Economy Archives - Page 43 of 136 - the patient investor

March 30, 2017

APRA fiddles while housing risks grow

From Westpac today (emphasis added):

….With the Reserve Bank sharing our caution around 2018, along with ample capacity in the labour market (unemployment rate is 5.9% compared to full employment rate of 5.0%) and stubbornly low wages growth, there is only scope to cut rates. But as we have argued consistently, a resurgent housing market disallows such a policy option. Indeed, the minutes refer to “a build- up of risks associated with the housing market”. A tighter macro prudential stance seems appropriate.

Indeed, as we go to press, APRA has announced new controls, restricting the “flow of new interest-only lending to 30 per cent of total new residential mortgage lending” with a particular focus on limiting interest only loans with a loan-to-value ratio [LVR] above 80%. Currently, “interest-only terms represent nearly 40 per cent of the stock of residential mortgage lending by ADIs”, so this policy will restrict the terms at which a marginal borrower can access credit (investors and owner-occupiers). APRA also noted that they want banks to manage growth in investor credit to “comfortably remain below the previously advised benchmark of 10 per cent growth”. This is not a hard change to the target as had been mooted recently in the press (some suggesting the 10% limit could be as much as halved), but it does suggest lending to investors will continue to grow at a pace meaningfully below 10%. Looking ahead, the next RBA Stability Review (April 13) may provide more clarity on the macro prudential policy outlook and potential triggers for further action. For the time being though, the 2015 experience offers an understanding of the potential impact of this further tightening.

To head off a potential bubble burst, the RBA and APRA need to drastically slow house price growth. I am sure the big four banks are urging caution but they would be the worst hit by a meltdown. What APRA is doing is fiddling around the margins. To make housing investors think twice about further borrowing, APRA needs to cut the maximum LVR to 70%. And half that for foreign borrowers.

March 25, 2017

More evidence of a bull market, except in Australia

One of my favorite indicators of financial market stress is Corporate bond spreads. The premium charged on the lowest level of investment-grade corporate bonds, over the equivalent 10-year Treasury yield, is a great measure of the level of financial market stress.

Moodys 10-year BAA minus Treasury yields

Levels below 2 percent — not seen since 2004 – 2007 and 1994 – 1998 before that — are indicative of a raging bull market. The current level of 2.24 percent is slightly higher, reflecting some caution, but way below elevated levels around 3 percent.

The Financial Stress Index from St Louis Fed measures the degree of stress in financial markets. Constructed from 18 weekly data series: seven interest rate series, six yield spreads and five other indicators. The average value of the index is designed to be zero (representing normal market conditions); values below zero suggest low financial stress, while values above zero suggest high market stress.

St Louis Financial Stress Index

Current levels, below -1, also indicate unusually low levels of financial market stress.

Leading Index

The Leading Index from the Philadelphia Fed has declined slightly in recent years but remains healthy, at above 1 percent.

Philadelphia Fed Leading Index

Currency in Circulation

Most recessions are preceded by growth in currency in circulation falling below 5 percent, warning that the economy is contracting.

Currency in Circulation

Current levels, above 5 percent, reflect healthy financial markets.

Australia

On the other side of the Pacific, currency growth is shrinking, below 5 percent for the first time in 7 years. A sustained fall would warn that the economy is contracting.

Australia: Money Supply

Further rate cuts, to stimulate the economy, are unlikely. The ratio of Household Debt to Disposable Income is climbing and the RBA would be reluctant to add more fuel to the bonfire.

Australia: Household Debt

There is no immediate pressure on the RBA to raise interest rates, but when the time comes the impact on the housing market could be devastating.

March 18, 2017

A huge hole in Trump’s promise to bring back US manufacturing jobs | Business Insider

By Pedro Nicolaci da Costa:

US manufacturing employment has been declining since a 1970 peak, a drop that accelerated after China’s entry into the World Trade Organisation but, tellingly, not after the US entered the North American Free Trade Agreement with Mexico and Canada in 1994.

….SoftWear’s business, along with so many others across the US, should remind Trump of a factor he has yet to acknowledge: the role of automation in reducing the number of manufacturing jobs available…..

That fits a nationwide pattern of manufacturing output hitting record highs in recent years, even as manufacturing employment continues its steady decline.

….Mark Muro, a senior fellow and the director of policy at the Metropolitan Policy Program at the Brookings Institution, wrote in MIT’s Technology Review. “No one should be under the illusion that millions of manufacturing jobs are coming back to America.”

Source: There is a huge hole in Trump’s promise to bring back US manufacturing jobs | Business Insider

March 17, 2017

Gold rallies as Dollar falls

The Dollar Index rally is falling despite rising interest rates. Chinese sell-off of foreign reserves to support the Yuan may be a factor.

Dollar Index

Spot Gold rallied off support at $1200/ounce. Recovery above $1250 would confirm an up-trend, with the next target at $1300.

Spot Gold

March 17, 2017

Robert Shiller: Is he right that stocks are overpriced?

I frequently come across stocks such as Netflix [NFLX], trading on a forward PE of 137 (Morningstar), or even Coca Cola [KO] and Procter & Gamble [PG] that leave me muttering about unrealistic valuations.

Nobel laureate Robert Shiller this week commented that he was no longer buying stocks as he believed they were overvalued. His justification is the CAPE index which compares current stock prices to the 10-year average of inflation-adjusted earnings.

Shiller CAPE Index

The index is below its Dotcom high but is approaching the same level that it peaked at in 1929. Is the CAPE index flawed or does this portend disaster?

Bear in mind that Shiller is not selling all his existing stocks — he has merely stopped buying — and is the first to point out that the CAPE index is a poor tool for timing market tops and bottoms.

Before we make any rash decisions let us compare Shiller’s index to a few other handy measures of market valuation.

Warren Buffett’s favorite

Warren Buffett’s favorite measure of market value is to compare total stock market capitalization to GDP. The higher the ratio, the more the stock market is overvalued.

US Market Cap to GDP

This looks even worse than the CAPE index, with market cap to GDP well above its 2007 high and well on its way to Dotcom levels.

Adapting the ratio to include offshore earnings of multinational companies makes very little difference to the results. Here I compare market cap to GNP as well as GDP. GNP, or gross national product, includes offshore earnings of domestioc companies rather than just domestic earnings as with GDP. The end result is much the same.

US Market Cap to GNP

Market Cap to Corporate Profits

When we compare market capitalization to current profits after tax, however, valuations are still high but nowhere near the irrational exuberance of the Dotcom era.

US Market Cap to Profits after Tax

The current peak resembles earlier peaks in the 1980s and 1960s.

What this tells us is that corporate profits are rising faster than GDP. And that a 10-year average may be a poor reflection of future sustainable earnings.

Sustainable Earnings

Are current earnings sustainable? There is no clear answer to this. But there are some key criteria if earnings are to remain at current levels of GDP.

First, wage rate growth remains low. The graph below illustrates how profits fall when employee compensation rises (per unit of value added).

Wage Rates

Second, that interest rates stay low. The Fed is doing its best to normalize interest rates but monetary tightening would spoil the party. That is, deliberate tightening by the Fed to subdue rising inflationary pressures.

A third element is corporate taxes but there seems little risk of rising taxes in the current climate.

The key variable for both #1 and #2 is wage rates. At present these are subdued, so no cause for alarm.

Wage Rates

….yet.

March 16, 2017

Confidence in housing falls to lowest level in 40 years

From Eryk Bagshaw & Peter Martin at SMH:

Confidence in the housing market has collapsed, with the number of Australians describing property as the wisest place to put their savings falling to its lowest level in more than 40 years.

The Melbourne Institute of Applied Economic and Social Research has been asking about the wisest place to store savings since it began its consumer confidence survey in 1974. Real estate has been one of the most popular answers, often eclipsing bank deposits and paying down debt as the wisest place for savings.

Australian Housing Confidence

Westpac’s Bill Evans: “There is no doubt nervousness about the sustainability of prices.”

Lack of confidence is a vulnerability rather than sign of an imminent collapse. It may also reflect consumer nervousness about record low interest rates (lowest in more than 40 years) and the impact on affordability, and house prices, when rates eventually rise.

Source: Confidence in housing collapses to lowest level in 40 years: survey

March 14, 2017

Equities Could See a Setback, But This Bull Market Isn’t Over | Bob Doll

Sensible view from Bob Doll at Nuveen:

….Given evidence of stronger economic growth, we could see the Fed become slightly more aggressive about its rate policies, but probably not to the point that it would derail the equity bull market.

On balance, we think the risks are skewed to the upside for stocks. While we could see higher volatility and a near-term correction, we expect equities to move higher over the coming year.

Source: Weekly Investment Commentary from Bob Doll | Nuveen

March 10, 2017

Gold bears grow as Fed hints at rate hike

The Fed is expected to hike interest rates next week. 10-year Treasury yields broke resistance at 2.5 percent, signaling an advance to the 2013/2014 high of 3.0 percent. Breakout above 3.0 percent is still a way off but would complete a large double bottom signaling the end of the 30-year secular bull market in bonds. Rising interest rates are bearish for gold.

10-year Treasury Yields

The Dollar Index rally continues to meet resistance, with tall shadows on the last four weekly candles signaling selling pressure. Rising interest rates could strengthen the advance, with bearish consequences for gold, but Chinese sell-off of foreign reserves (to support the Yuan) is working against this.

Dollar Index

Spot Gold is testing support at $1200/ounce. Recovery above $1250 would indicate that the recent down-trend has ended. But breach of support is more likely and would warn of another test of long-term support at $1050/ounce.

Spot Gold

March 10, 2017

Australia’s economic growth is slowing.

Employment and Participation rates are falling.

Australia Employment & Participation Rates

Wage rate growth is slowing.

Australia Wage Rates

Slowing wage rate growth and inflation confirm that the economy is faltering.

Australia Underlying Inflation

The RBA, with one eye on the housing bubble, has indicated its reluctance to cut rates further. Increased infrastructure spending by Federal and State governments seems the only viable alternative.

With the motor industry winding down and apartment construction headed for a cliff, this is becoming increasingly urgent.

March 10, 2017

US Job Growth, Wage Rates & Inflation

Payrolls jumped by a seasonally adjusted 235,000 jobs in February, setting the Fed on track for another rate rise next week.

US Job Growth

GDP growth is projected to lift in line with employment, wage rates and hours worked. At this stage, the Fed is still attempting to normalize interest rates rather than slow the economy to cool inflationary pressures.

Projected GDP

Wage rate growth remains muted, at close to 2.5 percent, so rate hikes are likely to proceed at a gradual pace.

Hourly Wage Rates and Money Supply

The need to tighten monetary policy is only likely to be seriously considered when wage rate growth [light green] exceeds 3.0 percent [dark green line]. Then you are likely to witness a dip in money supply growth [blue], as in 2000 and 2006, with bearish consequences for stocks.

*The dip in 2010 was a mistake by the Fed, taking its foot off the gas pedal too soon after the 2008 crash.