The soon-to-be-renamed-Boring-Book, for its constant uniformity of mediocre Goldilocks data offered little to strengthen bulls or bears (as usual) but it seems weather was the key once again. With 119 references to "weather" (6 times more than the January report), they remind us that:
- *FED SAW ECONOMY GROW EVEN AS HARSH WEATHER SLOWED HIRING, SALES
- *FED SAYS OUTLOOK 'AMONG MOST DISTRICTS REMAINED OPTIMISTIC'
But - the "m" words continue to dominate:
- *FED SAYS MOST REPORTS OF IMPROVEMENT WERE 'MODEST TO MODERATE'
As 8 of the 12 districts "reported improved levels of activity"... but but but the weather. Healthcare concerns were cited 16 times.
Sometimes you just have to sit back, look at some charts, and say WTF...
A considerable area of investor concern remains on emerging economies. As UBS' Larry Hatheway notes, the last thing that vulnerable emerging economies need at the moment is worries about a global growth slowdown, if that is indeed what is happening. That’s particularly true given that one of the relative few bright spots in the emerging complex of late was improved PMIs, reflecting some pickup in global manufacturing, exports and trade. While that lift might not help the down-trodden commodity producers within the emerging complex, it is helpful for the more manufacturing-oriented economies of Asia, selected parts of EMEA, or Latin America. But as Hatheway warns below, emerging vulnerability is about much more than just growth.
... our default is a Goldilocks scenario between now and the next FOMC meeting in mid-March. It means that bad macro news is good market news, and vice versa. If the next ISM manufacturing number (no one cares about ISM services) is a big jump upwards, the market goes down. Ditto for the February jobs number. If they’re weak, though, that’s more pressure on the Fed and another leg up for markets. Place your bets, ladies and gentlemen, the croupier is about to spin the roulette wheel. Pardon me if I sit this one out, though. My crystal ball is broken. If I’m right, what does this mean for the real world? It means an Entropic Ending to the story … disappointing, slow and uneven growth as far as the eye can see, but never negative growth, never an honest assignment of losses to clear the field or cull the herd. That’s not my vision of a good investment world, but who cares? I’ve got to live in the world as it is, even if it’s a long gray slog.
How many times in the last few days have we been told that Turkey - or Ukraine or Venezuela or Argentina - are too small to matter? How many comparisons of Emerging Market GDP to world GDP to instill confidence that a little crisis there can't possible mean problems here. Putting aside this entirely disingenuous perspective, historical examples such as LTCM, and ignoring the massive leverage in the system, there is a simple reason why Emerging Markets matter. As Reuters reports, European banks have loaned in excess of $3 trillion to emerging markets, more than four times US lenders - especially when average NPLs for historical EM shocks is over 40%.
Yes, it is true that, just as had happened six months ago when the Fed first started its public ruminations about whether and when to start to reduce its stimulus, emerging markets have suffered a further bout of turbulence and it is also true that some of these are facing increasingly fraught social and political tensions, to boot. The cynic would say that such periods of upheaval are almost intrinsic to their designation as "emerging" but he would also be quick to point out that such susceptibilities are supposed to be rewarded with either a yield premium or its converse, a price discount. The ironists among market punters will even attempt to construe all this as a reason to buy more developed world stocks on the premise that the money flooding out of such places as Thailand, the Ukraine, Turkey, and Argentina will be parked in the S&P and the DAX (perhaps overlooking the fact that the purchase price of these now-unwanted positions was most likely borrowed, meaning that their liquidation will also extinguish the associated credit, not re-allocate it). The Goldilocks lovers will also tend to assume that any such disruption will serve to delay the onset of genuine tightening and may even induce further ill-advised stimulus measures on the part of the major central banks.
Some of us stopped believing in fairytales long ago and then there were those that never thought that Goldilocks ate anybody’s porridge. So, there are two types of believers.
Unintended consequences may have developed from QE policies that are not fully understood. They may materialize more clearly during the withdrawal process. Any of a number of obstacles could push the Fed ‘off course’ from the smooth landing that its baseline scenario suggests:
- Certainly, expanding the balance sheet by over $3 trillion has had a significant impact on valuations, market functioning, and asset allocation, so those effects could cause some market turbulence as they revert back to normal.
- Emerging markets, which benefited heavily in the early years of QE, have recently shown some disruptions, such as, slowing economic growth, weakening currencies, and capital outflows.
- Political and social concerns about income and wealth inequalities have grown due to the use of asset prices as a policy tool.
- Structural unemployment from long-term joblessness and technological advancement cannot be addressed through easy money.
- Politics is still polarizing, which in turn creates on-going economic headwinds.
Most economic observers are predicting that 2014 will be the year in which the United States finally shrugs off the persistent malaise of the Great Recession. In contrast, we believe that the episode has, for the moment, established supreme confidence in the powers of monetary policy to keep the economy afloat and to keep a floor under asset prices, even in the worst of circumstances. The shift in sentiment can only be explained by the growing acceptance of monetary policy as the magic elixir that Keynesians have always claimed it to be. This blind faith has prevented investors from seeing the obvious economic crises that may lay ahead. Based on nothing but pure optimism, the market believes that the Fed can somehow contract its $4 trillion balance sheet without pushing up rates to the point where asset prices are threatened, or where debt service costs become too big a burden for debtors to bear. The more likely truth is that this widespread mistake will allow us to drift into the next crisis.
Each quarter the Fed releases their assessment of the economy along with their forward looking projections for three years into the future. The reality is, however, is that the Federal Reserve simply cannot verbally state what they really see during each highly publicized meeting as it would roil the markets. Instead, they use their communications to guide the markets expectations toward reality in the hopes of reducing the risks of market dislocations. The most recent release of the Fed's economic projections on the economy, inflation and unemployment continue to follow the same previous trends of weaker growth, lower inflation and a complete misunderstanding of the real labor market. Reminiscent of the choices of Goldilocks - the reality is that the Fed's estimates for economic growth in 2013 was too hot, employment was too cold and inflation estimates were just about right. The real unspoken concern should be the continued threat of deflation and what actions will be available when the next recession eventually comes.
BlackRock said there is a 20% risk that world events could go badly wrong, either because the eurozone acts too late to head off deflation or because of a chain reaction as the Fed starts to wind down stimulus in earnest. As The Telegraph notes, BlackRock’s risk indicator is almost as high as it was just before the dotcom bust. "The ratio of the two is the key. High valuations combined with low volatility can make for a lethal mix. This market gauge sounded the alarm well before the Great Financial Crisis." Furthermore, the largest asset manager in the world warns, "troubling trends of growing inequality and weak wage growth, bring into question the sustainability of profit margins." What is good for investors is corrosive for societies, hardly tenable equilibrium.
Today's nonfarm payroll number critical "make or break" margin, as estimated earlier by Deutsche Bank's Jim Reid, is a tiny 30K: "anything above +200k (net of revisions) will lead to a further dip in risk as taper fears intensify and anything less than say +170k will probably see a decent relief rally after a tricky week for markets." Goldilocks of course will be the expected 185K but what economists forecast rarely if every happens. So it is likely that what the BLS reports will either be good for the economy and horrible for market, or vice versa. So we decided to put this 30K in context. The charts below show both the average and the annual seasonal adjustment between the unadjusted and the final, adjusted nonfarm payroll print. In the past decade, the average November seasonal adjustment is the highest of all months, amounting to 1.165 million jobs! In other words, the 30K critical difference will fit nearly 40 times in just what the BLS' Arima X 13 smoothing simulator adjusts the actual print by in order to get what it believes is the appropriate trendline, ignoring entirely that in the New Normal all historical seasonal adjustments are no longer applicable.
As stocks hit new records and small investors—finally—return to the market, some analysts are getting worried. Risk assets have rallied to previous bubble conditions. Powered by unprecedented refinancing and recap activity, 2013 is now the most productive year ever for new-issue leveraged loans, for example. This has been great for corporations as financing and refinancing has put them on a stronger footing. Where M&A activity still lags the highs of the last boom, issuers have jumped into the opportunistic pool with both feet. And why not? Secondary prices are high and new-issue clearing yields remain low. Yet very inadequate movement has been evidenced on the hiring front. And after all the improvement in ebitda, where do we go from here? Forward guidance will clearly be harder. One might argue that we are back in a Goldilocks fantasy world, where the economy is not so strong (as to cause inflation and trigger serious monetary tightening) or so weak (as to cause recession and a collapse in profits) but "just right". Yet, it seems unlikely that issuers with weaker credit quality could find it so easy to sell debt without the excess liquidity created by the Fed and other central banks.
Bond markets may be closed today for Veterans' Day, but equities and far more importantly, FX, are certainly open and thanks to yet another overnight ramp in the ES leading EURJPY, we have seen one more levitation session to start off the week, and an implied stock market open which will be another record high. There was little overnight developed market data to digest, with just Italian Industrial Production coming in line with expectations at 0.2%, while the bulk of the attention fell on China which over the weekend reported stronger Industrial Production and retail sales, while CPI was just below expectations and additionally China new loans of CNY 506 billion (below est. of CNY 580bn) even as M2 in line, should give the Chinese government the all clear to reform absolutely nothing. That all this goldilocks and goalseeked data is taking place just as the Third Plenum picks up pace was not lost on anyone.
Just as Friday ended with a last minute meltup, there continues to be nothing that can stop Bernanke's runaway liquidity train, and the overnight trading session has been one of a continuing slow melt up in risk assets, which as expected merely ape the Fed's balance sheet to their implied fair year end target of roughly 1900. The data in the past 48 hours was hot but not too hot, with China Non-mfg PMI rising from 55.4 to 56.3 a 14 month high (and entirely made up as all other China data) - hot but not too hot to concern the PBOC additionally over cutting additional liquidity - while the Eurozone Mfg PMI came as expected at 51.3 up from 51.1 prior driven by rising German PMI (up from 51.1 to 51.7 on 51.5 expected), declining French PMI (from 49.8 to 49.1, exp. 49.4), declining Italian PMI (from 50.8 to 50.7, exp. 51.0), Spain up (from 50.7 to 50.9, vs 51.0 expected), and finally the UK construction PMI up from 58.9 to 59.4.