In a June 11 interview, Fred Goodwin, Global Macro Strategist for State Street Bank confirmed the main points on the economy and markets that my columns have been articulating for several months, especially the past few weeks. The global risk-on trade for equities is being driven by US markets, which in turn reflect expectations on QE. The upshot of Goodwin's analysis and the other sources I have cited and discussed is that a recession by 2014 is likely. This column reviews main indicators for that outcome and offers thoughts on allocation of assets. Before closing I also will mention factors that could prevent or mitigate a recession.
Goodwin points to some of the same key data I have noted: ISM - PMI declining since July 2009 and now below 50, indicating economic contraction ("general economy seems sluggish and pensive"), 7 quarters of recession in Europe and a 2-1 ratio of US tax increases to spending cuts like that undertaken last year in France and Italy. As I did in my June 10 piece explicitly, reiterating the point and using bold to ensure it was heeded, he stated that uncertainty about continued Fed debt creation, yield suppression and asset inflation has become a key negative factor in markets. I do not expect this fear-inducing quality to diminish: clearly it is part of the socio-fiscal package. Those kept on their toes with bated breath lose power to those upon whose words and hints they hang. Healthy markets riding an organically strengthening economy will not live or die on interpretation of hints from policy makers. That is what happens as power is concentrated.
Rather than review the main points of my many columns on this topic going back to "Buy the Ski-Jump Market, Eye the Exits" in which I quoted John Williams' view that in due course the absence of an organic economic recovery (as opposed to artificially boosted equity indices) will batter the markets, I will consider price action and defensive allocation in particular sectors including basic materials, commodities and the crushed PM (precious metals) arena.
With a few notable exceptions like Southern Copper (SCCO), -4.47% on heavy trading and nearing its 52-week low, volume June 11-12 was light-average. Major producers and suppliers of basic materials and commodities, -- steel, iron ore, coal, aluminum, chemicals, oil, gas and related services all were down and most down more heavily than the June 11 -.89% drop in the S&P (SPY) and -.80 June 12. As was the case Monday June 3, the sole exceptions in this core group were the Grains index (JJG) +1.30% that seemed like ripening wheat in a desert and mega-cap Royal Dutch Shell (RDS.B) with its $8.28 EPS, up a tiny .03%. June 12, RDS.B, -.22 again was the least affected by the general drop and major oil & gas giants were least bad.
On June 11, British Petroleum (BP) -.44%, Exxon (XOM) -.72 and Caterpillar (CAT) -.33% alone of the group fell less than the S&P. June 12 the drop was worse as of this writing (3 - 4 pm EDT) especially for Chevron (CVX) -1.33% June 12. Heavy losses were widespread in economic bellwethers: in steel, Nucor (NUE) was -1.71%. NUE was one of the handful of major companies outside the PM space that on June 12 recovered a bit. June 11-12 Arcelor (MT) fell 2.89% and then an additional -2.21% Wednesday, worse than the mixed commodity miners which, as usual YTD fell hard with Rio Tinto (RIO) -1.39% and Freeport-McMoRan (FCX) being least bad, -1.78% and Vale (VALE) -2.17 and SCCO worst: its decline June 11 more than tripled the day's fall in Copper (JJC) -1.42%. RIO was fractionally up June 12 on expectations that its great copper and gold mine, Oyu Tolgoi in Mongolia will begin regular production Friday. Readers hastening to buy its majority owned Turquoise Hill (TRQ) should remember that the Mongolian election campaign still has two - 6 weeks to run (depending on whether a run-off occurs) and that the GOM (government of Mongolia) has made RIO's development there an adventure.
On June 12 copper futures rose on formal announcement of lowered supply from Grasberg Minerals District in Papua, Indonesia while FCX completes a comprehensive review of procedures following the May 15 collapse of a training tunnel. The delay withdraws 40 million lbs Cu (copper) from world supplies and 40k oz Au (Gold). The site's produce is owned 60-40 by FCX and RIO. These issues are transient and do not affect an overall economic and market analysis.
If the housing market truly was burgeoning Weyerhaeuser (WY) -1.71% and -3.24% and Timber (CUT) -.54% and -1.45% would not be sagging. WY had been "in recovery" YTD but since the May 21-2 hints about tapering down QE has surrendered nearly all its 2013 gains. Even such stalwarts now depend on fiscal juice rather than fundamentals for performance.
The least stricken sectors as measured by broad-based Vanguard ETFs were those I have been recommending as defensive positions in overbought markets: Consumer Staples (VDC) -.30%, Health Care (VHT) -.44% and Utilities (VPU) -.62% which after a slide of a few weeks is steadying as investors sense that the indices are like thin islets floating shakily on a morass. June 12, VDC -.27 and short-term bonds (VCSH)-.13 again held best amid the broad-based decline.
Reinforcing Goodwin's point about America being the ridge-pole upholding hopes of global recovery was the carnage among international equities. The Vanguard ETFs for world small caps (VSS) was -1.30%, Emerging Markets (VWO) -1.97% and Global ex-US real estate (VNQI) -1.54%. For 5 weeks REITs have sent cautionary signals on growth from Market Vector ETF (MORT) off about 11% the past month and -1.64% June 11 as Vanguard's US REIT (VNQ) fell -1.48% on heavy volume. After rising nearly 25% YTD, VNQ has yielded half these gains in 3 weeks as the DXY USD index has fallen sharply. REITs again fell harder than SPY June 12 while international ETFs saw similar decline.
Notable shifts in the fixed income space are the past month's plunge of High Yield prices as typified by Barclay's ETF (JNK) which till May 10 had surged YTD as its yield fell to record lows. In the past 30 days its share price has fallen 5% and is a harbinger of trouble in bond markets if QE is tapered down and more generally of disordered values in bonds caused by liquidity injections. An example of this is anomalous action in intermediate term issues like Vanguard's ETF (VCIT) which in recent weeks often has been more volatile than long-term corporate bonds (VCLT). This occurred again June 11 with VCIT -.47% while VCLT was -.13%. The numbers are broken and never has it been truer that past performance is no guarantee of future results. Partly this distortion reflects Fed purchases of T-bills which varies greatly day-to-day: as little as $.5 billion to nearly $6 billion. This core of current monetary policy greatly complicates useful readings of markets and all but insures a major correction.
In these unsteady times markets take their cue from Fed meetings: June 14 will offer info on industrial production with a FOMC meeting June 18-19. The hyper-sensitivity of markets to Fed hints and stats indicates the degree to which our economy and world economies are de facto managed or, if you prefer massaged by fiscal policies from our Central Bank. Bear in mind that what regional Fed Presidents and the Chair say are not necessarily what they will do: changes of mind as well as long-nurtured crises can rationalize a change of course. This is ample reason for those who dislike volatility and artifice or whose means are limited to tread lightly in these markets, allocating more to cash and short-term investment grade ETFs .
Confirmation of this assessment can be found in a Morningstar column from the second week of October 2012, 8 months ago. They noted that the price/value on the S&P had risen to .94 (1 = fair value) and was starting to look overbought. The index then stood at 1430, about 15% lower than today. Since then retail sales growth has slid significantly and so has manufacturing PMI. Working hours/week and real wages for those employed also have fallen: be careful.
Takeaways: If there are clear statements at the FOMC next week that QE will continue then keep riding on broad, low-cost indices like Vanguard's S&P (VOO) or Total Market (VTI). One can cherry-pick stocks like Vanguard National Resources (VNR), an oil and natural gas LTP that is trading in the middle of its 52-week range and pays a monthly dividend that annualizes to 8.5%. The energy space has lagged YTD and mega caps with enormous reserves, economies of scale and credit resources like XOM, Chevron or RDS.B should hold up if tapering begins, or is expected to begin or if, as is likely recession in Europe and industrial contraction in China drag everything lower. Mega cap producers of essentials like RIO (profiled here), FCX and BHP Billiton (BHP) will weather prolonged contractions. You can play the oil and gas part of this area with the Vanguard Energy ETF (VDE) which yields 1.90% and is weighted toward major players.
Among mixed-commodity small caps with a sound thesis, asset mix and high dividend consider Sprott Resource (OTCPK:SCPZF) with its blend of agriculture and agri-nutrients (27%), oil and gas (48%), drilling services and gold bullion (24%). It pays a monthly dividend that annualizes to 11.42%. Since the mid-April drop in PMs it has declined below its 42-month base at $4/share and invites entry. It is a well-capitalized income play that should hold up even if things get rocky.
A last word on precious metals: the two-day period saw bifurcated results that indicate a likely future scenario. June 11 saw another dark day for the sector while June 12 PMs were an oasis in the desert. In addition to Tuesday's -3.72% flop of the Junior Gold Miners (GDXJ) and Silver Miners (SIL) -3.82, major producers Barrick Gold (ABX), Goldcorp (GG) and Newmont (NEM) continue to be spurned. As usual YTD, GG, -3.22% was least bad followed by NEM and ABX. Some analysts, using a $1300/oz target see debt issues endangering the dividend of NEM while GG's cleaner balance sheet is chief among peers. Value opportunities are clear but the sector is enslaved to action in the futures market on the metals. Gold (GLD) held up better June 11 than the S&P and most equity classes except consumer staples. This is a sign of things to come when reality becomes too big to ignore and a rise in suppressed PM prices pulls up discarded miners. Indeed June 12 was an example as PM miners (GDXJ was an exception) outperformed both general markets and bullion. Silver bellwether, Silver Wheaton (SLW) was among the best, +1.68%.
It is possible to forestall a full recession and generate the organic growth lacking amid this year's happy indices. Helpful changes in government policy would include tax credits for businesses based on hiring full-time workers, cutting the corporate tax rate to 12% and repeal of the "affordable care" act which has caused great turmoil among businesses, including lay-offs and has drained time and expertise among medical professionals from medicine to insurance law. A clear announcement that a very gradual tapering of debt creation will begin not now but by a date certain, say 4Q 2013 also would help markets transition to levels in synch with an economy that can sustain organic growth. I hope these changes will occur: they would help everyone. It is unclear however that government will limit its influence on socio-economic activity. Perhaps genuine debate can ease such changes.
In February I quoted and discussed at some length the view of John Williams that at some point this year the de facto recession within the economy will be acknowledged. Barring changes like those noted above, that time nears. Short-term action will be affected greatly by next week's FOMC meeting. If QE continues those with a cushion can still overweight equities. But the safer course for everyone is to invest in consumer staples, healthcare, utilities and major energy producers like those named above. Given troubling economic fundamentals, one cannot fault those who increase cash or short-term bond positions and add gold bullion. The bottom of the latter is uncertain but its upside is very large. Supporting this point, stressed in my previous piece, Tekoa da Silva writes of a new CFTC report that "US Banks and Major Traders" have shifted from short to massive long positions in gold portending a rise in PMs just as the indices prepare to correct. This too should be considered as one of the fundamentals in the macro picture. PM sector out-performance June 12 has been seen several times this month and by fits and starts should continue. The PM mining sector will recover: the degree depends on organic economic growth sustained by sounder fiscal policies.