The ECB warns banks to prepare for coronavirus related jump in cybercrime

The ECB warns banks to prepare for coronavirus related jump in cybercrime

Never underestimate people’s ability to take advantage of a crisis, including the current coronavirus as cyber-criminals have been quick to take advantage of the understandable levels of fear. This morning NortonLifeLock (NLOK) sent an email to its clients warning about a phishing email going around that uses the logo of the CDC Health Alert Network claiming to provide a list of local active infections. Recipients are asked to click a link where they are then to enter email login credentials, which are then stolen.

Also this morning, the European Central Bank warned banks that there may be a jump in cyber attacks as hackers look to exploit virus-related chaos.

The watchdog urged banks in a letter this week to test the capacity of their technology systems “also in light of a potential increase of cyber-attacks and potential higher reliance on remote banking services.”

The outbreak has prompted lenders to ask more employees to work from home or spread them across different offices, while more clients may choose online banking over going to branches. While banks have improved defenses against hackers in recent years, the ECB has called cybercrime and technology deficiencies some of the top risks for the industry this year.

The ECB letter is part of efforts to ensure banks can keep functioning in case they’re directly affected by the coronavirus outbreak that’s rippling through the global economy.

These warnings follow a recently published blog post by Fortinet (FTNT) on how it has seen a significant increase in malicious activity surrounding the coronavirus. In the post, the company shared it has found reports appearing from “trusted sources, such as governmental agencies, news outlets, etc. that were actually malicious.” Fortinet goes on to point out the World Health Organization (WHO) is contending with malicious activity as “criminals are disguising themselves as WHO to steal money or sensitive information.”

We suspect in the coming months we are likely to see a spike in companies reporting cyber attacks and data privacy violations, which will not only shortcomings but also spur demand for companies found in the Foxberry Tematica Research Cybersecurity & Data Privacy IndexOur advice is to wash your hands frequently and be wary of what you click on and where you click. It’s a viral world.

Source: Banks Told to Prepare for Cybercrime Jump in Coronavirus Fallout – Bloomberg

Disclosure: NortonLifeLock (NLOK) and Fortinet (FTNT) are constituents in the Foxberry Tematica Research Cybersecurity & Data Privacy Index


Don’t Judge a Book by Its Cover

Don’t Judge a Book by Its Cover


It’s the end of July and has been hot as hell for much of the world this week, around 107 Fahrenheit in Paris yesterday! So I’ll do my best to keep this look into economy and markets a bit shorter than my usual. When economies and markets are near a turning point, often the headlines tell a very different story than is revealed by digging deeper into the data – you can’t judge a book by its cover. In this week’s issue of Context & Perspectives:

  • Budget Debate Off the Table Until 2020
  • Investors Just Not That into the Stock Market
  • Global Manufacturing Weakness Continues to Spread
  • Next Week, the Fed Re-Takes Center Stage


Budget Debate Off the Table Until 2020

Apparently, the Democrats were also feeling the heat as they managed to work out a deal on a 2-year budget with the President, so at least that drama is off the table until after the elections. Maybe at some point during the elections, someone will mention the enormous level of debt the government has accumulated, while Social Security remains a massively underfunded elephant in the room. Or maybe not. We live in interesting times.


Investors Just Not That into the Stock Market

While the market continues to grind higher, digging into the details we find that investors have really not been loving this stock market. Over the past 52 weeks, according to data from the Investment Company Institute (ICI), investors have pulled $329.4 billion out of equity funds, another $94.0 billion out of hybrid funds and put $75.7 billion into bond funds. So how has the market continued to march higher? Over the past five years, investors have been net sellers of the market with corporations themselves the net buyers through stock buybacks, which isn’t quite as rosy as it may first seem.

Some of these buybacks are being funded through debt, which has led global corporate debt to reach unprecedented heights, as I discussed in my last piece when I pointed out the proliferation of not just corporate debt, but also the increasing numbers of zombie corporations. There are a few others also concerned with this, as was discussed in a Barron’s article yesterday, you might recognize just a few of these names.    

Part of why investors are selling while corporations are buying back their own shares is likely a function of demographics. As the Baby Boomers move adjust portfolios as they move into retirement, their portfolio construction will naturally have to change and that shift, in a period of central bank interest rate suppression, is much harder than it was for generations past. The level of income that can be feasibly generated from a portfolio today is much less than what the Baby Boomers’ parents enjoyed. At the other end of the spectrum, Millennials are saddled with unprecedented levels of student debt, so they aren’t exactly big buyers of shares either. Between central bank manipulations and demographics, this is a very different investing environment.

Given the relative strength of the US economy compared to the global economy, which is slowing more dramatically, it is interesting to note that large-cap stocks, (which tend to have more international exposure) have been outperforming small-cap stocks at a level not seen since January 2008 – ahem, share buybacks, anyone? 



Global Manufacturing Weakness Continues to Spread

This week’s Markit manufacturing PMI came in at 50.0, meaning no change in output, and was the weakest level since March of 2009. The United States wasn’t alone as Germany’s Markit Manufacturing PMI was the lowest since July of 2012 and the Euro Area as a whole came in at the lowest level since December 2012. A composite of the five Federal Reserve manufacturing activity indices (courtesy of Bespoke Investment Group) reveals that all nine subcomponents have declined year-over-year, with Prices Paid leading the decline, down -24.2% and New Orders coming in the second worst, down -22.2%. New Orders are also down -10.2% from just this past April. That is not exactly a rosy leading indicator. The International Monetary Fund has cut global growth forecasts four times this year.

When looking at manufacturing globally, the first company to come to mind is Caterpillar (CAT). The company reported results for the June quarter that confirmed the overall slowing we’ve been seeing in the global industrial sector. Sales growth for the company has weakened along with various indicators of slowing we’ve been seeing come in from all over the world. We aren’t seeing an imminent crash, but Caterpillar’s results certainly support the theory of spreading weakness. Sales for the bellwether company peaked in North America in February 2018 at 30% year-over-year and have been falling ever since, with June’s 12% year-over-year growth rate the weakest in 18 months. North America remains the strongest region for the company and one of only two posting positive growth. The rolling three-month average global sales growth rate is down to its lowest level in about 14 months and the company’s streak of 28 consecutive months of rising sales is being threatened. This tells you an awful lot about the global economy.


The Consumer & Government Props Up GDP . . . with Debt

Friday morning the first estimate for GDP for the second quarter was released, rising 2.1% versus expectations for 1.8% – 2.0% and up from 3.1% in the first quarter. This quarter was all about the consumer with personal consumption expenditures up 4.3% (annual rate), the strongest performance in six quarters. At the same time, American Express (AXP) and Capital One Financial Corp (COF) reported an increase in the number of accounts overdue by 30+ days in the second quarter. Personal Savings also declined -3.6%. Spending up, debt up and savings down – not exactly a sustainable trend?

Looking further at the consumer, on the positive side, the solid quarterly earnings report from short-term staffing provider Robert Half (RHI) provided evidence that we are seeing domestic wage growth with the bill rate (which is basically the cost of waters for the company’s customers) was up 5% year-over-year in the past three quarters. That’s good news for the consumer, but keep in mind this is not a leading indicator. On the other hand, employment at small businesses, which does tend to be a leading indicator as small businesses are quick to respond and adjust to the changing economy, fell by 23k in June after having fallen 38k in May. The last time we saw back-to-back drops of that magnitude was in early 2010. For all the hoopla over employment, the last Job Openings and Labor Turnover Survey found that job openings were down -4% from the cycle high and new hires were down -4.4%. Again, not saying we are falling off a cliff here, but we are looking for indicators that the trend is changing direction and these data points clearly point towards that assessment.

Friday’s GDP report also found that gross private domestic investment declined -5.5%, the worst showing since the December quarter of 2015 with spending on non-residential structures falling -10.6%. This drop on business investment took a full percentage point off of GDP – to be fair, they are awfully busy buying back their own shares. If businesses are cutting back on investments in machinery and structures, isn’t hiring going to be affected? That will affect consumer spending. When looking at that fall in domestic investment, keep in mind the trade wars and how Chinese foreign direct investment has declined by about 90% over the past two years. 

Along with a jump in consumer spending, government spending also jumped, rising 5% on an annual basis. That is the biggest increase in spending since the second quarter of 2009 when the economy was literally falling off a cliff. Not to be a negative Nancy here, but digging into the math a bit we see that consumer spending and government combined rose at a 4.4% annual rate while the rest of the economy contracted at a -12.1% rate.

In the end, and I’m doing my best to wrap this up quickly for all of you struggling with the heat, all eyes remain on the entities most responsible for the health of the stock market these days – central banks. The European Central bank policy announcement this week kept the benchmark despite the rate at negative 40 basis points but indicated the bank is considering additional quantitative easing and potentially a tiered deposit rate scheme to help protect bank profitability – not exactly a shocker given the poor condition of many of the region’s banks. The outgoing head of the ECB, Mario Draghi, stated that the outlook “is getting worse and worse.” In response, the German 10-year yield traded as low as negative 42 basis points. For context, the US 10-year closed the same day at 2.075%. 


On Tap Next Week, the Fed Re-Takes Center Stage

Next week the Federal Reserve is expected to cut its key rate by at least 25 basis points and the market is pricing in further cuts to follow. Many are arguing that the Fed needs to be Gretzky and move to where the economy is going to be, not where it is today. They may be right, but the Fed has backed itself into a really tough corner. A typical rate-cutting cycle sees 525 basis points of cuts. Today, it has about half of that to work with and over the coming months the economy is facing quite a few potential shocks:

  • Brexit – now that Boris is in charge it could get ugly.
  • The feud between the odd-couple political coalition in Italy is intensifying at a time when European leadership is particularly weak and facing Brexit. Just what the EU needs, more instability.
  • Trade wars. 
  • Iran tossing around missiles and threats in the Strait of Hormuz

The Fed may want to keep some of those precious few arrows in its quiver. It is also facing competition in the race to the bottom as many of the world’s central banks are either cutting or are looking to begin cutting rates in the near future. Meanwhile, the market continues to grind higher.

NIRP – a Central Bank Roadblock to Wealth

NIRP – a Central Bank Roadblock to Wealth

You’ve probably heard some references to the idea that the central bank policy of keeping rates artificially low or negative hurts savers and is partially responsible for the widening wealth gap – the rich get richer and the not-so-fortunate face bigger headwinds. There are a few ways in which this policy harms the less-than-uber wealthy, some obvious and some not too obvious. I recently experienced one of the less obvious first-hand, and I’m still pretty peeved thank you very much, Mr. Mario Draghi.


The most obvious way is by reducing the level of income that can be generated from relatively safe investments. At the start of 2000, the 10-year Treasury bond yielded over 6.5%. Today it yields all of 2.4% while the High Yield 100 yields just 5.6%. Yep, junk bonds today yield less than the 10-year Treasury did at the start of the millennium.


What that means is savers have to take on a lot more risk to generate even less income than was possible 17 years ago. Think about that when you read about the shrinking Middle Class, part of our Rise and Fall of the Middle Class investing theme.


Good thing that the largest generation in American history is at or near retirement when they most need to generate income from their savings – argh! What this means is that this generation, which is the key demographic driver behind our Aging of the Population investing theme, is forced to take on way more risk than any prior generation to get a lot less out of their savings. The potential ramifications of this reality when we inevitably get a meaningful pullback in the markets is unnerving given the state of the average retiree’s level of savings and the dire straits of most pension plans. According to Vanguard’s 2016 How America Saves Report, the average 401K balance is $96,288, but for those Baby Boomers that are now turning 70 the average 401(K) balance is $200,358.  Yes, you read that right… no wonder we keep reading the average Baby Boomer is under saved for their golden years.


There is another way in which these policies make it more difficult to become rich. One of the paths to wealth has been investing in new and upcoming companies – finding the next up and coming companies set to ride our thematic investing themes much the way Microsoft, Facebook, Qualcomm or Google have. This is often done through private equity/venture capital firms who pool together investors’ money and then put it in a selection of privately held companies.


The dynamic between companies looking for funding and those looking to invest involves competition on both sides. Those looking to invest compete to find those that are most likely to succeed to the greatest degree. Those looking for funding look for those that will be most useful to them in terms of developing and building the business as well as those that will give them the highest valuation because a higher valuation means giving away less of the pie.


Now we get to what has me steaming.


Recently I was involved in a process to invest money into a privately held company in southern Europe. The idea was that the funds would be used to buy up some of the competition, grow the business and then take it public in around 5 years – pretty standard stuff. All parties involved knew that there were multiple firms looking to put money into this company as well, so all were aware that each would have to give the highest valuation possible within required return constraint to the company.


After more months’ work than I would like to recall, the offers were submitted. A bit later everyone learned that all the offers received were tightly grouped, except for one that gave a valuation that was more than 25% higher than the second highest!


What the hell?


Turns out the investing group with the highest valuation was a fund of one of the biggest global banks and doesn’t source the funds it invests from private investors, but is instead able to pull directly from the European Central Bank at a negative interest rate! The returns this fund generates simply goes to the bank’s bottom line. Not to cry foul, but that’s a very different landscape to be playing on.


With the yield curve increasingly flat these days, it doesn’t take much to improve a bank’s bottom line. The rest of the investing suitors instead had to price their offerings at levels that would generate attractive enough returns to make it worth their investors’ while to have their money locked up for many years. The bank’s cost of capital may be negative thanks to the European Central Bank’s policies, but have you met anyone who is happy losing money on an investment?


ZIRP (Zero Interest Rate Policies) and NIRP (Negative Interest Rate Policies) hurt those trying to build wealth by not only suppressing interest rates, but by giving those who can access central bank provided lending directly, an impossible advantage. Aside from seriously ticking everyone in the aforementioned investing beauty pageant off, this policy also results in highly concentrated assets and wealth. Those closest to the central banks, which means those who are already uber-wealthy and powerful, have access to cheaper capital than the rest of us, giving them a serious advantage.

This problem affects all investors. Most of those who invest in private equity funds have no visibility into just how many investments their fund managers have lost to competitors like this. The story I just told ripples across all types of investments, forcing savers to accept lower returns along with higher risk levels.


Now I’m off to spend some quality time with my two favorite men, Ben and Jerry. Perhaps at this point, you’ll want to join me.

Falling Dollar as Trump Trade Tumbles into Investor “Meh”

Falling Dollar as Trump Trade Tumbles into Investor “Meh”

The U.S. dollar got hit hard again today as the Trump Trade continues to reverse and investor sentiment becomes more neutral – a big “Meh.”

The U.S. dollar is continuing its steep decline today as the AMEX U.S. Dollar Index makes new lows for 2017 and is nearing the lowest point over the past year, pushing down towards 94.

^DXY Chart

This represents not only an unwinding of the so-called Trump Trade, but speaks to how weak economic data has been coming in relative to expectations, (we’ve talked about this extensively which you can read about most recently here and here) AND relative to what we are seeing outside of the country. This decline has been driven primarily by the euro, the Mexican peso and the Japanese yen.

The dollar fell as the European Central Bank President, Mario Draghi, delivered a talk conveying more optimism for the European Union, citing growing political tailwinds, and the emergence of reflationary pressures. This came as Monday’s Durable Goods report showed the American economy is treading water, with Shipments and New Orders both dropping 0.2 percent month-over-month versus expectations for 0.4 percent gains. Core Capex has basically stagnated since February and despite all the euphoria in tech stocks, booking for new computers and electronics also declined 0.2 percent month-over-month and has now declined in 3 out of the past 4 months, which translates into a 6.5% decline on an annual basis: a long way from the 10 percent annual growth rate we saw at the start of 2017.

The Chicago Fed National Activity Index declined in May, the second decline in the past 3 months with the 3-month moving average essentially flatlining.

Looking over at France, with the recent win by Macron the economy there is looking much more upbeat as single-family housing permits rose 17 percent year-over-year versus 6 percent in the U.S. Single-family housing starts rose 19.4 percent in France and 8.5 percent in the U.S. In addition, mortgage purchase applications in the U.S. have fallen in 6 out of the past 7 weeks.

In Germany, the lfo business sentiment index recently hit a record high and across the Eurozone a collective sigh of relief can be heard as Italy is addressing its NPL (non-performing loan) problems. The latest was with a mix of state bailout, to the tune of €17b, on Banca Popolare di Vicenza and Veneto Banca that has equity and junior bondholders wiped out, protecting only senior note holders and depositors. More is likely to follow.

Looking at yesterday’s Consumer Confidence Survey, while the overall index rose from 117.9 to 118.9, it didn’t make up for the decline of 7.3 during April and May. That’s not terribly concerning, but this other bit in the details is. While the index for the Present Situation rose from 140.6 to 146.3 and is at the highest level since June 2001, Expectations fell again for the third consecutive month and are now at the lowest level since January. This type of divergence typically precedes a recession and if we look at these moves over the years, a recession typically hits 9 months after Expectations peak. That peak, so far, looks to have been in March.

Yes, but those Fed guys sound oh so confident despite tightening into an economy with slowing growth, declining inflation, weakening credit growth and a flattening yield curve.

  • Since World War II, the Fed has engaged in 13 tightening cycles
  • During 10 of those cycles, the economy slid into a recession
  • In the 3 where a recession did not occur, GDP growth fell by 2 to 4 percent. With current GDP growth struggling to get above 2 percent, that’s worth noting.

Meanwhile, the equity market is mostly yawning.

The VIX has now dropped below 10 eight times in 2017. To put that into perspective, in the 22 years from 1994 through the end of 2016, the VIX saw that level all of 7 times!

VIX Chart

In the past month, short position contracts on the VIX have doubled to now sit at a record level.

Over in the bond market, the view of the economy isn’t all that rosy. As of June 20th, the net longs on the 10-year Treasury hit a level we haven’t seen since December 2007.

Today’s AAII Investor Sentiment report showed that neutral sentiment is at its highest level since last August at 43.4 percent while bullish sentiment declined from 32.7 percent to 29.7 percent. This market is seriously astounding with a record 130 consecutive weeks where half the investors surveyed were not bullish, while we’ve had such a smooth melt up in the first half of 2017. Only one other year have we seen even less of a pullback during the first half! Meanwhile, the Bears are also scratching their heads with bearish sentiment falling from 28.9 percent to 26.9 percent, the lowest level since the first week of the year.

With economic data coming in well below expectations while the market has continued its melt up (today notwithstanding) despite bonds telling a worrisome tale with falling long-term rates and a flattening yield curve, it is no wonder investor sentiment is increasingly a neutral “meh..” or perhaps more of an “Eh…?”


FOMO, Musical Chairs or Soros?

FOMO, Musical Chairs or Soros?

FOMO aka Fear of Missing Out has been running high, pushing the S&P 500 today to reach into severely overbought territory, moving more than two standard deviations above its 50-day moving average. In the chart below the middle orange line represents the 50-day moving average, with the top and bottom orange lines two standard deviations from that moving average.  The index’s relative strength indicator is nearing 70, the level typically considered extreme overbought.

^SPX Chart

^SPX data by YCharts

Looking at the CNN Fear and Greed Index, we can see that Greed, or more likely FOMO, is ruling the day.

2016-06-08 Fear & Greed1

In fact, “Greed” is at a level not seen in over two years.

2016-06-08 Fear&Greed Over Time

Looking at all the momentum indicators, it is likely that the market will take out the highs from last year, breaking out of the longer-term trend of lower lows and lowner highs, which would be very bullish.

2016-06-08 SPX LT

Market breadth has strengthened as well, which is also a bullish indicator. The chart below shows the percent of stocks in the S&P 500 which are above their 50-day moving average. More stocks moving up is bullish when the overall index is moving up rather than having the index moving up based on a few mega-cap high fliers.

2016-06-08 SPX Pctabove50day

All this while revenue for the S&P 500 has been falling for five quarters and earnings for four, which means that investors are paying more for each dollar of earnings to push prices up. At the same time we are starting to see upward pressures on labor costs, which will harm margins (don’t forget that already falling top line revenue) along with some hints of inflation and oil, a major input to darn near everything, having doubled in price since the February lows. Global growth expectations continue to be revised downward and political instability is widespread from domestic, with the Clinton v Trump drama just getting started, to international from political crisis in South America to China flexing its military muscles to the upcoming Brexit vote.

Outside of FOMO, I think we are also seeing the impact of the central bank game of musical chairs wherein central banks remove more and more chairs from the room, courtesy of quantitative easing programs, while the number of players in the room is rising with more and more retirees desperately needing to generate some sort of return from their savings. Recently the European Central Bank started buying corporate bonds, because hey, driving sovereign bonds into negative territory just wasn’t enough fun. That means those corporate bonds (chairs) with their nice yield (cushions) have been pulled from the room so there are fewer and fewer places to put asse(t)s.

But what’s that phrase?

Don’t fight the Fed! 

Fair enough and it can and probably should be extended towards most all major central banks.

Then comes along a fellow named George. You might recall that ‘ole George (Soros to be exact) had a little kerfuffle a few decades back involving a central bank, (Bank of England). He’s one guy that did fight… and won. In today’s market George is once again making a bet against the central banks’ desire to keep asset prices up. He’s sold stocks and buying gold and gold miners. When the guy who fought a central bank and won goes for gold and dumps stocks, it just might be worth a few moments’ consideration.

In the interim, looking at all the data I can wrap my noggin’ around, it looks to me like stocks are more likely to keep moving higher for at the least near term. How near? Now that is the question and what keeps me up at night. This is a market that must be watched closely and looks to me an awful lot like a house of cards, but that house can be built higher. Just know if you want to play the game, that this is what you are standing on.

Fed in a Rate Hike Corner

The Fed has trapped itself in a rate hike corner, having told the markets for nearly a year that the economy is doing great and it will need to raise rates, soon…very soon. Now there are signs of the economy weakening, other nations are devaluing their currencies and the U.S. is still stuck in ZIRP (Zero Interest Rate Policy). We’ve hit the point where the Fed must act or lose enormous credibility.

Yesterday was the biggest one-day decline in the Dow Jones Industrials Average since 2009 after the ECB provided less stimulus than was expected. This continued the decline that began with Janet Yellen’s testimony before Congress Wednesday, which left most market watchers thinking that a rate hike is all but assured. This morning we learned that private sector job growth for November came in above consensus expectations, which will have the market fairly convinced that a rate hike is all but assured. So what is this rate hike thing all about?

Why Do We Care About the Fed Rate Hike?

The rates set by the Fed act as the building blocks for all other interest rates, from the rates on your mortgage, to your auto loan, to rates of return on CDs and even corporate bond rates. When the Fed changes its rates, the rates on everything else move up or down with it as well. If the Fed does hike rates this month, for example, home mortgage rates will rise.  However, given that the Fed rate hike isn’t expected to be much, the increase will likely be minimal.

Why are super-low, zero rates a problem?

The problem with low rates is all about risk versus return. When the Fed pushes rates really low, it makes it hard to generate a reasonable return on savings. Right now this is particularly difficult for the nation given the baby boomers, the largest generation, are either in or about to enter retirement, when they need to generate income off their savings the most.

In order to deal with the low rates, investors are forced to take on more risk than they would otherwise.  You can think of risk as the likelihood of success. The higher the probability of success, the lower the demanded rate of return – no need to pay much to get people to invest in a nearly sure thing, but a really risky venture – now that takes a bigger promise of return to attract investors. So we have all these people needing to generate income from their retirement savings and they are being forced to take on more risk than they really should because interest rates are so low.

This has some major implications for the economy:

  • Some retirees/investors will refuse to take on excess risk. This means they have to live on less as their retirement cannot provide the kind of income that as reasonable to expect years ago. So they will spend less – that impacts the economy.
  • More “risky” investments are getting money than is normal. Risky investments by definition have a higher failure rate. This means we will have a higher failure rate in the economy, which means more money lost than is normal. This also impacts the economy. More money lost, less money to spend and invest in the future.

Fed in Danger!

The next problem is the Fed has presented itself as being able to jump start the economy. The first quantitative easing problem began in November 2008 – seven years ago! If the Fed hopes to have any credibility concerning its ability to affect the economy, at some point it has to be able to say, “Look, it worked. The economy can stand on its own now!”

The Fed also faces asymmetric risk in that if the economy strengthens, it has plenty of room to hike rates, but if it weakens, there isn’t much room to maneuver as there is no evidence that negative rates at a central bank are stimulative.

The Fed has also been telling the markets for over a year that the economy was just about, almost there, oh so close… to being ready to stand on its own without the super low rates to support it. Chairwoman Janet Yellen has been telling us that she needed to see table job growth…well, we’ve been seeing at least headline job growth. (The underlying reality of the quality of the jobs is another thing entirely.)  Once again, the Fed is facing a credibility problem if they don’t raise rates here after so much lip service.
Problem is, our domestic rates are effectively being raised when other central banks around the world lower their rates.  The ECB just lowered their primary rate to NEGATIVE 0.3%.  Yup, they now charge interest on the money banks leave with them… That’s like Wells Fargo charging ME for the money I have in a savings account with them. However, the ECB didn’t lower rates as much as was expected which has given Yellen and company a much needed reprieve! Since the ECB didn’t go as negative as was expected, the dollar index actually fell over 2% yesterday for its largest single day decline since 2009.

You can almost hear Draghi, “Here’s your chance Janet, if you are ever going to do it, do it now!” Want to bet that after the Fed raises this month, the ECB will lower rates again further?

Strong Dollar Implications

With the US raising rates while other major economies are lowering rates… some to even below zero, that makes the US dollar stronger and stronger.  Now this is fantastic for traveling as an American, but it is pure hell for American businesses that sell internationally. This means they sell less and will need to look to making more of their stuff outside the US where it is cheaper.

The strengthening dollar is also a major problem for emerging markets.  Earlier we talked about how investors needed to put money in riskier stuff than normal to try and generate any sort of reasonable return. One of the places they put money was in emerging markets.  Companies in these economies figured out that Americans were desperate for returns and they could get us to invest if they sold bonds denominated in US dollars.  Given that the dollar has been falling in value since the mid 1980s, with a brief upturn around the dotcom boom/bust, these companies were confident that they could issue in USD and lower rates than in their domestic currency, but wouldn’t likely have to worry about the exchange rate changing against them.

Ooops –the dollar has been strengthening significantly, which means those bonds are becoming insanely expensive for companies in emerging markets and many will end up defaulting. Ouch!  That hurts investors, but also isn’t likely to make us a whole lot more friends around the world. An argument can easily be made that we exported the pain we would have felt from all that quantitative easing to emerging markets and now they are paying the price for us! Not helpful at a time when the US is already struggling with its international relations.

China isn't the only country slowing

China isn't the only country slowing

Slow-TurtleChina isn’t the only country slowing, as we are sure you’ve all been hearing, the global economy is slowing to a level that ought to make everyone pay attention. Earlier this month the International Monetary Fund (IMF) cut forecasts for 2015 yet again, projecting 3.1% versus its prediction in July for 3.3% and its April prediction for 3.5%.  This means that this year, despite the unprecedented level of monetary stimulus injected all over the world by government desperate to get things moving… the world economy will grow at its slowest pace since the global financial crisis.

Last week, Citibank cut its global growth forecast for 2016 for the fifth consecutive month, predicting 2.8% versus the previous forecast of 2.9%. Keep in mind that Citibank’s chief economist William Buiter has stated previously that global growth below 3% coupled with a significant output gap effectively represents a global recession. Now that’s just one person’s opinion, but it conveys the importance of these numbers.

If we take a brief tour around the globe, we’ll see that the Eurozone in 2014 finally posted positive growth of 0.9%, after having contracted in 2012 and 2013. The first quarter’s growth rate came in at 0.5% with the second quarter slowing slightly to 0.4%, giving the economy about 1.2% growth year-over-year.

In mid-November, we’ll get the first estimate for the third quarter, which so far is likely to be at around the same pace as the second. On Friday, we got some good news when the Eurozone Markit Composite PMI (Purchasing Manager’s Index) came in at 54 (above 50 is expansionary). The data for services came in nicely at 54.2 with manufacturing unchanged from the prior month at 52. So there is some growth in the region, though from a historical perspective it is still relatively weak. So let’s dig into the details.

If we dig a bit deeper, we see that the Eurozone’s largest economy, Germany, is suffering from the slowing in China and Russia, two major export partners with its 2nd quarter GDP coming in at 0.4%. Consumer confidence has been falling since the first quarter, but it still maintains an enviable unemployment rate of less than 5%, with a youth unemployment rate of 7%, which bodes well for the nation’s productivity in the future.

France, the Eurozone’s second largest economy, on the other hand experienced no growth in the second quarter, versus expectations for a 0.2% increase with an unemployment rate of just under 11% and a youth unemployment rate of nearly 25%.

Italy, the Eurozone’s third biggest economy experienced just 0.2% growth versus 0.3% expected. Unemployment has remained stubbornly high at nearly 12% with youth unemployment over 40%, which is a devastating number for the future of the country.  However, Prime Minister Matteo Renzi has made a lot of progress in reforming the government, so despite those rather dour numbers, consumer confidence is higher today than it has been over the past 12 years! Directions are important – we can’t just look at the numbers in isolation.

So things aren’t great in Europe, but they aren’t horrible either… however, significant growth seems perpetually illusive with rising concerns that the slowing in China and the emerging markets could be a tipping point for the area, which is likely why the head of the European Central Bank, Mario Draghi, hinted last Thursday that the ECB (Europe’s version of the Fed) is willing and ready to inject more quantitative easing into Europe’s economy. More QE, the now omnipresent heroin of the stock market was promised and equity indices all over soared!

So what about China? How bad it is there? Truth is, no one really knows. The country is based on an ideology that requires opacity at all levels of government, so accurate data or even an honest attempt at accurate data is something we are unlikely to ever get from official sources.

Those sources recently reported that China’s growth in Q2 was 6.9%, close enough to the official target of 7.0%, but being below, it provides a wee bit of cover for some stimulus. And wouldn’t you just know it! The People’s Bank of China, essentially their Fed, just lowered lending rates…a coincidence we’re sure!

Taking a step back, China has cut their 1-year interest rate 6 times since November of 2014, lowering the rate from 5.6% to 4.35%… but we’re sure everyone there is quite calm! The Required Deposit Reserve Ratio for Major Banks has been lowered 4 times since February, from 19.50% to 17.50%. This ratio determines how much leverage banks can have, which translates into loans. The lower the ratio, the greater the leverage which means more loans… more of nothing to see here folks? We don’t think so.

Here are a few more interesting data points:

  • China’s export trade has fallen -8.8% year to date.
  • China import trade is down 17.6% year to date.
  • Railway freight volume is down 17.34% year over year.
  • China hot rolled steel price index is down 35.5% year to date
  • Fixed asset investment is up 10.3% sounds great? (averaged +23% 2009-2014)
  • Retail sales are up 10.9%, the slowest growth in 11 years
  • China Containerized Freight Index, which reflects the contractual and spot market rates to ship containers from China to 14 destinations around the world, has just hit its lowest level in history, now 30% below where it was in February and 25% below where it was at its inception 17 years ago.

You get the point. It is slowing and we suspect it is slowing a lot more than the official GDP numbers would indicate.

Why should those of us outside China care? Because China has been a major supporter of global growth since the financial crisis. When all hell broke loose in 2007 & 2008, China put its infrastructure spending into high gear. That meant that those economies that supply commodities had a backup buyer for their exports when everyone else was crashing, which put a vital floor under the global economy.

But China couldn’t keep it up indefinitely, and we are seeing the consequences of that nation’s shift from a primarily export driven, massive infrastructure-building economy to a more domestic demand-driven economy with a lot less infrastructure spending.

China has been Germany’s fourth-largest export partner, with Russia not that far behind. Falling oil prices and sanctions have crippled Russia’s economy, so it also isn’t buying much from Germany. If Germany sells less, it’ll buy less from other nations… and keep in mind that all those Eurozone countries are just barely eking out positive growth, so small changes will have an impact.

Onto those emerging economies, many of which were benefiting from China’s infrastructure spend as they are primarily commodity exporters. If we look at what has happened to commodity prices over the past twelve months, you can get an appreciation for just how painful this has been for many of these countries. Keep in mind that 45% of global GDP comes from commodity export nations – commodity prices crater and these nations can buy less stuff from other nations – more headwinds to growth.

In fact, 2015 will be the fifth consecutive year that average growth in emerging economies has declined. This is a serious drag on the advanced economies, which on the other end of the spectrum, will likely post their best growth since 2010 – albeit growth that isn’t all that spectacular.

Japan… well it’s still stuck between barely growing and contracting, regardless of how much the Bank of Japan tries to kick start the economy. Japan’s industrial output unexpectedly fell in September, raising concerns that the nation may be slipping back into another recession. Production declined 0.5% in August following a 0.8% decline in July versus economists’ expectations for a 1% gain. Inventories rose 0.4% in August over July, and expanded in five of eight months this year, which is a hindrance to future growth as with rising stockpiles of unsold goods, companies are less likely to expand output in the future.

As for Latin America, Argentina is still a mess and Brazil is in a recession, with many of the other countries doing alright. Chile is expected to be around 2.5% for 2015. Colombia 2.8%… like we said, ok, not great.

In the US, things aren’t awful, but not exactly robust, which is why I had been predicting for months that the Fed would not hike rates in September.

  • For example, the Industrial production index came in with another decline of -0.4% in September versus expectations of -0.2%, which makes it the 5th decline out of 8 reported figures in 2015.
  • Capacity utilization, which measures to what degree the economy is taking advantage of its ability to make stuff, was expected to drop from 78% to 77.8%. Instead, it fell further to 77.6%, for the 7th decline out of 8 readings in 2015. This means the U.S. continues to use less and less of its capacity to make stuff – hardly shocking given the wide misses in manufacturing data reported by regional Federal Reserve banks for August.
  • September retail sales came in below expectations, rising a seasonally adjusted 0.1% from August versus expectations for 0.2%. The good news is the increase came from a 1.8% month-over-month increase in auto sales. Overall retail sales, when we exclude autos and gasoline, have not grown since January.
  • U.S. producer prices in September posted their biggest decline in eight months, at a drop of -0.5%, as energy costs fell for the third month in a row. This means that the Producer Price Index is now down 1.1% year-over-year as of the end of September.
  • U.S. total business sales also declined in September, down -0.58% month-over-month and down -3.09% year-over-year as of August.

Going forward, I still remain very skeptical that the Fed will raise rates. The fact that China is continuing to loosen its monetary policy and comments out of the ECB concerning it likely embarking on further easing only add to our skepticism as the moves by China and the ECB will already put upward pressure on the dollar, harming U.S. exports. A rate hike would only exacerbate the dollar strengthening against other currencies.

Fed tightening has been a trigger in nine of the last eleven recessions, so you can see yet another reason for the Fed to be cautious.

The tough thing now is that with a Fed that can’t seem to make up its mind, investors are left wondering what to do, so they end up selling the good and the bad when they get nervous. This will make for increased volatility, but that also means more opportunities for those that keep focused on the goal and don’t get distracted by shorter-term market dramatics.

Risk On?

Risk On?

This morning I spoke with Matt Ray on America’s Morning News about the recent market action. Are we back to risk on? Here is a bit more detail on our discussion.

Equity markets have rebounded to an impressive extent after the recent correction, with the S&P500 less than 5% away from its all time highs, last seen in late May, while the VIX, the measure of volatility has closed in on a two-month low after having spiked up in August.

So were all those machinations between the summer and today much ado about nothing?  To answer that, we need to understand what drives returns.  The answer, like most things in life, is it’s complicated. Over the long-term, investment returns are based on fundamentals – ideally finding a company with an excellent management team that has products or services that are in high demand for a growing demographic with shares at an attractive price. But, in the short to medium-term, returns are all about risk – are investors seeking risk or withdrawing from it?

Today, the answer to the question of affinity for risk relies more and more upon bureaucrats, which makes the investor’s job an awful lot like a fortune-telling gazing into her crystal ball.



Who the hell knows what insanity will get blurted out next… particularly if Donald Trump has access to a mic or a twitter feed!

The Fed has now become a primary source of uncertainty, (contrary to what they claim is their intent) while politicians and bureaucrats muddy the waters in countless ways, such as when Hillary Clinton took to twitter to bash biotech pricing.  I understand her outrage, but in today’s world of instant communication via social media, a few words can have an enormous impact and countless unintended consequences.

We’ve seen high profile investors like David Einhorn with Greenlight, John Paulson, and Michael Novogratz of the flagship Fortress macro fund, (which is now liquidating) struggling to live up to their reputations as fundamentals are easily overwhelmed by bureaucrat commentary and the market’s tendency to try to read central bank tea leaves.

So where are we today?  The S&P 500 is again closing in on its all-time high, but if we look a bit deeper we see that 63% of the stocks in the S&P 500 are still below their 200-day moving average and credit spreads remain elevated. When I see lack of breadth like this, meaning that indices are moving up based on a small group of stocks, and we see credit spreads still indicating that investors aren’t running towards risk, I remain cautious.

If we look at history to get an idea of probabilities, the S&P 500 has found itself below its 200-day moving average with more than 50% of the stocks within it also under their 200-day -moving average 24% of the time.  Annualized returns when the market has been in this position have been 9.7%, which sounds pretty good, except the maximum interim loss during those times has been 50%! (Hat tip to John Hussman for his data) So you may get decent returns, but there’s a good chance you’ll lose your lunch in the process.

If we look at the economic fundamentals, we have more cause for concern:

  • Total US business sales are down 3.09% year-over-year
  • US capacity utilization is also down year-over-year, (we are using less of our ability to make stuff than we did last year)
  • Industrial production contracting in 8 of the last 9 months
  • The producer price index is down 1.1% year-over-year, not exactly a sign of impending inflation)
  • Retails sales fell yet again in September
  • The Federal Reserves GDPNow currently estimates 3Q GDP to be 0.9%, (not exactly an overheating economy)
  • This morning we also learned that China’s GDP growth rate slowed to 6.9%, which is the weakest since the Great Recession. That will hurt Germany (major exporter to China) which is already suffering from Russia’s slowdown (big exporter to them as well) as it tries to keep the rest of the Eurozone afloat.  Mario Renzi is doing his best to get Italy turned around, but give the man a break!

If we look at earnings so far with 58 companies having reported, it isn’t exactly inspiring either

  • The percentage of companies beating on earnings is above the average, which sounds pretty good until…
  • The percentage of companies beating on revenues is below average
  • This means that earnings beats are coming from cost-cutting and financial engineering with things like share-buybacks – no indicative of long-term growth
  • As far as valuations, today the forward price-to-earnings ratio is 16, which above the 5-year and 10-year average of 14.1, which means that despite the dour fundamentals, stocks are still rather pricey.
  • Within the S&P 500, nine companies have offered weak December quarter outlooks compared to only one that has raised expectations

With fundamentals not giving us much to go on, in the short-to-near term it is all about that risk, which means investors need to be focused on how will the major indices behave as they approach their 200-day moving averages?  If they blow right past the 200-day AND if we see credit spreads (the different between the risky stuff and the safer stuff) get narrower, then it is back to game on, likely through the rest of the year, regardless of what is happening under the covers.


Damn It Janet, Yellen isn't tellin'

Damn It Janet, Yellen isn't tellin'

Last week Janet (I’m not tellin’) Yellen gave her annual two-day Congressional testimony, making it clear during Tuesday’s discussion that she wants to move away from the concept that Fed guidance is a pledge and appears to still prefer more tortoise than hare policy moves, assuring the markets that while the Fed will remove the word “patient” from its forward guidance at some point, that change in wording alone will be insufficient for investors to assume a hike is imminent, leave the markets fretting, “Damn it Janet, Yellen isn’t tellin’.”

Ms. Yellen reminded Congress of the Fed’s dual mandate under Humphrey Hawkins and pointed out that while employment has improved, the participation rate is lower than expected and wage growth remains sluggish, leaving room for improvement.

So according to Yellen’s testimony, part of the Fed’s dual mandate has made progress, but not enough. The dual mandate also refers to long-run growth and stable prices. For growth, Q4 was just revised down to 2.2% for 2.6% annualized. The exceptionally cold weather over much of the U.S. coupled with the West Coast port closures/work-slowdown give little hope for a strong Q1. For example, Macy’s (M) recently reported that while at year-end the port slowdown had not yet had a material impact, “Since then… inventory levels have been negatively impacted particularly in apparel and accessories. Approximately 12% of our first quarter merchandise receipts are being delayed and this will have some impact on our sales, gross margin and expense in the first few months of the year.” The recent posts on economic data, ISMs, retail sales, NAHB, NFIB, durables and even consumer sentiment have all lined up below expectations with payroll the only bright spot, but only time will tell if that was more reflective of a drop in productivity.

As for the stable price goal, which has evolved into a quest for around 2% annual inflation, the US Producer Price index is down 0.27% as of January on a year-over-year basis. US Core Producer Price index is up 1.76% as of January on a year-over-year basis. Consumer prices are also well below the target 2%.

2015-02 Inflation Indicators

While Ms. Yellen did say the Fed is becoming less patient with low rates, we continue to see this Fed as more dovish and the data isn’t screaming inflation or a potentially overheating economy. Additionally, once the Fed does start rate hikes, we don’t think it will follow its usually pattern of consistent hikes with every meeting after the increase is initiated. Lastly, even though the likely vector for rates is eventually higher, investors should focus on the velocity of those increases. The initial quarter point increase would only happen if the economy could digest it, how soon and how fast subsequent increases come is what will really matter.

What does this mean for investors? First, this time really is different. The Fed has never waited this long, (five years) into a bull market to raise rates, nor has the world ever seen so much monetary stimulus coming from so many of the largest central banks. Therefore, when looking at historical norms, they need to be discounted to a degree given just how far off the reservation we are this time…perhaps even as far as Peter Pan’s Never, Never Land.

Investors also need to take into account just how many central banks around the world have been cutting rates. In the past few months, 16 central banks have cut rates: Albania, Australia, Canada, China, Denmark, Egypt, Europe (ECB), India, Pakistan, Peru, Romania, Singapore, Sweden, Switzerland, Turkey and Uzbekistan! All of the G7 and China are moving towards easing while the US alone is contemplating tightening. Today government bonds of various maturities in about ten countries are selling at negative yields! People are buying guaranteed losses. While Ms. Yellen didn’t mention the strength of the dollar on Tuesday as she did in January, the Fed is most certainly aware that raising rates in the US, with so many negative yields around the world, would increase demand for the dollar, pushing the currency up even further, which while lovely for importers, is brutal for US exporters.

Currency Wars – It's On!

Currency Wars – It's On!

2015-01-26 Currency WarLast Wednesday the European Central Bank (ECB) announced that it is launching its own quantitative easing program that was double what had been rumored, at an impressive €1.2 trillion. ECB Chairman Mario Draghi was able to pull off a program of this size by having some 80% of the bond-buying executed by national central banks. The agreement is that Germany will only buy German government bonds, France will only buy French bonds and so on. This was key to getting the program approved because if Spain or Italy goes off the rails, the German Bundesbank’s balance sheet won’t be immediately devastated. This is the main driver behind the rally in German bonds beyond the periphery bonds, which is also driving the rally in US bonds, as the markets can’t indefinitely maintain such a large spread between the only perceived risk-free rates left!

Despite all the rhetoric concerning how the economy is so very ship shape and all is going well on at least this side of the Atlantic, last year the best performing sectors were defensive ones: utilities and healthcare. This year with the crash in oil prices, the energy sector is forced to significantly delay capital expenditures and will by necessity put downward pressure on wages. Gasoline and diesel prices across the US have now fallen for a record 16 straight weeks. For the rest of the economy, the threat of global slowing and deflation may make many businesses hesitant to invest aggressively in expansions.

Central bankers across the globe have been on the frontlines of the newest form of international altercations, currency wars, which is driving yields into truly bizarre territory. Two weeks ago the Swiss National Bank removed the three-year currency cap on the franc and cut key rates having told the market just a month earlier that there were in fact no plans to remove the cap, sending markets into a veritable tizzy. India cut its key rate by 25 basis points and Bank of Korea lowered its outlook. Last week the Bank of Canada surprised everyone by lowering its main interest rate by a quarter percentage point for the first time since 2009. In Japan, Bank of Japan Governor Kuroda cut the nation’s core inflation forecast to 1% from 1.7%. Earlier last week the International Monetary Fund cut its forecast for inflation in advanced nations almost in half.   The result of these moves has left the Swiss 10-year yield in negative territory, the German 10-year at 0.52%, the French 10-year at 0.70% and the Japanese 10-year at 0.23% given that expected rates of inflation are all above these levels in their respective nations, 10-years in much of the develop world are now in negative real yield territory.   The currency war is on!

Those negative real yields reflect that most European countries are in or nearly in a recession. Italy for example is in a recession for the third time in six years, suffering from a 9% drop in output since 2008, and with unemployment increasing steadily from 7.8% in 2009 to 13.4% in November 2014. The ECB is expected to inject a massive monetary stimulus in an attempt to bolster the economies of these beleaguered nations, but the root of the problem isn’t monetary, thus the solution cannot solely be monetary. For example, in the January 10th edition of the Economist, Rwanda, which was in a bloody civil war just 20 years ago, is now cited to be a better place to do business than Italy! (Remember how we earlier mentioned that it is easier to start a business in Italy than in the U.S.?) No amount of monetary stimulus can fix those structural problems.

So we have defensive sectors outperforming and a material decline in trading volume, which tells you that investors are nervous.   Which brings us to the recent turn around in the yellow metal. Gold has traditionally had an inverse relationship with the dollar. For example, over the past four years the SPDR Gold Shares ETF (GLD) has had a -0.45 correlation with the Amex Dollar Index (DXY). From December 15th through yesterday, that correlation had completely reversed to be 0.75.   In 2015 so far, the correlation has been a mind-boggling 0.84! That’s a nearly perfect positive correlation. With central bankers around the world under pressure to manipulate their currency so as to inflate asset prices rather than having elected politicians deal with the very real structural problems, we believe it is no surprise to see gold once again showing strength. It has long been viewed as one of the only reliable stores of value and as long as the currency wars wage, will likely show continued strength, albeit with bumps along the way.