Goldilocks

In this past weekend's missive we  showed, in rather excruciating detail in multiple charts, that complacency in the financial markets is at extremely elevated levels. Investors behave much the same way as individuals who addicted to gambling. When they are winning they believe that their success is based on their skill. However, when they began to lose, they keep gambling thinking the next “hand” will be the one that gets them back on track.  Eventually - they leave the table broke. It is true that bull markets are more fun than bear markets. Bull markets elicit euphoria and feelings of psychological superiority. Bear markets bring fear, panic and depression. What is interesting is that no matter how many times we continually repeat these “cycles” – as emotional human beings we always “hope” that somehow this “time will be different.” Unfortunately, it never is, and this time won’t be either.

With the Fed now fully engaged, and few if any policy tools left, the effectiveness of continued artificial stimulation is clearly waning.  Lower mortgages rates, interest rates and excess liquidity served well in priming the pumps of the real estate and financial markets when valuations were extremely depressed.  However, four years and four programs later, stock valuations are no longer low, earnings are no longer depressed and the majority of real estate related activity has likely been completed. It is for this reason that the returns from each subsequent program have diminished.  The reality is that Fed may have finally found the limits of their effectiveness as earnings growth slows, economic data weakens and real unemployment remains high.  Reminiscent of the choices of Goldilocks - it is likely the Fed's estimates for economic growth in 2013 are too hot, employment is too cold and inflation estimates may be just about right.  The real unspoken concern is the continued threat of deflation and the next recession.

For a while there, one might have been forgiven for believing that all was going to be well; that the recovery was V-shaped and the new-normal was nothing but the old-normal and Goldilocks would reappear. It appears, however, that the central bank lipstick slapped on the deflationary pig of the over-levered global economy is starting to wear off. As the following 4 charts show, things are not as 'recovering' as many hoped (and still hope).

HSBC's China Flash PMI just printed above expectations at 51.7, disappointing those hoping for more stimulus but just Goldilocks enough to satisfy the world that China is firing on all cylinders... But, and there's always a but, the following chart suggests that the diffusion-driven survey-based PMI data may be just a little different from the hard data on the ground. Of course, everything could have magically turned around in the last 3 weeks (aside from Copper demand and PBoC repo/rev. repo that is). For now, we tip our hat to the well planned PMI print as indicative that all is well in the smog-ridden pig-barren nation but scratch our chin at just what is powering all this growthiness...

The grind lower in initial jobless claims continues, which from an upwardly revised 342k (was 340K) last week, declined to 332K in the most recent week ended March 9, on expectations of an increase to 350K. This was the third consecutive beat in a row and the lowest total print since January, which in turn takes it all the way back to January 2008. Continuing claims were also better than expected, dropping from an upwardly-revised 3113K, to 3024K, on expectations of a 3090K print. According to the BLS, unlike the last time we had an abnormally low print, no states were estimated this time around.

Water is wet. Sky is blue. Spring follows Winter. All things we hold as true and yet, it appears the last of these has managed to foil the best laid plans of Dick's Sporting Goods amid their dismal earnings call. The company at once blamed 'warmer weather' than expected for shrinkage in its outerwear sales and because "it didn't look like Winter was going to come," the firm then blamed excessively cold weather and its lack of outerwear inventory to meet those needs. Just as the firm said, "we're not as smart as we look," as it appears that unless we get Goldilocks perfection year-round, retail sales are all but a pure guess on meteorological mysticism.

Below are the expectations of the biggest banks for today's Nonfarm Payroll number to be announced in just over two hours:

• Morgan Stanley +135K
• Barclays Capital +150K
• Goldman Sachs +150K
• Bank of America +160K
• JPMorgan +165K
• HSBC +179K
• Deutsche Bank +180K
• UBS +190K

Think Americans are the only people in the world toiling under a gargantuan debtload, which at last check was a massive $55.3 trillion, or about $175K per person? Think again. Meet Sherry Sheng, a 29-year-old Shanghai policewoman, who bought herself a 4,000 yuan ($642) black fur jacket, splurging for the last time before she starts paying off the mortgage on her first home.

Sherry is what is known as a Chinese "housing slave."

The ongoing message from the mainstream media, analysts and most economists is that the economy has turned the corner and we are set for substantially stronger growth in the coming year.  While that sounds great on the surface the economic data has yet to hint at such a robust recovery.  What is worrisome is that CNBC has started using the term "Goldilocks economy" again which is what we were hearing as we approached the peak of the market in early 2008.  As David Rosenberg pointed out in his morning missive: "Maybe, it's just this:  so long as there is a positive sign in front of any economic metric, no matter how microscopic, all is good.  After all, you can't be 'sort of in recession' - it's like being pregnant... either you are or you are not." The bottom line is that ex-artificial stimulus, and other fiscal supports, there is little in the way of an economic recovery currently going on.  In order for the economy to reach "escape velocity" it will be on the back of sharply rising employment and wages which are needed to prime consumer spending.  This is not happening as the the gap between wages and rising cost of living continues to drive the consumer to shore up that shortfall with more debt.  

In what may come as a surprise to some, advance retail sales for January printed on top of expectations of a +0.1% increase in sequential sales, although the forecast range was very wide, from -0.7% to +0.6% as many analysts were concerned what the impact of the payroll tax expiration would be on sales. This is a moderation of the January growth when retail sales rose 0.5%.  And while the headline number was goldilocks, the core reading excluding autos and gas came at 0.2% or slightly below expectations of a 0.4% print. What was even more curious is that the commerce department said department store sales rose the most since February 2012. Retail sales “relatively flat” as end of tax holiday likely had effect, says Bloomberg Government economist Nela Richardson. In B-grade economic news,  import price index up 0.6% M/m vs est. 0.8%  increase(range 0.2%-1.2% gain); prior revised to 0.5% drop from down  0.1%.

As the chart below shows, in some 200 years of history, when expressed as a ratio of total sovereign debt to tax revenues, the empirical data as compiled by Reinhart and Rogoff ranges from 2x to 16x. This is shown by the blue bars in the chart below.  So where are we in this cycle as the debt clock counts down? As the red bars show, we are in a very uncomfortable place, with Japan now at the highest such ratio in history, well above the highest recorded which always ended up in default, while the US, whose such ratio is over 600%, is above the long-term average of about 520% public debt/revenue. The problem is that every current and subsequent attempt to reflate merely pushes both of these higher, until one day the marginal growth creation of every dollar in new debt becomes negative. How much higher can consolidated global debt go before global GDP is not only no longer growing, but every incremental dollar in debt has a negative impact on GDP, as was the case for the US in the fourth quarter? Keep an eye on global economic growth: if and when the world enters outright recession: the most feared outcome by all central bankers who realize they are out of weapons and their only recourse is much more of the same, that may be cue to quietly leave town.

Six years ago today, with the S&P 500 around 1460 - having risen 20% without a correction for seven months - a handful of Wall Street's best and brightest joined CNBC's Larry Kudlow and Bob Pisani to discuss the Goldilocks economy, why the bears are wrong, and where the market is going next. Sometimes, we just need a reminder to snap us out of that recency bias... for example, Bob Pisani: "We have got a global rally going on... and the important thing is... there's a floor to the market - every time, for the last seven months, they sell the market down for 2 days, it comes right back... When you are in a global expansion like this, to sell...is foolish."

The goldilocks economy continues as January nonfarm payrolls number comes in right as expected, or 157,000, a tiny miss to expectations of 165,000, down from the upwardly revised 196,000 (was 155,000 previously), leading to an unemployment rate of 7.9%, higher than the 7.8% expected. The seasonal adjustment for January was in line with expectations, or 2.120 million, as the actual decline in jobs December to January was a whopping 2.84 million. The NSA Birth/Death adjustment subtracted some 314K jobs in January.

There has been an burst of exuberance as of late as the market, after four arduous years, got back to its pre-crisis levels.  Much has been attributed to the recent burst of optimism in the financial markets from: better than expected earnings, stronger economic growth ahead, the end of the bond bubble is near, the long term outlook is getting better, valuations are cheap, and the great rotation is here - all of which have egregious holes. However, with the markets fully inflated, we have reached the point that where even a small exogenous shock will likely have an exaggerated effect on the markets.  There are times that investors can safely "buy and hold" investments - this likely isn't one of them.

As expected, moments ago the ECB announced the results of the first LTRO repayment option. According to media reports, a total of €137.2 billion will be repaid as 278 banks participate in the repayment. The consensus expectation was for a repayment figure of €84 billion, so a figure substantially more than both the expected, as well as the whispered goldilocks number of €100 billion. The banks that will free themselves of the LTRO stigma will be disclosed in time - there is no public list, however as a reminder some 523 banks participated in the first LTRO. Since Europe is currently in the risk on phase, don't expect an immediate retaliation against the primarily non-core banks that opt to keep the LTRO funds. The market response so far has been one of risk on, due to the perceived implication that the interbank market is healhtier than expected, coupled with a push up in the EURUSD as the repayment is, as noted previously, a gross deleveraging of the ECB balance sheet coming at a time when every other bank is explicitly devaluaing their currency. Indeed, moments after the announcement the EURUSD ramped up to 1.3460 despite some ugly UK GDP news earlier.