Last week I wrote that you should stay in the middle lane, which is what I did, apart from a few trades to take advantage of rising oil. Had the Russian ambassador let me know that he would take to heart Secretary of State John Kerry's off-the-cuff answer to the question on whether anything might derail military action - an answer Kerry intended as rhetorical - I would have been more bullish. Or perhaps I was out when the ambassador called. Yet it's another good illustration of something I observed about last week, namely the perils of trying to guess the near-random walk of policy decisions.
Yet avoiding a missile attack in Syria is not one of the miracles I alluded to in the title. Ambassador or not, there was enough antipathy a week ago, the President's reluctant resolve notwithstanding, to the prospects of military action that one should hardly be dumbfounded by the prospect of yet another trip to Middle Eastern limbo. No, this week I am writing about two rather more familiar miracles: China, and the US stock market. Both have been little short of miraculous for an extended period of time.
The larger miracle for me is China. I am not referring to the country's industrialization, but to its latest batch of data and the role it plays in a larger picture. Let's begin with the trade data, since that was the first of many releases over the last several days. China has 32 provinces, over a billion people, and yet it can release its monthly trade one week after the end of the month. It takes us about five or six weeks. I suppose they could have a few million people counting the data in order to get it out so quickly, but I doubt it. Nor do they release revisions, so far as I know. Exports were up, imports were down - why, that will help GDP. What a surprise.
The data that really caught my eyes and then made them dilate were waiting for me Tuesday morning. Industrial production, up 10.4% year-on-year. Retail sales, up 13.4% year-on-year. Heady stuff, though nothing out of the ordinary from the Middle Kingdom. Hang on, though - what was that inflation data again from the weekend? Consumer price inflation, 2.6% year-on-year. Producer price inflation, (-1.8%) year-on-year.
I have never met an economist who will tell me in person that he or she actually trusts the accuracy of Chinese data, though most are understandably reluctant to do more in public than cough and roll the eyes, perhaps adding a judicious mutter from time to time. It could be that I just don't get out enough. But I find it very difficult to believe that a country can be producing consistent double-digit growth in industrial production, retail sales, and a number of other categories, along with high single-digit growth in GDP and rising wages, and yet be running consumer inflation of 2.6% and negative producer inflation - for a country that is about to overtake the US as the world's largest oil importer to boot. It doesn't add up.
There is a certain type of fund manager, usually Asian-based, who manages emerging-market equities and gold (I'm not sure why the two so often go hand-in-hand, but they do), has a fairly libertarian streak and loves to criticize the US deficit, trade policies, and above all the Federal Reserve. That's not really unique - most fund managers tend to favor their own country and region, and if you're going to be long gold, I suppose ranting at the Fed just comes with the job (N.B. - I'm not talking about Marc Faber, whose skepticism I rather enjoy).
The part that gets me is their proclivity for penning long essays on the futility of Fed policy and how it and vile regulatory policies are going to bring the US to its knees. Duly noted, but when I ask how China can possibly pull off such a conjuring trick as 13% annual retail sales growth with no inflation, and double-digit industrial growth with deflation (!), the answer is always the same - oh you know, the government controls the economy there. They can do what they want. Apparently state control works miracles there, but upon crossing the waters turns into disaster here, somewhat like French cheese.
What I really believe is that the Chinese government can print whatever data it sees fit to print. I don't believe that they have invented a brave new form of state-controlled economics that actually produces such miracles. Yet the Western media - and many analysts and managers - seem to lap it all up without question. One reason is that we want to believe that China is going to save the globe somehow by reinvesting its own money on its own infrastructure, perhaps reigniting the spiral of importing iron ore and copper in vast enough amounts to pull Australia, Brazil and Caterpillar (CAT) out of their respective slumps.
Someday this facade of dubious data is going to come apart and catch the Western world in a painful surprise. I don't know when it will be, nor do I have a sense it's just around the corner, but it's coming. I am not one of those who believe that the country can manage its property and real estate bubble by pumping more money into state company production, particularly in infrastructure. China may indeed be to the 21st century what the US was to the 19th - a popular investment thesis - but investors would do well to keep in mind how many European investors were completely ruined by the periodic busts of our 19th-century forebears.
Much has been written already about the miracle of a stock market that believes that the country is entitled to 25% annual returns on equity while the country grows at 2% in real terms and corporate profits are flat. The miracle I am writing about this week is not that, but that we may yet get back to the all-time high on another stroke of the Fed pen.
I don't know what the Fed will do next week, beyond providing me with lots of material for next week's column. I'm keeping my investing strategy neutral. But I do suspect that if the Fed comes back with some form of taper-lite, whereby the committee knocks off a very small amount - say, $10 billion or so - it could engender a relief rally that puts equities right back on the path to the magic 1750 (magical because it's such a popular target). It won't be a straight line, because Fed rallies tend to peak a day or so after the meeting and the last week of September is often a rough one for stocks. But the path to my long-mooted October high is beginning to show signs of visibility.
Yet when I look at the latest data for wholesale sales data and job hiring and turnover (the JOLTS survey), they tell me that the recovery is over. That's right, the recovery leg is over. That doesn't mean, however, that a downturn has begun or has to begin, only that we have plateaued
The following chart shows the hire, openings and separation rates for the last ten years:
This dovetails with last week's revelation that the labor-force participation rate is at its lowest in 35 years. This can't be good for growth - someone has to take care of all those people not in the labor force.
The next chart shows wholesales and inventories over the last twenty years.
We're four-plus years into the recovery now. First note the flattening out of labor market dynamics at subdued levels, and then at the pattern above. So far as wholesale sales and inventories go, the year-on-year growth in inventories fell again, this time to its lowest level since August 2010. The growth in 12-month sales has stalled out at around the 3% level, running roughly between 2.5% and 3.0% for five months in a row now.
The money question is how much further can equities rise on the back of a sideways economy and even a reconverted Fed? My baseline answer is to say a little further, but not a lot. To have more legs would need a catalyst, and in that sense it may be instructive to recall 1998. Corporate profit growth was negative for most of that year - the economy was clearly slowing. However the dot-com bubble was just coming into its own, and it engendered a last massive burst of investment money that propped the economy up for another fifteen months or so (despite the short-lived mini-crash in the fall of 1998 that followed Russia's default and the ensuing collapse of Long Term Capital).
A Chinese investment boomlet won't do much for the US economy, despite the business media's dim perception of how these things work. The question is what it might do for equity sentiment, and that's a more difficult proposition. A timid Fed, another kick of the fiscal can down the road, inaction on Syria, Merkel's re-election and the next thing you know the market could be back to rallying again on nothing more than the status quo and disasters not happening. I wouldn't like that as an investor, because rallies built on that sort of ephemera have bigger subsequent declines, but lamentably, they never ask for my permission first.
On the other hand, one of the foregoing might take a turn for the worse and we slide smoothly (or not) into the ditch. What's an investor to do? Stay safe, stay hedged and play it down the middle until one of these policy decisions actually get made. I don't like hoping for miracles, and still shudder - at times quite violently - every time someone utters the name "Hank Paulson." I've no desire to add another name to the list.