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.
Mexico pushes mobile payments to help unbanked consumers ditch cash | Reuters

Mexico pushes mobile payments to help unbanked consumers ditch cash | Reuters


The evolution of mobile payments in emerging economies sits right at the intersection of our Digital Lifestyle and New Global Middle Class investing themes. Just as we saw emerging economies able to leapfrog with communication infrastructure thanks to the advent of the mobile phone, so are we now seeing them leapfrog with retail banking options. A recent article on Reuters describes what is happening just south of the border where “Mexico’s new leftist government is betting on financial technology to help lift people out of poverty.”

“In the future, it will no longer be necessary to have a bank in the sense of a traditional, established bank,” said Arturo Herrera, Mexico’s deputy finance minister. “Mobile phones will become banks.”Phone-based banking has proven a hit among the poor in other emerging markets such as China, India and Kenya. Those efforts have been driven by private sector companies that offer user-friendly, affordable apps.

This is similar to what we are seeing in India as that nation also looks to take advantage of mobile technology to provide banking services to the hundreds of millions of its citizens that are currently unbanked, giving them an ability to work their way out of poverty that would have otherwise been impossible.

Our investing themes look towards those companies providing the technology that allows for such implementations and those companies that will benefit as these implementations are rolled out.

Source: Mexico pushes mobile payments to help unbanked consumers ditch cash | Reuters

Signs of Slowing Economy Continue to Mount

Signs of Slowing Economy Continue to Mount


The market is now back in a bullish mood that is driven primarily by the “not gonna happen” news flow hopes. Rate hike? Not gonna happen. Government shutdown repeat? Not gonna happen. China trade war escalation? Not gonna happen. The question is, just how long can the “not gonna happen” hopes keep pumping hot air into a market when we are staring down a likely earnings recession amidst a global economic slowdown?

  • Housing remains a miserable mess – just look on Zillow at the breadth of the price reductions.
  • The employment picture isn’t quite what the headlines would lead one to believe.
  • Consumer confidence looks to have peaked and is falling.
  • Consumer credit trends and retail sales are flashing warning signals.
  • Corporate earnings and loan demand are also flashing warning signs as are shipping rates.
  • Geopolitical risks are profuse and profound ranging from no-deal Brexit fallout to Italy’s ongoing battles in the EU to US-China trade relations to rising military tensions between the US and Russia to relations between Italy and France at lows not seen since WWII.
  • The level of bullish sentiment is no longer a contrarian positive with the AAII poll of individual investors putting the bull camp at 40% versus 32% last week and the highest level in the past three months. Bears are down to an 8-month low of 23% versus 50% back in December. Even the CNN Money Fear & Greed index is back in greed mode after hitting fear one month ago.

Housing Headwind

More than 12 years after the US housing market started an epic crash in 2007, an unprecedented number of homes are still underwater (meaning the outstanding mortgage on the home is at least 25% above the home’s current market value), according to a real-estate market report from ATTOM Data Solutions. This is clearly a consumer headwind that is part of our Middle-Class Squeeze investment theme. The states with the highest share of mortgages include Louisiana (21%), Mississippi (17%), Arkansas (16%) and Iowa (15%). Of the over 7,500 zip codes having a minimum of 2,500 properties examined in the report, 27 had more than half of all properties underwater including zip codes in cities such as Chicago, Cleveland, Trenton, Memphis, Saint Louis, Virginia Beach and Detroit. If you’re a real estate investor, you should be taking note and as is often said with stocks, you should be building your shopping list.


Job Picture Not So Rosy

This week we received the Job Openings and Labor Turnover Summary for December from the Bureau of Labor Statistics (BLS) which revealed a record high 7.335 million job openings. The unemployment rate has risen from the November low of 3.7% to 3.9% in December and 4.0% in January – possibly indicating that we are now on an uptrend. There are now 1.17 job openings for every job seeker, with December slightly below November’s all-time record high of 1.19 job openings.

We are also seeing a record high length of time to hire someone, which is derived by taking the number of job openings and dividing it by the number of hires. Prior to the financial crisis, this metric was always less than one month, but in August 2014 it broke above a month for the first time in recorded history and has been rising ever since then to a new high in December of 1.24 months. We see this as confirming that employers are having an increasingly difficult time finding the right talent for the position.

This would make one think that the consumer is doing great, but as always, digging below the surface reveals a different picture. At the start of February, the January Payroll report got a lot of attention as job growth utterly blew away estimates, coming in at 304,000 new jobs versus expectations for just 170,000. However, the other employment survey from the Bureau of Labor Statistics (BLS), the Household Survey, rather than providing confirming view of the labor market revealed a very different picture, click here to read about how the two differ in the data they track.

The Household Survey found that employment dropped 251,000 in January, the first such decline in five months, some of which can be attributed to the government shutdown. But employment for the prime working-age population declined 46,000 in January after an 11,000 drop in December and 48,000 in November – more of that Middle-Class Squeeze investment theme at work.

The last time we saw employment in this demographic decline for three consecutive months was in October 2009. The number of full-time jobs declined 76,000 while the number of people working part-time for economic reasons rose 10.5% to 5.145 million which is a 16-month high. The number who are working part-time because of “slack work business conditions” rose a whopping 19.4% to 3.45 million which is a 23-month high. For both metrics this was the biggest one-month change since September of 2001 – a month no one can forget – and before that February 1982, both times the economy was in a recession. The Household Survey also revealed that the largest category of hiring was for those with a high-school education or less, which may explain why average hourly earnings rose the smallest amount since October 2017 at just 0.1%.


Consumer Credit Warning Signs

The latest Senior Loan Office Survey found that demand for auto loans, credit card loans, GSE-eligible mortgage loans, qualified jumbo mortgage loans, non-qualified mortgage jumbo loans, non-qualified mortgage non-jumbo mortgage loans, government mortgage loans, and consumer loans ex-credit card and ex-auto all are in contraction mode. In a nutshell – folks are not interested in borrowing any more than they already have. That is not what we typically see during economic expansion. We are also seeing a record high 7 million Americans are 90-days or more behind on their auto loan payments – yet more Middle-Class Squeeze.


Consumer Confidence Falling

With the job market not quite as rosy as the headlines would suggest coupled with the trends in consumer credit, it wasn’t a big surprise to see the Conference Board’s Consumer Confidence index fall to an 18-month low in January, dropping to 120.2 from 126.6 in December versus expectations for 124.0. The January reading also marked the third consecutive decline after hitting an 18-year high of 137.8 in October. Gluskin Sheff’s David Rosenberg summed up the results quite succinctly in his tweet.

Retail Sales Take Biggest Hit Since 2009

US Retail sales saw the biggest one-month drop in December since September 2009 with even ecommerce sales suffering as retail sales fell -1.3% month-over-month and up just 2.1% year-over-year. Retail sales ex-gasoline stations fell -0.9% in December and even the typically strong non-store retailers, which includes mail-order and ecommerce as are part of our Digital Lifestyle investment theme, saw sales decline -3.9%. However online players such as Amazon (AMZN) – a Tematica Research all-star – and eBay (EBAY) still enjoyed strong sales gains through the holiday season.

That’s the sequential comparison. On a year over year basis, retail sales in December 2018 rose 2.1% year over year with stronger gains registered at Clothing & Clothing Accessories Stores (+4.7%), Food Services & Drinking Places (+4.0%), Nonstore retailers (+3.7%) and Auto & other motor vehicles (+3.4%). That’s not to say there weren’t some sore spots in the report – there were, but they are also the ones that have been taking lumps for most of 2018. Sporting goods, hobby, musical instrument, & bookstores fell 13% year over year in December, bringing the December quarter drop to 11% overall. Department Stores also took it on the chin in December as their retail sales fell 2.8% year over year.

While that’s a more favorable view, the reality is December Retail Sales came in weaker than expected. Between the government shutdown, falling equity prices, global trade wars and ballooning debt levels, folks opted to keep their wallets in their pockets this past holiday season. In keeping with our Middle-Class squeeze investing theme, consumers looked to stretch the dollars they had to spend, which helps explains Costco Wholesale’s (COST) eye-popping, by comparison, December 2018 same-store sales of 7.5% in December (7.1% excluding gasoline prices and foreign exchange). Those consumer wallet share gains, which likely continued into January with Costco’s same-store sales of 6.6% (7.3% excluding gasoline prices and foreign exchange), and its expanding warehouse footprint are why Costco is Tematica’s Middle-class Squeeze leader.


Corporate Earnings and Confidence Weakening

The earnings outlook for companies in the S&P 500 continues to deteriorate with expectations down to 1% year-over-year growth for 2019 versus 5% just a few months ago. The last Federal Reserve Beige Book found that 25% of the US is in contraction with the remaining 75% expanding at only a modest to moderate pace. The corporate outlook isn’t all that rosy either as venture capital investors are advising their start-ups to hold onto more cash. For example, Index Ventures is reportedly telling their entrepreneurs they need 18 to 24 months’ of coverage versus 9 to 12 months’ worth a year ago according to an article in the Financial Times.

It isn’t just the big guys that are struggling. Economic confidence for small companies declined during most of 2018 and in January reached its lowest level since President Trump was elected according to a monthly survey for the Wall Street Journal by Vistage Worldwide. The report noted that for the first time since the presidential election, small firms were more pessimistic about their own financial prospects than they were a year earlier, including plans for hiring and investment. In January 2018, 83% of the firms surveyed expected to grow revenues over the coming year versus 66% by January 2019. This decline was affirmed by the ISM non-manufacturing PMI report which found that the share with growth dropped from 94.4% last September to 50% today – the lowest since January 2016. The share contracting rose to 44.4%, the highest level since January 2016.


Corporate Loan Demand Echoing Consumer Weakness

Just as we saw demand for consumer credit declining, so has demand for corporate credit been on the wane. Demand for commercial and industrial loans from large and middle-market firms has been flat or in contraction in 10 of the past 13 quarters. For smaller firms, demand has been flat or in contraction in 9 of the past 13 quarters. Demand for commercial real estate loans for construction and land development has been in contraction since the first quarter of 2017.


No Love in the Eurozone

On Valentine’s Day we learned that economic growth in the eurozone was a meager 0.2% quarter over quarter in the fourth quarter of 2018 – so basically flat. Year-over-year growth stood at just 1.2% for the final quarter of 2018. This came after news that the eurozone economic powerhouse Germany had no growth itself in the fourth quarter after a contraction of -0.2% in the third quarter – narrowly missing a recession. Italy experienced its second consecutive quarter of economic contraction, putting it in a technical recession. All this put further downward pressure on the euro versus the US dollar.

Another major headwind in the Eurozone that has consequences far beyond the region is the lack of any Brexit deal. To put the situation in perspective, nations in the Eurozone have been trading with the United Kingdom for 30 years, resulting in highly integrated economies and corporations. Imagine being a grocery store manager in Edinburgh, Scotland and not knowing how your near-daily imports of fruits and vegetables from France are going to be affected or being a Swede working in London, who owns a home there and having no idea how your residency or work situation may be altered.

Without a long-term free trade agreement between the UK and the EU, new trade barriers will have to be introduced at borders and the prospect of different rules on standards and safety could make it harder and more expensive for companies to import and export. The cost of a no-deal Brexit will also affect consumers. The UK imports 30% of its food from within the EU. While companies can build up inventories in advance, there is a limit to what can be done given the shelf-life of some products and raw materials and limits to storage capacity. On top of that, all the additional storage and inventory represents additional business costs, diverting resources from investment in the company and its employees.

There is also no love lost these days between France and Italy, with relations between the two nations at levels not seen since the end of WWII. Italy’s relationship with the Eurozone, in general, has been challenging as its per capita GDP has grown all of 1% in the nearly two decades since it joined the unified currency while France has enjoyed 17% growth, Spain 23% and Germany 29%. For reference, the United States has seen per capita GDP grow 25% during this time.

Relations between the two traditionally close allies that are France and Italy have been degrading since mid-2018 when Italy’s Deputy Prime Minister Luigi Di Maio and Matteo Salvini of the League part starting firing pot-shots at Macron and France over immigration policies. Macron has occasionally fired back, for example, to criticize Salvini when he refused to allow a boatful of migrants rescued in the Mediterranean to step on Italian soil, forcing them to remain on the boat while it was docked. The group has since been moved out of Italy and Salvini has been sued by the court of Catania (where the ship was docked) for the kidnapping of minors. Good times.

Earlier this month France recalled its ambassador to Italy, something it last did in 1945 after Italy’s Deputy Prime Minister Luigi Di Maio – who is also the head of the anti-establishment 5-Star Movement (Cinque Stelle) – met with members of France’s Gilet Jaune (Yellow Jacket) movement. These are the folks who have been protesting in France and amongst other acts of violence, have set fires in cities all across the nation including Paris. To say they have been vexing France’s President Macron would be a massive understatement.

This tension could not be coming at a worse time when the no-deal Brexit crisis looming.


Global Shipping Confirms Weaker Growth

The Baltic Dry Index (BDI), which tracks the cost of moving bulk commodities and is considered a leading indicator of global trade, is down more than 50% since the start of the year. Shipping brokers in Singapore and London have reported capsized vessels, the largest ships that move bulk commodities like iron ore, coal and aluminum, had been chartered in the spot market for as low as $8,200 a day last week. Break-even costs for carriers can be as high as $15,000 a day, and daily rates in the capesize market hovered above $20,000 last year. That’s a serious drop-off in demand, and the BDI tends to be a leading indicators investors and traders watch closely much the way we also watch rail traffic and truck tonnage data.


The Bottom Line

Signs of slowing continue to mount both domestically and internationally, alongside rising geopolitical risks and excessive bullishness in domestic equity markets. This is a good time for investors to put together a shopping list of those stocks that will enjoy long-term tailwinds despite global economic slowing and add them to your portfolio when they reach an attractive price point as we are likely to see a pullback in the markets soon.


Late Car Payments Hit Record High

Late Car Payments Hit Record High

Today the Washington Post featured a piece that highlights what we at Tematica have been saying for months and is highlighted in our Middle-Class Squeeze investment theme. All is not well in many American households at a time when unemployment is at a 50-year low, there are more job openings than there are job seekers and the powers that be keep telling us how great things are. The Post article noted:

A record 7 million Americans are 90 days or more behind on their auto loan payments, the Federal Reserve Bank of New York reported Tuesday, even more than during the wake of the financial crisis era.

This is particularly concerning given that a car is often more important than even making a mortgage payment or a credit card minimum payment as it is how most people get to work.

A car loan is typically the first payment people make because a vehicle is critical to getting to work and someone can live in a car if all else fails. When car loan delinquencies rise, it’s a sign of significant duress among low-income and working-class Americans.

Given that the population has increased since the Financial Crisis, the actual percent of auto loan borrowers that were 3-months or more behind on their payments is at 4.5% versus the peak of 5.3% in late 2010, but the record high number is concerning at a time when the economy is supposedly firing on all cylinders. What happens when it really does slow?

We are seeing similar worrying signs in the recent Federal Reserve Senior Loan Officer Survey which found that demand for consumer loans is in full-on contraction. This is not something you see when the economy is strong and people are confident about their financial future.

We will be discussing this and much more in our Context and Perspectives piece to be released later this week.

Source: A record 7 million Americans are 3 months behind on their car payments, a red flag for the economy – The Washington Post

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