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The economic outlook based on freight shipments is growing dim.Global expansion has peaked.

Please consider the Economic Outlook from Freight’s Perspective.

Cass' Growing Concerns

 
  • When the December 2018 Cass Shipments Index was negative for the first time in 24 months, we dismissed the decline as reflective of a tough comparison. When January 2019 was also negative, we again made rationalizations. Then February was down -2.1% and we said, “While we are still not ready to turn completely negative in our outlook, we do think it is prudent to become more alert to each additional incoming data point on freight flow volume, and are more cautious today than we have been since we began predicting the recovery of the U.S. industrial economy and the rebirth of the U.S. consumer economy in the third quarter of 2016.”
  • When March was down -1.0%, we warned that we were preparing to ‘change tack’ in our economic outlook.
  • With April down -3.2%, we see material and growing downside risk to the economic outlook. We acknowledge that: all of these still relatively small negative percentages are against extremely tough comparisons; the two-year stacked increase was 6.6% for April; and the Cass Shipments Index has gone negative before without being followed by a negative GDP. We also submit that at a minimum, business expansion plans should be moderated or have contingency plans for economic contraction included.
  • The initial Q1 ’19 GDP report of 3.2% suggests the economy is growing faster than is reflected in the Cass Shipments Index. Our devolvement of GDP explains why the apparent disconnect is not as significant as it first appears.
  • The weakness in spot market pricing for many transportation services, especially trucking, is consistent with the negative Cass Shipments Index and, along with airfreight and railroad volume data, heightens our concerns about the economy and the risk of ongoing trade policy disputes.
 

European Airfreight vs Eurozone PMI

European airfreight volumes were negative since March 2018, but only by a small singledigit margins (-1% to -3%), until November 2018. Unfortunately, since then, volumes have started to further deteriorate. Our European Airfreight Index was down -6.8% in February and -1.5% in March.

Asia Pacific Airfreight

Asian airfreight volumes were essentially flat from June to October 2018, but have since deteriorated at an accelerating pace (November -3.5%, December -6.1%, January – 5.4%, February -13.3%, March -3.3%). If the overall volume wasn’t distressing enough, the volumes of the three largest airports (Hong Kong, Shanghai, and Incheon) are experiencing the highest rates of contraction.

Even more alarming, the inbound volumes for Shanghai have plummeted. This concerns us since it is the inbound shipment of high value/low density parts and pieces that are assembled into the high-value tech devices that are shipped to the rest of the world. Hence, in markets such as Shanghai, the inbound volumes predict the outbound volumes and the strength of the high-tech manufacturing economy.

Shanghai Airfreight

The data underlying economic history is clear: the more unrestricted and robust global trade is, the more prosperous the global population becomes. Open markets of free trade are the greatest method to efficiently allocate resources and ensure that the best quality goods made by the most efficient producers are available to everyone. Unrestricted global trade lifts hundreds of millions, even billions, of the world’s population out of poverty. ‘Protectionism,’ like so many government regulations and programs, frequently produces results that are the exact opposite of the intended outcome.

Whether it is a result of contagion or trade disputes, there is growing evidence from freight flows that the economy is materially slowing. Our confidence in this outlook is emboldened by the knowledge that since the end of World War II (the period for which we have reliable data) there has never been an economic contraction without there first being a contraction in freight flows. Conversely, during the same period, there has never been an economic expansion without there first being an expansion in freight flows.

Welcome Views on Free Trade

It is extremely refreshing to see an article discussing free trade that gets a 100% Mish approval.

 

To the excellent Cass synopsis, it's important to add that when free trade stops, wars frequently start. Moreover, the result is never any good whether wars start or not.

The Great Depression is the classic example of the collapse in trade.

Although the Smoot-Hawley Tariff Act did not cause the "Great Depression" it did help turn a depression into the "Great Depression".

Prior to the Great Depression, the term recession did not exist. Thus, when you hear talk of the Fed saving the day preventing another depression, it's total nonsense.

All the recessions following the Great Depression would have been labeled depressions before 1929.

Global Recession

There is no official definition of a "global recession". Some define the term as under 2% growth. Others say under 3.0%. I am willing to split the difference.

The US recession may not have started yet, but a global recession (under 2.5% growth), likely has.

Courtesy of Mish

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Ms. DiMartino Booth, why is the Federal Reserve bad for America?
Because of its intellectual dishonesty. The Fed noticed around 2009 that if they had had a more reliable and realistic inflation gauge on which to set policy, they would have seen the crisis coming. But despite that recognition, they chose to do nothing about it.

Are there more realistic inflation gauges?
Several Federal Reserve Districts have come up with alternative gauges. The underlying inflation gauge from the New York Fed for example also includes asset price inflation. And it runs about one percentage point higher than what the Fed measure is – they prefer the core Personal Consumption Expenditures Price Index, the core PCE.

How would monetary policy look like with a more realistic inflation gauge?
Monetary policy would be much different. The Fed would not have been able to maintain a monetary policy as easy as it has done over the last couple of years. Central bankers are hiding behind the core PCE being at 1,6%. They’re saying that this gives them cover to not normalize interest rates. But even the core Consumer Price Index has been north of 2% for 14 months.

What does this mean for current monetary policy?
Former Fed Chair Janet Yellen lead the slowest rate hiking campaign in the history of the Fed. Had she been using a more realistic inflation gauge, she would not have left current Chair Jay Powell with having to play catch-up. He wasn’t able to normalize interest rates, nor to run down the balance sheet as much as he would have been able to otherwise – and had Ben Bernanke not insisted on the 2% inflation target.

What is the reason behind the inflation target of 2%?
Alan Greenspan and Paul Volcker said that the best inflation rate as far as households and businesses are concerned is 0%. There is nothing that is damaging to a household about inflation being non-existent. As Greenspan and Volcker both pointed out: If you have 2% inflation steadily for 50 years, the value of the dollar in your wallet is diminished. Inflation is corrosive as a factor of time.

What about the risk of falling into deflation?
A deflation in wages, as we saw during the Great Depression, is the worst-case scenario. But Japan has served as a modern-day reminder that households are not going to be injured by very very low levels of inflation. In a disinflationary environment with a decent level of growth, you’re not running that risk. You’re still going to have job creation and economic growth. But you’re not going to have the pressure of rising prices on households. Housing makes up 33% of the average US household budget, and housing inflation has gone through the roof in recent years. Not that it’s captured correctly in the metric that the Fed uses.

So, why is the Fed aiming for 2%?
When Stanley Fisher was vice chair, he asked the same question during his first Federal Reserve meeting. He said, why do you insist on using this antiquated broken method? One of the staffers raised his hand and said if we didn’t use it, then the models would not work.

Why has the Fed become more dovish recently?
Credit market volatility picked up appreciably last year as we moved from 2,1 trillion $ of global Quantitative Easing for the full year 2017 to zero in December. This drained liquidity from the system on a global basis. In December, we had had no junk bond issuance in the US for a record period of 41 days. There were outflows from bond funds and spreads started to widen.

So the reason for the Fed being more dovish wasn’t the stock market?
Not as much as it has to do with how problematic and difficult it would be to address a seizing up in bond market liquidity with monetary policy, given that we have got nearly 250 trillion $ of debt worldwide. The fact that Powell completely changed his approach and started sounding like he was channeling a combination of Janet Yellen and ECB President Mario Draghi implies, that there’s not much the Fed can do to address a liquidity crisis.

How liquid is the bond market now?
Some weeks ago the issuance in the junk bond market dried up for an entire week. After that, Powell had his Draghi moment at the Chicago Fed conference, saying the Fed would do whatever it takes to sustain the economic expansion.

What do you expect at the Fed meeting on June 19th?
I expect the Fed to lower its expectations for economic growth and the labor market and prepare the financial markets for the possibility of a rate cut if conditions were to deteriorate. Powell will lay the groundwork for having as much flexibility as the Fed needs to cut rates. It’s quite clear that it is a global coordinated effort, given the communiques out of European Central Bank and the bank of Japan where we’re starting to hear about rate cuts from these two institutions.

What is the state of the US economy?
The US economy is definitely slowing. The CEO confidence is at the lowest level since the last quarter of 2016.

Is there a recession imminent?
It could just be a matter of either we are already in recession or it is coming very soon.

But stock markets trade near record highs.
The market is expecting the Fed to be very aggressive in launching a rate cut campaign. Powell and others have given speeches recently that appear to advocate negative interest rates, as is the case in Europe and in Japan, and also more Quantitative Easing. A lot of the optimism in stock markets is based upon investors’ perceptions that if the Fed pumps enough liquidity into the system, that will allow for stock markets to never correct.

So Powell will save the stock market.
That’s the reigning theory. Jay Powell will save the day. We have never seen an episode in US history when we technically are in a recession and when earnings decline quarter after quarter but we don’t see a negative impact in the stock market. But try telling that to the stock market.

How will monetary policy look like in a couple of years?
I have no idea. We are falling further down into the rabbit hole of unconventional monetary policy.

Is there any way to get out?
I don’t know. There is so much debt. They have created debt in order to resolve an over-indebtedness problem. So it’s the policy makers themselves that have made the situation that much worse. Think about insurance companies and public pension plans throughout Europe and Japan. How do you sustain yourself when interest rates are negative?

What can the Central Banks do?
There are no easy choices to be made. If you’re Draghi’s replacement, what do you do? Do you just say, okay let Italy go, it’s only the third largest sovereign debt market in the world. Central Bankers have made their choices much more difficult by insisting on never normalizing. It was well-known in the US in 2008 that there was a liquidity problem that was seizing the market, not the cost of credit. The Fed didn’t even have to go below 2% in 2008 because what was plaguing the financial system was a lack of liquidity. Those problems were resolved with the facilities that were created by the New York Fed. The problems were not resolved by taking interest rates to 0%. The price of money at times of financial market disruption is irrelevant.

Courtesy of Finanz and Wirtschaft

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What Yield Curve Inversion Is Telling Us

The US yield curve has (almost) inverted, and this has been making headlines for the last couple of months now. This should come as no surprise, as the yield curve is perhaps the most reliable recession indicator out there. But what does an inverted yield curve tell us about future returns? Our analysis shows that while asset class returns in general are somewhat subdued between the first date on which the yield curve inverts and the start of the recession, the inversion of the yield curve is not followed by extraordinary deviations in returns.

Definition

Before moving over to the results of our analysis, we would like to dwell briefly on the definition of the yield curve, and the combination of maturities in particular. In most empirical research, the yield curve is either defined by the differential between the 10-year and 3-month US Treasury yield (10Y-3M), or the 10-year and 2-year US Treasury yield (10Y-2Y). The reasons for preferring one over the other depends on many things, including data availability – the 3-month US Treasury yield has a much longer history;  the degree to which you want to capture short-term versus long-term views on GDP growth and inflation, which is likely to be better reflected in the 2-year yield; and/or forecasting accuracy and timeliness, a point we will get back to later. As noticed by the New York Fed in its study ‘The Yield Curve as a Leading Indicator: Some Practical Issues (2006): “Spreads based on any of the rates mentioned are highly correlated with one another and may be used to predict recessions.” Hence, we will look at both the 10Y-3M and 10Y-2Y inverted yield curves, also because this leads to at least one interesting observation.

Inversions and recessions

As mentioned, the yield curve qualifies as one of the best, if not the best, recession forecasters. For the 10Y-2Y yield curve, we have reliable data covering the last five US recessions, all of which were accurately forecasted well in advance, as shown in the right panel in the table above. The lag between the first ‘inversion date’ and the start of the recession, as determined by the National Bureau of Economic Research (NBER), averages 21 months, ranging from 11 months until the 1981 recession to 34 months until the 2001 recession. The results for the 10Y-3M yield curve, as shown in the left panel in the table above, are highly comparable, with an average lead time of 19 months until the next recession. The data further reveals that prior to the last five recessions, the 10Y-2Y yield curve inverted before the 10M-3M yield curve on each occasion. From this angle, the 10Y-2Y yield curve should be the preferred recession indicator, as it ‘detects’ the next recession first.

The available data history for the 10Y-3M yield curve is longer, covering the last seven recessions. We find that the 10Y-3M yield curve correctly predicts these two additional recessions (1970, 1973) as well. However, it also seems to have given a false signal. On 12 January 1966, the 10Y-3M yield curve inverted for six days, but the next recession did not start until January 1970, or four years later. Obviously, the time horizon for which to assign forecasting power is arbitrary, but four years is considerably longer than in other cases. In addition, between early 1967 and December 1968, the 10Y-3M yield curve did not invert once, suggesting that we are looking at a separate period of yield curve inversion. Unfortunately, we can’t compare these inversions with the 10Y-2Y yield curve, due to a lack of data. Therefore, we will focus on the last five recessions, for which we have data on both the 10Y-3M and 10Y-2Y yield curve, for the remainder of this analysis.

Inversions and asset class returns

So, what does yield curve inversion tell us about (future) asset class returns? The table above shows the average and median annual returns on most major asset classes, US stocks, global stocks, commodities, gold, US Treasuries and US corporates, as well as US real GDP growth for both yield curves. The returns are calculated as the index change between the first negative reading of the yield curve leading up to a recession, and the first day of that same recession. In short, it calculates the performance between the inversion date and the start of the recession. The last row of the table shows the average annual return for the full sample period, from August 1978 until 1 January 2008. As can be derived from the table, this period was an exceptionally strong period for both stocks and bonds, with average annual returns above their longer-term history.

We will now summarize our main findings. First, while there are differences between the returns calculated using the 10Y-3M and 10Y-2Y yield curve, the results are highly comparable. Choosing either yield curve does not lead to different conclusions. Second, while variation in returns is substantial, they are far from extreme. For example, the average and median annual return on all asset classes is positive. No asset class shows severe and structural weakness after inversion, with only gold realizing a negative return in three out of the five inversion periods. But, as the table shows, gold returns are pretty erratic in any case. At the same time, none of the asset classes – again apart from gold –  realized an extraordinarily high average return either. Having said that, for all asset classes the average annual return between yield curve inversion and recession was lower than for the full sample, except for commodities.

The deviation from the full sample average return is relatively large for US corporate bonds. For both yield curves, the average annual return after inversion was significantly below 3%, against a full sample return of 8.9%. This observation fits the perception that credits tend to struggle late cycle, as short-term interest rates are lifted by the Federal Reserve and leverage tends to rise. Global stock performance also trails between yield curve inversion and recessions: the average annual return is less than half than the full sample return. This can be explained by the defensive nature of US stock markets, and the fact that most other regions are highly dependent on the US economy, given their ‘openness’. It is a well-known maxim that when the US sneezes, the rest of the world catches a cold.

Lastly, with a 7% return, commodities are the only asset class which realized a much better return than the full sample average (2.8%) after yield curve inversion. This fits the characterization of commodities as ‘being late cycle.’ As final demand increases during economic expansion, so too does the demand for commodities. Hence, since raw materials are needed to produce goods now, the forward-looking aspect is likely to be of lesser importance than it is for equities and bonds.

A word on growth

Before moving over to the final part of this analysis, a quick word on growth. As is shown in the final column of the table above, average real GDP growth between yield curve inversion and the start of the recession is very close to, and even slightly above, the average of the full sample. This implies there is no such thing as a gradual cooling of the economy before slipping into recession. This helps explain why forecasting recessions is incredibly hard. Just ask the IMF, which has not been able to predict even half of the recessions just months before they started.

Has the yield curve inverted?

The yield curve, be it either the rate difference between the 10-year Treasury yield and the 3-month or 2-year yield, has a strong track record in predicting recessions. But has it inverted? Out of the last five recessions, the 10Y-2Y yield curve was always the first to signal a recession. This time, however, the 10Y-3M yield curve briefly inverted in late March, while the 10Y-2Y yield curve did not. While one should refrain from arguing that ‘this time is different’ as much as possible, the fact that the 10Y-3M curve inverted first makes this case different by definition. Quantitative easing followed by quantitative tightening (balance sheet reduction) could perhaps explain this divergent sequence, providing a potential argument why this yield curve inversion ‘doesn’t count’. But there were compelling reasons (a savings glut, structural budget surpluses) before to explain why yield curve inversions should not precede a recession. When looking at both yield curves and their forecasting history, it’s simply impossible to say if a recession signal has been given.

Still, as we believe it is possible to establish that we are in the later stages of the economic cycle, it could prove prudent to become somewhat less enthusiastic about the return prospects of corporate bonds (as reflected in our multi-asset portfolios) and be a bit more optimistic about those of commodities. To be continued…...

Courtesy of jeroenbloklandblog

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Yield Curve Inversion We're All Watching

Whether you're watching CNBC, Twitter or another news outlet, you're hearing a great deal of talk about the odds increasing that the Fed will drop rates soon.  Everyone's cheering it on..........yet no one's talking about recession possibilities.  Don't say 'recession' on live tv!  Keep that notion out of your head!  At least I believe that's what Trump is thinking as he warms up for his 2020 campaign.  He wants the market "up, up, up".  A strong stock market with plenty of green and profits in your pocket.  If it fails after 2020, so be it.  At least he'll have his re-election and be further away from any prosecutorial attacks for four more years.  If he loses, blame it all on the Democrats!

In the meantime our yield curve continues to invert, or decay if you see it that way; implying a rough road ahead for the U.S. as China and European countries slowing low and behold, the U.S. having a "global market", the U.S. looks to be slowing as well.  Shocker!

Now the US housing market is slowing and everybody should be aware of this.  Then there's the Washington Post declaring “Wall Street Predicts Economy Slowing Dramatically.”  The story says investment bank Goldman Sachs is predicting a second-half of 2019 slowdown due to the fading effects of federal tax cuts and rising federal interest rates. 

So what do traders do?  Of course they now believe Powell will "bail us out" once again and lower rates, rather than raise.  Save us from the big slowdown!  The big question now is, how low can he go?  Now where near as low as they did after the financial crisis but will it be enough?  They're now betting on a rate cut in September but at least one Pragmatist stands by his guns and hopes for a hike - bring it now.  I wish he were right but this is a market under Trump.  All normal bets are off.

Consider this:  The U.S. is on average two years ahead of Europe in terms of economic rebound and growth.  If we cut rates, they follow.  If we hike, they will eventually follow suit........once the nasty Brexit turmoil is behind them, but it won't be this year.  The U.S. should be leading.  We should hike further and let  equities suffer their correction.  That would be a buying opportunity for all. 

The 2020 election should have nothing to do with price discovery.  Keep it separate and apart.  Now we must consider, will Trump let us?

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Maybe you've never heard of MMT (Modern Monetary Theory). But no doubt, as the 2020 election nears, you will. It's the latest contentious buzzword to hit Washington, D.C.

The idea, despite its name, is not new or "modern." But it has set off a heated political and economic debate, with Fed Chairman Jerome Powell telling Congress last week that Modern Monetary Policy is "just wrong."

Does Modern Monetary Theory, or MMT, represent a brave new future of ever-expanding government spending to meet Americans' vital needs? Or is it a dangerous idea that could lead to runaway inflation, financial disaster and, ultimately, collapse?

The theory, in a nutshell, says that because the U.S. can borrow in its own currency, it can simply print more money when it needs to pay off its debts. All the Fed has to do is keep interest rates low. Simple. It's an increasingly popular idea among left-leaning economists.

 

Fed Chairman Powell: MMT Is 'Just Wrong'

Not surprisingly, however, when Fed Chairman Powell testified before Congress on Tuesday, he pulled no punches on Modern Monetary Theory.

"The idea that deficits don't matter for countries that can borrow in their own currency I think is just wrong," Powell said, describing one of MMT's main pillars. "And to the extent that people are talking about using the Fed — our role is not to provide support for particular policies. Decisions about spending, and controlling spending and paying for it, are really for you (Congress.)"

Mainstream economists — even on the left — don't like the MMT idea.

For one thing, it violates a widely-held tenet of conventional monetary theory: That the quantity of money matters, especially for inflation. MMT maintains if inflation becomes a problem, just raise taxes. And print money to pay your bills.

Critics also note that MMT would support politicians issuing massive amounts of new debt backed by the printing press. Spending and debt would soar, crowding out private investment by sucking up private savings.

In response, leading proponents argue that those who oppose MMT don't really get how it works.

"The MMT framework rejects this, since government deficits are shown to be a source (not a use!) of private savings," writes Stephanie Kelton, a professor at Stony Brook and former economic advisor to Sen. Bernie Sanders' 2016 presidential campaign, in a recent Bloomberg piece. "Some careful studies show that crowding-out can occur, but that it tends to happen in countries where the government is not a currency issuer with its own central bank."

MMT Used To Justify Federal Spending

This is more than just another dorm-room debate with no consequences.

Democratic Party proposals like the Green New Deal, Medicare for All, and guaranteed incomes and jobs, will cost enormous sums. By at least one estimate, the 10-year tab for the progressive Democratic agenda now emerging from Congress could total $93 trillion. Only MMT, proponents say, could pay for it all.

This idea, in particular, angers MMT's foes.

"It is intellectually fraudulent, though I suspect Stephanie (Kelton) is a true believer," economist Dan Mitchell, co-founder of the free-market Center for Freedom and Prosperity, told IBD. "In any event, it is the fiscal/monetary equivalent of a perpetual motion machine. Sort of turbocharged Keynesianism."

Other economists note Modern Monetary Theory is a decades-old idea that's been debated, and discarded, by mainstream economists. MMT has only recently re-emerged as a way to justify more spending.

"The theory does ... lend itself to use, if not to abuse, by big spending proponents," said George Selgin, director of the Cato Institute's Center for Monetary and Financial Alternatives. "They like to harp on its observation that governments' right to create money gives them practically unlimited spending capacity. That claim is true, if not banal. But it's also misleading: Governments may be able to spend without limit; but outside of recessions they can't do so to any great extent without having to make their citizens ultimately foot the bill, either by paying higher taxes or by having to endure inflation.

"When politicians promise something for nothing, people should be wary," he added. "There's nothing to MMT that should make them any less so."

MMT: Inflation Threat?

Even Paul Krugman, himself a liberal-left economist, finds MMT lacking. "When people expect inflation, they become reluctant to hold cash, which drives prices up and means that the government has to print more money to extract a given amount of real resources, which means higher inflation, etc.," he wrote last month. "Do the math, and it becomes clear that any attempt to extract too much from seigniorage (printing money) — more than a few percent of GDP, probably — leads to an infinite upward spiral in inflation. In effect, the currency is destroyed."

The Congressional Budget Office now predicts $1 trillion annual federal deficits during the next decade. And the Treasury reports that total U.S. national debt now exceeds $22 trillion.

So a lot hangs on the key question posed by Modern Monetary Theory: Do federal deficits and debts matter at all? Supporters of MMT say not if the Fed holds rates below the growth of both GDP and debt. That would stabilize the debt-to-GDP ratio, and hold down inflation.

But others argue the inflation risks of MMT are huge. The Fed since 1990 has kept inflation at about 2% by targeting it. Its political independence gave it room to do so. Examples abound elsewhere of central banks running the printing presses to please politicians, resulting in hyperinflation and economic collapse — Venezuela, Zimbabwe and Argentina, for example.

Courtesy of IBD

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Bull Trap?

The bulls are back. $SPX up nearly 8% in January and nearly 14% off of the December lows. What slowing global growth? What reduced earnings expectations? Trade wars? Who cares. It’ll all sort itself out, all that matters was the Fed caving in spectacular fashion laying the foundation for the big bull case. The central bank 2 step is back: Dovish + dovish = nothing but higher prices. The lows are in, what else can I buy? This pretty much sums up current sentiment.

And so goes the familiar script during emerging bear markets, a general sense of relief that the lows are in and a return of optimism and greed after an aggressive counter rally following an initial scary drop. Long forgotten are the December lows after a torrent consecutive 6 weeks of higher prices.

While indeed a renewed fully dovish Fed may be all that’s needed to keep 2019 bullish (after all this playbook has worked for the past 10 years) there is evidence that this rally may turn out to be a big fat bull trap.

And it’s not a single data point, but rather it’s a confluent set of factors that are acting in concert that give credence to this possibility.

Let me walk you through the factors step by step.

Firstly here’s the big monthly chart of everything as I call it which includes $SPX, some basic technical elements, but also a price chart of the 10 year yield ($TNX) and the unemployment rate:

Note the common and concurrent elements of the previous two big market tops (2000 & 2007) versus now:

  1. New market highs tagging the upper monthly Bollinger band on a monthly negative RSI (relative strength) divergence – check

     

  2. A steep correction off the highs that breaks a multi-year trend line – check

  3. A turning of the monthly MACD toward south and the histogram to negative – check

  4. A correction that transverses all the way from the upper monthly Bollinger band to the lower monthly Bollinger band before bouncing – check

  5. A counter rally that moves all the way from the lower Bollinger Band to the middle Bollinger band, the 20MA – check

  6. A counter rally that produces a bump in the RSI around the middle zone alleviating oversold conditions – check

  7. All these events occurring following an extended trend of lower unemployment, signaling the coming end of a business cycle – check

  8. All these events coinciding with a reversal in yields – check

  9. All these events coinciding with a Federal Reserve suddenly halting its rate hike cycle – check

I submit that the current counter rally is consistent with all of these factors. Indeed, as with counter rallies in the past, this rally remains below its broken trend line.

What can we learn from the counter rallies during the two previous emerging bear markets?

In 2008, following the 2007 top, $SPX fell deep below its 200MA, but then saw an aggressive counter rally in a rising wedge pattern that stopped at the 200MA before everything reversed:

What did optimistic, the coast is clear, buyers know then? Nothing as $SPX didn’t bottom until 666 in March 2009.

In 2001 $SPX rallied hard from a yearly low in December (similar to now) and the high was made on January 31, the last trading day of the month. Unbeknownst to buyers then that day turned out to be the high for YEARS to come as markets turned south in advance of the coming recession:

Lows didn’t come until 2002/2003.

Look, my eyes are wide open here, I recognize that between the dovish Fed and a potential China deal markets may just drift higher and any pullbacks could turn into buying opportunities.

However, as long as $SPX remains below its 200MA without a confirmed breakout above the confluent set of elements discussed above suggest there is well founded risk that this market can still turn into a full fledged bear market. After all growth is slowing, earnings growth is slowing and the last 3 times the Fed halted its rate hike cycle a recession soon followed.

And what do we have so far? An aggressive counter rally below the 200MA in a very steep ascension pattern approaching key .618 fib resistance:

In early 2018 the 200MA was support, in the fall it became resistance. $SPX remains below it and I think it’s fair to say we’re no longer oversold. Indeed a dovish Fed has now been priced in. Jay Powell made sure of that on January 4th and confirmed it this week. That carrot is gone.

While the bull case remains technically unconfirmed at this stage the bull trap scenario will also remain unconfirmed for some time. The first few down days following the peak in January 2001 and the peak in May 2008 did not have anyone waving a big white flag screaming the top is in. It’s easy to see these things in hindsight, but much harder, if not impossible, if you’re in the thick of things. And this is where we are now, in the thick of things, and will be for weeks to come, but I suspect we’ll know more in the next month or two. Stay sharp.

Courtesy of Northmantrader

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With the SPX up ~8% in just the last month, increasingly nervous investors who still vividly recall the freefall days of December 2018, are wondering what will stop the unrelenting rally according to JPMorgan's Adam Crisafulli who writes this morning that while there are always risks, none of the (known) ones seem particularly threatening at the moment.

Still, according to the JPM strategist, investors should be wary about chasing the SPX above 16x (i.e. above ~2750) but the index is more likely to touch 16.5x (>2800) than it is to hit 15x (<2600) based on everything known right now.

With that modestly bullish bias in mind, Crisafulli lists 14 things that can go wrong and send stocks sliding once more.

  1. TSYs and the USD fail to ratify the Fed optimism – at some point the TSY curve needs to steepen and the USD has to weaken in order to confirm the dovish takeaways from the recent Fed decision.  If TSY yields fall across the board (or even worse, if the curve flattens) and/or the USD stays bid, this would suggest growth is set to soften going forward.
  2. Growth softens – US growth loses steam, European decelerates further, and China fails to stabilize.  At the moment, this seems unlikely – the US is on a healthy track and China data of late has contained some silver linings (Europe is a bigger wildcard).
  3. The US and China fail to reach a trade agreement – while its always possible Trump could move forward and hike tariffs after the 3/1 ceasefire deadline, this seems very unlikely and all signs point to a Washington-Beijing détente.  The question at this point should be what happens to the existing tariffs – are they rescinded instantly or kept in place to ensure Chinese compliance?  
  4. Trump ratchets up pressure on Eurozone auto OEMs – the Commerce Department is likely to soon grant Trump the authority to implement auto tariffs on national security grounds although it seems unlikely the White House will actually take this step.  The CQ4 market volatility has led to a clear reduction in White House trade threats and it seems unlikely this is an agenda Trump wants to pursue aggressively heading into ’20.
  5. Earnings estimates continue to drift lower – the ’19 consensus has drifted down from ~$178 back in Oct/Nov to ~$172-173 at present.  A ~$172.50 number is enough to support the SPX at present levels but should it slip any further obviously this would represent headwinds for the SPX.  Given that CQ4 earnings are largely over, the ’19 consensus probably won’t change much for the next few weeks.
  6. Super-cap tech stocks exhibit ongoing fatigue – it wouldn’t be shocking to see the super-cap tech stocks continue to trade sideways as they digest years of outperformance and this would be a headwind for the SPX given their enormous weighting in the index (although this could help fuel further outperformance for cyclicals and EMs as the tech dollars search for a new home)
  7. Investors could become more sensitive to valuations – investors may not be comfortable chasing the SPX above 16x but that still means the index can get to ~2750 (and 16.5x would get the index above 2800).  Based on the present fundamental landscape, the odds of the SPX touching 16.5x are higher than they are for the index to return back to 15x.
  8. Washington engages in a big debt ceiling battle – given the recent wall funding fracas, some may worry about a protracted battle around the debt ceiling but this probably won’t occur.  Neither side has made serious debt ceiling threats while the White House clearly is attempting to moderate its policies and rhetoric in a bid to quell market volatility.  The debt ceiling has been suspended until 3/2 although it probably won’t become binding until the summer.  
  9. The Mueller report legally jeopardizes Trump – media reports suggest the Mueller report could hit as soon as mid-Feb although it seems this may wind up be anticlimactic and probably won’t legally undermine Trump.
  10. The Fed attempts to recalibrate market expectations around tightening – stocks right now assume the Fed is permanently over with tightening and could conclude its balance sheet run-off process sooner than anticipated just a few months ago.  However, if US data stays on its present track, int’l growth improves, and stocks extend their gains, the odds of one final hike could rise (although this probably won’t be a problem for stocks for a couple more months at least).
  11. Brexit is “hard” and disorderly – the odds of this actually happen are low (the 3/29 exit date is very likely to be pushed back as neither the UK nor the EU want a “hard” exit) and regardless the SPX should be relatively insulated from any fallout.  
  12. Crude supplies spike and oil prices collapse – stocks are very positively correlated to oil and thus a softening in Brent prices would undermine the SPX.  This may be a risk going forward to the extent the OPEC+ supply agreement crumbles and/or a change in leadership in Venezuela leads to a spike in output from that country but for the next few months oil is likely to stay on its present track (in fact, the near-term risks are skewed to the upside given further tensions in Venezuela and the upcoming expiration of Iranian sanction waivers).  The next OPEC meeting is Apr 17-18 and US Iranian sanctions waivers will expire at the end of Apr (it isn’t clear which waivers will be extended).  
  13. Investors grow more nervous about tax rates ahead of the 2020 US election – this is something stocks should worry about given surging deficits and increased political support for higher tax rates on top earners but for the next few years investors probably won’t worry.  
  14. Draghi is replaced by someone very hawkish (or someone who unnerves markets in some other fashion) – Draghi’s term concludes at the end of Oct but it seems very unlikely the ECB shocks markets with his replacement.  The more important question right now isn’t who will replace Draghi but instead if the ECB will hike rates this year at all (or will they ever hike rates).

Courtesy of ZeroHedge

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U.S. stocks experienced their third straight week of gains, with the S&P 500 Index rising 2.6% and gaining more than 10% since Christmas Day.1 Investors were encouraged by comments from the Federal Reserve indicating a less aggressive policy stance and a sense that trade issues may be improving. Strong outflows from stock funds have also been an important contrarian indicator that investor capitulation had reached a limit. Several market areas were standout performers last week, including industrials, retail sectors, technology and energy, which was helped by a 7.5% climb in oil prices.1 A near -term consolidation is possible, given the strong climb over the last few weeks, but a return to December’s lows seems unlikely.

 

1. The Fed should remain data dependent, which should be good for stocks. Fed comments in October seemed to indicate it would continue to raise rates and sell off its balance sheet for the foreseeable future. But Fed Chair Jerome Powell walked back those comments in early January, causing investors to breathe a sigh of relief. If concerns about the global economy ease, we could see a couple of additional rate hikes this year. Conversely, weakening economic sentiment could cause the Fed to stand pat. In any case, the central bank appears focused on continuing to promote economic growth.

2. Trade concerns have eased a bit, at least for now. At the minimum, the United States and China appear committed to additional trade negotiations. Given that both President Trump and President Xi are eager for a political win makes it likely that some sort of deal could be reached.

3. The jobs market remains an important source of economic strength. December’s employment report was, in a word, stellar. We are keeping a close watch on wages, which have been accelerating in recent months as the jobs market tightens. This increase could represent an eventual source of inflation.

4. Manufacturing is slowing, but remains healthy. January’s ISM manufacturing data dropped sharply, but remained in expansion territory.2

5. The ongoing government shutdown could become a negative for economic growth. The current shutdown now has the dubious distinction of being the longest in history. Last week, JP Morgan lowered its forecast of first quarter GDP growth from 2.25% to 2%.3 The longer this shutdown continues, the more economic damage it is likely to cause.

 

Despite the late-2018 correction, fundamentals remain solid

Stocks have rebounded strongly over the last three weeks, regaining almost half of what they lost in the sharp meltdown in the fourth quarter of 2018. Greater stability in bond yields has certainly helped equity market sentiment. We think bond markets will likely remain relatively stable given that the Fed looks to be backing off from its rate-tightening campaign and a spike in economic activity seems unlikely. At the same time, news on the trade front appears to be improving, even if specifics about a deal remain scarce. Other geopolitical risks could persist, but outside of trade we doubt any of them will significantly affect global economic growth. A combination of greater bond market stability, a pause in the Fed’s rate hiking and some improvement around economic sentiment may help equity markets continue to recover.

Although the financial headlines have been pessimistic since October, overall economic and market fundamentals remain solid. Monetary and fiscal policy remain equity-friendly, the economy is still growing, companies are enjoying solid profit margins and corporate earnings are expanding. In other words, we see no real signs of a recession on the horizon.

That said, though, we think the highs for the current bull market may have already been realized last year. We believe volatility is likely to remain relatively elevated, which means we could see another near-term selloff at any point. Overall, we think equity markets are topping out, but that process can take quite a while and there is still room for upside. To us, this suggests that 2019 will be a year where investment selectivity is critical. In particular, we suggest focusing on companies with higher earnings quality and lower leverage.

Courtsy of Bob Doll @ Nuveen

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Macro And Credit - Buckling

Watching with interest the slowly grind higher in US interest rates with some weakening signs coming from US economic data such as the US trade deficit in goods getting spanked with orders for larger domestic appliances and other durable goods falling by a cool 3.7% from the month before, led by a hard drop in vehicle demand, when it came to choosing our title analogy for this week's conversation we reminded ourselves of "buckling" being a mathematical instability that leads to a failure mode. When a structure is subjected to compressive stress, buckling may occur. Buckling is characterized by a sudden sideways deflection of a structural member. This may occur even though the stresses that develop in the structure are well below those needed to cause failure of the material of which the structure is composed. As an applied load is increased (US interest rate hikes) on a member, such as a column, it will ultimately become large enough to cause the member to become unstable and it is said to have buckled. Further loading will cause significant and somewhat unpredictable deformations, possibly leading to complete loss of the member's load-carrying capacity. If the deformations that occur after buckling do not cause the complete collapse of that member, the member will continue to support the load that caused it to buckle. If the buckled member is part of a larger assemblage of components such as a building, any load applied to the buckled part of the structure beyond that which caused the member to buckle will be redistributed within the structure. In a mathematical sense, buckling is a bifurcation in the solution to the equations of static equilibrium. At a certain point, under an increasing load, any further load is able to be sustained in one of two states of equilibrium: a purely compressed state (with no lateral deviation) or a laterally-deformed state. Obviously we thing that financial markets have reached a bifurcation point and we have yet to see how the buckle of rising interest rates will be redistributed within the complex structures without leading to some renewed avalanche in some parts of the markets.
 
In this week's conversation, we would like to look at the vulnerability of equities and credit markets to a more hawkish tone of the Fed which would lead to more aggressive rate hikes should the "Big Bad Wolf" aka inflation continue to rear its ugly head.  
 
Synopsis:
  • Macro and Credit - Hike it till you break it
  • Final chart - Afraid of buckling? Watch credit availability
In our March 2017 conversation entitled "The Endless Summer" we concluded our missive at the time asking ourselves how many hikes it would take before the Fed finally breaks something. Given the arrival of a new Fed "sheriff" in town one might wonder if the pace will be as gradual as it seems should the Fed feels it is falling behind the curves when it comes the "Big Bad Wolf" aka inflation and current loose financial conditions. As we pointed out in our recent conversations the recent uptick in inflation coincided with a sharp sell-off in equities. Sure, one would point out to us that correlation doesn't mean causation, but, it certainly felt like the very crowded short-volatility complex was looking for a match that triggered the explosion and for some their ultimate demise.  The U.S. Average Hourly Earnings triggered the "buckling" as it brought back the fear in the markets of the return of the Big Bad Wolf aka "inflation".  For some it seems like us, it seems the "Big Bad Wolf" has already blown apart the "short vol" pig's house which was made of straw. If indeed the short-vol house was made of straw we wonder if the pig's equities markets house is made of sticks or and if the pig's credit markets house is made of bricks. The difficulty for the Fed in the current environment is the velocity of both the rates rise and inflation, because if indeed the Fed hike rates too quickly then it will trigger some other avalanches down the capital structure (short-vol complex being the equity tranche or first loss piece of the capital structure we think). If inflation and growth rise well above trend, then obviously the Fed will be under tremendous pressure to accelerate its normalization process. It is a very difficult balancing act.
 
When it comes to the bounce back for equities following the short-vol avalanche, which could have been possibly triggered by the recent uptick of inflation, we read with interest Deutsche Bank's Asset Allocation note from the 23rd of February entitled "Inflation and Equities" with the long summary below:
"The recent uptick in inflation coincided with a sharp correction in equities
Whether this was cause and effect is debatable for a variety of reasons and around half the correction reversed quickly (Stretched Consensus Positioning, Jan 31 2018; An Update On The Unwind, Feb 12 2018). Nonetheless, late in the business cycle with a tight labor market, strong growth, a lower dollar, higher oil prices and a fading of one off factors, all point to inflation moving up. What does higher inflation mean for equities? We discuss five key questions.
Is inflation bad for margins and earnings? Historically, higher inflation has been associated with higher margins and strong earnings growth
■ Conceptually, higher inflation is ambiguous. From a pricing vs cost perspective, whether higher inflation leads to higher or lower margins depends on the relative strengths of price vs wage and other input cost inflation. It depends on the relative importance of variable vs fixed costs. And on the extent to which corporates can increase productivity in response to cost pressures. It is notable that while markets seem to have been surprised by the recent uptick in wage inflation, corporates have been noting it for at least a year. Finally, inflation does not occur in a vacuum. The drivers of higher inflation matter and when it reflects strong growth, it implies not only higher sales but operating leverage from fixed costs can raise margins and amplify the impact on earnings.
Historically, the empirical evidence is unambiguous. Higher inflation was clearly associated with higher margins and strong earnings growth.
Does higher inflation mean lower equity multiples? By how much? A 1 pp rise in inflation compresses equity multiples by 1 point or a decline in prices of around 5% from recent pre-correction levels
■ The correlation between bond yields and equities depends on the driver: inflation (-) or real rates (+). Contrary to popular notions that higher bond yields mean lower equities, the historical relationship between bond yields and equities has been ambiguous (Long Cycles In The Bond-Equity Correlation, May 2014). Instead, the impact of higher yields on equities depends on whether they reflect higher inflation (-) which has always been negative for equities; or whether higher yields reflect higher real rates (+) which have always been positive for equities until real rates reached very high levels (greater than 4%--seen only once during the Volcker disinflation) (Do Higher Rates Mean Lower Equity Multiples? Sep 2014).
■ Why is higher inflation negative for equity valuations? When inflation moves up, the hurdle rate for all nominal investments moves up and in turn bond yields and earnings yields (inverse of the equity multiple) move up.
■ A 1pp rise in inflation compresses multiples by 1 point. A majority (70%) of the historical variation in the S&P 500 multiple is explained by its drivers: earnings/normalized levels (-); payouts (+); rates broken up into inflation (-) and real rates (+); and macro vol (-). Our estimates imply that a 1pp rise in inflation lowers the equity multiple by 1 point or a 5% decline in prices from the recent peak. Our house view and the consensus sees a somewhat smaller rise in inflation over the next 2 years. These ranges of increases in inflation imply a modest pullback in equities that would put it within the bands of normal 3-5% pullbacks that have historically occurred every 2-3 months.
Is the inflection in inflation a leading indicator of the end of the cycle? How long is the lead? On average 3 years, but the Fed’s reaction is key
With an average correction in equities of 21% around recessions, the timing of the next one is obviously key. If the recent uptick marks the typical mid- to latecycle inflection up in inflation, how long after did the next recession typically occur? On average 3 years, which would put it in late 2020. But the timing is likely determined critically by the Fed’s reaction. Historically, a Fed rate-hiking cycle preceded most recessions since World War II, with recessions occurring only after the Fed moved rates into contractionary territory. Arguably the Fed did this only after it was convinced the economy was overheating and it continued hiking until the economy slowed sufficiently or went into recession. At the current juncture, core inflation has remained below the Fed’s target of 2% for the last 10 years and several Fed officials have argued for symmetry in inflation outcomes around the target, i.e., to tolerate inflation above 2%. It is thus likely that the Fed will welcome the rise in inflation for now and simply stick to its current guidance, possibly moving it up modestly.
How high will inflation go? If inflation expectations remain range bound, core PCE inflation will stay within its narrow band of 1-2.3% in which it has been for the last 23 years
Outside the Great Inflation of 1968-1995, core PCE inflation has remained in a remarkably narrow band (Six Myths About Inflation, Oct 2017). The period since 1996 encompassed 3 business cycles that saw unemployment fluctuate between 3.8% and 10%; the dollar rise and fall by 40% more than once; oil prices rise 7-fold and almost completely reverse. Yet inflation remained in a narrow band unusual for an economic time series. Indeed, with a standard deviation of 35 bps, much of the range of variation in inflation since 1996 cannot be differentiated from the normal noise inherent in macro data.
The stability of inflation across large business- dollar- and oil-cycles in our view reflects the stability of inflation expectations which are the only driver of inflation over the long run. Inflation expectations have been stable since the mid-1990s, fluctuating for most of the last 23 years in a tight 50bps range and for most of it in an even narrower 30bps range. Following the dollar and oil shocks of 2014-2015, inflation expectations fell out of and are still 20bps below this range and 50bps below average. Absent large unexpected and persistent shocks, inflation expectations evolve slowly. It has in fact been difficult for policy makers to effect changes in inflation expectations as the recent experience of Japan and  the 10-year miss on the core PCE inflation target in the US illustrate (Six Myths About Inflation, Oct 2017).
What about all the stimulus? The impact of the stimulus will follow a pickup in growth with long lags (1½ years)
It is well known that inflation responds with long lags to growth, a tightening labor market and the dollar. Consider that the correlation between real GDP growth and core CPI inflation is a modest positive 5%. But when GDP growth is lagged by 6 quarters, the correlation jumps to a much stronger 80%. The lagged relationship implies that a sustained 1pp increase in GDP growth raises core inflation by 20bps after 1½ years. Our house forecast for GDP growth which is above consensus implies GDP growth of near 3% and core inflation peaking around 2.2% in 2020.
Growth outcomes significantly above our house view would need to materialize and sustain to raise inflation above and outside the band of the last 23 years. Moreover there would be plenty of lead time with growth needing to sustain at high levels for a prolonged period (1½ years) before it moved inflation up."  - source Deutsche Bank
As we repeated in numerous conversation, for a bear market to materialize you would need a significant pick-up in inflation for your "buckling" to occur and to lead to a significant repricing of risky asset prices such as equities and US High Yield. But what is very interesting to us is that the buildup in the trade war rhetoric coming from the US could be a harbinger for higher inflation down the line given that companies would most likely increase their prices with rising import prices that would be passed on already stretched consumers thanks to solid use of the credit cart (nonrevolving credit). 
 
In our recent conversation "Bracket creep", which describes the process by which inflation pushes wages and salaries into higher tax brackets, leading to a fiscal drag situation, we indicated that with declining productivity and quality with wages pressure building up, this could mean companies, in order to maintain their profit margins would need to increase their prices. To repeat ourselves "Protectionism", in our view, is inherently inflationary in nature. 
 
To preserve corporate margins, output prices will need to rise, that simple, and it is already happening. This can have a significant impact on earnings particularly when the S&P 500 Net Income Margins LTM is at close to record levels as indicated in Deutsche Bank's note:
"Inflation and earnings
Is inflation bad for margins and earnings? Historically, higher inflation has been associated with higher margins and strong earnings growth
Conceptually, higher inflation is ambiguous. From a pricing vs cost perspective, whether higher inflation leads to higher or lower margins depends on the relative strengths of price vs wage and other input cost inflation. It depends on the relative importance of variable vs fixed costs. And on the extent to which corporates can increase productivity in response to cost pressures. It is notable that while markets seem to have been surprised by the recent uptick in wage inflation, corporates have been noting it for at least a year. Finally, inflation does not occur in a vacuum. The drivers of higher inflation matter and when it reflects strong growth, it implies not only higher sales but operating leverage from fixed costs can raise margins and amplify the impact on earnings.
Historically, the empirical evidence is unambiguous. Higher inflation was clearly associated with higher margins and strong earnings growth.
- source Deutsche Bank
 
With the S&P 500 Net Income Margins LTM close to record levels and with the recent rise in prices operated by companies recently, it remains to be seen how long can margin levels remain this elevated. Sure, the fiscal boost provided by the US government should provide additional support yet the big question for us is relative to the US consumer and its sensitivity to rising prices as we discussed in the final point of our conversation "Harmonic tremor". Have we seen peak "Consumer confidence" and peak PMIs recently? One thing for certain is that Citigroup’s US Economic Surprise Index (CESIUSD Index) as an indicator of economic momentum has started to "buckle" recently. There is a clear relationship between the CITI's Economic Surprise Index and the Fed's monetary policy. When the Fed is in tightening mode, good news such as rising inflation expectations is generally seen as bad news. In spread terms, only high yield is sensitive to macro surprises. Moreover, the response of high yield spreads to macro surprises is "monotonic" in ratings: the lower the rating, the stronger the response. In our conversation "A shot across the bows", we indicated the following when it comes the Citi Economic Surprise Index (CESI). It could potentially indicate that economic fundamentals are trading ahead of themselves and could portend some credit spreads widening in the near future given there is a reasonably strong relationship between the inverse of Citigroup Economic Surprise Index and both the IG CDX and HY CDX. So all in all, you want to watch what the CESI does in the coming weeks and months. 
 
But moving back to the impact of the "Big Bad Wolf" aka inflation on equity multiples, we read with interest as well the other part of Deutsche Bank's report on the impact inflation can have:
"Inflation and equity multiples
Does higher inflation mean lower equity multiples? By how much? A 1 pp rise in inflation compresses equity multiples by 1 point or a decline in prices of around 5% from recent pre-correction levels
■ The correlation between bond yields and equities depends on the driver: inflation (-) or real rates (+). Contrary to popular notions that higher bond yields mean lower equities, the historical relationship between bond yields and equities has been ambiguous (Long Cycles In The Bond-Equity Correlation, May 2014). Instead, the impact of higher yields on equities depends on whether they reflect higher inflation (-) which has always been negative for equities; or whether higher yields reflect higher real rates (+) which have always been positive for equities until real rates reached very high levels (greater than 4%--seen only once during the Volcker disinflation) (Do Higher Rates Mean Lower Equity Multiples? Sep 2014).
Why is higher inflation negative for equity valuations? When inflation moves up, the hurdle rate for all nominal investments moves up and in turn bond yields and earnings yields (inverse of the equity multiple) move up.
■ A 1pp rise in inflation compresses multiples by 1 point. A majority (70%) of the historical variation in the S&P 500 multiple is explained by its drivers: earnings/normalized levels (-); payouts (+); rates broken up into inflation (-) and real rates (+); and macro vol (-). Our estimates imply that a 1pp rise in inflation lowers the equity multiple by 1 point or a 5% decline in prices from the recent peak. Our house view and the consensus sees a somewhat smaller rise in inflation over the next 2 years. These ranges of increases in inflation imply a modest pullback in equities that would put it within the bands of normal 3-5% pullbacks that have historically occurred every 2-3 months.
- source Deutsche Bank
 
Obviously from a "buckling" perspective the big question is whether higher yields reflect higher real rates (+) which have always been positive for equities until real rates reached very high levels, or, are they reflecting a higher inflation risk, in which case the repricing could be more severe as the Fed would probably step up on its hiking gear. For the positive momentum to hold and goldilocks environment to continue, you would need inflation and growth not running too hot, so that the Fed can gradually hike rather than stepping up its hiking pace. This is as well clearly highlighted by Charlie Bilello from Pension Partners in his blog post from the 15th of February entitled "Inflation, deflation and stock returns".
 
Again, it is a matter of "velocity" in the movement. An exogenous factor such as a geopolitical event that would trigger a sudden and rapid rise in oil prices would of course upset the situation and be much more negative for equities as we saw with the huge rise in oil prices prior to the Great Financial Crisis (GFC) of 2008.
 
One might therefore rightly ask if indeed inflation could be a leading indicator for recession. This is also a point which has been discussed in Deutsche Bank's very interesting note:
"Inflation as a leading indicator of recession
Is the inflection in inflation a leading indicator of the end of the cycle? How long is the lead? On average 3 years, but the Fed’s reaction is key
With an average correction in equities of 21% around recessions, the timing of the next one is obviously key. If the recent uptick marks the typical mid- to latecycle inflection up in inflation, how long after did the next recession typically occur? On average 3 years, which would put it in late 2020. But the timing is likely determined critically by the Fed’s reaction. Historically, a Fed rate-hiking cycle preceded most recessions since World War II, with recessions occurring only after the Fed moved rates into contractionary territory. Arguably the Fed did this only after it was convinced the economy was overheating and it continued hiking until the economy slowed sufficiently or went into recession. At the current juncture, core inflation has remained below the Fed’s target of 2% for the last 10 years and several Fed officials have argued for symmetry in inflation outcomes around the target, i.e., to tolerate inflation above 2%. It is thus likely that the Fed will welcome the rise in inflation for now and simply stick to its current guidance, possibly moving it up modestly.
- source Deutsche Bank
 
It is most likely that the Fed's hiking process was due to its fear of not being behind the curve when it comes to rising inflation. Yet with a yield curve flattening and loose financial conditions in conjunction with renewed fear of a trade war that would entail pricing pressure and imported inflation with a bear market in the US dollar, there is indeed a big risk in having the Fed having to move at a more rapid pace than it would like to. The balancing act of the Fed is incredibly difficult but, it boast a first mover advantage other the likes of the ECB and the Bank of Japan. Volatility might have been repressed but in all honesty, it is in Europe where the repression has been the most acute as it can be seen in government bond yields.
 
The big question surrounding the potential lethality of the "Big Bad Wolf" aka inflation lies in the velocity of inflation expectations. On that specific point, Deutsche Bank gives us additional food for thoughts in their lengthy note:
"Inflation and inflation expectations
How high will inflation go? If inflation expectations remain range bound, core PCE inflation will stay within its narrow band of 1-2.3% in which it has been for the last 23 years
■ Outside the Great Inflation of 1968-1995, core PCE inflation has remained in a remarkably narrow band (Six Myths About Inflation, Oct 2017). The period since 1996 encompassed 3 business cycles that saw unemployment fluctuate between 3.8% and 10%; the dollar rise and fall by 40% more than once; oil prices rise 7-fold and almost completely reverse. Yet inflation remained in a narrow band unusual for an economic time series. Indeed, with a standard deviation of 35 bps, much of the range of variation in inflation since 1996 cannot be differentiated from the normal noise inherent in macro data.
■ The stability of inflation across large business- dollar- and oil-cycles in our view reflects the stability of inflation expectations which are the only driver of inflation over the long run. Inflation expectations have been stable since the mid-1990s, fluctuating for most of the last 23 years in a tight 50bps range and for most of it in an even narrower 30bps range. Following the dollar and oil shocks of 2014-2015, inflation expectations fell out of and are still 20bps below this range and 50bps below average. Absent large unexpected and persistent shocks, inflation expectations evolve slowly. It has in fact been difficult for policy makers to effect changes in inflation expectations as the recent experience of Japan and the 10-year miss on the core PCE inflation target in the US illustrate (Six Myths About Inflation, Oct 2017).
- source Deutsche Bank
 
As long as growth and inflation doesn't run not too hot, the goldilocks environment could continue to hold for some months provided, as we mentioned above there is no exogenous factor from a geopolitical point of view coming into play which would trigger an acceleration in oil prices. Though, in similar fashion to volatility, the game can continue to be played provided "implicit inflation" or "inflation expectations" remain below "realized" inflation. In similar fashion to the demise of the short-vol trade, if there is a change in the 23 years narrative and suddenly "realized" inflation is above "expectations" then obviously this would be another grain of sand that could trigger some new avalanches in financial markets. We are not there yet we think.
 
Finally in our final chart below, given the late stage of the credit game, we think it is becoming essential to track any changes in credit availability in the months ahead given our loose financial conditions have been and the flattening of the US yield curve.
 
  • Final chart - Afraid of buckling? Watch credit availability
We have long posited that "Credit availability" is essential and a good predictor of upcoming defaults as far as US High Yield is concerned. The most predictive variable for default rates remains credit availability and if credit availability in US dollar terms vanishes, it could portend surging defaults down the line. The quarterly Senior Loan Officer Opinion Surveys (SLOOs) published by the Fed are very important to track. The SLOOS report does a much better job of estimating defaults when they are being driven by a systemic factor, such as a turn in business cycle or an all-encompassing macro event. Tightening in credit standards in conjunction with rate hikes will eventually weight on High Yield, and we are already seeing some fund outflows in the asset class (15th consecutive week). Our final chart comes from CITI Global Economics View note from the 23rd of February entitled "How Could Equity Sell-offs Affect Global Growth" and displays US Non-financial corporations Debt Outstanding as a percentage of GDP and AAA-BBB Effective Yield Spread for Industrial Corporate Bonds (1997-2017):
"What to watch?Given that a tightening in financial conditions poses a risk to the outlook, we would monitor:
  • The durability of the sell-off: that’s rather obvious – a brief period of financial tightening is unlikely to have any material implications on the real economy.
  • Credit availability and credit spreads: given the stage of the business cycle, prospects for higher inflation, and lower monetary accommodation in advanced economies, we think credit availability and credit spreads amid high leverage across some sectors and economies are key indicators to assess whether financial conditions are starting to feed through to economic activity (Figure 6).

 

  • Sentiment measures: measures of household and business sentiment are at very high levels across most AEs. A decline in sentiment would probably be a precursor to some moderation in spending intentions, even though the relationship between consumer sentiment and real consumption appears to have declined in recent years." - source CITI
If further loading of the credit mouse trap will eventually cause significant and somewhat unpredictable deformations, possibly leading to complete loss of the member's load-carrying capacity, low recoveries and significant losses for credit investors, when it comes to assessing a potential "buckling" in the credit markets, apart from the "Big Bad Wolf" aka inflation being the enemy of volatility and leverage, credit availability is an essential part of the credit cycle.
 
Stay tuned!
 
 
 
Courtesy of Macronomy

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Market Predictions For 2018? Bring 'Em On!

Saxo Bank has a few

Naturally, predictions like this are more for bank PR than education but they have some value.

For one, they're a reminder that unexpected, huge and unpredictable moves happen in markets. And they happen far more often than we expect.

The thing is, they usually happen somewhere you least expect.

As for this set of predictions, let's hope this trader is you (from the report):

"World markets are increasingly full of signs and wonders, and the collapse of volatility seen across asset classes in 2017 was no exception. The historic lows in the VIX and MOVE indices are matched by record highs in stocks and real estate, and the result is a powder keg that is set to blow sky-high as the S&P 500 loses 25% of its value in a rapid, spectacular, one-off move reminiscent of 1987. A whole swathe of short volatility funds are completely wiped out and a formerly unknown long volatility trader realises a 1000% gain and instantly becomes a legend."

Courtesy of ForexLive

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The Fastest Growing Brands Of 2017

In a modern business era of near-constant disruption, which brands are winning the hearts of consumers the fastest?

Today’s charts look at the brands that are trending upwards. See below for the brands that have gained the most in brand value since last year, as assessed by BrandZ in their report on the world’s 100 most valuable brands.

Onwards and Upwards for Tech

As many big name brands try to find their footing in today’s fast-paced consumer environment, it’s not surprising to see up-and-coming tech brands skyrocketing in value.

Biggest Movers in Tech

In line with growing revenues, tech brands like Amazon, Facebook, and Netflix are also flying high with their brands. Amazon, for example, had its brand value soar 41% since last year to make it the fourth most valuable brand in the world at $139 billion. Chinese tech companies are gaining traction in the eyes of consumers as well, with Tencent and Alibaba both growing their brand values at clips of 20% or higher.

Note: the measure of “brand value”, not to be confused with company valuation metrics like market cap, is a way of quantifying the dollar value that a particular brand’s image is contributing to the overall value of a corporation.

Other Big Movers

Although tech brands seem to be moving up the list in unison, it’s also worth examining the brands in other sectors that have seen their brand values rapidly increase.

Biggest Movers in Tech

The brands seen here have some interesting commonalities and points worth noting.

Firstly, despite not being a tech brand, Adidas was actually the fastest-growing brand in the whole report with a 58% increase in brand value from 2016 to 2017. According to the analysis, the apparel brand saw its retro sneakers “connect perfectly” with the fashion moment.

Next, alcohol brands also generally performed admirably. Three of the brands that had double-digit growth were owned by the world’s largest beer company, AB InBev – and two of those brands (Skol and Brahma) are Brazilian. Further, Kweichow Moutai, a Chinese liquor maker that surpassed Diageo earlier this year in market capitalization, is also rising fast.

Also of interest is that two 3G Capital restaurant brands, Burger King and Tim Horton’s, happened to increase substantially in brand value. Of course, 3G Capital owns a stake in the aforementioned AB InBev as well.

New Entrants

The following brands are the newest entrants on the 2017 edition of the top 100 list:

Biggest Movers in Tech

However, as we transition into 2018, these new entrants may have very different fortunes ahead of them.

On one hand, Salesforce has been outlining when it’ll hit $20 billion in sales, and Netflix is still crushing expectations for subscription growth.

On the opposite side of the spectrum, Snap Inc. recently reported slow user growth, which made shares tumble 18% in value. The company’s platform, Snapchat, is locked in a battle with Instagram for users, and it remains to be seen how this will affect both company and brand values down the road.

Courtesy of VisualCapitalist

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There is no shortage of cognitive biases out there that can trip up our brains.

By the last count, there are 188 types of these fallible mental shortcuts in existence, and they constantly impede our ability to make the best decisions about our careers, our relationships, and for building wealth over time.

Biases That Plague Investors

In today’s infographic from StocksToTrade, we dive deeper into five of these cognitive biases – specifically the ones that really seem to throw investors and traders for a loop.

Next time you are about to make a major investing decision, make sure you double-check this list!

Courtesy of: Visual Capitalist

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All of the World’s Money and Markets

When we talk about the giant size of Apple, the fortune of Warren Buffett, or the massive amount of global debt accumulated – all of these things sound large, but they are actually extremely different in magnitude.

That’s why visualizing things spatially can give us a better perspective on money and markets.

How Much Money Exists?

This infographic was initially created to show how much money exists in its different forms. For example, to highlight how much physical cash there is in comparison to broader measures of money which include saving and checking account deposits.

Interestingly, what is considered “money” depends on who you are asking.

Are the abstractions created by Central Banks really money? What about gold, bitcoins, or other hard assets?

A New Meaning

However, since we first released this infographic in 2015, “All the World’s Money and Markets” has taken on a different meaning to us and many others. It’s a way of simplifying a complex universe of currencies, assets, and other financial instruments in a way that people can understand.

Numbers represented in the data visualization range from the size of the above-ground silver market ($17 billion) to the notional value of all derivatives ($1.2 quadrillion as a high-end estimate). In between those two extremes, we’ve added many other familiar measures, such as the GDP of California, the value of equities, the real estate market, along with different money supply metrics to give perspective.

The end result? A visually pleasing, but enlightening new way to understand the vast universe of global assets.

Courtesy of: Visual Capitalist

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Will Credit Cause A Slowdown

Saxo Bank thinks a slowdown in credit growth is bad news

IF THERE is a consensus at the moment, it is that the global economy is finally managing a synchronised recovery. The purchasing managers' index for global manufacturing is at its highest level for six years; copper, the metal often seen as the most sensitive to global conditions, is up by a quarter since May

But Steen Jakobsen of Saxo Bank thinks this strength will not last. His leading indicator is a measure of the change in private sector credit growth. This peaked at the turn of the year and is now heading down sharply. Indeed the change in trend is the most negative since the financial crisis (see chart). Since this indicator leads the economy by 9-12 months, that suggests a significant economic slowdown either late this year or early  in 2018. He says that

This call for a significant slowdown coincides with several facts: the ECB’s QE programme will conclude by end-2017 and will at best be scaled down by €10 billion per ECB meeting in 2018.  The Fed, for its part, will engage in quantitative tightening with its announced balance sheet runoff. All in all, the market already predicts significant tightening by mid-2018.

Given the role played by central banks in propping up the economy and markets since 2009, it is certainly plausible that their role will be vital in ending the recovery.  And while copper is a good leading indicator, so is the bond market. At the turn of the year, most people thought the ten-year government bond yield would rise as a Trump stimulus fulled the global recovery; the yield is now 2.06%, down from 2.44%.

Courtesy of TheEconomist

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Market Complexity Could Trigger the Next Crash

Complex systems are all around us.

By one definition, a complex system is any system that features a large number of interacting components (agents, processes, etc.) whose aggregate activity is nonlinear (not derivable from the summations of the activity of individual components) and typically exhibits hierarchical self-organization under selective pressures.

In today’s infographic from Meraglim we use accumulating snow and an impending avalanche as an example of a complex system – but really, such systems can be found everywhere. Weather is another complex system, and ebb and flow of populations is another example.

Markets are Complex Systems

Just like in the avalanche example, where various factors at the top of a mountain (accumulating volumes of snow, weather, temperature, geology, gravity, etc.) make up a complex system that is difficult to predict, markets are similarly complex.

In fact, markets meet all the properties of complex systems, as outlined by scientists:

1. Diverse
System actors have different points of view. (i.e. bullish, bearish, long, short, leveraged, non-leveraged, etc.)

2. Connected
Capital markets are over-connected, and information spreads fast. (i.e. chat rooms, phone calls, emails, Thomson Reuters, Dow Jones, Bloomberg, trading systems, order entry systems, etc.)

3. Interaction
Trillions of dollars of securities are exchanged in transactions every day (i.e. stocks, bonds, currencies, derivatives, etc.)

4. Adaptive Behavior
Actors change their behavior based on the signals they are getting (i.e. making or losing money, etc.)

And like the avalanche example, where a single snowflake can trigger a much bigger event, there are increasing signs that the complexity behind the stock market has also reached a critical state.

Markets in a Critical State

Here are just some examples that show how the market has entered into an increasingly critical state:

Record-Low Volatility
The VIX, an index that aims to measure the volatility of the market, hit all-time lows this summer.

Bull Market Length
Meanwhile, the current bull market (2009-present) is the second-longest bull market in modern history at 3,109 days. The only bull market that was longer went from the 1987 crash to the Dot-com bust.

Valuations at Highs
Stock valuations, based on Robert Schiller’s CAPE ratio (which looks at cyclically-adjusted price-to-earnings), are approaching all-time highs as well. Right now, it sits 83.3% higher than the historical mean of 16.8. It was only higher in 1929 and 2000, right before big crashes occurred.

Market Goes Up
Investor overconfidence leads investors to believe the market only goes up, and never goes down. Indeed, in this bull market, markets have gone up 67 of the months (an average gain of 3.3%), and have gone down only 34 months (average drop of -2.6%).

Here are some additional signs of systemic risk that make complex markets less stable:

  • A densely connected network of bank obligations and liabilities
  • Over $70 trillion in debt added since Financial Crisis
  • Over $1 quadrillion in notional value of derivatives
  • Non-bank shadow finance through hedge funds and securitization make risk impossible to measure
  • Increased leverage of banks in some markets
  • Greater concentration of financial assets in fewer companies

In other words, there are legitimate reasons to be concerned about “snow” accumulation – and any such “snowflake” could trigger the avalanche.

In complex dynamic systems that reach the critical state, the most catastrophic event that can occur is an exponential function of scale. This means that if you double the system, you do not double the risk; you increase it by a factor of five or 10

– Jim Rickards, author of Road to Ruin

The Next Snowflake

What could trigger the next avalanche? It could be anything, including the failure of a major bank, a natural disaster, war, a cyber-financial attack, or any other significant event.

Such “snowflakes” come around every few years:

1987: Black Monday
The Dow fell 508 points (-22.6%) in one day.

1994-95: The Mexican peso crisis
Systemic collapse narrowly avoided when the U.S. government bailed out Mexico using the controversial $20 billion “Exchange Stabilization Fund”.

1997: Asian financial crisis
East Asian currencies fell in value by as much as -38%, and international stocks by as much as -60%.

1998: Long Term Capital Management
Hedge fund LTCM was in extreme distress, and within hours of shutting down every market in the world.

2000: The Dotcom crash
Nasdaq fell -78% in 30 months after early Dotcom companies crashed and burned.

2008: Lehman Brothers bankruptcy
Morgan Stanley, Goldman Sachs, Bank of America, and J.P. Morgan were days away from same fate until government stepped in.

Shelter from the Avalanche

The Fed and mainstream economists use equilibrium theory, regressions, and correlations to quantify the markets. And while they pay lip-service to black swans, they don’t have a good way of forecasting them or predicting them.

Markets are complex – and only complexity theory and predictive analytics can help to shed light on their next move.

Alternatively, investors can seek shelter from the storm by investing in assets that cannot be digitally frozen (bank accounts, brokerage accounts, etc.) or have their value inflated away (cash, fixed-income). Such assets include land, precious metals, fine art, and private equity.

Courtesy of: Visual Capitalist

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China Plans To Ban Sales Of Fossil Fuel Cars Entirely

China’s big electric vehicle push is about to get even bigger: The country is planning to end the sale of fossil fuel-powered vehicles entirely, with regulators working currently on a timetable of when the ban will ultimately take effect, according to Bloomberg.

China is the world’s largest auto market, with 28.03 million vehicles sold last year, a boost in demand of 13.7 percent vs. 2015 sales numbers. The nation has already done a lot to incentivize manufacturers to develop and sell new EVs, including allowing foreign automakers to create a third joint venture with local automakers (a standard requirement for doing business in the country for auto OEMs) so long as it’s dedicated to the creation of EVs exclusively.

The government has also created a number of incentive programs for OEMs, including subsidies. This will add to its positive efforts to drive more EV sales in China with the ultimate negative condition on the other side – at some point, automakers just won’t be able to do business at all in the country if they’re still selling a mix of fossil fuel and electrified vehicles.

This isn’t the first time a governing body has said it would eventually phase out the sale of traditional fuel vehicles: France said it will stop selling fossil fuel cars by 2040 in July, and the UK has committed to the same timeline for sales of those vehicles.

Critics have suggested that a ban on fossil fuel vehicles is likely impractical, because it would stretch an already taxed supply chain, which has some hard limits in terms of the volume of lithium available for lithium-ion battery cells, for instance. But automakers are already responding to this rising trend with expanded EV model lineups and, in the case of Volvo for instance, plans to eventually sell exclusively all-electric or hybrid cars.

China’s timeline for establishing this ban will be crucial in terms of how quickly we see the global shift to EVs occur, as it’s going to be an immense lever in terms of automaker strategic planning internationally, as well as in the country.

Courtesy of TechCrunch

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Well, here it comes—September. It’s widely considered the worst month of the year for equities for good reason since it has historically seen the worst performance. Per Ryan Detrick, Senior Market Strategist, “September is the banana peel month, as some of the largest dips tend to take place during this month. Although the economy is still quite strong, this doesn’t mean some usual September volatility is out of the question—in fact, we’d be surprised it volatility didn’t pick up given how calm things have been this year.”

With the Federal Reserve, Bank of Japan, and the European Central Bank all set to announce interest rate decisions this month, and the S&P 500 Index up on a total return basis nine consecutive months as of the end of July, the stage is set for some fireworks in September.

Here’s some data to consider as September approaches:

• Since 1928, no month sports a lower average return than September, with the S&P 500 down 1.0% on average. February and May are the only other months that are generally in the negative, while July surprisingly tends to be the strongest month of the year.

• Since 1928, the S&P 500 has been higher in September only 43.8% of the time, which is by far the lowest amount—as no other month is less than 50%. December is up most often at 73.0%.

• Since 1950, September has been the worst month of the year down 0.5%, while the past 20 years it has been the second weakest month, with August faring worse.

• The worst September ever for the S&P 500 resulted in a 30% drop in 1931. In fact, no other month has had more 10% drops than September at seven. Interestingly, January is the only month that has never been down 10% or more.

• Over the past 10 years, September has been positive on average, with the S&P 500 up 0.1%. But it is worth noting that September has been lower each of the past three years.

• Since 1950, if the S&P 500 starts the month of September above its 200-day moving average (like 2017 will), it tends to do much better, as it is up 0.4% on average versus down 2.7% if it starts the month below the 200-day moving average.

• Last, August is historically a weak month as well. Generally, when the S&P 500 is lower in August what we tend to see in September is that the month is down as well. On average it’s been down 0.4%, right in line with the average monthly return.

IMPORTANT DISCLOSURES
*Please note: The modern design of the S&P 500 stock index was first launched in 1957. Performance back to 1950 incorporates the performance of predecessor index, the S&P 90.
The economic forecasts set forth in the presentation may not develop as predicted.
The S&P 500 Index is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.
The 200-day moving average (MA) is a popular technical indicator which investors use to analyze price trends. It is the security or index’s average closing price over the last 200 days.

Courtesy of lplResearch

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