Leading Economic Indicators
From a financial market psychology standpoint it is however very important that central bankers don’t appear clueless. A majority of market participants needs to be able to suspend disbelief to an sufficient extent, i.e., they must be able to share in the collective hallucination that central bankers actually do know what they are doing. When it is no longer possible to maintain this facade, many things are likely to be suddenly questioned – and among these is the question whether it makes sense to remain exposed to yet another gargantuan asset bubble.
The question on everyone's mind is whether the economy is strong enough to withstand rate hikes by the Federal Reserve? In our opinion, the answer is no. The economy continues to ebb and flow between weak growth and no growth. This puts the Federal Reserve at risk of a policy mistake that could trip the economy into an outright recession. While there have certainly been positive bumps in the data, as pent-up demand is released back into the economy, the inability to sustain growth is most concerning.
Currently, there are things occurring that are very troublesome, and in more normal times, would likely already have investors heading for cover. However, in today's liquidity fueled, Central Bank supported environment, that has yet to be the case. The reason was best described recently by Dr. Robert Shiller "I call this the 'new normal' boom ó it's a funny boom in asset prices because it's driven not by the usual exuberance but by an anxiety." What happens next is only a guess. However, historically, it hasn't been the outcome that investors were hoping for. But then again, maybe "bearish bull" isn't as much of an oxymoron as it is just a warning.
Since QE programs have not been effective at creating organic economic growth, the only effective monetary policy tool of the Fed to stave off the effects of a recessionary drag, lowering interest rates, is not available. This is why, despite weak economic growth, little inflation and a large amount of labor slack in the economy, the Fed has consistently hinted that they will likely raise the overnight lending rates in June. Therefore, since the Fed is "data dependent," a boost to GDP, via the recalculation of the numbers, would be vastly supportive in justifying that increase. However, is economic growth really stronger than currently reported? We can look at some alternative measures of the economy to answer that question.
The largest problem with the data sets below is that they are all subject to large historical revisions. This is why the NBER is ALWAYS well after the fact in pronouncing the start and end of recessions in the U.S. economy. Given the ongoing interventions from the Federal Reserve and the current administration, it is likely that many of the statistics, and seasonal adjustment metrics, have been skewed in recent years. In the quarters ahead it is likely that we could see rather sharp adjustments to historical data which may suggest the economy has been far weaker than headline statistics have suggested.
Central bankers in the U.S., Europe and Asia have created another massive bubble. This time it is a bubble in stocks, bonds and real estate simultaneously. There is no place to hide. But we’d put my money on war, chaos, and revolution. There will be no impunity for our gambling.
The negative divergence of the markets from economic strength and momentum are simply warning signs and do not currently suggest becoming grossly underweight equity exposure. However, warning signs exist for a reason, and much like Wyle E. Coyote chasing the Roadrunner, not paying attention to the signs has tended to have rather severe consequences. When the market eventually cracks, the "disposition" effect will trump all the good intentions of "buying and holding" for the long-term. The eventual "panic to sell" will lead to a significant destruction in investment capital and a reversion in investor psychology to extreme negativity. While the basic premise of investing is to "buy low" and "sell high," repeated studies show that there are precious few who do.
We often hear various Fed officials described as hawks or doves but Janet Yellen’s Fed brings to mind another avian metaphor. They are afraid to raise rates for fear that doing so would upset the asset market inflation process and derail what is left of their theory. In her press conference last week Yellen said that stock market valuations were on the high side of historical norms, an appellation that only works if one includes the stock bubble of the late 90s. It seems that she and the other members of the FOMC have decided that another epic stock market bubble is better than admitting they were wrong. This FOMC doesn’t have any hawks or doves, only chickens.
As we noted over the weekend when we showed a simple contango math calculation by SocGen according to which storage costs imply another 20% drop in Brent prices, now none other than Goldman - which has been oddly bearish on oil over the past few weeks - says that its Brent forecast remains at $40/bbl for two simple reasons: i) the global inventory glut is set to resume and ii) it's the weather's fault there has been a slowdown in the crude build-up.
Thanks to the People's Bank of China...
Perhaps the biggest shock following last night's completely expected and very predictable (previewed here over a month ago) Japanese slide into triple- (actually make that quadruple) dip recession, is that it took the BTFTripleDip recession algos as long as they did to recover most of the overnight futures losses. Because after surging to 107 on a confused short squeeze kneejerk reaction, the USDJPY subsequently tumbled 150 pips to 105.50 as rationality briefly emerged, and the market wondered for a few brief hours if rewaring the destruction of one's economy is actually a prudent thing. Then, however, when European traders started walking into work, the now default USDJPY levitation on no volume came right back, and with that the correlation algo buying of E-mini futures, no doubt helped by the Bank of Japan itself taking advantage of the CME's ES liquidity rebate program. Because without confidence as expressed by the lowest and only common denominator left - global equities - there is nothing else.
So much for any Scottish referendum vote "surprise": the people came, they voted, and they decided to stay in the 307-year-old union by a far wider margin, some 55% to 45%, than most polls had forecast, even as 3.6 million votes, a record 85% turnout, expressed their opinion. The gloating began shortly thereafter, first and foremost by David Cameron who said "There can be no disputes, no re-runs, we have heard the settled will of the Scottish people." Queen Elizabeth II, who is at her Scottish castle in Balmoral, is expected to make a rare comment on Friday. But while a No vote was where the smart betting money was ahead of the vote anyway, and is thus hardly a surprise, the most curious thing overnight was the complete roundtrip of cable, which was bought on the rumor and then sold off on the news, roundtripping by nearly 200 pips.
David Rosenberg, in one of his recent missives, wrote: "...based on the current trend in the LEI and the level of the diffusion index, history suggests that the next recession is at least four years away." While anything is certainly possible, it is highly unlikely that the current economic environment is supportive of another four years of a "struggle along" economy. Given the artificial supports during recent years, the extreme extension in assets prices, record levels of margin debt and the chase for yield in "junk credits," it is highly possible that the next recessionary decline could be much larger than the historical average.
With the FOMC Minutes in the books, the only remaining major event for the week is the Jackson Hole conference, where Yellen is now expected to talk back any Hawkish aftertaste left from the Minutes, and which starts today but no speeches are due until tomorrow. And while the Minutes were generally seen as hawkish, stocks continue to levitate, blissfully oblivious what tighter monetary conditions would mean to an asset bubble, which according to many, is now the biggest in history. And speaking of equities, US futures climbed to a fresh record high overnight on just the right mix of bad news.
For a centrally-planned market that has long since lost the ability to discount the future, and certainly respond appropriately to geopolitical events, yesterday was a rough wake up call with a two punch stunner of not only the MH 17 crash pushing the Ukraine escalation into overdrive, but Israel's just as shocking land invasion of Gaza officially marking the start of a ground war, finally dragging global stocks out of their hypnotized slumber and pushing risk broadly lower across the globe, even if the now traditional USDJPY and AUDJPY ramp algos have woken up in the past few minutes and will be eager to pretend as if nothing ever happened.