Turning Heads I Win, Tails You Lose Inside Out

Turning Heads I Win, Tails You Lose Inside Out

For much of the current expansion, cycle investors have been forced taught to believe in a Heads-I-Win-Tales-You-Lose investing environment in which good economic news was good for equities and bad economic news was also good for equities. Good news obviously indicates a positive environment, but bad news meant further central bank intervention, which would inevitably raise asset prices.

Those who didn’t buy-the-dip were severely punished. Many fund managers who dared to take fundamentals into consideration and were wary, or put on portfolio protection, saw their clients take their money and go elsewhere. An entire generation of market participants learned that it’s easy to make money, just buy the dip. That mode just may be changing as the past two weeks the major indices have taken some solid hits. Keep in mind that while the headlines keep talking up the equity markets, the total return in the S&P 500 has been less than 5% while the long bond has returned over 18%. Austria’s century bond has nearly doubled in price since it was first offered less than two years ago!

Earnings Season Summary

So far, we’ve heard from just under 2,000 companies with the unofficial close to earnings season coming next week as Wal Mart (WMT) reports on the 15th. The EPS beat rate has fallen precipitously over the past week down to 57.2%, which if it holds, will be the lowest beat rate since the March quarter of 2014. Conversely, the top line beat rate has risen over the past week to 57.4% which is slightly better than last quarter, but if it holds will be (excepting last quarter) the weakest in the past 10 quarters. The difference between the percent of companies raising guidance versus percentage lowering is down to -1.8% and has now been negative for the past four quarters and is below the long-term average.

With 456 of the 505 S&P 500 components having reported, the blended EPS growth estimate is now -0.72% year-over-year, with six of the eleven sectors experiencing declining EPS. This follows a -0.21% decline in EPS in Q1, giving us (if this holds) an earnings recession. The last time we experienced such a streak was the second quarter of 2016.

The Fed Disappoints

Last week Jerome Powell and the rest of his gang over at the Federal Reserve cut interest rates despite an economy (1) the President is calling the best ever, (2) an unemployment rate near the lowest level since the 1960s, at a (3) time when financial conditions are the loosest we’ve seen in over 16 years and (4) for the first time since the 1930s, the Fed stopped a tightening cycle at 2.5%. We have (5) never seen the Fed cut when conditions were this loose. They were looking to get some inflation going, Lord knows the growing piles of debt everywhere would love that, but instead, the dollar strengthened, and the yield curve flattened. Oops. That is not what the Fed wanted to see.

The President was not pleased. “What the Market wanted to hear from Jay Powell and the Federal Reserve was that this was the beginning of a lengthy and aggressive rate-cutting cycle which would keep pace with China, The European Union and other countries around the world,” he said in a tweet. “As usual, Powell let us down.”

The dollar’s jump higher post-announcement means that the Fed in effect tightened policy by 20 basis points. Oops2. The takeaway here is that the market was not impressed. It expected more, it priced in more and it wants more. Now the question is, will the Fed give in and give the market what it wants? Keep in mind that both the European Central Bank and the Bank of England are turning decisively more dovish, which effectively strengthens the dollar even further.

Looking at past Fed commentary, the track record isn’t exactly inspirational for getting the all-important timing right.

But, we think the odds favor a continuation of positive growth, and we still do not yet see enough evidence to persuade us that we have entered, or are about to enter, a recession.” Alan Greenspan, July 1990

“The staff forecast prepared for this meeting suggested that, after a period of slow growth associated in part with an inventory correction, the economic expansion would gradually regain strength over the next two years and move toward a rate near the staff’s current estimate of the growth of the economy’s potential output.” FOMC Minutes March 20, 2001

“At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems to likely be contained.” Ben Bernanke, March 2007

“Would I say there will never, ever be another financial crisis? You know probably that would be going too far but I do think we’re much safer and I hope that it will not be in our lifetimes and I don’t believe it will be.” Janet Yellen, June 2017 (This one is going to be a real doozy)

This time around Fed Chairman Powell told us that what we are getting is a “mid-cycle policy adjustment.” Wait, what? We are now (1) in the longest expansion in history with (2) the lowest unemployment rate in over 50 years as (3) corporate leverage levels reaching record levels at a (4) time when more of it is rated at just above junk than ever before in history. This is mid-cycle? I’m pretty sure this one will be added to the above list as some serious Fed facepalming. Now I think these folks are incredibly bright, but they are just tasked with an impossible job and live in a world in which their peers believe they can and ought to finesse the economy. So far that theory hasn’t turned out all that well for anyone who doesn’t already have a good-sized pile of assets.

Domestic Economy (in summary because it is August after all)

  • We are 3-year lows for the US ISM manufacturing and services PMIs.
  • We are seeing a shrinking workweek, contracting manufacturing hours and factory overtime is at an 8-year low.
  • Just saw a contraction in the American consumer’s gasoline consumption.
  • American households just cut their credit card balances, something that happens only about 10% of the time during an expansion. Keep in mind that Q2 consumer spending was primarily debt-fueled when looking towards Q3 GDP.
  • The Organization for Economic Co-operation and Development (OECD) Leading Economic Indicator for the US fell to a 10-year low in June, having declined for 18 consecutive months. A streak of this nature has in the past always been indicative of a recession. Interestingly that same indicator for China just hit a 9-month high.
  • The Haver Analytics adjusted New York Fed recession risk model has risen from 50% in early January to a 10-year high of 80%.

Global Economy

  • The IMF has cut world GDP forecasts for the fourth consecutive time.
  • We have 11 countries so far in 2019 experiencing at least one quarter of shrinking GDP and 17 central banks are in cutting mode with Peru the latest to cut, the Royal Bank of Australia hinting at further cuts and Mexico and Brazil likely next in line.
  • Some 30% of the world’s GDP is experiencing inverted yield curves.
  • Over half the world’s bond market is trading below the Fed funds rate.
  • Despite the sanctions on Iran and OPEC output cuts, WTI oil prices have fallen over 20% in the past year.


  • The Eurozone manufacturing PMI for July fell to 46.5, down from 47.6 in June and is now at the lowest level since the Greek debt crisis back in 2012 as employment declined to a six-year low with a decline in exports. Spain came in at 48.2, 48.5 for Italy and 49.7 for France.
  • Germany, long the economic anchor for the Eurozone and the world’s fourth-largest economy, has negative yields all the way out 30 years and about 40% of Europe’s investment-grade bonds have negative yields. The nation’s exports declined 8% year-over-year and imports fell 4.4% in June as global demand continues to weaken.
  • France had its industrial production contract -2.3% in June versus expectations for -1.6%.
  • Italy’s government is back in crisis mode as the two coalition ruling parties look to be calling it quits. Personally, I think Salvini (head of the League) has been waiting for an opportune time to dump his Five Star partners and their recent vote against European Infrastructure gave him that chance. The nation is likely heading back to the polls again at a time when Europe is facing a potential hard Brexit, so we’ve got that going for us.
  • The UK economy just saw real GDP in Q2 contract 0.2% quarter-over-quarter. Domestic demand contracted -3%. Capex fell -0.5% and has now been in contraction for five of the past six quarters. Manufacturing output also contracted -2.3% in the worst quarter since the Great Financial Crisis.


  • South Korean exports, a barometer for global trade, fell 11% year-over-year in July. The trade war between South Korea and Japan continues over Japan’s reparations for its brutal policy of “comfort women” during WWII.
  • The trade war with China has entered the second year and this past week it looks unlikely that we will get anything sorted out with China before the 2020 election. The day after Fed’s rate decision Trump announced that the US would be imposing 10% tariffs on $300 billion of Chinese goods starting September 1st. In response, China devalued its currency and word is getting out that the nation is preparing itself for a prolonged economic war with the US. The rising tension in Hong Kong are only making the battle between the US and China potentially even more volatile and risky. Investors need to keep a sharp eye on what is happening there.
  • Auto sales in China contracted 5.3% year-over-year in July for the 13th contraction in the past 14 months.
  • Tensions are rising between India and Pakistan thanks to India’s PM Modi’s decision to revoke Kashmir’s autonomy.

US Dollar

When we look at how far the dollar has strengthened is have effectively contracted the global monetary base by more than 6% year-over-year. This type of contraction preceded the five most recent recessions. While the headlines have been all about moves in the equity and bond markets, hardly anyone has been paying attention to what has been happening with the dollar, which looks to be poised the breakout to new all-time highs.

Reaching for new all-time highs?

A strengthening dollar is a phenomenally deflationary force, something that would hit the European and Japanese banks hard. So far we are seeing the dollar strengthen significantly against Asian and emerging market currencies, against the New Zealand Kiwi and the Korean Won, against the Canadian dollar and the Pound Sterling (Brexit isn’t helping) and China has lowered its peg to the dollar in retaliation against new tariffs in the ongoing trade war. There is a mountain of US Dollar-denominated debt out there, which is basically a short position on the greenback and as the world’s reserve currency and the currency that utterly dominates global trade. As the USD strengthens it creates an enormous headwind to global growth.

The deflationary power of a strengthening US dollar strength in the midst of slowing global trade and trade wars just may overpower anything central banks try. This would turn the heads-I-win-tales-you-lose buy-the-dip strategy inside out and severely rattle the markets.

The bottom line is investors need to be watching the moves in the dollar closely, look for those companies with strong balance sheets and cash flows and consider increasing liquidity. The next few months (at least) are likely to be a bumpy ride.

Japan – watching disruption adoption to deal with its aging population

In Japan, the number of elderly people aged 65 or older accounts for roughly 27%  of the country’s 127.1 million population and by 2050 it’s expected to reach 40%. This data from World Population Review suggests Japan is the oldest country in terms of aged population and will remain so. For us here at Tematica, it means watching the rollout and adoption of disruptive technologies that will help stem some of the pain points from an Aging Population. Examples include autonomous cars, robotics, artificial intelligence and the Internet of Things as well as worker re-education. How these are embraced, or not, could be signals for adoption in the US and EU in the coming years as those populations age as well.


Japan’s aging population will require more investment in technology such as artificial intelligence and robots to make up for a decline in the labor force for economic growth, according to a government report released Friday.

The report warned that the country is also experiencing the worst labor shortage in a quarter century, and some industries such as transportation services and construction may already be seeing earnings suffer as a result.

“Amid an aging population, (Japan) needs to drastically strengthen the supply side of the economy in order to deal with the labor shortage and realize sustainable growth,” it said.

“It is crucial that we invest in human resource development and implement features of the fourth Industrial Revolution such as AI, IoT (internet of things), and robots.”

The report, which Toshimitsu Motegi, minister of economic and fiscal policy, submitted to the Cabinet on Friday, paints a future where traffic accidents decline thanks to self-driving cars, automated translation removes language barriers, and people can receive medical care remotely.

Japan is already a leader in industrial robotics, the report said, but falling behind elsewhere. Only around 20 percent of Japanese companies currently make use of IoT compared with more than 40 percent in the United States, and the use of AI is likewise still largely limited to the financial sector and some manufacturers, it said.

The country will also need to make better use of its shrinking population by training more tech-savvy workers, the report said, pointing out such workers make up a much smaller portion of the workforce than in other advanced economies including Britain and France.

Source: Japan economy needs AI, robots to offset aging population: white paper

Japan leverages autonomous driving to address trucking industry shortage

Japan leverages autonomous driving to address trucking industry shortage

One of the problems with US investors is they tend not to look much past thier shores for investment opportunities or confirming data points. Here at Tematica, we recognize our investment themes are global in nature, and that causes us to take a more wholistic perspective. The US is not the only country battling truck and truck driver shortages nor is it the only one that looks to address these problems and others with Disruptive Technoloiges and Business Models, such as autonomous driving. Much like the US, Japan is likely dealing with not only an aging population, but also the increasing shift toward digital commerce that is driving (no pun intended) robust growth in package shipping.

We often say here at Tematica that the more thematic tailwinds pushing on a companies the businesses. When it comes to confirming data points, the more the better holds true, especailly with confirmation across geographies.


Japan’s fleet of internet-connected trucks is expected to grow by 150% to more than 500,000 in 2020 as commercial vehicle makers cater to a logistics industry suffering from a driver shortage, corporate plans show.

UD Trucks, a Japan-based unit of Volvo Group, plans to have 100,000 connected trucks on Japanese roads in 2020 and 150,000 in 2025. Its Quon line of heavy-duty trucks features communications systems as standard equipment. The company will also offer a wider variety of remote services, such as predicting engine problems to ensure efficient maintenance.

Mitsubishi Fuso Truck and Bus will expand the range of connected models in its Super Great line. These systems will also be added to new models, such as the electric eCanter, which is slated for a full rollout in 2020. The automaker is aiming for 100,000 connected trucks by that year.

Isuzu Motors, planning 250,000 connected trucks by fiscal 2020, will expand the monitoring service in its heavy-duty Giga series to light and medium trucks. Hino Motors will roll out similar services for medium and heavy trucks in April.This influx would boost the share of connected trucks in Japan to around 15% of the country’s 3.5 million or so trucks, up from about 5% now.

Source: Half a million connected trucks to ease Japan’s driver shortage – Nikkei Asian Review

Japan, China, and the U.S. working-age populations a headwind to global growth

Japan, China, and the U.S. working-age populations a headwind to global growth

A new report from Deloitte highlights one of the downsides of our Aging of the Population theme – the simple fact that economic growth is tied to the number of working-age people in a country’s population. Given prospects for a rising working population, India is widely expected to be the driver of global growth in the coming years while Japan, China, and the U.S. contend with a shrinking working age population. According to Gallup, worldwide 32% of working-age adults are employed full time, and that likely means global growth will be challenged in the coming years as that working-age population shrinks further.

A new report by Deloitte Insights, however, says that China will soon be playing second fiddle to India as the biggest driver of global growth.The report, entitled Ageing Tigers, hidden dragons, argues that there is a “third wave” of economic growth in Asia.

The first wave was led by Japan in the 1990s before China took over. But the Chinese-led second wave has already peaked, making way for a third wave driven by India.

The third wave will be mostly driven by a massive increase in workers. Over the next decade, India’s working-age population will rise by 115 million. This is more than half of the 225 million expected across Asia as a whole.

Within two decades, India’s potential workforce will rise to 1.08 billion.

But it’s not just an increase in workers that will help propel the Indian economy. The new workers will be “much better trained and educated than the existing Indian workforce”, says Deloitte.

Meanwhile, Japan’s working-age population will shrink by more than 5 million, and China’s by 21 million, over the next 10 years.

In fact, India’s working population will soon outstrip China’s. While China’s population is already ageing, this won’t happen in India until halfway through the century.

China’s ageing problemImage: DeloitteChina’s ageing population will slow down its growth potential. While its one-child policy is no longer in force, the effects are still being felt. Soon, there will be fewer people of working age. Not only that, but because of the one-child policy, China’s population has aged faster than elsewhere.

As a result, China won’t feel the full benefit of its years of economic growth. “This is yet to seep into the consciousness of most of the world, which still regards China simply as a country with an extremely large population,” states Deloitte.

Source: China will grow old before it gets rich. | World Economic Forum

Manufacturing Goes Bipolar but Yellen is Feeling Good

Manufacturing Goes Bipolar but Yellen is Feeling Good

The recent US manufacturing data has gone biopolar while over in Europe and even Japan, manufacturing is more solidly strenghtening. Then there is Fed Chair Janet Yellen’s recent assurances… this week is shaping up to be full of entertainment outside of yesterday’s fireworks!

ISM Manufacturing data for June indicated solid growth in most areas but was also considerably better than expectations (57.8 versus expectations for 55.3, up from 54.9 in May, a 3-year high) at a time when most economic data is coming in at or weaker than expectations.

source: tradingeconomics.com

  • New orders rose to 63.5 from 59.5
  • Backlogs gain 2 points to hit 57
  • Supply deliveries rose by near 4 percent to reach 57
  • Employment hit 3-month high at 57.2 from 53.5
  • But…. The prices paid index fell to a 7-month low of 55 from 60.5 in May, 68.5 in April and 70.5 in March. Ehh? Production and demand rising but prices are dropping month after month after month?

To further emphasize that this month’s ISM manufacturing report might not be all that telling is the U.S. Census Bureau Construction Spending report which was flat for May versus expectations for a gain of 0.3 percent month-over-month. Given that this one measures what was spent rather than sentiment, we tend to give it more weight. Most of the components saw a month-over-month drop in spending, including manufacturing (down -1.7 percent), residential (down -0.6 percent), commercial (down -0.7 percent), highway and street (down -1.0 percent), lodging (down -0.3 percent), communication (down 1.9 percent), transportation (down -1.2 percent). Overall total private construction dropped 0.6 percent month-over-month while public construction rose 2.1 percent. Other than that all good – sheesh!

Bear in mind that the last time ISM manufacturing came in around 58 was August 2014, after which the annualized GDP growth rate slowed to 2.3 percent. The time before that was early 2011 which preceded a slump to 1.9 percent growth for GDP.

On the other hand, the Markit manufacturing survey told a very different story, one that was more consistent with what we saw in the Construction Spending report, falling to a six-month low of 52 from 52.7 in May. We like to confirming data points and sorry Mr. ISM, your cheese is standing alone this month.

Also contradicting the ISM, June auto sales declined 0.9 percent month over month, dropping to 16.5 million units at an annual rate and making for the fifth decline in the past six months. The first half of the year has seen sales drop at a 20 percent annual rate. A drop of this magnitude occurred last in 2010 when markets were fretting about the likelihood of a double-dip and the Fed was moving towards loser policies.

We’d point out that this lack of pricing power isn’t just here, as the Eurozone and Japan are experiencing the same phenomenon, with Japan experiencing a 43-year high for labor shortage without much in the way of upward pricing pressures.

In contrast, the Markit Nikkei Japan Manufacturing PMI continued to improve in June, extending the current sequence of expansion to ten months with gains in both production and new orders.

IHS Markit Spain Manufacturing PMI revealed that Spanish manufacturing completed a strong second quarter with growth of output, new orders and employment remaining elevated. June saw further sharp rises in output and new orders with the rate of job creation at near-record highs. Purchasing activity increased at the fastest pace so far in 2017.

IHS Markit Italy Manufacturing PMI saw sharp and accelerated increases in output and new orders in June with output picking up on the back of robust export orders. Even employment rose amid a rebound in business sentiment.

IHS Markit France Manufacturing PMI saw new orders increase at a sharper pace in June with output growth moderating. The index rose to 54.8 from 53.8 in May and was only just shy of April’s six-year high.

IHS Markit/BME Germany Manufacturing PMI rose to a 74-month high with the fastest growth in new orders since March 2011 as input prince inflation slowed to a 7-month low. The 12-month outlook for production remained strongly positive.

Back in the U.S., on top of the contradictory manufacturing data, there is the ECRI leading indicator which has fallen now for three consecutive weeks, with a decline in six of the past seven and now sits at its lowest point since December 9th, 2016.

Mr. Market seems utterly unimpressed with continued trend for economic data to disappoint relative to expectations as the CBOE VIX net speculative shorts is now at the highest level ever – so apparently there is nothing of concern here.

Fed Chairperson Janet Yellen seems to agree, “Would I say there will never, ever be another financial crisis? You know probably that would be going too far but I do think we’re much safer and I hope that it will not be in our lifetimes and I don’t believe it will be.”

Really? That’s quite a statement, but then…

“But, we think the odds favor a continuation of positive growth, and we still do not yet see enough evidence to persuade us that we have entered, or are about to enter, a recession.” Alan Greenspan, July 1990

“At this juncture, however, the impact on the broader economy and financial markets of the problems in the subprime market seems to likely be contained.” Ben Bernanke, March 2007


What We’re Watching This Week

What We’re Watching This Week

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As you probably know, this week is a shortened one following the 3-day holiday that was President’s Day. We still have a number of companies reporting their quarterly earnings this week, and that includes the Tematica Select List’s own Universal Display (OLED). The shares have had a strong run, up just over 28 percent year to date, and that likely has them priced near if not at perfection. Last week, Applied Materials (AMAT) gave a very bullish view when it comes to the ramping organic light emitting diode manufacturing capacity, as the industry prepares for Apple (AAPL) and others switching to this display technology. Consensus expectations for Universal’s December quarter results are EPS of $0.42 on $68.6 million in revenue. We expect a bullish outlook to be had when Universal reports its results this Thursday.

Alongside Universal Display, there will be a few hundred other companies reporting. Among those, we’ll be tuning into reports from Wal-Mart (WMT), Macy’s (M), JC Penney (JCP) and TJX (TJC) for confirming data on our Amazon (AMZN) thesis. Similarly, we’ll be looking at Cheesecake Factory’s (CAKE) for confirmation in the restaurant pain that is benefitting our McCormick & Co. (MKC) and United Natural (UNFI) shares.

On the economic data front, the calendar is a tad light, with the highlight likely to be the next iteration of the Fed’s FOMC minutes. Given Fed Chairwoman Janet Yellen’s two-day testimony on Capitol Hill that we touched on above, we’re not expecting any major surprises in those minutes. Even so, we’ll be pouring over them just the same.

This morning we received the February Flash Manufacturing PMI metrics from Markit Economics and not only did Europe crush expectations hitting a six-year high in February. Across the board, from business activity to backlogs of work and business confidence, the metrics rose month over month. One item that jumped out to us was the increase in supplier delivery times, which tends to be a harbinger of inflation — something to watch in average selling price data over the next few months. Turning to Japan, the Markit flash manufacturing PMI rose to 53.5 in February, its highest level since March 2014, with sequential strength in all key categories — output, exports, employment and new orders. but Japan hit it’s highest level since March 2014.


Here at home, the Flash U.S. Composite Output Index hit 54.3 in February, a downtick from 55.8 in January, but still well above the 50 line that denotes a growing economy. The month over month slip was seen in manufacturing as well as the service sector. Despite that slip, new manufacturing order growth remained faster than at any other time since March 2015 and called out greater demand from energy sector clients. No surprise, given the rising domestic rig count we keep reading about each week.

Manufacturers also called out that input cost inflation was at its highest level since September 2014 and we think this is something that will have the Fed’s ears burning.


Currently, our view is the next likely rate hike by the Fed will be had at the May meeting, which offers plenty of time to assess pending economic stimulus, immigration and tax cut plans from President Trump. Again, we’ll be watching the data to determine to see if that timing gets pulled forward.

Stay tuned for more this week.

America First? When it comes to GDP we get the bronze!

America First? When it comes to GDP we get the bronze!

Yesterday we talked about how the American economy, despite all the euphoric headlines since the election, didn’t deliver much of a performance in the fourth quarter and in fact we saw the weakest full-year GDP growth rate since 2011 which was well below the U.K.’s 2016 growth rate of 2 percent. Today we learned that the Eurozone as well kicked our economic tuckus in 2016.

GDP grows 0.6% in final quarter of 2016, beating expectations and taking annual figure to 1.8%

Yep, that hurt. So much for America being the “cleanest shirt in the economic laundry.” Despite headwinds ranging from the accelerating Greek drama to the mountain of Italian non-performing loans that led to the nationalisation of Banca Monte dei Paschi di Siena, Brexit, failed Constitutional reforms leading to the resignation of Prime Minister Renzi in Italy …. the list goes on, they beat us.


Last week talks between the U.S. and Mexico hit a serious bump after a President Trump Tweet led Mexico’s President Peña Nieto to cancel their upcoming meeting, while the administration has been threatening a 20 percent tax on imports from Mexico, which would put serious upward price pressure on, (among other things) fruits, vegetables and auto parts. Today Peter Navarro, Trump’s top trade advisor, accused Germany of currency exploitation. According to the FT, “In a departure from past US policy, Mr Navarro also called Germany one of the main hurdles to a US trade deal with the EU and declared talks with the bloc over a Transatlantic Trade and Investment Partnership dead.”

While last week’s meeting with the British Prime Minister Theresa May ended with some serious hand-holding, over the weekend the President’s sudden implementation of an immigration ban left, “our closest ally flailing after the UK government was openly contradicted by US diplomats over which British nationals were covered by the measure.”

After Trump’s election victory, the Bank of Japan was initially more optimistic about more favourable economic conditions amid expectations for stronger American growth. That enthusiasm has been fading as yesterday, ahead of a two-day policy meeting, officials are less optimistic about the impact on Japan’s economy. According to the Wall Street Journal, “We now realise that we know very little about him.”

Trump’s team has been poking our allies in some uncomfortable ways, making many around the globe nervous, and yet the VIX (a measure of implied volatility) is pretty much yawning.

The 90 percent of the America economy that is not represented by either inventory build or state and local government spending managed to grow at a whopping 0.6 percent annual rate in the fourth quarter.

Amidst all this, the Fed keeps talking about further rate hikes

Under Armour (UA) just released its fourth quarter and full year results and was yet one more citing currency headwinds.

Upon the announcement of Trump’s immigration ban on Friday, the markets started to fall. Monday the S&P 500 fell 60 basis points and is now down 0.76 percent from its most recent closing high last Wednesday. Bespoke compiled headlines over the past few days that reveal concerns the Trump hope trade is starting to fade.

Is this an inflection point? Too soon to tell, but we can say that having an administration with no political history who has pretty much tossed out the rule book is likely to cause heightened volatility, which is not reflected in market pricing. Erecting trade barriers and surprising the market, let alone allies, is likely to induce more caution in the C suite.

This morning we also saw that compensation costs in 2016 rose 2.2 percent, significantly faster than GDP of 1.6 percent, which makes another Fed hike more likely. We’ll be hearing from the Federal Reserve on Wednesday and will be looking to see if the tone from the FOMC meeting is more dovish than we heard in Fed Chair Janet Yellen’s testimony on January 19th. We will also hear from over 100 companies this week on their earnings, putting the relative complacency in the markets to a test.

Source: Eurozone’s economic recovery picks up speed

March Market and Economic Update

March Market and Economic Update

The U.S. stock market has given investors a bumpy ride so far this year, but it has been more than 500 days since the S&P500 experienced a correction of 20% of more, a run which has occurred only 10 times in the past 100 years so we really ought not complain despite the increased Pepto on Wall Street. January gave the market jitters as the S&P500 closed down 3.6% from its December 21st close. Cupid brought some respite in February, recovering some of those losses with the S&P closing down only 0.6% from the Dec 31st close. As of March 14th, the S&P was essentially flat from last year’s close, making the broader indexes in 2014 so far Shakespearean much-ado-about-nothing. In comparison, the Dow and the S&P 500 were up around 10% at this point last year.


The CNN Money’s Fear and Greed Index shown above illustrates that in the past week, the markets have experienced a shift from “Extreme Greed” to entering “Fear” territory. This index looks at seven indicators, shown below. Stock price strength indicates that the number of stocks hitting their 52-week highs is at the upper end of its range. The yield demanded on junk bonds is higher than what has been typical for the last two years, while the S&P 500 has typically been further above the 125-day average than it is now, indicating that investors are committing capital to the market at a slower rate than they had been previously. We are also seeing puts at among the highest level seen in the last two years, indicating significant concerns that the market’s direction is likely to change for the worse. Overall, the market today is a lot like a sophomore headed to his first dance, sitting on her father’s couch as he waits for his date to emerge; understandably nervous, but still holding onto hope that the night could be a success.









While the U.S. markets have been pushing higher and higher, other markets around the world have been even more ambitious.






From June 2012 to December 30th the Nikkei rose over 90%, (up 52% in 2013 alone) but has since stumbled from its Dec 30th high and is now up around 70%, having briefly entered into a bear market (20%) contraction by last month. The index as of March 14th sits down 12.21% from its year-end high, falling 3.3% last Friday. I’ll bet there’s a bit more sake being consumed this quarter in the after-hours!






The Euro Stoxx 50 Index, the leading blue-chip index for the Eurozone, has gained over 50% since June 2012, outperforming the S&P, despite the region’s sluggish economy. The chart at right illustrates the growth rates, (or lack thereof) for the Eurozone and its major economies through 2012. Estimates for 2013 aren’t much better, with the region as a whole contracting 0.4%, Germany up just 0.5%, while Spain and Italy are estimated to have contracted as well by, falling 1.2% and 1.8% respectively.

Unemployment in the region started 2012 at 10.2%, but has frustratingly worsened to 12.1% today and is anything but consistent across member nations. Unemployment in Spain, Italy and Greece are 26.7%, 12.7% and 28% respectively with youth unemployment shockingly high at 57.7%, 41.6% and 61.4% respectively! In contrast, German unemployment is just 5.2% with youth unemployment an enviable 7.5%. The impact of these employment levels for the young in the southern European nations will be a drag on those economies for decades to come as studies show the early years are critical for developing skills which impact an individual’s income generating potential over their entire career. I imagine many parents in these nations would be happy to be able to complain about not seeing their kids enough as they start their careers and build their young lives!

Meanwhile over in Japan, despite the massive run up in its stock market and levels of monetary stimulus that could make Bernanke blush, things are also not rosy either. Japan’s economy grew even more slowly than initially calculated in the final three months of 2013 and posted another record current-account deficit in January, increasing the likelihood that an economy already struggling with ugly demographics is in for yet more near-term angst. According to government figures, the overall economy grew just 0.7% on an annualized basis in the final three months of 2013, a downward revision from the initially projected 1% growth. The slight silver lining is business investment, which grew by an annualized 3% in the fourth quarter, compared with a preliminary reading of a 5.3% increase. Consumer spending was up an annualized 1.6%, revised lower from a preliminary 2% rise.

China too is showing signs of slowing. Forecasts for China’s GDP growth were cut by many in the investment banking world on Thursday after Beijing reported the biggest slowdown in investment for more than a decade coupled with the slowest retail sales expansion in nine years. Confidence was further undermined by news that a well-known steel mill has failed to repay loans that came due last week, the first default on corporate debt that the government has allowed.

European growth in aggregate just isn’t happening and the reforms needed to induce it are politically challenging to say the least. Japan continues to try and get out of its decades long funk. The Chinese engine which fueled much growth post-financial collapse is sputtering. In the US, as we predicted in last month’s newsletter, GDP growth for Q4 2013 was revised downward from an initial estimate of 3.2% to 2.4% versus Q3 2013 growth which is estimated to have been 4.1%. GDP growth for the full year of 2013 is estimated to be about 1.9% falling from 2.8% in 2012. Even with the downgrade, growth for the second half of 2013 is now estimated to be 3.3% versus 1.8% in the first half, showing an improvement, but not exactly a robust economy.

On the global front, keep in mind that for almost 30 years, the U.S. ran growing trade deficits, which effectively provided a lot of stimulus for foreign exporters; in other words we bought a lot of stuff from other countries, (funded in part by increasing debt levels) which helped their economies grow in a global form of seller-financing. We’ll buy your stuff if you lend us the money by buying our Treasuries. The chart above shows the magnitude of this trade deficit over time. Notice that since 2006 the deficit has been shrinking which may please those who prefer “made in America”, but is bad news for the countries from which we used to buy!









I’ll leave this review with one of my favorite sayings, hat tip to Warren Buffet for refreshing my memory in his most recent letter to shareholders, “A bull market is like sex. It feels best just before it ends.” Something to always keep in mind when one is tempted to chase returns.

Bottom Line: The economies of the largest nations and regions around the world continue to struggle to grow in line with historical norms, while their respective stock markets have experienced a wild run up in recent quarters. This makes continued across-the-board-increases in broad indexes increasingly unlikely, thus having a broadly diversified portfolio, with exposure to various markets and asset classes is even more important. The reduction in correlations between investments provides opportunities for those who are patient and pay attention.


November Economic Indicators

November Economic Indicators

The market has been on a tear, so what do November’s economic indicators tell us?

J GDP beats: On November 7th we learned that 3rd quarter GDP was better than expected at 2.8%, which of course pushed stocks lower in today’s good is bad and bad is good upside down market.

K Unemployment beats, but in lower paying sectors. On November 8th the U.S. Bureau of Labor Statistics reported that, “Total nonfarm payroll employment rose by 204,000 in October, and the unemployment rate was little changed at 7.3 percent. Employment increased in leisure and hospitality, retail trade, professional and technical services, manufacturing, and health care.” Later in the day CNBC reported, “Breaking (11:32AM EST) Europe stocks close lower after US jobs data.” Remember, good news is bad news these days.

J Mortgage delinquency improves: The delinquency rate declines 2.8% in October for mortgages according to Lender Processing Services, making October 2013 10.7% lower than the same period last year. The number of homes entering foreclosure is also down 30% compared to a year ago.

K Borrowing returns: The deleveraging cycle in the U.S. appears to have bottomed out, with household debt rising $127 billion in Q3 to $11.28 trillion, which was the largest increase since the first quarter of 2008. Mortgage balances increased $56 billion and auto loans $31 billion, giving Detroit more cause for optimism. Investment-grade U.S. companies have issued a record of over $1 trillion in bonds so far this year. Keep in mind though as borrowing accelerates, all those bank excess reserves sitting at the Federal Reserve (see chart below) may make their way into the economy, which could result in inflation when the total stock of money in the economy jumps.



K The European Central Bank cut its benchmark interest rate to a record low of 0.25% from 0.5% on November 7th, moving more quickly than expected to stimulate the euro zone economy in the face of falling inflation. Inflation in the euro zone unexpectedly declined to an annual rate of 0.7% in October, well below the E.C.B.’s official target of about 2%, raising concerns of deflation, which many believe would be harmful to the economy.

L Germany’s economy is continuing to improve, while concerns are growing that France may be heading back into a recession and Italy is still floundering. The latter two are unsurprising since much of their economic malaise can be traced to fundamental fiscal problems such as labor laws that make it risky to hire new employees since letting them go (perhaps because they don’t work out or the business doesn’t grow as much as was expected) is frightfully difficult. Many businesses just don’t want to take the risk. Add to that a mountain of red tape that make starting and growing a business attractive only to those who enjoy the idea of continually pounding their head against the wall.

K China appears to still be in expansion mode, but is slowing. Japan’s economy seems to be responding well at the moment to its Central Bank’s policy of continual monetary loosening, with exports posting their largest gain in three years. Looks good for now, but give me a few cups of coffee and a cupcake or two and my engines get revving like nobody’s business. What serves as a kick start can end in an angry digestion and a cranky post-sugar high.

L Emerging market stocks are struggling as whispers of taper talk continue to linger, bringing to mind Don Coxe’s observation that, “Emerging markets are markets you can’t emerge from in an emergency.” Still wary from the last market crash, investors seem to be seeking areas where they think they can escape quickly if there is a rush for the exits. However, emerging market equities are currently priced at more attractive valuations than their developed world counterparts.

J U.S. energy sector rising: Petroleum exports as of July, according to the U.S. Commerce Department, are up 11% year-over-year, which is nearly 10 times the pace of total exports. Imports of petroleum products have dropped 6% year-over-year, which puts the nation back to mid-1990s levels. Oil related imports are now at a record low of 10% of all imports, compared to 12% last year and 15% five years ago.

Where's the Boogeyman?  Rising Volatility?

Where's the Boogeyman? Rising Volatility?


With the markets on a roll and volatility still at record lows, my prose may at times appear overly cautious as I assess the markets, but remember that’s my job. Portfolio managers are essentially professional worriers, looking around every corner and under every data point for the hint that a major shift is on its way as our primary job is to protect. These days many of us feel like we are in a CNBC version of a thriller, with the ominous music getting louder and louder as our handsome hero approaches the dimly lit house. When is the boogeyman going to jump out!?

“For as long as I can remember, veteran businessmen and investors – I among them – have been warning about the dangers of irrational stock speculation and hammering away at the theme that stock certificates are deeds of ownership and not betting slips… The professional investor has no choice but to sit by quietly while the mob has its day, until the enthusiasm or panic of the speculators and non-professionals has been spent. He is not impatient, nor is he even in a very great hurry, for he is an investor, not a gambler or a speculator. The seeds of any bust are inherent in any boom that outstrips the pace of whatever solid factors gave it its impetus in the first place. There are no safeguards that can protect the emotional investor from himself.” J Paul Getty (Hat tip to John Hussman for helping us recall this sage sentiment.)

Looking at today’s markets, “Never have investors reached so high in price for so low a return. Never have investors stooped so low for so much risk.” Bill Gross of PIMCO on May 14th, 2013. Ouch!

On May 22nd the markets became exceptionally jittery, the boogeyman soundtrack getting a tad louder.  Concerns over a withdrawal or reduction of the Fed’s bond buying program from Ben Bernanke’s comments before Congress coupled with the minutes of the FOMC added to increasing nerves over the level of data fakery coming out of China, which has turned up the volatility volume considerably.  Keep in mind that if the stock market were to be reflective of the fundamentals and not experiencing a Fed induced bubble, why the tizzy fit at the slightest whisper that the Fed could reduce its bond buying program, a program which has seen the Fed’s balance sheet increase a mind-blowing 40% year-to-date?  Whether this is the beginning of a correction or a temporary blip remains to be seen, but the dramatic swings during the day warrant caution.  Is that the theme from Halloween I hear in the distance?

2013-06-03 NikkeiMay 22nd the Japanese Nikkei fell 7.3%, its biggest drop since the tsunami/nuclear disaster in March 2011.  Before Thursday, the Nikkei has risen 50% this year and 10% in less than two weeks.   Kudos to ZeroHedge for the chart at right which points out how similar the recent run up has been to the boom and following bust in 1987.

After the tumult in Japan, investors quickly jumped out of riskier assets. Spanish and Italian government bonds weakened, as did more-speculative currencies like the South African rand. Havens such as German government bonds and the Swiss franc gained. Gold rose.

Hong Kong’s Hang Seng dipped by 2.5%. Shanghai maintained a moderate fall at just 1.2%.  The following day all the major European markets dropped by over 2%.

2013-06-03 FedBalanceSheet
Bottom LineI doubt the past few rocky few days are the start of the correction we’ve been expecting as the primary drivers of the market run, namely Central Bankers, are still putting pedal to the metal, despite the nerves over yesterday’s FOMC meeting notes, (see charts at right).  I do think that it is likely we will continue to see volatility increase in the coming months before we see any potential significant correction.