The market is going great so no need to worry, right?

The market is going great so no need to worry, right?


There are weeks when sitting down to write this piece is tough because not much worthy of note has happened in the markets or the economy outside of the usual noise. This week, that was most definitely not the case. Thank God it is Friday – we all need a break.


New Market Highs and the Economy Gets Uglier

Thursday the S&P 500 closed at a new all-time high and is now above its 50-day, 100-day and 200-day moving averages. The post Federal Reserve Open Market Committee meeting debrief gave the market essentially what it wanted, a significantly more dovish stance with plenty of reasons to believe future rate cuts are imminent. Perhaps the Marty Zweig adage, “Don’t fight the Fed,” has been flipped on its head to “Fed, don’t fight the markets.” Unemployment is at multi-decade lows with more job openings than unemployed persons, rising hourly earnings, and improving retail sales while the market hits all-time highs and yet the Fed is preparing to stimulate. Yeah, something’s off here.

Stocks may be partying like it is 1999 (for those who remember that far back) but the yield on the 10-year closed at 2.01% Thursday. To put that in context, on June 9th when the 10-year was down to 2.09%, the Wall Street Journal ran an article asserting that, “Almost nobody saw the nosedive in bond yields coming, but a few players were positioned well enough to profit. Some think there is more room for yields to fall further,” along with this chart. To be clear, despite not one respondent predicting the yield on the 10-year would fall below 2.5% in 2019, none of these economists are idiots, but the thing is they all tend to read from the same playbook.

The stock market is giddy over its expectations for lower rates, yet the spread between the 3-month and the 10-year Treasury has been inverted for four weeks as of this writing, not exactly a ringing endorsement for economic growth prospects. Every time this curve has been inverted for 4 consecutive weeks, it has been followed by a recession (hat tip @Saxena_Puru) for this chart. Note that the chart uses 10-year versus 1-year until the 3-month became available in 1982. Much of the mainstream financial media and fin twit believe this time is different. Time will tell.

The red arrows denote 4 consecutive weeks of inversion and the blue arrows mark bear-market lows (20% declines).

Then there is this, with a hat tip to Sven Henrich whose tweet with a chart from Fed went viral – that in and of itself says a lot.

Both US imports and exports have declined from double-digit growth in 3Q 2018 to essentially flat today. The recent CFO Outlook by Duke’s Fuqua School of Business found that optimism about the US and about their own companies amongst CFO’s had fallen from the prior year.

The shipments of goods being moved around the country have plummeted since the beginning of 2018, as shown by the Cass Freight Index.

The Morgan Stanley Business Conditions Index fell 32 points in June, the largest one-month decline in its history.

If all that doesn’t have your attention, consider that the New York Fed’s recession probability model puts the probability that we are in a recession by May 2020 at 30%. Note that going back to 1961, whenever the probability has risen to this level we have either already been in a recession or shortly entered one with the exception of 1967 – 7 out of 8 times.

But hey, the market is going great so no need to worry right? If that’s what you are thinking, skip this next chart from @OddStats.


Geopolitics – From Bad to Oh No, No No

Brinksmanship with Iran continues as in the early hours of Friday we learned that the US planned a military strike against Iran in response to the shooting down of an American reconnaissance drone. The mission was called off at the last minute after the President learned that an estimated 150 people would likely have been killed. Frankly, the official story sounds a bit off, but what we do know is that we are in dangerous territory and one can only hope that some cooler heads prevail, and the situation gets dialed back a whole heck of a lot.

Given we weren’t enjoying enough nail-biting out of the Middle East news, an independent United Nations human rights expert investigating the killing of Saudi journalist Jamal Khashoggi is in a 101-page report recommending an investigation into the possible role of the Saudi Crown Prince Mohammed bin Salam citing “credible evidence,” and while not specifically assigning blame to bin Salam, did assign responsibility to the Saudi government. This week the US Senate voted to block arms sales to Saudi Arabia, rebuking the President’s decision to use an emergency declaration to move the deal forward. This matters when it comes to investing because there are some seriously high-stakes games being played out that have the potential to suddenly rock markets without any warning.

Over in Europe more and more data points pointing to a slowing economy, which led to European Central Bank President Mario Draghi to announce that more stimulus could be in the works if inflation fails to accelerate. At the ECB’s annual conference in Sintra, Portugal Draghi stated that, “In the absence of improvement, such that the sustained return of inflation to our aim is threatened, additional stimulus will be required.” It isn’t just inflation that is troubling the region. Euro Area Industrial Production (ex Construction) has only seen increases in 2 of the last 11 months.

Italy continues to struggle with its budget deficit outside the limits allowed by the European Union, leading to a battle between Rome and Brussels. Friday Deputy Prime Minister Matteo Salvini (head of the euro-skeptic Lega party) threatened to quit his position if he is not able to push through tax cuts for at least €10 billion. While the US has been laser-focused on the Fed (and the president’s tweets) the Italian situation is getting more tense and a time when UK leadership with respect to Brexit is also getting a lot more tense. To put the Italian problem in perspective and understand why this problem is not going away, look at the chart below.

Today, Italy’s per capita GDP is 2.8% BELOW where it was in 2000 while Germany is 24.8% higher. Even the beleaguered Greece has outperformed Italy. Italy’s debt level is material to the rest of the world, its economy is material to the European Union, its citizens are losing their patience and its leadership consists of a tenuous partnership between a far-right, fascist-leaning Lega and a far-left, communist(ish) 5 Star movement lead by folks that very few in the nation respect. So that’s going well.

As if the European Union didn’t have enough to worry about as its new parliament struggles to find any sort of direction or agreement on leadership, the parliamentary process for selecting the next Prime Minister of the UK is down to two finalists. Enthusiam is rampant.

A hard Brexit is looking more likely and that is not going to be smooth sailing for anyone.


The Bottom Line

All this is a lot to take in, but there is a bright light for the week. Anna Wintour, Vogue’s editor-in-chief and eternal trend-setter, has given flip-flops her seal of approval. So, we’ve got that going for us. If that didn’t put a little spring into your step, I suggest you check out this twitter feed from Paul Bronks. Your soon-to-be more swimsuit ready abs will thank me, but your neighbors will wonder what the hell is going on at your place.

More Rolling Over from JOLTS and NFIB

More Rolling Over from JOLTS and NFIB

Yesterday’s JOLTS reports from the Bureau of Labor Statistics led further credence to our assessment that the economy is in the later stages of this business cycle, with many areas showing signs of rolling over.

Like much of the data we’ve seen lately, Job Openings came in below expectations, with 5,666k openings versus expectations for 5,950k with rather profound drops in Mining and Lodging, (not a shock given what’s been going on with crude oil) and Health Care and Social Assistance, (which is likely reflective of the very high-profile battle over the future of the Affordable Care Act. What is surprising is how much June’s openings fell from the prior month, down 301k. We’ve only seen such a large drop five other times during this business cycle, which makes this a rare event indeed.

This chart shows that while job openings have been on a long-term upward trend, the rate of growth has been slowing since late 2014 and is moving towards a negative year-over-year trend. This is exactly what we would expect to see in the later stages of the business cycle.

 

The source of weakness in job openings looks to be in two main areas: Health Care and Mining.

While brick and mortar retail has been getting seriously slapped around thanks to the forces behind our Cash Strapped Consumer and Connected Society investing themes, retail job openings haven’t seen the same kind of downturn as health care and energy.

We have also see the pace of hirings moderating since late 2015, which is also as would be expected at this stage of the cycle.

The NFIB Small Business Optimism Index also disappointed, coming in at 103.6 in June versus expectations for 104.4 and below May’s 104.5. This metric has now been negative for five consecutive months and is now at a seven-month low. Four of the index’s components improved, while five declined and one remained flat. Looking through the various components, rollover is the phrase of the day.


The component for “Now is a good time to expand” dropped all the way to a seven-month low, erasing the post-election enthusiasm.

The metrics for expecting the “economy to improve” really bombed, after reaching 50 after the election, then falling in five of the past six months to sit at a seven-month low of 33 in June. This measure is matched in its rather dour outlook by sales expectations, which have dropped to 17 from 31 at the beginning of 2017, with actual sales turning down faster than expectations.

Bottom Line: More and more indicators are flashing warning signs that the economy is slowing. The economy and the market, however, are two very different things and as history has shown many times over, an over-priced market can get even more over-priced.  This economic data shows that there are increasing downside risks with shrinking upside potential for the broader markets as a whole, but it isn’t a reliable timing tool. Our investing thematics seek to identify those areas that can experience growing demand thanks to long-term trends that extend beyond cyclical forces.

A Shocking JOLTS Report?

A Shocking JOLTS Report?

Yesterday’s JOLTS report from the Bureau of Labor Statistics revealed that Job Openings have hit a record high, (since the data has been recorded starting in 2000) of 6.044 million. While that sounds like a good thing, robust demand for labor and all, the challenge is that while companies have plenty of job openings, they don’t seem to be able to find the right person for the job, which is part of our Tooling and Retooling theme.

In fact, the number of Job Openings first became greater than the number of Hires back in August 2014 and has been rising overall since then. This is not a terribly good sign because when companies have positions they cannot fill, that reduces the overall productivity of the businesses. When positions remain empty for months, or maybe even years, everyone needs to work around the void, impacting their overall ability to take care of their workload.

Given the significant advances made in technology across a wide range of applications, we suspect that this disconnect between skills available and skills needed will continue. This creates opportunities for those companies that can bridge that gap, either by offering training for those potential employees that are the closest fit or those that look to provide this service for a fee, paid either by the job seeker or those companies desperate to fill positions.

It isn’t just Job Openings that are in record territory.

The weekly initial claims report tends to be rather volatile, which is why we prefer to look at the 4-week moving average, so as to smooth some of those bumps out but still give us rather high-frequency trend data. As you can see in the chart below, we are at levels not seen in forty-four years. The only two times this metric has been lower since the data has been recorded was in 1973 (221,250) and 1969 (179,750), which are 16,750 and 58,250 below the most recent data at 238,000. Keeping in mind that this statistic has dropped by over 55,000 since February 21st, we are likely to be nearing the low for this cycle.

The Private Discharge rate is also reaching record lows at 1.2 percent in April. the raw totals here were the fourth-lowest on record at 1.479 million in April.

Looking at where the Job Openings are most prevalent, Health and Social Assistance, which is a subset of Education and Health Services, accounts for over 17.5 percent of the total reported openings, with Leisure and Hospitality another major driver: neither of these are particularly high paying areas. State and Local government openings have also reached new highs, which is particularly interesting given the rather dour financial situations of most of these.

The big question is why is the spread between openings and hirings so large? The answer is likely a function of many variables ranging from a workforce that is less mobile than in generations past, to the exceptional levels of misallocated skill development that we saw pre-Great Recession thanks to the temporary shifts in employment related to the housing bubble. Let’s not forget the impact of all that enormous student debt which is likely part of the reduced mobility as the burden of loans has sent many a grad back to live with mom and dad. What we can say for certain is that we are seeing a material structural shift in the U.S. employment picture.

The jobs data is giving definite indications that we are nearing a turning point in the economy, which is consistent with the majority of US economic data that has been broadly underperforming relative to expectations. The chart below shows the Citigroup Economic Surprise Index has reached multi-year lows.

We think our less enthusiastic view of the economy, relative to the main-stream financial media’s gung ho outlook, is supported by the recent trend in the yield on 10-year Treasury bonds, which closed below the 200-day moving average for the second consecutive day. At 2.18 percent, the bond market isn’t factoring in much GDP growth.

 

Bottom Line: The recent employment data on top of the trend in weaker-than-expected economic data is consistent with the low-growth potential indicated by the 10-year Treasury rate. The Tematica Team is a pretty upbeat bunch, but we do our best to let the data do the talking and what it is telling us is that we are nearing a turning point in this business cycle.