Author Archives: Lenore Hawkins, Chief Macro Strategist

About Lenore Hawkins, Chief Macro Strategist

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.
Is Everyone Looking the Wrong Way?

Is Everyone Looking the Wrong Way?


Over the past few months, the investing markets have considered Federal Reserve Chairman Powell enemy number one. Earlier this week the markets once again showed that America’s central bank drives sentiment more than any other factor, forget trade wars, forget earnings, forget political drama, it is the Fed and only the Fed that matters. That may sound somewhat simplistic to all the fundamental analysts and market technicians out there, but let’s face facts – it’s true.

Even the end of the 35-day long government shutdown barely generated a response from the markets.

What did generate interest was the rumor that the Fed may be considering ending its $50 billion-a-month drawdown of its balance sheet.

The afternoon of Wednesday, January 30th, after a much more dovish tone out of Powell, the stock market closed up for the first time after the past eight FOMC meetings – the longest post-FOMC losing streak on record. The prior meeting on December 19th was followed by a gut-wrenching 1,800-point crash in the Dow over the following four sessions. As we were nearing the end of 2018, it looked and smelled like the Fed went too far yet again, as it had done in 10 of the past 13 post-WWII hikes – so much for the narrative of the omniscient central banker. As Mark Twain wrote, “History doesn’t repeat itself, but it does rhyme.”

Investing is all about finding an inflection point, where the market is wrong – pricing an asset too high or too low, believing a policy to be beneficial when it isn’t or vice versa. Given the ubiquitous nature of the belief that the Fed is the central bank that really matters to the market, what if that supposition is wrong?

What if everyone is looking in the wrong direction with the wrong set of expectations? What if everyone ought to be looking in the direction of our New Global Middle Class investing theme? We will start to explore that idea in this week’s piece along with an assessment of the domestic and global economy.

As Chris Versace and I wrote in our book Cocktail Investing, there are three major participants in an economy: consumers, business and government. To understand what is happening in an economy one needs to understand the vector and the velocity associated with each one of these participants.


Households’ Outlook Dims

Our Middle-Class Squeeze investing theme was again front and center this week in the domestic economy. This week we got a rather dour report on how the Household sector of the economy is feeling about the future with the University of Michigan’s monthly index of Consumer Sentiment, which gauges American’s view on their own financial condition as well as the economy in general. In January U.S. Consumer Confidence dropped to 90.7 versus expectations for 96.8, hitting an 18-month low despite initial jobless claims dropping to a 49-year low, likely thanks to the double-whammy of the partial government shutdown and the recent volatility in the financial markets.

The decline was driven primarily by deteriorating expectations about the future, with that portion of the index declining 11% in January after falling 13% in December. On the other end of the spectrum, consumer’s assessment of current conditions is a mere 2% below the August peak which puts the spread between consumer’s outlook for the future and their present situation at nearly the largest since 1967. The only period in which the spread was greater was January through March of 2001 – the recession began in March 2001. Hat tip to David Rosenberg of Gluskin Sheff for the chart below.

We will be watching this metric particularly closely in February as well as the February Manufacturing Index given the recent drop in the 6-month view.

The rather glum outlook continues to be a headwind to the housing sector. House sales, excluding newly built homes, fell by 10% in December compared with the same month in 2017, according to the National Association of Realtors. Interestingly, this sharp fall off occurred despite the late 2018 rollover in mortgage rates, which as any a home buyer knows makes for a lower cost of total home ownership.


Slowing Corporate Sector

We are knee deep in the December 2018 quarter earnings season with around one-third of the S&P 500 companies having reported so far with an aggregate increase of 14.2% in earnings per share on an increase of 5.6% in revenue. While that sounds pretty good at first glance, what concerns us is that the beat ratio so far is the lowest since 2014, despite having the second most aggressive estimate cuts in the months going into this season since the depths of the financial crisis. On top of that, expectations for 2019 are being materially scaled back with expected EPS growth having fallen to just 1.6% year-over-year in the March quarter, driven in large part by weakening revenues for those companies with a lot of international sales exposure. As we’ve heard from a growing number of companies over the last few weeks, they are feeling the pinch of the trade war as well as the strong dollar.

One theme that keeps rearing its head is the impact of weakness in China, which is no small matter given that according to the US Census Bureau, America’s exports to China have doubled over the 10 years through 2017 to reach $130 billion a year. Companies ranging from Caterpillar (CAT) to Apple (AAPL), NVIDIA (NVDA) to Stanley Black & Decker (SWK) and 3M (MMM) have commented on the impact of a Chinese slowdown.

Caterpillar expects its Chinese markets to be flat in 2019. NVIDIA reported weaker Chinese demand for its computer chips and gaming consoles. H.B. Fuller Co (FUL) reported that weaker demand from China will reduce its profits by $20 million this year. PPG Industries (PPG) reported sales of its coatings for cars made in China fell 15% in the December quarter.

Despite these declines, however, luxury goods associated with our Living the Life investing theme continue to boom in China according to LVMH-Moet Hennessy Louis Vuitton (LVMHF). During its earnings conference call, the company shared that “growth in China has accelerated in Q4 compared to the previous quarters and the beginning of this year is the same.” That strength was corroborated by Ferrari (RACE) that reported its sales in China, Hong Kong and Taiwan rose nearly 13% year over year in the December quarter, and forecasted a pickup in its China business during the first half of 2019. Some of this may reflect the non-US nature of those companies, but the more pronounced driver is more than likely demographic in nature as captured by the rising middle class in China and the allure of aspirational goods, but also the rapid rise in wealthy and ultra-wealthy Chinese, a key cohort when it comes to the Living the Life tailwind.



While the partial government shutdown has finally come to an end, at least temporarily, inside the beltway is increasingly looking like a kindergarten class that has missed its afternoon nap. The US federal deficit continues to be quite large compared to post WWII norms.

The sheer size of the federal deficit combined with the Federal Reserve program to reduce its balance sheet means that roughly $1.3 trillion is being pulled away from the private sector. The more money the government needs, which means increased Treasury bond supply, the less money is available to be spent in the private sector – this is referred to as the crowding out effect of large government deficits. The Fed’s actions along with the increase deficit spending are one of the factors behind the recent drop is equity prices as the money has to come from somewhere. Less money in the private sector means demand for private sector assets declines which impacts prices. What about China? Well, it is no longer a buyer of US debt and may well have become a net seller.


Global Economy

In 2017 the world’s leading economies accelerated in sync, boosting equity prices. In 2018 the U.S. economy surged on thanks in part to fiscal stimulus in the form of tax cuts and increased government spending while the rest of the world slowed. In 2019 the world looks to be once again syncing up to slow down. The IMF warned that “the global expansion is weakening and at a rate that is somewhat faster than expected”. The fund revised down its forecasts, particularly for advanced economies with the world’s economy forecast to grow by 3.6% in 2020. Although that is stronger than in some previous years, the IMF thinks “the risks to more significant downward corrections are rising”, in part because of tensions over trade and uncertainty about Brexit.

The Global Zentrum fur Europaische Wirtschaftsforschung (ZEW) Economic Sentiment Index echoes what we’ve seen from the Michigan Consumer Sentiment Index.

Italy has now had two consecutive quarters of contracting GDP, which means that technically Italians are breaking out the Barolo and sadly toasting to their latest recession. Germany, which has been the strongest economy in the Eurozone, saw its economy contract 0.2% in the third quarter of last year, its industrial production decline 1.9% in November, and retail sales crash 4.3% in December, sparking fears that the country is on the brink of a recession as well. Recent federal statistics have Germany’s economy growing by just 1.5% in 2018 versus 2.2% in 2017 with the IMF forecasting just 1.3% in 2019. According to data published by IHS Markit, France’s Composite Output Index that reflects its manufacturing and services economy remained in contraction mode at 47.9 in January, down from 48.7 in December. As a reminder, a reading below 50 indicates a contraction, while one above 50 indicates growth. Against that backdrop, it’s not shocking to read that European Central Bank President Mario Draghi say “The European Central Bank is ready to use all its policy tools to support Europe’s softening economy, including by restarting a recently shelved bond-buying program.” As for the U.K., consumer confidence with respect to the economic outlook fell to a 7-year low in January.


China Slows

China has the second largest economy in the world and will soon replace the US as the world’s largest retail market as it benefits from the tailwinds in our New Global Middle Class investing theme. What happens in China matters to the rest of the world. For example, China has become the largest importer of wood in the world and the largest exporter of things made from wood, ranging from furniture to flooring. While China’s economy will eclipse that of the US, growth doesn’t come in a straight line and we are seeing warning signs:

  • China’s economy has slowed 6.4% in the fourth quarter of 2018, the third consecutive deceleration. Growth slowed to 6.6% in 2018, the slowest growth since 1990 when sanctions were imposed following the Tiananmen Square massacre.
  • Manufacturing PMI in January stood at 49.5 and was 49.4 in December, showing 2 consecutive months of contraction.
  • Property sales, which had been a reliable source of growth which took advantage of borrowing opportunities have been slowing.
  • The growth in retail sales has fallen to its lowest level in more than 15 years.
  • Sales of cars fell last year for the first time in more than two decades.
  • Companies have started cutting back hiring and incomes are growing more slowly, weighing on consumer sentiment. The middle three quintiles of China’s population by income distribution saw earnings increase by only about 2% last year in real terms.
  • Defaults are on the rise. Corporate bond defaults reached 19 billion yuan in the first half of 2018 versus 14 billion in the same period of 2017. Smaller banks in rural areas, which would be the first to feel the pain, are seeing rising levels of bad loans.

As a result, China is letting up on its drive to deleverage its economy and Chinese investment into Europe and America fell by 73% in 2018. China has already pivoted towards more supportive economic policies. It has sped up spending on infrastructure, trimmed income taxes and relaxed some restraints on bank lending. China has a massive population that it needs to keep employed and was the world’s engine during the last financial crisis, providing a floor under demand as much of the rest of the world was crashing.


What If They Are Wrong?

The US today has the highest non-financial private sector debt to GDP ratio in history. Overall the global debt to GDP ratio is the highest we’ve ever seen. Most likely the Fed tightening cycle has come to an end and the next thing we are most likely to see is easing, but this time perhaps that cure is already used up?

We’ve already seen materially diminishing returns from Fed stimulus efforts in the past.

What if this time around the only central bank that truly matters is China’s?

What if China decides to alter its monetary policy, its peg to the dollar, to help its slowing economy thereby creating a cascade across the east as its neighbors scramble to respond?

What if the only bank in the world that can affect asset prices this time, that can actually create inflation is the one for the biggest consumer of raw materials in the world, the one in the East at the People’s Bank of China while everyone is looking the other way?

What if indeed…

How many investors are factoring that into their thinking? Is President Trump contemplating that as US-China trade talks continue? We’ll be watching so stay tuned.



India’s Mobile Monsoon

India’s Mobile Monsoon


An article in this week’s Economist points out some phenomenal data that speaks to our Global Rise of the Middle Class investing theme. While the Middle Class in many developed nations is under pressure, part of our Middle-Class Squeeze investing theme, we are seeing technology help leapfrog infrastructure needs in many emerging markets. In India, mobile data is giving people access to the global economy in ways that was utterly impossible just a few years ago.

Just three years ago there were only about 125m broadband internet connections in India; by last November the number had reached 512m. New connections are growing at a rate of 16m per month, almost all on mobile phones. The average Indian phone user now consumes more mobile data than most Europeans.

Incredible economies of scale possible in the most populous nation on earth make for business models that are not feasible elsewhere.

So as not to limit the market to people who can afford smartphones, Jio also launched its own 4g feature-phone, the JioPhone, which it says is “effectively free”. Customers pay only a refundable deposit of 1,500 rupees ($21) for the device, with which they can use WhatsApp, watch YouTube and take pictures. As Mr Ambani said last year, for most users their Jio connection “is not only their pehla [first] phone but also their pehla radio and music player, pehla tv, pehla camera and pehla Internet”.

Which has lead to incredible adoption rates.

Data in India now cost less than in any other country. On average Jio’s users each download 11 gigabytes each month.

The opportunities here are staggering, but as we’ve seen pushback on globalization in much of the developed world, so too is India looking to protect is domestic companies from foreign competition. Draft rules revealed last July would require internet firms to store data exclusively in India. Another set of rules that went live last October require financial firms to store data locally, too. On December 26th India passed rules that hit hard at Amazon (AMZN) and Walmart (WMT), which dominate e-commerce there, preventing them from owning inventory in an attempt to protect local digital and traditional retailers.

Investors are well served to look beyond just the U.S. economy which is facing growth headwinds from slowing population growth, aging demographics and enormous debt loads with a mountain of unfunded liabilities across pensions and Social Security. In India, a country with a massive population that is relatively young and with productivity levels well below those of developed economies, small improvements can generate enormous returns for both its citizens and investors.

Source: Mukesh Ambani wants to be India’s first internet tycoon – India’s new Jiography

The World’s Biggest Brands Going Green With Refillables

The World’s Biggest Brands Going Green With Refillables

We are seeing yet another shift in consumer products at the intersection of our Clean Living and Disruptive Innovators investing themes wherein the world’s biggest consumer brands are looking to provide their products to consumers in refillable containers so as to reduce waste. This creates a tailwind behind those providing the containers and the refilling services.

A recent Wall Street Journal article discussed the massive potential impact of this change.


Refillables once dominated industries such as beer and soft drinks but lost out to convenient, affordable single-use containers. In 1947, refillables made up 100% of soft-drink containers by volume and 86% of beer containers, according to the Container Recycling Institute, a nonprofit. By 1998 those figures dropped to 0.4% and 3.3%, respectively.

Our Clean Living investing theme goes beyond just what we put into and on our bodies to our impact on our environment. The WSJ article points out that those companies that provide the more environmentally friendly offerings will be able to attract those consumers who value that feature, an ever-growing portion of households.

Critics question whether the project will achieve scale in the face of high costs and entrenched consumer behavior. But, if successful, the companies say the efforts will reduce waste from single-use packaging. It could also be a way to woo eco-conscious consumers, glean data and foster brand loyalty.

We are still in the early stages of this, so your team at Tematica will be keeping a close eye on how this progresses and which companies are best poised to take advantage of the new packaging and fulfillment needs.

Unilever will sell nine brands in refillable containers as part of the initiative, which will be run by recycling company TerraCycle Inc. and start with 5,000 shoppers in New York and Paris in May. The pilot will extend to London later this year and cities including Toronto and Tokyo next year, according to TerraCycle.

Do I really use 100 of these over 8 years?

Unilever estimates a refillable steel container for its Axe and Dove stick deodorants will last eight years—long enough to prevent the disposal of as many as 100 traditional deodorant packages.

The range of products to be offered is quite extensive.

PepsiCo will sell its Tropicana orange juice in a glass bottle and Quaker Chocolate Cruesli cereal in a stainless-steel container as part of the trial.

P&G will sell 10 brands, including Pantene shampoo in an aluminum bottle, Tide laundry detergent in a stainless-steel container and an Oral B toothbrush with a durable handle and a replaceable head.

This can also be a way to increase switching costs, which will serve to improve brand and product loyalty.

“It’s really about a new delivery system and making sure once people are hooked into this they stay with the product,” said P&G’s chief sustainability officer, Virginie Helias.

The bottom line here is consumer tastes are ever evolving. Successful investing requires looking towards what features consumers will be wanting in the future and how they will want them fulfilled.

Source: The World’s Biggest Brands Want You to Refill Your Orange Juice and Deodorant – WSJ

Less Booze, More Kombucha?

Less Booze, More Kombucha?

We’ve all read the statistics on just how chubby Americans have become and all the lovely little health problems that come along with those extra pounds, from diabetes to heart disease not to mention the physical discomfort of lugging extra pounds around. Making healthier eating and drinking choices is part of our Clean Living investment theme and this week the Wall Street Journal ran an article discussing how as Americans increasingly lay off the booze, the world’s biggest brewers and liquor companies are having to push beyond their traditional fare and roll out teas, energy drinks, and nonalcoholic spirits.

As a confirmed wine lover who owns more wine fridges than I’m willing to publicly admit and who is also known to enjoy a great glass of scotch (travel tip British Airways offers Johnnie Walker Blue in first class)  or a gin and tonic, (new favorite gin is Darjeeling) I’m struggling to wrap my head around kombucha or spiked coconut water (who knew there was such a thing) to replace the heaven of pouring a glass of Barolo, but I applaud the effort by a nation that clearly has room for improvement on the health front.

According to the Wall Street Journal,

Americans’ consumption of ethanol, or pure alcohol, has declined sharply over the past couple of decades. Alcohol consumption stood at 8.65 liters per person in 2017—the most recent year for which data is available—compared with 10.34 liters in 1980, according to research firm Bernstein….


New data show that U.S. alcohol volumes dropped 0.8% last year, slightly steeper than the 0.7% decline in 2017. Beer was worst hit, with volumes down 1.5% in 2018, compared with a 1.1% decline in 2017, while growth in wine and spirits slowed, according to data compiled for The Wall Street Journal by industry tracker IWSR.

Way to go America!

From an investors standpoint…

IWSR forecasts low- and no-alcohol products in the U.S.—still a small slice of the market—to grow 32.1% between 2018 and 2022, triple the category’s growth over the past five years.

And this trend has legs…

Diageo Chief Executive Ivan Menezes said last year that adults opting for lower alcohol options was “an important trend over the next many years” and that the company was “putting a lot of focus behind it.”

The bottom line is as consumers look to make healthier choices, companies are forced to respond by altering their offerings. Those that recognize the change and take advantage of it are part of our Clean Living investing theme, those that don’t… well … remember Blockbuster?

For the entire article go to: As Americans Drink Less Alcohol, Booze Makers Look Beyond the Barrel – WSJ

As the Market Bounces Off Oversold Conditions, is this the Start of Another Bull Run?

As the Market Bounces Off Oversold Conditions, is this the Start of Another Bull Run?

Market Reversal

So far in 2019, we are seeing a reversal of the heavily oversold conditions from the end of 2018. Those stocks that were hit the hardest in 2018 are materially outperforming the broader market in 2019. For example, through the close on January 16, 62% of stocks in the Financial sector were above their 50-day moving average, the highest of any sector, versus 44% for the S&P 500 overall. To put that into perspective, Financials have not been the top performer for this metric in 273 trading days, the second-longest such streak since 2001 and only the fourth streak ever of more than 200 trading days. It isn’t just financials as the Energy sector, which was the worst performing sector in 2018, has the third highest percent of stocks above their 50-day in 2019.

While impressive looking, this shift doesn’t necessarily bode well for the Financial sector, nor for the broader market according to data compiled by Bespoke Investment Group.


Stock Performance After Streaks Ended



This recent outperformance by Financials in 2019 is particularly fascinating when I talk to my colleagues at various major financial institutions. Here are a few of the comments I’ve been hearing, paraphrased and without attribution for obvious reasons:

“This deal is way too small for you guys, but I wanted to let you know that our team is working on it.” –  (M&A consultant)

Send it over.We are so late in the cycle that we are looking at damn near anything.” –  (Partner at one of the largest global private equity firms)

“What can we do to better serve your company? We are making a major push this year into better serving companies of this size.” –  (Partner at one of biggest investment banks to a very surprised member of the Board of Directors of a recently IPO’d company whose market cap would have normally left it well below the bank’s radar. After some investigation, many other board members for companies of a similar size in the sector have been getting the same phone calls from this bank.)

The big financial institutions are having to work their way downstream to find things to work on – that’s a major peak cycle indicator and does not bode well for margins. It also doesn’t bode well for the small and medium-sized institutions that will likely need to become more price competitive to win deals in this new more competitive playing field.

We have also seen some wild moves in a few of our favorites such as Thematic Leader Netflix (NFLX), which reported its earnings after the close on January 17th. Netflix sits at the intersection of our Digital Lifestyle and Disruptive Innovators investing themes and has seen its share price fall over 40% from the July 2018 all-time highs to bottom out on December 24th. Since then, as of market’s close on January 17, shares gained nearly 50% – in around all of 100 trading hours! While about 10% of that can be attributed to the recent price increase that will amount to about $2 or so per month for subscribers, there are greater forces at work for a move of such magnitude. No one can argue that either direction was based on fundamentals, but rather a market that is experiencing major changes.

One of the most important leading indicators as we start the Q4 earnings seasons was the miss by FedEx (FDX) and the negative guidance the company provided for the upcoming quarters. FedEx’s competitor United Parcel Service (UPS) is part of our Digital Lifestyle investing theme – how are all those online and mobile purchases going to get to you? Both FedEx and UPS are critical leading indicator because they touch all aspects of the economy and transportation services, in general, have been posting some weak numbers lately in terms of both jobs and latest price data.

In what could be reflective of both our Middle Class Squeeze investing theme, Vail Resorts (MTN) also gave a negative pre-announcement, stating that its pre-holiday period saw much lower volumes than anticipated despite good weather conditions and more open trains. The sour end of the year in the investment markets and the weakness we’ve seen in markets around the world may have led many decided to forgo some fun in the snow. We’ll be keeping a close eye on consumer spending patterns, particularly by income level in the months to come.

Investor Sentiment Slips

According to the American Association of Individual Investors, bearish investor sentiment peaked at 50.3% on December 26, right after the market bottomed. Bullish sentiment over the past month rose from 20.9% to 38.5% but then stalled this week, falling back to 33.5% as the markets reached resistance levels. Bullish sentiment is now back below the historic average but still well above the December lows. Bearish sentiment, on the other hand, is on the rise, up to 36.3% from last week’s 29.4%. This is just further indication that much of what we’ve seen so far in 2019 is a recovery from the earlier oversold conditions.

As we look at the unusual pace at which the major indices lost ground in the latter part of 2018 and the sharp reversal in recent weeks, I can’t help but think of one of the many aspects of our Aging of the Population investment theme. A large portion of the most powerful demographic of asset owners is either in or shortly moving into retirement. Many already had their retirement materially postponed by the losses incurred during the financial crisis. They are now 10+ years older, which means they have less time to recover from any losses and have not forgotten the damage done in the last market correction. I suspect that we are likely to see more unusual market movements in the years to come than we have since the Boomer generation entered into the asset gathering phase of life back in the 60s and 70s. Today this group has a shorter investment horizon and cannot afford the kinds of losses they could 20+ years ago.

The Shutdown and the Fed

Aside from a rebound against the oversold conditions, another dynamic that has the market in a more optimistic mood, at least for the near term, is the narrative that the government shutdown is good news for interest rates as it will likely keep the Federal Reserve on hold. Given that estimates are this shutdown will cost the economy roughly 0.5% of GDP per month, it would be reasonable for the Fed to stay its hand.

Inflation certainly isn’t putting pressure on the Fed. US Producer Prices fell -0.2% last month versus expectations for a -0.1% decline. The bigger surprise came from core ex-food and ex-energy index which fell -0.1% versus expectations for an increase of +0.2%. Keep in mind that core PPI declines less than 15% of the time, so this is meaningful and gives Powell and the rest of the FOMC ample cover to hold off on any hikes at the next meeting.

US import prices fell -1% month-over-month in December after a -1.9% decline in November, putting the year-over-year trend at -0.6%. That’s the first negative year-over-year print since August 2014. Yet another sign that inflation is rolling over.


Economy Flashing Warning Signs

Despite all the hoopla earlier this month over the December’s job’s report, this month’s Job Openings and Labor Turnover Survey (JOLTS) report showed that for the first time since the end of 2017 and just the 6thtime in this business cycle, hirings, job openings and voluntary quits fell while layoffs increased in November.

By digging further into the details of the Household survey as well we see that people holding onto more than one job rose +117k in December, accounting for over 80% of the total employment gain. On top of that, the number of unincorporated self-employed rose +126k. These two are things we normally see when times are tough, not when the economy is firing on all cylinders. Not to be a Negative Nancy or Debbie Downer here, but the prime-working-age (25-54) employment shrunk -11k in December on top of 48k the month before. This was before things started to get really scary for many workers with the government shutdown. Imagine how many more are now looking for a second job to make ends meet while they wait for those inside the beltway to work this mess out.

We also got a materially weak New York Empire Manufacturing survey report this week that saw New Orders decline for the second consecutive month and a sharp drop in the 6-month expectation index. The New York Federal Reserve’s recession risk model is now placing odds of a recession by the end of 2019 at over 21%, having more than doubled since this time last year and having reached the highest level in 10 years. Powell and his team at the Fed have plenty of reasons to hold off on hikes. I wouldn’t be surprised if their next move is actually to cut.


NY Fed Recession Probability


Risks, what risks, we don’t see no stinking risks

US economy isn’t as strong as the headlines would make you think. The political dialogue going back and forth while on the one hand entertaining in a reality TV I-cannot-believe-he/she-just-said-that kind of way isn’t so funny when we look at the severity of problems that need to be addressed – excessive debt loads, a bankrupt social security program, a mess of a healthcare sector – just to name a few. The market today isn’t pricing much of this in, and based on the year to date move in the major market indices, particularly not the potential economic damage the government shutdown if the situation worsens.

If we look outside the US, the market’s indifference is impressive. UK Prime Minister Theresa May’s Brexit plan suffered a blistering defeat in Parliament, the largest such defeat on record for over 100 years, leaving the entire Brexit question more uncertain than ever and it is scheduled to occur just over two months away. In the two days post the Brexit vote back in 2016 the Dow lost 870 points and the CBOE Volatility Index (VIX) rose 49%. This time around the equity markets were utterly disinterested and the VIX actually fell 3.5% – go figure. A messy Brexit has the potential to have a material impact on global trade and yet we basically just got a yawn from the stock market.

Over in Europe flat is the new up with Germany’s GDP expected to come in every so slightly positive and this is a nation that accounts for around one-third of all output in the euro area – with China a major customer. Overall, Eurozone imports and exports fell -2% in November.

The other major exporter, Japan, just saw its machinery orders fall -18.3% in December after falling -17% in November. Japan already had a negative GDP quarter in Q3 and the latest data we’ve seen on income and spending aren’t giving us much to be positive about for the nation.

The Trade War continues with some lip service on either side occasionally giving the markets brief moments to cheer on some potential (rather than actual) signs of progress. The overall global slowing coupled with the trade wars is having an effect. China’s exports for December were far worse than expected, -4.4% from year-ago levels vs expectations for +2%. Last week Reuters reported that China has lowered its GDP target for 2019 to a range of 6% to 6.5%, which is well below the 6.6% reported output gain widely expected last year which itself is the weakest figure since 1990. Retail sales growth has fallen to a 15-year low as auto sales contracted 4.1% in 2018, the first annual decline in 28 years. With a massive level of leverage in its economy, banking assets of $39.1 trillion as of Sept. 30, and nearly half of the $80.7 trillion 2017 world GDP, (according to the World Bank) waning economic growth could be a very big problem and not just for China. We’ll be watching this as it develops given our Rise of the New Middle-class and Living the Life investing themes.

The bottom line is we’ve been seeing the markets bounce off seriously oversold conditions after a breathtakingly rapid descent. The fundamentals both domestically and internationally are not giving us reason to think that this bounce is the start of another major bull run. With all the uncertainty out there, despite the market’s recent “feel good” attitude, we expect to see rising volatility in the months to come as these problems are not going to be easily sorted out.


Debt Bombs Ticking Across the Globe

Debt Bombs Ticking Across the Globe


There are times when writing from the macro perspective can be challenging, particularly when macro takes a backseat as it is prone to do during parts of the business cycle. This year macro is back with a bang.

JPMorgan recently assessed the chance of a recession in 2019 has risen to 35%from just 16% in March based on macro data alone. The markets realize that the underlying dynamics have changed and are grappling with what to expect next:

  • As we mentioned last time, in 2017 only 1 of the 70 asset classes Deutsche Bank tracks closed in negative territory despite many being inversely correlated – clearly a market behaving oddly. As of mid-November, 90% were in the red for 2018 as the overexuberance of 2017 is forced to pay the piper.
  • In 2017 44 of the 47 country stocks in the global MSCI index closed up for the year. As of the December 11thclosing, only 3 are in the green.
  • The suppressed volatility in 2017 has led to hyper in 2018 as the S&P 500 has lost 3% or more in three market sessions this year with not one gain of 3% or more, a dynamic which last happened in 1936. The Dow Jones Industrial Average has experienced four days of 3%+ losses and no daily gains of that magnitude, a dynamic which last happened in 1897. (Hat tip to David Rosenberg of Gluskin Sheff)

Market dynamics are reflecting the increase in macro/political volatility across much of the world, but the headlines have yet to catch up with the primary drivers underlying the deep changes. In our previous Context & Perspectives piece, I discussed how we are seeing a profound decline in the level of liquidity at a time when debt levels are back to record highs. This week is a highlight reel of warning signs in the context those record levels of debt.

  • US employment
  • US Treasury balance sheet and yield curve inversion
  • Oval Office produces day time TV level drama
  • US China Trade War
  • UK Brexit Drama Spikes
  • Paris on Fire
  • Italy sees an opportunity


USA Employment Picture

Last Friday’s Nonfarm payrolls were significantly below expectations at +155k versus expectations closer to +200k on top of downward revisions of 12k to the prior two months. That’s not great, but amidst all the hype around this being a phenomenally strong economy, the workweek shrunk to a 14-month low of 34.4 hours from 34.5 in October. That translated effectively into 370k jobs lost, which means that the real picture for employment was a net loss of -215k (+155k new payroll -370k from shortened work week). The -0.2% decline in aggregate hours worked, the second decline in the past three months, means that unless there was a big jump in productivity, output, aka real economic activity, contracted for the month.

We also saw a decline in earnings with average weekly income falling -0.1% given the decline in the average workweek and an increase of hourly earnings of +0.2% versus +0.3% expected. This is the first decline in weekly earnings in 2018 and may call into question the expectations around Christmas shopping.

The recent University of Michigan Consumer Sentiment survey found that an increasing number of respondents are expecting unemployment to be higher in the next twelve months than lower and a recent Gallup poll found that Americans plan to spend less on holiday gifts today than they expected back in October and less than they expected to spend in 2017. The $91 decline in expected spending since October is, “one of the steeper mid-season declines, exceeded only by a $185 drop that occurred in 2008, as the Wall Street financial crisis was unfolding, and a $102 drop in 2009 during the 2007-2009 recession.” The environment is changing.

Putting it all together, last month saw a contraction in the workweek, in the index of aggregate hours worked and in average weekly earnings – not exactly a story of a robust economy despite the headline 3.1% year-over-year rise in average hourly earnings, the strongest read since 2009. Digging into the details can give a different picture.

Earlier this week the JOLTS (Job Openings and Labor Turnover Survey) saw the number of job openings increase in October to 7.08m from September’s 6.96m, but still below the August peak of 7.29m. The number of voluntary quits declined to a 4-month low. This was likely thanks to, per data from the Atlanta Fed Wage tracker, ‘job switchers’ and ‘job stayers’ enjoying the same wage gains for the first time in three years. This is an indicator of rising wage pressures which puts pressure on margins at a time when as the FT put it, “Cracks in the corporate debt market begin to show.”

October also saw a greater-than-expected increase in consumer credit to $25.4b versus the $15b driven largely by student debt and auto loans – debt, debt and more debt.

Over the past few weeks your Tematica Research team has called out some Thematic Signals here, here and here that illustrate between the impact our Aging of the Population and the Middle Class Squeeze investing themes, many American consumers continue to struggle.


US Treasury Balance Sheet and Yield Curve Inversions

This week’s CPI report was in line with expectations at 2.2% year-over-year and showed inflation that is high enough for the Federal Reserve to proceed with another rate hike this month, but the bond yield landscape is changing. On December 3rd, the 3-year Treasury note yield exceeded that of the 5-year for the first time since 2007, which is known as a yield curve inversion. As of December 12th, the 5-year yield sat below the 2-year. The spread between the 10-year and the 2-year is at a level not seen since 2007 and is close to inverting as well. The spread between the 10-year and the 3-month (which is closely watched as a recessionary signal) has plummeted from 136 basis points in February to just 44 and been cut in half in the past month alone. This has the Federal Reserve’s attention.


As a reluctantly avid Fed watcher, (I wish monetary policy wasn’t such a driving force in the global economy these days) I’d be remiss if I didn’t point out this fascinating tidbit. On June 27, 2017, when the VIX Volatility Index sat at 11, US Federal Reserve Chair Janet Yellen said,

“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.”


On Tuesday December 11th, 2018 (532 days or 1.46 years later) when the VIX sat at 22, now former US Federal Reserve Chair Janet Yellen said on CNBC,

“I’m not sure we’re working on those things in the way we should, and then there remain holes, and then there’s regulatory pushback. So I do worry that we could have another financial crisis. ″

You can’t make this stuff up.

On top of raising rates to tighten financial conditions, the Federal Reserve tapering has reduced its balance sheet by 8.3% since its tapering program commenced 13 months ago – that’s a solid level of liquidity drain as we’ve discussed in our last Context & Perspective piece.

The futures market is now pricing in less than 20 basis points of rate hikes next year versus over 55 basis points just a few months ago.

Oval Office Drama

Just when you thought the acrimony inside the beltway could not possibly get worse, it did. On Tuesday December 11thPresident Trump and Vice President Pence met with House Minority Leader Nancy Pelosi and Senate Majority Leader Chuck Schumer in the Oval Office while the network TV cameras rolled to discuss the impending government shutdown.

If this is a preview of what we can expect in the next two years with a divided government, the markets are right to be concerned with Capitol Hill’s ability to take constructive action if/when the economy slides into a recession let alone deal with the immediacy of a potential government shutdown which would leave federal employees without a paycheck at Christmas.

At a time when corporate balance sheets are the weakest they’ve been since the financial crisis, the federal deficit is at a percent of GDP not seen outside of a war or a recession. Total public debt outstanding has risen by $1.7 trillion (or 6.6%) since the start of the year. The current debates in DC are not focused on reducing the deficit, but rather a battle over where to spend. This means we are likely to see a greater supply of Treasury bonds on the market in the coming year(s) to compete with the high level of corporate debt that will need to be refinanced as we discussed in our last piece.


This level of dysfunction is particularly concerning when we look around the world and see political volatility outside the US also reaching heights rarely seen. Keep in mind that during the prior financial crisis leadership in much of the world’s leading nations were much more stable. The bottom line here is the current market volatility doesn’t fully reflect the heightened political risks emerging.


US China Trade War

The trade war between the US and China has seen some major fireworks over the past few weeks from the arrest of China’s Huawei’s CFO Meng Wanzhou to Canada granting her bail to rumors that China plans to submit a proposal to reduce its 25% surcharge on US-made vehicles. One day it is acrimony, the next rumors of attrition. What we do know is that China’s economy is weakening, (China imports rose just 3% year-over-year versus expectations for 14%) and the trade wars are having an impact on both nations. Regardless of one’s political preferences on this topic, when the two largest economies in the world go head-to-head, it is going to have a negative impact on global growth in at least the near-to-medium term.

Tying this back to the debt issue, given China’s black box economy with data tightly controlled by its government, it is impossible to have accurate data on just how high the nation’s debt level has reached. Estimates are that China’s total debt has hit more than 300% of GDP(according to the Institute of International Finance), versus the “official’ level of 47%, and Chinese distressed assets have grown by over 25% in the 18 months according to data from PwC.

China’s economic growth has been heavily dependent on ever-rising levels of debt and is showing signs of stumbling. As the world’s second largest economy, when China struggles the world will feel it.

UK Brexit Drama Spikes

The UK was not to be outshined by this week’s Oval Office “disagreement” as its political strife spiked when Prime Minister Theresa May postponed the Parliamentary vote on the agreement she reached with the European Union on fears that it had a snowball’s chance in hell of passing. The EU leaders insist that there will be no fundamental changes made and the Prime Minister survived a vote of no confidence in her leadership the night of December 12thas euro-skeptic MPs attempted a coup against her to wrest control of the final 106 days of Brexit talks. She was forced to agree to not lead the Tories into the next election, which puts her at risk of becoming a lame duck like her German counterpart, Angela Merkel.

We are quickly moving towards the worst of all possible outcomes, at least in the near-to-medium term, with no deal between the European Union and the United Kingdom and the UK lacking any strong leadership as it sails into uncharted political territory. All this uncertainty it a major headwind to economic activity on both sides at a time when people in the UK and the EU are increasingly angry over the lack of improvement in household finances as it has also been struggling under the Middle Class Squeeze. Voters will be looking for more rather than less government spending if/when their respective economies weaken, which means even more debt in a world awash with it.

Paris on Fire

Over the past weekend Paris erupted into violent protests, the magnitude of which is under debate, but the result of which was a clear – a loss a political firepower for France’s President Macron as he agreed to roughly €10 billion in concessions, including a minimum wage hike and tax breaks for employers. Many in France have also been suffering from Middle Class Squeeze and are frustrated by their leaders’ ongoing inability to shift the economy into something that provides them with better opportunities. Their demands mean more government spending which means more debt.

France is now on track to have the biggest budget deficit in the EU next year and Macron’s credibility and political power have taken a serious blow. This is yet another dangerous blow to the European Union.


Italy Sees and Opportunity

While Paris was burning, Italy’s Matteo Salvini and Claudio Borghia were loving (and tweeting)  what this would likely mean for their budget talks with Brussels, who as you may recall had sent the Italian leadership back to the drawing board in Rome to hammer out a budget with a smaller deficit. To put their deficit in perspective, the rejected plan was for 2.4% of GDP versus the US on track this year for over 6.6%. The troubles in Paris may give Rome confidence to push back against Brussel’s demands as they meet on December 12th. Late on the night of Wednesday December 12thrumors started to fly that perhaps the Italians would reduce the planned deficit to 2% of GDP. Either way, Italy is facing a weak and weakening economy with nearly €200 billion of Italian bonds coming due next year that will need to be reissued in addition to its current deficit.

Fighting Brussels is one thing, but the debt markets are another thing entirely and they are not pleased with what they see as evidenced by the widening spread between the Italian and the German 10-year, which has reached the highest level since the worst of the eurozone crisis. Moody’s has downgraded Italy’s rating to Baa3 while S&P and Fitch held their ratings but downgraded the nation’s outlook. If Italy’s economy weakens further, and its economy already contracted by -0.1% in the third quarter versus the prior, it could lose its investment grade standing which would have a major impact on bond markets as Italy’s external debt was $2.5T at the end of 2017.

When it comes to the problems arising from Aging of the Population and the Middle Class SqueezeItaly is in even worse shape than the United States and its banks still hold an elevated level of domestic debt. The employment situation is worsening.

The banking sector is quite vulnerable.

Italy, like France and the UK, is facing voters who a frustrated with the lack of improvement in the household finances and the populist movements sweeping across them are looking for governments to spend their way into national prosperity. Neither Italy, France, Germany nor the UK have strong or stable political leadership and GDP growth is faltering. This is not good.

According to data from the International Monetary Fund’s October 2018 Edition of the World Economic and Financial Survey, since the inception of the unified currency, Italy has seen all of a 1% increase in its per capita GDP (as measured by chained domestic currency) while even beleaguered Greece has enjoyed a 5% increase. On the other end of the spectrum Ireland has seen its per capita GDP nearly double with an increase of 89%, Germany is in second place with a 29% improvement while the US and the UK both have seen a 25% improvement. Is it any wonder that voters in Italy are becomingly increasingly skeptical of the euro?


Putting it all together

In our last Context & Perspective piece I discussed how we are seeing a profound decline in the level of liquidity at a time when debt levels are back to record highs. In this week’s piece, I discuss the trends across major parts of the world that are likely to lead to even more debt. We look to be in the final innings of what the master investor Ray Dalio of Bridgewater Associates refers to as the debt super-cycle. These cycles tend to run 50-75 years and we are today at the far end of that range with excessive leverage across much of the world, highly concentrated lending portfolios and a mismatch between assets and liabilities and/or liabilities and asset cash generation potential.

We’ll be talking about this more in the coming months but before then, I highly recommend Mr. Dalio’s free book on how to navigate a debt crisis, which you can get a copy of here. The impact of all this debt on the economies of the world will have a profound impact on tomorrow’s investable markets.


Retirement Plans Disappear When Parents And The Kids Return Home

Retirement Plans Disappear When Parents And The Kids Return Home

A recent Wall Street Journal article points out that the American dream is further out of reach for a growing number as plans for retirement go up in smoke thanks to the needs of aging parents and their adult children.

A 2014 study by the Pew Research Center found 52% of U.S. residents in their 60s—17.4 million people—are financially supporting either a parent or an adult child, up from 45% in 2005. Among them, about 1.2 million support both a parent and a child, more than double the number a decade earlier, according to an analysis of the Pew findings and census data.

Rather than enjoying the fruits of their decades of labor, many are finding that their household burdens are growing as they enter their sunset years.

More Americans find themselves housing two generations simultaneously, just when they thought they could kick back and retire. Instead, they face the strain of added expenses, constant caregiving and derailed dreams.

This pressure is coming as our Aging of the Population investment theme sees more senior citizens with inadequate savings and a healthcare system that is unable to provide the care they need at a price they can afford. On the other end of the spectrum, adult children are struggling with student debt levels the likes of which this country has never before seen and years of lackluster wage growth.

The squeeze is coming from both ends. With lifespans growing longer, the number of 60-somethings with living parents has more than doubled since 1998, to about 10 million, according to an Urban Institute analysis of University of Michigan data, and they are increasingly expensive to care for. At the same time, many boomers are helping their children deal with career or health problems, or are sharing the heavy burden of student loans.

This helps explain why discount retailers are expecting their customer base to continue to expand. Those companies that are able to help consumers push their dollars further [such as Amazon (AMZN), Costco (COST), Walmart (WMT)] have a growing set of tailwinds supporting them.

Source: ‘I Was Hoping to Be Retired’: The Cost of Supporting Parents and Adult Children – WSJ

Debt Levels + Falling Liquidity = EPS Pressure Ahead

Debt Levels + Falling Liquidity = EPS Pressure Ahead


Investing markets across the board have taken a serious beating in 2018. According to Deutsche Bank, of the 70 asset classes they track, 63, or 90% of them, are in the red for the year. In 2017 only 1 of the 70 closed in the red. We’ve undergone a massive shift in the investing landscape which bears further investigation.

Taking a step back to look at the market and the economy, over the nine years since the depths of the financial crisis bear market in March 2009 the S&P 500 rose 330% through its September peak. During that time GDP averaged an annual growth rate of 2.1%, which is just two-thirds of the average annual GDP growth rate from 1990 through 2007. In comparison, in the nine years between 1990 and 2000, the S&P 500 rose 350% within an economy that grew an average of 3.7% a year. During these two periods the S&P 500 gained roughly the same amount, but in the current period GDP rose at just over half the pace of the 1990 to 2000 period.

Why did we see such a profound increase in the S&P 500 when the economy was growing so much more slowly?

You can thank all that central bank provided liquidity in the form of various quantitative easing programs primarily provided by the Federal Reserve, the European Central Bank, Bank of Japan and let’s not forget the phenomenal growth in debt in China. As I described on this week’s Cocktail Investing Podcast, you can think of liquidity as water being poured into the global economic pool. As more water flows in, the level of the water, which is akin to the price of assets, rises. However, not all assets rise at the same rate every time. Last time around the increasing levels of liquidity were focused in housing and we saw real estate prices in much of the world rise at record rates. This time around the rising liquidity has been focused in the investing markets.


Draining the liquidity stimulus for the stock market

Today the water in that pool is being drained as global liquidity is shrinking at the fastest pace since 2008. The Federal Reserve is reducing liquidity in two ways, one by raising rates and the other by shrinking its balance sheet. When the Federal Reserve raises the Fed Funds rate, the result is higher short-term interest rates. That makes borrowing both more expensive for the borrower and riskier for the lender as the borrower has a higher hurdle to be able to service the debt. The Fed is currently shrinking its balance sheet at an effective annual rate of about $600 billion by not reinvesting those bonds it holds that mature. This means that when a bond the Fed owns for say $100 matures, the Fed receives the $100 and does not use it to purchase another bond, which means that $100 stays at the Fed and is effectively removed from the money supply.

On November 28th, Federal Reserve Chairman calmed the markets with his speech at The Economic Club of New York stating that rates, “remain just below the broad range of estimates of the level that would be neutral for the economy.” The market cheered this shift in tone from his stance in early October when he stated that rates were, “a long way from neutral.” One has to wonder how much the criticism coming out of the White House may have impacted such a change in the outlook for the economy in just 56 days. With most economic data available only on a monthly basis, it seems odd that one month’s worth of data would warrant the material shift that the market now expects. For months the data coming in has been suggesting a slowing economy both in the US and abroad, but we’ve seen nothing dramatic over the past 56 days.

The markets are now pricing in one more rate hike in 2018 and only one more in 2019, down from the prior view of up to four next year, which put downward pressure on the US Dollar that lasted all of one day, with the DXY US dollar index back in the green by the following morning. I’d like to point out that the target interest rate range is estimated to be between 2.5% and 3.5%. The Fed’s rate range today is between 2% and 2.25%, so we could be looking at future hikes that would total anywhere from 25 to 125 basis points. Powell also specifically mentioned that “equity market prices are broadly consistent with historical benchmarks such as forward price-to earnings ratios,” which indicates he isn’t worried about the recent stock market weakness.


Follow the Fed’s balance sheet deleveraging

While rising rates are good news for margins at banks, US banks look to be shoring themselves up for a slowdown. The inimitable David Rosenberg of Gluskin Sheff recently pointed out that, “They have shed assets in four of the past five weeks. On a four-week basis, bank assets have declined at nearly a 4% annual rate…. The part of the balance sheet that is expanding, and by the fastest pace, is bank holdings of Treasury securities which have bulged at a 13% annual rate over the past 13 weeks (and by 16% over the past four weeks.)”

In Asia (ex-Japan) the central banks’ supply of currency and bank reserves have decreased by 7% in real terms since the US Dollar started its recent move up in April. This is the steepest contraction in the monetary base since January and October of 2008 when it contracted by 11%.

Overall the inflation-adjusted global monetary base has contracted just five times since 1980 – 1982, 1990, 1998, 2011 and 2006. Every time the contraction either preceded or coincide with global economic slowdown. The question then is, what will be most affected?


What goes around is bound to come around

The last time around we saw liquidity raise home prices to record heights so when the liquidity flows reversed, home prices fell. Those areas in which prices had risen the fastest fell the hardest. This time around we’ve seen an increase in stock prices and a significant increase in corporate debt, which has increased by 86% from the 2007 peak by the end of the second quarter of 2018. As we see rates rising, here are some points that are cause for concern:

  • Global debt has reached a record $247 trillion, 318% debt to GDP – a ratio far above the roughly 200% in 2008.
  • The level of corporate debt has hit an all-time record high of $6.3 trillion, which looks manageable as in aggregate US companies have $2.1 trillion in cash to service that debt, but that cash is concentrated in the hands of a few behemoths.
  • The ability to service that debt is weak for many. The cash-to-debt ratio for speculative-grade borrowers fell to a record low of 12% in 2017, well below the 14% seen in 2008. This means that for every dollar they generate in cash flow, they have $8 of debt.
  • It isn’t just the speculative grade that is struggling. Over 450 investment-grade companies that are not in the top 1% of cash-rich issuers also have cash-to-debt ratios that are quite low, around 21%. Rising rates mean even weaker coverage ratios.
  • The quality of debt is low by historical norms. Moody’s Covenant Quality Indicator has been sitting at the lowest level of classification for the past 18 months, just slightly off its August 2015 record low.
  • 25% of all corporate debt is maturing over the next 3 years.
  • $2.2 trillion of corporate debt (more than one-third) is floating rate, which means as interest rates rise, interest payments on existing debt rises, which means margin compression.
  • An early warning sign — Deutsche Bank 6% coco bond has risen to 10.3%, the highest rate since 2016. Investors expect that Germany’s biggest bank will take serious hits in the next recession.

And what about that debt… about that debt… about that debt?

As we look to the holiday shopping season, it isn’t just corporate credit that has our attention. Our Middle-Class Squeeze investing theme is front and center when we see that in the third quarter the delinquency rate on credit card loan balances spiked to 6.2% at smaller banks (the group that excludes the 100 largest). That is well above the peak of 5.9% we saw during the financial crisis. The pace of the decline is also concerning, more than doubling in the past two years from less than 3% to 6.2%. The credit card charge-off rate at these same banks was 7.4% in the third quarter and has now been above 7% for five consecutive quarters. In comparison, during the financial crisis the charge-off rate was above 7% for only four consecutive quarters. You read that right, the charge-off rate has been worse in the past five quarters than in the debts of the financial crisis.

But hold on a minute, overall credit card and other revolving consumer credit was just $1 trillion in the third quarter, which is right about where it was at its prior peak a decade ago despite a population that has grown by about 20 million people. Doesn’t that mean that consumer debt isn’t a concern? If we look at the credit card delinquency rates for the top 100 banks, things do in fact look pretty good for the consumer, sitting at just 2.5%, which is well below the over 6.5% rate in the depths of the financial crisis.

The message here is that while the banks overall are not in danger here from credit card debt, what we are seeing is that those consumers who are the most vulnerable — those with weaker credit history — are already getting into trouble with their credit cards at a time when we are being told the economy is stronger than ever. What happens to them and to the smaller banks that serve them when times inevitably get tougher?

Overall retail sales in October, when adjusted for inflation, rose just 2%, at the lowest end of the post-financial crisis range but e-commerce continues to be extremely strong, reflecting our Digital Lifestyle investment theme. Total retail sales not adjusted for inflation rose 4.6%, but eCommerce accounted for the bulk of that, rising 14.5% from a year ago.


Falling liquidity plus upcoming debt refinancing will be a headwind to earnings.

The bottom line is we are in the midst of major shifts in market dynamics. The outsized performance of the stock market relative to the weak rate of economic growth was fueled by liquidity injections courtesy of many of the world’s central banks. Now that liquidity is draining out of the global economy at a meaningful rate at a time when the US is engaging in a level of deficit spending unheard of outside of a recession or war, so we are seeing a major increase in Treasury bond issuance. That means less liquidity as we see a significant increase in the supply of new Treasury bonds. The overall US corporate balance sheet is quite weak, particularly when we remove the handful of large cash holders. With over one-third of the outstanding corporate bonds floating rate and one-quarter of all corporate bonds rolling over the in next three years, rising interest rate expenses will be adding to the rising margin pressures from the tightest labor market in decades. In other words, a headwind to EPS generation that investors and the multiples they assign to the stock market will have to contend with.

In the coming months we will be watching for any changes in fiscal policy coming out of DC to gauge the level of Treasury bond issuance. We will be watching the dynamics in corporate credit as many will need to favor shoring up their balance sheets over dividends or buybacks. For investors, this is a time to ensure that not only are the companies in which you have invested benefiting from the types of long-term tailwinds we focus on with our investing themes, but to also review the financial health of the companies in your portfolio. There will be a price to pay for the past corporate debt extravaganza.


While The Market Regained Some of Its Footing, It’s Shaky At Best

While The Market Regained Some of Its Footing, It’s Shaky At Best


Key Points from This Report:

  • Did the election matter?
  • Italy is a growing problem for the Eurozone and U.S. Investors should care
  • The rising dollar and interest rates
  • Another strong jobs report – be careful what you wish for
  • More signs that the global economy is slowing
  • The trade war with China continues with no end in sight.
  • The Market has found at least some shaky footing


Did the Election Matter?

The big news of the week was the non-news of the election, which gave both sides sufficient wins to claim victory. The market engaged in what was likely a brief “thank-God-there-were-no-surprises-this-time” rally the following day. For investors, the election means that any further tax cuts are highly unlikely and while the need for infrastructure spending is something both parties agree on, the budget process for that spending has the potential to be reminiscent of a Jerry Springer episode – let the games begin.

We’ll probably hear more threats concerning impeachment, but the election results make it unlikely that will be anything more than the usual vitriol coming out of the beltway these days. Overall the election ended up being a non-event, followed by a relief rally… but several issues remain that could complicate matters for the market and investors.


Italy is a growing problem for the Eurozone and U.S. Investors should care

Italy continues to vex both the eurozone and those pundits who insist that cooler heads will prevail. I live a good portion of my time in Italy and I can assure you, there are no cooler heads in Italy’s leadership and its citizenry are becoming more and more enraged by their governments’ endless inability to address the myriad of issues facing the nation, regardless of which party or coalition is in charge. Keep in mind that Italy faces even more challenging demographics than the U.S., (which in comparison is akin to our Aging of the Population investing theme on steroids) as its population is skewed even older thanks to insanely high youth unemployment, which drives many of the young to look outside their birth country for better opportunities.

The U.S. isn’t alone in its desperate need for infrastructure investment. Remember that bridge in Genoa, Italy that collapsed in August killing 43 people? Despite the promises in the days following the tragedy that the nation’s leadership would mobilize all available resources immediately and get a new bridge for this vital part of the region’s infrastructure up as soon as humanly possible, nothing has been done.





And that is just a bridge. Last week the nation was hit with massive storms that caused an incredible amount of damage, inflicting even more pain on a country that is already a mess. I expect Italy will not be the one to blink first when it comes to the revised budget due to Brussels later this month. There will be a showdown with the rest of the Eurozone and it is going to get even messier.

For some perspective, just 10 years ago Luigi Di Maio, the leader of the Five Star Movement and Deputy Prime Minister, was living with his parents and working as a drinks server at the Napoli stadium. In just 10 years he’s gone from one of those guys walking around, hocking drinks from his tray, to leading Italy. Is it any wonder that the rest of Europe’s leadership isn’t exactly thrilled with Italy’s leadership choices?

Adding to the drama, France’s leader, Emmanuel Macron, looks to be struggling under all the pressure and Germany’s Angela Merkel is now a lame-duck having announced she is stepping down as the leader of her party and will not be seeking reelection. Europe is without strong leadership at a time when it desperately needs it. This is going to get worse before it gets better.

Why should investors care what happens in Italy?

The eurozone economy is nearly the size of the United States’ and Italy is both too big to save and too big to fail without putting the entire region into an economic tizzy. Italy has the potential to seriously rock the markets at a time when interest rates are rising most everywhere, and dollar liquidity is shrinking.


The rising dollar and interest rates

With global liquidity shrinking at the fastest pace since 2008, the dollar continues to strengthen, causing a variety of problems for a broad swath of market participants. The strong dollar has been causing pain in the commodity complex and those economies tied to it, for example, this week U.S. West Texas Intermediate (WTI) crude fell more than 21% from last month’s four year high. The recent strong jobs reports mean the Fed is likely to continue on its rate hike path and Thursday’s post-meeting announcement referred to a strengthening labor market and economic activity rising at a strong rate – pretty much like the Bat-signal for more hikes coming. The lack of foreign buyers of Treasury auctions is adding to rate pressures. So far in calendar year 2018, we have seen half the level of foreign buying we saw in 2017.


Another strong jobs report – be careful what you wish for

Last month businesses added an additional 250k to the U.S. workforce, well above the expected roughly 200k, but the real number would have been even more incredible had it not been for the 198k that were not at work due to weather conditions – a level three times the historical norm thanks to Hurricane Michael. Without Mike, the number would have been closer to +400k, so while Wall Street is getting serious jitters as the bears have been pacing around the major indices, Main Street is busy hiring. Break out the champagne and party hats?

Err, not so fast. As much as I love a glass of the chilled bubbly, digging into the details gets me a bit nervous to see that while construction activity has been contracting for several quarters, the sector has added 100k to its ranks since July. Contracting activity levels while growing payrolls? Not exactly good for the bottom line. The Federal Reserve’s Beige book has been a compendium of executive angst over the impact of trade wars on their businesses, but transportation services grew their ranks by 25k, the most in 13 months. This is likely because 100% of the net new jobs over the past four months have gone to those with a high school education or less. Great for the development of skills in that cohort, not so great for their employers who are experiencing lower productivity levels, which translates into earnings pressure for investors.

Cocktail Investing Podcast Episode 85We also saw wages rise +3.1% year-over in October from +2.8% in September, the fastest rate since 2009. We suspect consumers in our Middle-class Squeeze investing theme are cheering as are retailers that are gearing up for the 2018 holiday shopping season – for more on that, check out this week’s Cocktail Investing Podcast where we talk with the National Retail Federation and its consumer survey findings for holiday shopping this year.

Back to the October wage gains, we strongly suspect the Fed is watching as increased pay pressures have pulled 711k into the workforce, which pushed the labor force participation rate up by +0.02% in October. Without the new entrants into the workforce, the unemployment rate would have dropped to 3.3%, which would be the lowest level in 65 years!

So, jobs look fantastic right? Errrmmmmm, yes but… the manufacturing workweek was cut a second time by 0.2% since June to the lowest number of hours since January – could be the trade war is cutting folks’ hours. Overall, the labor market is exceptionally tight so no wonder the Fed this week announced that “The labor market has continued to strengthen and … economic activity has been rising at a strong rate,” keeping in place its plan to continue to gradually raise rates.


More signs that the global economy is slowing

While the US is still humming along, most are not paying attention to the slowing happenings outside our borders. The IHS Markit Composite PMI in the euro area dropped to a 2-year low of 53.1 in October from 54.1 in September while Italy dropped to its lowest level since November and is now in contraction territory- anything below 50 is in contraction. Germany’s real manufacturing orders year-over-year declined -2.2%. Eurozone GDP slowed to a 5-year low in Q3 of a less than +1% annual rate. The US will not be unaffected by the slowing outside its borders.


The trade war with China continues with no end in sight.

We’ve already talked a lot about this in previous weeks, so we will just leave this one with a note that China is looking to regain its place as the world’s dominant nation and its leader has his job for life. The strange events surrounding many high-profile people ranging from the leader of Interpol to actress Fan Bingbing to Alibaba’s Jack Ma give the impression that some seriously strange things are going on in the nation and perhaps the CCP leadership is looking to close ranks and tighten its grip – there is going to be a lot more to this story in the months and years to come.


The Market has found at least some shaky footing

Finally, after a brutal October, the market has managed to regain some of the ground it lost in the early days of November but let me point out that it is unusual for the S&P 500 to lose 10% or more twice in any given year. Going back roughly half a century, such double dipping typically precedes or occurred in conjunction with a recession, (with the exception of 1987 which wasn’t much fun).

As earnings season is nearing a close, corporate share buyback programs have been able to restart their purchases, helping put a (temporary?) floor under the market. I remain warry that we haven’t seen the end of this period of volatility.


The Disruptive Tech in Down Dog

The Disruptive Tech in Down Dog

I’ve written a few times this week here and here about how disruptive technologies can upend industries, quickly tossing leading companies into the back of the pack. Given that it is Friday afternoon where I am in Genova, Italy and we’ve had a week of horrendous storms, I’m looking forward to a relaxing weekend that will see me spending a decent amount of time curled on the couch working through my required weekly reading. That brings me to the subject of this post, the disruptive technology of yoga pants.

Yoga pants? Seriously? Yep. I just read an article in Bloomberg entitled How America Became a Nation of Yoga Pants.

I personally think that all clothing ought to have at least some sort of stretch so yoga pants are right up my alley for everything from down dog to walking the dog to lounging when I’m dog tired and loving some doggone good wine. But I digress. How can yoga pants possibly reflect disruptive tech you ask? Bloomberg answers.

In 2014, teenagers began to prefer leggings over jeans. Then people started wearing athletic clothing (or athleisure, but it’s mostly just yoga pants) to run errands. Now they’re wearing yoga pants to the office. U.S. imports of women’s elastic knit pants last year surpassed those of jeans for the first time ever, according to the U.S. Census Bureau.

To be fair, this preference for “elastic knit pants” may have some correlation to the health challenges of the American public resulting in expanding waistbands. But part of the shift in preferences is also reflective of our Clean Living (focusing on living a healthier lifestyle) and Guilty Pleasures investing themes. If you’ve seen the price of Lululemon Athletica (LULU) clothing you understand the guilt.  Bloomberg reports that,

Yoga pants have similarly managed to plunge denim into an existential crisis, threatening Levi Strauss & Co. so deeply that it had to scramble to adapt. The company added stretch and contouring to its jeans while hoping to retain some of their rugged essence.

So where is the disruptive tech involved?

“Consumers expect a lot more,” said Sun Choe, chief product officer at Lululemon. “They’re washing their garments more and more, and from a quality standpoint, it needs to stand up. They’re expecting some versatility in their product. They expect to be able to wear that pant or tight to Whole Foods or brunch.”

Ok, so that doesn’t sound terribly impressive, but then there is this.

Now there are fabric labs, especially in the athletic-wear space. Lululemon’s research arm does motion-capture testing and uses pressure sensors that allow researchers to test how garments work as they move. The team can even test “hand feel” to help it figure out how to “engineer sensations” for that critical commercial moment when you feel the fabric for the first time, said Plante.


Those labs have a large customer base to impress.

What was once a simple stretchy legging, it seems, has become an engineering marvel. Not too surprising, though, when you realize that about $48 billion is being spent on activewear in the U.S. every year.

Those yoga pants account for a large portion of that spend.

Active bottoms and leggings are now a $1 billion industry, according to NPD Group analyst Marshal Cohen.

With a phenomenal range of available options.

These days, there are more than 11,000 kinds of yoga-specific pants available at retailers worldwide, according to data from retail research firm Edited, across both men’s and women’s apparel.

The bottom line is that no industry, business model or product is immune from the threat of disruptive technology.

Source: How America Became a Nation of Yoga Pants – Bloomberg