Data or Divination?

Data or Divination?

You’ve probably already learned that on Wednesday the Federal Reserve Open Market Committee increased its Fed Funds rate to 0.75 – 1.0 percent. The markets were concerned that we would hear a much more hawkish tone from the Fed, which would have implied a possibly faster pace of rate hikes. Chair Janet Yellen’s prepared speech coupled with the Dot Plot, (that marks the interest rate expectations of participants over time) assuaged those fears as the median rate projections over the next few years remained largely unchanged, with two more expected in 2017.

The markets interpreted this release as more dovish than expected, which likely has thrown the Fed for a bit of a loop and makes further tightening more likely. There is just no way they wanted to see stocks get even more over-priced after hiking this week.

Watching her talk and then listening to some of the financial media’s usual suspects I found myself unsuccessfully trying to stifle rants at the television. Luckily I stopped short of hurling my Apple TV remote at the big screen.

In her remarks, Yellen referred to the employment participation rate and how it will continue to naturally be below historical norms due to the evolving demographics in the U.S. She is correct to some degree, as this year the first baby boomers are turning 70 years old with around 1.5 million joining them every year for the next 15 years – fair enough Janet and thanks for validating our Aging of the Population investing theme. She is also correct in that there has been a profound decline in the rate of growth of the working-age population. For the native population, this is a function of two things. First, the percentage of the population in the child bearing and raising years is lower today than it was when the baby boomers were in this phase of life. Second, people — some of which fit our Cash-strapped Consumer investing theme — simply have fewer children. The growth rate of the work age population peaked in the late 1990s early 2000s and has been steadily declining ever since.

That, however, doesn’t explain why the percent of the working-age population, (those aged 25 – 54 years) employed remains well below where it has been for decades and is today back where it was in the early-1990s. In fact, the percent of this group that is actually in the workforce remains below the levels we saw from those early 1990s through to the middle of the financial crisis when it plummeted to levels not seen since the mid-1980s. While Chair Yellen is correct to some degree, her statement was misleading. Plenty of people who would have been working in decades past are choosing to opt-out. This is something that needs to be looked at as it is a material headwind to growth, and could mean greater costs our society has to bear in the coming years.

Also, while the Fed’s mantra for years has been, “We are data dependent,” neither she nor many of her colleagues appear to be all that interested in today’s data. In her opening statement at yesterday’s press conference, she asserted that, “Waiting too long to scale back some accommodation could potentially require us to raise rates rapidly sometime down the road, which in turn could risk disrupting financial markets and pushing the economy into recession.”

Some of her colleagues appear to have already upgraded their forecasts in anticipation of a successful implementation of fiscal policy changes by the new administration. That is pretty far from being data dependent – that’s more crystal ball economics.

So how about looking at some of that real data?

Over the past 13 weeks, commercial and industrial loans have contracted at an annual rate of 1.5 percent. The last time we saw this level of decline was in October of 2010 when the Fed decided to launch multiple rounds of quantitative easing. This time they are in the midst of a rate hike cycle.

In fact, in the fourth quarter of 2016, U.S. nonfinancial companies reduced net borrowing such that while the five years ending in September 2016, annualized net borrowing for this group average $420 billion. In the 4th quarter of 2016, that annualized rate dropped to $68.5 billion

Residential real estate credit is experiencing the same decline, falling at a nearly 2 percent annual rate on a 13-week rolling basis. We haven’t seen this kind of a slide since December 2014. Overall the growth in consumer lending has been nearly cut in half since the start of 2017, with the biggest drop in auto loans and credit cards.

Looking at those auto loans, annualized losses on subprime loans in January were 9.1 percent, up from 8.5 percent in December and 7.9 percent in January 2016. January’s rate is the worst we’ve seen since January 2010 and is driven in part because lenders are getting lower prices than expected on their repossessed cars after a flood of used cars has hit the market thanks to generous lease terms offered by manufacturers. This trend is unlikely to change given that in January 5.09 percent of subprime car loans were at least 60 days delinquent versus 4.66 in January 2016.

As always, we like to look for confirming data points on slowing lending and voila, the M2 money velocity is down 3% from its pace in March of 2016. This number declines as there is more saving than spending.

But there is so much optimism in the soft data!

Well, I’m optimistic about the shape of my abs come June, but frankly, there is a bit of work to be done between now and then before I’m getting anywhere near a bikini. Optimism doesn’t replace the gym and lots of sweat.

The National Federation of Independent Business Small Business Optimism Index dropped slightly in February to 105.3 from 105.9 in January, which is the first decline since September and a three-month low, but on its face nothing particularly worrisome. However, hiring plans dropped to the lowest rate since November at 15 percent versus 18 percent previously. Capex also took a hit, falling to 26 percent in February after falling to 27 percent in January from 29 percent in December. Yes, but that economy is just getting ready to take off…

Hold on there partner, because the number of net companies expecting stronger sales dropped to 26 percent in February from 29 percent in January from 31 percent in December – quite the pattern here.

Earlier this week we learned from the Bureau of Labor Statistics that weekly wages declined over the past year and wouldn’t you know it, the NFIB’s index on plans to boost labor compensation follow this same trend, falling to 17 percent in February from 18 percent in January and 20 percent in December.

Speaking of jobs, one of the market mantras for future growth is how the new administration’s plans around trade will boost American jobs. Hmmm, the economy is going to get rockin’ and rolling because all these great new jobs will appear. But today, the share of small businesses reporting that the quality of labor is one of their biggest problems sits at 17 percent, the highest level since November 2001 and up from 15 percent in January and 12 percent in December.  Yesterday’s Job Openings and Labor Turnover Survey revealed that job openings remain unchanged at 5.6 million with hires and separations also relatively unchanged. Recall that we’ve seen one of the widest divergences between job openings and hirings in history, which shows that there are jobs, but companies can’t find the right person. Talk about a rather confirming data point for our Tooling & Retooling investing theme.

Obviously having more jobs that pay well and help continually develop skills in the nation is a beautiful thing, but today companies are already having a tough time filling the positions they have available, which is a drag on the economy. It isn’t obvious how using trade policy to create a whole bunch of new positions to fill without doing something to help develop or find the right talent to fill those positions will be a boon for the economy.

But, but, but…. inflation!

What about all this impending inflation? The NFIB’s share of companies reporting inflation as their top concern is now tied at a record low 1 percent, down from 2 percent in January and December which was down from 3 percent in November. Yet if you watch the financial news media, it is as if rising inflation is an absolute given.

Wait a rootin’ tootin’ minute  High Priestess of Global Macro, that headline Producer Price Index (PPI) came in well above market expectation for 0.1 percent, rising 0.3 percent month over month with the year over year pace at 2.2 percent versus expectations for 1.9 percent. Gotcha!

Fair enough, but as always, let’s look a little deeper. Whenever we look at a percentage increase, it is important to look at the base we are coming off of relative to history. The second half of 2015 saw PPI energy plummet, hitting a low in February 2016. PPI energy is up nearly 20 percent year over year which added a full percentage point to the headline PPI inflation rate. Energy isn’t the only commodity that bottomed out last February while their rebound rates have been slowing recently, so their impact is declining.

Clearly, a lot to ponder as we assess the true vector and velocity of the economy. Given that it’s St. Patrick’s Day tomorrow, this Irish high priestess will do that pondering over a lovely pint of Guinness.

Trump on accelerator while Fed tapping the breaks

Trump on accelerator while Fed tapping the breaks

While the headlines have been dominated by talk of whether or not President Trump can get Congress to work with him and to just what extent the Republicans will unite behind him, the bigger but much less obvious battle is between the White House and the Fed. While the Trump administration is talking all about accelerating the economy, the Fed is jawboning tapping the brakes.

 

The essential point, however, is that the Fed does not want faster growth. Fed officials estimate that the economy is already growing at something like the maximum sustainable pace. Fed officials predicted in December that the economy would expand 2.1 percent this year, slightly faster than the 1.8 percent pace they regard as sustainable. The Fed will publish new projections on Wednesday.

Spoiler alert, historically the Fed has always won this battle.

As investors and savers we would love nothing more than to finally see this economy back to normalized interest rates, with the Atlanta Fed’s GDPNow forecasting an abysmal 1.2 percent growth rate for the first quarter, after the sorry sub 2 percent we saw last quarter, this is hardly an economy that is at risk of overheating.

While Trump’s team is heralding bringing back jobs into the U.S., implying that there will be more jobs available to job seekers, the Fed is singing a different tune.

Fed officials, by contrast, see the pace of job growth as unsustainable. The unemployment rate fell below 5 percent last May. Since then, employment has continued to expand at an average of 215,000 jobs a month — more than twice the job growth necessary to keep pace with population growth. The faster growth is good news for the economy, indicating that adults who gave up on finding jobs are returning to work. The question is how long that can continue.

Team Trump is looking to accelerate the economy through a series of fiscal policies ranging from the repeal of the Affordable Care Act, to tax cuts to regulatory reform. The market is pricing in a high success rate with rapid implementation and negating, as it often does, the potential impact of rate hikes.

Recall that from June 2004 to June 2006 the FOMC hiked its federal-funds rate 17 consecutive times over 24 months for a massive 425 basis points total, more than quintupling the Federal Funds rate, which ultimately burst the economic and market bubble.

The bottom line is that fiscal and monetary policy takes time to have an impact, while today’s markets are priced for more immediate gratification. That’s a bit like buying that dress I love for next week’s event two sizes too small, because hey, I’m planning on hitting the gym hard! Optimism is great, but a little realism makes for longer-term success.

Source: Trump Wants Faster Growth. The Fed Isn’t So Sure. – The New York Times

Federal Reserve Bank of Atlanta’s GDPNow forecast for Q1 drops to 1.3 percent

Federal Reserve Bank of Atlanta’s GDPNow forecast for Q1 drops to 1.3 percent

While the headlines have been all about the Republicans proposed replacement for the Affordable Care Act (aka Obamacare), the Atlanta Fed issued their latest forecast for first quarter GDP, which has been lowered yet again and is now sitting near stall speed at 1.3 percent.

 

The GDPNow model forecast for real GDP growth (seasonally adjusted annual rate) in the first quarter of 2017 is 1.3 percent on March 7, down from 1.8 percent on March 1.

 

We also saw signs of slowing from across the Atlantic where in a major blow to the acceleration narrative in Europe, German Factory orders plunged 7.4% in January, the biggest sequential decline since the financial crisis and the second-largest sequential decline on record. (Hat tip to Bespoke Institutional for the chart)

We are also watching nerves get a bit tigher on the global stage following Sunday night’s test of North Korean ballistic missiles. In response, the U.S. military is deploying its Terminal High Altitude Area Defense system (THAAD) to South Korea. This is strictly a defensive weapon, but be on the watch for a reaction to China that may see this as more of an offensive move.

Why care about such a military move? With the Atlanta Fed forecasting weaker Q1 GDP, signs of weakness in the Eurozone and now rising global tensions, Fed Chair Janet Yellen and her Committee have a lot to contemplate as they discuss a potential rate hike this month.

If all that didn’t get your attention, the OECD just released a report today in which they warned that the

In financial markets, there are apparent disconnects between the positive assessment of economic prospects reflected in market valuations and forecasts for the real economy. Equity valuations have increased significantly further in many major markets over the past six months, despite the large rise in nominal interest rates and with long-term nominal and real GDP growth expectations based on consensus forecasts barely changed. Expectations for corporate earnings growth in the euro area and the United States have also not been revised up over this period.

The report went on to further discuss the issues surrounding global trade.

A roll-back of existing trade openness would be costly, with a significant share of jobs in many countries linked to participation in global value chains. An increase in trade barriers in the major global trading economies – Europe, the United States and China – roughly equivalent to an average increase of tariffs to the bound tariff rates in 2001, the year when the trade negotiations under the Doha Development Round started, would have a major adverse impact on trade and GDP, particularly for those economies that imposed new trade barriers.

Turns out that quite a few folks are seeing disconnects and are concerned that anti-trade measures have the potential to be harmful to growth.

Source: GDPNow – Federal Reserve Bank of Atlanta

Fed’s Yellen boosts expectations of March rate rise

Fed’s Yellen boosts expectations of March rate rise

As the Federal Reserve’s GDPNow revises estimates for the first quarter 2017 GDP growth down to a decidedly unimpressive 1.8 percent, today Fed Chair Janet Yellen gave an audience in Chicago a quasi-definitive on a March hike.

 

Following a week of hawkish messages from top US rate setters, the Fed chair told an audience in Chicago on Friday that a further increase in short-term interest rates was likely to be “appropriate” at the Fed’s policy meeting on March 14-15 if employment and inflation stay in line with officials’ expectations.

So let me get this straight, one of the Fed’s own is expecting GDP for the first quarter of 2017 to be even weaker than last quarter’s abysmal 1.9 percent, both of which are well below the 3.2 percent median of the longer-term, 4-quarter rolling average. So naturally, they ought to raise rates, something that is done to cool an overheating economy. Cue eye roll.

 

Clearly, there must be something else to this. Perhaps….?

Side note – here’s a great explanation for why EV/EBITDA is a fantastic valuation tool.

Wouldn’t be a shocker to us if the Fed is taking action based on their fears of what a seroiusly overheating equity market could do given that since the financial crisis, the Fed has been increasingly using Wall Street as a barometer for success. Oddly, we can find no such missive in any of the Fed’s marching orders, but hey, that’s just us. We’re sure this little experiment will be pulled off without a hitch… cue second eye roll.

We are moving further into unchartered territory with those in D.C., which makes for a fascinating divergence between optimism and uncertainty, which are normally more inversly correlated for obvious reasons.

 

Bubble, bubble toil and trouble dear Janet!

Source: Fed’s Yellen boosts expectations of March rate rise

Cavuto and Fed Rate Hike

It was all rate hike, all day as I spoke with Neil Cavuto on Fox News concerning the likelihood of a rate hike and its impact on the economy. Please excuse the hair – I have no bloody idea what the hair/makeup department was thinking!  Apparently they thought I needed more body – perhaps this was a bit of an overshoot!?

Hopefully I was able to deliver some thoughtful comments that could override the astounding helmet head!