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3 Things Worth Thinking About

Tyler Durden's picture




 

Submitted by Lance Roberts of STA Wealth Management,

Surge In Sentiment Surveys

There is an interesting divergence going on between sentiment based surveys, specifically the ISM Manufacturing and Non-Manufacturing surveys, and actual underlying economic data.  This week saw both surveys rise sharply to cyclically high levels despite weakness in actual new orders and consumer consumption.

It is also somewhat intriguing that two groups measuring the same data are getting vastly different results.  While the Institute of Supply Management survey saw sharp increases in optimism, Markit's surveys of the same manufacturing and services related data saw declines. This is one of those cases where only one can be right.

The chart below shows the composite index of the ISM surveys (simple average of manufacturing and services data).

ISM-Composite-090414

There is a running pattern in the surveys which the initial decline mid-economic cycle reverses back up to cycle peaks. The next decline in sentiment is during the latter stage of the economic cycle prior to the onset of the ultimate recession. The recent surge in survey activity, ex-underlying strength in the actual data, suggests that sentiment is anticipating a recovery that may or may not occur. 

The chart below shows just the ISM Manufacturing survey compared to core-durable goods orders.  Core-durable goods are ex-defense and aircraft orders which is a better metric of what the average consumer is doing.  The data, however, is very volatile, so I have smoothed with the monthly changes with a simple 12-month average.

ISM-CoreDurableGoods-090414

Because I have smoothed the data with a 12-month average there is a slight lag to the data.  However, what is clear is that there is a very high correlation between core-durable goods and manufacturing sentiment.  Currently, sentiment is well ahead of actual activity which suggests that either the economy is about to come roaring back to life, which is what has been priced into the financial markets currently, or there will be disappointment.

There are a couple of important considerations with respect to your outlook with how this will ultimately be resolved. As I will discuss in just a moment, despite the ECB's attempt to stimulate the Euro-economy the deflationary pressures are picking up steam and the majority of economies are slowing. With 40% of domestic corporate profits coming from the global community, the Eurozone is the largest consumer, it is very likely the economic drag will be felt in the U.S. soon.  Secondly, the U.S. is about to enter back into a period of the year where unseasonably cold weather will resurface once again.  It is currently estimated that this winter will be as cold, or colder, than last which resulted in a 2% decline in economic activity in the first quarter of this year.

ECB Buys Bonds - Expects A Different Result

The European Central Bank announced this morning, much to the delight of stock market investors, that they are lowering interest rates from 0.15% to just 0.05%, which results in a negative real interest rate for depositors, and will begin buying asset backed bonds from its members.  Via CNBC:

"Draghi announced the ECB would purchase asset-backed securities (ABS) and covered bonds to boost the economy and boost inflation."

If the goal of boosting inflation and the economy through buying bonds sounds oddly familiar, it is because it is exactly what the Federal Reserve and Bank of Japan set out to do.  In both cases, it was a significant miss.  The U.S. economy has muddled along with economic growth and inflation running below 2% with Japan just printing a near 7% drop in GDP despite a program three-times the size of the U.S. on a relative basis.

The issue of the inability to translate monetary policy into actual economic prosperity is something I discussed at length yesterday wherein I quoted Brad Delong:

"Instead, despite the absence of a significant increase in employment or a substantial increase in inflation, the Fed already is cutting its asset purchases and considering when, not whether, to raise interest rates."

In other words, what the Federal Reserve has figured out is that they are creating another asset bubble that must be unwound to some degree before it bursts. With interest rates at the zero-bound, an important tool of the Federal Reserve to support economic growth in the future has been exhausted. This leaves them few options for the future.

The interesting aspect to this is that despite expressed concerns by the Federal Reserve of inflated areas of the asset markets, the momentum chase has continued pushing asset prices to all-time highs.  Likewise, the influx of liquidity by the ECB will likely push assets even further creating the anticipated "melt-up" in asset prices in the months ahead.

However, what is becoming abundantly clear, is that these monetary programs and interventions have little effect on the middle class which is where the most help is really needed.

What is that old saying about repeating an action and expecting a different result?

Interest Rates And Sentiment

While the ECB's actions certainly aren't likely to cure the real problems that plague the Eurozone, primarily financially insolvency, what is clear is that investors love the idea of "more" liquidity.  David Tepper of Appaloosa Management tweeted out this morning following the ECB's decision to buy bonds that this is "the beginning of the end" for bonds.

As Zerohedge aptly noted:

"Empirically, Tepper may be right: in the past every time a central bank has launched a massive easing program (think QE1, QE2, Twist, QE3, etc.) it resulted in aggressive stock buying offset by bond selling. The issue is when said programs came to an end, and led to major selloffs in equities, pushing bonds to newer and lower record low yields. So perhaps for the time being, we may have seen the lows in the 10Year and in the periphery.

More importantly, it also explains why central banks now have to work in a constant, staggered basis when easing, as the global capital markets simply can not exist in a world in which every single central bank stops cold turkey with...liquidity injections."

Interest-Rates-QE-090414

I seriously doubt this is the end of the "bond bull" due to many reasons I will discuss next week.  However, with respect to the ECB's decision the size and scope of the purchases fall well short of the broad, large-scale asset purchases advocated by many economists (similar to the measures used by the Federal Reserve). While the announcement was "bullish" for investors wanting liquidity, it will likely have little effect on the broad deflationary pressures that are keeping rates under pressure. 

However, as I stated, bullish sentiment was bolstered by the news. The chart below shows the composite index of both individual and professional investor "bullish vs. bearish" sentiment. Currently, the index is at levels reached only once before in the history of the data.  At 3.02, the index signals extreme bullish sentiment in the short term and is at levels that exceed all previous minor and major market peaks.

AAII-INVI-Composite-Bullish-Sentiment-090414

While there is currently no "technical" reason to become overly cautious on the markets (bullish trends are still firmly in place), there are many reasons to be "aware" of the rising risks.

Market reversions, when the occur, are extremely rapid and tend to leave a rather brutal "scar" on investment portfolios. There is clear evidence that economic growth is being impacted by deflationary pressures on a global scale. This suggests that the sustainability of current and projected growth rates of profits is questionable given the magnitude to which leverage has been used to boost margins through share repurchases. Manufacturing profits through artificial means, ie. cost cutting and share repurchases, are finite in nature, and most of the benefit of such activities have already been fully harvested. If the current rise in sentiment surveys is not met with actual activity in the near future this could pose a problem for over zealous investors.

 

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Thu, 09/04/2014 - 18:41 | 5182222 Barbarossa296
Barbarossa296's picture

Don't worry, we'll get a good nuclear war going before we have to deal with these problems.

Thu, 09/04/2014 - 18:52 | 5182263 Al Huxley
Al Huxley's picture

Even then, unless Wall Street is taken out, don't expect the market to sell off (ane even in that case, as long as they can get the disaster recovery sites live quickly we should still get a green close).

Thu, 09/04/2014 - 18:57 | 5182290 knukles
knukles's picture

And another thing to worry about today.
Joan Rivers mysteriously dies 2 months after openly talking about Mike & OB on Beyonce's 33rd birthday.

Thu, 09/04/2014 - 19:02 | 5182311 darteaus
darteaus's picture

AND she's Jewish from New York, so...

Thu, 09/04/2014 - 19:04 | 5182324 negative rates
negative rates's picture

And lost her husband in 87.

Thu, 09/04/2014 - 19:08 | 5182334 knukles
knukles's picture

1+9+8+7=25
2+5=7

See...
ssssshhh... don't tell anyone else

Thu, 09/04/2014 - 19:45 | 5182471 himaroid
himaroid's picture

WTF?

Thu, 09/04/2014 - 20:12 | 5182572 knukles
knukles's picture

Exactly ... made nonsensical to be like the rest of today.  And yesterday.  And likely tomorrow.

Thu, 09/04/2014 - 19:05 | 5182330 knukles
knukles's picture

Attend the first Bilderberg meeting at Oosterbeek in 1954 before turning her seat over to Queen Beatrix.  Was a past mistress to George Soros. 
Serious Illuminati stuff, my friend

Thu, 09/04/2014 - 19:42 | 5182463 himaroid
himaroid's picture

Far out man.

Thu, 09/04/2014 - 19:42 | 5182460 himaroid
himaroid's picture

Good thing no one listens to us.

Thu, 09/04/2014 - 19:01 | 5182304 darteaus
darteaus's picture

Is "good nuclear war" an oxymoron or a redundancy?

Thu, 09/04/2014 - 18:51 | 5182260 absente reo
absente reo's picture

"Market reversions, when the occur, are extremely rapid"

Well, when they occur, yes, but the trouble is, the markets can fanny about in distribution mode, with lots of fake-break-then-rip-back-up moves, etc., for months if not a year or more, as per 2006/7/8, to make even the most diehard bear think it's never going to happen, to make billions of $ of puts expire worthless etc., until the final cataclysmic break.

Thu, 09/04/2014 - 18:57 | 5182288 Al Huxley
Al Huxley's picture

Exactly - its a big fucking crooked casino, but if anyone insists on playing, why fight the casino owners just 'on principal, because these fucking crooks have rigged the market and everythings ridiculously overvalued, and the economy's in the toilet, and blah blah blah'.

Thu, 09/04/2014 - 18:51 | 5182261 aVileRat
aVileRat's picture

In 2008 the oil and bond markets were first to crack when large players, unable to exit their positions panic-sold via direct market broker programs (DMA's) into air-pocket rich markets with little natural buy orders to control the rapid flury of sale activity.

Given the rapid deflation in net speculative oil positions, despite the large backdrop in unresolved systemic events, I think this is the top, or someone bigger is definitly voting with their feet that the nth return going into December is not worth the potential downside after a solid 29% YTD.

Hedge accordingly.

 

Thu, 09/04/2014 - 19:10 | 5182340 darteaus
darteaus's picture

Today, there are so many markets with so much money invested deeper and deeper into a market position, and this is happening in in so many differnent time zones, AND the players just keep investing deeper with more and more money to keep their current position from collapsing.

And we have a world full of money/power grubbing politicians instead of statesmen (except for Farange and Marine le Pen), that when bad things start to accelerate, they won't be able to rise to the occasion.

This market collapse is going to be Biblical.

Thu, 09/04/2014 - 18:54 | 5182272 Bangalore Equit...
Bangalore Equity Trader's picture

What these brilliant anal-ists don't factor in is the trillions just injection into the 'merican economy by the money factory. Once you understand this all this hocus-pocus without respect to that gorilla is an ice-bucket challenge. Cold water used to elicit screams, ooh's and aah's. whatever you 'mericans are toast, black and crisp.

Thu, 09/04/2014 - 19:15 | 5182300 darteaus
darteaus's picture

I'm American, can somebody PLEASE shorten the list?

Thu, 09/04/2014 - 19:20 | 5182373 knukles
knukles's picture

What's the line on Seattle-Packers tonite?

Thu, 09/04/2014 - 19:19 | 5182370 OC Sure
OC Sure's picture

Authoritarian banks cannot print or digitally blip productive work.

They introduce the imitation of productive work into the economy and then it is exchanged for actual productive work.

How can productive work increase when the mechanism of the system is necessarily decreasing it?

(Sentiment surveys are not the problem and there can be only one solution.)

Thu, 09/04/2014 - 19:41 | 5182457 himaroid
himaroid's picture

This is good analysis for a change.

But stocks and tbonds both look vulnerable here, to me. I would not be surprised if yields spike and hold through 10 & 30 yr auctions. Stocks spike temporarily on the bogus good NFP tomorrow and then sell hard for a few days.

 

No applause, just throw money.

Thu, 09/04/2014 - 20:16 | 5182586 buzzsaw99
buzzsaw99's picture

The bond bull is not dead only because free markets ARE DEAD.

Thu, 09/04/2014 - 21:39 | 5182895 christiangustafson
christiangustafson's picture

S&P 500 needs to go visit her 200 DMA.  

After that, one more high ... then le déluge.

Thu, 09/04/2014 - 22:01 | 5182913 MollyHacker
MollyHacker's picture

The HFT moral of the story is, is your bid is front-run with an even faster program ready to quote-stuff so the end result is always higher asks or is it called something like flushed-backed?

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