This is looking more and more like 2000 and to a lesser extent 2007 all the time. Namely, a late cycle stock market (NYSEARCA:SPY) that refuses to quit, but with an economy that refuses to cooperate.
Even with the SPY at $201.10 (futures trading) as I write this slightly after midnight EDT, there is massive downside risk based on fundamentals. So even though Brexit is roiling markets, the topics discussed herein ultimately mean more to US markets for US and other investors. So I'm going to submit this without referring much to Brexit until the summary. Again, I'm writing this as a US citizen and resident who made the decision some time ago that the US markets and economy were the most attractive (or least unattractive) globally and thus mostly ignored international investing on that basis.
As soon as interest rates backed up substantially this week, I found bonds attractive; in this article, I reveal and discuss a much longer perspective on this topic.
From a modern historical standpoint, the facts of the stock versus bonds "battle" has been gotten completely wrong by the media. These facts also orient me toward the under-rated asset, bonds. To wit: we are now in the 51st year since stocks and bonds have, more or less, yielded the same total returns. Yet if you read the WSJ, Barron's, or of course have the financial news networks or news shows on the TV, it's "all stocks all the time."
Obviously stocks are more profitable business lines for the financial industry than bonds.
So I've been oriented more toward bonds than equities the last few years because half a century of history, greater predictability and less hype work for me.
However, just a week ago, T-bond yields had crashed so low, and the stock market had sold off a bit simultaneously, that I wrote a macro article that basically said, a pox on both your houses; I'll favor cash. Which I did, with a fair amount of my trading portfolio; meaning, I took profits on some Treasuries in our IRAs.
This was done when the RSI (relative strength index) on the daily charts dropped to as low as 25 (oversold), with the yields on the 10-year down to 1.51% on Thursday morning. Thursday, a mere week later, they were up to 1.74%. In a world where cash yields are close to zero in the US and lower than that in Canada and the UK, and zero or so in the eurozone or Japan, this is how I think of that yield change: it's an increase of 23/151 or 15%.
Just think of the panic that goes on in the financial media when the dividend yield on the SPY increases by 15% in a week. They call it, or act as if it is, a crash. That they do so shows how "crash" has been defined down, but so it goes. Yet the same thing goes on with bond yields and it's not even reported on.
At the same time, the SPY has increased over 2% since then, which means its dividend yield has decreased by over 2%. In other words, almost overnight, the murder of one British MP has catalyzed close to a 20% relative gain of stock yields versus bond yields.
This is a big move on a percentage basis, yet in the next sections, I'll present the data that argues that this is just technical action, and that the past week's fundamentals are not bullish for stocks. Rather, this looks similar to the last two pre-election periods where a 2-term President was leaving office and lengthy booms were faltering.
I'll begin with the most reliable high-frequency data that few appear to pay attention to.
Gallup's daily spending plunges
The Gallup polling organization has been running the same real-time poll that's a good proxy for discretionary consumer spending for some years now. In real time, I have found it very useful. In 2013, this proxy showed that the surge in the SPY was for real, as the 2009-12 tremendous slump in spending ramped up toward (but not to) the prior baseline.
Since then, spending has been a complete dud, and the latest spending data during and subsequent to the Father's Day weekend appears to have broken the modest upward momentum of recent weeks.
Gallup reports 3-day and 14-day average spending. The spending as of Thursday, June 23, covers June 20-22 as I understand it, which is Monday-Wednesday. This cratered to $72 as of Thursday's data, which is lower than any 3-day data I can see for June in 2013, 2014 or 2015. The more reliable 14-day data plunged from a respectable or even good $100 range earlier in the month back to $86. This is similar to or notably lower than 14-day average spending in 2013, 2014 or 2015.
Thus the never-revised data that Gallup directly obtains, without modeling or adjustment of the data, with a modest error range, suggests that after even 1% inflation in consumer goods the past 3 years, per capita discretionary consumer spending in real terms has been flat or down this entire period.
Worse, the 3- and 14-day data from June 28, 2008 were $96 and $94. That was no aberration. The 3- and 14-day data from June 20, 2008 were $83 and $93. That in turn appeared aberrationally low at the time, at least the 3-day data did.
For example, as of May 11, 2008, the 3- and 14-day spending numbers were $102 and $110. That $110 has not been reached at any time this "recovery" even though the Fed has "printed" about $3.5 T dollars via QE, taking the money supply up an unbelievable 4X in several years instead of a typical 7% per year (which is still high).
As everyone knows, the peak of economic activity was in November-December 2007, so May and June 2008 represented about a half-year into the Great Recession.
So this spending number is pathetic, 8 full years on and unimaginable Fed "money printing."
But the spending story is actually worse than that.
The GSEs were taken into conservatorship as September began. That was in the setting of a worsening but not widely recognized recession. Shortly after that, the Lehman disaster hit. The day after the announcement that Lehman had failed with no bailout, the SPY soared (Brexit/Bremain traders, take note). Then the crisis was upon us. Numerous large, super-regional banks began being absorbed by TBTF banks, as the very term 'TBTF' began to come into use. Gasoline prices plunged, which should have allowed lower spending as people merely maintained their standard of living.
Yet despite this spreading disaster, 14-day consumer spending as measured by Gallup was higher than now on the following days in 2008:
- Sept. 30 - $93
- Oct. 29 - $90
- Nov. 12 - $88
So, within measurement error, mid-late October and early November spending (remember, these average the prior 14 days beginning the day before the date of the actual report) was the same as or higher than it was the past 14 days.
That's really pretty disgraceful for a "recovery."
Yet the story gets even worse when noting that these are the dollar spending numbers provided at the time. They are not adjusted for inflation.
So, if one averages the $88 and $90 from autumn 2008 to get $89, it's reasonable to add about $13 to that for cumulative consumer inflation to get to $102. Compare that to the current $86 and perhaps a moderately higher number for all of May-June (the number averaged $93 in May).
Basically there has been no recovery from near the depths of the Great Recession. That's as in none.
Yet QE has forced so much money into chasing risk assets that the President can do what President Bush did before him (before the meltdown) and President Clinton before him: point to the record stock market as a sign of a strong economy.
Consumer spending is up mostly because of mandated healthcare inflation, food inflation (especially shrinkflation), and rental inflation; plus population growth.
Nothing like this has ever happened in this country outside of the Great Depression. Maybe it will change, but the latest Father's Day and post-Father's Day data are consistent with the well-established stagnation.
And this, in turn, is much more consistent with current 10-year T-bond rates than with a P/E on the SPY of 24.4X and a Shller P/E of 26.3.
I go through this because all other data are corroborative. Just from Thursday we got two new data points that are similar. Here they are.
Markit also says that consumer spending is disappointing
On Thursday, Markit reported the "flash" US manufacturing PMI. This is "softer" data than is ideal. While the headline number was up marginally from May at 51.4, the details were worse than that. First, the actual manufacturing output number was below zero (the public report does not quantify it). Second, here is the commentary from Markit's economist:
The flash PMI for June brought welcome news of improved performance of manufacturing, but the sector still looks to have acted as a drag on the economy in the second quarter, leaving the economy reliant on the service sector and consumers in particular to drive growth.
"Any improvement could be largely traced to better export sales, in turn linked to the weakening of the dollar compared to earlier in the year. Domestic demand was again worryingly weak, especially from business customers, meaning overall growth of order books remains subdued.
That's pretty bad. Markit finds that manufacturing was recessionary in Q2 and the B-to-B business demand, which of course includes the (larger) service sector, is poor. Overall, once again we have begun to see specific and direct comparisons with the Great Recession. The economist, Dr. Williamson, concludes by saying:
"Despite the improvement in the current month, the three months to June has seen the worst quarter for manufacturing in terms of both production and employment growth since 2009.
Yikes - yet another reference to 2009; these have been popping up this year in US economic data for the first time since the Great Recession. But it's not surprising when looking at the consumer spending data.
In addition, Markit found intensifying cost pressures and price increases thereby imposed. This is occurring while business is sluggish: therefore, stagflation with a Fed that is looking to fight said inflation. This is also consistent the 2007 situation. The US certainly would have been in recession before December had it not been for booming exports related to the weak dollar and seemingly impregnable BRIC economies.
Yet another implication of this boost to manufacturing from the declining dollar and the repeated failure of the Fed to raise interest rates even once this year is that the USD was not truly strong this past year or two. It was just that as in 1998, the rest of the world was weaker.
Remember the timing in that bubble. In 1998, oil prices crashed. Even though that was unequivocally good for the US, which had a small E&P sector then, the US economy weakened. The Fed saw the US and global weakness, cut rates ("printed money") thrice in H2, then the bubble reinflated and worsened. But, importantly, corporate profits did not rise much, ultimately peaking for the cycle in late 1997. As has been the case with secondary indices here, the Value Line Index was hit hard in 1998, did not come close to joining the SPY or NASDAQ in setting new highs in 1999, and collapsed again in 2000 as those indices roared to fresh new highs.
Here we are, two years and then some since the peak in the oil market. And of course, the US this time round had a much more substantial hydrocarbon sector of the economy. So is Y2K, 2 years on from the oil collapse of 1998, analogous to 2016, 2 years on from the peak of the oil market?
Thus I think there are worrisome signs in the details of the evolving, real-time economic data as revealed both by Markit and Gallup - two non-governmental sources of data that do not retroactively revise previous data (and for obscure reasons).
Then there's the Chicago Fed's CFNAI:
The National Activity Index confirms no significant recovery this "cycle" at all
Here's a chart from ZH showing the monthly results from the CFNAI going back to 2009:
This is a chart showing expansion or contraction based on a broad array of economic data points that sum to the CFNAI. Red, down monthly bars far outweigh the green, positive bars.
The only periods of reasonably sustained "green-ness" were during QE 1 and then QE 3. That's it - artificial money-printing steroids or amphetamines if you like. Before moving on to the latest data, it's important to look at this, because it's consistent with the evolving negative revisions to growth that the government's statisticians have been making this year and before this year (with more downward revisions apparently coming to GDP).
This horrible performance fits exactly with the trends shown on the Gallup consumer spending site (full graph not shown; please review at that link at your leisure).
So basically the economy has never recovered according to this as well as with Gallup. All that occurred in H2 2009 and the next year or so was inventory restocking, eventually including labor. This was really proven by the fact that all the mainstream economists really and truly expected 2010 to have a "recovery summer." They really believed it, and they were proven those 6 years ago to have no clue - and they still have no clue. That's why the emergency "QE 1.5" the Fed felt forced to do in August 2010 - the reinvestment of maturing bonds - is still in effect.
Before going to Thursday's report on May, some additional perspective arising from all the above data.
The bond market has gotten it gradually right all along. The Fed was unable to move because it was not really suppressing interest rates to near zero. It was the real economy that was pushing rates to the floor. If one was observant, that became crystal clear - proven - during Operation Twist in 2012.
That's because what was going on then was that the Fed was selling short-term securities and buying long-term bonds. There was no QE for that period other than the ongoing QE 1.5, which has become a permanent fixture keeping asset prices elevated but proportionately so.
If the Fed was massively selling short bonds, as it was doing, that should have pushed short rates up off the bottom. But it did not. Rates remained pinned near zero on the short end as long rates were forced downward by the combination of the weak economy and Fed buying. The 10- and 30-year bond interest rates are today about where they were then (partly artificially), but the upsloping yield curve in 2012 foreshadowed noticeably higher rates. So the bond market got it wrong even with those record low 10- and 30-year T-bond rates in 2012. Based on recent trading levels, they should have been even lower then.
Now, in addition to the above conclusion, and in addition to the weak Gallup and Markit data about the domestic economy, we almost have one of two recession signals from the CFNAI.
First, the introductory statement from the Chicago Fed in its report:
Led by declines in production-related indicators, the Chicago Fed National Activity Index (CFNAI) fell to -0.51 in May from +0.05 in April. All four broad categories of indicators that make up the index decreased from April, and all four categories made negative contributions to the index in May.
That's pretty darn bad. All four sectors were in contraction. Yikes (again)! The report continues with some details, which are not too pretty:
The index's three-month moving average, CFNAI-MA3, decreased to -0.36 in May from -0.25 in April. May's CFNAI-MA3 suggests that growth in national economic activity was somewhat below its historical trend. The economic growth reflected in this level of the CFNAI-MA3 suggests subdued inflationary pressure from economic activity over the coming year.
The CFNAI Diffusion Index, which is also a three-month moving average, moved down to -0.30 in May from -0.23 in April. Twenty-eight of the 85 individual indicators made positive contributions to the CFNAI in May, while 57 made negative contributions. Twenty-eight indicators improved from April to May, while 56 indicators deteriorated and one was unchanged. Of the indicators that improved, 12 made negative contributions.
The report then goes on to provide two recession indicators, one of which has almost been triggered. That's the 3-month diffusion index, which at -0.30 is "oh so" close to the recession signal number of -0.35 (and might be revised to that for all we know next month).
The other recession signal, the CFNAI-MA3, which is at -0.35, requires -0.70 to be triggered, so that's safe for now.
But this is a very bad sign. The CFNAI has basically been negative since December 2007 except for some periods of massive quantitative easing.
I think this is a challenge to the bulls.
One additional bit of breaking data from Thursday, then a wrap-up.
Other flash PMIs are poor as well
It's not just the US. The world is in a funk, and that's the way it is. Markit had some other flash reports Thursday. The one from the world's 3rd largest economy was especially dismal:
Manufacturing conditions worsen for the fourth consecutive monthFlash headline PMI signals marked decline in operating conditions.
Also, the chronically depressed EU economy had its flash report:
Eurozone growth slips to weakest in nearly one-and-a-half years.
This is not horrible, but these are month-to-month comparisons by purchasing managers. So if conditions have been poor most of the time, a marginal upturn is not too encouraging.
However, at least the eurozone was positive. This actually becomes worrisome for the US, because Markit had this to say in its Japan commentary:
"Latest survey data pointed to a further deterioration in manufacturing conditions in Japan. Both production and new orders declined at marked rates, led by a sharp drop in international demand.
If the eurozone was doing OK, what parts of the world could a "sharp drop" in demand come from? Only two: the US and China. And of course a decent part of China's import demand is for assembly and subsequent finished goods export to the US and EU (and back to Japan, etc.).
So no matter how the British referendum comes out, I do not think it is all that material for a US-based investor who's investing mostly in the US markets and who has a longer-term perspective. These stories go on and on and on. How they affect asset prices is unpredictable and changeable, and thus I think it's easier for now to focus on more settled themes. Again, this is written as a US investor, not an EU resident, a Brit, etc.
Basically, I think that the US economy does not support a P/E, averaging the TTM EPS of the SPY and the Shiller P/E at a level above 25X.
Now I want to sum up and put matters in both a personal and other perspective.
The bigger picture
In my second month as a blogger, on January 6, 2009, (before there even was a Zero Hedge to set a new standard of bearishness), I wrote that the US was going Japanese, though in its own way as the global superpower with an inherently stronger economy. By saying this, I meant that as an investor, I was going to take the economic "under" and also that a structural downtrend in interest rates was likely in gear. That was why I titled that particular blog post: Land of the Setting Sun. These were the points I made as to why the bulls on the economy who thought the Great Recession were wrong in thinking the economy would snap back strongly:
The days of living off the sweeping victory in WW II have ended or are ending. The same is largely true with the Cold War victory; that party ended September 11, 2001. As with Japan, giant deficits are bipartisan policy. Massive wealth transfers to the undeserving corporate losers are also bipartisan and Fed policy. This is the zombification of America just as much as Japan did with its big banks in the 1990s. It is worse here and now for at least two reasons. One reason is that at least Japan could point to its culture and find a reason to support the zombie companies. Our zeitgeist was supposed to be 'agin that. The second reason is that we lectured Japan contemporaneously not to create zombies, and we were probably correct: but how hard it is for the doctor to diagnose and treat himself!
I think these comments hold up pretty well. I went on to say in the blog post:
Americans are looking at disordered finances, economic stagnation, and political discord rising from the above. The people are dispirited and see the rot in the body politic. The October bank bailout, supported with excessive force by no good reason and/or changing rationales by the Establishment, was a defining moment. Massive wealth transfers have gone and continue to go to the worst-run giant companies in America. All this in a world of domestic peace, good harvests, abundant raw materials, a hard-working labor force, a general culture of honesty and fair dealing among the people at large (excepting the higher levels of government and many businesses), and unchallenged world dominance. This should be among the best of times.
The above, and the concluding punch line still look good more than 7 years on:
We deserve better than it looks like we are going to get.
And so it has been following the "oh so" Japanese move in 2008 to bail out the banks and reward the bankers, and fundamentally fix nothing.
If anyone wants to take the "over" and be bullish on economic growth in the US right now by going long the SPY, great, go for it. I'll root for you - but stay - for now - with the non-cyclical healthcare sector for the most part in my (underweighted) equity exposure.
Since we are always in new times, and the past shows us different patterns as we move forward into the future, it's most important to always be humble not only about the future but about the present and even the past. So my "take" is caution and taking some prudent gambles, which as I mentioned at the top, was much more quickly than I anticipated a week ago, to resume some extra betting on the long bonds I sold. Markets move quickly, and so did I.
A word on Brexit and the markets
Re the referendum, I wrote an InstaBlog Wednesday titled:
If The Queen Favors Brexit, Has She Been Sniffing The Winds? Investment Implications
My main point there was that since the bookies had "Remain" at 3:1 odds, I'd take the "under" and remain cautious. I thought it was more like the toss-up that it is as of about 10 PM as I prepare to finalize and submit this for publication. A second point was that even if the vote was for "Leave", there was a good chance that leaving would not actually occur. So, as an American, I was just going to trade normally until there were actual results - which at 12:18 AM EDT there appear to be.
At this time, the yields on Treasuries have collapsed to 1.50% and 2.37% on the 10- and 30-year bonds. The British pound is down to $1.35, down almost 9%. WTI and Brent crude oil are each down 5%. And the SPY is down a symmetric 4.44%.
My reaction is that in view of the deteriorating US economic fundamentals, this rapid turnaround in the bonds is not something I'm going to take trading profits on. My sense is that my longstanding 1% target for the 10-year is in play. Certainly, the breakdown in yields a couple of weeks ago did put new lows for at least the 10-year and perhaps the 30-year in play.
As far as US stocks go, once again it goes back to not seeing clearly how Brexit will affect them beyond short-term roiling. So I'm going to stick to fundamentals and continue to look at cyclicals with disfavor based on all the above fundamentals.
I also plan to look very carefully at purchasing a British pound ETF and/or a domestically-oriented British stock fund. This may be a classic over-reaction.
Concluding thoughts - staying data-dependent
In my view, it's extremely important - nay, crucial - to look past the drama of an important event such as the vote for Brexit and remain au courant with the real facts on the ground. What pattern have they created? Has the pattern changed?
I think not. Whether the US is in or soon heading into a recession is not the key point. That key point is whether the massive historical overvaluation of equities will continue. Based on all the facts I have discussed above, and the pattern into which they fit going back to the onset of the Great Recession; and the lead-in to the 2000-2 stop-start bear market(s), my game plan is to continue to underweight US stocks and handle the bond market fluctuations as best as I can. Mostly that's with buy-and-hold muni bonds and a core of Treasuries; then with trading around liquid Treasuries and ETFs (NYSEARCA:TLT).
The vote for Brexit, which I congratulate the country for simply holding, changes relative valuations but not, from a US perspective, the fundamentals of the US company and valuations of the markets. I continue to see the fundamentals of the US economy as meriting, under traditional valuations, a P/E of no more than 10X TTM GAAP EPS, and that's without a recession.
Thanks for reading on this fraught day. Best of luck to all.
Disclosure: I am/we are long TLT.
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.