Rising long-term rates could spoil the party

Real GDP for the September quarter reflects an annual growth rate of 2.9% for the US, well below the Atlanta Fed GDPNow estimate of 5.4%. Growth in weekly hours worked declined to 1.5% for the 12 months ended September, indicating that GDP is likely to slow further in the fourth quarter.

Real GDP & Estimated Total Weekly Hours

New Orders

Manufacturers’ new orders for durable goods, adjusted for inflation, shows signs of strengthening.

Manufacturers' New Orders: Durable Goods

Transport

Transport indicators show a long-term down-trend but truck tonnage has grown since May 2023.

Truck Tonnage

Container (intermodal) rail freight likewise grew for several months but then turned down in August..

Rail Freight

Growth in weekly payrolls of transport and warehousing employees slowed to an annual rate of 3.6% in September but remains positive.

Transport & Warehousing Weekly Payrolls

Consumer Cyclical

Light vehicle sales continue to trend higher, suggesting consumer confidence.

Light Vehicle Sales

Housing

New housing starts (purple) have been trending lower since their peak in 2022 but new permits (green) are now strengthening.

Housing Starts & Permits

New single family houses sold are trending higher.

New Home Sales

Despite a steep rise in mortgage rates. In a strange twist, higher rates have reduced the turnover of existing homes on the market, with owners reluctant to give up their low fixed rate mortgages. Low supply of existing homes has boosted sales of new homes, lifting employment in residential construction.

30-Year Mortgage Rate

The National Association of Home Builders Housing Market Index (HMI), however, reflects falling sentiment — likely to be followed by declining new home sales and housing starts.

NAHB/Wells Fargo Housing Market Index

HMI is a weighted average of three separate component indices. A monthly survey of NAHB members asks respondents to rate market conditions for the sale of new homes at the present time; sales in the next six months; and the traffic of prospective buyers. (NAHB)

Financial Markets

The ratio of bank loans and leases to GDP declined to 0.44 in the third quarter but remains elevated compared to levels prior to 2000.

Bank Loans & Leases

The cause of ballooning debt is not hard to find, with negative real interest rates for large parts of the past two decades.

Real Fed Funds Rate

Now real rates are again positive and money supply is contracting relative to GDP, the days of easy credit are at an end. A significant contraction of credit is likely unless the Fed intervenes, either by cutting rates or expanding its balance sheet to inject more liquidity into the system.

M2 Money Supply/GDP

Commercial banks continued to raise lending standards in Q3, making credit less accessible.

Bank Lending Standards

Conclusion

This is not a normal market cycle and investors need to be prepared for sudden shifts in financial markets.

The US economy is slowing but cyclical elements like light vehicle sales and new home sales are holding up well.

The rise in long-term Treasury yields, however, is likely to cause a sharp credit contraction if the Fed does not intervene by cutting rates or expanding its balance sheet (QE).

10-Year Treasury Yields

The Fed is reluctant to intervene because this would undermine their efforts to curb inflation. But they may be forced to if there is a credit event that unsettles financial markets.

Moody's Baa Corporate Bond Yield minus 10-Year Treasury Yield

Fed intervention is unlikely without a steep rise in credit spreads. But would be especially bullish for Gold.

Strong US retail activity unlikely to last

Real retail sales remain strong, holding above the pre-pandemic trend (dotted line) in September.

Real Retail Sales

Supported by a strong jobs market, with low unemployment.

Unemployment Rate

The labor market remains tight, with employers holding on to staff — cutting weekly hours rather than resorting to layoffs.

Average Weekly Hours Worked

The consumer sentiment trough in June 2022 coincided with a peak in gasoline prices. Sentiment has been rising over the past 12 months but this could be derailed by a spike in gas prices.

University of Michigan Consumer Sentiment & Gasoline Prices

The up-trend in light vehicle sales reflects growing consumer confidence.

Light Vehicle Sales

The NAHB homebuilder sentiment index (blue below) is falling sharply, however, warning that the recent recovery in new building permits (red) is about to reverse. Residential housing is a major cyclical employer and a collapse of building activity would warn that recession is imminent.

NAHB Sentiment Index

Industry & Transport

Industry indicators show gradually slowing activity but no alarming signs yet. CSBS Community Bank Sentiment index indicates slightly improved business conditions in Q3.

CSBS Community Banks Index - Business Sentiment

Investment in heavy trucks — a useful leading indicator — remains strong.

Heavy Truck Sales

Intermodal rail freight traffic — mainly containers — declined in August after a four-month rally. But the longer-term trend is down.

Rail Freight

Truck tonnage increased in August for the fifth month but earlier breach of the long-term up-trend (green) warns of weakness ahead.

Truck Tonnage

Manufacturers new orders for capital goods, adjusted by PPI, indicates declining activity which is likely to weigh on future growth.

Manufacturing Orders: Capital Goods

Conclusion

The tight labor market supports strong consumer spending but high mortgage rates are likely to slow homebuilding activity causing a rise in cyclical employment. A sharp increase in crude oil could also cause higher gasoline prices which would damage consumer sentiment.

Industry and transport activity is gradually weakening but has not yet caused alarm.

“How did you go bankrupt?” Bill asked.

“Two ways,” Mike said. “Gradually, then suddenly.”

~ Ernest Hemingway: The Sun Also Rises

Tech heavyweights pause for breath

Good progress has been made combating the pandemic but daily COVID cases seem to be struggling to break through a floor between 50 and 60 thousand. The vaccine roll-out is ahead of schedule but people need to stop listening to idiots like Rand Paul — who went to the Senate gym while infected — and listen to the Chief Medical Adviser whose advice is to wear a mask.

Daily US COVID Cases

Stocks have paused after the recent run up in Treasury yields. When both stocks and bonds are being sold, there is nowhere to hide.

The Nasdaq 100 is testing support at 12000. At this stage the correction looks mild, with declining Trend Index remaining above zero, but breach of 12000 would signal a test of the Sep 2020 low.

Nasdaq 100

The S&P 500 is performing better but Volatility troughs above 1.0% still warn of elevated risk.

S&P 500 & Twiggs Volatility 21-Day

The big five tech stocks are a mixed bag. Alphabet (GOOGL) and Facebook (FB) show strength. Microsft (MSFT) looks stable, while Mazon (AMZN) and Apple (AAPL) are trending lower.

AAPL, AMZN, GOOGL, FB, MSFT

When leaders no longer lead normally signals the final stage of a bull market. The chart below shows the Russell 2000 small caps ETF (IWM) clearly outperforming the large cap Nasdaq (QQQ) and S&P 500 (IVV) indices with all the tech heavyweights.

IVV, IWM, QQQ

@Schuldensuehner

The steeper yield curve benefits banks, who profit from the wider net interest margin. Major banks have climbed 60% to 80% over the past six months, with Goldman Sachs (GS) leading and Bank of America (BAC) the laggard.

Major Banks

Consumer durables sectors are, again, a mixed bag. Household Goods (HG) is flat, Apparel Retail (RA) is climbing steadily, while Automobiles (AU) is down sharply — mainly because of Tesla (TSLA).

Consumer Durables

Though light vehicle sales were down a million units in February.

Light Vehicle Sales

And heavy truck sales were down 4,000 units compared to January.

Heavy Truck Sales

Prospects for the tire industry are improving. Goodyear (GT) retraced to test its new support level after breaking out above its high from late 2019. Respect would confirm another advance.

Goodyear Tyre Co. (GT)

Conclusion

The recovery is going to be a long hard slog with frequent setbacks. Banks are doing nicely but stocks generally are over-priced and ripe for a major adjustment. There are signs that this is the final stage of the bull market and market risk is elevated.

USA: Sales up, daily COVID-19 cases down but jobs still scarce

Daily new COVID-19 cases in the US are clearly falling as the vaccine roll-out takes effect.

USA: COVID-19 Daily Cases

But daily deaths are still rising and may take another few weeks to level off.

USA: COVID-19 Daily Deaths

January payroll figures show the economic recovery has stalled, with total jobs contracting by 6.08% compared to January 2020.

Payroll Growth

Hours worked are down 4.4% compared to last year.

Real GDP & Hours Worked

Average hourly earnings jumped 5.44% for production and non-supervisory workers but these are distorted by strong job losses in the lowest pay grades.

Hourly Wage Rates

Retail sales (excluding food) have also been artificially boosted by government stimulus which added roughly 20% to disposable income.

Retail Sales Excluding Food

Light vehicle sales are similarly boosted.

Light Vehicles

While housing starts are climbing in response to record low mortgage rates.

Housing Permits & Starts

Total unemployment claims (state and federal) declined to a still high 17.8 million for the week ended January 16th.

DOL: State & Federal Unemployment Claims

The proposed Biden stimulus will support households and businesses but employment is likely to remain weak until the COVID-19 outbreak is clearly under control.

Conclusion

Economic activity is expected to remain weak in the first half of 2021. A key determinant will be the length of time it takes to bring the COVID-19 outbreak under control. Subsequent recovery is likely to need strong fiscal support, with federal debt expected to grow faster than GDP in 2021. This will require continued Treasury purchases by the Fed and commercial banks, with interest rates remaining low throughout 2021.

Nasdaq: Devil take the hindmost

I am fond off quoting Jesse Livermore’s maxim “You don’t argue with the tape” but Livermore was a keen student of market conditions and based his decisions on far more than just price action in the market.

We are witnessing a spectacular stock market rally, driven by retail investors and hedge funds piling into the market while institutional investors are sitting on the sidelines.

The Nasdaq 100 broke through resistance at 10,000, new highs signaling a fresh primary advance. Bearish divergence on Twiggs Money Flow index may warn of selling pressure but it is hard to argue with the tape. Only a fall below 9500 would signal another decline and that seems unlikely at present.

Nasdaq 100

Even retail sales (ex food) have recovered sharply, from -15.3% in April to -1.4% in May (annual % gain).

Retail Sales (ex Food)

Light vehicle sales are more sluggish but June sales of 13.05 million are still a sizable bounce.

Light Vehicle Sales

So why are many old investment hands acting with such caution?

We know that the efforts to contain the COVID19 outbreak are struggling, with over 60,000 new cases per day, but the economy still seems in good shape.

COVID19 Daily Cases

Source JHU CSSE

Let’s look at where the money is coming from.

Federal Debt

Treasury debt has expanded by more than $3 trillion in the last four months (March 9 – July 9) as the government does everything in its power to cushion the economy from an unprecedented shutdown. Rescuing airlines, bailing out Boeing, emergency business loans, job preservation schemes, and supporting Fed purchases of a wide variety of financial assets to keep the plumbing of financial markets open. Every way they can, government has been flooding the market with money and some of that has found its way to the stock market. Whether through boosting stock purchases, enabling companies to raise debt or boosting consumer spending to buoy up sales, the market is flying on borrowed money.

Steep up-trends like this typically end in a blow-off. A trend is self-reinforcing if rising prices attract more investors who in turn bid up prices even further. A steady influx of new investors is required to sustain the trend, else it dies.

Similar self-reinforcing cycles are evident in nature, where they expand violently outward at an exponential rate until they run out of fuel. The fuel driving the event may differ, from dry tinder in a forest fire, warm ocean temperatures in a hurricane, consumable vegetation in a locust plague, …..or exposed population in a virus outbreak. The cycle expands, feeding on itself, until the fuel is exhausted.

A stock market blow-off is no different. The up-trend will continue for as long as rising prices are able to attract new investors. It will stop when the source of new money dries up. In this case, when Treasury tries to slow the unsustainable growth in federal debt. Then it becomes a case of devil-take-the-hindmost as a preponderance of sellers attempt to offload their stocks on a rapidly shrinking pool of buyers.

Still cautious

Inflationary pressures are easing, with average hourly earnings growth declining to 3.35% in June, for Production and Non-Supervisory Employees, and 3.14% for Total Private sector.

Average Wage Rates

But this warns that economic growth is slowing. Annual growth in hours worked has slowed to 1.25%, suggesting a similar decline in GDP growth for the second quarter.

Real GDP and Hours Worked

Jobs growth held steady at 1.5% for the 12 months ended June 2019, after a decline from 2.0% in January.

Payroll Growth

Further decline in jobs growth is likely in the months ahead and a fall below 1.0% would warn that recession is imminent.

The Case Shiller index warns that growth in housing prices is slowing.

Case Shiller Index

Growth in construction expenditure (adjusted for inflation) has stalled.

Construction Expenditure/CPI

Retail sales growth is faltering.

Retail Sales

Units of light vehicle sales has stalled.

Light Vehicle Sales

And capital goods orders (adjusted for inflation) are faltering.

Manufacturers Orders for Capital Goods

One of the few bright spots is corporate bond spreads — the difference between lowest investment grade (Baa) and equivalent Treasury yields — still low at 2.3%, indicating that credit risk is benign.

Corporate Bond spreads

The S&P 500 broke through 2950 and is testing 3000. The 3000 level is an important watershed, double the 2000 and 2007 highs at 1500 (1552 and 1576 to be exact), and I expect strong resistance.

S&P 500

A rising Trend Index indicates buying pressure but this seems to be mainly stock repurchases and institutional buying. Retail money, as indicated by investment flows into ETFs, favors fixed income over equities despite the low yields.

ETF Flows source: ETF.com

It’s still a good time to be cautious.

The prevailing wisdom is that markets are always right. I take the opposite position. I assume that markets are always wrong……I watch out for telltale signs that a trend may be exhausted. Then I disengage from the herd and look for a different investment thesis. Or, if I think the trend has been carried to excess, I may probe going against it. Most of the time we are punished if we go against the trend. Only at an inflection point are we rewarded.

~ George Soros

US Retail & Light Vehicle Sales slow

Retail sales growth (excluding motor vehicles and parts) slowed to 2.4% over the 12 months to June 2017.

Retail Sales ex Motor Vehicles & Parts

Source: St Louis Fed & US Bureau of the Census

Seasonally adjusted light vehicle sales are also slowing.

Light Vehicle Sales

Source: St Louis Fed & BEA

Seasonally adjusted private housing starts and new building permits are starting to lose momentum.

Housing Starts & Permits

Source: St Louis Fed & US Bureau of the Census

The good news is that Manufacturer’s Durable Goods Orders (seasonally adjusted and ex Defense & Aircraft) are recovering.

Manufacturing Durable Goods Orders ex Defense & Aircraft

Source: St Louis Fed & US Bureau of the Census

Cement and concrete production continues to trend upwards.

Cement & Concrete Production

Source: US Fed

And estimated weekly hours worked (total nonfarm payroll * average weekly hours) is growing steadily.

Estimated Weekly Hours Worked

Source: St Louis Fed & BLS

All of which suggest that business confidence is growing and consumer confidence is likely to follow. Bellwether transport stock Fedex advanced to 220, signaling rising economic activity in the broader economy.

Fedex

Target: 180 + ( 180 – 120 ) = 240

The S&P 500 broke resistance at 2450, making a new high. Narrow consolidations and shallow corrections all signal investor confidence typical of the latter stages of a bull market. The immediate target is 2500* but further gains are likely.

S&P 500

Target: 2400 + ( 2400 – 2300 ) = 2500

The stock market remains an exceptionally efficient mechanism for the transfer of wealth from the impatient to the patient.

~ Warren Buffett

US: Why the enthusiasm?

Retail sales are surging, with Retail & Food (ex-Motor Vehicles) growing above 5% a year for the first time since 2012.

Retail & Food Sales

Light vehicles sales are back at their 2000-2006 norm of 17.5 million units a year, reflecting consumer confidence.

Light Vehicle Sales

Housing remains soft but growth in new starts and building permits continues.

Housing

Durable goods orders are also soft but unlikely to remain so if retail sales growth continues.

Durable Goods Orders

Inflationary pressures are likely to rise. Which is why the Fed expects to increase the pace of interest rate hikes in 2017.

Priming the Pump

US stocks are buoyant on hopes that a Donald Trump presidency will benefit business, with major indexes flagging a bull market. But promises come first, the costs come later. While I support a broad infrastructure program and the creation of a level playing field in global markets, the actual execution of these ideas is critical and should not be allowed to be hijacked by the establishment for their own ends.

Erection of trade barriers is a useful negotiating position but is unlikely to be achieved without enormous damage to the global economy. As long as your trading partners think you are crazy enough to do it, they may be more amenable to establishing fair ground rules for international trade. If they don’t believe the threat, they will be happy to continue on their present path. So Trump walks a fine line between reassuring his allies and the domestic market, while keeping others guessing about his intentions.

Before we get carried away with hopes and expectations, however, we need to evaluate the current state of the economy in order to assess the current potential for growth.

The Cons

Let’s start with the negatives.

Construction spending is slow, at about three-quarters of pre-GFC (and sub-prime) levels. It will take more than an infrastructure program to restore this (though it is a step in the right direction). What is needed is higher growth expectations for the economy.

Construction Spending to GDP

Industrial production is close to its pre-GFC peak but has been declining since 2014.

Industrial Production Index

Job growth is slowing. Decline below 1.0 percent would be cause for concern.

Employment Growth

Rail and freight activity also reflects a slow-down since 2015.

Rail & Freight Index

The Philadelphia Fed’s broad-based Leading Index has also softened since 2014. Decline below 1.0 percent would be cause for concern.

Leading Index

One of my favorite indicators, this graph compares profit margins (per unit of gross value added) to employee costs. There is a clear cycle: employee costs (per unit) fall after a recession while profits rise. As the economy recovers and approaches full capacity, employee costs start to rise and profits fall — which leads to the next recession. At present we can clearly see employee costs are rising and profit margins are falling.

Profits and Employee Costs per unit of Value Added

It will be difficult for corporations to continue to grow earnings in this environment. Business investment is falling.

Gross Private Nonresidential Fixed Investment

Plowing money into stock buybacks rather than into new investment may shore up corporate performance for a while but hurts construction and industrial production. Turning this around is a major challenge facing the new administration.

The Pros

Retail sales are rising as increased employee compensation costs lift consumer confidence. Solid November sales with strong Black Friday numbers would help lift confidence even further.

Retail Sales

Light vehicle sales are also recovering, a key indicator of consumers’ long-term outlook.

Light Vehicle Sales

Rising sales and infrastructure investment are only part of the solution. What Donald Trump needs to do is prime the pump: introduce a fairer tax system, minimize red tape and reduce political interference in the economy, while enforcing strong regulation of the financial sector. Not an easy task, but achieving these goals would help restore business confidence, revive investment, and set the economy on a sound growth path.

In the short run, the market is a voting machine
but in the long run it is a weighing machine.

~ Benjamin Graham: Security Analysis (1934)

US Light Vehicle Sales disappointing

June US Light Vehicle Sales came in at a disappointing seasonally adjusted annual rate of 16.689 million vehicles. Light vehicle sales, an important barometer of consumer confidence, have been trending lower since November 2015. Further falls would be cause for concern.

Light Vehicle Sales