Lenore Hawkins serves as the Chief Macro Strategist for Tematica Research. With over 20 years of experience in finance, strategic planning, risk management, asset valuation and operations optimization, her focus is primarily on macroeconomic influences and identification of those long-term themes that create investing headwinds or tailwinds.
Since 2020 and 2021 (so far) haven’t been frightening enough, just days before the Super Bowl a hacker tried to break into a Florida city’s water system in order to increase the amount of sodium hydroxide (aka lye) in the city’s water, a potentially deadly and caustic poison.
Thankfully the hacker wasn’t terribly sophisticated and the nefarious attempts were identified and blocked, but it does expose how our increasingly connected world is increasingly vulnerable to nefarious actors. As technology evolves and public utilities, along with nearly every other aspect of our lives, become more connected, and as the move towards 5G allows for more remote monitoring, more opportunities are available to cause harm.
From our homes to our finances, from our cars to our offices and our communities, the need for cybersecurity is only increasing, expanding the tailwinds behind our Cybersecurity and Privacy investment theme Cybersecurity and Privacy investment theme.
Federal investigators are searching for the hacker behind an attempted poisoning of a Florida city’s water system just days before the Super Bowl.
I’m either blessed or cursed, depending on your perspective, to live a life across both sides of the Atlantic, with operating bases in California, Ireland, and Italy This gives me a rather in-my-face perspective on how the various regions operate and respond to global events. One of the most striking differences is, and sorry to say this, the archaic nature of the US retail banking system. Ask someone in Ireland if they’d like to be paid by check and they’ll look at you like you just asked if they’d like their pint out of a can or from the tap.
It really is astounding that a nation known for its tech hubs has payment processes that have remained unchanged for decades. As with many other things digital, the pandemic accelerated the shift towards electronic banking.
By May, more than 45% of Americans had changed the way they dealt with their bank, a survey of 1,000 people by consultancy FIS found.
According to an article in the Financial Times (referenced below), Well Fargo (WFC) has seen a 35% increase in the number of checks deposited digitally and a more than 50% increase in online wire transactions. The push to get clients to do more digitally is driven in no small part by its promise to investors that it will cut $10 billion in costs.
Bank of America, the country’s second-biggest bank by assets, after Wells Fargo, reports that nearly 40% of the clients’ checks are deposited online. Digital sales of mortgages have accounted for about 60% of the activity in 2020. The bank’s AI chatbot is handling about 400,000 interactions per day now, twice the level a year ago.
As retail banking consumers become increasingly comfortable with digital banking services the need for robust digital infrastructure only becomes greater. Yet another visible tailwind to Tematica’s Digital Infrastructure theme.
We’ve been hearing about this new 5G technology for years and how it is going to revolutionize our lives, make autonomous vehicles, the Internet of Things possible, and reduce cholesterol levels. Ok, maybe not that last one, but it has been touted as being a Very Big Deal. So just what is 5G?
5G refers to the 5th generation mobile network. It is a set of technology standards that drive very low latency with a very large number of simultaneous connections allowing for data transmission at very high speed. Say that five times fast.
It also tends to be used as a shorthand method for referring to a series of spectrum bands.
It is also referred to in use cases, such as with the aforementioned driverless cars.
It is also used to distinguish a certain class of devices from others. For example, while Apple’s next-generation iPhone will be the iPhone 12, its being commonly referenced as Apple’s 5G iPhone.
The headlines are increasingly dominated by frightening images of people wearing masks or encased in hazmat suits along with words like “pandemic,” not exactly pleasant over morning coffee. We are being told that this virus isn’t all that much worse than the usual flu, yet cities are being quarantined, travel is being restricted or outright banned, and companies are making all kinds of severe contingency plans. How can this be no worse than the usual flu if everyone seems to be having a total meltdown?
I did some simple math to show why this virus could be both:
(A) something I personally don’t need to get overly worked up over when it comes to my own health, while at the same time
(B) a major medical threat on a global level.
Sounds like I’ve lost my mind right? Just give me a few minutes and we’ll walk through the numbers.
The breakdown for the impact of the typical influenza virus every season is illustrated in this chart from the Center for Disease Control (CDC). Since 2010 the number infected by an influenza virus every year ranges from 9.3 million to 45 million. The number hospitalized ranges from 140,000 to 810,000 and the number that die from the virus ranges from 12,000 to 61,000.
In the chart below I took the midpoint of each of the ranges shown above. I realize that those ranges are quite large so simply taking the midpoint of the numbers loses some meaning, but bear with me here as we are just looking to understand magnitudes. On average 8.23% of the population of the United States has been infected by the seasonal influenza virus every year since 2010. Of those who have been infected, 1.75% have needed hospitalization and 0.134% have died.
If we assume that the coronavirus is just an average flu bug, then we can use these averages. In the example below I assume that 1.75% of those that contract the virus need hospitalization and 0.134% will die. In the chart below I show how many will need hospitalization and how many will die based on 5% to 50% of the population contracting the virus.
(Please note on the chart below that I took the total number of hospital beds from the 2020 American Hospital Association’s 2020 AHA Hospital Statistics, developed from the 2018 AHA Annual Survey. I estimated the number of ICU beds using data from the Society of Critical Care Medicine which referenced AHA data that found the ration of ICU beds to total beds to be 14.3% in a 2015 study. Surprisingly enough the number of ICU beds is not an easy number to find.)
The problem quickly becomes evident. Under our assumptions, when the percent of the population infected by the virus gets between 15% and 20% of the total population, there simply aren’t enough hospital beds in the country even if every single bed is dedicated to someone with the coronavirus. This is the problem. It isn’t the health risks to any one particular person, but rather the sheer number of people that this virus may be able to infect.
So while the risk to me of needing hospitalization may be no worse with coronavirus that the usual flu, there may be no beds available to treat me if I end up needing one! Now I’m worried.
According to the Center for Disease Control (CDC), on average, about 8% of the US population gets sick from the flu every season, with a range of between 3% and 11% depending on the year. What about the contagiousness of the typical flu? This is from the CDC:
People with flu are most contagious in the first 3-4 days after their illness begins.
Some otherwise healthy adults may be able to infect others beginning 1 day before symptoms develop and up to 5 to 7 days after becoming sick.
Some people, especially young children and people with weakened immune systems might be able to infect others for an even longer time.
Part of why the typical flu is not as contagious as the coronavirus is because you know more quickly when you are sick. The problem with the coronavirus is we are seeing evidence that people can be contagious for more than 14 days and may not have any symptoms. This gives the coronavirus the potential to totally blow away the usual 3% to 11% infection rate during a typical season.
This is why the virus can have the same health risk to any particular person as the usual flu bug while at the same time being an enormous health risk on a city, state and national level. Recall the movie Mission Impossible 2 where our hero Ethan Hunt needs to stop the biological weapon “Chimera” from getting out? Chimera was fatal within 20 hours and those infected quickly experienced severe symptoms. That movie got it all wrong. The most dangerous virus would be one that infects its host and is easily transmitted from one person to the next for years without its host having any symptoms. With such a virus, by the time we even knew of its existence, the majority of the world’s population could already be infected.
As a final note, in the example above we assumed a fatality rate (meaning the percent of those infected that die) of just 0.134%. In China, as of February 11, 2020, according to data compiled by Statista, the fatality rate has been much higher – 21.6x higher in Hubei, 17.2x higher nationwide and 3x higher in other regions excluding Hubei.
As of February 27, 2020 at 18:00 Central European time, there were 650 confirmed cases in Italy, 17 deaths and 45 healed. This makes for a mortality rate of 2.6% which is 19.5x more deadly than our example. Current statistics can be found here.
In South Korea, as of the writing of this piece, the total confirmed cases had reached 2,022 with 13 deaths. This makes for a mortality rate of 0.64% which is 4.8x more deadly than our example.
According to LiveScience.com, as of the afternoon of February 28, 2020 there are have about 83,704 confirmed cases and 2,859 deaths. This makes for a mortality rate of 3.4% which is 25.5x more deadly than our example.
On that note, I’m going to go wash my hands… again.
While investor focus this week looks to be squarely on COVID-19 and its potential economic impact, the very real costs of cybersecurity threats, which are features in our Safety & Security investment theme, continue to grow at an impressive pace, rising nearly 30% in 2019 from 2018 and nearly 340% over the past 5 years.
“The FBI’s Internet Crime Complaint Center (IC3) has released its 2019 Internet Crime Reportwhich found that 2019 was a record year for both victims of internet crime and dollar losses in the United States. 467,361 complaints were logged by IC3 in the last calendar year – 1,300 per day on average. The most frequent internet crimes recorded in 2019 were phishing, non-payment/non-delivery scams and extortion. Individuals and businesses lost $3.5 billion in total, an increase on the $2.7 billion lost in 2018.”
Donna Gregory, the chief of IC3, said that while the FBI did not see an increase in new types of fraud in 2019, “criminals are getting so sophisticated” and that “it is getting harder and harder for victims to spot the red flags and tell real from fake.” The companies in the Foxberry Tematica Research Cybersecurity & Data Privacy Index look to provide solutions for and benefit from this growing problem.
Tuesday the overnight funding markets broke down and the Fed took a few tries to get their (now rusty) open market operations up and running to resolve the liquidity crunch for the first time since the financial crisis — TBD if the week’s liquidity crunch was “idiosyncratic” as many pundits claim. FedEx (FDX) results gave everyone a bit more to worry about with respect to the global economy as if we needed that.
Wednesday the Fed both met expectations and simultaneously confused the hell out of markets.
The biggest market move was ignited when the (claimed) Yemeni Houthi rebels (aka Iran?) attacked the Saudi Aramco Abqaiq oil processing facility. That attack on what is the largest such facility in the world led to Brent crude oil prices rising as much as 19.5%, a record intraday spike. US West Texas Intermediate (WTI) futures rose as much as 15.5%, the biggest jump since December 2008. The attack took an estimated 5% of global oil production (around 5.7 million barrels per day) offline, more than the Iraq invasion of Kuwait in August 1990, which was a loss of 4 million barrels a day and the hit to Iranian production in 1979 during the Islamic revolution. The Saudis are claiming it was no big deal and all will be resolved in a matter of weeks.
Currently, the US and Saudi Arabia are claiming that there is conclusive proof that Iran was actually behind the attack. The US has been following a policy of maximum pressure on Iran and in response, Iran has been following a policy of maximum chaos from attacks in Strait of Hormuz to (potentially) this latest attack on a vital input to the global economy. With all the geopolitical stability (sarcasm), the world really needed this jolt of additional risk.
We will never really know just how severe the strike was as that would be a clear security risk for Saudi Arabia — why show those who attacked what they got right and what they missed so they can improve on another round? Only time will tell if they are able to get production up as quickly as has been promised, with most back online by October. I did mention last time that volatility was seriously underpriced!
US Dollar Liquidity Warning Signs
I’ve been warning for quite some time that we would likely see significant liquidity strains in the coming months as the Treasury issues an unprecedented volume of bonds, the baby boomers take their forced seasonal minimum distributions and the impact of higher bank reserve requirements is more acutely felt thanks to the Fed’s tapering. Last week we saw what may be the first hints of problems to come as with the price of oil spiking higher, the demand for US dollars spiked as well. Starting last Tuesday, the Federal Reserve had to provide liquidity four consecutive days in a row, pumping around $200 billion into the US financial system, something we haven’t seen since just prior to the 2008 financial crisis.
There is no clear consensus on what is causing this and there wasn’t back in 2008 either. Many are claiming this is an isolated event due to a combination of unique circumstances from the strike on Saudi Arabia and tax filings this month. If you’d like more details, I highly recommend this read. Only time will tell if this truly was idiosyncratic or if we are seeing warning signs of liquidity problems — I’ll be watching this one closely. Last Friday the Fed announced that it would extend overnight repo operations of “at least $75 billion” each day until mid-October — that doesn’t read idiosyncratic to me.
Major Moves in Bonds
Looking at longer-dated bonds using the Merrill Lynch 10+ Year US Treasury Index as a proxy, we see that August enjoyed the best monthly gains since December 2008. As equities were taking it on the chin, long bonds were getting a lot of love. But then, in the first ten trading days of September, long-term Treasuries lost 6.5% — the worst ten-day start to a month going all the way back to at least 1987. I say at least 1987, because that’s when daily data begins, so we cannot go back farther. In a period of just six weeks, longer-dated Treasuries saw their best monthly gain in almost eleven years followed by the worst start to a month since daily data began – at least thirty years! These are not normal bull market moves.
As I’ve mentioned in prior issues, the Treasury has been issuing massive amounts of debt. When the federal government hit the debt ceiling, its deficit spending was funded by the Treasury’s general fund account – its piggy bank. Now that the debt ceiling issue has been punted, the Treasury is issuing bonds to both refill its piggy bank and fund the government’s ever-growing fiscal deficit. As those bonds are issued, they are financed in the short-term by the repo markets.
The most recent Bank of America Merrill Lynch Fund Manager Survey gives some color to the dramatic moves in bonds. The survey found that 38% of respondents expect a recession within the next year, up from 34% in August. The biggest tail risk concern for the group (40%) was the trade war with China. Bond allocation for the group dropped to a net 36% underweight after having August’s allocation reach the highest since September 2011. Overall long US Treasury remains the most crowded area for the fourth consecutive month.
Last week the Federal Reserve cut the funds rate by (as expected) 25 basis points to a 1.75-2.00% range. What wasn’t expected was the lack of agreement amongst members with two dissents, Esther George and Eric Rosengren preferring no cut. And then there was Jim Bullard preferring a 50-basis point cut. Five FOMC members want to raise rates again before the end of the year (really!?) with another five wanting to go on hold and seven want to cut one more time. No one is looking for more than one more cut before 2020. In response, the yield curve flattened and President Trump took to Twitter to express his disapproval.
Equity Bumping Against the Ceiling
We are now seeing equity markets both in the US and Europe bumping up against some major overhead resistance.
The Stoxx 600 has failed to push up above 392.5 five different times in the past fifteen months, three in the past three months alone. Yet another failure here likely means dropping down to test the 200-day moving average.
The S&P 500 is also getting quite a headache, having trouble breaking through the same 3,025 level from July. We’ve now had two rate cuts and yet the S&P 500 cannot break into new highs. Seasonality is not on the side of the bulls.
The major US indices have little to show over the past year. Since the beginning of September 2018 the S&P 500 has gained all of +3.1%, the Nasdaq a whopping +0.1%, the Dow Jones Industrial Average +3.7%, the NYSE Composite +0.6% and the small cap Russell 2000 has lost -10.4% – some bull market. The S&P 500 remains in a rather profound consolidation mode.
That said, overall breadth looks decent as all eleven S&P 500 sectors have more than 55% of their component companies above their 50-day moving average. The past week four out of five days the S&P 500 Advance/Decline line has been negative – so breadth has been weakening. We’ve seen strength in the last hour of trading, which is typically a bullish sign as investors are willing to take on overnight risk despite the potential headline or tweet risk. On the other hand, the defensive Utility and Real Estate sectors both have 100% over their 50-day while the cyclical Energy, Industrials and Financial sectors, which had previously been headwinds for the major indices are now more supportive with more than 80% of their components trading above their 50-day. When Utilities are consistently outperforming, do you really call that a bull market?
Taking a step back to look at the bigger picture of equities and bonds, I see a rather troubling picture, shown below (click to enlarge). Looking at the long-term trendlines for the S&P 500 on a weekly basis versus the spread between the US 10-year Treasury yield and the US 3-month yield, major market turning points tend to happen when that spread is negative (shaded in light grey in the S&P 500 weekly). Before anyone gets apoplectic over this one, no person nor any chart for that matter ought to be relied upon to divine the future. We can only deal in probabilities, so we look at a wide range of data points to see if there is a consistent story being told.
It is also interesting to see that this past week General Motors (GM) suffered its first strike since 2008. The car manufacturer is not alone. Strikes of 1,000 or more workers are expected to affect more than half a million workers this year, the most since 1986 and an increase over last year’s multi-decade high. This coming at a time when earnings growth for many companies has become more and more of a challenge.
This past week FedEx (FDX) reported its second-biggest earnings decline since 2001 after missing its EPS estimates and lowering its guidance. From a macro perspective, the shipping company’s growth has historically closely tracked US GDP – another concerning data point. The company’s quarterly revenues were down slightly year-over-year for the first time since its June 2009 report. The company lowered its full-year 2020 EPS estimates from $14.62 to between $11 and $13, citing the US-China trade war.
The Bottom Line
While the economic data for the US came in stronger last week, with the one exception for the Empire Manufacturing report, overall the economy is on a slower (slowing) trajectory, highly dependent on consumer spending fueled by falling savings rates. A recent Gallup poll found that more American’s think the economy is getting worse than better. The US-China trade war, coupled with rising geopolitical tensions and uncertainty (Brexit), is hampering growth around the world as execs from the multinationals and many small business look to hunker down until the dust clears. Volatility remains under-priced and the safety plays more attractive for the time being.
The markets closed last week in a bullish mood on the news that (stop me if you’ve heard this one before) the US and China will be back at the negotiating table in October. You don’t say! Oh but this time we have schedules and a list of attendees so it is totally different.
The past three days of bullishness have been in sharp contrast to the chaos of August during which global stock markets lost around $3 trillion in market cap thanks to the ongoing trade wars and more data pointing to global slowing. As of Friday’s close, over the past year, the S&P 500 is up 3.7%, the Nasdaq 2.5%, Dow Jones Industrial Average up 3.4%, the NYSE Composite Index up 0.17% and the Russell 2000 is down -12.1%. During August 2,930 acted as a resistance level for the S&P 500 multiple times, but the index managed to break through that level last week, which is typically a bullish signal.
As the markets have taken an immediate about-face on the reignited hopes for progress in the trade wars, we’ve seen a profound flip-flop in equity performance which gave many a portfolio whiplash.
Those stocks with the lowest P/E ratios that were pummeled in August are up an average of 5.3% since last Tuesday’s close.
The stocks that held up best in August are barely breakeven over the final three trading days last week while those that were soundly beaten down in August are up the most so far in September.
Stocks with the most international revenue exposure are materially outperforming those with primarily domestic revenue exposure.
While corporate buybacks have been a major source of support for share prices in recent years, corporate insiders have been big sellers in 2019 selling an average of $600 million worth of stock every trading day in August, per TrimTabs Investment Research. Insider selling has totaled over $10 billion in five out of the first eight months of 2019. The only other time we’ve seen so much insider selling was in 2006 and 2007.
August saw an additional $3 trillion of bonds drop into negative territory. We are now up to $17 trillion in negative-yielding bonds globally, with $1 trillion of that corporate bonds – talk about weak growth expectations! We also saw the yield on the 30-year Treasury bond drop below the dividend yield for the S&P 500 recently. The last time that happened was in 2008.
The yield on the 10-year Treasury dipped below the 2-year multiple times during the trading day in August but closed for the first time inverted on August 26th. August 27th the spread between the 10-year Treasury yield and the 2-year rate fell to negative 5 basis points, its lowest level since 2007. Overall the yield on the 10-year Treasury note fell 52 basis points during the month of August – that’s a big deal. The last time we saw a fall of that magnitude in such a short period of time was in 2011 when fears of a double-dip recession were on the table. Currently, the real yield on US 10-year is sitting in negative territory which says a lot about the bond market’s expectations for growth in the coming years. Keep that in mind as you look at the PE multiple for the S&P 500 after having two consecutive quarters of contracting EPS.
A growing number of countries have their 10-year dropping
into negative territory:
Switzerland first in January 2015
Japan in February 2016
Germany and Netherlands in the Summer of 2016
Finland and Denmark in the Fall of 2016
Ireland, Latvia, Slovakia, Belgium, Sweden, Austria, France all negative
The US is now the only nation in the developed world with any sovereign rate above 2% (h/t @Charlie Bilello). My bets are that we are the outlier that won’t stay an outlier indefinitely.
Recently the Italian 10-year bond dropped to new all-time lows as Cinque Stelle (5 Star) movement managed to team up with the center-left Democratic Party of former Prime Minister Matteo Renzi. Don’t expect this new odd-couple coalition to last long as these two parties have basically nothing in common save for their loathing of Matteo Salvini and the League, but for now, the markets have been pacified. These two parties detest one another and were trading insults via Twitter up until about a month ago. This marriage of convenience is unlikely to last long.
The European Central Bank meets on September 12th, giving them one week head start versus the Federal Reserve’s Open Market Committee meeting, which is September 17th & 18th, kicking off the next round of the central bank race to the bottom. The ECB needs to pull out some serious moves to prop up Eurozone banks, which are near all-time lows relative to the broader market. We’ll next hear from the eternally-pushing-on-a-string Bank of Japan on September 19th.
Dollar Strength continues to be a problem across the globe. The US Trade Weighted Broad Dollar Index recently reached new all-time highs, something I have warned about in prior Context & Perspective pieces as being highly likely. It’s happened and this is big – really big when you consider the sheer volume of dollar-denominated debt coming due in the next few years and that this recent move is likely setting the stage for significant further moves to the upside.
In the context of the ongoing trade war with China, the renminbi dropped 3.7% against the dollar in August, putting it on track for the biggest monthly drop in more than a quarter of a century as Beijing is likely hunkering down for a protracted trade war with the US, despite what the sporadically hopefully headlines may say.
Make no mistake, this is about a lot more than just terms of trade. This is about China reestablishing itself as a major player on the world stage if not the dominant one. For much of the past two millennia, China and India together accounted for at least half of global GDP. The past few centuries of western dominance have been a historical aberration.
As the uncertainty around Brexit continues to worsen (more on this later), the British pound last week dropped to its lowest level against the dollar in 35 years, apart from a brief plunge in 2016 likely for technical reasons.
The US economy continues to flash warning signs, but there
remain some areas of strength.
Consumer Spending rose +0.4% month-over-month in July, beating expectations for an increase of +0.3%.
Average hourly earnings for August increased by 0.4% month-over-month and 3.2% year-over-year, each beat expectations by 0.1%.
ADP private nonfarm payrolls increased by 195,000 in August versus expectations for 148,000.
Unemployment rates for black and Hispanic workers hit record lows.
The prime-age (25-54) employment-population ratio hit a new high for this business cycle, still below the peak of both the prior and 1990s expansion peaks, but still an improvement.
While employment growth is slowing, jobs continue to grow faster than the population.
Despite the weakest ISM Manufacturing report in years, the ISM Non-Manufacturing report painted a much rosier picture of at least the service sector. While expectations were for an increase to 54.0 from 53.7 in July, the actual reading came in well above at 56.4. In contrast to the ISM Manufacturing report, New Orders were much stronger than the prior month and only slightly below the year-ago level.
The Citi Economic Surprise Index (CESI) has continued to recover, moving above zero (meaning more surprises to the upside than down) for the first time in 140 days after having been in negative territory for a record 357 days.
Nonfarm payrolls increased by only 130,000 versus consensus estimates for 163,000 and only 96,000 of those jobs came from the private sector – the slowest pace since February. Both July and June job figures have been revised lower, which is basically what we have been seeing in 2019. A long string of revisions to the downside means there is a material shift in the labor market. Total nonfarm payroll employment increased by 130,000 in August.
Job growth has averaged 158,000 per month in 2019, below the average monthly gain of 223,000 in 2018.
University of Michigan Consumer Confidence survey total contradicted the Conference Board’s findings with its main index falling the most since 2012 in August, dropping to the lowest level since President Trump took office. Concerns over tariffs were spontaneously mentioned by 1/3 of the respondents. The most concerning data from the survey where Household Expectations for personal finances one year from now experienced the biggest one month drop since 1978, falling 14 points.
Consumer spending doesn’t look so great when you look at the drop in the Personal Savings rate from 8.0% in June to 7.7% in July, which means that 75% of the increase in spending was at the cost of savings. Net income only rose 0.1% in nominal terms in July versus expectations for a 0.3% increase – not at all consistent with the narrative of a strong labor market.
The Chicago Fed’s Midwest state economy survey found that the number of firms cutting jobs rose to 21% in August from just 6% in July while those hiring dropped to 25% from 36%.
The Quinnipiac University poll found that for the first time since President Trump took office, more Americans believe the economy is getting worse (37%) than believe it is improving (31%).
Camper van sales dropped 23% year-over-year in July. This has historically been a pretty accurate leading indicator of future consumer spending.
The Duncan Leading Indicator (by Wallace Duncan of the Dallas Fed in 1977) has turned negative year-over-year for the first time since 2010. A Morgan Stanley study found that when this indicator has turned negative, a recession began on average four quarters later, with only one false positive out of seven going back to the late 1960s.
While expectations were for the ISM Manufacturing Index to increase from 51.2 to 51.3 in August, the reading came in at 49.1 (below 50 indicates contraction), the fifth consecutive monthly decline in the index and the first time the index has dropped into contraction in three years. Even worse, the only sub-index not in contraction was supplier deliveries. New Orders (the most forward-looking of all sub-indices) hasn’t been this weak since April 2009.
Durable Goods New Orders and Sales are improving but remain in contraction territory while Inventories are rising at around a 5% annual pace – that’s a problem.
US Producer Prices experienced their first decline in 18 months.
The Atlanta Fed’s GDPNow estimate for the third quarter has fallen to 1.5%.
US Freight rates have fallen 20% from the June 2018 high. Even more dire warning comes from freight orders, which dropped 69% in June from June 2018.
That nation that has been the region’s strongest economy is
struggling as the fallout from the US-China trade war expands around the world.
TheGerman unemployment rate rose for the fourth consecutive month.
German retail sales took a bigger battering than expected in July, falling 2.2% from June to reveal the biggest drop this year in the latest indication that Europe’s largest economy may well slide into recession. Since February, monthly retail sales figures have either declined or been flat, with the exception of the 3% gain in June.
A recent survey revealed that employers are posting fewer jobs, intensifying fears that the downturn in the country’s manufacturing industry has spread into the wider economy.
Manufacturing orders came in weaker than expected, declining -5.6% versus expectations for -4.2%.
Construction activity has contracted at the fastest rate since June 2014.
Germany’s export-dependent economy shrank 0.1% in the second quarter while the central bank warned this month that a recession is likely.
The rest of Europe continues to weaken.
Italian industrial orders fell -0.9% in June, making for a -4.8% year-over-year contraction
French consumer spending is up all of +0.1% year-over-year.
Spain’s flash CPI has fallen from 0.5% year-over-year in July to 0.3% in August year-over-year.
Switzerland’s year-over-year-GDP growth has fallen to 0.2% versus expectations for 0.9% – treading water here.
Brexit has turned into an utter mess as Prime Minister Boris Johnson has lost his majority in Parliament. Novels could and likely will be written on this mind-boggling drama in what was once one of the most stable democracies in the world. Rather than put you through that, as they say, a picture is worth a thousand words.
The challenge for anyone negotiating terms for Brexit with the Eurozone basically comes down to this.
Understanding this impossible reality, here is what to expect in the coming weeks.
For those who may not be convinced that this is a material problem, this is an estimate of the impact of a hard Brexit on the Eurozone alone.
Around 70% of the world’s major economies have their Purchasing Managers Index in contraction territory (below 50) – that is a lot of slowing going on. Much of the world is drowning in debt with excess productive capacity – a highly deflationary combination.
We are witnessing a major turning point in the global economy and geopolitical landscape. The past 60 post-WWII years have primarily consisted of US economic and military dominance, increasing levels of globalization and relatively low levels of geopolitical tension.
Today we are seeing a shift away from an optimistic world of highly interconnected global supply chains towards one driven by xenophobia and nationalism. We are seeing rising economic and political tensions between not only traditional rivals but also between long-term allies. In the coming decades, the US economy will no longer be the singular global economic and military powerhouse, which will have a material impact on the world’s geopolitical balance of power.
The big question facing investors is whether the US and much of the rest of the world are heading into a recession. Many leading indicators that have proven themselves reliable in the past indicate that this is highly likely but today really is different.
Never before in modern history have we had these levels and types of central bank influence. Never before have we had such a long expansion period. Never before have we had this much debt, particularly at the corporate level. Never before have we had such profound demographic headwinds. On top of all that, we have a directional shift away from globalization that is forcibly dismantling international supply chains that were decades in the making with no clarity on future trade rules.
Will central bankers be able to engineer a way to extend this expansion? No one who is intellectually honest can answer that question with a high level of confidence as we are in completely uncharted territory. This means investors need to be agile and put on portfolio protection while it remains relatively cheap thanks to historically low volatility levels.
I’ll leave you with a more upbeat note, my favorite headline of the week.
Last week ended with equity markets taking another dive that accelerated into Friday’s close as the trade war with China intensified heading into its eighteenth month with China announcing that it will impose retaliatory tariffs on US goods. The S&P 500 closed down 2.5% for the third time this month. After the close President Trump launched a twitter storm to announce additional retaliatory tariffs in response to China’s. So that’s going well.
Investors face challenging times as the major market movers have simply been words (tweets) coming from politicians and bureaucrats, the prediction of which is akin to assessing the next missive from a Magic 8-Ball.
While many continue to talk about the ongoing bull market,
the major US equity market indices have seen four consecutive weekly declines
and are all in the red over the past year with the small cap Russell 2000 down
well over 10%, sitting solidly in correction territory. On the other hand, this
year has seen the strongest performance out of long-maturity Treasuries since
at least 1987.
How many bull markets see the total return for the long bond
outpace the S&P 500 by over 16%.
This comes at a time when the domestic economy is in it 121st month, the longest is post-war history, which means that many have not lived through a recession as an adult.
As the adage goes, expansions don’t die of old age, but their footing becomes less sure over time and we are seeing signs of rockier terrain. One sign comes from the yield curve which has been flattening steadily since October 2018 with the spread between the 10-year and the 3-month falling from over 100 basis points to -39. The most widely watched part of the curve, between the 10-year and 2-year, has inverted four times in the past few weeks.
This 2-10 inversion is most closely watched as over the past 50 years it has preceded all seven recessions. Credit Suisse has found that on average a recession hit 22 months after the 2-10 inversion occurred.
The third of August’s four inversions came as Kansas City Federal Reserve President Esther George and Philadelphia Fed President Patrick Harker stated in a CNBC interview that they don’t see the case for additional interest rate cuts following the cut in July. Mr. Market was not looking to hear that.
This past week we also received the meeting minutes from the prior Fed meeting with led to July’s 25 basis point cut which gave the impression of a Fed far less inclined to cut than the market was expecting with most Fed participants seeing July’s cut as part of a recalibration but not part of a pre-set course for future cuts. Keep in mind that central bank rate cuts are a relative game and ECB officials have been signaling a high likelihood of significant accommodative measures at the September meeting, saying the ECB “will announce a package of stimulus measures at its next policy meeting in September that should overshoot investors’ expectations.”
Another source of bumps on the economic road comes from the manufacturing sector, both domestic and international. A recent IHS Markit report found that the US manufacturing sector is in contraction for the first time in nearly a decade as the index fell from 50.4 in July to a 119-month low of 49.9 in August – readings below 50 indicate contraction.
According to the Institute for Supply Management, US manufacturing activity has slowed to a nearly three-year low in July. By August New Orders (a key leading indicator) had dropped by the most in 10 years with export sales falling to the lowest level since August 2009.
New business growth has slowed to its weakest rate in a decade, particularly across the service sector. Survey respondents mentioned headwinds from weak corporate spending based on slower growth expectations both domestically and internationally – likely caused by the ongoing trade war that got much, much worse this past week.
In a note to clients on August 11th, Goldman Sachs stated that fears of the US-China trade war leading to a recession are increasing and that the firm no longer expects a trade deal between the two before the 2020 US election. The firm also lowered its GDP forecast for the US in the fourth quarter by 20 basis points to 1.8%.
Global manufacturing has also been slowing, with just two of the G7 nations, Canada and France, currently showing expansion in the sector. In July, China’s industrial output growth slowed to the weakest level in 17 years.
Germany is seeing the most pronounced contraction with its manufacturing PMI dropping from 63.3 in December 2017 to 43.6 this month. German car production has fallen to the levels last seen during the financial crisis.
Overall, we see no sign of stabilization in global manufacturing as global trade volumes look to be rolling over, leaving the economy heavily dependent on growth in the Consumer and the Service sectors. Keep in mind that the last time global trade volumes rolled over like this was back in 2008.
The consumer is yet another source of bumps on the economic road. Ms. Pomboy’s tweet is perfect.
As for that debt, Citigroup recently reported that its credit-card delinquency rate had risen to 2.91% in July from 2.56% in June versus its three-month average of just 1.54%. With all the positive stock moves we’ve seen in retail, keep in mind that the story for many has been more about earnings than actual growth.
For example, Nordstrom (JWN) shares rose 21% after it delivered stronger-than-expected earnings, but that was off of weaker than expected revenue of $3.87 billion versus expectations for $3.93 billion. Nordstrom also slashed net sales guidance for the fiscal year as well as earnings guidance. Management forecast net sales for the year to decrease by about 2%. It previously estimated sales would be flat to 2% down. It also slightly lowered guidance on earnings per share to a range of $3.25 to $3.50, compared with the prior guidance of between $3.25 to $3.65. Did I mention shares rose 21%?
US Consumer sentiment fell to 92.1 in August, the lowest reading for 2019, versus expectations for 97 and down from 98.4 in July. If sentiment continues to degrade, how long will the consumer continue to load up credit cards in order to spend?
It isn’t just the consumer that is taking on more debt – yet
more economic bumps. The federal government deficit rose by $183 billion to
$867 billion during just the first 10 months of this fiscal year as spending
grew at more than twice the rate of tax collections. The Congressional Budget
Office expects the annual budget deficit to be more than 1 TRILLION dollars a
year starting in 2022. Total public debt, which includes federal, state and
local has reached a record 121% of GDP in 2019, up from 69% in 2000 and 43% in
Keep in mind that debt is pulling resources out of the private
sector and at such high levels, fiscal stimulus becomes more challenging in
times of economic weakness. The only time debt to GDP has been higher was after
WWII, but back then we had relatively young population and a rapidly growing
labor force compared to today.
I’ve mentioned before that I am concerned with the strengthening dollar. Dollar denominated on balance sheet debt is over $12 trillion with roughly an additional $14 trillion in off-balance sheet dollar denominated debt – that’s a huge short USD position. The recent resolution of the debt ceiling issue means that the US Treasury now needs to rapidly rebuild its cash position as I had been funding the government through its reserves. This means that we will see a drain on global liquidity from the issue of over $200 billion in Treasury bills.
I’ve also written many times in the past concerning the dangers that lie in the enormous levels of corporate debt with negative yielding corporate debt rising from just $20 billion in January to pass the $1 trillion mark recently – more bumps on the road.
As I said at the start of this piece, this expansion is the longest in post-war history which doesn’t itself mean a recession is imminent, but it does mean that the economy is likely to be more vulnerable. Looking next at the economic indicators we see quite a few that also imply a recession is increasingly likely.
The President’s twitter storm in response to China’s tariffs and the continually rising geopolitical uncertainties that create a strong headwind to any expansions in the private sector only increase risks further. Perhaps by the time you read this piece some part of the rapid escalation of the trade war will have been reversed, as foreign policy has become increasingly volatile day-to-day, but either way, the view from here is getting ugly.
For much of the current expansion, cycle investors have been forced taught to believe in a Heads-I-Win-Tales-You-Lose investing environment in which good economic news was good for equities and bad economic news was also good for equities. Good news obviously indicates a positive environment, but bad news meant further central bank intervention, which would inevitably raise asset prices.
Those who didn’t buy-the-dip were severely punished. Many fund managers who dared to take fundamentals into consideration and were wary, or put on portfolio protection, saw their clients take their money and go elsewhere. An entire generation of market participants learned that it’s easy to make money, just buy the dip. That mode just may be changing as the past two weeks the major indices have taken some solid hits. Keep in mind that while the headlines keep talking up the equity markets, the total return in the S&P 500 has been less than 5% while the long bond has returned over 18%. Austria’s century bond has nearly doubled in price since it was first offered less than two years ago!
Earnings Season Summary
So far, we’ve heard from just under 2,000 companies with the unofficial close to earnings season coming next week as Wal Mart (WMT) reports on the 15th. The EPS beat rate has fallen precipitously over the past week down to 57.2%, which if it holds, will be the lowest beat rate since the March quarter of 2014. Conversely, the top line beat rate has risen over the past week to 57.4% which is slightly better than last quarter, but if it holds will be (excepting last quarter) the weakest in the past 10 quarters. The difference between the percent of companies raising guidance versus percentage lowering is down to -1.8% and has now been negative for the past four quarters and is below the long-term average.
With 456 of the 505 S&P 500 components having reported, the blended EPS growth estimate is now -0.72% year-over-year, with six of the eleven sectors experiencing declining EPS. This follows a -0.21% decline in EPS in Q1, giving us (if this holds) an earnings recession. The last time we experienced such a streak was the second quarter of 2016.
The Fed Disappoints
Last week Jerome Powell and the rest of his gang over at the Federal Reserve cut interest rates despite an economy (1) the President is calling the best ever, (2) an unemployment rate near the lowest level since the 1960s, at a (3) time when financial conditions are the loosest we’ve seen in over 16 years and (4) for the first time since the 1930s, the Fed stopped a tightening cycle at 2.5%. We have (5) never seen the Fed cut when conditions were this loose. They were looking to get some inflation going, Lord knows the growing piles of debt everywhere would love that, but instead, the dollar strengthened, and the yield curve flattened. Oops. That is not what the Fed wanted to see.
The President was not pleased. “What the Market wanted to hear from Jay Powell and the Federal Reserve was that this was the beginning of a lengthy and aggressive rate-cutting cycle which would keep pace with China, The European Union and other countries around the world,” he said in a tweet. “As usual, Powell let us down.”
The dollar’s jump higher post-announcement means that the Fed in effect tightened policy by 20 basis points. Oops2. The takeaway here is that the market was not impressed. It expected more, it priced in more and it wants more. Now the question is, will the Fed give in and give the market what it wants? Keep in mind that both the European Central Bank and the Bank of England are turning decisively more dovish, which effectively strengthens the dollar even further.
Looking at past Fed commentary, the track record isn’t exactly inspirational for getting the all-important timing right.
But, we think the odds favor a continuation of positive growth, and we still do not yet see enough evidence to persuade us that we have entered, or are about to enter, a recession.” Alan Greenspan, July 1990
“The staff forecast prepared for this meeting suggested that, after a period of slow growth associated in part with an inventory correction, the economic expansion would gradually regain strength over the next two years and move toward a rate near the staff’s current estimate of the growth of the economy’s potential output.” FOMC Minutes March 20, 2001
“At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems to likely be contained.” Ben Bernanke, March 2007
“Would I say there will never, ever be another financial crisis? You know probably that would be going too far but I do think we’re much safer and I hope that it will not be in our lifetimes and I don’t believe it will be.” Janet Yellen, June 2017 (This one is going to be a real doozy)
This time around Fed Chairman Powell told us that what we are getting is a “mid-cycle policy adjustment.” Wait, what? We are now (1) in the longest expansion in history with (2) the lowest unemployment rate in over 50 years as (3) corporate leverage levels reaching record levels at a (4) time when more of it is rated at just above junk than ever before in history. This is mid-cycle? I’m pretty sure this one will be added to the above list as some serious Fed facepalming. Now I think these folks are incredibly bright, but they are just tasked with an impossible job and live in a world in which their peers believe they can and ought to finesse the economy. So far that theory hasn’t turned out all that well for anyone who doesn’t already have a good-sized pile of assets.
Domestic Economy (in summary because it is August after all)
We are 3-year lows for the US ISM manufacturing and services PMIs.
We are seeing a shrinking workweek, contracting manufacturing hours and factory overtime is at an 8-year low.
Just saw a contraction in the American consumer’s gasoline consumption.
American households just cut their credit card balances, something that happens only about 10% of the time during an expansion. Keep in mind that Q2 consumer spending was primarily debt-fueled when looking towards Q3 GDP.
The Organization for Economic Co-operation and Development (OECD) Leading Economic Indicator for the US fell to a 10-year low in June, having declined for 18 consecutive months. A streak of this nature has in the past always been indicative of a recession. Interestingly that same indicator for China just hit a 9-month high.
The Haver Analytics adjusted New York Fed recession risk model has risen from 50% in early January to a 10-year high of 80%.
The IMF has cut world GDP forecasts for the fourth consecutive time.
We have 11 countries so far in 2019 experiencing at least one quarter of shrinking GDP and 17 central banks are in cutting mode with Peru the latest to cut, the Royal Bank of Australia hinting at further cuts and Mexico and Brazil likely next in line.
Some 30% of the world’s GDP is experiencing inverted yield curves.
Over half the world’s bond market is trading below the Fed funds rate.
Despite the sanctions on Iran and OPEC output cuts, WTI oil prices have fallen over 20% in the past year.
The Eurozone manufacturing PMI for July fell to 46.5, down from 47.6 in June and is now at the lowest level since the Greek debt crisis back in 2012 as employment declined to a six-year low with a decline in exports. Spain came in at 48.2, 48.5 for Italy and 49.7 for France.
Germany, long the economic anchor for the Eurozone and the world’s fourth-largest economy, has negative yields all the way out 30 years and about 40% of Europe’s investment-grade bonds have negative yields. The nation’s exports declined 8% year-over-year and imports fell 4.4% in June as global demand continues to weaken.
France had its industrial production contract -2.3% in June versus expectations for -1.6%.
Italy’s government is back in crisis mode as the two coalition ruling parties look to be calling it quits. Personally, I think Salvini (head of the League) has been waiting for an opportune time to dump his Five Star partners and their recent vote against European Infrastructure gave him that chance. The nation is likely heading back to the polls again at a time when Europe is facing a potential hard Brexit, so we’ve got that going for us.
The UK economy just saw real GDP in Q2 contract 0.2% quarter-over-quarter. Domestic demand contracted -3%. Capex fell -0.5% and has now been in contraction for five of the past six quarters. Manufacturing output also contracted -2.3% in the worst quarter since the Great Financial Crisis.
South Korean exports, a barometer for global trade, fell 11% year-over-year in July. The trade war between South Korea and Japan continues over Japan’s reparations for its brutal policy of “comfort women” during WWII.
The trade war with China has entered the second year and this past week it looks unlikely that we will get anything sorted out with China before the 2020 election. The day after Fed’s rate decision Trump announced that the US would be imposing 10% tariffs on $300 billion of Chinese goods starting September 1st. In response, China devalued its currency and word is getting out that the nation is preparing itself for a prolonged economic war with the US. The rising tension in Hong Kong are only making the battle between the US and China potentially even more volatile and risky. Investors need to keep a sharp eye on what is happening there.
Auto sales in China contracted 5.3% year-over-year in July for the 13th contraction in the past 14 months.
Tensions are rising between India and Pakistan thanks to India’s PM Modi’s decision to revoke Kashmir’s autonomy.
When we look at how far the dollar has strengthened is have effectively contracted the global monetary base by more than 6% year-over-year. This type of contraction preceded the five most recent recessions. While the headlines have been all about moves in the equity and bond markets, hardly anyone has been paying attention to what has been happening with the dollar, which looks to be poised the breakout to new all-time highs.
A strengthening dollar is a phenomenally deflationary force, something that would hit the European and Japanese banks hard. So far we are seeing the dollar strengthen significantly against Asian and emerging market currencies, against the New Zealand Kiwi and the Korean Won, against the Canadian dollar and the Pound Sterling (Brexit isn’t helping) and China has lowered its peg to the dollar in retaliation against new tariffs in the ongoing trade war. There is a mountain of US Dollar-denominated debt out there, which is basically a short position on the greenback and as the world’s reserve currency and the currency that utterly dominates global trade. As the USD strengthens it creates an enormous headwind to global growth.
The deflationary power of a strengthening US dollar strength in the midst of slowing global trade and trade wars just may overpower anything central banks try. This would turn the heads-I-win-tales-you-lose buy-the-dip strategy inside out and severely rattle the markets.
The bottom line is investors need to be watching the moves in the dollar closely, look for those companies with strong balance sheets and cash flows and consider increasing liquidity. The next few months (at least) are likely to be a bumpy ride.
It’s the end of July and has been hot as hell for much of the world this week, around 107 Fahrenheit in Paris yesterday! So I’ll do my best to keep this look into economy and markets a bit shorter than my usual. When economies and markets are near a turning point, often the headlines tell a very different story than is revealed by digging deeper into the data – you can’t judge a book by its cover. In this week’s issue of Context & Perspectives:
Budget Debate Off the Table Until 2020
Investors Just Not That into the Stock Market
Global Manufacturing Weakness Continues to Spread
Next Week, the Fed Re-Takes Center Stage
Budget Debate Off the Table Until 2020
Apparently, the Democrats were also feeling the heat as they managed to work out a deal on a 2-year budget with the President, so at least that drama is off the table until after the elections. Maybe at some point during the elections, someone will mention the enormous level of debt the government has accumulated, while Social Security remains a massively underfunded elephant in the room. Or maybe not. We live in interesting times.
Investors Just Not That into the Stock Market
While the market continues to grind higher, digging into the details we find that investors have really not been loving this stock market. Over the past 52 weeks, according to data from the Investment Company Institute (ICI), investors have pulled $329.4 billion out of equity funds, another $94.0 billion out of hybrid funds and put $75.7 billion into bond funds. So how has the market continued to march higher? Over the past five years, investors have been net sellers of the market with corporations themselves the net buyers through stock buybacks, which isn’t quite as rosy as it may first seem.
Some of these buybacks are being funded through debt, which has led global corporate debt to reach unprecedented heights, as I discussed in my last piece when I pointed out the proliferation of not just corporate debt, but also the increasing numbers of zombie corporations. There are a few others also concerned with this, as was discussed in a Barron’s article yesterday, you might recognize just a few of these names.
Part of why investors are selling while corporations are buying back their own shares is likely a function of demographics. As the Baby Boomers move adjust portfolios as they move into retirement, their portfolio construction will naturally have to change and that shift, in a period of central bank interest rate suppression, is much harder than it was for generations past. The level of income that can be feasibly generated from a portfolio today is much less than what the Baby Boomers’ parents enjoyed. At the other end of the spectrum, Millennials are saddled with unprecedented levels of student debt, so they aren’t exactly big buyers of shares either. Between central bank manipulations and demographics, this is a very different investing environment.
Given the relative strength of the US economy compared to the global economy, which is slowing more dramatically, it is interesting to note that large-cap stocks, (which tend to have more international exposure) have been outperforming small-cap stocks at a level not seen since January 2008 – ahem, share buybacks, anyone?
Global Manufacturing Weakness Continues to Spread
This week’s Markit manufacturing PMI came in at 50.0, meaning no change in output, and was the weakest level since March of 2009. The United States wasn’t alone as Germany’s Markit Manufacturing PMI was the lowest since July of 2012 and the Euro Area as a whole came in at the lowest level since December 2012. A composite of the five Federal Reserve manufacturing activity indices (courtesy of Bespoke Investment Group) reveals that all nine subcomponents have declined year-over-year, with Prices Paid leading the decline, down -24.2% and New Orders coming in the second worst, down -22.2%. New Orders are also down -10.2% from just this past April. That is not exactly a rosy leading indicator. The International Monetary Fund has cut global growth forecasts four times this year.
When looking at manufacturing globally, the first company to come to mind is Caterpillar (CAT). The company reported results for the June quarter that confirmed the overall slowing we’ve been seeing in the global industrial sector. Sales growth for the company has weakened along with various indicators of slowing we’ve been seeing come in from all over the world. We aren’t seeing an imminent crash, but Caterpillar’s results certainly support the theory of spreading weakness. Sales for the bellwether company peaked in North America in February 2018 at 30% year-over-year and have been falling ever since, with June’s 12% year-over-year growth rate the weakest in 18 months. North America remains the strongest region for the company and one of only two posting positive growth. The rolling three-month average global sales growth rate is down to its lowest level in about 14 months and the company’s streak of 28 consecutive months of rising sales is being threatened. This tells you an awful lot about the global economy.
The Consumer & Government Props Up GDP . . . with Debt
Friday morning the first estimate for GDP for the second quarter was released, rising 2.1% versus expectations for 1.8% – 2.0% and up from 3.1% in the first quarter. This quarter was all about the consumer with personal consumption expenditures up 4.3% (annual rate), the strongest performance in six quarters. At the same time, American Express (AXP) and Capital One Financial Corp (COF) reported an increase in the number of accounts overdue by 30+ days in the second quarter. Personal Savings also declined -3.6%. Spending up, debt up and savings down – not exactly a sustainable trend?
Looking further at the consumer, on the positive side, the solid quarterly earnings report from short-term staffing provider Robert Half (RHI) provided evidence that we are seeing domestic wage growth with the bill rate (which is basically the cost of waters for the company’s customers) was up 5% year-over-year in the past three quarters. That’s good news for the consumer, but keep in mind this is not a leading indicator. On the other hand, employment at small businesses, which does tend to be a leading indicator as small businesses are quick to respond and adjust to the changing economy, fell by 23k in June after having fallen 38k in May. The last time we saw back-to-back drops of that magnitude was in early 2010. For all the hoopla over employment, the last Job Openings and Labor Turnover Survey found that job openings were down -4% from the cycle high and new hires were down -4.4%. Again, not saying we are falling off a cliff here, but we are looking for indicators that the trend is changing direction and these data points clearly point towards that assessment.
Friday’s GDP report also found that gross private domestic investment declined -5.5%, the worst showing since the December quarter of 2015 with spending on non-residential structures falling -10.6%. This drop on business investment took a full percentage point off of GDP – to be fair, they are awfully busy buying back their own shares. If businesses are cutting back on investments in machinery and structures, isn’t hiring going to be affected? That will affect consumer spending. When looking at that fall in domestic investment, keep in mind the trade wars and how Chinese foreign direct investment has declined by about 90% over the past two years.
Along with a jump in consumer spending, government spending also jumped, rising 5% on an annual basis. That is the biggest increase in spending since the second quarter of 2009 when the economy was literally falling off a cliff. Not to be a negative Nancy here, but digging into the math a bit we see that consumer spending and government combined rose at a 4.4% annual rate while the rest of the economy contracted at a -12.1% rate.
In the end, and I’m doing my best to wrap this up quickly for all of you struggling with the heat, all eyes remain on the entities most responsible for the health of the stock market these days – central banks. The European Central bank policy announcement this week kept the benchmark despite the rate at negative 40 basis points but indicated the bank is considering additional quantitative easing and potentially a tiered deposit rate scheme to help protect bank profitability – not exactly a shocker given the poor condition of many of the region’s banks. The outgoing head of the ECB, Mario Draghi, stated that the outlook “is getting worse and worse.” In response, the German 10-year yield traded as low as negative 42 basis points. For context, the US 10-year closed the same day at 2.075%.
On Tap Next Week, the Fed Re-Takes Center Stage
Next week the Federal Reserve is expected to cut its key rate by at least 25 basis points and the market is pricing in further cuts to follow. Many are arguing that the Fed needs to be Gretzky and move to where the economy is going to be, not where it is today. They may be right, but the Fed has backed itself into a really tough corner. A typical rate-cutting cycle sees 525 basis points of cuts. Today, it has about half of that to work with and over the coming months the economy is facing quite a few potential shocks:
Brexit – now that Boris is in charge it could get ugly.
The feud between the odd-couple political coalition in Italy is intensifying at a time when European leadership is particularly weak and facing Brexit. Just what the EU needs, more instability.
Iran tossing around missiles and threats in the Strait of Hormuz
The Fed may want to keep some of those precious few arrows in its quiver. It is also facing competition in the race to the bottom as many of the world’s central banks are either cutting or are looking to begin cutting rates in the near future. Meanwhile, the market continues to grind higher.