Posts tagged Us Macroeconomic Data
There is something almost symmetrical about it all. On December 19 last year the Federal Reserve delivered a hawkish monetary policy statement that sent the stock market into a tailspin. Two days later the US government shut down. Fast forward to January 25 of this year. The US government reopened amid generally upbeat sentiment in asset markets. Several days later, the Fed surprised traders with a decidedly dovish policy statement hinting at a pause, not only in further interest rate hikes but in winding down the central bank’s balance sheet of bonds purchased during the quantitative easing (QE) era of 2008-14. Stocks surged in the aftermath of that announcement and closed out a January for the record books. Hallelujah, exclaims Mr. Market. The Fed put is back and better than ever!
What Exactly Changed?
The January Federal Reserve Open Market Committee (FOMC) statement was not just a tweak or two away from the December communiqué – no, this was closer to a full-blown U-turn. As much as investors thrilled to the news that the Fed was solidly back in their corner to privatize gains and socialize losses, there was quite a bit of head-scratching over what exactly was so momentously different in the world over this 30 day interval. The FOMC press release seemed to say little about changes in economic growth prospects, with a strong labor market and moderate inflation paving the way for a sustained run of this growth cycle. True, it chose the world “solid” to characterize growth, which may be a slight demotion from “strong” as the adjective of choice in December. And yes, muted inflation affords some leeway to adjust policy if actual data were to come to light. But real (inflation-adjusted) rates are nowhere near recent historical norms, as illustrated in the chart below.
“Muted inflation” is the Fed’s term to describe the current level – but is it really “muted?” The chart above shows the Consumer Price Index (the blue dotted line) to be squarely within a normal range consistent with growth market cycles in the late 1990s and the mid-2000s. Yet in both of those cycles real rates were much higher, as is clear from the gap between nominal 2-year and 10-year yields (green and crimson respectively) and the CPI. Is the Fed worried that real rates at those levels today would be harmful? If so, there must be some element of fragility to the current economy that wasn’t there before.
Oh, Right. That.
Or, maybe that’s not it at all, as the FOMC press release sort of gives away in the next sentence. “In light of global economic and financial developments…” Aha, there it is, the language of the 2016 Yellen put reborn as the 2019 Powell put. What, pray tell, could those “financial developments” possibly be? A stock market pullback, blame for which was almost entirely laid at the feet of those two FOMC press releases last September and December? Once again, monetary policy appears to be based principally on ensuring that market forces not be given free enough latitude to inflict actual damage on investment returns.
And maybe that’s fine – perhaps the pace of growth will continue to be slow enough to allow the Fed to ease off the monetary brakes without any collateral damage. If that turns out not to be the case, though, then we foresee some communication challenges ahead. The data continue to suggest the growth cycle has a way to go before petering out. Today’s jobs report was once again robust, with year-on-year wage growth solidifying a trend in the area of 3.2 percent year-on-year. Unfortunately we won’t know about Q4 2018 GDP for some time, as the Bureau of Economic Analysis was impacted by the government shutdown and does not yet have a date for when its analysis will be ready for release.
March is probably safe – the likelihood of a rate hike then is now close to zero. But if Powell has to go back to the market sometime later in the year and ask investors to get their heads around another rate hike – a U-turn from the U-turn, in effect – that would likely be problematic. This Fed still has a learning curve to master when it comes to clarity of communication.
Financial markets move to the metronome of data, but not only data. Optics and perception also factor into the equation. Experience tells us that perception can quite easily become reality. Thousands of trader-bots are primed on any given day to lurch this way and that, often on the basis of no more than the parsed verbiage of a Fed speech or a “presidential” tweet. Sometimes the waves generated by those bots cross each other and cancel out. Other times they all find themselves going in the same direction and create a tsunami.
When “Buy the Dip” Met “Sell the Rally”
Many of the headline data points continue to suggest that there is little reason to worry. The latest batch of jobs data came out this morning and were not way out of line with expectations – net positive payroll gains and a steady, but not overheated, pace for wage growth. In public statements Fed chair Powell projects confidence about growth prospects heading into next year. But other indicators are flashing yellow, if not necessarily red. Oil prices suggest a tempered demand outlook. Fed funds futures contracts are sharply backing away from the presumption of three rate increases next year and perhaps even a shift back to rate cuts in 2020. The picture for global trade remains as opaque as it has been for much of the year, leading to reductions in 2019 global growth estimates by the IMF.
With that in mind, it seems increasingly plausible that the current volatility in risk asset markets is something different from the other occasional pullbacks of the past few years. This one is more grounded in the perception that an economic slowdown is ahead. Not “tomorrow” ahead or “next January” ahead, but quite plausibly sometime before the calendar closes on 2019. What we’re seeing in this pullback (for the time being, anyway) is a roughly balanced approach to buying the dips at support levels and selling into relief rallies at the resistance thresholds. Having made it through a negative October without the bottom falling out, the animal spirits to propel a sustained upside rally are thus far being kept in check. Perception is running ahead of actual data, as it frequently does.
Pick Your Flavor
None of this means that a slowdown (or worse) is absolutely, definitely in store in the coming months. But if it seems like an increasingly probable outcome, how does one prepare? There is never any shortage of blow-dried heads in the media to tell you that “when the economy does X the market does Y” with “Y” being whatever pet theory its proponent is hawking on the day. The problem is that there is no statistical validity to any kind of pattern one might discern between slow or negative growth in the economy and the direction of stock prices. There simply aren’t enough instances for an observation to be meaningful. The US economy has technically been in recession just five times since 1980 (two of which were arguably one event, the “double-dip” recession of 1980-81). There’s no statistical meaning to a sample size of n=5, just like flipping a coin five times does not give you the same insight that flipping a coin 10,000 times does.
The last three recessions occurred, respectively, in 1990, 2001 and 2008. The chart below shows the trend in real GDP growth and share price movements in the S&P 500 over this period.
Here is what jumps out from the above chart: the pullback in the stock market during the relatively mild recession of 2001 was much more severe than the one that accompanied the deeper recession of 1990. Consider: 2001 barely even made it into the history books as a technical recession (the story of how recessions become official makes for an interesting article in and of itself – stay tuned for our 2019 Annual Outlook this coming January!) Yet the bloodbath in stocks was a sustained bear market over nearly three years. By contrast, the market fell just short of, and never technically went into, a bear market during the 1990 recession. 2001 was closer in terms of damage done to the Big One, the Great Recession of 2008.
Here is where we come back to our favorite hobby horse: inferring useful meaning from past instances is misguided, because each instance has its own miserable set of unique variables, like every unhappy family in “Anna Karenina.” Before the 2001 recession happened, you will recall, the high-flying technology sector crashed in a stunning mess of shiny dot-com valuations. A financial crisis – a crisis born of nosebleed asset valuations – precipitated a minor contraction in the real economy. And of course in 2008 it was another financial crisis, this one deeper and holding practically the entire global credit market in its grasp, that begat the near-depression in the economy that followed.
We think of 2001 and 2008 as “recession-plus,” where the “plus” factor arguably contributes more to the severity of the pullback in risk assets than do the macroeconomic numbers relating to jobs, GDP, prices and sales. It was no fun for investors as those numbers turned south in 1990, but the pain was relatively shallow and short-lived. Not so for the multi-year tribulations of 2001 and 2008.
Now, there is no clear path from where we stand today to either a 1990-esque standalone recession, a more severe situation driven by exogenous factors, or just a simple slowdown in growth. Or even (though less likely) a second wind of the growth cycle driven by a yet-unseen burst of productivity. Nor has perception, while currently trending negative, yet become reality. We imagine those bot-generated waves will collide and cancel out a few more times before the trend becomes more sustainably directional. Meanwhile, planning for alternative scenarios is the priority task at hand.
Happy September! Now that the month is upon us, the kids back at school and the weekends filling up with tailgates or trail runs (or both, even better), it’s time to think about that possible rate hike a couple weeks away. Just kidding – we’re not thinking much about a September hike because we think that is well and truly baked into the cake already. We’re thinking more about that possible December hike, the year’s fourth, which is less fully priced into current asset markets but which we see as increasingly likely. Today’s job numbers add a resounding notch to our convictions.
Meet the New Data, Same As the Old Data
Sometimes it can seem like the world is changing in unimaginable ways every day. However, one just has to study macroeconomic trends over the past four-odd years to be reassured that, economically speaking at least, not much ever seems to change at all. We often use the chart below in client discussions to drive this point home: in terms of jobs, prices, sentiment and overall growth – the big headline data points – the story more or less remains the same.
In brief: monthly payroll gains have averaged 215,000 in 2018, including today’s release showing job creation of 201K in August (and also factoring in a downward revision to July’s numbers). Real GDP growth is above-trend, consumer confidence has not been higher for literally the entire millennium, and consumer prices are above the Fed’s 2 percent target for both core and headline readings. This composite view suggests a fundamentally stronger economy than the one we had in between the two recessions of the previous decade. What is inconsistent with this picture of strength is a Fed funds rate staying much longer at 2 percent. It was 2 percent at the end of 2004, on its way to a peak of 5.25 percent by the time that growth cycle peaked. With the caveat that nothing in life is ever certain, including economic data releases, the picture shown in the above chart tells us to plan on that fourth rate hike ringing out the old year come December.
As the US rate scenario settles into conventional wisdom, there is plenty of upside room for the dollar (a rising rate environment, all else being equal, is a bullish indicator for the national currency). While the greenback has traded strongly against the euro and other major developed market currencies this year, at $1.15 to €1.00 it is far from its late 2016 peak when it tested euro parity.
Where the dollar’s strength can do much more harm, though, is in emerging markets. Many of those currencies are at decades-long, if not all-time, lows versus the dollar already. The dollar is up 22 percent against the Brazilian real this year, and 12.6 percent versus the Indian rupee. If you hold emerging markets equities in your portfolio you are feeling this pain – when your equity price returns are translated from the local currency back into dollars you are directly exposed to those currency losses. For example, the MSCI Emerging Market index reached an all-time high in local currency terms back in February of this year. But in US dollar terms – shown in the chart below – the index has never recovered its pre-financial crisis peak reached in November 2007.
We’ve communicated our sentiments about emerging markets frequently on these pages – while important as an asset class given the size of these economies (and the wealth therein), emerging markets have underperformed domestic US stocks on both an absolute and risk adjusted basis over a very long time horizon. They enjoyed a sustained period of outperformance during the mid ‘00s in conjunction with the commodities supercycle – and again for about a year following the reversal of the ill-considered “Trump trade” fever after the 2016 election. During that latter growth spurt we elected to sit tight with our underweight position rather than try any fancy tactical footwork. We stand by that decision today.
We have yet to arrive at our conclusions for positioning in 2019, in EM or any other asset class. But from where we sit today the most convincing picture of the global landscape points to a continuation in the US up-cycle, with the attendant implications of a stronger dollar and further downside potential in other markets, particularly emerging ones. That does not necessarily imply blue skies ahead for US assets – there are some complicating factors at home as well, which will be themes for forthcoming commentaries. But we see little out there today arguing for a bigger move into emerging markets.
They say numbers don’t lie, right? So what to make of the 4.1 percent real growth rate in US gross domestic product (GDP) from the first to the second quarter of the year? We feel quite comfortable in predicting that the narrative of today’s news cycle will be anything but unified. Depending on what news source you turn to for a first take on today’s Bureau of Economic Analysis release, you may be told that this quarterly number is in fact the dawning of the Age of Aquarius, when peace will guide the planets and love will steer the stars (hi, kids! ask your parents…). Or, alternatively, that 4.1 percent really isn’t 4.1 percent at all, but a fictitious sugar high delivered on a transitory pile of soybeans, never to be seen again.
As usual, the reality is somewhere between delusional happy talk and delusional apocalypse-now talk. Here’s an actual picture of GDP growth over the full cycle of the economic recovery that began in the middle of 2009. We show both the quarter-to-quarter rate of growth and the somewhat smoother year-on-year growth trend.
Something Old, Something New
The best way, in our opinion, to interpret the current trend in GDP growth is to ascribe much of it to factors that have been underway for some time. Consumer spending is by far the largest single component of GDP, accounting for more than 70 percent of the total, and Americans have continued to not disappoint in their purchasing predilections. Fixed private sector investment – both residential and commercial – also reflects continuing confidence by homeowners and businesses alike. The mix will change in any given quarter – nonresidential construction and intellectual property investment were key drivers this quarter while residential investment declined – but the overall trend has stayed positive. This is the “something old” – a continuation of the modest but steady growth that has characterized recent years.
The “something new” shows up in an usual jump in US exports, which grew by 9.3 percent overall and which was dominated by certain categories of goods. Enter the “soybeans” meme. It appears that other countries have been stockpiling various products from the US which they expect to jump in price on account of the new tariff regime. Those bags and bags of soya beans from Iowa really were a second quarter phenomenon, were mostly related to China, and have mostly stopped with the implementation of the first wave of tariffs imposed by Beijing on US products earlier this month.
Looking beyond the quirks of any given quarter – and as the above chart shows, these numbers do bounce around considerably – the longer term question is how much of this growth is sustainable. The average annual rate of GDP growth since the second quarter of 2009 has been 2.4 percent. Many economists argue that even that number is too high – remember that for a good chunk of this time much of the growth came courtesy of direct monetary intervention by the Federal Reserve, which is no longer in effect. The fiscal stimulus put in place at the end of last year – windfall tax cuts to US businesses – may have the effect of elevating fixed investment above trend levels for a few more quarters, but that has the longer-term implications of significantly higher deficits and thus borrowing costs. This could be a particularly thorny problem if it converges with a sustained period of higher interest rates as the Fed tries to “normalize” borrowing rates.
There has not been much in the way of market reaction to today’s GDP release – partly because the number was largely in line with consensus estimates and thus already baked into stock prices. Investment sentiment around GDP appears largely dominated by the “something old” theme – different quarter, same trends – while ascribing little in the way of impactful news to either transitory short term phenomena like soya bean exports or the longer term borrowing implications of the fiscal stimulus. This way of looking at what is arguably the economy’s lead headline number also assumes that the trade tensions are mostly smoke and mirrors and will not metastasize into an all-out hot war (which view got some support this week with a surprisingly docile outcome of trade talks between the US and the EU).
What has some observers feeling blue, even when most data point to continued growth in the economy and with corporate sales and earnings, is that this recovery cycle is already long by historical standards. We have discussed this in other recent commentaries, usually with the caveat that every cycle is different and that recoveries don’t end because they pass some arbitrary calendar milestone. We do not think we are in for some super-long period of above-trend growth. Neither, however, do we see a compelling case for an imminent winding down of this cycle.
Stock prices rise and fall on account of all sorts of influencing factors on any given day. For the time being, at least, the overarching economic narrative does not give us much cause to be feeling blue.
The financial news headlines on this, the first Friday of the second half of 2018, seem fitting. Appropriately contradictory, one might say, providing a taste for what may lie ahead in these next six months. First, we have news that Donald Trump’s splendid little trade war is happening, for real now! Tariffs have been slapped on the first $34 billion worth of products imported from China. On the other side of the ledger, an American ship full of soya beans was steaming full-on to reach the Chinese port of Dalian in time to offload its supply before facing the retaliatory tariffs mandated from Beijing. Too bad, so sad, missed the deadline. Apparently the fate of the ship, the Peak Pegasus, was all the rage on Chinese social media. The trade war will be Twitterized.
The second headline today, of course, was another month of bang-up jobs numbers led by 213K worth of payroll gains (and upward revisions for prior months). Even the labor force participation rate, a more structural reading of labor market health, ticked up (more people coming back into the jobs pool is also why the headline unemployment rate nudged up a tad from 3.8 to 4.0 percent). Hourly wages, a closely followed metric as a sign of potential inflation, recorded another modest year-on-year gain of 2.7 percent.
So there it is: the economy continues to carry on in good health, much as before, but the trade war has moved from the theoretical periphery to the actual center. How is this going to play out in asset markets?
Manufacturers Feel the Pain
The products covered by this first round of $34 billion in tariffs are not the ones that tend to show up in Wal-Mart or Best Buy – so the practical impact of the trade war will not yet be fully felt on the US consumer. The products on this first list include mostly manufacturing components like industrial lathes, heating equipment, oil and gas drilling platform parts and harvester-thresher combines. If you look at that list and think “Hmm, I wonder how that affects companies like Caterpillar, John Deere and Boeing” – well, you can see for yourself by looking at the troubled performance of these companies’ shares in the stock market. As of today those components will cost US manufacturers 25 percent more than they did yesterday. That’s a lot of pressure on profit margins, not to mention the added expense of time and money in trying to figure out how to reconfigure supply chains and locate alternative vendor sources.
Consumers Up Next
The question – and probably one of the keys to whether this trade war inflicts real damage on risk asset portfolios – is whether the next slates of tariffs move from theoretical to actual. These are the lists that will affect you and me as consumers. In total, the US has drawn up lists amounting to $500 billion in tariffs for Chinese imports. In 2017 the US imported $505 billion from China – we’re basically talking about the sum total of everything with a “Made in China” label on it. Consumers will feel the pain.
If it comes to pass. The collective wisdom of investors today has not yet bought into the inevitability of an all-out trade war. US stocks are on track to notch decent gains for this first week of the second half. The job numbers seem to be holding the upper hand in terms of investor sentiment. Sell-side equity analysts have not made meaningful downward revisions to their sunny outlook for corporate sales and earnings. Sales for S&P 500 companies are expected to grow at a rate of 7.3 percent this year. That reflects an improved assessment from the 6.5 percent those same analysts were projecting three months ago – before the trade war heated up. The good times, apparently, can continue to roll.
Since we haven’t had a global trade war since the 1920s, we can’t model out just how these tariffs, in part or in full, will impact the global economy. Maybe the positive headline macro numbers, along with healthy corporate sales and profits, can power through this. Perhaps the trade war will turn out to be little more than a tempest in a teapot. We may be about to find out.