5 years has hit a record low.
  • If the Fed won’t run out of room to cut rates in the next recession and inflation won’t run out of control after it cuts rates (remember the market is pricing in more rate cuts, so that inflation estimate assumes rate cuts), there isn’t much downside to the Fed cutting rates a couple times in 2019. 
  • The yield curve is predicting a 39% chance of a recession in the next year.
  • as of August 15th the TLT’s 14 day relative strength index hit 84.99 which is the highest level since 2003.
  • Very Solid Retail Sales Growth – yearly retail sales growth was 3.4% which was up from 3.3%. That doesn’t seem great, but the comp was very tough.
  • July 2018 yearly sales growth of 6.5% was the highest growth rate since February 2012
  • The control group is where this report really shined. quarterly annualized control group sales growth was 9.7%.
  • Online retail sales growth was phenomenal. It drove this report. Based on the size of this category, it’s reasonable to say this was the best reading since online sales began.
  • Low interest rates might allow real residential investment growth to end its 7 quarter streak of being a drag on GDP growth. 
  • In July, mortgage applications for new home purchases were up 31.2% yearly.
  • An improved housing market along with solid consumer spending growth is a recipe for the economy to avoid a recession regardless of what the yield curve shows.

8/15/19 – Yield Curve & Household Leverage Predict Different Cyclical Outcomes

  • The yield curve has become a hot topic again in the financial press because the most widely followed 10-2 spread finally inverted.
  • the 10-2 curve has a good track record of predicting recessions, that stocks usually rally in the period after the inversion and before the recession, and that it takes about 21 months on average for there to be a recession after the inversion (assuming the indicator is correct).
  • if everyone is looking at an indicator, it will lose the ability to generate alpha. That’s how events get priced in before they occur.
  • the yield curve likely won’t predict a recession in this cycle. The difference between this cycle and every other cycle is US households haven’t catalyzed domestic or global growth. Therefore, the yield curve may not matter.
  • Compare the net increase in household liabilities (lagged 1 year) as a percentage of GDP with the 10 year 3 month spread (the yield curve). 
  • Housing debt increased from $9.65 trillion to $9.81 trillion. That’s still below the Q3 2008 record of $9.99 trillion. That’s a big decline in leverage in real terms and as a percentage of GDP.
  • The burst of the housing bubble catalyzed a deleveraging period which has allowed this expansion to last over 10 years.
  • student loan debt growth is slowing. This shouldn’t be a surprise as debt growth in the double digits like it was earlier in the cycle would have caused student loan debt to encompass the entire economy quickly.
  • housing delinquencies fell from 1% to 0.9% which is the lowest rate since Q2 2006.
  • Since June 2018 housing payments as a percentage of income have fallen from 18.2% to 16.5%.
  • When you adjust for mortgage rates, real housing payments have been steady in the past 50 years. 

8/14/19 – Healthcare Services Inflation YoY Highest On Record

  • the only previous time sentiment on global equities was this negative was in the 2008-2009 financial crisis. The difference between then and now is stocks haven’t fallen much yet.
  • There probably needs to be more economic weakness to justify a bigger decline in equities.
  • The recent service sector PMI wasn’t recessionary.
  • The z-score of fund manager positioning furthers the notion that investors are nervous about risk assets. Cash had the highest z score (about 1.5) and equities had the lowest z score (about -1.7). America had a modestly positive reading. 
  • Core CPI Increases In July
  • healthcare services inflation was driven by health insurance inflation which was 15.88% which is a record high.
  • Small Business Confidence Remains Elevated
  •  industrial production growth in China fell from 6.3% to 4.8% which was the slowest pace since February 2002. Economists expected 5.8% growth.

8/13/19 – How Low Could Interest Rates Go In The US?

  • The later maturity part of the curve is debatably the most important now because the inversion in the near term part of the curve can be explained by saying the Fed is simply behind the market when it comes to rate cuts.
  • The catalyst for a recession doesn’t need to be large if the economy isn’t growing robustly.
  • a net 43% of fund managers expect lower short term rates and 9% expect higher long term rates in the next year. That’s the most bond bullish survey since November 2008.
  • With core PCE inflation never sustaining above 2% this cycle, the Fed probably didn’t need to raise rates as high as it did if you work based on the assumption that it can cut rates below zero. 
  • A study found that Euro rates can get to -4.5%. The bounds in the US and the U.K. might be -1.3% and -2.5%
  • In this case, the Fed has more capacity to cut rates to combat the next recession than previously thought.
  •  a record net percentage of fund managers saying firms are overleveraged.
  • in Q1 2009, non-financial corporate debt as a percentage of the market value of corporate equities was 69%; it’s 34% in Q1 2019. 
  • The percentage spikes when equities fall; based on last cycle, it’s odd to see the current concern rising before the fall in equities. 
  • On the other hand, corporate debt to GDP is near a record high. However, corporations are more internationally focused, so domestic GDP isn’t the perfect divisor.
  • Corporate debt will only be an issue outside of a recession if rates rise.
  • Junk debt is always an issue during recessions because profits dwindle, and financial conditions tighten (spreads widen). It’s an open ended question if it will become more of an issue in this cycle.
  • 33% of fund mangers have taken out protection against a big decline in stocks in the next 3 months. 51% haven’t taken out protection. That’s the highest net percentage in the history of this survey which was started in 2008.
  • a net -5% of fund managers expect value stocks to outperform growth stocks in the coming year.
  • However, the value factor is overweight energy and financials which isn’t a great place to be with the expected global decline in oil demand growth due to the slowdown and the inversion and decline in yields which is hurting the banks.  

8/12/19 – Hiring Growth Diverges From Retail Sales Growth

  • July core PPI fell from 2.3% to 2.1% which missed estimates for 2.4%.
  • core PPI has recently been falling sharply, while core CPI has been stable.
  • core PPI excluding trade services fell from 2.1% to 1.7%. This report implies the Fed’s favorite inflation metric (core PCE) will show weakness, allowing it to cut rate in September. 
  •  It’s not a shock to see that hiring and retail spending growth are correlated. 
  • yearly retail sales growth (including food services) with the 3 month moving average of hiring growth have recently diverged.
  • Retail sales growth has been in the low single digits and hiring growth has recently gone negative.
  • There have been periods such as in 2012 and 2016 (the other slowdowns in this expansion) where hiring growth was negative while retail sales growth was positive.
  • However, if this weakness in hiring growth continues, retail sales growth will inevitably come down.
  • This is just like how income growth can fall below spending growth, but eventually either income growth needs to improve, or consumption growth will decline
  • Conventional wisdom in real estate says that there is limited housing supply, making it tougher for new buyers to find affordable housing. The support for this is that housing starts are low, which makes it tough to buy a starter home. 
  • even though there haven’t been as many houses built this cycle, there has been an increase in Monthly Supply Of Houses In The United States (FRED) relative to sales recently.
  • Yearly home price growth of 3.4% in May was the lowest since September 2012.
  • new homes aren’t sold to first time buyers because they are too expensive. 91% of the homes bought by first time buyers are existing homes.
  • The median age of first time buyers is 32.
  • in 1980 there were 2.8 people per household and now there are 2.5 people. this has occurred while new single family homes have gotten larger. 
  • Housing supply isn’t the biggest issue; it’s demand. 

8/9/19 – Is Extreme Bearishness A Contrarian Indicator?

  • Sentiment surveys show that investors got extremely nervous during this recent correction over the past few weeks.
  • It’s quite remarkable that the percentage of bears got almost as high as the December 2018 mini-bear market and the percentage of bulls fell nearly as low as then. 
  • At the worst, the S&P 500 fell 6.8% in August 2019; stocks fell about 20% late last year.
  •  the percentage of bears literally doubled from the previous week as it went from 24.1% to 48.2%. That’s much higher than the long term average of 30.5%.
  • Hedge fund managers became the most bearish since February 2016 based on their net short to net long ratio
  • It’s best to follow the market in real-time when timing extreme fear.
  • 82% of investors don’t see a recession occurring in the next year, while 87% see one occurring in less than 3 years.
  • The American Association of Individual Investors also asked traders what they thought of the Fed’s rate cut. 30% of traders said they didn’t like it.
  • US Financial Conditions Index tightened after the first fed rate cut (slightly negative at -0.113)
  • The 10 year treasury is 2 standard deviations rich according to Bank of America’s model based on the economy
  • Even though it has become tougher to sign up for unemployment claims which has suppressed them, initial claims continue to be inversely correlated with stocks.
  • When initial jobless claims claims are low, stocks are high and vice versa.
  • Jobless claims continue to signal that stocks will move higher.

8/8/19 – How Do Rate Cuts Affect The Stock Market?

  • stocks trade on future earnings which means earnings estimates are important.
  • We can’t look too far into the future though because estimates always start at about 10% growth.
  • It’s best now to look at the rate of change of Q3 and Q4 estimates.
  • This entire year the most interesting quarter has been Q4 because its easier comps allow it higher EPS growth. 
  • If estimates stay near where they are now, we could see double digit EPS growth which could be a bullish catalyst for equities.
  • The 30 year treasury bond yield recently hit 2.12% which is just over 3 basis points above the all-time record low reached in July 2016. 
  •  from 2013 to 2019 the US went from accounting for about 40% of the yield paid out in the global investment grade fixed income market to 88%.
  • 76.47% of central banks’ last rate change was a cut.
  • NY Fed Index Predicts More Unemployment Rates Will Rise
  • Currently 29.4% of states have a higher unemployment rate this year versus last year. This model predicts that percentage reaching 68% in the next 12 months.

8/7/19 – One Indicator Shows August 2019 Recession

  • The June JOLTS report told us the same thing that the July monthly BLS report did. The labor market is seeing slowing growth. 
  • Job openings peaked at 7.626 million in November 2018.
  • We only have proper data from the last cycle because this report started in 2000.
  • In the last cycle, job openings peaked in May 2007 which was 8 months before the recession.
  • This is only one data point and therefore should not be the sole basis to form a thesis around, but if the same thing were to happen, there would be a recession starting in August 2019
  • Openings didn’t fall much prior to the 2007-09 recession, so the fact that they are currently near their high isn’t a problem for the recession call based on historical context.
  • Hires have been far below openings for a while. That wasn’t a big issue when both were increasing on a yearly basis, but now they are falling.
  • The situation is the reverse of openings for construction and food services as their hiring increased 
  • On a yearly basis, restaurant hiring was up 13.6%, construction hiring was up 9.5%, and retail trade hiring was up 3.9%. 
  • the quits rate was steady at 2.3% which is 0.2% off the record high
  • As of August 2nd, the NY Fed’s recession probability index hit 31.48%
  • The Case Shiller 20 city non-seasonally adjusted home price growth rate fell from 2.5% to 2.4% in May. The national growth rate fell from 3.5% to 3.4%. That’s the lowest growth rate since September 2012.
  • The June pending home sales report signals good things about the future housing market with yearly growth rate up 1.6% which ended its streak of 17 months of declines.
  • Pending home sales leads existing home sales by 1-2 months.

8/6/19 – Is This Stock Market Correction Forecasting Disaster?

  • The S&P 500 had its 4th quickest 5% correction in this bull market since 2009. 
  • this is only the 2nd 5% correction of the year. Since 2009, the average is 3 per year. 
  • On average since 1928, there have been 17 daily declines of 2% or more per year; there have been 5 in 2019 as of August 5th.  
  • China was the 4th largest market for U.S. farm products in 2018.
  • The global services economy actually improved in July unlike manufacturing.
  • US Markit Services PMI Improves
  • The July non-manufacturing ISM PMI fell from 55.1 to 53.7 which is the weakest reading since August 2016

8/5/19 – YTD Average Monthly Job Creation Lowest Since 2010

  • The 10% tariff on $300 billion worth of goods starting on September 1st will be mostly on consumer and capital goods.
  • Based on the weakness in the global manufacturing PMI (49.3), the modest decline in the ISM manufacturing PMI wasn’t as bad as it could have been. 
  • 42.9 is the overall economy breakeven line.
  • The July labor report showed a continuation of the slowdown in job creation growth. This is probably related to the cyclical slowdown and the fullness of the labor market
  • average monthly job creation in 2019 is only 165,000, which is the weakest since 2010.
  • the manufacturing workweek fell from 40.7 hours to 40.4 hours. Overtime hours fell from 3.4 hours to 3.2 hours. The next stop after cuts to hours worked is firing workers.
  • The unemployment rate rose from 3.6% to 3.7%.
  • The underemployment rate fell 0.2% to 7% which is the lowest reading since December 2000.  The lowest reading on record going back to 1994 is 6.8%.
  • the prime age participation rate fell from 82.2% to 82% which is the lowest reading since September 2018. The peak of 82.6% in January 2019 might have been the cycle peak.
  • This was a poor month for weekly wage growth because hours worked fell from 34.4 hours to 34.3 hours
  • The cycle peak for average weekly wage growth on a nominal basis was 3.6% in October 2018. The next 3 months will have very tough comparisons, so growth might continue to fall. 
  • the flow of unemployed to employed implies a plateauing of wage growth. (Job finding rate 9 month lead compared to Atlanta Wage Growth Tracker)

8/2/19 – Is All Bad News, Bad News For Markets?

  • the Challenger Job Cut report showed fewer job cuts and the jobless claims report was strong again.
  • While generally the Fed’s most powerful tool is forward guidance, given the noncommittal stance towards future rate cuts by the Fed, the market is making a decision on behalf of the Fed with regards to the likelihood of the next policy action.
  • Stocks rallied on the bad economic news because they mean more rate cuts. Afterwards, stocks sold off on the tariff news which also means more rate cuts. To be fair to the market, the manufacturing weakness was expected, and the new tariff wasn’t.
  • Treasury yields fell rapidly on Thursday and Friday as the 10 year yield fell to 1.86% which is the lowest level since November 2016.
  • the 3 month annualized returns in the JP Morgan global government bond index are the highest since 2009 (returns are in the 99th percentile).
  • JP Morgan global manufacturing PMI lowest since October 2012
  • 19 of 30 countries contracted, which is the most since August 2012
  • new orders index actually increased from 49 to 49.3. 
  • Weak June Construction Spending – The real weakness was in residential construction as it fell 8.1% yearly. Real residential investment has been negative for 6 straight quarters.
  • Only multi-family construction did well, but it wasn’t enough to offset the weakness in the other categories.  
  • Markit Manufacturing PMI – weakness remained as employment fell for the first time since mid-2013. Output expectations were the lowest ever (since July 2012). Purchasing activity fell for the first time since April 2016.  This report is consistent with manufacturing production declining at an annualized rate of over 3%.

8/1/19 – Was The “Midcycle Adjustment” A Big Mistake?

  •  the Fed didn’t guide for any more rate cuts which is against expectations for 2 more cuts in 2019.
  • under Powell, the Dow has fallen 9 of 12 Fed meeting days (because of hawkish stance)
  • This was the first cut in 3,878 days which is the longest streak since 1954
  • Interestingly, this was the S&P 500’s third worst performance during a rate cut in a expansion since 1990
  • The 2 worse days were the March 2001 cut and the December 2007 cut which were both right before recessions.
  • It’s worth noting the Fed plans to end its QT program in August which is 2 months before it stated it would. 
  • the net percentage of consumers expecting lower interest rates hit its highest level since 2012.
  • 70% of the major central banks are easing.
  • It’s possible this combined monetary stimulus turns the global economy around next year, but not immediately.

7/31/19 – Will Consumers Continue To Drive GDP Growth?

  • The latest data revision shows Q1 corporate profits were revised down by $245 billion, but wages and salaries were revised higher by $228 billion.
  • This explains why we think the revision was related to the exercising of stock option plans. NIPA counts employee stock ownership plans as income at the point of exercise rather than when the options are granted. This income is offset against corporate profits. 
  • With prior data, real income growth was lower than real consumption growth. That’s obviously unsustainable in the intermediate term. 
  • during the 2015-2016 slowdown, real consumer spending growth was quicker than income growth. That didn’t last, allowing the consumer to replenish its savings.
  • It’s actually a good thing the savings rate temporarily fell rather than consumption growth because a decline in consumption growth could cause a recession.
  • The consumer has room to increase its spending growth just to catch up to income growth. This could drive GDP growth for the rest of the year
  • Consumer confidence index near 2018 highs, and highs of this expansion.
  • The consumer’s assessment of the job market is probably the most important figure in this report because consumers have direct knowledge of the labor market.
  • The percentage saying “jobs are plentiful” increased from 44% to 46.2% and the percentage saying jobs are “hard to get” fell from 15.8% to 12.8%.
  • the breakdown of the two components of core PCE inflation: acylical and procyclical – Acylical inflation is affected by industry specific factors more than the vacillations in the economy and procyclical inflation is sensitive to the economy.
  • Acylical inflation and procyclical inflation are below their 2004-2007 average. If the economy starts generating inflation, at least the acylical component will suppress it a bit.  

7/30/19 – GDP Revised To Show A Slowdown

  • Economists and investors spend a lot of time forecasting the advanced GDP report, but the truth is, the final reading sometimes is significantly different. 
  • That’s what makes studying the economy like playing darts blindfolded with a moving target. Even reported data doesn’t tell you the whole story.
  • The latest information is usually the most pertinent to making intermediate term forecasts, but sometimes revisions tell a new story. 
  • To be clear, data revisions tell you new information about the cycle, not about secular trends.
  • The savings rate tends to be affected sharply by revisions. It is a plug in the data which means it’s a result of other surveys rather than a direct survey.
  • The increase in the savings rate due to data revisions is mostly related to higher compensation and net income.
  • Perhaps, the upward revision to compensation may be related to employees exercising their stock options.
  • The savings rate is now at 8.1%.
  • This improved savings rate supports the narrative that has been in place all cycle. The consumer’s balance sheet is in great shape because they have deleveraged and have a relatively decent savings rate.
  • the point is the consumer won’t be the cause of economic issues
  • home builders have shifted away from building starter homes to building more expensive homes which offer higher margins.
  • Less than 50% of homeowners are 18-44. That percentage was above 60% in 2009. To be clear, the aging population means young people will have less of a share.  (continuation of a secular shift)
  • compare unrevised and revised yearly GDP growth. This chart looks a lot like the ECRI coincident indicator’s yearly growth which told us what the revisions would look like before they happened..
  • the nominal GDP growth rate has been tracking the 10 year treasury yield if you lag the 10 year treasury yield by 3 months. – If you’re trying to forecast nominal GDP growth, then follow the 10 year bond yield.
  • in Q2 the global economy had its 3rd straight quarter of negative trade growth.
  • The July flash manufacturing global PMI showed continued weakness.

7/29/19 – Good & Bad: Earnings & Q2 2019 GDP

  • The Earnings Scout’s data says we aren’t in an earnings recession, while according to FactSet’s data it’s still inconclusive. 
  • There is no formal definition of an earnings recession, but if you take it to mean 2 quarters of negative yearly growth, determining if one exists is meaningless
  • The last earnings recession in the first half of 2016 was followed by a huge ramp in earnings growth in 2017 and 2018.
  • An ‘earnings recession’ isn’t like an economic recession which portends more risk.
  • The communication services sector has had an amazing quarter so far. 
  • This quarter has been mired by weakness from international firms.
  • firms with more than half of their revenues coming from abroad had a 13.6% decline in EPS.
  • final domestic private demand ( GDP without Inventory/trade effects or government spending.
  • ^ real final sales growth – this slowdown is defined by the weakness in Q4 2018 and Q1 2019. 
  • Government spending growth was 5% which is the fastest growth in a decade.
  • non-defense Federal spending was +15.9% q/q SAAR, the fastest increase in over 20 years and the 2nd biggest increase in 30 years. Spending growth was higher than during the financial crisis when the unemployment rate went above 10%.
  • The government is either spending excessively relative to history or that report needs to be revised
  • If the consumer is strong, causing imports to grow quicker than exports, it’s not a negative even though it hurts GDP growth.
  • GDP growth was more negatively impacted by net exports and inventory investment than it was help by government spending. 
  • Q1 GDP growth was inflated and Q2 growth was suppressed.
  • The worst part of this report was that real residential investment growth was negative for the 6thstraight time.
  • We think it’s best to look at growth excluding net exports, inventory investment, and government spending growth. Through that lens, quarterly growth doubled from Q1.
  • If real final sales growth stays strong, the second half should see higher headline growth because inventory investment will need to pick up. 

7/26/19 – Core Capital Goods Orders Growth Highest Since February 2008

  • there are more bears than bulls among individual investors while the stock market is near its record high – 32% of individual investors are bears and just 31.7% are bulls.
  • The CNN fear and greed index shows similar results as it is at 59 which is only slightly in the greed category. However, that index is low because of the junk bond market.
  • The yield spread between junk bonds and investment grade bonds puts this segment in the extreme fear category. The spread is pretty close to where it peaked at in December 2018.
  • There isn’t widespread pessimism obviously, but having about half the percentage of bulls of January 2018 when stocks are now higher is noteworthy. It could mean there’s room to the upside even after this amazing 2019 rally.
  • The monthly gain in the June core capital goods orders was the highest since February 2008. 
  • There isn’t much evidence in this report to support the weakness seen in Markit’s July flash manufacturing PMI. 
  •  the share of 18-34 year olds living at home has stayed elevated (in the low 30% range) for the past few years.
  • Modestly Weak Kansas City Fed Index
  • Jobless claims continue to stay correlated with the stock market as they fell 10,000 to 206,000. the 4 week moving average has fallen every week in July. It’s now at just 213,000.

7/25/19 – Weakest Manufacturing PMI Of This Cycle

  • MBA purchase applications continues to be one of the few housing data points that shows positive yearly growth.
  • The June new home sales report was terrible because it missed estimates and the prior 3 months were all revised lower. 
  • The cycle high of new home sales is firmly entrenched at 715,000 in November 2017.
  • The 3 month average is 636,000 which is significantly below the 2019 peak of 673,000 in April.
  • Median new single family home prices were $310,400. That’s 0% yearly growth.
  • Obviously, new homes cost a bit more than existing homes. In June they cost $24,700 more.
  • On a non-seasonally adjusted basis, prices peaked at $343,400 in November 2017.
  • There isn’t much room for sales and starts to decline in a real recession because results have been so weak in this expansion.
  •  the current population adjusted new home sales is very close to previous cycle troughs.
  • This July Markit flash reading had some incredibly weak data points for a report where the composite hit a 3 month high
  • The negative headline is that the manufacturing PMI fell from 50.6 to 50 which is a 118 month low.
  • This is only the flash reading, but if the final reading is similar, the ISM manufacturing PMI will probably fall as well
  • the new orders index in the ISM manufacturing report affects the leading indicators index. 
  • the manufacturing output index fell from 51.2 to 48.9 which is a 119 month low.
  • the composite index hit a 3 month high. It went from 51.5 to 51.6 because the service sector PMI improved.
  • The service sector is much larger than manufacturing.
  • Manufacturing is more cyclical.
  • One reason this 10 year business cycle has had 2, going on 3, slowdowns is because of the volatility in the manufacturing sector. 
  • the IHS Markit PMI composite employment index fell to a 27 month low even though the service sector, which employs the most workers, saw an improvement in business activity.
  • This weakness in the employment reading was spurred by the lowest ever business optimism print. This index was created in July 2012.
  • The other record low was service sector business expectations for the next year. It fell to the lowest level since October 2009 when it was created. 

7/24/19 – Rate Cut Impact On Housing & Earnings Revisions

  • The housing market continues to stumble along with negative growth in the first half of the year even though there are low interest rates, the unemployment rate is low, and real wage growth is high.
  • In the 2nd half of 2019, growth will improve, but that shouldn’t be seen as a victory since results were poor late last year.
  • June Existing Home Sales Miss Estimates
  • Housing market – cash sales fell from 22% last year to 16%. Cash sales were 19% of existing home sales in May.
  • Both the FHFA housing market index and the Case Shiller index have been showing declines in price growth.
  • Dramatic Decline In Richmond Fed Index
  • the July Empire and Philly Fed indexes increased sharply which raised expectations. Now we have 2 positives and 1 negative. 
  • Richmond Fed index lower than 92% of all prior readings dating back to 1994.
  • This report disagreed with itself because the current index was poor and the expectations readings were fine. 
  • There is no overall expectations index. However, you can get an idea of what it would be by looking at shipments, new orders, and employment because they make up the current index.
  • the earnings revisions factor tends to do really well 13 weeks after the first Fed rate cut of the cycle.

7/23/19 – Stocks Begin To Price In 2020 Election

  • Chicago Fed index has been negative for 7 straight months.
  • Every prior negative streak of 7 or more months has coincided with recessions since the 1960s. 
  • The Chicago Fed national activity index has been very close to positive in the past 2 months, so saying it signals a recession is coming, misconstrues the data.
  • Only 51 of the 85 indicators in this index have been reported. This would be like claiming a football game is over when one team is up by 3 points heading into the 4th quarter. 
  • the ISM manufacturing PMI and payrolls growth help forecast elections.
  • Manufacturing might rebound next year as it seems to be already showing signs of improvement. 
  • Payrolls growth might be weak in 2020 because of how full the labor market is.

7/22/19 – This Hasn’t Happened Since 1990

  • Since 1990, the Fed has never cut rates while the financial conditions index was above 0. It is now near 2.
  • This rate cut won’t have much of a positive effect on financial conditions. The goal is to keep them where they are. 
  • If inventory investment and net exports didn’t drive Q1 growth so high, many would have claimed the economy was either in a recession or headed for one.
  • University of Michigan consumer confidence index has been correlated with real consumer spending growth
  • the percentage of homeowners who have paid off their mortgage has steadily increased from 2006 to 2017. As of 2017, it was 37% which is a 5.5% increase over the prior 10 years.

7/19/19 – How Big Will The Fed Rate Cut Be?

  • The Fed blackout period before the July 31st Fed meeting is from July 20th to August 1st
  • since 1960, 99% of rate cuts have occurred with a lower unemployment rate and 65% have occurred with higher inflation.  92% have occurred from higher Fed funds rates.
  • this cut in July will be the first cut of the decade. The previous low for a decade was 19 cuts in 1960.
  • The recent jobless claims, BLS labor report, retail sales, and Philly Fed reading, have all been strong, but the Conference Board Leading index suggests the Fed might be right to cut rates because economic growth is slowing. 
  • Recessions occur 2-15 months following Conference Board Leading index negative readings, although, recessions don’t always follow them.
  • The leading index was hurt by building permits, ISM new orders, and initial jobless claims
  • The 4 week moving average of initial jobless claims rose throughout June, but has fallen in July.
  • The first 2 manufacturing regional Fed reports improved in July. Plus, the stock market has risen.
  • It seems likely that the leading economic indicators index will rebound in July.
  • The Philly Fed index rallied to the upside as it improved even more than the Empire Fed index. 
  • This economic expansion is about to be 121 months which is the longest since the 1800s. It’s compound annual GDP growth rate of 2.3% is the slowest since at least the 1950s.
  • This expansion may have had a low average growth rate because there hasn’t been nearly as quick household debt growth.
  • That also means that even though this expansion has been long, the risk of a deep recession is low.
  • Government debt will be a problem, as most bearish investors commonly point out, but that can be either a few years or a few decades away. Forming an investment thesis around an event that cannot be timed easily does not lead to high probability outcomes.

7/18/19 – Just An Insurance Rate Cut Or Something More?

  • The Beige Book was consistent with what we have heard from the Fed in the past few weeks, namely economic growth is modest, but the Fed is still cutting rates this month because of crosscurrents which are the trade war and global economic slowdown. 
  • the IFR Beige Book Diffusion index fell from -39.5 to -44. Based on the decline in the Fed’s usage of strong and strength among other changes, the Fed is deemed to be very dovish. This supports the notion that the Fed will cut rates 50 basis points in July.
  • Usually, we already know what the Fed will do before its meeting. The only uncertainty is what the Fed will say in its statement.
  • anytime market rates the odds as above 33%, the anticipated Fed move is in play. When the odds are above 50%, it is priced in.
  • There have been 3 housing reports in the past few of days. The first was the July NAHB housing market index.
  • June housing starts and permits missed estimates. Starts have been weak this entire cycle. the peak in permits this cycle is below the past 5 cycle peaks. 
  • Foreign investment in US homes is falling, leaning on an already weak housing market.
  • when the Bank of America survey shows a high net percentage of fund managers thinking business cycle risk is above normal, it has been a buy signal for stocks. It has been a sell signal when the net percentage is low. 
  • Similarly, when fund managers don’t expect better profits, the S&P 500 has bottomed.
  • Cass Freight index was weak again in June.

7/17/19 – Does Best Retail Sales Growth Since 2005 Signal Cycle Peak?

  • Anyone fearful of the decline in nominal hourly earnings growth is ignoring the greater decline in inflation.
  • headline CPI fell 14 basis points in June and nominal weekly earnings growth only fell 1 basis point. That was a clue the retail sales report would be strong.
  • both average real weekly earnings growth and average real weekly earnings growth for production and non-supervisory workers increased.
  • Low skilled workers tend to see higher wage growth late in the cycle when the labor market is full
  • the recent real wage growth is the most important of the cycle because the most people looking for work are seeing the gains as the unemployment rate is very low.
  • Retail sales in the control group  Yearly growth was 4.6% which was the highest reading since October 2018, a cycle high in yearly control group sales growth.
  • Retail sales 3 month annualized sales growth was 7.5% in Q2 which is the highest reading since Q4 2005 when it was 8.4%
  • relatively weak non-recessionary June industrial production report.
  • the 3 month weighted average of the percentage of manufacturing sub-sectors that are in a recession fell modestly.
  • the net percentage of fund managers who think business cycle risk is above normal is the highest since the 2011-2012 slowdown. It is about 70%.
  • fund managers were bearish at troughs and bullish at peaks
  • Arouba-Diebold-Scotti Index Shows No Sign Of A Recession (US Business Conditions Index) – uses weekly initial jobless claims, monthly payroll employment, industrial production, personal income less transfer payments, manufacturing and trade sales, and quarterly real GDP to create an index that tracks real business conditions. 

7/16/19 – Fund Managers The Least Bullish On Value Stocks Since 2010

  • the net percentage of fund managers who see value stocks outperforming growth stocks has fallen to the negatives.
  • This response is likely related to sector performance. The value factor is overweight financials and energy while growth is overweight healthcare and tech
  • If fund managers see the Fed cutting rates because of slower growth, they might want to avoid financials
  • Highly anchored low inflation expectations is actually a reason to not bet against inflation staying low in the short-term.
  • There is a 7 year low in global inflation expectations. 
  • the percentage of the labor force that is 16-34 years old spiked around when inflation was very high in the 1970s and 1980s. Inflation has been low this cycle and so has the percentage of workers in this age range.
  • July Empire Fed general business conditions index showed modest improvement possibly because of optimism on trade. We need to see the rest of the regional Fed indexes before determining if this is a real bounce in manufacturing optimism.

7/15/19 – Is The Stock Market In A Bubble?

  • The entire point of reviewing the PPI report is to determine where core PCE will be when it’s released on July 30th
  • Each tenth of a percent wouldn’t matter if the Fed wasn’t using core PCE inflation to set interest rates.
  • it’s notable that the moment the Fed gave up on low inflation being transitory, it perked up a bit.
  • The Inflation Adjusted PE Multiple Is Average
  • The S&P 500 is up over 20% year to date, but stocks aren’t extremely expensive because they were very cheap at the start of the year.
  • the S&P 500’s trailing PE multiple was 17.5 as of the start of Q3 which is 0.9 above the 50 year median.
  • Median PE based on Inflation range shows 17.7 for 1-2% inflation.
  • Monetary policy allows for easy financial conditions and inflation to be low, but if earnings don’t grow, stock prices won’t go up in the long run. 
  • earnings have tracked both the performance of the S&P 500 and the Europe 600 index.
  • Q2 earnings season growth will be slow because of tough comps and the weak global economy, but there’s nothing to fear. 
  • 83.37% of S&P 500 stocks are above their 50 day moving average.
  • don’t be scared off by record highs. It’s common for contrarians to get negative when stocks are at a record. Being at a record is normal. 
  • S&P 500 being at a record high not a good enough reason to be bearish, stocks actually do really well following records
  • the S&P 500 follows records with gains in the next 6 months 82% of the time.

7/12/19 – The Fed’s Plan: Extend & Pretend

  • core PCE is almost always below core CPI. 
  • Headline CPI fell from 1.8% to 1.66% which was the lowest reading since February
  • Once again, in core inflation, price increases were much higher in services than commodities.
  • Shelter inflation is the biggest category, so it has a huge impact on the headline and core result. 
  • The Case Shiller national home price index was up 3.55% yearly which is the weakest reading since September 2012.
  • Powell Doesn’t Believe In Phillips Curve
  • many more Fed members see downside risks to the economy that upside risks.
  • If the Fed was looking at the labor market, it wouldn’t be cutting rates because initial jobless claims just hit a 3 month low.
  • the Fed has cut rates 17 times with the S&P 500 within 2% of its record high since 1980.
  • 1 year after these rate cuts, the S&P 500 is up an average of 15%, with the worst gain being 3.2%. That’s right; every single time stocks rallied in the next year. 
  • But the Fed is utilizing forward guidance more than ever, so rate cuts are already priced in.

7/11/19 – How Overheated Is The Stock Market?

  • Skepticism is great for bull markets, although, to be clear, the data needs to prove the skeptics wrong or else stocks will fall. 
  • One great measurement of the size and scope of rallies is the percentage of stocks in the S&P 500 above their 50 day moving average. 
  • 78.2% of stocks are above their 50 day moving average which is much higher than the low late last year and slightly below the high this February. – This indicator was a great bottom signal in December
  • The US economic surprise index and the S&P 500 seem to act independently, but Oxford Economics found a correlation
  • since the start of the expansion, the 12 month moving average of the U.S. surprise index and the yearly change in the S&P 500 have tracked each other up until recently.
  • Markit global PMI composite index was steady at 51.2 in June.
  • the rolling 3 month average of the Fed’s usage of the terms: challenges, fears, risks, shocks, and uncertainties is elevated.

7/10/19 – Be Cautious Of Recession Indicators

  • The worst thing an indicator can do is go from great to good
  • since reports can be volatile and revised, it’s incorrect to become bearish because of one data point.
  • The number of job openings is still above the number of people looking for work. The labor market is relatively full.
  • There were about 2 quits for every 1 layoff or discharge. That means about 2/3rds of the time a worker left, it was voluntarily. 
  • The quits rate at state and local education jobs hit 1% which is a record high. 
  • The healthcare and social assistance group has the tightest labor market as there were about 2.5 job openings for every unemployed worker.
  • NFIB Small Business Index is still strong at 103.3 but uncertainty rose to the highest level since March 2017
  • 6 of the 10 indexes in this small business report fell.
  • Small business credit availability is tied for the highest reading of this cycle and 2 points away from the highest reading ever (going back to 1986)
  • real residential investment growth has been negative for 5 straight quarters – Our question is how weak can housing starts get if this cycle barely even saw much of an increase? 
  • On the negative side, single family new home sales peaked in November 2017. If a new peak isn’t reached soon, this will quickly become a recession warning.
  • 75% of the time when residential fixed investment has turned negative there has been a recession.
  • Rarely has US Residential Fixed Investment turned negative without a recession; in fact, only false signals were ’64, ’87, and ’95. That’s a 75% track record since ‘55. After signal, returns on US equities are statistically different from average across measured periods.
  • The NY Fed’s recession indicator is the treasury spread – Anyone who claims this indicator guarantees a recession soon isn’t reading it correctly.

7/9/19 – The S&P 500 Can’t Rely On Multiple Expansion In 2020

  • Fund flow is a technical indicator where the average of the high, close, and low is multiplied by trading volumes. The theory is this metric measures the excess demand for securities.
  • A positive flow occurs when a stock is purchased at an uptick and a negative flow occurs when it is bought on a downtick.
  • there is a record disconnect between global flows and global equity returns.
  • European equities are seeing their longest stretch of outflows in a decade. 
  • In 2019, multiple expansion has driven most of the S&P 500’s returns. 
  • A lot of the multiple expansion this year is make up for last year.
  • stocks got cheap in late 2018
  • 12 month forward PE ratio of the S&P 500 fell below the 5 year and 10 year average late last year
  • unless stocks fall sharply between now and the end of the year, stocks will start 2020 more expensive than they started 2019.
  • Instead of following a year with severe multiple compression, 2020 will follow multiple expansion.
  • If earnings growth comes close to meeting estimates, stocks will look cheap at current prices. If earnings don’t grow, the multiple will be just as high as it is now.
  • Earnings growth estimates start at somewhere around 10% before economic data and guidance come out. 
  • Comps help if growth is near the long term trend, but if the weakness leaks into 2020, there will be big negative revisions to 2020 estimates. 
  • Q4 will be the start of 2020 in a sense because it faces easier comps like 2020.  It will be a leading indicator for next year.

7/8/19 – Market Usually Underprices Rate Cut Odds

  • the percentage of bulls was higher than the percentage of bears in the latest AAII sentiment survey.
  • That ended the 7 week streak of bears being more prevalent than bulls which was the longest streak since February 2016. 
  • the market usually underprices the odds of rate cuts. It would be a first if the market overpriced the chances of cuts.
  • 3 month rolling average of hourly earnings
  • CPI peaked at 2.95% in July 2018.
  • 2 months in a row, small businesses have created negative jobs. Let’s watch the next few reports to see if this becomes a trend.
  • bears state the ADP report better measures job growth at small businesses than the BLS report
  • the historical correlation between job leavers and the quits rate implies the 14.7% job leavers rate means the quits rate will hit a record high.
  • A high quits rate means the labor market is strong
  • If more people quit, there should be higher wage growth. 

7/5/19 – ‘Other’ Drives U.S. Stocks Higher In 2019

  • the market doesn’t perfectly price in data immediately
  • The biggest factor affecting markets may not be what most anticipate.
  • It’s a big claim to say the main reason stocks are higher isn’t macroeconomic data, Fed news, trade news, or international news.
  • Chinese June manufacturing PMI was 49.4 which missed estimates for 50.1 and fell from 50.2 in May.
  • flood of negative earnings pre-announcements is a headline crime
  • 13 more firms reporting negative guidance than average is the equivalent of a 2.6% increase in firms issuing negative guidance 
  •  7 of 11 sectors have had more firms issue negative earnings guidance than their 5 year average. 
  •  Tech usually has the most negative guidance and it is having a relatively poor quarter, so the overall number has increased. 
  • tech has a 20.12% weighting in the S&P 500, while industrials are at 9.2% and staples are at 7.42%. (All as of the end of last year.) These are all factors to consider.

7/4/19 – YTD Job Cuts Highest Since 2009

  • May Construction Spending Report
    • Very bad –  down 0.8% monthly and 2.3% yearly.
    • Residential construction spending fell 11.2% yearly.
    • Single family spending fell 7.6%
    • multi-family spending was up 9.3%.
    • Single family housing has become unaffordable which is why multi-family housing is being built at a higher growth rate.
    • spending on multi-family housing in billions of $ is significantly below that of single family housing, so it can’t push overall growth to the positive side.
    • The weakest part of this construction report was in home improvements. Spending on them fell 22% yearly. 
    •  It’s worth noting how Home Depot and Lowe’s stocks haven’t fallen with this index; they have rallied with the overall market.
  • June Job Cuts
    • Layoff announcements can be thought of as a leading indicator because the announcements occur before they happen.
    • Fell in June
    • Challenger Job Cut Report – is highly volatile and can be manipulated by a few big companies. 
    • That’s why it’s best to look at quarterly averages
    • quarterly cuts fell 26% in Q2
    • But, year to date cuts are still up 35% from last year as this is the highest first half total since 2009
    • the biggest spike in the past 4 years occurred early in the 2nd half of 2015.
  • ISM non-manufacturing PMI
    • Services sector in a slowdown
    • The business activity and new orders indexes have been in a positive trend for 119 months.
    • This expansion is about to be 121 months old at the end of July, making it the longest one since the 1800s. 
    • Unlike the manufacturing report, the non-manufacturing prices index was up 3.5 points which means the nominal index improved.
    • Are firms overstating impact of tariffs to raise prices?
  • Markit services PMI
    • improved from 50.9 to 51.5.
    • The May reading was a 39 month low. 
    • This index had a big improvement in the 2nd half of the month as the flash reading was 50.7.
    • That means the index was 52.3 in the 2nd half. 
    • Services output growth was the 2nd slowest since August 2016 (the slowest was May).
    • Services firms had the weakest business confidence since June 2016.
  • June ADP Report
    • showed improvement, but small business job growth remained weak. 
    •  improved to 102,000 jobs created
    • 6 month moving average of small business job creation is about 0

7/3/19 – Worst Weakness Since Last Recession

  • The rate of change of analyst estimates tells you where stocks are going.
  • Earnings Scout data shows there is likely to be positive earnings growth in Q2
  • firms usually beat estimates (since they set expectations)
  • earnings estimates generally fall – what matters is the rate of change of the descent. This is better than looking at if the company beat or missed estimates.
  • Cornerstone Macro Confidence indicator in relation to real consumer spending growth
  • IBD/TIPP Economic Optimism Index
  • Markit PMI
    • The flash Markit composite reading which measures the first 2 weeks of the month was terrible for both the manufacturing and services sectors just like in May.
    • This time the June reading showed a bit of a rebound which goes against the narrative that the economy is cratering.
    • Job creation was the lowest since August 2016
    • US PMI was one of the highest in the world as the global manufacturing PMI was only 49.4.
    • Manufacturing production growth improved, but it was the 2nd slowest growth rate since June 2016. The slowest was in May.
  • ISM manufacturing PMI
    • very similar to the Markit reading in that it was the lowest PMI since October 2016
    • new orders index fell 2.7 points to 50 which is the weakest reading since August 2016.
    • The difference between new orders and the inventories spread (PMI minus inventories) signals the worst weakness since the last recession is coming. This indicator leads the composite by 3-6 months.

7/2/19 – Low Inflation Enables Rate Cut

  • Low Inflation
    • Low inflation is not the entire reason Fed is likely to cut rates. Core PCE has been below 2% for most of this cycle.
    • Main reason for cut is cyclical slowdown and the impact of uncertainty the trade war has created.
    • But low inflation enables the Fed to cut rates, to stimulate growth, since their goal is 2% inflation.
    • But in that case Fed never should have raised rates in the first place unless the goal is to have room to cut rates in next slowdown/recession.
    • Many market participants are starting to believe that core PCE inflation above 2% on a sustained basis is an unreasonable assumption
    • The Fed needs healthcare inflation to go up to meet its 2% target.
  • May Inflation
    • headline PCE inflation was 1.5% which was down from 1.6%
    • core PCE inflation rate was 1.6% (the one Fed looks most closely at)
    • Tough comparisons until January 2020 (improves argument for Fed to cut rates with low relative inflation).
    • The best part of the PCE report was the solid headline income growth. 
    • real yearly disposable income growth was 2.3%.
    • PCE report caused the Atlanta Fed GDP Nowcast estimate for real personal consumption expenditures growth to fall from 3.9% to 3.7%.
  • Oxford Economics
    • sees core PCE inflation staying below 2% and core CPI falling towards 2%.
    • sees growth slowing this year and 3 rate cuts in the next 9 months.
  • UofM Sentiment Survey
    • current index, which is more closely related to discretionary spending growth, increased from 110 to 111.9.
    • consumer sentiment index increased from its initial reading of 97.9 to 98.2 which was still below May’s reading of 100 – weakness caused by expectations.
    • This solid report diverges from The Conference Board index’s weakness which was driven by low income earners.
    • Michigan report’s modest decline was driven by high income earners. 
    • In June, the estimate for inflation in the next year fell from 2.9% to 2.7% and in the next 5 years it fell from 2.6% to 2.3%
  • Chicago Fed PMI
    • Chicago Fed PMI was a disaster as it fell from 54.2 in May to just 49.7 in June
    • first contraction since January 2017
    • Chicago Fed report includes responses from the services sector, so it’s not directly comparable to manufacturing reports.
    • The production index hit a 3 year low and was down 15.5% on the quarter.
    • The employment index fell to 50.8 in Q2 which is the worst reading since Q4 2016. 
    • signals a contraction in manufacturing and non-manufacturing activity. 

6/28/19 – 18.5 Year High In Consumer Confidence

  • 18.5 Year High In Consumer Confidence
    • The fact that the Bloomberg Consumer Comfort index hit its highest level since December 2000, ruins the bearish narrative
    • consumer confidence follows the stock market
    • There also might have been a political bent to this reading as sentiment among Democrats was the highest since 2001
    • Confidence index for people earning less than $50,000 increased to the highest level since at least 2010
    • That’s the exact opposite of what the Conference Board survey showed. In that index, consumers making under $15,000 had the lowest confidence since 2016. 
    • Investor confidence wasn’t that high in the latest AAII individual investor survey even though stocks hit a record high last week
  • Case-Shiller Home Price Growth Falls
    • the national Case-Shiller home price index’s yearly growth was 3.5% in April.
    • That’s the lowest growth rate since September 2012.
    • The 20 city index had lowest growth rate since September 2012 as well.
  • MBA Report & Mortgage Rates
    • MBA home applications report showed a decline in weekly purchase applications, but strong yearly growth.
    • 30 year fixed mortgage rate fell 11 basis points this week to 3.73%. That’s the lowest rate since November 10th, 2016.
    • Purchase applications were down 1% after falling 4%. They were up 9% yearly.
    • The refinance index was up 3% after falling 4%
  • Pending Home Sales
    • yearly growth was -0.7%.
    • On the other hand, this was the highest reading since last July.
  • ISM Manufacturing PMI To Fall 
    • If the 5 regional Fed manufacturing reports are accurate, the ISM PMI will fall to about 50 in June from 52.1.
  • Jobless Claims shows labor market is strong
    • Jobless claims in the week of June 22nd may have risen 10,000 to 227,000 because of the end of the school year.
    • Jobless claims have been below 250,000 for a record 90 straight weeks.

6/27/19 – Why Economic Slowdown Continues

  • headline durable goods orders reading
    • disappointing
    • the U.S. economy has seen a continuation of economic reports not meeting estimates
    • durable goods orders, non-defense excluding air shows continued decline but not as bad as 2015-2016 slowdown.
    • Economists usually focus the most on core orders because aircraft orders can be volatile
    • durable goods orders is a leading indicator and doesn’t directly affect GDP growth. 
    • These are just orders, not actual production. However, they signal where production is headed.
  • U.S. economic surprise index is at -68.1 which is near the low for the year.
  • Q2 GDP growth is still expected to be about 2% which is far from a recession. 
  • Contrarian indicator?
    • the net percentage of fund managers taking out protection from a stock market decline in the next 3 months is higher than it was in 2008.
    • Sometimes when everyone sees a negative catalyst and prepares for it, the results aren’t as devastating as they were feared. 
    • In this survey, long treasuries was the most crowded trade for the first time ever.
  • Q2 S&P 500 EPS Estimates
    • 89% of the first 18 firms to report beat EPS estimates on 4.71% growth and 71% beat sales estimates on 2.67% growth.
    • We are seeing growth acceleration.

6/26/19 – Next Recession Starts March 2020?

  • June Conference Board consumer confidence report
    • from great to good.
    • fell to its lowest level since September 2017
    • monthly decline is the 5th worst since the financial crisis
    • The only worse declines were in October 2008, February 2009, February 2010, and August 2011.
    • The big monthly decline was made worse by the negative May revision
    • Both present and expectation indexes fell.
    • Conference Board index is further off its cycle high than the University of Michigan survey and the Bloomberg Consumer Comfort survey
    • weakness driven by a less favorable measurement of the business environment and the labor market.
  • Conference Board – Labor Market
    • Some economists believe the only valuable information from consumer sentiment readings is the consumer’s opinion on the labor market.
    • Those saying jobs are hard to get increased sharply from 11.8% to 16.4%.
    • previous increases similar to this amount (awful in rate of change terms) were all during recession however doesn’t mean the economy is in a recession now. 
    • The differential of jobs plentiful versus jobs hard to get fell 5.9% which was the worst reading in 12 months (not terrible), but the biggest decline since February 2009.
  • Low Vol Index
    • The new popular trade is going long low volatility stocks. 
    • low vol index has the highest percentage of stocks trading above their 150 day moving average since 2013.
    • consumer staples stocks have never lost money in any 5 year period since 1977.
    • the number of stocks with greater than 19% sales growth has fallen since 2000
  • June Richmond Fed manufacturing report 
    • not as bad as the other regional Fed manufacturing reports
    • Its weakness was located in the expectations portion like the Dallas Fed report.
  • Weak New Home Sales
    • The May new home sales report was bad
    • negative revision to March report made it so that the cycle high is now November 2017.
    • The median lag time from the cycle peak to the next recession is 28 months.
    • If that peak holds and this cycle has the median lag time, the next recession will start in March 2020.
    • new home sales are still above their bottom late last year.
    • The lowest reading was 557,000 in October.

6/25/19 – Fed To Cut Rates With Very Loose Conditions

  • Historic First Half Stock Market Returns
    • 6th time ever the S&P 500 is up 10% or more in the first half and 5% or more in June
    • The returns in the prior 5 examples in the 2nd half all didn’t match the first half gains
  • Rate Cuts
    • the Fed doesn’t have much ammo as rates are starting this cut cycle the lowest since at least 1955
    • The 1995 rate cut that is commonly referred to by the bulls as a similar circumstance occurred when there were slightly tighter conditions.
    • since 1975 rate cuts have occurred 26 times with the S&P 500 having year to date gains of 15% or more.
    • when the Fed funds futures market expects an action 31 days in advance of the decision, the market is correct 75% of the time.
  • May Chicago Fed National Activity index
    • suggests the economy isn’t doing so poorly and isn’t in need of a rate cut
    • went from almost signaling a recession is near, to signaling the slowdown could be ending
    • look at the 3 month average to smooth such volatility
  • Dallas Fed Report – current conditions mixed, future reading terrible

6/24/19 – Historical Returns Following First Rate Cut

  • S&P 500 hasn’t been up 15% headed into the last week of the first half since 1998.
  • Investor Sentiment – doesn’t show euphoria despite stock market rally.
    • CNN Fear and Greed index is at 52 which is neutral.
    • AAII individual investor sentiment survey showed more bears than bulls which is strange near record highs.
    • As of June 19th, the NDR trading sentiment composite for the S&P 500 was at 45.56 which is neutral.
    • Treasury market shows euphoria – NDR reading was at 67.34 which is excessive optimism.
  • Best Returns For Some Assets Following First Rate Cut
    • S&P 500 only averages only 2.9% returns in 3 months.
    • Gold 5.5% in 6 months
    • US Treasury 10 Year 10.8% in 1 year.
    • Brent 13.5% in 6 months (peaks with gold).
  • June Markit PMI
    • Worse than May PMI
    • Suggests increased risks for recession – This is one of the worst readings this cycle.
    • Flash composite index fell from 50.9 to 50.6 – lowest reading in 40 months
    • Services activity index fell from 50.9 to 50.7 which is also a 40 month low.
    • Anything below 50 is a contraction.
    • Future expectations index fell to 57.8 – lowest reading in the 9.5 year history of this series & 13 points below its average.
    • Manufacturing PMI fell from 50.5 to 50.1 – lowest reading in 117 months.
    • Manufacturing output index fell from 50.7 to 50.2 – 37 month low. 
    • Flash readings are just from the first half of the month
    • Payrolls index in this report was the weakest since April 2017
  • The business outlook index hit its all-time record low.
  • Outlook for the start of 2020 is getting worse. 
  • ECRI leading index has increased in the past 2 weeks from 144 to 144.6, the yearly growth rate has fallen from -1.3% to -2.3%.
  • ECRI leading index leads the economy by 2-3 quarters which means there will be weakness in the beginning of next year.
  • May 2019 Existing-Home Sales:
    • Sales prices were up 4% monthly and 4.9% yearly to $277,700.
    • This was the biggest price increase since August 2018.
    • This is the 87th straight month of yearly gains. 
    • All four regions showed a growth in prices from a year ago.
    • The Northeast had the largest gain of 6.6% followed by the Midwest with a gain of 5.6%.

6/21/19 – Leading Index Near Recessionary Warning

  • In May, the leading economic index was helped by the consumers’ outlook and the leading credit index. It was hurt by the stock market, the ISM new orders index, and jobless claims.
  • The ISM manufacturing index might take a hit in June based on the first two regional Fed reports. 
  • the 6 month moving average of the 6 month rate of change for the leading index was up 0.6%.
  • Since 1960, there have been 2 instances where this index has gone negative without there being a recession soon after.
  • In the past 7 cycles, this index has gone negative between 2 and 15 months before recessions.
  • The Philly Fed index wasn’t a historic disaster, but it wasn’t good either as the general business conditions index fell 
  • It’s no surprise that when you combine the dreadful Empire Fed index with the weak headline index from the Philly Fed that you get a low average.
  • the average of the two indexes has an 89% correlation with the ISM PMI.
  • This average implies the PMI will be close to 50 if not below 50. 
  • The Dallas Fed index comes out on the June 24th, the Richmond Fed report comes out on June 25th, and the Kansas City Fed report comes out on June 27th
  • Since stocks are elevated even after the weak Philly Fed report, you might not lose out on potential profits by waiting until the other regional Fed reports come out before going bearish. They will give us a better idea if the ISM PMI will be weak. 
  • if there’s a trade deal, then these results will be ignored because trade tensions are partially why they are weak.
  • Weekly Activity Index – alternative calculation of economic growth – inputs include, jobless claims, intermodal freight transportation, consumer comfort, Redbook retail sales, oil prices, federal taxes and spending, and other proprietary data.
  • compare yield curve with bull and bear markets instead of recessions – Usually, when the 10 year 3 month curve inverts and then steepens, there is a bear market. The main exception was in the early 1990s.
  • Some investors think the current inversion is just because the Fed has rates too high. Others think the curve is done flattening and when it steepens, there will be a recession.
  • The 10 year 2 year differential never inverted as it bottomed at 9 basis points in December 2018. Some think that was the inversion moment which means when the curve steepens sharply, there will be a recession.

6/20/19 – Will Mixed Economic Data Result In Rate Cuts?

  • 10 FOMC members voted in June; the decision was 9-1 in favor of keeping rates stable. 
  • Since 8 out of 17 participants supported 2 hikes in 2019 and there was only 1 dissent for a cut in June, likely most of the members calling for cuts weren’t voting members. That lowers the possibility of a cut as most of the doves don’t get to vote this year.
  • the Fed is going with insurance cuts like it did during 1995 in which it successfully prevented a recession.
  • the market implied probability of insurance cuts versus a recessionary cuts in the next year.
  • recessionary cuts is consistent with 4 or more cuts.
  • insurance cuts is consistent with up to 3 cuts.
  • There is now a 100% chance the Fed cuts rates at the July 31st meeting. Whenever the odds are above 70% that decision usually happens. 
  • One of the reasons the Fed guided for a cut in 2020 and 7 members stated they support 2 cuts this year is because of weak inflation
  • The Fed is finally recognizing that the decline in inflation isn’t transitory.

6/19/19 – This Indicator Signals Late Cycle

  • Since December 2018, the S&P 1500 housing market index has rallied in line with inverted 30 year fixed mortgage rates. The correlation has been very high.
  • the traffic of prospective buyers index fell 1 point to 48. Anything below 50 is a contraction.  This index has been below 50 since last October. 
  • Even though both May housing starts and permits beat estimates and starts were revised higher, this wasn’t a great report.
  • Maybe the improvement in its Housing Market index means this decline is near its end.
  • Speaking of predicting housing starts – mortgage applications are correlated with future housing starts growth.
  • The Cass Freight Shipments index shows the economy is headed in the wrong direction as yearly growth in May was -6%.
  • fund manager survey was shockingly bearish. Clearly, these fund managers think economic weakness and the risk of an all-out trade war with China aren’t priced in. 
  • Specifically, fund managers had the largest increase in cash positioning since the 2011 debt crisis. They had the lowest allocation to equities in relation to bonds since May 2009.
  • 87% of fund managers think the global economy is late cycle.
  • To be clear, the global economy has had 2 recessions since the last U.S. recession. In those recessions, the economy was said to have been mid cycle in this survey. 
  • Among fund managers –  the monthly drop in equity allocation was the 2ndbiggest ever and the overall equity allocation was the 2nd lowest ever.

6/18/19 – Does Low Inflation Mean Rate Cuts Are Next?

  • the market’s 2 year estimates of the Fed funds rate haven’t been accurate.
  • However, near term projections are accurate because the Fed can influence the market to properly price in what it will deliver so there are no surprises.
  • When the market projects at least a 70% chance of a specific action/inaction on rates, it is almost always correct. 
  • the first rate cut of the cycle has been 50 basis points in 4 of the past 5 cycles.
  • That doesn’t mean there will be a cut of that size now because the economy looks to be in a slowdown rather than a recession just like in 1995-1996 when the Fed cut rates 25 basis points. 
  • Plus, the Fed doesn’t have as much room to cut rates since the effective Fed funds rate is only at 2.39%
  • 5-10 year inflation expectations fell 0.4% to 2.2% which is the lowest point in the 40 year history of the University of Michigan survey.
  • this was the biggest monthly decline in the new orders index since November 2010. The only bigger declines in the past 18 years were November 2010, after Lehman Brothers failed in 2008, and after September 11, 2001
  • The Empire Fed reading was terrible, but that weakness needs to be confirmed by other regional Fed reports before we start expecting a manufacturing recession.
  • If you average all the regional Fed readings, you get an estimate for the ISM manufacturing PMI.

6/17/19 – Two Solid Economic Reports Curtail Recession Fears

  • The retail sales update was like 2 reports in 1 because there was a major positive revision to April’s numbers and May’s growth in the control group beat estimates.
  • They support the stock market’s June rally and call into question any rate cuts that could be coming in July or September. 
  • This is why we follow trends instead of hanging our hat on monthly readings.
  • Economic reports can be revised to show the opposite result of the initial reading.
  • Keep in mind, both of these reports affect Q2 GDP growth, so they are both very important
  • These results in retail aren’t near cycle highs, but they signal the slowdown isn’t that bad. This doesn’t necessarily mean there won’t be a recession soon as growth was 3.3% before the last recession. At least it’s likely the economy isn’t in a recession now.  
  • Industrial production index  is nowhere near the weakness of 2015. While this is an industrial production slowdown, it’s not a recession yet.

6/14/19 – Will Fed Cut Rates With Stocks At Record Highs?

  • The Fed funds futures market is often wrong about the intermediate term future. 
  • Fed funds futures market short term predictions are usually spot on because the Fed doesn’t like shocking the market. 
  • If the futures market is wrong, the Fed will try to shift expectations.
  • This all leads to the point that we are very likely to see our first cut of the cycle in the next couple months.
  • There are two false narratives going around. The first is that the Fed can’t cut rates when the stock market is near its record high.
  • The market could be wrong to rally, but the Fed must react to the weak economic reports which have led to forecasts of 1.9% Q2 GDP growth. 
  • Specifically, the Fed cut rates when the market was at a record high in July 1995, August 1991, July 1990, and July 1989. It can do that again.
  • The second false narrative is that rate cuts mean the cycle is over and we’re headed for a bear market. That’s not true.
  • If the Fed preemptively cuts rates to stop a slowdown from becoming a recession, there won’t be a bear market recession.
  • in 5 straight cycles stocks had positive returns after the first cut. There were only negative returns in the past 2 cycles.  
  • Earnings estimates have barely declined in June which is great news for stocks.
  • One reason estimates haven’t fallen much is because very few firms report in the 3rd month of the quarter.
  • It’s fine to state how business is going, but you can’t just extrapolate trends to predict recessions like CFOs are doing. (linear thinking is incorrect)
  • almost 50% of American CFOs see a recession by Q2 2020.
  • CEOs are similarly bearish on the economy. The CEO business confidence index is near the cycle lows.
  • Stanley Druckenmiller made headlines when he said the economy is in a productivity boom because of the internet and that productivity is being measured incorrectly. That’s ironic because productivity growth has been increasing lately. 
  • the estimated 20 quarter percent change annualized productivity growth is near the highest point in 30 years.
  • Productivity growth has been low this cycle, but it has been increasing lately.
  • We hear all the time about how the mobile internet has made us more productive, but how social media apps also waste our time.
  • The correct measurement of productivity growth is an open ended question.
  • In Q1, workers became much more productive which is great for employers because it pushed unit labor cost growth into negative territory. 
  • unit labor costs predict core CPI. If that’s the case, core CPI will fall in the next year.

6/13/19 – The Main Indicator That Impacts Early Fed Cut

  • inflation needs to fall to give the Fed room to cut rates.
  • We don’t know the exact inflation rate where cuts make sense, but anything lower than April’s inflation is a strong start. 
  • Declining nominal wage growth isn’t a problem if inflation falls.
  • It’s no surprise housing catalyzed inflation because housing is 42.202% of the CPI index.
  • core CPI was 2.3% in July 2018. It was this mini-cycle’s peak.
  • The most common age in America was 27 in 2018. 
  • the percentage of people from 25-40 has increased in the past few years, but it’s below what is was in the 1990s. That’s because baby boomers are living longer. 
  • In 2018, the number of babies born was the lowest in 32 years; it was the 4th straight year of declines.
  • the national 30+ days delinquency rate for mortgages was 4% in March which is the lowest level in 13 years. That’s a great sign for the housing market which leads the economy.
  • This cycle won’t see as high of a spike in delinquencies because buyers were more qualified.

6/12/19 – How Important Is Stock Market To Economy?

  • As of Q1 2019, U.S. households had $124.7 trillion in assets. $88.9 trillion of that is financial assets, $17.5 trillion is corporate equities, and $8.8 trillion is mutual fund shares.
  • In Q1, equity allocation was 29.6% which is below the cycle high of 31.3% in Q3 2018 because of the correction in Q4 2018.
  • Interestingly, the allocation fell to 27.7% in Q4 and that is equal to the Q2 2007 peak.
  • The only higher peak than Q3 2018 was in the late 1990s/early 2000s.
  • Keep in mind that through inductive reasoning we can see that this high allocation isn’t necessarily a problem. That’s because valuations are more important than how much stocks U.S. households own. U.S. households aren’t the only buyers of stocks.
  • The point here isn’t that the stock market is in a bubble that is about to collapse. Rather, it’s about how important the stock market has become to the economy.
  • The reflexivity theory, which explains how the market can affect the economy, is in full force given how much money consumers have in equities.
  • It’s more important for politicians and policy makers to keep the market up than almost ever before. 
  • The reality is stocks reflect expectations and impact the economy. If the Fed didn’t care about the stock market, it would be a mistake.
  • in Q4 2018, the change in household net worth as a percentage of disposable income had the largest decline since the 2008 financial crisis. Furthermore, the increase in Q1 was the largest single quarter jump since the tech bubble.
  • We must take a new look at inflation with the understanding that the Fed is being pressured to cut rates this year
  • The Fed conveniently looks at core PCE inflation which is usually the lowest inflation calculation.
  • Since March 2012, core PCE inflation has only been above 2% once.
  • PPI tells a slightly different story.
  • The Fed would be in a major predicament if it based policy on core PPI because it’s above 2%
  • small business confidence increased in May despite the decline in the stock market. 

6/11/19 – Gap Between Job Openings & Hiring Increases

  • For much of the JOLTS report’s recent history, we have seen the gap between job openings and hiring increase.
  • openings have been above hires since 2015.
  • Hiring hasn’t kept up with openings which has been a negative in this report.
  • It’s good to see employers looking to hire people, but if they don’t actually hire anyone, then there’s no benefit to the economy.
  • Higher openings than hires gives off the signal that there aren’t enough workers to fill the vacant job openings. 
  • The prime age labor force participation rate doesn’t agree with JOLTS as it shows there is still supply in the labor market.
  • The data from JOLTS only goes back to 2000, so our ability to analyze this record breaking cycle is limited.
  • The Sahm Recession indicator uses the unemployment rate to come up with the odds of a recession. since 1970, this indicator has never called for a recession that didn’t happen and has successfully predicted each one.  This calculation eliminates some of the noise that’s created by the month to month shifts. The indicator is the 3 month average of the unemployment rate in relation to the prior 12 month low. The current rate is at the cycle low. There’s only an 8% chance of a recession in the next 6 months.
  • It’s a red flag if mortgage borrowers have 40% of their disposable income going to their house payment. Meanwhile, renters are at 37.5%.
  • It became more affordable to buy a house after the housing bubble burst, but rent as a percentage of disposable income has kept rising. 

6/10/19 – Underemployment Rate Hits A New Cycle Low

  • The best way to describe the May labor report is most of the stats were consistent with a full labor market; the notable exceptions were the declines in the prime age labor force participation and yearly wage growth. 
  • In a full labor market, you see job growth consistent with population growth, the unemployment rate low, and high wage growth.
  • This report was tarnished by the negative revisions to March and April. They were pushed down by the exact amount of jobs created in May. Technically, there were no new jobs created.
  • The May reading gets all the headlines, but we follow the revisions just as closely because that data is more accurate.
  • In the past few years, we’ve seen shocking headlines which end up being revised in the next couple months.
  • Usually, when a report misses estimates by a lot, it gets revised higher and when a report surpasses estimates, it gets revised lower.
  • It wasn’t impossible to see this coming as year to date job cuts were up 39% and the ADP report showed only 27,000 jobs were created in May. 
  • We wouldn’t be surprised if this BLS report is revised modestly higher in the next 2 months.
  • The U3 unemployment is the lowest since December 1969 and 0.2% below the trough in the 1990s cycle.
  • the U6 (marginally attached) unemployment rate fell from 7.3% to 7.1%. the past 2 cycles bottomed at rates of 6.8% and 7.9%. It is closing in on the 1990s cycle low.
  • The prime age employment to population ratio was stuck at 79.7% and its cycle peak is 79.9%
  • The prime age labor force participation rate looks a bit worse as you can see from the chart below. It fell from 82.2% to 82.1% and is down from its cycle high of 82.6%.
  • The employment population ratio counts people who are employed, while the labor force participation rate counts people who are in the labor force.
  • You can be unemployed and in the labor force.
  • The greater decline in the prime age participation rate from the recent peak might be because people left the labor force.
  • The prime age participation rate shows the labor market has slack, while the U6 rate says it doesn’t have much slack.
  • Weekly earnings growth fell, but at least inflation is also falling.

6/7/19 – The Big Mistake When Analyzing Corporate Debt

  • the NFIB small business survey and the Conference Board consumer confidence index both show the labor market is strong
  • jobless claims in the week of June 1st were 218,000 which matched the prior reading; claims are near a historic low in relation to the size of the labor market.
  • Year to date job cuts are up 39% compared to last year. There have been 289,010 cuts in 2019. 
  • Regarding S&P 500 Quarterly EPS – The 10 year average decline is 2.2% and the 15 year average decline is 3.1%. This quarter was better than all averages.
  • At this point of the year, we must turn our attention to Q3 earnings estimates because the guidance firms are now putting out affect that quarter. Guidance is everything for investors.
  • the percentage of BBB corporate bonds increased above the percentage of AAA-A debt. That leads you to believe corporate debt quality is a huge problem.
  • BBB bonds are in 3 categories, BBB+, BBB, and BBB-. the growth in BBB+ is the highest. That means BBB on average is safer than usual.
  • Citi, AT&T, and Verizon caused 47% of the increase in BBB debt. 
  • Corporate debt quality isn’t terrible.

6/6/19 – Which May Services PMI Is Accurate?

  • The strong May ISM non-manufacturing report was a surprise because most economic reports have been weak in the past few weeks, the flash Markit services PMI was weak, and the ISM manufacturing PMI was weak.
  • this scenario is like the slowdown from 2015 to 2016 when the manufacturing PMI cratered and the non-manufacturing PMI declined modestly, but never fell below 50 which signals a contraction.
  • the services PMI was a disaster as it was the lowest reading since February 2016.
  • New orders growth was the lowest since March 2016.
  • Business confidence was the weakest since June 2016.
  • Input cost inflation was the weakest since September 2016.
  • Combining the service and manufacturing PMIs puts the composite at 50.9 which is down from 53 and the lowest reading since May 2016.
  • The downside miss on the ADP report of 158,000 was the worst since December 2008.
  • We need to see another bad reading and this one not revised much higher, before we get worried. 
  • Job growth had the largest decline since March 2010.
  • In the past 30 months, the education component in the ADP report had an 80% correlation with the BLS report.
  • Education lost 1,000 jobs in May. It’s bad news that the most accurate part of the ADP report showed job losses. 
  • Leisure and hospitality had a 67.8% correlation and added 16,000 jobs. Of the industries with the 4 highest correlations, 3 showed negative job creation.
  • manufacturing had just a 39% correlation and it added 3,000 jobs. 
  • The professional and business component had a -35.1% correlation and added 22,000 jobs.
  • The Fed is widely expected to cut rates twice this year which is bad for the banks. If this is a proactive cut which prevents a recession like in 1995, the banks will be ok.   

6/5/19 – Is Economy Entering Recession Or Getting Out Of One?

  • Adding to the litany of economic reports that have caused the median Q2 GDP growth estimate to fall to 1.7% is the weak April construction spending report.
  • Total construction spending had the weakest yearly growth reading since June 2011. Negative growth usually means the economy is going into a recession or just coming out of one.
  • There were huge gains in federal and state spending as on a year over year basis they were up 13.3% and 15.2%. So much for there not being an infrastructure spending bill. Spending was led by highways and streets as well as educational buildings.
  • Improved government spending does nothing to allay fears of a cyclical slowdown in the private sector.
  • The market has lowered its expectations for the Fed funds rates quicker than Friday only 20 times since 2008. Out of those 20 times, 19 were during the financial crisis and the other one was the day after Brexit.
  • We look at the whole yield curve instead of just one section – over 50% of the yield curve has inverted which is a clear recession warning.
  • Since 1980, this percentage of inversion has always meant a recession was coming in the next couple years.
  • one of the catalysts of a potential recession is the trade war. One rate cut won’t stop the trade war from raging on. The trade war ending is probably the bulls’ best bet to avoid history repeating itself.
  • In theory, if rate cuts are already expected, they shouldn’t cause stocks to rally when they occur.
  • Stocks rallied on Tuesday after Powell spoke, but the Fed futures market didn’t move much which suggests his speech didn’t cause the rally. Stocks had entered the day very oversold.
  • Some research suggests that the tariffs are hurting non-Chinese businesses more than Chinese firms.
  • In the machinery, computers, electrical equipment, and miscellaneous manufacturing industries, the products exported to America mostly come from U.S. and other non-Chinese companies located in China.

6/4/19 – Stocks Forecast An 18.8% Chance Of A Recession

  • If the average recession causes stocks to fall 26%, then the current correction (as of June 4th) in stocks forecasts an 18.8% chance of a recession.
  • We get that number by dividing the current losses by 26%. One issue with this simple calculation is it doesn’t account for valuations. If stocks are very cheap, then they might not fall 26% from their peak in a recession.
  • If stocks are very expensive, like in the late 1990s, stocks can fall more than 26% even in a small recession. The 2001 recession was short lived and shallow, but the market fell over 50%.
  • This reminds investors who listen to doom and gloomers that stocks don’t need to fall 50% in a recession.
  • Not every recession is as bad as 2008 and not every market starts as expensive as the one in the late 1990s was.
  • The best part of this calculation is it puts every correction in terms of how likely a recession will be.
  • There has been a global decline in interest rates which has pulled US treasury yields lower.
  • The U.S. economy is more globalized than ever. It is being hurt by the cyclical downturn in the global economy after it avoided such an impact last year because it was helped by the fiscal stimulus. 
  • the percentage of global bonds outstanding with a negative yield has increased to above 25%.
  • The percentage of negative yielding bonds outstanding peaked at around 32% in the summer of 2016 which is also when the U.S. 10 year bond yield troughed.
  • Some investors wonder why we pay any attention to the manufacturing sector since it is a relatively small part of the economy. We follow it because it is highly cyclical. It can lead the economy lower or it can be a false alarm. 
  • even though manufacturing’s employment share has fallen in America, its production share is second to China.
  • Less than 5% of jobs are in manufacturing, but about 20% of production share is in this sector.
  • May manufacturing PMI was weakest since October 2016 which was the beginning of the recovery from the last manufacturing recession.

6/3/19 – The Longest US Economic Expansion Or 2008 Style Recession Next?

  • If the economy doesn’t fall into a recession by June 2019, this will be tied for the longest expansion since the 1800s.
  • The consensus is for 1.7% GDP growth in Q2.
  • While economic reports have been weak, very few of them suggest the economy is in a recession.
  • The bears love to point to 2008 when the economic data was revised sharply lower after the fact. How about the 10 years since then when economic data wasn’t revised sharply lower to indicate a deep recession?
  • Bears have suffered from extreme recency bias when claiming the next recession will be as bad as the last one. While that’s not impossible, remind yourself that consumers have deleveraged this cycle and the type of mortgages that led to the housing bubble are illegal now. 
  • This is the 3rd slowdown of this 10 year expansion. The prior 2 didn’t have large enough catalysts to push the economy into a recession.
  • While the economy is more diversified, it’s also more integrated into the global economy which gives it a new risk. If you think the Fed can perfectly control the economy (and prevent recessions), how come it can’t get inflation to its 2% target?
  • Extreme viewpoints on the bullish and bearish sides are usually catalyzed by biases.
  • To be clear, there are circumstances where it makes sense to be extremely bullish or bearish, but those are rare occasions.
  • the recession models that use the yield curve have been starting to show a higher risk of a recession.
  • NY Fed’s recession model, predicted by treasury spreads 12 months ahead, shows the risk of a recession increasing.
  • the Duncan Leading indicator is now predicting a recession. Since the late 1960s, this recession indicator had only one false positive reading which was in the mid-1980s.
  • This indicator reviews parts of the economy that are affected by cyclical demand such as household spending and compares those readings with economic growth. Specifically, the indicator is durable goods plus fixed investment as a percentage of final sales.
  • If durables goods and fixed investment are growing faster than final demand, a peak in the indicator should come before a decline in economic activity.
  • Real disposable income growth increased while real consumer spending growth fell on a yearly basis. That means the savings rate increased. 
  • We haven’t seen the full effects of the tariffs on the hard data because the latest hard data is from April and the biggest tariff by far was announced on May 10th.

5/31/19 – Best Leading Indicator For GDP Growth?

  • The big unsustainable driving forces of Q1 GDP growth, which were net exports and the change in inventories, were revised lower.
  • There’s risk that trade and inventory will drag down Q2 growth
  • gross domestic income growth was only 1.4% which was much weaker than GDP growth.
  • GDI is the sum of all income in the economy instead of the sum of all production.
  • The calculation is GDI equal rental income plus interest income plus profits plus wages plus statistical adjustments.
  • GDO is the average of GDP and GDI. It was up 2.2% quarterly and 2.5% yearly. It’s a good leading indicator for GDP growth.
  • In Q1 the decline of imports into the US from China was made up for by other emerging markets. Imports from Vietnam, South Korea, and India were up 40%, 18% and 15%. 
  • in nominal dollars, Mexico was the biggest beneficiary of this shift. It will be interesting to see how trade shifts if the trade war with Mexico ratchets up in the coming months.
  • German 10 year bond yield hit -21 basis points which is its lowest yield in history.
  • when the 10 year yield falls below the 3 month bill it becomes a valid indicator of heightened recession risk when it stays inverted for 10 days. We are on day 7 now.
  • The average time, after this inversion reaches 10 days, until the next recession is 311 days based on the last 7 basis cycles. Keep in mind the 10 year yield is still higher than the 2 year yield and the 30 year yield is still the highest.
  • Most of the curve isn’t signaling there will be a recession, which in our view may be the most important indicator. Treasury investors just see nominal growth slowing significantly.
  • Pending home sales are a leading indicator for the housing market.
  • Despite the decline in home price growth and the decline in interest rates (the average 30 year fixed rate fell to 3.99% in the week of May 30th which is the lowest reading since January 11th, 2018), April pending home sales missed expectations.
  • since 2001, pending home sales are up 2.8%. Population adjusted pending home sales are down 11.3% in that period.

5/30/19 – The Trade War Is A Major Issue For Stocks

  • The trade war is a big deal for the economy because it creates uncertainty causing a multiplying negative effect.
  • Businesses hate uncertainty because it is tough to plan for it. Investors hate uncertainty because it amplifies every data point.
  • If a company can’t predict where it will be in the future, each report is extremely critical which causes excess volatility.
  • That explains why each trade related news item affects stocks. Firms with high visibility get a premium.
  • in April 18% of firms stated they would increase their hiring and capex spending if a comprehensive trade deal was struck.
  • the new tariffs that were announced on May 10th potentially caused 30% more firms to cut hiring and capex plans, and 14% less firms to increase hiring and capex plans.
  • China produced 71.4% of the rare earths last year and owns 37.9% of global resources. 
  • The volatility in stocks in May has been catalyzed by the same issues that hurt stocks in Q4 2018.
  • The Fed is considered to be too hawkish, the economy is slowing and at risk of falling into a recession, trade tensions are high, and earnings revisions are weak.
  • It’s arguable that the economy and trade war are in worse shape than 6 months ago. New tariffs were enacted and Q2 GDP growth is on pace to be about 1.8%.
  • If the Q2 economic reports are accurate, it’s plausible to suggest that EPS surprises won’t be as great as they were in Q1. It’s very possible we see below 4.91% EPS growth in Q2.
  • In housing we are seeing falling rates, increasing affordability, increasing new home sales growth, and the improvement in the home builder sentiment index.
  • The housing market has had a solid spring, but home price growth fell to either a 7 year low or a 4 year low in March depending on which index you follow.

5/29/19 – Recession Watch In Effect

  • For the first 4 months of the year, markets were giving off conflicting signals as treasuries were signaling there was going to be a big slowdown in growth while stocks were rallying as if the economy was ready to match 2018’s solid performance.
  • The U.S. 10 year bond yield hit its lowest level in 19 months
  • 10 year real yields are the lowest since January 2018.
  • The Fed funds futures market is now pricing in 77 basis points of rate cuts by the end of 2020
  • there is now $10.7 trillion in global negative yielding bonds which is the most since October 2016.
  • The Adjusted Yield Curve For QE and QT Shows A Recession Could Occur Soon
  • the consumer’s optimism about the labor market reached a cycle high.
  • The percentage of consumers saying jobs are plentiful increased from 46.5% to 47.2%. The only higher peak going back to 1967 was in the late 1990s.
  • We’re not huge believers in reviewing the difference between the present and expectations indexes because both are relatively high. It’s not like expectations are far below their cycle high. That would be disconcerting.
  • The good news is the consumer is confident and optimistic about the future.
  • The bad news is tariffs are hurting manufacturing and are about to impact the consumer.

5/28/19 – 20 Steps To A Recession

  • With such a long expansion, some investors have thrown out their playbook for timing the next recession.
  • Some even believe the Fed has outlawed the business cycle by responding to every worry the market has. While the Fed has learned from prior cycles, it hasn’t ended the business cycle because there are always new circumstances.
  • If the Fed could perfectly control the economy, we’d see higher annual growth than we have this cycle.
  • Growth per year has been slow, which is why the total growth in this expansion isn’t at a record even though this expansion is nearly the longest since the 1800s.  
  • The follow up question to the analysis of whether a recession is coming is if a recession is priced in.
  • This isn’t a binary situation where there are only two options: a recession or no recession.
  • Forecasting recessions is done in terms of levels of certainty.
  • For example, if you think there is a 40% chance of a recession in the next 6 months and the market is pricing in a 5% chance of a recession, you could go underweight stocks.
  • Recession calls which implicitly say there is nearly a 100% chance of a recession are worthless.
  • When the economy enters a cyclical slowdown, there is heightened risk of a recession.
  • You then must find a potential recessionary catalyst.
  • Since the economy is in a slowdown, that’s something you should do now.
  • Since the stock market falls 26% on average during recessions, you can divide the current decline by that to get the odds of an average recession.
  • Since the market hasn’t fallen 5% this entire year, there hasn’t been much pricing in of a recession.
  • The 20% decline in late 2018 mostly priced in a recession.
  • Base metals and the 5 year treasury are showing there is a higher chance of recession than what stocks and credit spreads are pricing in.
  • An all-out trade war could catalyze a recession.
  • There doesn’t necessarily need to be a massive catalyst to push the economy into a recession if it’s already in a cyclical slowdown.
  • Since the economy is in a slowdown and there is a trade war, the stock market isn’t pricing in a recession either because investors don’t realize the economy is in a slowdown or they don’t see the trade war as a big risk.
  • if PMIs fall below 50, you should be on watch for a recession

5/27/19 – Q2 GDP Growth Could Be Below 2%

  • The April durable goods orders report was weak. 
  • We are seeing the likelihood of below 2% Q2 GDP growth increase quickly
  • Most of the positive economic results are coming from housing, while the manufacturing sector is heading towards a recession.
  • A slight beat combined with a terrible revision isn’t good news.
  • The all-important core capital goods orders reading was terrible which is why this report wasn’t good.
  • Core orders growth was the weakest since January 2017 which was the beginning of the current cyclical upswing which is now ending.   
  • the durable manufacturers’ inventory to sales ratio has been increasing because of decreased demand growth.
  • The spike decreases the likelihood that inventory investment will boost GDP growth in Q2 like it did in Q1.
  • It wouldn’t make any sense for firms to boost inventories after they just did especially since economic growth is weakening.
  • Following April and May economic reports, estimates for Q2 GDP growth have quickly fallen 
  • The later in the quarter, the more accurate Nowcasts become because they include more economic reports.
  • The June 19th Fed meeting is shaping up to be the most critical Fed meeting since last December because the economy is weakening, but the Fed hasn’t agreed with the futures market that there will be at least one cut this year.
  • The global surprise index has been negative for 270 days.
  • It’s time for the Fed to realize the U.S. economy is in its 3rd slowdown of this expansion. If the Fed doesn’t react properly, the risks of a recession occurring could increase.

5/24/19 – Is This The First Recession Warning?

  • The May Flash Markit PMI reading was terrible as it is consistent with just 1.2% GDP growth. 
  • Business confidence fell to its lowest level since at least 2012.
  • the services business activity PMI fell from 53 to 50.9 which was the lowest reading in 39 months.
  • We already know the manufacturing sector is much weaker than last year. If the services sector follows suite, this will be a deep slowdown.
  • The level of outstanding business fell for the first time this year and employment growth fell to a 25 month low.
  • Output prices fell for the first time since February 2016. It’s clear inflation is falling, with the only mitigating factor being tariffs.
  • The manufacturing sector PMI fell from 52.6 to 50.6 which was a 116 month low.  this reading was downright terrible as it is below any point during the 2015-2016 manufacturing recession.
  • new orders fell for the first time since August 2009 when the economy was just exiting the last recession.
  • New Home Sales median cyclical peak before recessions is 28 months. That’s what makes the new cycle high important as the previous high was 17 months ago. The indicator went from predicting a recession in 11 months, to resetting and predicting one in 27 months. That can be taken away if March’s reading is revised lower in the May report.
  • from March 1st to May 1st Q2 earnings growth estimates only fell from 2.32% to 1.47%. That’s a decline of 0.85%.
  • in the first 23 days of May, EPS estimates fell from expecting 1.47% growth to 0.1% growth. That’s a decline of 1.37%, meaning the decline was larger in less than half the time.
  • The Markit PMI flash reading implies rising risks of a recession occurring as early as this year.
  • Earnings estimates have cratered in May, supporting the S&P 500’s 4.07% decline month to date.

5/23/19 – Fed Has No Plan To Cut Rates In 2019?

  • The big takeaway from the May Fed Minutes which were released on May 22nd is that the Fed won’t be cutting rates in the near term.
  • The June meeting is one of the meetings where the Fed provides specific guidance on rates and economic reports like the unemployment rate and GDP growth.
  • the stimulative effect of fiscal policy is diminishing
  • The housing market will play a big role in whether GDP growth can get above 2% in Q2. The MBA applications index doesn’t look as great in May as it did in April. 
  • Lately, Trump’s leverage in the trade deal negotiations with China has increased. 

5/22/19 – Will The Fed Cut Rates In 2019?

  • you don’t often hear discussion about how much lower inflation could be if there weren’t tariffs.
  • The best case scenario for the Fed to avoid having to cut rates in 2019, is for there to be a trade deal which would lead to an upswing in the economy
  • The Fed and the Fed funds futures market have a big disagreement on future policy.
  • Expected Fed rate cuts explain why the 2 year yield is at 2.24% which is below the effective Fed funds rate of 2.42%.
  • The existing home sales report doesn’t matter to GDP, but it is important because most homes sold are in this category.
  • Existing home sales were weak on a monthly basis, but strong on a 3 month basis. 
  • uncertainty is a large component of the potential effect of the trade war on GDP.
  • Growth and inflation are low partially because of the trade war, but also because of cyclical weakness.
  • Yearly growth will be positive near the end of the year because of the very weak comps.

5/21/19 – Which American Workers Are At Risk Of Automation?

  • Low-wage workers are enjoying the fastest wage growth
  • Modest improvements aren’t talked about as much as hardships such as those caused by mass layoffs. 
  • The employment to population ratio for those 25 years old and over without a high school degree peaked at 44.9% in October 2018. That’s the record high going back to 1992.
  • Those with a high school degree have an employment to population ratio of 55.9% which is significantly below last cycle’s peak of 61.5%.
  • The employment to population ratio for those with a Bachelor’s degree or higher is 72.3% which is below its previous cycle peak of 77.2%
  • Those with a college degree or higher still get paid more and have a 30% higher employment to population ratio. 
  • about 10% of American workers are at high risk of automation which is defined as a job with 70% or more risk of automation.
  • The expected value here is about 7%, although you’d also need to add in the large majority of jobs that have a medium/low risk of automation.     
  • Regarding trade war – The severe case is 25% tariffs on all Chinese goods. That would hurt 2019 S&P 500 EPS by 6%.
  • The direct impact on S&P 500 firms’ EPS could be between 2% and 6% this year. 
  • The trade war’s impact could be greater than this because many businesses are holding off on big investments until they get clarity on the trade situation.

5/20/19 – Trade War Escalates, A Tax Increase On Middle Class

  • Based on GDP per capita, China isn’t a developed economy, but its huge population makes it the powerhouse of global growth.
  • for middle income Americans most of the benefit from the tax cut will be taken away once the 25% tax rate on $200 billion in goods is implemented.
  • The May preliminary consumer confidence reading was the best since January 2004
  • the net effect of the 25% tax rate on $200 billion in goods on 2020 core PCE inflation will be negligible because economic growth will be hurt.
  • It’s too early to say for sure what the Fed will do, but if tariffs stay in place long enough, cuts are likely. 

5/17/19 – A Recession Warning In Industrial Production & Housing?

  • After the weak April retail sales and industrial production reports, the estimates for GDP growth fell. 
  • Just like how the retail sales report was weak because of the adjustment due to the late Easter, there was a quirk in the industrial production calculation
  • Historically, when yearly industrial production growth is negative, it means a recession is likely. The major exception was in 2015-2016.
  • It will be interesting to see if the economy avoids a recession when the manufacturing sector contracts again to determine if the diversification away from manufacturing makes the economy more recession resistant.
  • 16 out of 23 industrial groups are contracting which is the same level as the peak in the last industrial production recession.
  • Only 30% of industrial production groups are expanding. A drop below 40% has previously meant widespread weakness that implies a recession.
  • the capacity to utilization rate fell from 78.5% to 77.9%. The economy isn’t near running out of slack
  • Monthly manufacturing output growth has almost always been below its 6 month average when the 15th is after the payroll survey week and 22 working days. This calendar issue has a strong track record. 
  • Most of the housing data has been beating estimates, but we can’t be extremely excited about a market where single family permits fell 4.2% monthly and overall permits fell 5% yearly. That’s even with declining interest rates.

5/16/19 – Are These Red Flags In Retail Sales & Consumer Debt?

  • One excuse for this weak retail sales report was that consumers received lower tax refunds than they may have expected.
  • Lower tax rates mean lower refunds.
  • Consumers often are subject to mental accounting bias which is when they put money in boxes even though it is fungible.
  • This ‘found money’ from a tax refund is often spent right away rather than saved.
  • The other reason results were poor is the timing of Easter. The holiday was on April 1st last year and April 21st this year. That means there was more spending in March last year and this year had more spending in April.
  • The results are switched during the seasonal adjustment process, but it’s possible that the adjustment went overboard.
  • To counteract the effect of seasonal adjustments while accounting for the Easter shift, we can look at March and April’s 2 year unadjusted growth stack
  • Don’t be fooled by the bearish investors into thinking that household debt being at a record high means the consumer is in trouble.
  • Wealth is also extremely high because of the rise in asset prices like the stock market.
  • For example, total debt increased from $12.68 trillion in Q3 2008 to $13.55 trillion in Q4 2018. In that period, the net worth of households and non-profits increased from $61.689 trillion to $104.329 trillion.
  • That’s a much bigger increase than there was in household debt; the consumer has deleveraged in this expansion, as we have pointed out before.
  • delinquency rates show the health of the consumer. 
  • The 90+ day delinquency rate on auto loans increased from 4.5% to 4.7% which is the highest rate since Q4 2011.
  • The 90+ day credit card delinquency rate increased from 7.8% to 8.3% which is the highest rate since Q2 2015

5/16/19 – Global Economy Slowing: Trade War Isn’t The Only Risk

  • The Fed’s two mandates are stable prices and maximum employment. Skeptics think the third, most powerful mandate, is to keep the S&P 500 up.
  • To be fair to the Fed, the stock market is a leading indicator of the economy, so if the stock market falls it could be a warning that the economy may be deteriorating.
  • Also, if the stock market falls significantly, that could hurt the economy further through reflexivity.
  • Bearish investors hate the concept of the Fed helping the stock market, but they are in a difficult position of managing not only the cost of currency, but perception and confidence in their ability to do so.
  • None of us can control whether the Fed helps the market. We can only react to policies and changes to the economy.
  • If you have been angrily short stocks since December because you are mad the Fed turned dovish, you have lost money trying to prove a point.
  • You can utilize free speech to criticize any policy decision, but don’t involve your portfolio in philosophical arguments.
  • Reality, just or unjust, and perception of reality, is what matters for portfolio returns.
  • fund managers where the S&P 500 would need to fall to for the Fed to cut rates. The most popular answer was 2,350.
  • China’s retail sales had the lowest growth rate since May 2003.
  • The April Cass Freight shipments reading was terrible, signaling the American economy is in a slowdown.  
  • The movement of tangible goods is a great indicator for the health of the economy.
  • Shipments growth is getting closer to the weakness seen in the 2015-2016 slowdown. 
  • This is the exact weakness the ECRI leading indicator forecasted would happen in Q2 and Q3 at the start of the year.
  • the main catalyst for the potential EPS contraction in Q1 was multinational firms. 
  • The trade war will only increase the divide between domestic and multinational firms.
  • If the stock market declines, the Fed will be more likely to cut rates, but the market already expects a cut anyway because the American economy is in a slowdown.

5/15/19 – Can Tariffs Bankrupt Americans?

  • China officially retaliated against America’s 25% tariff on $200 billion in goods with its own tariff on $60 billion of American goods. Over 5,000 goods will be taxed at a 25% rate. 
  • Other goods will be taxed at a rate of 20% which is an increase from 5% and 10%.
  • the current 25% tariff rate on $200 billion worth of goods from China will cost GDP $62 billion, employment 200,000 jobs, and households $490.
  • If tariffs are levied on all imports from China, it will cost GDP $100 billion, employment 360,000 jobs, and each household $800.
  • The trade war’s impact to GDP could push America into a recession if cyclical weakness continues, but it won’t if the cycle turns up. 
  • A 360,000 decline in employment wouldn’t be a major disaster since the labor market is close to full. 
  • The real question is if the cycle is turning and the labor market is about to have sustained weakness.
  • We’re most concerned about the trade war’s impact on households because real quarterly consumption growth was already weak in Q1.
  • real final sales to domestic purchasers grew at the weakest rate in 6 years. 
  • According to survey, 60% of Americans don’t have $1,000 in emergency savings. 
  • While tariffs aren’t a new expense like a car repair or an emergency room visit, they will cost households money by making many goods more expensive.
  • The $200 billion tranche of tariffs will have more consumer goods than the previous tranches.
  • The final $325 billion tranche has the most consumer goods.
  • Added expenses will cause consumers to take on more credit card debt, reduce spending, borrow from their friends and family, and take out personal loans.
  • Increased costs for households mean increased inflation
  • President Trump has targeted China not just because it is the nation America has its biggest trade deficit with. He has targeted China because of its alleged violation of intellectual property laws. 
  • The Fed is more likely to respond to this trade war with a rate cut than a rate hike even though inflation will increase because it needs to support the economy. 

5/14/19 – Shelter Inflation Stays High Despite Decline In Home Price Growth

  • 4 week moving average of initial unemployment claims has increased.
  • This isn’t a recessionary warning, but it is something to follow closely as jobless claims are finally following the boost in layoff announcements seen in Q1
  • Even with all this analysis, we still aren’t sure about the labor market because claims have lost correlation with the labor market since states have lowered the amount of unemployment benefits and how many people qualify.
  • That being said, jobless claims are still in the Conference Board’s leading indicators index.
  • Claims won’t hurt the index in April, but they could hurt it in May if the results stay where they are now. 
  • As per usual, inflation was driven by medical costs and shelter. Those make up about half of CPI.
  • The fact that housing is the most important component of inflation and is above overall inflation makes it the number one category to follow. 
  • It’s a surprise to those who aren’t experienced with shelter inflation that it is hasn’t fallen recently because home price growth has cratered. 
  • Shelter inflation actually increased while home price growth fell. If the recent trend in home price growth continues, it will fall below shelter inflation for the first time since August 2012.
  • Commodities are 37.3% of CPI and services are 62.7%.
  • Rising jobless claims need to be monitored closely. You can look at weekly claims, yearly growth in claims, unadjusted claims, and the 4 week average to get the full picture.

5/10/19 – Trade War Impact On Consumer Prices, Stocks & Global Economy

  • You can look at which stocks declined to determine if the sell off is trade related.
  • We like to look at the Dow versus the Russell 2000, the semiconductors, and stocks like Emerson Electric to determine trade’s effect on the market.
  • You can also use soybean prices which are a key export from America to China.
  • One thing to keep in mind with the trade war’s effect on the market is it was performing well until now; there are corrections almost every year.
  • Specifically, in the past 40 years, 38 have had declines of at least 5%. There haven’t been any in 2019.  
  • With the global economy already facing cyclical headwinds, this trade war could be a fatal blow to the expansion. 
  •  the new tariffs, which is tranche 3, will hit consumer goods which is obviously a negative because the consumer drives about 2/3rds of U.S. economic growth.
  • Just like how China switched to Brazilian soybeans, American firms will need to switch to cheaper alternatives with this new tariff rate.
  • The trade war isn’t the main catalyst of a potential global recession as the global economy isn’t in good shape for cyclical reasons.  

5/9/19 – Lower Nominal Wage Growth Than Usual

  • The difference between the U6 unemployment rate and the U3 unemployment rate measures the percentage of marginally attached workers and workers who are part time for economic reasons.
  • a great jobs market that is weakening is the worst case scenario for stocks and the economy.
  • At the last bottom in April 2006, average hourly earnings growth for production and non-supervisory workers was 3.94%. It was 3.89% in October 2000. This cycle has had lower wage growth as it was 3.44% and 3.33% in February and March of this year. That’s one indication that the labor market isn’t as full as it was then.
  • The prime age labor force participation rate falling from 82.5% to 82.2% in April tells us that the decline in the number of employed people and the decline in the number of people in the labor force wasn’t mainly caused by workers retiring.  In October 2000 it was 83.6% and in April 2006 it was 82.8%. 
  • Low wage growth is being helped by minimum wage hikes at the state level. It’s also increasing because the employment to population ratio for people without a high school diploma is near a historic high.
  • Low wage workers are usually crushed by recessions and outperform at the end of expansions.
  • Keep in mind, that not only does wage growth underperform in recessions, the unemployment rate for low wage workers also spikes higher than it does for mid and high wage workers.
  • One new point we hadn’t previously considered is the effect of general merchandise stores’ wage growth on the calculation of low wage industry growth.
  • while low wage growth excluding general merchandise stores is elevated, it’s not nearly as high as the calculation that includes them.
  • The effect general merchandise stores have had on low wage growth has been heightened in the past 12 months.
  • average hourly earnings growth at general merchandise stores has soared, but weekly hours growth has plummeted. This decline in hours growth is similar to, but more pronounced than the decline in hours worked in the overall labor market. 
  • we review weekly earnings growth closer than average hourly earnings growth when reviewing the overall labor market.
  • While EPS growth was less than half the 3 year average, it was positive which ends the fears of an earnings recession in the near term.
  • The only issue with earnings season is it’s almost over.
  • Earnings won’t provide much of a catalyst for the overall stock market for the next 2 months.
  • That means investors will focus more on trade worries and economic reports which have been weak. 
  • The labor market is full according to the U6 rate minus the U3 rate. However, the prime age labor force participation rate disagrees.

5/8/19 – Job Openings Outpace Hiring Growth

  • Weak hiring growth indicates that businesses aren’t serious about filling job openings or there isn’t enough skilled talent to meet demand.
  • The gap between openings and hiring increased to a record 1.828 million as there were 5.66 million hires.
  • With the decline in weekly average earnings growth in April, in many industries it’s much easier to acquire talent if employers raise wages.
  • Before claiming there is a shortage of workers, recognize that every type of worker can be acquired for the right price and that labor dynamics differ vastly based on location and industry. 
  • Even though the savings rate fell from 7.3% to 6.5%, credit card debt actually fell in March, signaling the consumer isn’t taking too much risk.
  • trade volumes have fallen 2 straight quarters for the first time since the 2008-2009 global recession.
  • a full blown trade war could take 45 basis points off global growth which would be enough to push the global economy into a recession.

5/7/19 – US Earnings Season Was Above Average

  • Sometimes investors get confused about how earnings affect stocks.
  • Stocks trade based on future earnings expectations.
  • The latest earnings report gives us the best clue as to how that future will turn out.
  • Analysts make their estimates based on company guidance. That’s why changes to analysts’ forecasts correlate with stocks.
  • Some inexperienced investors might be confused why stocks usually rise while estimates fall. Estimates start high and meander lower.
  • If they fall at a slow pace or rise (which is rare), it’s good news; if they fall sharply, it’s bad news.
  • Saying stocks should fall because estimates fall would be the same thing as saying stocks should rise because estimates are beaten. Both are incorrect.
  • Aggregate estimates are almost always beaten. Companies usually give “beatable” guidance.
  • The final mistake investors can make is believing high, long term future estimates.
  • It’s not a positive if earnings estimates 12 months or further in advance are optimistic because they are usually strong unless the economy is in a recession.
  • Analysts often start with a base case scenario of about 8%-10% growth and work from there.
  • When comps are high, estimates are lower and when comps are easy, estimates are higher.
  • longest losing streak for global manufacturing PMI in 20 years.  Keep in mind, it’s not as weak as the 2008 financial crisis; it’s just a longer streak.
  • Further weakness would put the global economy at an increasing risk of a recession. Luckily, America is outperforming in both manufacturing and services.

5/6/19 – The Missing Stat Ignored By The Unemployment Rate

  • It always seems like whenever there is a bad report, the revisions are higher and whenever there is a great report, the revisions are lower. You can’t fully trust the initial reading of this report
  • the unemployment rate fell to 3.6% which is a 49 year low. It’s good to see that rate fall if jobs are being created; it’s not great to see that rate fall if people are leaving the workforce. Both occurred, but more people left the workforce than there were jobs created. 
  • There was an enormous 646,000 increase in the number of people not in the labor force. This sent down the labor force participation rate from 63% to 62.8%.
  • One way of looking at broad unemployment is – the U6 unemployment rate, which includes marginally attached and part time for economic reasons workers, plus the number of people not in the labor force divided by the civilian non-institutional population.  
  • As usual professional & business services and education & health services added the most jobs
  • the average weekly hours worked plus overtime hours for production workers in manufacturing fell 2.33% yearly. That growth is below the 2015-2016 recessionary low. It’s the worst growth rate since the financial crisis. The mitigating aspect is this reading faced the toughest comp since 2011; the comps will get easier from here.
  • If the labor market was as tight as the unemployment rate implied, we’d see higher wage growth. 
  • Since the overall labor force participation rate fell significantly, it’s no surprise that the prime age labor force participation rate fell. 
  • For all those people who complain about productivity growth being low because of a lack of investment – R&D investment growth and scientific research development services employment growth have spiked.

5/3/19 – How Much Stock Market Would Crash Without Stock Buybacks?

  • One big misnomer is that stock buybacks have caused a massive bubble in stocks. 
  • Buybacks are more responsive to profits than dividends because firms make sure to keep dividends manageable, so they will only be cut in an extreme situation.
  • the S&P 500 would only be 5% lower if the money used for buybacks was held as cash. So much for buybacks creating a massive bubble in stocks
  • The S&P 500’s total return would be 10% lower if buybacks were replaced with dividends. 
  • If buybacks were replaced with reinvestments, the S&P 500 would be 2% lower.
  • It’s very easy to claim firms should just invest their excess capital in their businesses. However, when you’re actually running the business you need figure out if the rate of return and the risk makes sense for investors. If it doesn’t, firms return the money to shareholders. 
  • 2019 has been an interesting year because both stocks and treasuries have rallied. Stock investors like when profits rise, which implies a strong economy. Bond investors like when growth and inflation are weak
  • real final sales growth to domestic purchasers was the lowest in 6 years in Q1.
  • Powell’s tenure has been unusual because, as the chart below shows, there have been zero FOMC dissents per meeting.
  • The last Fed chair with zero dissents per meeting was Thomas McCabe who was chair from 1948 to 1951. 
  • In August 2018, the PMI was in the 90th percentile. Manufacturing growth is weaker than last year, but it’s not as bad as it was in 2015 and 2016 during the last manufacturing recession. 
  • Global manufacturing employment growth was the weakest since September 2016. 

5/2/19 – Is Below Trend Inflation A Reason To Cut Rates?

  • The Fed Lowers IOER By 5 Basis Points, The goal is to regain control of the Fed funds rate.
  • A change of a few basis points doesn’t have a huge impact on the economy, but the market wants to know the Fed has control of the rate.
  • The Fed also directed the NY Fed’s Open Market Desk to conduct open market operations such as overnight reverse repurchase operations at an offering rate of 2.25% to maintain control of the FOMC’s target rate.
  • The reality of Fed statements is most of what is said is simply a statement of fact. 
  • Under Powell, the Fed is focusing more on press conferences and less on the statement. 
  • Inflation being below the Fed’s target isn’t news. It has been below the target most of this expansion. 
  • Powell Won’t Cut Rates Because Of Low Inflation
  • Positive economic growth and a low unemployment rate don’t beget a rate cut.
  • Remember, the Fed can get away with saying inflation is transitory because it bases policy on predicted inflation, not past inflation. 
  • Speaking of the stock market, this slightly hawkish meeting gave the signal that the stock market is on its own because the Fed won’t further support it by cutting rates. 

5/1/19 – Home Price Growth Falls To The Lowest In 6.5 Years

  • If the housing market weakens further, which isn’t what we think will happen, there isn’t much room for it to fall. Housing starts can’t fall much because they haven’t risen much this cycle
  • residential credit availability index is nowhere near its peak in 2006.
  • the real residential component of GDP fell 5 straight quarters and the economy isn’t close to a recession.
  • rising interest rates and a weakening labor market would hurt housing. The housing market isn’t impenetrable; it just won’t crash the economy like it did last time
  • With falling interest rates, housing started to become more affordable in some areas in a sequential basis. However, nationally, on a yearly basis, the situation actually got worse, although at a lesser rate.

4/30/19 – Inflation & Income Growth Implications On Fed Rate Cut

  • On an unrounded basis, core PCE is below core CPI by 48 basis points. The largest difference in the past 4 years was at the start of 2016 when core CPI was 84 basis points above core PCE. 
  • Inflation skeptics follow headline CPI the closest because it’s usually the highest. We use headline CPI as the deflator for real wage growth, but PCE works too. The key difference between the two is the Fed follows PCE closer than CPI.
  • with the decrease in the core PCE inflation rate, the real Fed funds rate is spiking. 
  • The past 3 cycles saw the real Fed funds rate deflated by core PCE peak much higher before rate cuts and recessions ensued.
  • the median FOMC estimate for the neutral real Fed funds rate is now below the real Fed funds rate. The difference is tiny now, but if core PCE falls a bit more, it could cause the Fed to either raise its estimate of the neutral real Fed funds rate or cut rates. We think the Fed is most likely to take the easy way out and change its estimate. 
  • the Fed doesn’t need to cut rates if inflation is weak. It needs to cut rates if the economy is very weak and the labor market is in trouble.
  • yearly real disposable income growth was 2.3% in March which was the lowest rate since early 2017.
  • when consumer spending growth is above income growth, the savings rate is likely to fall.
  • the lowest savings rate this cycle was 5.8% in February 2013. 
  • This savings rate could drop towards that of Feb 2013 if consumer spending keeps growing faster than income. It’s more likely that we see consumer spending growth drop than the savings rate crater. Neither are good things.
  • 5 year annualized growth rate of real personal income excluding government transfer payments. We look at this to ignore the effect of the government and focus on the private cyclical economy.  Usually when there is a big drop there is a recession.

4/29/19 – Everything Wrong With Q1 2019 GDP Report

  • The Q1 GDP report was controversial because of the effects of inventory, trade, and the price index, which is otherwise known as the deflator
  • We’ve already mentioned in previous articles how it’s problematic to rely too heavily on this report. It’s simply an estimate of what growth might have been in Q1.
  • This GDP report shouldn’t completely change your viewpoint on the economy. The economy has been in a modest slowdown and continues to be in one after this report was released. 
  • Q1 2019 had the fastest first quarter GDP growth since Q1 2015.
  • GDP growth has been above 2% for 8 straight quarters. That’s the longest streak since 2005.
  • On a yearly basis, this GDP report was fantastic as growth was 3.2% which was the highest rate in 4 years.
  • This headline reading signals no economic slowdown, but final sales signal otherwise. It was the lowest growth rate in 6 years, meaning this report supports the thesis that there is an economic slowdown.
  • Final sales exclude the effect of net exports and private inventories. 
  • even though nominal GDP growth fell, real growth rose because inflation fell.
  • real consumer spending growth was weak. 
  • We expect the housing market to improve in the next few quarters as real wage growth is strong and mortgage rates have fallen. 
  • according to the Housing Market Index, traffic to open houses fell in April, so this slowdown will be tough to overcome.
  • In the short run, inventories can wreak havoc on GDP growth. Investors try to ignore inventories because in the long run they have no effect on GDP. 
  • Consumer spending’s contribution to GDP growth has fallen 3 straight quarters and business investment’s contribution wasn’t strong either.
  • GDP growth was driven by productivity growth.
  • productivity’s quarterly annualized growth of 2% was double the average growth in 2006 and 2007.
  • Weekly hours worked wasn’t a factor which is good news because growing hours worked isn’t sustainable.
  • Population growth slowed. Population growth is a long run factor that has little to do with short economic cycles.
  • The employment to population ratio improved slightly as more people are working in this tight labor market.

4/26/19 – Historical Inflation Regimes

  • Inflation along with economic growth was more volatile in the 1800s than it has been recently.
  • It’s very clear that inflation spikes during times of geopolitical turmoil as there are embargos, tariffs, and war that prevent the production of commodities. 
  • we are living in a low inflationary environment compared to past decades because we live in a relatively peaceful time.
  • the Q1 homeownership rate in America fell from 64.8% to 64.2% 
  • Even though the economy has been in an expansion for almost 10 years, the rate recently bottomed in Q2 2016 at 62.9%
  • This Q1 2019 decline is probably a bump in the road on the way higher because baby boomers are living in their homes longer and a huge swath of millennials is about to be in the low 30s age group which is prime first home buying time.
  • It’s highly unlikely that the homeownership rate will hit the 2004 peak of 69.2% again because lending standards are tougher. However, it’s not out of the realm of possibilities to see it match the early 1980s peak of 65.8%.
  • Since 2014, low tier rentals have been seeing faster price growth than the overall market.
  • Low end rentals are defined as rentals that are less than 75% of the regional median.
  • the 6 month expectations index for the average employee work week fell from 13 to -5. This is the weakest reading since late 2015 when the manufacturing sector was in a recession.  

4/25/19 – US Fiscal Stimulus Declines While Stocks Rally

  • the almost 17 forward PE multiple on the S&P 500 is about 2 points above the 10 year average and slightly above the 5 year average.
  • stocks trade off the rate of change in analysts’ future estimates. These are based on forward guidance companies give out.
  • Companies gave out tragic guidance last quarter and are giving out sequentially improved guidance this cycle. 
  • Valuations come into play when measuring the delta of movements.
  • To be clear, the elevated forward PE multiple isn’t a red flag to get out of the market and start shorting. 
  • As of Tuesday, 74.4% of S&P 500 stocks were above their 200 day moving average. That’s the highest since February 2018. The cycle peak early in this expansion was 96%.
  • New home sales account for about 11.7% of the housing market. 
  • The number of new homes sold may have been juiced by builders giving out discounts as the median price of new homes sold fell
  • the ratio between existing home sales and new home sales is continuing to normalize.
  • the fiscal stimulus’ effect on GDP growth will fall throughout 2019 which means the economy needs to have a cyclical recovery to prevent this slowdown from getting worse.
  • the effect of the fiscal stimulus is highest in Q3 2018 and Q4 2018. It is projected to help Q1 2019 GDP growth by about 0.5%
  • On the positive side, Q2 earnings estimates have declined at a more gradual pace than last quarter. 

4/24/19 – Why Value Stocks Might Not Be Good Value

  • The biggest reason stocks are rallying is because the decline last year was a mistake, an overreaction to the economic slowdown. 
  • when the economy isn’t in a recession, bear markets are repudiated on average after 6.5 months. and 19 months if in a recession.
  • Value stocks have underperformed growth stocks this cycle. Some traders take this to mean the economic cycle is almost over. Some are simply buying value stocks and going underweight or shorting growth stocks.
  • going long value stocks is a de facto bet against tech and healthcare stocks.
  • the correlation between the ratio of value stocks versus growth stocks and the ratio of financials & energy stocks versus technology & healthcare stocks is high.
  • Value indexes rely on valuation metrics like P/E and P/B to pick their members.
  • Russell 1000 Value looks at P/B alone. S&P 500 Value looks at some combination of P/E and P/B.
  • Accounting rules generate book assets for the financial and energy sectors which give them low valuations. Tech and healthcare have less traditional assets and spend more on R&D.
  • This explains why value stocks have done so poorly versus growth stocks.
  • Chicago Fed National Activity Index showing the weakest 3 month average since May 2016. Anything negative means growth is below the long term trend. The index has been negative for 3 months. 
  • In the first 2 months of the year, traders who bought stocks were betting that estimates were crashing way too quickly. 

4/23/19 – Are Economic Depressions A Thing Of Past?

  • Saying that we are in a new era of booms and busts because of the huge stock market collapses in 2000 and 2008 is simply incorrect.
  • We are in a new era of placidness, not a new era of unpredictability. 
  • To be clear, it’s possible that stocks will fall as much as they did in the past two recessionary bear markets again.
  • The 2008 financial crisis was the worst recession since the Great Depression, but from 1870 to the Great Depression there were 6 deeper recessions. 
  • the number of “new homes sold, but not yet started” has increased. It’s not a logical leap to expect starts to increase after “houses sold, but not started” increase
  • the number of new home inventories that have not yet started has spiked substantially. Therefore, new home inventories under construction should increase soon
  • The inventory of potential starts and the demand for new homes signal a rebound in the housing market in the next few months.
  • Bidding wars for houses are much less prominent in 2019 than they were from 2016 to mid-2018 as the chart below shows. This reflects the transition from a sellers’ market to a buyers’ market.
  • because earning estimates are usually cut, the estimates will point to negative Q2 growth soon.

4/22/19 – Is Deflation Dead?

  • Thinking one long cycle means recessions have been abolished is falling into the trap of recency bias.
  • This cycle has been helped by the consumer’s deleveraging.
  • If the consumer would have leveraged up, annual growth would have been higher, but then there would have been a risk of a bust like in 2008.
  • Low leverage might have allowed the past 3 slowdowns during this long cycle to not turn into a recession
  • The expansion has also been helped by the fact the labor market started with a lot of slack (supply) as the recession of 2008 pushed up the unemployment rate and made many people give up looking for work, so they weren’t counted as unemployed.
  • Even after about 10 years, the prime age labor force participation rate isn’t at the previous cycle’s peak. 
  • Another factor that has lengthened this cycle is the lack of sustained above trend inflation. 
  • Low inflation allows the Fed to keeps rates at or below the long run rate instead of setting hawkish monetary policy that stifles economic growth.
  • The economy’s reliance more on services and less on manufacturing has made it less volatile
  • We use manufacturing as a leading indicator, but it has become noisier since manufacturing has been shrinking as a percentage of the economy. 
  • Even when manufacturing hemorrhages jobs, it’s no match for the normal job gains in healthcare and education. 
  • Year over year nominal services growth has only been in a recession once since the Great Depression, while goods PCE has been in a recession 6 times.
  • yearly real services PCE growth was only in a recession in 2008. 
  • In the same sense, services PCE inflation is less volatile than goods PCE inflation.
  • Goods inflation has mostly been below services inflation. This partially explains why bouts of deflation have become much rarer.
  • While the ECRI leading index called for a slowdown, Q1 GDP growth doesn’t look problematic as of mid-April. 
  • Keep in mind, GDP gets updated a few times, so the initial reading can be way off.
  • Housing is a leading indicator for recessions. It seems like the call is still being made for one sometime in 2020 or 2021.
  • Keep in mind that the housing market isn’t as big as last cycle so it can’t do as much damage to the economy.

4/19/19 – Industrial Production & Retail Sales Review

  • Despite the ECRI leading index being helped by the stock market, it has a great track record, so don’t scoff at that contribution.
  • The ECRI leading index is more updated than the Conference Board index which means it’s possible the Conference Board index starts to forecast growth acceleration in late 2019 in future reports.
  • It’s starting to show us the possibility of an economic growth turnaround late this year into early next year.
  • the leading index’s 6 month growth rate is barely positive and it’s below the coincident indicator’s growth rate.
  • There’s a huge difference between industrial production and industrial stocks.
  • We still follow hard data reports like industrial production even if it looks like the market doesn’t care. 
  • the weighted 3 month average of manufacturing sub-sectors that are contracting isn’t elevated.
  • manufacturing is still growing. It’s just much weaker than it was last year. This probably isn’t a manufacturing recession yet.
  • March retail sales report was fantastic, especially the all-important core results.
  • the importance of the spring home selling season is important – peaks in activity are usually in the spring.
  • The housing market index is a sentiment index for home builders.
  • the healthcare sector is plummeting. The performance relative to the market is the worst since 2013 as the S&P 500 is up in the mid double digits and the healthcare sector is flat/down.
  • In the 2020 race, the GOP will have 22 Senators up for re-election and the Dems will have 12. The map is better for the Dems than in 2018, but now they are starting with the Senate at 53-47 in favor of the GOP.

4/18/19 – The Truth About IPO’s

  • All we care about is finding the truth.
  • What’s interesting is that more people are interested in supporting their existing preconceptions of reality than they are to question them.
  • Most people believe they have already discovered their version of the truth, and its very difficult to change your opinion if data shows your previous views may be incorrect.
  • But that is our only purpose, to seek the truth, as the data shows, whatever it may be, without letting our preconceptions hold us back from discovering it.
  • IPO data can be manipulated to support whatever narrative you want.
  • Many bears/skeptics complain that the number of public companies has fallen below that of the late 1990s. That could mean competition has fallen as industries become centralized.
  • the percentage of IPOs making no money is at a record high.
  • Either you have money losing companies going public like in the 1990s or have fewer firms go public. Skeptics can’t have it both ways.
  • The issue who is to say what is a high number of public companies?
  • Skeptics complain about these firms being private, but then when we see their financials, they complain they aren’t good enough to be public.
  • Keep in mind, you’re the last investor that is investing in IPO’s, at a much higher (usually) valuation than everyone else who got in before you.
  • the IPO market isn’t showing signs of euphoria like in the late 1990s. 
  • the U.S. listed IPOs in 2018 with market caps above $500 million, 33% were net income positive and another 8.5% were free cash flow positive while having negative net income.
  • 134 firms had their IPO in 2018. The peak this cycle was 206 in 2014. 
  • The median age of IPO companies in 2017 and 2018 was 13 and 12 years, respectively. The average is 7 years old. In 1999, the median age was only 4.

4/17/19 – No More Recessions Ever Again?

  • Now that the recession scare is over, the chatter on Wall Street is about how there might not be a business cycle any longer. 
  • There is a tendency to extrapolate previous events onto the future and exaggerate claims to make the news and sound intellectual. 
  • A long expansion shouldn’t change your viewpoint of expansions because there is no defined length of time recessions and expansions must last. This isn’t the longest expansion in world history.
  • Fund managers almost always need to invest in something and can’t underperform for long. They face career risk if they take a big stance against the market and are proven wrong. Being a fund manager can hurt performance because investments don’t play out on a consistent predictable time table.
  • Some individual investors underperform because they don’t question themselves because they can’t get fired from managing their own money. Sometimes when investors are wrong, they seek out evidence to support their failed thesis, putting them in a bigger intellectual hole and causing them to underperform because they don’t correct their initial mistake.
  • fund mangers stepped up their equity exposure and lowered their cash stake because they needed to chase the market. This is bad news for investors that are bullish because there are less bearish investors that can invest into the market (convert to bullish) to provide fuel for a rally.
  • Growth in China has spiked a few times since 2013, but each increase was only part of a long term trend of declines. 

4/16/19 – Beginning Of New Economic Expansion?

  • The difference between the 10 year yield and the 2 year yield never inverted and the percentage of the curve that was inverted never got to threatening levels.
  • Also, its important to point out the the length of time that the curve is inverted matters, which was also a nonevent. The longer it’s inverted, the greater risk it poses to the economy. 
  • Since late March, yields have soared which implies expectations for nominal growth improved.
  • Global fund manager survey shows about 85% of respondents stated the U.S. yield curve inversion doesn’t signal there will be a recession in 2019.
  • There’s a tendency for recession calls to be about 2 years in advance. That prediction is long enough in the future to not need to be supported by near term data, but close enough to signal worries are high.
  • There isn’t evidence of a recession this year.
  • The lack of consumer leverage has prevented potentially 3 slowdowns from becoming recessions (if this slowdown ends without one).
  • Investors are the most overweight utilities and for good reason. Rates have fallen along with growth. Low rates make utilities’ dividend yields attractive as they trade like bonds. 
  • net percentage of fund managers expecting a stronger global economy in the next year fell to the 2008 recessionary lows in late 2018/early 2019.  
  • The global economy may have fallen into a recession sometime in 2018 or 2019. These managers weren’t wrong.
  • the OECD global leading indicator fell lower in February 2019 than the previous 2 troughs earlier in this cycle.
  • This OECD leading indicator might be near a trough rather than being on the cusp of another 2008 like crash.
  • the number of countries out of 18 with leading indicators rising has increased in the past couple of months. This type of bottom is usually the start of an intermediate term rally in stocks.
  • The U.S. ECRI leading index suggests the U.S. economy will recover in late 2019/early 2020.
  • You won’t make much money if you wait until the economy looks great to buy stocks.

4/15/19 – Which Economies Are Slowing/Accelerating?

  • Stock prices aim to reflect future changes to earnings. 
  • Sometimes they don’t accurately reflect future earnings; that is where alpha is generated. 
  • The ECRI leading index is supposed to project how the economy will do 2-3 quarters in advance.
  • The ECRI growth rate almost hit recessionary levels at the start of this year. This implies economic weakness in Q2 and Q3 of this year.
  • The ECRI coincident indicator’s growth rate bottomed at about 1% in the summer of 2016. February shows yearly growth of 2.2%.
  • This index is proprietary, so we can’t pick apart each contributing factor to see if we agree with it.
  • Regardless of whether the slowdown ends soon, it doesn’t look like it will end in a recession based on this leading index.
  • Q1 EPS estimates have been beaten soundly, but revenues barely beat estimates. That’s likely because EPS estimates were low and revenue estimates were high.
  • Sales are always beaten at a lower rate, but this time the difference is much larger than usual. 
  • The number of firms mentioning currency issues led the list of excuses just like Q1. Remember, these are the same firms reporting earnings in the beginning of the quarter. In these industries, there must be labor constraints. That’s consistent with the low unemployment rate and high average hourly earnings growth. 
  • In the short run, China could be rebounding slightly, but in the long run growth is slowing as the country faces issues with transitioning into a service based economy instead of one based on exports.
  • China wants to build up its middle class rather than being the home of cheap labor.
  • China will contribute an enormous 30.9% to global growth because of its size and high growth rate.
  • Over the next decade, the torch should be passed from China to India.
  • India is expected to grow GDP at the 4th highest rate as it could be 7.7%
  • India has much better demographics than China. China’s median age is 37.3 and India’s is 27. 
  • India’s working age population will increase by over 200 million and China’s will fall by over 200 million.
  • India’s population is expected to exceed China’s by 2024.

4/12/19 – A Great GDP Doesn’t Solve Retirement Crisis

  • Reports that include everything, such as GDP, tend to miss out on the intricacies of the economy.
  • You can have high GDP growth, but low wage growth and low productivity growth. 
  • To be clear, the Fed has a dual mandate of keeping prices stable and having low unemployment.
  • Strong GDP isn’t one of the Fed’s goals, but it is pivotal to all economic policy. If GDP is focused on less, different policies might be enacted.
  • GDP just measures the whole economy, but not who is prospering.
  • Since the goal is prosperity, maybe GDP shouldn’t be that important.
  • Not relying on GDP growth for all policy decisions would be prudent, otherwise if you measure the economy ineffectively, you get ineffective policy.  
  • Back when baby boomers were in their 20s, the internet didn’t exist. There weren’t low cost ETFs and robo advisors. That means it’s easier to save now than before. 
  • On the other hand, pensions are increasingly less prevalent which means people have no choice but to save themselves.
  • In 1979, 84.4% of private sector workers participated in a retirement plan with a pension. In 2000, that fell to 40%. As of 2014, that was only 27.7%.
  • 29% stated they never plan to retire.
  • 24% said they don’t know when they will retire.
  • 26% stated they will retire at 70 or older. 
  • only 55% of boomers have retirement savings. 
  • of the boomers with retirement savings, 28% have less than $100,000.
  • GDP isn’t all policy makers need to look at to set fiscal and monetary policy. We must focus on the details and look at other metrics. The goal is a higher standard of living, not a higher GDP number.   

4/11/19 – Housing Market Forecasts Economy

  • The housing market is looking strong this spring selling season. This improvement could help the real residential investment component of GDP. 
  • the MBA purchase applications index has been in an uptrend for a few years.
  • Consumer opinions on the housing market improved in Q1 2019
  • Refinancing has increased in the past few weeks, but it is low compared to earlier in this cycle.
  • mortgage delinquencies have fallen to 10 year lows.
  • There were 3 important takeaways from this inflation report. Firstly, services inflation dominated commodities inflation. Secondly, sequential price growth improvement was seen in food and energy. Therefore, headline inflation will soon rise above core inflation. Finally, shelter inflation was still high despite the weakness in home price growth.
  • The housing market is strengthening which should boost the real residential investment component of GDP in Q2.
  • Housing leads the economy by the most out of the leading indicators.
  • If the housing market is turning around, we need to restart the countdown clock for the next recession.
  • Inflation isn’t an issue for the Fed. For now, the Fed can get away with not hiking rates. That’s allowing stocks to rally and the economy to potentially get out of this slowdown without a recession.

4/10/19 – Are Indentured Servant Student Loans Worth It?

  • One of our previously held beliefs which was changed by research was that we thought buyback blackout windows caused stocks to fall. That turns out not to be the case. 
  • The time it takes to recoup a bachelor’s degree hasn’t increased in the past three decades.
  • It actually takes less time to recoup the cost of a degree now than in the 1980s. 
  • the college affordability crisis is more about financing than the increase in tuition prices or stagnant incomes. Parental assistance has been replaced with student loans. Loans with high interest rates cause wealth to shrink rather than accelerate through compound interest.
  • When students agree to share their future income with an investor instead of taking out student loans it can be considered a partial indentured servitude. We think of this deal as a bet against yourself achieving great income growth
  • The Income Sharing Agreement (ISA) market is only worth tens of millions of dollars while the overall student debt market is worth $170 billion. 
  • The spread between openings and hires fell for the wrong reason. It was down over 400,000 to 1.391 million. We want to see hires increase, not openings decrease.
  • The state and local government’s quit rate in the education industry increased to the highest level since at least 2000.
  • Usually quits increase when wage growth is high and the labor market is fluid. In this example, the quit rate is elevated because of poor pay as there are large teacher’s union strikes across the country.

4/9/19 – Negative Economic Signals Credit Score Inflation & Incorrect GDP Estimates

  • One of the biggest risks to the economy is that many banks and other institutions have lower lending standards than they think
  • In this cycle, loans look good because borrowers have a seemingly high credit score. However, if most consumers have a high score, what does it really mean? 
  • The improved labor market doesn’t explain why the average score is higher than it was before the financial crisis. Part of the reason scores are higher could be that consumers are less leveraged this cycle.
  • Credit reports can only include a contract or an agreement to pay
  • FHA is looking to clamp down on underwriting standards. 
  • If credit scores are in doubt, the best way to look at borrowers is debt to income. About 5% more borrowers have a debt to income ratio above 50% than at last cycle’s peak. To be clear, this is for government backed loans; private lending is in much better shape.
  • Temporary professional and business services payrolls might hold the key to future economic performance because it is easier to let go temporary workers than permanent workers.
  • Weakness in temp payrolls could be a negative signal for the economy going forward.  
  • The initial GDP report is similar to an educated guess at how the economy did
  • Initial and even final GDP reports are meaningless in big recessions. 
  • It took until 2010 for the BEA to recognize growth was negative in Q1 2008. 
  • The stock market is showing potential overvaluation relative to economic signals.  That doesn’t signal anything about short term returns as overvaluation often begets more overvaluation. It’s just worth noting.

4/8/19 – Median Unemployment Duration & March BLS Review

  • It’s important to recognize large variances in the initial jobless claims report are normal.
  • Manufacturing sector job creation has been weak in the past 2 months which supports the sequential decline in the Markit manufacturing PMI readings in February and March. 
  • The manufacturing sector is much more sensitive to changes in the economy than the education and health services.
  • The biggest contributor to job creation (education and health services) isn’t economically sensitive partially explaining why the BLS reading isn’t a leading indicator. 
  • The criticism of the BLS report for not leading the economy is unfair. Just because it doesn’t lead, doesn’t make it unimportant.
  • The BLS reading is a product of inflows and outflows, while it’s job openings and hiring that get cut first. That also makes it not a leading indicator.
  • If you think of yourself as a manager, it’s easy to see why economic uncertainty would cause a slowdown in hiring and that it would take significant weakness to start firing workers.
  • unemployment rate and underemployment rate were both unchanged at 3.8% and 7.3%.
  • The underemployment rate is at a cycle low and the unemployment rate is a tick above its cycle low.
  • We follow the prime age participation rate (unchanged at 82.5%) the closest because it’s not affected by changes to demographics unlike the labor force participation rate.
  • On this basis, the labor market is tightening but there is still slack left.
  • The overall participation rate is lower than recent cycles because the median age in America is increasing and because teenagers don’t work as much. 
  • Those 55 and older have seen job gains of 36.3% since January 2009, highest of any age group.
  • The median year over year change in the duration of unemployment increased for the first time since July 2016. This was the biggest yearly increase since 2011.
  • The difference between the unemployment rate for those without a high school diploma and those with a bachelor’s degree and higher has been below 4% since January 2018. It has never been this low for this long. That’s the benefit of a very long expansion.
  • Real wage growth helps the consumer, but pay raises hurt businesses’ margins especially those that are labor intensive. 

4/5/19 – What Jobless Claims Mean For Stock Market Returns & Employment

  • jobless claims as a percentage of the labor force has been making new record lows for years.
  • The bad news about low jobless claims being low is they don’t necessarily mean great stock returns are coming soon.
  • The best situation for stocks is high claims are that are falling and the worst is low claims that are rising.
  • Interestingly, when claims are at a new 3 year low and the stock market is within 5% of its 3 year high, returns are one standard deviation below random.
  • Whether jobless claims are increasing slightly or at new cycle lows isn’t nearly as important as the question of whether jobless claims accurately reflect the labor market. It’s not a surprise that some analysis says they don’t since it’s a pretty big stretch to say this is by far the best labor market since 1969.
  • This isn’t a bad labor market, but the prime age labor force participation rate isn’t as high as it was in the 1990s and real wage growth isn’t at a record high. 
  • layoffs and discharges aren’t high, but they also aren’t at the lowest level since 2006.
  • The Challenger Job-Cut report actually signifies there might be a problem in the labor market as announced layoffs were at a 4.5 year high in Q1.
  • Claims being historically low doesn’t mean the labor market is historically great because fewer people are applying for benefits. 60% of recently laid off workers in early 2018 applied for unemployment benefits. That’s below the 75% rate in the prior two expansions.   
  • States have made it harder to get benefits, the size of benefits has decreased, and the duration of benefits being paid has fallen in some states. It’s easy for a state to make cutbacks on these benefits when the labor market is strong, but when it is weak, people will demand that benefits increase.
  • The problem for state budgets is states can’t count on paying out lower benefits in a recession. Plus, the higher jobless rate will hurt their revenue intake. Unsurprisingly, if a state can’t make do in good times, it will severely struggle in bad times.
  • Manufacturing PMI’s do not show the full picture of the economy.
  • Chinese growth in nominal fixed asset investments, infrastructure spending, and industrial production have all improved on a 6 month over 6 month annualized basis.
  • The global economy definitely slowed in 2018, but it might be improving now as the service sector improved.

4/4/19 – Weak Job Creation & Mixed Services PMIs

  • The ADP report missed estimates, but it was significantly higher than the February BLS reading, so it doesn’t have predictive value
  • most macro analysts still follow the manufacturing sector even though it has shrunk as a percentage of the economy. That might be because it is more sensitive to changes in the economy. The sector can be a signal of an incoming change of either weakness or strength.
  • While education and healthcare employ more people than construction, it’s not volatile category. It won’t be the first category to signal a phase change in the economy.
  • the 5 month decline in 30 year interest rates was the largest since 2010.
  • the latest economic reports out of America, emerging markets, and the G10 nations have been missing estimates.
  • The surprise indexes for the G10 and U.S. are at post-recession lows. Missing estimates by the most since the financial crisis isn’t the same as growth being the slowest since then, but it’s far from a positive. 
  • the accelerate that started in durable goods in 2017 looks to be ending

4/3/19 – Positive & Negative Of Corporate Earnings Trends

  • the rate of change in the decline in earnings estimates has moderated
  • Guidance is much better than last quarter. 
  • The results aren’t as good as 2018, but that was a very rare moment catalyzed by the tax cut.
  • Low single digit declines are a good thing.
  • every single Fed tightening cycle has ended with an earnings recession except in 1994.
  • In the mid-1990s consumer credit exploded with the highest yearly growth being 15%. 
  • The mid-1990s was the start of the housing bubble. That bubble extended the expansion to 10 years.
  • This time American consumers are deleveraging, the Eurozone’s household debt to GDP ratio is falling, and China’s investments to GDP are falling.
  • The same debt driven catalysts that existed on the consumer side in previous decades are less of a factor today to prop up corporate earnings growth.
  • The average earnings decline in mild recessions is only 9%.  That leads to an 18% decline in stocks.
  • The average deep recession causes a 25% decline in S&P 500 earnings and a 33% decline in stocks.
  • The earnings recession during the financial crisis took down earnings by 45%. That was by far the biggest decline in earnings since 1948. 
  • Interestingly, if there’s a mild recession, the average stock market decline is less than the Q4 2018 bear market. 
  • Over 20 year annualized basis across asset classes, the S&P 500 increased 3.7% more per year than investors’ portfolios. That’s a huge difference when gains are compounded.
  • You can either invest a portion of your funds on your own, while having a large percentage in an index fund or you can change the stance of your portfolio depending on your macro viewpoint. For example, you can boost your long bond exposure if you see a slowdown coming. Those small shifts avoid huge underperformance risk.
  • discount sales growth and the orange line shows department sales –
    The difference between the two as measured by the white bars is the largest since the financial crisis. 
  • This means the consumer isn’t doing as well as the headline Redbook reading suggests. 
  • the next recession probably won’t lead to another 45% EPS decline because there aren’t consumer bubbles keeping this economy afloat like in previous decades. 

4/2/19 – Weak Retail Sales & Mixed Manufacturing Reports

  • The stock market may have increased because it was the first day of the month and the quarter. Since 2003, the S&P 500 has increased 75.6% on the first day of the month.
  • It is said automatic investments cause this great performance. You could set your automatic purchases to the last day of the month to make this extra money.
  • Retail Sales Control Group vs. Personal Consumption Expenditures: comparing the 3 month average monthly growth in the control group for retail sales with personal consumption expenditures quarter over quarter growth implies PCE will be weak in February and consumption growth will be weak in Q1.
  • ISM new orders index was significantly above the Markit new orders index in 2017 and 2018.
  • New order growth is close to the 2016 lows.
  • The ratio of new orders to existing inventory fell to the lowest level since June 2017. This implies April might be weak as well.
  • the share of ISM components improving over the last 6 months has been above 50% since 2010. That’s the longest steak in history as even the 1990s expansion couldn’t top that.
  • Cyclical indicator shows probability of a downturn is the highest since 2005. 
  • the unemployment rate isn’t as good as the prime labor participation rate at measuring the labor market.
  • It’s better to look at the percentage of the curve that’s inverted than the 2s 10s curve.

4/1/19 – Is The Stock Market Right To Rally In Q1 2019?

  • The S&P 500 increased 13.07% in Q1 2019 which was the best quarterly increase since Q3 2009. 
  • The main catalysts of this equity rally in the beginning were the fact that the economy wasn’t going into a recession, the Fed’s transition from being hawkish to dovish, and the potential end of the trade war.
  • The continuation of the rally is based on the thesis that economic growth will rebound after this weak Q1.
  • The ECRI leading index is now starting to show one of the first signs that this slowdown will end.
  • the ECRI leading index still implies growth will be weak in Q2 and Q3 because it projects growth 2-3 quarters ahead of time. The improvements now are all about late 2019 and early 2020. 
  • The level of euphoria in the market is subjective. You can look at moving averages, PE multiples, price returns, or other oscillators. For example, the CNN fear and greed index is at 49 which is neutral. 
  • Another indicator not close to showing froth is NYSE margin debt.
  • It’s a chart crime to look at nominal NYSE margin debt; margin debt should be looked at as a percentage of the overall market. 
  • Margin debt as a percentage of the Wilshire 5000 is about 2% which is a 13 year low.
  • In 2008, it briefly peaked at 2.8%.
  • YoY margin debt growth is a solid measurement of euphoria.
  • The current market is dramatically different from those peaks as margin debt is down yearly.
  • The Merrill Lynch fund manager survey showed cash positions were the highest since January 2009.  
  • The 3 month average of new home sales was 630,000 which is the best since last June.
  • recently homebuilders have been moving towards building homes at lower price points
  • The new home price premium to resale is the lowest since 2009 as it is below 25%. However, it is still above the long run average of 17.1%.
  • You can spot a perma bear if he/she only cites the Conference Board survey and you can spot a perma bull if he/she only cites the University of Michigan report. We study both because we’re focused on the truth rather than trying to push a thesis that isn’t fully supported by evidence.
  • the expected change in real income is historically high.

3/29/19 – Jobless Claims Are Amazing. Why Be Bearish?

  • Q1 S&P 500 earnings are set to show a yearly decline as firms are facing extremely tough comparisons.
  • It’s worth noting that right before earnings season estimates usually drop so that most estimates end up being beaten.
  • It’s not that there are nefarious analysts out there trying to trick you into buying stocks.
  • Instead, firms give beatable guidance and analysts base their models on what firms project.
  • Smart investors follow the trend in estimate revisions to make sure they aren’t fooled. We follow estimate trends of the overall index. 
  • technology led the pack with negative revisions this quarter as the semiconductor industry is weak and the global economy is pulling down firms with international exposure which tech leads the pack in.
  • That being said, this isn’t a disaster because tech usually leads the pack in this category. Its 5 year average of firms with negative revisions is 20.2 which is the highest out of any sector.
  • Healthcare had the highest differential of negative versus positive revisions. The healthcare sector saw 14 more negative revisions than positive ones; its negative revisions were 5.9 above its 5 year average which was the worst differential versus a sector’s average.
  • The best differential between Q1 guidance and the 5 year average was industrials which had 6 negative revisions this quarter and has 10.1 on average.
  • (Talking about Jobless Claims) the 4 week average fell from 225,000 to 217,250. The 4 week average is only 6,750 above the cycle low in September. It’s very wrong to cite that bottom as somehow meaningful.
  • Investors sometimes joke that you could only follow the jobless claims and be a great investor
  • Pending home sales experience the 14th straight month of annual decreases.
  • Analysis that predicts recession probability based on yield curve probability is the same as saying there will be a recession because the business cycle is too long. This is only one metric using just a few data points. You should be skeptical.
  • be careful of assuming there will be a recession a couple years from now because this goalpost can easily be moved to 2022 and beyond.
  • Jobless claims are low. If they correctly forecast a solid March labor report, predictions for a recession will die down even with some parts of the yield curve inverting. 
  • Earnings will decline slightly on a yearly basis in Q1, but it’s far from a disaster as revenue growth will be solid and Q2 growth is expected to be slightly positive.
  • Look at the effect Q1 guidance has on Q2 estimates to formulate your investing opinion.
  • Interestingly, the 10s 2s curve says there might be a recession soon, but most economists don’t see it yet

3/28/19 – Yield Curve Not Signaling A Recession

  • 10 year bond yield is projecting 1.4% GDP growth in the next year which is below the blue chip estimate for about 2% growth
  • With some of the yield curve inverting, there are debates among investors over which parts of the curve to follow. We think it’s best to follow every part by looking at the percentage of the curve that has inverted.
  • only about 30% of the curve has inverted which doesn’t meet the peaks prior to the past 4 recessions.
  • Each of the last 3 peaks has been lower than the previous one. If that trend continues, the percentage still needs to increase from here to forecast a recession.
  • 18 months following the yield curve inversion in the past 5 cycles, on average real EPS growth was -9.3%. It was -0.2% after 12 months and 2.5% after 6 months. This explains why stocks don’t immediately fall after inversions.
  • The initial GDP report is a summary of economic output subject to revisions. Some say the revisions make it worthless because by the time the revisions are released, the quarter is far in the past.
  • Whether you follow GDP or not, it’s safe to say it’s not a good arbiter of whether a recession is coming or even if it is underway.
  • the GDP growth initially reported prior to the last two recessions didn’t indicate a recession was coming.
  • Currently, ECRI isn’t forecasting a recession this year; its leading index’s growth rate has improved, but is still negative.
  • (Talking about housing) Borrowers are the most qualified in this cycle than any other one throughout history. Prices can fall, but there won’t be a surge in defaults like in 2008.
  • Investors are beginning to project rate cuts, but the Fed funds futures market has a terrible track record of predicting intermediate term rates.

3/27/19 – Buying Plans For Houses & Autos Increase

  • Some economists only follow what consumers say about the labor market because that’s what consumers know best
  • mentions of labor market costs on quarterly earnings calls have been elevated in the past few quarters.
  • Job creation needs to meet its 3 month average to help confidence. 
  • The South is the biggest housing market.
  • Chinese manufacturing new exports orders are declining at the quickest rate since 2009.
  • Consumer confidence was mostly weak, but the Redbook same store sales growth improvement in the back half of March signals retail sales growth could be solid. 
  • In China, 2019 GDP growth is set to be worse than 2018 growth despite the stimulus.

3/26/19 – Sectors That Outperform In Yield Curve Inversion

  • The yield curve is important because not only is it an economic indicator, it also impacts the economy.
  • The banks’ ability to conduct normal operations where they lend long and borrow short is affected by the curve
  • An inverted curve lowers net interest margins, discouraging lending. When firms don’t have access to capital, economic growth halts.
  • the smaller the bank is, the more it is impacted by a flattening yield curve.
  • If you had forecasted this recent yield curve flattening, you could have shorted the KBW small bank index and went long the XLF (as a hedge in case the curve didn’t flatten)
  • The banks also don’t like the recent decline in rates. When rates rise, banks can raise rates on loans quicker than they do on savings accounts. 
  • the long term historical median relative PE of the large cap bank stocks is 76%.
  • The current relative PE is 57% which puts the banks near the cheapest valuation relative to the market in 40 years. They were only cheaper in the early 2000s. 
  • therefore, the banks might decline less than the market if there is a recession when the yield curve steepens
  • It’s worth noting how regulations and banking have changed in the past 40 years. This is far from a perfect indicator that guarantees future outperformance.
  • not as many have inverted this cycle as they have prior to the last 4 recessions. 
  • Another important distinction of this cycle is the curve has gradually inverted instead of sharply inverting.  The fact that it hasn’t come as a surprise may help banks cope with the issue. 
  • the difference between the 10 year yield and the 30 year yield is already starting to increase. When the curve steepens, it’s a sign of an ongoing recession.
  • sometimes steeping doesn’t mean much such as in early 2015. When the difference gets close to an inversion, and then steepens, it’s more likely to mean something negative.
  • consumer staples outperform the overall market after the yield curve inverts because consumer staples flourish in a ‘risk off’ environment
  • the last two times the 10 year yield fell below the 3 month yield, the XLP staples ETF outperformed the S&P 500 by 27.6% and 24.53%. 
  • professional and business services temporary employment divided by all workers not in this category is compared with the civilian unemployment rate. When the temporary worker ratio rises above the civilian unemployment rate, it’s a recessionary signal. This indicator isn’t close to waving a red flag.
  • Just buying the S&P 500 isn’t passive investing. That’s actively picking an index you think will outperform the world
  • The economy probably isn’t in a recession now because the temporary help ratio is below the overall civilian unemployment rate.

3/25/19 – The Yield Curve Inverts: Average Stock Market Returns, Recession Risk & Rate Cut Probabilities

  • the spread between the 10 year yield and the 3 month yield went negative which means the yield curve inverted.
  • The concept that bonds are the ultimate arbiter of economic truth needs to be thrown out. There is short term momentum driven mispricing in this market just like stocks. 
  • Treasury yields are being pushed lower by the decline in global yields as the German 10 year bond yield went negative for the first time since September 2016. 
  • There is $10 trillion in negative yielding global debt outstanding. 
  • Despite the rallying stock market and record high leading conditions index, the decline in yields suggests growth and inflation will fall just like the fund managers survey suggested. 
  • Many economists consider the 1998 inversion to be a false alarm because it was far ahead of the 2001 recession, which was 3 years early.
  • However, the stock market peaked in March 2000, which was 18 months after the inversion.
  • The cumulative average returns aren’t tragic like many bearish investors project as stocks increase 9.2% in the next 24 months after this inversion.
  • The worst sequential period for stock market returns following an inversion is from 24 to 30 months where they fall 5.7% on average.
  • there is a 70.3% chance the Fed will cut rates at least once in 2019.
  • Markit March PMI was disappointing 21 month low for manufacturing PMI and larger than expected services decline and a 33 month low for output. This overall PMI was weak in rate of change terms, but still projects over 2% Q1 GDP growth which is above the consensus.
  • Manufacturing output and PMI output index in Germany declined sharply both hitting a 79 month low. Even though the services index only fell slightly to 54.9 from 55.3, the composite index fell from 52.8 to 51.5 which was a 69 month low.
  • ECRI signals a weak Q2 and Q3, but a potential end to the slowdown late in the year or early next year.
  • The February existing home sales report signaled low rates might finally be helping housing as sales increased from 4.93 million to 5.51 million which was a 11.8% monthly gain. Expectations were for 5.1 million making this the biggest beat since at least 2005. 

3/22/19 – Key Recession Signal That’s Not The Yield Curve

  • investors buying stocks at current levels believe the decline in earnings will begin and end in Q1 2019.
  • Q1 2019 earnings results won’t be great, but the market is looking past that. 
  • On average, the S&P 500 recovers from bear markets in 6.5 months when the economy isn’t in a recession. The September top was about 6 months ago meaning the rally is right on schedule.
  • The leading indicators index increased for the first time in 5 months in February
  • The key recession signal where the coincident indicators surpass the leading indicators hasn’t been triggered.
  • Since the leading index is back to its record high, it means the recession signal, which measures the time the index is away from its record high, is off the clock.
  • The leading index has peaked a median of 10 months before the following recession, implying the next recession is at least 10 months away.  
  • In March survey, only a net 3% of fund managers were overweight equities.
  • The net percentage of fund managers expecting short-term rates to increase fell to a 6 year low. 
  • Now being short European equities is the most crowded trade.
  • The percentage of fund managers who stated they want firms to increase their capex fell to a 10 year low.
  • If you think the economy will falter, you wouldn’t want firms to expand their operations.
  • However, the outlook wasn’t extremely dire because the desire for firms to return cash to shareholders increased at the behest of wanting them to improve their balance sheets.
  • In a recession, the strength of a firm’s balance sheet is critical because credit markets seize up.
  • regional Fed indexes help us predict the ISM PMI
  • March regional Fed reports don’t tell us anything about manufacturing yet.

3/21/19 – Fed Funds Rate To Stay Below The Neutral Rate

  • At its March meeting, the Fed did exactly what most prognosticators expected it to do as it didn’t raise rates, it lowered 2019 hike guidance from two to zero, and detailed how it would end QT. 
  • Specifically, the Fed will shrink the size of the balance sheet unwind to $15 billion per month from $30 billion per month starting in May, and QT will end in September.
  • It’s just worth pointing out here that when a result meets estimates, it doesn’t always mean the corresponding asset won’t move.
  • the expectations for GDP growth, the unemployment rate, PCE inflation, and core PCE inflation didn’t change much, but interest rate guidance changed sharply.
  • Some might ask how the Fed could stop hiking rates if it thinks GDP growth will still be above the long run rate, unemployment will be below the long run rate, and the estimate for core PCE inflation didn’t change.
  • because the Fed didn’t change its estimate for the long rate, the Fed funds rate is now not expected to exceed it this cycle. 
  • The Fed had been advocating for raising rates above the neutral rate since September 2017.
  • It’s important to remember that the neutral rate is an estimate.
  • the difference between the 10 year yield and the 3 month treasury bill has fallen to 5 basis points, which is historically a reliable recession indicator once its negative.
  • The yield curve has flattened while stocks have rallied this year. Investors started anticipating less rate hikes even as stocks rallied because of the economic growth slowdown.
  • fund managers are increasingly seeing global growth and inflation being below trend in the next 12 months.
  • the biggest tail risks fund managers have named historically, includes quantitative tightening which was once considered was the biggest tail risk. It ended up not causing damage and the Fed is ending the program later this year.
  • To be clear, when something is named as a tail risk, managers aren’t wrong if it doesn’t happen. Sometimes no tail risks occur.
  • Also, the situation can change, meaning at the time something should be considered a big risk, but then the facts change.
  • In March, fund managers named China’s slowdown as the biggest tail risk as its economy is seeing continued slowing growth despite its fiscal stimulus.

3/20/19 – Fund Managers Aren’t Bullish Equities

  • The net percentage of fund managers that said they were overweight equities was 3% which is the lowest level since September 2016.
  • This skepticism is similar to the prior two slowdowns in this expansion. Fund managers are following the economy rather than chasing the momentum.
  • If fund managers move towards being overweight U.S. stocks because they see growth accelerating again, we will likely see new records set.
  • This survey is the opposite of most non-professional investor surveys on U.S. equities which show some level of exuberance and overvaluation.
  • Remarkably in such an amazing environment for equities fund managers are overweight cash relative to historical positioning.
  • The net percentage of fund managers who think the dollar is overvalued is the highest since 2002.
  • fund managers are highly overweight utilities, while going underweight industrials. Both S&P sectors have rallied strongly this year. 
  • the consensus has predicted higher 10 year yields since the early 1990s, which has usually been a mistake.
  • Economists only predicted lower yields in 2 of 26 years.
  • bond yields have driven sector performance as the ratio between banks and utilities’ returns has been correlated with the 10 year yield. That relationship exists even as stocks have fallen while yields have fallen.
  • gold is inversely correlated with real yields.
  • Inflation and yields are falling, making it tough to say where real yields are going.
  • the difference between the 10 year yield and the 2 year yield is correlated with the ratio of value stocks to growth stocks. Once the curve starts to steepen, value stocks might begin to outperform.
  • there is now $9.32 trillion in negative yielding debt outstanding, a new high.
  • Anytime real wages are growing faster than 1%, it’s great news
  • Regarding the Cass Freight index, know that there has never been an economic contraction without there first being a contraction in freight flows.

3/19/19 – Why Counter-Cyclical Is Outperforming Cyclical Sector

  • The average country return as of March 15th is 11%; that is the highest average since 1987.
  • The S&P 500 is 3.34% off its record closing high in September.
  • The ratio of the cyclicals divided by the defensives is underperforming the S&P 500. To be clear, the cyclicals are consumer discretionary and the utilities are defensives.
  • A big reason for this change in the relationship is the decline in treasury yields which is pushing money into the utilities. Utility stocks trade based on their dividend yield. 
  • The yield curve flattening and the economy slowing make utilities do well in the ‘risk off’ trade. Finally, the utilities are seeing relatively solid earnings revisions.
  • The treasury market is has an extremely tight range for the 10 year 2 year yield spread. The 3 month range (log scale) of this spread is the tightest ever. This could signal that the yield curve is about to have a big move soon
  • a yield curve inversion doesn’t mean a recession is coming in the near term.  On average, stocks don’t fall immediately after inversions as recessions start over a year after the curve inverts.
  • the difference between openings and hires increased to a record 1.78 million. 
  • Quits increased almost 100,000 to 3.49 million which shows there is moderate mobility in the labor force.
  • construction and manufacturing industries have very tight labor markets. The ratio of construction workers trying to get a job to the total jobs available in this industry was 33.5 to 1 in January 2010 which was a record high. This ratio has fallen to 1.8 to 1 which is a record low.

3/18/19 – Stocks & Treasuries Tell A Different Story

  • stocks are acting as though the economy is ready to rally higher, while treasuries are showing bond investors expect growth to decrease
  • the difference between the 7 year treasury yield and the 6 month yield is -3 basis points as that part of the curve has inverted.
  • Last cycle that inversion occurred in late 2005, making it about 2 years before the next recession.  
  • the leading index’s growth rate improved from -3.7% to -2.9%. While that’s still indicating economic growth will be weak in the next 2-3 quarters, it’s much better than the yearly growth rate of -6.7% in the first week of the year which was a 7 year low
  • The economy may have narrowly missed a recession as the ECRI leading index troughed at a lower growth rate than in 2015-2016 (the last slowdown).
  • the decline in profits in Q1 will be in 8 sectors while the decline was only in 4 sectors in 2015.
  • the manufacturing sector is weak. It’s not as bad as the slowdown from 2015 to 2016
  • We shouldn’t be surprised by the weak February industrial production report because the ISM and Markit surveys showed growth weakened.
  • The year over year change in the current conditions index is extremely negative. There have only been 3 times where it was down worse and there wasn’t a recession.
  • Households in the top 3rd of the income distribution were less optimistic than the overall index. This makes sense because they have seen less wage growth recently than the bottom income earners. 
  • We think since the consumer has excess savings, inflation is modest, wages are accelerating, interest rates have fallen, and home prices are increasing at a slower rate, the housing market will have a solid spring selling season.
  • Parts of the yield curve have inverted which means a recession could occur in 2020 or 2021.
  • Q1 earnings weakness is more broad based than the 2015-2016 earnings recession, but revenue growth is set to be positive.
  • The February industrial production report was weak, but the March consumer sentiment reading improved.

3/15/19 – What Real Rates Are Saying About Economy

  • Back in the summer of 2018, inflation estimates were riding high as economists expected the Fed to hike rates 3 times in 2019
  • Everything changed when the economy started slowing, energy prices crashed, and the Fed balked at the idea of raising rates at all as they introduced the word “patience”.
  • the Fed is highly unlikely to raise rates in this environment as the Fed fund futures market shows there is a zero percent chance of a hike this year. 
  • The February PPI reading was the last inflation reading the Fed will get before its March 20th meeting where there is no chance of a hike and a 1.3% chance of a cut.
  • The February PPI report showed headline yearly inflation fell from 2% to 1.9%. 
  • Few economists are projecting inflation to be above the Fed’s 2% target for the June and September 2019 meetings.
  • The Fed funds rate deflated by core PCE inflation is just barley positive. It never even fell to the negatives in the 1990s business cycle.
  • The Fed can’t raise rates in this slowing environment where the 10 year yield is this low. The only way real rates will rise this year is if core PCE falls.
  • The decline in mortgage rates, real wage growth, and the decline in house price growth should all combine to help the housing market in the spring selling season.
  • Growth in passive funds is dominating active funds which is why passive funds are stealing market share.
  • At the end of 2018, in America there was $5.7 trillion in passive funds and $7 trillion in active funds.
  • Passive funds are 31.8% of the market and are set to pass active funds in 2021
  • The percentage of passive ownership in the S&P 500 float is 15%. It was slightly below 5% in 2008.
  • The next crisis could be interesting because of the high passive ownership.
  • Net worth as a percentage of disposable income is near a record high which is why it has become more politically important to keep the stock market up.
  • Investing in stocks has become like a public utility in the sense that 7% gains per year are expected and access is easier than ever.
  • The S&P 500 probably just lapped its best 10 year return period in a while because the stock market bottomed in March 2009.
  • Because the S&P 500 has returned 16.7% annualized in the past 10 years, some passive investors are going all in on the index. 
  • If you live in America and your paycheck is determined by the health of the American economy, it’s not great diversification to only invest in American stocks.

3/14/19 – Are Rising Labor Costs A Problem For Economy?

  • As of Q4 2018, student loan debt totaled $1.569 trillion
  • Interestingly, the total endowments of the top 101 universities was $479.232 billion in 2018-2019. That’s an increase of 80% from 2015. That’s amazing because total student debt increased 23.3% in that period.
  • It’s a broken system where the government prides itself on giving students access to debt while it subsidizes colleges. 
  • College education has become more of a signaling factor to employers than a way to improve students’ knowledge.
  • Small businesses listing the cost of labor as their single most important issue hit a record high.
  • The employment to population ratio of those without a high school degree is near a record high.
  • Bearish investors like to point out that after this index peaks there are recessions. Just because it is at a record high, doesn’t mean it will plummet soon. There needs to be a catalyst for a recession to occur. 
  • The Fed is pausing its rate hikes, the consumer isn’t leveraged, and fiscal policy is helping growth. Therefore, you shouldn’t fear the record high in this chart yet.
  • When the unemployment rate rises, labor share increases.
  • It’s notable that the prime age labor force participation rate doesn’t signal the labor market is as tight as the unemployment rate indicates.
  • Policy makers ought to be careful of limiting the incentive structure of capitalism while trying to improve the long term downtrend in the labor share.
  • the labor pool could be running dry as the labor market matures
  • immigration is a long term driver of slack in the labor market.
  • when there are negative real rates, productivity growth suffers.
  • Baby boomers first joined the labor force in the 1970s and started leaving it in the 2000s.
  • lower half is seeing almost double the wage growth of the upper half because low income workers always do the best at the end of the cycle. 

3/13/19 – February CPI & Implication For March FOMC Meeting

  • The all important February CPI report showed both headline and core inflation fell.
  • That partially explains why stocks and treasuries have rallied this year.
  • Treasury yields have embedded inflation expectations. 
  • Core CPI determines Fed policy. 
  • Tough comparison means core inflation will likely fall below 2% in the next reading.
  • That will support the Fed’s patience. To be clear, patience means the Fed won’t hike rates this year.
  • Headline inflation was pushed lower by energy as it was -5% which was the weakest reading since August 2016. 
  • Average hourly earnings growth deflated by CPI was 2.3% in February which is an expansion high.
  • When deflated by core CPI, growth accelerated to 1.4% which is the highest level since the beginning of the expansion. 
  • Current real wage growth is way more important because more people have jobs.
  • The Phillips curve is broken, meaning wage growth hasn’t catalyzed inflation. That means real wage growth is sustainable if the labor market stays strong.
  • Low wage workers are seeing the most benefits. This occurs at the end of expansions because low wage jobs have the most volatility. 
  • real wage growth has been consistent ever since inflation stabilized in the mid-1990s.
  • Real wage growth was very tough to achieve when inflation was high from the late 1960s to the early 1990s. 
  • Production workers’ quarter over quarter annualized and year over year average wage growth has accelerated to 3.7% and 3.5%. That’s the best growth in about 10 years.
  • Earnings growth accelerating as buybacks hit record highs doesn’t imply buybacks helped wage growth. We are just saying buybacks didn’t prevent real wage growth.
  • Consumption growth should be strong in 2019 if this Goldilocks situation stays in place.   

3/12/19 – How Much Slack In The Labor Force?

  • The amount of slack in the labor market varies depending on which metrics you follow. 
  • Probably the best depiction of the labor market is a chart that includes hours worked, hourly pay growth, and the number of employed people. Effectively, it is weekly earnings multiplied by the number of workers in the labor force.
  • This expansion’s peak was in February 2015 when it hit 5.04%.
  • The economy is at a unique point where there has been an increase in people looking for work while the percentage of people who got a job isn’t falling.
  • The labor force participation rate is also worth reviewing because it helps measure slack in the labor market – which made the highest reading since September 2013.
  • The civilian non-institutional population over the age of 16 fell from 258,888,000 to 258,239,000.
  • We aren’t sure why the population calculation fell sequentially, but we can tell you in this expansion the population fell 4 times and every time the decline happened in January.
  • The labor force is the divisor in the labor force participation rate and the divided in the unemployment rate calculation
  • The pool of available labor is hovering where it bottomed last cycle and is above the 1990s cycle bottom.
  • The unemployment rate is in the process of bottoming. It might not have reached its trough, but it is close. 
  • Full employment doesn’t mean the economy is headed for a recession.
  • Declining yearly private payroll growth is in the full employment zone, which lasts for 18-24 months.
  • Year over year employment growth hasn’t shown enough signs that it has peaked yet, but given the low unemployment rate, it could be close. 
  • Economists have wrongly stated the labor market was at full unemployment for a few years because they didn’t think discouraged workers would come back to the labor market.
  • They thought the unemployment rate would stay structurally high.
  • The good news is even if the economy is at full employment, there probably won’t be a recession in the next few quarters.
  • The retail sales report improved from January because the economy isn’t in a recession and real wage growth improved.
  • The proxy for aggregate income growth was extremely strong in January.

3/11/19 – Does Terrible February Headline Job Creation Signal Turning Point?

  • February’s headline job creation of only 20,000 was a disaster as it missed Bloomberg’s estimate by 160,000 jobs which is the biggest miss since November 2008 which was the heart of the financial crisis.
  • This report was so weak, it came close to ending the record long 101 month streak of job creation.
  • The sequential job creation decline of 291,000 was the 3rd biggest drop since June 2010.
  • The weak February report was a surprise because jobless claims are still near historic lows and the ADP report showed 183,000 private sector jobs added
  • The 3 month average job creation is still 186,000 and the 12 month average is still 209,000 which is solid. 
  • This was the 3rd recent near-recessionary economic report as the December retail sales and December housing starts were bad.
  • Even though job creation was weak, the unemployment rate fell from 4% to 3.8%.
  • This exemplifies why it was impractical for bearish investors to assume 3.7% was the bottom for the cycle and that the labor market was turning because the rate increased slightly. 
  • Small changes to the unemployment rate don’t signal cycle changes.
  • U6 unemployment rate which includes those working part time for economic reasons and those marginally attached to the labor market, cratered from 8.1% to 7.3% to a new expansion low.
  • The labor market isn’t full yet even though this is about to be the longest expansion since the 1800s and this is by far the longest streak of job creation ever.
  • The overall labor participation rate was steady at 63.2% which met estimates.
  • the age adjusted labor force participation rate is below last cycle’s peak and much below the peak in the late-1990s.
  • If the prime age labor participation rate increases 0.4% per year as it has in the past year, it would take 3.58 years for the rate to reach the average peak in the last 3 cycles. The labor market is still decently away from full employment.
  • The economy is in a slowdown, but it’s not as weak as the February labor report indicates.

3/8/19 – Leading Indicator For Jobless Claims & Minimum Wage Impact

  • There is a lot of misinformation on buybacks which get the blame for low productivity growth and CEOs making a high amount of money in relation to their production and non-supervisory employees.
  • We’ve even seen the outlandish claim that buybacks are corporations profiting off insider information even though firms announce buybacks before they execute them. Investors can buy stocks ahead of corporations.
  • Buybacks increased quickly in 2018 as they exceeded capex for the first time since 2007. 
  • Stocks fell in 2018, so buybacks don’t guarantee stocks will move higher and form a bubble.
  • Capex increased in 2018, but at a certain point businesses have no place to put the money so they dutifully return it to shareholders who invest it in other projects
  • Investors usually would rather a mature firm give the money back instead of trying to make risky acquisitions, while taking on debt. If shareholders wanted to own a risky stock, they would buy one.
  • buyback yield increased from 2.28% to 3.37% in 2018 which is only the highest yield since 2011.
  • Buybacks were higher as a percentage of income in 2007-2008 and 2015-2016. Those were years of earnings weakness. 
  • In China – 15 million babies were born in 2018 which was a 12% decline from 2017. That signals citizens don’t think the economy is strong enough to have kids. 
  • States with no minimum wage increases from 2013 to 2018 saw workers in the 10th percentile have 8.4% wage growth in that period. Workers experienced 13% wage growth in states with minimum wage hikes.
  • However, the main catalyst for wage growth is cyclical improvement. The tight labor market is pushing up wages.
  • If a minimum wage increase prevents some people from getting jobs, it’s not as big of a deal in a tight labor market because there are so many jobs available
  • This doesn’t prove the minimum wage is a positive policy because it doesn’t show the workers who couldn’t get jobs because they didn’t have enough skill to be worth the minimum wage
  • Challenger Job Cuts increased from 52,988 to 76,835 in February which is a 3 year high. The quarter average is a leading indicator for jobless claims. Therefore, while claims are very low now, they could increase in Q2.
  • Q4  Productivity growth was 1.8% and unit labor cost growth was 1%.
  • China is an export driven economy that is trying to rely more on services like other developed countries. 
  • To grow GDP per capita, China needs to improve worker productivity instead of being the place for the cheapest labor.

3/7/19 – Americans Living Paycheck To Paycheck

  • In theory, if the labor market gets to full employment in the next few quarters and there isn’t an immediate recession, the economy will be limited by the working age population growth.
  • There isn’t an exact level we can point to where full employment will be reached, but the peak in the prime age labor force participation rate in 1999 gives us a big clue as to how full the labor market can get.
  • Interestingly, even though America is a developed economy and China and Russia are emerging markets, America is the one with the highest expected working age population growth. 
  • China is developing because of its low GDP per capita, but its population will actually peak somewhere between 2030 and 2035. America has great long term demographics.
  • This supports the notion of heavily weighting American stocks in your long term portfolio. 
  • If you live in America, critics will scream going overweight America is home country bias.
  • Forgetting about this bias, it is bad for diversification if you heavily invest in the country you get your paycheck from.
  • The good news is American large caps have a high percentage of their sales coming from international markets. Therefore, you’ll never be completely ‘all in’ on America unless you put all your money in a small cap ETF.  
  • Despite the doom and gloom in the media which states American consumers are highly indebted and aren’t seeing their personal balance sheets improve, the percentage of people living paycheck to paycheck is declining.
  • The bad news is that there are still about the same amount of people living paycheck to paycheck as those who aren’t doing so. 
  • People think the good times will live forever when the economy is strong, but unfortunately the labor market is highly cyclical.  
  • During the last recession, consumers learned the hard way that taking out too much leverage can be catastrophic.
  • The leverage consumers took out last cycle might end up being a record that lasts for decades. 
  • The ratio of debt to disposable income for consumers has fallen steadily during this expansion. Usually, the cycle ends when leverage gets too high, but in this case it hasn’t increased. 
  • the net worth to disposable income ratio is very high because asset prices have soared
  • Bears use this peak as a signal that stocks are overvalued, but ultimately stock prices are determined based on firms’ future cash flows not how high their value gets in relation to disposable income.
  • total household debt payments as a share of disposable income have fallen. That’s because housing debt growth has been limited this cycle and because interest rates are low.    
  • leisure and hospitality industry only added 4,000 jobs which was the lowest number since September 2017. 

3/6/19 – Is The U.S. Economy Still In A Slowdown?

  • The current home sales rate is much lower than previous cycles even though the population is higher. 
  • Median home sales prices were $303,500 in November which was a 21 month low.
  • November had the weakest yearly price growth since February 2009. The monthly improvement still meant yearly growth was -7.1%.
  • That shows us that even though the housing market isn’t in a bubble because mortgages are being given to well qualified buyers, there would be a big decline in housing prices if interest rates increased.
  • An increase in home supply would be a problem for prices normally. However, the situation isn’t as dire as it seems because “new homes for sale, but not yet started” exploded in December
  • New home activity has softened which is why builders have held back housing starts, while building the pipeline of new projects. If activity increases, housing starts will increase since the pipeline is strong.
  • A housing market rebound in 2019 would end the economic slowdown.
  • ISM services outperformed manufacturing by one of the largest amounts in the past 18 years.
  • The relative divergence doesn’t signal much for the economy. The most important aspect is services dominates the economy, so wherever it goes, the economy goes.
  • This ISM reading was so strong it makes you wonder if the economy is even in a slowdown. The answer is simple. If the hard data reports match this reading, the economy isn’t in a slowdown.

3/5/19 – Stocks Caught In The Middle Of Two Narratives

  • The extraordinary rally in the first two months of 2019 is tough to gauge because earnings estimates crashed in January and most economic readings haven’t been great.
  • Dow has had its best start to a year since at least 1987
  • 2019 earnings estimates have collapsed, but earnings still won’t be terrible. Earnings are balanced out by the decent revenue growth estimates.
  • The weak earnings estimates and stock market rally have pushed the S&P 500’s forward PE ratio to 16.03 which is up from 13.92 to start the year.
  • If earnings growth is only expected to be slightly negative, actual results should push it positive because estimates are almost always beaten.
  • The latest consumer sentiment report showed plans to buy a home are the lowest since July because people think homes aren’t affordable.
  • The homeownership rate bottomed this cycle at 63% in Q2 2016, hitting the lowest level since at least 1980.
  • The homeownership rate was 64.6% by the end of 2018.
  • Even with this increase in the homeownership rate, housing debt fell in Q4 from $9.56 trillion to $9.54 trillion
  • The current 5 year average growth in household formation is similar to the growth from 2001 to 2005.
  • Now population growth is creating more demand for housing which is a problem because housing starts have been low this expansion.
  • For US the Markit PMI fell to 53 which is an 18 month low
  • Delivery times and prices paid fell more than production and new orders which shows there aren’t capacity constraints, and inflation is decelerating. However, demand is also weakening, so it’s far from a perfect picture.

3/4/19 – Q4 GDP Report Implications For Stock Market

  • First, economic analysis is partially done to forecast equity returns.
  • Second, stock returns affect consumer and small business confidence, meaning they affect the economy through reflexivity.
  • AAII investor survey shows the percentage of bears has fallen to just 20% which is the lowest since January 2018 when investors had record high euphoria.
  • Bull markets are built on skepticism and die from euphoria.
  • When viewing GDP, there is a battle between those who follow quarter over quarter annualized growth and those who follow year over year growth. Both rates are important.
  • Quarter over quarter growth is the most highly cited.
  • In Q4 2018 Consumer spending was the largest contributor to GDP.
  • December housing starts missing estimates by the most in 12 years 
  • January Personal Income report showed the highest savings rate since January 2016 which was the last recession scare where there was a volatile stock market.
  • The Q4 GDP report was solid because of the spike in business investment growth and the solid consumption growth.
  • If the housing market rebounds in 2019, it will be a solid year.
  • However, economic growth looks to be starting the year out poorly as two Q1 Fed Nowcast estimates are below 1%.
  • Inflation remained low which means the Fed can continue to avoid rate hikes.
  • The savings rate spiked which reinforces the notion that the consumer isn’t overly leveraged.

3/1/19 – Home & Auto Affordability Still A Problem For Many

  • The easiest place to look when determining when home price growth will stop falling is wage growth. 
  • Case Shiller home price index has been increasing quicker than weekly wage growth (both non-seasonally adjusted) for over 6 years.
  • The gap has been starting to close as the tightening labor market is increasing wage growth and the weak housing market is lowering house price growth.
  • The 30 year mortgage rate peaked at 4.94% in November and is currently at 4.35%.
  • Even with slowing price growth and declining interest rates, the very positive February consumer sentiment report showed plans to purchase a car/truck and a house both were the lowest since July.
  • Keep in mind, the worries about the declining stock market and government shutdown passed by the time this survey took place, so declining buying plans are true negatives.
  • Non-banks are now giving out more mortgages than large banks and small banks combined.
  • Most non-banks are loan processors for government agencies. Most of these loans are bound by qualified mortgage law. QM law limits the debt to income ratio to 43%, limits points and fees to less than 3% of the amount borrowed, and doesn’t allow toxic loan features such as being interest only, having negative amortization, terms beyond 30 years, and balloon loans.
  • America is moving closer to ‘peak car’ especially among younger generations as 26% of 16 year olds had their drivers license in 2017, while almost half had their license 36 years ago. 
  • The average age of cars and trucks increased from slightly above 8 in 1995 to slightly below 12 years in 2018.
  • The share of household expenditures in percentage terms spent on cars and trucks declined from the high single digits in the 1980s to the mid-single digits in the 2010s.
  • The average amount that’s financed for new cars was $29,921 as of Q3 2018. At the start of this expansion, the average amount was slightly over $24,000. That’s an increase of about 25%.
  • To handle such expensive car loans, the length is being stretched out. As of Q3 2018, the average loan was 65.59 months which is almost 5.5 years. It started the cycle at 60.27 months.

2/28/19 – The Distorted Reality Of The Housing Market

  • The housing market leads the economy, housing has become unaffordable, and 8 out of the past 10 recessions have been catalyzed by weakness in residential investment.
  • The positive aspects of the housing market are that interest rates have fallen, the consumer has deleveraged this cycle, especially in terms of housing debt, private lending standards are much higher than the previous cycle in terms of credit scores and due diligence (zero doc loans are illegal), housing wasn’t built up as much as last cycle, and prices haven’t soared as high in real terms.
  • When stats are in nominal terms they are deceiving.
  • For instance, housing debt peaked at $9.99 trillion in Q3 2008. If you just wait until that level is reached again to claim there’s a bubble, you will be grasping at straws because every year there is inflation and population growth. The current $9.54 trillion in housing debt is much more sustainable.
  • Even in a recession, delinquencies won’t get as high as they did during the last recession.
  • Housing debt isn’t a problem because mortgage debt as a percentage of personal disposable income is the lowest since at least 1980.
  • While the national, 10 city composite, and 20- city composite house price indexes are at a record in nominal terms, real prices are below their record high.
  • If homes aren’t affordable, lower price growth will ensue, but there won’t be a bubble burst like 2008.
  • Even though the MBA purchase applications index is in a near 3 year uptrend, it is nowhere near the peak in 2005.
  • Pending home sales are highly correlated with existing home sales lagged 18 months.
  • Zillow’s house price growth projections have a good track record, so they are worth following closely.
  • Since 2011, Zillow’s historical absolute error in predicting 10 city and 20 city price growth on a monthly and yearly basis is just 0.2% (both seasonally adjusted and non-seasonally adjusted).
  • Zillow expects national price growth to fall from 4.7% to 4.4%. That would be the weakest price growth since July 2015.
  • If this cyclical price weakness coincides with labor market weakness, then growth could fall to the flatline as increased affordability doesn’t matter if people don’t have jobs.
  • Weak price growth is terrible for home improvement retailers and home builders. It is good for the homeownership rate if the labor market holds up.

2/27/19 – Housing Market Impact on Fed Balance Sheet

  • Federal bank reserves are now at $1.6 trillion.
  • Powell stated bank reserves will likely end up at about $1 trillion plus a buffer by the time the unwind is over. This means the unwind will likely end by the end of 2019.
  • That’s because bank reserves are the only category of the balance sheet that is falling. ‘Other Fed liabilities’ have been stagnant and currency in circulation is increasing. 
  • The Fed currently holds $1.6 trillion in mortgage backed securities. It wants to only hold treasuries. 
  • The Fed could sell MBS instead of waiting for them to mature. If the Fed uses the money to buy short term treasuries, which is mainly what it holds now, it leaves itself open to do an “Operation Twist” where it sells short-term bonds to buy long-term notes to impact the economy in an uncertain situation.
  • In both scenarios, the Fed is a net buyer of treasuries for the next few years. It’s worth noting that the Fed could easily pause its goal to own no MBS if there are problems in housing market.
  • Housing starts data from December was absolutely terrible. Starts missed estimates by the largest amount in 12 years. 
  • The residential investment cycle is a great predictor of the economic cycle.
  • 8 of the 10 recessions since 1950 were caused by the household residential investment cycle. 
  • The best explanation as to why the housing market might not cause a recession this cycle is because the housing market wasn’t built up as much as every cycle since 1960. 
  • Permits as a percentage of the population are near previous cycle troughs.
  • Millennials are moving out later, so the amount of people per house is increasing, people are staying in their houses longer, the population is aging, and the birth rate is dropping. Even with these factors, we don’t think permits as a percentage of the population has much room to fall this cycle.

2/26/19 – Margins May Be Close To Plummeting

  • Margins look like they will fall in the coming quarters because the wholesale inventory to sales ratio has exploded higher.
  • Stock returns are based on expected earnings in the long run. There can be multiple expansion, but don’t let that distract you from following the economy and earnings estimates. 
  • Increases to inventories helps GDP, but in the intermediate term, it hurts margins if sales don’t increase as well
  • Firms need to discount products when inventory has been built up too much. 
  • The wholesale inventory to sales ratio (excluding petroleum) is highly correlated with NIPA (National Income & Product Accounts) profit growth. Profit growth won’t last in this bloated inventory environment.
  • There might not be an earnings recession in 2019, but the weak global economy is certainly hurting the internationally focused sectors such as technology. 
  • Stocks were overvalued in January and September 2018 because there where high negative revisions and low positive revisions, relative to the stock market. They were undervalued for the opposite reason in March and December 2018. Now, we are seeing high negative revisions and low positive revisions versus the stock market which is a sell signal.
  • GDP growth doesn’t need to be negative in a global recession. There have been 2 global recessions since the 2008 financial crisis.
  • Since 1961, global GDP growth has only been negative in one year (2009).
  • The Q1 WTO trade indicator fell to 96.3 which is ‘below trend’ growth. It’s the weakest reading since March 2010.
  • A weak global PMI signals weak earnings growth.
  • The global PMI also forecasts S&P 500 trailing EPS earnings. The correlation is high when you advance the PMI by 9 months.

2/25/19 – Leading Indicators Signal Slowdown Will Continue

  • The most important aspect of the economy is inflation because low inflation allowed the Fed to turn dovish which helped reverse last year’s bear market.
  • If the Fed would have set guidance for 3 hikes in 2019, stocks may not have recovered, and the yield curve may have inverted.
  • The great news for the economy is the Phillips curve is broken.
  • The Phillips curve says low unemployment drives high inflation.
  • Low unemployment has helped wage growth, but wage growth hasn’t driven inflation. 
  • If inflation spikes, the Fed will need to hike rates again which might not be handled well by stocks and the economy because it is still in a slowdown. 
  • A recovering housing market (falling 30 year rate, higher wage growth, lower prices) could increase inflation.
  • The Fed had an easy decision to turn dovish at the end of December because inflation was slow and growth was falling. It could have a tough decision if growth falls in the next few months, while inflation rises. 
  • The Conference Board Leading Economic Index and the ECRI weekly leading index both signal the economy will keep slowing in the next few months.
  • From the late 1960s until today, the range of peaks for the Conference Board Leading Economic Index before recessions has been between 7 months and 20 months.
  • February PMI reading was great because services were strong, and manufacturing was weak. This is a reversal from the January reading. Services are much larger than manufacturing. 
  • The Composite PMI was 55.8 which was an 8th month high. It was up from 54.4. The Services index increased from 54.2 to 56.2 which was also an 8 month high. The manufacturing PMI fell from 54.9 to 53.7 which was a 17 month low.
  • Bearish investors think Germany is about to go into a recession, but in Q4 German real private fixed investment growth was 5.1% and private consumption was up 2.6%. Q4 GDP growth was 1.4%. This report was ruined by temporary problems in the car industry as the change in stocks had a big negative impact on GDP growth after having a very positive impact in Q3. 

2/22/19 – Index Investing & Housing Market Show Mixed Results

  • Indexes are the best way to invest if you don’t have the inclination to do in-depth research. 
  • However, it’s still important to know what you own and why valuations and returns are where they are. 
  • The biggest misleading information about index funds is that a high percentage of stocks in the Russell 3000 are losing money. Since the standard PE multiple calculation ignores the money losers, those against index funds and the bears say you need to be wary of them. 
  • The stat shared is that about 25% of Russell 3000 firms don’t make money. 
  • The reality is that most of these firms that don’t make money have the least impact on the index which means investors who own the index have little exposure to these money losers. It’s highly unlikely these firms will impact the overall index meaningfully unless they become profitable, defeating the worry.
  • The money losers represent 7% of the market weight by trailing earnings and 1% by next 12 month earnings.  
  • When valuing international markets, make sure to track sector weightings. If you buy into a country that has a high weighting in financial stocks, that’s a de facto bet on the financials. 
  • It’s like how buying American ETFs that track the market is a de facto bet on the big internet names.
  • The US has a 20% weighting in information technology while Europe only has a 5% weighting. 
  • Earnings estimates have slowed their descent in the past couple weeks. That’s because there have been fewer firms reporting earnings, so there were fewer chances for firms to issue negative guidance which would catalyze negative estimate revisions. That’s not a great reason for estimates to stop cratering, but at least 2019 estimate declines will stabilize in the next few weeks before Q1 earnings season starts.
  • The 30 year mortgage rate fell from 4.94% in November to 4.37% as of February 21st.
  • Median monthly home prices fell 2.8% to $247,500. They were up 2.8% yearly. Discounting helped boost sales, but they still fell. The 2.8% gain was the weakest growth since 2012.
  • Adjusted for population, existing home sales fell 19.5% yearly and have been falling the entire cycle. This shows how small the housing market has gotten.
  • It would be impossible for the housing market to catalyze a recession like it did last cycle when population adjusted existing home sales growth exploded.

2/21/19 – Fed To End Unwind In 2019?

  • The Fed’s Minutes from its January meeting were released on February 20th. The biggest media headline from the Minutes was that the Fed plans to end the unwind of the balance sheet sometime in 2019. In fact, the number of times this statement was repeated surprised us.
  • Based on the Fed statement, we still don’t know the pace of the QT unwind. Whether it will end in 2019 or 2020 or 2021 is still an uncertainty. 
  • There is about $4 trillion in assets on the Fed’s balance sheet.
  • Domestic investors have offset the Fed’s and foreigners’ declines in holding share of U.S. treasuries.
  • Clearly, there isn’t a problem with demand for treasuries because interest rates have fallen recently. 
  • This change in balance sheet policy is illogical because the Fed shouldn’t ignore the stock market gains during the unwind since it started in October 2017, just because a recession scare caused a brief bear market.
  • Hawkish policy will have a 1.2% drag on GDP growth in 2019 if there are no rate hikes. That’s pretty large considering the drag from weak trade growth as tariffs and slowing global growth have caused global trade to grow below trend.
  • 3 hikes would push that negative impact to about 1.4%.
  • A survey of economists expects the Fed funds rate to end the year at 2.8% which is the equivalent of 1.7 hikes this year.
  • One theory is that the effects of QE and QT are proportional to spreads as these policies involve a swap of reserves for securities.
  • The spread was larger during QE than QT which explains why it’s possible QE had much larger effects than QT. It’s worth noting that the size of the balance sheet expansion will be much larger than the contraction.

2/20/19 – Is The Stock Market Overbought?

  • 92.45% of S&P 500 stocks are above their 50 day moving average. That’s the highest percentage since April 2016.
  • This level was never reached in the bear markets prior to the past 2 recessions.
  • The stock market is doing so well that about 72% of days this quarter have been positive which would be the most ever since 1928 if it’s maintained for the rest of the quarter. The current record is in Q2 1955.
  • Commercial hedgers were net long $9 billion worth of Nasdaq index futures at the end of January which is the most since the financial crisis. Hedgers are usually short.
  • It doesn’t make sense for the consumer to sharply pull back on spending with real wage growth accelerating and the economy producing so many jobs.
  • The Q1 2019 world trade outlook indicator is at 96.3 which is in the ‘below trend’ category. That’s the weakest reading since March 2010.
  • Chinese imports from America fell over 40% in January which was a record decline
  • The consumer sentiment index, NY Fed business activity index, and the Empire Fed manufacturing index all improved.

2/19/19 – Are Household Shelter Costs Increasing?

  • In general (rule of thumb), you need to live in the house for 7 years before moving for it to be worth the costs associated with buying such as closing costs and moving expenses.
  • Ratio of Shelter CPI Index to Median Household Income shows that
    as of the last few years, shelter has gotten more affordable relative to household income, but it is more expensive than it was in the 1980s.
  • This data is much different from charts that compare average hourly earnings growth with shelter CPI.
  • You can decide which relationship to follow. You should always try to look at information from multiple angles to get the best perspective.
  • The growth in household income in the 1980s was helped by women entering the workplace.
  • Shelter inflation encompasses rent, homeownership equivalent rent, lodging away from home, and tenants’ & household insurance. 
  • The cumulative gap between core CPI and core CPI ex-shelter this cycle is larger than last cycle.
  • millennials switch jobs less often than their predecessors in the 1970s-1990s.
  • important to note that when people are switching jobs a lot it’s a sign of a healthy labor market.
  • Job switchers have higher wage growth than those who stay with the same job. 
  • Openings were up 29.4% year over year in December and hires were up 7.1%. The difference between openings and hires was 1.428 million which was a new record.
  • Hires are below the 2006 level and further below the 2001 level while openings hit a record high.
  • This means the labor market isn’t as great as those periods which can be interpreted as good news because it means there’s more labor supply in the labor market.  

2/18/19 – Low Inflation Fueling Rally But Stocks Could Fall 20.16% In The Next Year

  • We don’t think inflation is focused on enough when reviewing where the business cycle is headed. 
  • The Fed’s dovish policy shift was supported by the January CPI report.
  • Lowest year over year change for headline CPI from December 2% to January 1.6%, since September 2016. This latest decline was caused by the oil price correction. 
  • When oil prices fall, core inflation is higher than headline inflation.
  • Core inflation should be similar or fall since there is a global economic slowdown.
  • Housing is the biggest component of inflation. 
  • Commodities inflation has fallen below zero on a year over year basis. It has catalyzed the inflation weakness. It is 37.3% of inflation.
  • Real wage growth has accelerated the fastest since 2009.
  • Keep in mind, real wage growth was irrelevant for many workers in 2009 because they didn’t have a job.
  • The 4 week moving average of the jobless claims index may have bottomed in September. It’s not signaling a recession, but it’s headed in the wrong direction. It increased from 225,000 to 231,750.
  • The unemployment rate is 4% which puts it above its 12 month moving average which is a big red flag for the economy and the stock market.
  • Currently, the jobless claims are at their one year high (250 above the next highest report), the unemployment rate is below 5% (at 4%), and the unemployment rate is 0.1% above its 12 month moving average. One indicator suggests that the average 1 year change in equities is -20.16%.

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