Analysis of the global economy
Bob Doll highlighted the disconnect between long-term and short-term rates in his latest review. The chart below plots the 3-month T-bill rate against 10-year Treasury yields.
At this stage, the disconnect is not significant. But a disconnect as in 2004 – 2005 is far more serious. Large Chinese purchases of Treasuries prevented long-term rates from rising in response to Fed tightening, limiting the Fed’s ability to contain the housing bubble.
Interesting review of Bob Doll’s ten predictions for the year. They highlight the hazards of making predictions: you can be right for the wrong reasons or wrong for the right reasons.
1 ❓ U.S. and global economic growth improves modestly as the dollar strengthens and reaches parity with the euro.
First quarter U.S. gross domestic product growth was relatively slow at 1.2%, but we think second quarter growth could approach 3%. We are on the wrong side of this second prediction, as the euro has advanced against the dollar.
2 ✔ Unemployment drops to its lowest level in 17 years as wages increase at the fastest pace since the Great Recession.
The first half of this prediction came true in May, when unemployment hit 4.3%, lower than the 4.4% reached in May 2007. Wage growth has remained stubbornly slow, but we expect wages will rise.
[Unemployment fell as expected but I would rate this a “?” as wage growth impacts on inflation and is an important part of the overall scenario.]
3 ❓ Treasury yields move higher for a third consecutive year for the first time in 36 years as the Fed raises rates at least twice.
In June, the Fed raised interest rates for the second time this year. Treasury yields, however, are lower now than at the start of the year.
[“X” IMO. A disconnect between long-term and short-term rates, as in 2004-2005, limits the Fed’s ability to control asset bubbles and inflation.]
4 ❓ Stocks hit their 2017 highs in the first half of the year as earnings rise but price/earnings multiples fall.
Equity markets hover close to their all-time highs, but the momentum that dominated the first part of the year has faded. Earnings have improved dramatically: S&P 500 earnings were up almost 14% in the first quarter, although multiples have risen.
[Stocks rising faster than earnings is typical of a stage III bull market]
5 ❓ Stocks outperform bonds for the sixth year in a row for the first time in 20 years while volatility rises.
Stocks are currently comfortably ahead of bonds. While volatility has actually fallen this year, we expect it to pick up in the coming months.
[Volatility is close to record lows and likely to stay there if no major geo-political surprises.]
6 ❌ Small caps, cyclical sectors and value styles beat large caps, defensive and growth areas.
We are on the wrong side of all three components of this prediction. We expect economic growth to rebound this year, which should lead investors to bid up cyclical and value sectors.
[Large caps and defensive stocks are overpriced because of low yields. Growth stocks are typical of stage III but normally joined by small caps.]
7 ✔ The financials, health care and information technology sectors outperform energy, utilities and materials.
A basket of our favored sectors (up 14.0%) is comfortably outperforming a basket of our least-favored ones (up 2.5%).
[Good call.]
8 ✔ Active managers’ performance improves as flows into equities rise.
Last year, only 19% of U.S. large cap active equity managers beat their benchmarks. As of May, 52% are ahead. The pace of equity fund outflows has also slowed this year.
[I would rate this a “?”.]
9 ✔ Nationalist and protectionist trends rise as pro-domestic policies are pursued globally.
President Trump announced a withdrawal from the Paris climate change accords, has reconsidered trade deals and questioned fellow NATO member states. In Europe, Brexit negotiations are ongoing, although the French presidential election provided a nod back toward globalization.
[Nationalism still dominates.]
10 ✔ Initial optimism about the Trump agenda fades in light of slow legislative progress.
It is almost hard to remember the high level of political optimism when we made this prediction six months ago. Now the pendulum may have swung too far in the opposite direction.
[Good call. Little has been achieved on infrastructure and tax reform.]
[Conclusion: Secular trends, as in #7, make the most reliable predictions, while it’s hard to beat a 50% success rate with shorter cycles.]
I don’t attach much significance to the Gold-Oil ratio on its own but it’s back in overbought territory, above 25.
The chart below — plotting inflation-adjusted prices (over CPI) — far better depicts the relationship between gold and crude oil. Each major spike in crude prices over the last 50 years has been followed by a rising gold price.
Falling crude prices are likely to weaken demand for gold over the next few years, both through lower inflation and declining foreign reserves of major oil producing nations.
The Dollar Index continues to test support at 96.50. The primary trend is down and breach of support is likely, signaling a decline to test the 2016 low at 92/93.
Spot Gold found support at $1250. A weaker Dollar and rising political uncertainty both favor an up-trend but rising interest rates are expected to weaken demand. Respect of support at $1250 would confirm the up-trend, while breach of $1200 would warn of another decline.
In stark contrast to the buoyant recent ABS jobs numbers, the Westpac Leading Index slowed:
From Matthew Hassan at Westpac:
The six month annualised growth rate in the Westpac-Melbourne Institute Leading Index, which indicates the likely pace of economic activity relative to trend three to nine months into the future, eased from 1.01% in April to 0.62% in May.
…..The index is pointing to a clear slowing in momentum. While the growth rate remains comfortably above trend, the pace has eased markedly since the start of the year….
Read more at Westpac.
The May 2017 ABS Labour Force Survey surprised to the upside, with employment increasing by 42,000 over the previous month (full-time jobs even better at +52,100). These are seasonally adjusted figures and the trend estimates are more modest at 25200 jobs.
Seasonally adjusted hours worked also jumped, reflecting an annual increase of 2.3%.
The Australian Dollar surged as a result of the impressive numbers but Credit Suisse warns that there may be some issues with the latest strong NSW estimates:
By state, the gains in full-time employment were particularly strong in NSW…..
But beware the sample rotation bias ….the ABS has confessed that for the sixth time in seven months, it has rotated the sample in favour of higher employment-to-population cohorts. Officials report that this has had a material impact on the NSW employment outcomes.
If the numbers are correct, there are only two areas that could account for the job growth: apartment construction and infrastructure. The former is unlikely to last and the latter, while an important part of the recovery process, are also not a permanent increase.
I would prefer to wait for confirmation before adjusting my position based on a single set of numbers.
One swallow does not make a spring, nor does one day.
~ Aristotle
WASHINGTON—The Trump administration proposed a wide-ranging rethink of the rules governing the U.S. financial sector in a report that makes scores of recommendations that have been on the banking industry’s wish list for years.
….If Mr. Trump’s regulatory appointees eventually implement them, the recommendations would neuter or pare back restrictions from the Obama administration, which argued the rules were necessary to guard against excessive risk taking and a repeat of the 2008 financial crisis.
Seems to me like the exact opposite of ‘draining the swamp’. The new administration proposes removing or limiting the rules intended to reduce risk-taking in the financial sector.
This could end badly.
Especially with bank capital at current low levels.
Source: Trump Team Proposes Broad Rethink of Financial Rulebook – WSJ
Growth of total hours worked, calculated as Total Nonfarm Payroll multiplied by Average Hours worked, improved to 1.575% for the 12 months to May 2017.
And the April 2017 Leading Index, produced the Philadelphia Fed, is tracking at a healthy 1.64%. Decline below 1.0% is often an early warning of a slow-down; below 0.5% is more urgent.
Dow Jones Industrial Average continues to advance. Rising troughs on Twiggs Money Flow signal long-term buying pressure.
Dow Jones Transportation Average is slower, headed for a test of resistance at 9500. But recent breakout of Fedex above $200 is an encouraging sign and the index is likely to follow.
We are in stage III of a bull market, but this can last for several years.
Falling wage rate growth suggests that we are headed for a period of low growth in employment and personal consumption.
The impact is already evident in the Retail sector.
The RBA would normally intervene to stimulate investment and employment but its hands are tied. Lowering interest rates would aggravate the housing bubble. Household debt is already precariously high in relation to disposable income.
Like Mister Micawber in David Copperfield, we are waiting in the hope that something turns up to rescue us from our predicament. It’s not a good situation to be in. If something bad turns up and the RBA is low on ammunition.
Annual income twenty pounds, annual expenditure nineteen nineteen and six, result happiness. Annual income twenty pounds, annual expenditure twenty pounds ought and six, result misery. The blossom is blighted, the leaf is withered, the god of day goes down upon the dreary scene, and — and in short you are for ever floored….
~ Mr. Micawber in Charles Dickens’ David Copperfield
From Bob Doll’s latest weekly update:
Investors remain highly focused on global political issues. Emmanuel Macron’s victory in France has reduced some political risk in Europe, but investors are growing increasingly skeptical about President Trump’s ability to deliver on his pro-growth agenda. The growing scrutiny over White House ties to Russian operatives, escalating risks of global terrorism and rising uncertainty around North Korea are all negatives for investor confidence.
But these negatives have not offset positive global macroeconomic conditions. Global economic growth is hardly robust, but looks better than it has in several years, especially in Europe. Manufacturing activity is improving and global trade appears to be recovering. Corporate profits are also trending higher across most markets and industry sectors. Financials remain a weak spot in many areas of the world, but we expect global bond yields will rise as economic growth solidifies, which should help this sector. Finally, monetary policy remains growth- and equity-friendly. The Fed is in the midst of a rate-hiking campaign, but should continue raising rates slowly and predictably…..
