Bloomberg News, a cheerleader for central bank activism, ran an article Wednesday with the following title and subtitles:
- Risk assets rallying even as global growth outlook worsens
- Markets are driven by central bank liquidity, Commerzbank says
The article goes on to introduce the subject this way:
At a time when risky assets including stocks, commodities, junk bonds and emerging-market currencies are rallying to multi-month highs, so are the havens, from gold, government bonds to the Swiss franc and the Japanese yen.
No matter that the U.S. labor market is deteriorating and the World Bank has just cut its estimates for global economic growth. Investors either don't believe the news is bad enough to kill a global recovery that's already long in the tooth, or they're betting that sluggishness in some of the biggest economies means central banks will stay more accommodative for longer.
"Everything is being driven by high liquidity that ultimately is being provided by central banks," Simon Quijano-Evans, chief emerging-market strategist at Commerzbank AG, Germany's second-largest lender, said in London. "It's an unusual situation that's a spill over from the 2008-09 crisis. Fund managers just have cash to put to work."
This is reportage on Bloomberg's part, not a recommendation to buy. As it usually does, it tries to balance the main message ("buy") with some alternative views ("worry") below the "web fold."
But the headline is clear as are the first few paragraphs, which is often all that busy traders bother reading. So the message is bullish, but I think it's wrong at this stage of the cycle in the US.
Yes, the central banks can create new monetary units, and those monetary units can and do get used to buy new government debt. Thus, the central banks knowingly monetize the debt via the intermediation of the primary dealers and other institutional investors. But, if the economic cycle turns down, and this debt monetization has been going on at a stable pace, the cyclical factors begin to outweigh the government spending. Or to point to a different aspect of the situation, if lenders are not capital constrained, then trading their bonds for newly "printed" central bank cash does not increase the amount of loans they make.
That's the thesis that I'm operating under, and it's why I've been long bonds and non-cyclical biotechs.
This article is to a degree a follow-on to my December 15, 2015 article titled Bear Afoot? No Recession Needed For A Possible Sighting. That was followed by a sharp 13% correction, after which central bank action and jawboning on a global scale led the bull move about which Bloomberg has just reported.
More important, since then, Treasury bonds have soundly beaten stocks. This is often an important indicator of oncoming recession, and this article updates the December article by now examining the case that the US either is in, or is on or near the cusp of, a business recession and that downside risk to equities over the next year or two is extreme.
Apologies for this extended lead-in to the meat of the article, but strangely, after I began writing this article, I saw the WSJ has reported that George Soros has joined his former investment manager Stanley Druckenmiller as well as Carl Icahn and is now investing bearishly. The article is titled A Bearish George Soros Is Trading Again.
After a long hiatus, George Soros has returned to trading, lured by opportunities to profit from what he sees as coming economic troubles.
Worried about the global economy and concerned that large market shifts may be at hand...
It sounds as though he's been converted tactically to the Zero Hedge point of view. Few, if anyone, have better intelligence of what's really going on than Mr. Soros. This is interesting to see. He joined me, in my blogging days, on the gold bandwagon over two years ago (I turned bullish on my blog around September 2009); it's heartening to have him join me again on the economically cautious side of the debate.
Not that it's fun sounding bearish. It was definitely more fun in 2010 and the first part of 2011 banging the drum for cyclicals such as oil stocks, multinationals, and the like. But cycles move along...
Here's a list of the main points discussed in separate sections of the article. I'm trying to focus on less-discussed points rather than extremely well-known data such as the BLS employment survey:
- bonds beating stocks, while oil prices rise (or fall) is a classic late-cycle, pre-recession pattern
- wholesale sales trends look like there's a textbook recession going on
- a generally-bullish top-20 economist has already concluded a recession could have begun by now
- continued miserable import-export data out of Asia reflects poorly on global demand
- sharply weakening online job listings mirror the 2008 recession pattern
- a company that tracks online sales activity shows it falling off a cliff
- all 5 Fed regional manufacturing surveys showed contraction last month
- Dr. Copper's illness relapses (again)
- A global measure of CPI is nearing extreme, lower lows
- Several aspects of the labor market look weak and declining
Bonds vs. stocks
Going back to every bear market or near-bear market since 1998, one finds the same pattern of churning stocks near a top, or in the case of 2011, a recovery top, and declining 10-30 year Treasury bond yields for some months before stocks crack.
In the current case, "safe" stocks are trading as if they are as safe as bonds. I take this to be a risky thing.
Since the December article, a zero coupon T-bond fund run by PIMCO (NYSEARCA:ZROZ), which has a duration around 27 years, and therefore somewhat close to that of the stock market (NYSEARCA:SPY), is the comparator I use. Both have risk, and simple math shows that if a risk asset with a long duration is in a bull phase, it will rise more than a risk asset with a short duration. Over the past 6 months, a simple Yahoo! Finance (YHOO) comparison between ZROZ and SPY shows ZROZ up 12% in price versus 5% for SPY. Plus, ZROZ has had a little higher set of payouts.
Seeing this, I'm looking at stocks as holding on because investors can't stand low and dropping bond yields.
The next points raise the question of whether the economy has the oomph to support that investment mindset.
Looking at wholesale sales trends makes the interest rate plunge appear rational; maybe a recession has actually begun (?)
The data and charts below are quite something, using government numbers, not Shadow Stats or the like. From Jeff Snider of Alhambra Partners (as usual bold print is mine for emphasis):
Wholesales [sic] sales are right back on track again after two months of being affected by the calendar. After rising 0.8% in February and 0.6% in March, sales declined by 5.3% Y/Y in April. For the first four months of the year combined, wholesale sales were down nearly 3% compared to the first four months of last year. Since sales in 2015 were lower than 2014, that leaves cumulative sales year-to-date in 2016 6.2% below the same period in 2014...
How can one rule out a recession when wholesale sales are down 6.2% over a 2-year period? N.B. that this excludes inflation. So, even at a mere 1% inflation rate, the actual decline may be more like 8% or more.
That may or may not persuade you that one may be going on or at least brewing.
If not, here's the pattern graphically. It looks just like the 2001-2 period, only worse, and is a lesser version of the Great Recession:
Yes, I get it. Ex post facto, oil and gas, and coal, are no longer part of the economy. Only it's not so simple. Yes, in 2000-2, as the Tech Wreck formed and moved along, there would have been no recession had there been no tech sector, but the over-investment in tech and telecom came in part because of a dearth of investment opportunities in other parts of the economy in the second half of the '90s. So it was a one-sided boom and a one-sided bust, but 2001 saw a mild recession, and that's that. That in turn led to enough panic and a Krugman call for a housing bubble, which was heeded. We know the rest of the story except we don't fully understand the recent past or the present, the future being unknowable.
The important point of the second chart, which the eye can skip quickly over and think the point is made, is subtle. It's visible by studying the first chart. Do you see it? The seemingly benign YoY resolution on the second chart is a bit of an illusion, because the downturn is lapping one year. This is seen on the first chart. This downturn has been going on for over a year; this is even better shown with better context with this additional chart from the same post:
I think this is meaningful and inconsistent with the story that the financial media promotes incessantly.
The wholesale economy has gone nowhere for more than 4 years; and longer than the graph shows if one adds some inflation adjustment. Sales went up after the 2012 slowdown, courtesy mostly of QE3 that began in Q4 2012. Then, as I've shown many times, the taper of QE3 and then the end of the taper removed the amphetamines, which have been gradually wearing off.
Let's move on to some comments from a well-known economist (and markets guy).
Mark Skousen's quasi-recession call
An innovative mainstream economist made a major contribution to economic measurements by persuading fellow economists, and eventually the U. S. government, that the manufacturing part of the economy was much larger than the small percentage it looks like when analyzing only final sales. This has led to an official measurement called Gross Output. Before going to his point of view, it's important to recognize that economic data gets revised and re-revised. This typically means that what early GDP data is reported is incorrect. That's been something to rely on, but we don't know in what direction the more accurate determinations will move in. So the following, from April, reflects Q4 2015.
From his website on April 21, a small part of the post reports this:
"The GO data and my own B2B Index demonstrate that total US economic activity has slowed dramatically. While the 'use' economy (NYSEMKT:GDP) is still barely growing, the 'make' economy (GO) is in recession," stated Mark Skousen, editor of Forecasts & Strategies and a Presidential Fellow at Chapman University. "B2B spending is in fact a pretty good indicator of where the economy is headed, since it measures spending in the entire supply chain, and it indicates tepid growth and maybe even a downturn."
When spending is barely growing, even a normal pullback toward less risky lending practices pushing spending negative. No matter that GDP may be measured higher based on Thursday's data on inventories; the bond market has brought the 10-year T-bond several points closer to zero with this the only important data point.
Again, this careful observation by Dr. Skousen fits with a mild spreading recession.
Asia deteriorating; S. Korea and Taiwan exports down since 2015 began
Broadly speaking, a major PMI survey of Asia, the Nikkei Asia Sector PMI, appears to have slumped to contraction in May. From the summary:
Only seven of 19 detailed sectors saw an expansion of output during May...
The strongest drop in output was reported in machinery & equipment, extending the current sequence of decline to two months...
As the export powerhouse region of the world, swinging negatively in May is consistent with a lot of other data shown below, and with the story that high quality bonds have been steadily, subtly and quietly beating the SPY.
Some export details show some of the gravity of the story.
While data out of China are suspect, S. Korea has strong national statistics. Trading Economics reports:
Exports from South Korea fell worse than expected by 6.0 percent in May of 2016 to USD39.8 billion, following a 11.2 percent decrease in April. It was the 17th straight month of decline and the smallest drop since November 2015. Outbound shipments fell for: semiconductors (-4.1 percent year-on-year), cars (-7.1 percent), auto parts (-2.7 percent) and ships (-16.6 percent). Sales to China, the largest market for South Korean products, fell by 9.1 percent and marking the 11th straight month of decrease. In contrast, exports were up 0.7 percent to the US.
This is also impressive. While sales to the US were basically flat, some or most of the exports to China would be expected to be components to be assembled for export to the US, EU etc. So this downtrend in exports does not spare the US from being a contributor to it.
Similarly, though less dramatically, Taiwan's exports are down over 6% YoY. And the US is in a well-documented import-export downturn that has also lasted over a year, so that YoY comparisons involve the lapping effect discussed above and next.
When a large exporter such as South Korea, as well as other countries including the US, have more than one year of YoY negative comparisons, it's difficult to pay any attention to the mechanical lessening of the negative YoY rate of change when, inevitably, it occurs. It's a serious matter and suggests that the nearly simultaneous decline in oil prices is part of a global economic downturn or near-recession.
Most or at least a great many better-paying jobs are posted online now; are YoY declines beginning?
From the financial blogger Mike "Mish" Shedlock, a chart from Real Time Macroeconomics showing a sharp decline in new online job listings:
This is differentiated from the BLS JOLTS survey, which lists all job listings of whatever age. This does not suggest positive growth and is consistent with the main BLS employment trends toward (much) slower employment growth.
Next is another bit of online data that is not well known.
Online spending data is scary (if reliable)
Several years ago, I interviewed the founder of Consumer Metrics for a blog post. This organization tracks online shopping activity up to the point of committing to the sale, but, to be fair, not the actual sale, which is happily private to prying electronic eyes. I've followed this company since, as I've seen it identify both bullish and bearish economic turning points. In line with the above graph and the general tenor of this article, some cliff-diving right about now is suggested by one of their main metrics:
Monthly Absolute Demand Index(3):
(Click here for best resolution)
(3) A projection of our basic year-over-year data into an aggregate absolute demand, reflecting the compounding impact of extended expansions or contractions. The data points represent month-long averages of the daily data, normalized so that the year-long average for 2005 would be at 100 in the chart.
This sudden drop-off also fits with other data, so I present it and give it a small amount of weight in thinking about current trends. It is difficult to be certain about this data, but Consumer Metrics has now been in business long enough that I think it would have closed up shop if its data were not reasonably accurate.
Regional Fed manufacturing surveys are consistent with mild or early recessionary conditions
Unfortunately, the farthest west these go are the Dallas and Kansas City Feds, but the uniformity of trend is a high-frequency bearish indicator. In a "normal" economy that's simply growing at the pace of, say, population growth plus productivity growth, which has been a standard way of thinking of getting to 1.5-2% annual growth as a baseline, manufacturing surveys should routinely show growth. That is, they should be above zero as a baseline.
In May, a simple one-month average of the 5 regional Fed manufacturing surveys averaged -7.5. All 5 were negative, some by marginal amounts.
So, this is consistent with the way recessions begin, as well.
Of note, the center of the financial world, New York City, has its own ISM report on business. This report said:
New York Metro current business conditions fell nearly 20 points to 37.2 in May, the weakest reading since April 2009 during the Great Recession.
These monthly numbers bounce around, but at the linked document, you can see there's a general downtrend that began in late 2014. Unsurprisingly, this is when QE3 ended. Also and perhaps more worryingly for both the economy and the stock market, the six-month outlook has moved down sharply the past 2 or so months.
Anyway, PMI levels below 40 get my attention, and even though I mentioned this survey in a prior article, it's extreme enough to note it again.
Dr. Copper is sick
Copper is said to be the base metal with an advanced degree in economics; therefore, the name Dr. Copper. If so, can it provide a diagnosis and prognosis for this FINVIZ chart?:
Where is there an end to this slow and strong downtrend?
Looking at copper on the FINVIZ monthly chart (click "M" on the upper right of the above chart) going back to the 1990s shows that another 50% price cut would not be a crazy possibility. After all, the Baltic Dry Index has undercut its 1980s low price in the past year or so. Here's copper since 1994:
A bearish point that's especially visible on the monthly chart is that in copper, the speculators have consistently made money trading this on the futures market. This is best seen by noting the net positioning of commercial hedgers, typically miners (and refiners), who have an equal and opposite positioning to those of speculators (red and blue lines).
The speculators have been net bearish consistently since 2011, as shown by the green line being above the line (long copper). So I'm taking that as a bearish signal for copper prices and therefore for the global economy.
Copper is not alone: Global inflation is extremely low and trending lower
Another non-perma-bear site, GaveKal, reports:
Our simple World CPI Proxy, which takes the average of 33 country CPI YoY growth rates, fell to just 1.01% in April. It is the lowest level since 2009. However, more importantly, global consumer prices have been below 1.31% YoY since the beginning of 2015 and below 2% YoY since the beginning of 2014. This is a significant change from the 2000-2007 period when the World CPI Proxy averaged a 2.79%.
As you may have seen, it's no surprise to me that the big downshift in inflation came beginning in 2015, just after the Fed's taper of QE3 ended.
Graphically, the blog shows CPI is shown against inflation surprises:
This steady drip of negative inflation surprises supports my structural bond bullishness that begin in late spring 2011, as documented in real-time on my blogs and then continuing on Seeking Alpha.
US labor markets may be weakening in a (? pre-)recessionary manner
The first thing to realize is that the labor market unequivocally has not recovered. This can be seen by looking at the number of people employed, but since Fed Chair Yellen and some other Fed-heads like to talk about the unemployment rate, here's a good current graph that shows that strangely, the unemployment rate diverged from the percentage of the population employed precisely after the Great Recession:
And no, this divergence had almost nothing to do with the Baby Boom retirement. The leading edge of the Baby Boom has only been turning 65 in the past year or two. The peak of the Baby Boom was in the late 1950s, so those people were only about 50 when the Great Recession hit. Plus, the sub-par economy led a rising percentage of older-65s to work.
What has happened is well known: numerous people dropped out of the labor force permanently. A smaller but still large number were dumped into schools on student loans, many of them never to be repaid in full if at all. Others went on disability with loosened criteria. So the simple arithmetic equation used to calculate the most common unemployment rate used by the media, U-3, was altered misleadingly.
So it's a serious issue when within this shrunken workforce, we see the following data points. First:
This is from Evercore ISI data via a tweet from Liz Ann Sonders of Charles Schwab (NYSE:SCHW); hat tip Mish.
Apparently the trend in Federal tax receipts and state tax receipts is yet another data point suggesting that a recession could be brewing or in its early stages.
Another, broader look at labor conditions comes from the Kansas City Fed. This also is consistent with early (pre-)recessionary conditions. Courtesy of Doug Short:
As you can see, these examples are almost everywhere in the economy.
Now for some concluding remarks.
Why a recession matters, why it may not, and thoughts on asset allocation
Going back to 1945 to now, many recessions have not been associated with bear markets in stocks, and many bear markets have not been associated with recessions. So there's no one-to-one relationship.
But when George Soros and Carl Icahn, who together may be worth $50 billion, decide that now's the time to be bearish, I think the above data, taken together, are appropriate to consider when thinking about portfolio management for the next months and years (not for short-term considerations, though).
Looking at the general economic tenor of Japan and the EU, increasingly it looks as though governments may be preparing, if necessary, to default quietly in the reverse way from inflation via zero or negative interest rates.
It is well within their prerogative to do so (not that it is or would be "right"). As an example of why this is so, before the Fed was formed, the U.S. government issued Treasury notes. Allegedly they were backed by gold, but under FDR in the '30s, the government defaulted on a gold bond. So much for promises to back money with gold. Anyway, all it would take would be some legislation and the Fed could leave the money creation business, or disappear altogether, and the government could just issue currency, scrip, electronic forms of payment, etc. (I don't expect the Federal government to give up its monopoly on money creation as some would prefer.) In that case, money and Federal debt would be delinked. Money would be transactional, but investors could not earn interest on government debt other than the existing debt. Government would just spend money directly into the economy, and what would occur with inflation, would occur.
This trend could occur in the US if a recession occurs any time soon, before growth and inflation bring higher nominal GDP growth as is expected in Washington.
If the Fed must give up normalizing policy due to recession, a next logical step is for interest rates to pancake down toward the level of T-bills once again. If there is a recognized recession, that would trigger additional deficit spending. As the agent of the government, the Fed would be forced to let the government's financing costs trend downward to accommodate the suddenly-accelerating deficit.
Thus a recession could well, in this environment, tend to lower interest rates even further of Federal debt and other debt that is viewed as highly secure, such as corporate and municipal debt rated 'AA' or higher.
On the other hand, equities as a group would, I believe, be under pressure both from changed psychology and from the stringencies on cash flows that occur during a recession and in the post-recession period. This would be especially likely given what I think are over-optimistic predictions for rapid and large increases in profits of the S&P 500 as early as Q3 and Q4 of this year.
Gold might move anywhere in a recession, but the rebound in commodities prices seen this year would also be pressured if there's a recession, as consumers and businesses adjust their plans to the new reality, temporary though it would be.
Now, it's critical to realize that there is a completely opposite and happier possible reality, in the interpretation of the data and/or in future near- and intermediate-term economic trends.
The reason I'm writing the article as I've done it, though, relates to my view of what's baked in the expectations cake, especially with the stock market.
Since right now stocks are trading on 'X' (a historically high) multiple of rapidly-increasing (projected) earnings this year and next, thus making their P/E look reasonable, my basic decision is to continue to underweight the US equity asset class. I think there's too much chance of a significant counter-factual narrative emerging, given all the issues discussed above as well as the highly-publicized weak BLS employment data for the past 3 months released last Friday.
Within equities, I continue to favor the recession-resistant pharma group, especially biotechs. I especially like biotechs because so many of the leaders are trading to a discount to the market in GAAP TTM EPS, with immense growth prospects over the years. These growth prospects leave those of utilities and soap and cola makers in the dust, but many or most of those stocks trade at much higher P/E's than those of Gilead (NASDAQ:GILD), Amgen (NASDAQ:AMGN), AbbVie (NYSE:ABBV), and even J&J (NYSE:JNJ). And as I've said before, I don't care about politics in re biotech. Pharma and biotech are essential parts of a modern economy. They will go through their pricing and innovation cycles as all industries do.
A final point to make is that recessions end. So, even if one is going on now, to be determined retrospectively, it may have ended before one is determined. What matters much more than the technical question of recession are compound growth rates; lumpy and bumpy or smooth do not matter all that much in the end.
Whatever comes to pass, I think the next year or two promise to be quite interesting for investors. Thanks for reading, and I look forward to any comments you'd care to share.
Disclosure: I am/we are long GILD.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: Not investment advice. I am not an investment adviser.