Deficit Spending & Employment Archives - Page 7 of 14

October 19, 2019October 19, 2019

ASX and 3 headwinds

Despite recent strong performance, investor enthusiasm may be cooling, with the Australian economy facing three headwinds.

Declining Household Spending

Household income growth is faltering and weighing down consumption. Household spending would have fallen even further, dragging the economy into recession, if households were not digging into savings to maintain their living standards.

Australia: Disposable Income, Consumption and Savings

But households are only likely to draw down on savings when housing prices are high. Commonly known as the “wealth effect” there is a clear relationship between household wealth and consumption. If housing prices were to continue falling then households are likely to cut back on spending and boost savings (including higher mortgage repayments).

Consumption is one of the few remaining contributors to GDP growth. If that falls, the economy is likely to go into recession.

Australia: GDP growth contribution by sector

Housing Construction

The RBA is desperately trying to prevent a further fall in house prices because of the negative effect this will have on household spending (consumption). But rate cuts are not being passed on to borrowers, and households are maintaining their existing mortgage repayments (increasing savings) if they do benefit, rather than increasing spending.

House prices ticked up after the recent fall, in response to RBA interest rate cuts. But Martin North reports that the recovery is only evident in more affluent suburbs with lower mortgage exposure (e.g. Eastern suburbs in Sydney) and that newer suburbs and inner city high-density units are experiencing record levels of mortgage stress.

Housing

Building approvals reflect this, with a down-turn in detached housing and a sharp plunge in high density unit construction.

Dwelling investment is likely to remain a drag on GDP growth over the next year.

Falling Commodity Prices

Iron ore and coal, Australia’s two largest commodity exports, are falling in price as the global economic growth slows. Dalian Commodity Exchange’s most-traded iron ore contract , with January 2020 expiry, closed at 616 yuan ($86.99) per tonne, close to a seven-month low. Falling prices are likely to inhibit further mining investment.

Iron Ore and Coal Prices

Metals & Mining

The ASX 300 Metals & Mining index is testing long-term support at 4100. Breach would complete a head and shoulders reversal, with a target of 3400.

ASX 300 Metals & Mining

Financials

The Financial sector recovered this year, trending upwards since January, but faces a number of issues in the year ahead:

customer remediation flowing from issues exposed by the Royal Commission;
net interest margins squeezed as the RBA lowers interest rates;
continued pressure to increase capital ratios are also likely to impact on dividend payout ratios;
low housing (construction and sales) activity rates impact on fee income; and
high levels of mortgage stress impact on borrower default rates.

ASX 200 Financials index faces strong resistance at 6500. There is no sign of a reversal at present but keep a weather eye on primary support at 6000. We remain bearish in our outlook for the sector and breach of 6000 would warn of a primary decline with a target of 5200.

ASX 200 Financials

REITs are experiencing selling pressure despite an investment market desperate for yield. Dexus (DXS) may be partly responsible after the office and industrial fund reported a 26% profit fall in the first half of 2019.

ASX 200 REITs

ASX 200

The ASX 200 is showing signs of (secondary) selling pressure, with a tall shadow on this week’s candle and a lower peak on the Trend index. Expect a test of support at 6400; breach would offer a target of 5400.

ASX 200

We maintain exposure to Australian equities at 22% of portfolio value, with a focus on defensive and contra-cyclical stocks, because of our bearish outlook.

October 12, 2019October 12, 2019

S&P 500 and Europe: New deal or a false dawn?

Donald Trump and is making noises about an interim trade deal with the CCP, while Boris Johnson appears to be making progress on a Brexit deal with Ireland premier Leo Varadkar.

Trump’s announcement is little more than a sham, intended to goose financial markets, with nothing yet committed to writing:

“Trump said the deal would take three to five weeks to write and could possibly be wrapped up and signed by the middle of November….”

…what could possibly go wrong?

The economy continues to tick along steadily, with unemployment and initial jobless claims near record lows.

Unemployment & Initial Jobless Claims

But high levels of uncertainty are likely to create a drag on consumer spending and stock earnings.

At the outset of Donal Trump’s presidency, value investor Seth Klarman, who runs the $30 billion Baupost Group hedge fund, predicted the impact that Trump would have on financial markets:

“The erratic tendencies and overconfidence in his own wisdom and judgment that Donald Trump has demonstrated to date are inconsistent with strong leadership and sound decision-making…..

The big picture for investors is this: Trump is high volatility, and investors generally abhor volatility and shun uncertainty…. Not only is Trump shockingly unpredictable, he’s apparently deliberately so; he says it’s part of his plan.”

In his letter, Mr Klarman warned: “If things go wrong, we could find ourselves at the beginning of a lengthy decline in dollar hegemony, a rapid rise in interest rates and inflation, and global angst.”

While not entirely prescient — we have low interest rates and low inflation — Klarman was right about the decline in dollar hegemony and the rise in global angst.

Markets are clearly in risk-off mode.

US Equity ETFs recorded a net outflow of $824m this week, compared to a net inflow of $2,104m into US Fixed Income. Year-to-date flows present a similar picture, with a 3.3% inflow into US Equity compared to 13.9% into US Fixed Income (Source: ETF.com).

ETF Flows YTD

Long tails on the S&P 500 candles indicate buying support. Expect another test of our long-term target at 3000. Volatility remains above 1%, however, indicating elevated risk. Breach of 2800 is unlikely at present but would offer a target of 2400.

S&P 500

According to Factset, the S&P 500 is likely to report a third quarter this year with a year-on-year decline in earnings.

The Nasdaq 100 paints a similar picture, with another test of 8000 likely.

Nasdaq 100

It is becoming impossible to justify current heady earnings multiples when reported earnings are declining.

Europe

If Johnson’s “free trade zone” for Northern Ireland can break the Brexit impasse, then there may be room for optimism over the future UK – EU relationship.

Europe seems to be stirring. Trailing a distant third, to North America and Asia in terms of investment performance, there are some early encouraging signs. A higher trough indicates buying pressure and breakout above 400 on DJ Stoxx Euro 600 would signal a primary advance.

DJ Euro Stoxx 600

The Footsie shows similar early signs of a potential recovery. A higher trough on the trend Index indicates buying pressure. Breakout above 7600 would signal a primary advance.

FTSE 100

Let us hope that this is not a false dawn and the UK and EU are able to resolve their differences.

For the present, our outlook for the global economy remains bearish and equity exposure for International Growth is a low 34% of portfolio value.

October 9, 2019October 12, 2019

Ultra-low interest rates may lead to a ‘debt trap’

The highly-regarded Stephen Bartholomeusz warns that central bank policies may lead to a ‘debt trap’:

“….With the world apparently re-starting the use of unconventional monetary policies even before central banks have extricated themselves from the legacies of a decade of those policies, there is a real risk that the impacts and the threats posed by their side effects will swell and that the world will be caught within what the BIS has previously described as a “debt trap’’ with no exit.

The other disturbing aspect of the [BIS] report is that it repeatedly says it is too early to assess the longer-term implications of the policies the central banks have employed.

Central bankers respond to the latest data – they respond to short-term signals – but the side-effects of their post-crisis policies have already been building for a decade and will continue to build while they maintain ultra-low or negative policy rates and keep buying bonds and other fixed interest securities to depress longer-term interest rates and suppress risk premia.

How those side-effects are unwound and how the banks extricate themselves from their policies and the legacies of those policies won’t be known until they try, but the potential for another crisis has been increased by the big surge in global leverage and the elevated asset prices the policies have encouraged.

Negative rates and quantitative easing and variations on those themes might, as the BIS report says, be useful additions to central bankers’ toolboxes but the past decade has shown they aren’t by themselves a panacea for economic ills and they bring with them potentially unpleasant side effects the longer they are in place.”

Debt traps occur when the interest rate needed to service the government debt is greater than the growth rate of GDP, according to former Fed governor Robert Heller:

“…In such a situation, debt service obligations grow more rapidly than the economy; eventually, the accumulated debt can no longer be serviced properly. In other words, the dynamics of the situation become unsustainable and a death spiral ensues.”

So far, central banks have responded by driving interest rates to record lows but unintended consequences are emerging, with low interest rates leading to low GDP growth. A feedback loop is emerging:

- Low interest rates

Australia: 10-Year Bond Yield

- Low bank interest margins

Australia: Bank Net Interest Margins

- Low credit growth

Australia: Credit & Broad Money Growth

- Low inflation

Australia: Underlying Inflation

- And low economic growth

Australia: GDP Growth

We are venturing where angels fear to tread: central banks trialing new policies without empirical evidence as to their long-term consequences.

Monetary policy should be administered judiciously, intervening only when the financial system is in dire straits, outside the realm of the regular business cycle. Instead monetary policy is treated as a panacea, the constant drip-feed building a long-term dependence on further stimulus.

The problem with ‘traps’ is that they are difficult to escape.

“If you find yourself in a hole, the first thing to do is stop digging.”

~ Will Rogers

[NOTE: I should clarify that Australia has relatively low fiscal debt and is not in any immediate danger of a debt trap. But the ‘lucky country’ would suffer severely from fallout if the US or China were caught in a debt trap.]

October 5, 2019

S&P 500 survives but risk is elevated

Our recession indicator, a 3-month TMO of seasonally adjusted non-farm payrolls, ticked up slightly to 0.52%. This reflects a slight improvement in monthly employment data but the indicator remains precariously close to the amber (high risk) warning level of 0.50%. The red warning level of 0.30% would signal extreme risk of recession.

Non-Farm Payrolls Recession Indicator

During the week we discussed the high cost of uncertainty and how this impacts on business investment and consumer spending. Slowing growth in hours worked suggests that real GDP growth is likely to slow towards an annual rate of 1.0%. This would obviously be a drag on stock earnings.

Real GDP and Hours Worked

The S&P 500 retreated from resistance at 3000 but a long tail on this week’s candle indicates buying support. Another test of 3000 is likely. Breach of 2800 is unlikely at present but would signal a reversal with a target of 2400.

S&P 500

21-Day Volatility remains high and the recent trough above 1.0% warns of elevated risk.

S&P 500 21-Day Volatility

The plunge on 10-Year Treasury Yields, testing support at 1.5%, also warns of a risk-off environment.

10-Year Treasury Yields

On the global stage, low manufacturing purchasing managers index (PMI) warn that Europe is at risk of recession. DJ Euro Stoxx 600 is retracing to test support at 360/366. Breach would signal a primary down-trend.

DJ Euro Stoxx 600

The Footsie is similarly testing support at 7000.

FTSE 100

Nymex Crude is heading for a test of support at $50/barrel. Trend Index peaks below zero warn of selling pressure. Breach of support would signal a primary down-trend — suggesting a contraction in global demand.

Nymex Light Crude

The outlook for the global economy is bearish and we have reduced our equity exposure for International Growth to 34% of portfolio value.

October 3, 2019October 3, 2019

The high cost of uncertainty

High levels of uncertainty in international trade, geopolitical outlook, and domestic politics in the USA are likely to have a domino effect on business and consumer confidence.

Business is likely to postpone or curtail new investment decisions. This is already evident in a down-turn in new capital formation, along with GDP growth, in the first half of the calendar year.

New Capital Formation

A similar picture is emerging in construction spending.

Construction/GDP

CEO confidence levels are way down.

A slow-down in business investment in turn impacts on employment, causing a decline in payroll growth and average weekly hours worked.

Non-farm Payroll Growth and Weekly Hours Worked

Which in turn impacts on consumer sentiment as employees’ anticipation of future earnings declines.

Consumer Sentiment

The feedback loop will be completed if consumption falls. Retail sales dipped sharply in late 2018 but are keeping their head above water.

Retail Sales

And purchases of durables, like light motor vehicles, have leveled off but there is no significant decline so far.

Light Vehicle Sales (Units)

New housing starts and building permits even kicked up in August in response to lower interest rates.

Housing Starts

Consumers have, so far, continued spending but a down-turn in the stock market would weigh heavily on sentiment and consumption.

The S&P 500 broke its rising trendline, indicating a correction. Bearish divergence on Twiggs Money Flow warns of secondary selling pressure and a test of support at 2800. Breach of support is by no means certain but would offer a target of 2400.

S&P 500

We have reduced our equity exposure for International Growth to 34% of portfolio value because of our bearish outlook for the global economy.

September 19, 2019September 19, 2019

Australia: Leading Index of Employment in 16th month of decline

The Department of Employment, Skills, Small and Family Business released their Monthly Leading Indicator of Employment for September 2019, recording its 16th straight month of decline.

Hat tip to Macrobusiness, this is a peach of an indicator, predicting Australia’s economic performance.

I have added % retracement in the ASX 200 to the graph below. Each of the significant past troughs in the Leading Index coincides with a drawdown of more than 20% in the ASX 200.

Leading Index of Employment

Is the current fall in the Leading Index a false alarm, as in the 2005/2006 raging commodities bull market, or are we in for another retracement?

Leading Index of Employment - Components

My money is on the retracement.

September 18, 2019September 21, 2019

Predicting recessions with payroll and unemployment data

Recessions are notoriously difficult to measure (even the NBER occasionally gets it wrong) and an official declaration of a recession may be lagged by more than 6 months. Economist Claudia Sahm devised the Sahm Rule, using changes in unemployment levels, as a more timely predictor of recessions.

Sahm rule: US Data

But the signal repeatedly lags the official start date of recessions by several months, limiting its usefulness for investment purposes.

In previous articles I observed that payroll growth is a good predictor of recessions. But payroll growth has been declining for decades; so it has been difficult to devise a one-size-fits-all-recessions rule. Until I turned to using momentum.

Twiggs Momentum is my own variation on the standard momentum formula and I applied this to monthly payroll data to arrive at a 3-month TMO.

Sweden: Sahm rule

The orange band on the above chart reflects the amber warning range, between 0.5% and 0.3%, where recession is likely. If TMO crosses below the red line at 0.3%, risk of recession increases to very high.

When the TMO falls below 0.5%, a recession is likely, but there is one false reading at 0.49% in 1986. So I treat 0.5% as an amber warning level.

There are no false signals below 0.3% in the last 50 years. So I treat the 0.3% level as a red warning — that recession risk is very high.

Some of the signals (e.g. 1975) are late but the TMO has a far better record, than the Sahm Rule, at giving timely warning of recessions.

The August 2019 TMO reading is an amber warning of 0.5%.

September 18, 2019

Sahm Rule: Sweden tips into recession

Sweden: Sahm rule

What is the Sahm Recession Rule?

Recessions are notoriously difficult to measure (even the NBER occasionally gets it wrong) and an official declaration of a recession may be lagged by more than 6 months. Economist Claudia Sahm uses the following rule as a timely indicator of recessions:

September 10, 2019September 10, 2019

Time to be defensive

Bob Doll at Nuveen says he does not expect a recession (for the next few quarters) but remains neutral towards stocks:

“Although stock prices have advanced over the last couple of weeks, investors remain focused on downside economic and policy risks and are increasingly concerned about a possible recession. The latest manufacturing readings hurt economic sentiment, while trade issues, turmoil in Hong Kong, the increasing likelihood of a messy, no-deal Brexit and a downturn in European growth are increasing worries.”

The Institute for Supply Management August Report points to an economic slow-down, with the Purchasing Managers’ Index (PMI) falling to 49.1 percent, from 51.2 percent in July. The New Orders Index also declined, to 47.2 percent from 50.8 percent in July. Readings below 50 indicate contraction.

“…The 2020 U.S. elections linger in the backdrop, offering potential to produce either a dramatic shift in economic policy should the Democrats retake the White House, or continued policy uncertainty should President Trump win reelection.

Against this backdrop, investors are struggling to position their portfolios. Consensus appears to say that it is time to turn more defensive, but U.S. Treasuries and other government bond yields appear to offer little if any value. Indeed, government bond markets are pricing in a high likelihood of a recession and a prolonged period of sluggish growth. At the same time, equity markets have been range bound over the last several months (and, by some measures, since the start of 2018) and are providing unclear signals.

In our view, the preponderance of the evidence suggests that growth will remain sluggish but a recession will be avoided, at least for the next few quarters. In other words, we think the signals coming from the equity markets are more accurate than those coming from government bond markets. Nevertheless, we continue to have a broadly neutral view toward stocks, and think investors should remain selective, focusing on such themes as companies that offer compelling value and those that have the ability to put relatively high levels of free cash flow to work.”

The wild card is the impact that high levels of uncertainty may have on business investment and employment.

This is a time to be defensive.

Bonds, traditional dividend-paying blue chips, and growth stocks all appear over-priced at current levels. Small caps are high risk in the current volatile environment and we are focused on large cap stocks with strong cash flows and defensible market position in non-cyclical industries. Some cyclical sectors may present value but investors need to be selective because of vulnerability to a potential down-turn.

September 7, 2019

S&P 500 buying pressure but payrolls disappoint

August labor stats, released today, point to low real GDP growth for Q3. Growth in weekly hours worked came in at a low 1.09% and GDP is likely to follow.

Real GDP and Hours Worked

While inflation is not the primary concern at the Fed right now, rising annual hourly wage rate growth (3.46% for total private) flags an increase in underlying inflationary pressure. This may make the Fed more hesitant about cutting rates despite Donald Trump’s tweet storm.

Average Hourly Wage Rate

Most important is the continued decline in annual payroll growth. At 1.38% for August, further weakness is likely and a fall below 1.0% would warn of an economic slow-down.

Real GDP and Hours Worked

The S&P 500 is headed for another test of resistance at 3000. The Trend Index oscillating above zero for the last 9 months indicates buying pressure but I expect strong resistance at 3000. Upside is limited while downside risks are expanding.

S&P 500

Semiconductors are doing better than expected, despite the trade war, but I suspect will weaken when the surge in orders ahead of tariffs tails off.

Semiconductors

Retail has stalled since late 2018 and bearish divergence on the Trend Index suggests selling pressure.

Retail

Automobiles, in a decline since 2017, have rallied over the last 6 months. But, again, further weakness is expected.

Automobiles

On the global front, weak crude oil prices flag an anticipated slow-down in the global economy. Breach of support at $50/$51 per barrel would be a strong bear signal, warning of a decline to $40 per barrel.

Nymex Light Crude

We maintain our bearish outlook and have reduced equity exposure for international stocks to 40% of portfolio value.