Tuesday, December 29, 2015

The Great Disruption: From Brawn to Brain (excerpt)

During 2016 and beyond, I will continue to investigate a new long-term theme: “The Great Disruption.” It is increasingly obvious that technology is disrupting business models. That’s what it has always done. It just seems to be doing it faster and in more industries than ever before. For example, previously I discussed how technological innovations are increasingly disrupting the energy and finance industries.

In the past, technology disrupted animal and manual labor. It speeded up activities that were too slow when done by horses, like pulling a plow or a stagecoach. It automated activities that required lots of workers. Assembly lines required fewer workers, and increased their productivity. The focus was on brawn. The Great Disruption is increasingly about technology doing what the brain can do. Today, I extend the analysis of The Great Disruption to the implications of the rise and proliferation of smart machines.

Smart Machines I: LOL or COL? Robots with artificial intelligence are coming. Should we laugh out loud--happy that they will do lots of our dirty work? Or should we cry out loud--fearing that they will take away all of our jobs? Perhaps the most significant disruptive force at the forefront of technological innovation is the meeting of machines and hyper-connected systems, according to a March Wired article. “Smart machines” are the birth child of this powerful combination. There isn’t a single agreed-upon definition for them yet. That’s probably because they are undergoing major development for a multitude of applications. In essence, smart machines are computing systems that are capable of making autonomous decisions, like robots and self-driving cars.

Like smartphones, smart machines are about to penetrate the world in a major way. In 2014, industrial robot sales increased by 29% to the highest level recorded for one year, according to the International Federation of Robotics. We humans can laugh about it or cry about it. Either way, the robot revolution is going to disrupt the way we work. Here are a few compelling reasons why the coming of robots is so important:

(1) Cost of a bot. At least two different types of manufacturing robots can currently be purchased for the cost of about a low-salaried employee. Baxter, the world’s first dual-arm collaborative robot for manufacturing, has a current base price of just $25,000, as listed on the Rethink Robotics website. Foxbots, also used to perform routine manufacturing jobs, cost about $20,000 per year, according to the December 2014 Harvard Business Review (HBR). Still, the fully loaded cost of purchasing and operating a robot varies widely across applications.

Several industries are on the verge of reaching, or have already reached, the point where it’s cheaper to employ robots than humans, according to a BCG note. For example: “A human welder today earns around $25 per hour (including benefits), while the equivalent operating cost per hour for a robot is around $8 when installation, maintenance, and the operating costs of all hardware, software, and peripherals are amortized over a five-year depreciation period. In 15 years, that gap will widen even more dramatically,” the analysts calculate.

(2) Ideal vs. idle workers. “Automation is inevitable. It’s a tool to produce abundance for little effort. We need to start thinking now about what to do when large sections of the population are unemployable through no fault of their own. What to do in a future where, for most jobs, humans need not apply,” said a C.G.P. Grey YouTube video as quoted in a 9/5 Barron’s thought piece. In the same regard, HBR warned that “we will soon be looking at hordes of citizens of zero economic value. Figuring out how to deal with the impacts of this development will be the greatest challenge facing free market economies in this century.”

Robots ultimately may make better employees than humans in a lot of ways. They don’t need to take bio breaks, eat lunch, go home to see their families, or sleep. And you won’t find them making trips to the water cooler, getting involved in office politics, or otherwise losing focus from assigned tasks. They can work anywhere and won’t hesitate to relocate. They can operate in dangerous environments without requiring employers to worry about lawsuits. They won’t care, complain, or get frustrated unless they’re programmed to do so--or learn to on their own.

Seriously, though, companies are sure to reap productivity boosts and labor cost savings from the use of robots and other smart machines, especially as they become smarter and more affordable. On its Q3 earnings call, Amazon executives touted the benefits of using robots over the cost: “[The] capital intensity [of our fulfillment centers using robots] is offset by their density and throughput. So it’s a bit of an investment that has implications for a lot of elements to your cost structure, but … pairing our associates with … robots to do some of the hauling of products within the warehouse has been a great innovation for us. We think it makes the warehouse jobs better and … our warehouses more productive.”

It’s not easy to estimate just how many human jobs will be replaced by robots. A 2014 Gartner presentation indicated that one in three jobs will be taken by smart machines by 2025. According to a lengthy 2013 Oxford paper, around 47% of total US employment is at high risk of automation over the next decade or two. Two high-tech industry pundits writing in HBR recently forecasted that nearly 30% of today’s workforce will be of no economic value by 2025. Forrester’s less extreme projection is that “16% of jobs will disappear due to automation technologies between now and 2025, but … jobs equivalent to 9% of today’s jobs will be created.”

Net, net, lots of jobs will be automated, but new kinds of jobs will be created too. Indeed, an engineering degree may be required for humans to remain competitive in the workforce. Of course, humans are still required to create and enhance robots as well as attend to their ongoing maintenance. Further, creative humans with soft skills unlikely to be matched in the robot world will certainly be more likely to be employable than low-skilled laborers. Before we know it, most humans at least will be required to work alongside robots.

Smart Machines II: They’re Here! As smart machine technology becomes more affordable and more widely adapted, it’s unlikely that any industry or occupation will remain untouched by its transformation. Robot labor has already had a transformational impact on goods-producing industries. More slowly adapting to the use of robot workers are service-related industries. However, many service-oriented fields are on the cusp of rapid transformation based on recent advances in robotic engineering. Let’s take a look at some examples by field.

(1) Manufacturing. Foxconn, the world’s largest contract manufacturer, initially installed 10,000 robots in 2011 and is now doing so at a pace of 30,000 per year. The robots are used to perform routine manufacturing tasks including spraying, welding, and assembly. During the summer of 2013, Foxconn’s CEO said at the company’s annual meeting: “We have over one million [human] workers. In the future we will add one million robotic workers.” (For more on this, see the prior-mentioned HBR article.)

(2) Apparel. Another production example, SoftWear Automation, an Atlanta-based start-up, is changing the way apparel is produced, as discussed in an 11/23 WSJ article. So far, SoftWear’s SewBots can do basic sewing tasks with a few human workers attending to them. Their engineers are working on getting the bots by next year to produce garments from start to finish.

(3) Logistics. In March 2012, Amazon announced its acquisition of Kiva Systems for $775 million. “Amazon has long used automation in its fulfillment centers, and Kiva’s technology is another way to improve productivity by bringing the products directly to employees to pick, pack and stow,” according to the press release. Fast-forward to the online retailer’s Q3 earnings call, when Amazon executives said that 30,000 bots were being used in 13 fulfillment centers. That’s double the 15,000 they had in 10 warehouses at the end of 2014. And their intent is to use robots more widely.

(4) Transportation. Previously, we discussed the proliferation of self-driving cars in detail. Recently hitting the roadways of Germany was a test of a semi-autonomous truck. Oh, and, let’s not forget the drones! We have heard a lot about Amazon’s testing of drones for end-to-end product delivery. (By the way, drones have many other applications outside of logistics. See Internet analyst and venture capitalist Mary Meeker’s slide #81-86 and 187-190 for more.)

(5) Restaurants. In a video of a recent Tokyo expo showcase, robots can be seen chopping carrots, mixing ingredients, icing a cake, and wrapping sushi rolls. The clip is titled: “Japan’s chef of the future is a robot.” In the US, the CEO of Panera Bread, a casual dining chain, said on the company’s Q3 earnings call: “Labor is going to go down … as digital utilization goes up, and--like the sun comes up in the morning--it is going to continue to go up … much as you are seeing it happen in Panera today.”

(6) Medicine. The Da Vinci robot is just what the doctor ordered. The four-armed surgeon-operated robot has already transformed the way patients are operated on in a UK hospital, as described in a 5/8 Guardian article. “You can rotate the instruments 360 degrees, so they are more dexterous than the human hand,” said the hospital’s robot coordinator. “We are going into places now that we couldn’t get into before.”

(7) Entertainment. The 12/14 Bloomberg showed a picture of a very creepy-looking robotic baccarat dealer named “Min” at a demonstration in the headquarters of a Chinese entertainment company. Currently, Min can only deal cards, but she’s in the shop to be programmed for interacting with customers. In the near future, robots like Min are expected to be introduced in US casinos.

Smart Machines III: Your New BFF. Indeed, there are certainly many other examples where robots can and will be utilized in the near future. Additionally, lots of new technologies that don’t require physical bots per se are automating jobs in service-related fields like journalism and finance. The point is: The robot revolution isn’t coming, it’s already here--and it’s everywhere! Today’s most impressive humanoid robots possess a variety of soft skills that can be leveraged in a multitude of ways across industries. Here are a few intriguing examples:

(1) Best frenemy. Japan’s Softbank’s cute-young-boy-like robot named “Pepper” demonstrated the ability to identify human emotions on stage at the WSJDLive 2015 conference. Like many of today’s smart machines, Pepper is also able to integrate various developers’ software applications to enhance “his” growing list of useful skills, like taking a selfie, as seen in a 2/15 Japan Times YouTube video.

Not all robots are cute, though. “Russia and China are building highly autonomous killer robots” was the title of a 12/15 Business Insider article. While a robot army may sound like a concept in your favorite science fiction movie, it may soon become a reality. A Russian defense contractor has said it will show prototypes of combat robots within two years, noted the article.

(2) Back to pre-school. Machines are learning the way toddlers do at Berkeley’s technology research hall. There, robots can be found playing with Legos, wooden spoons, model planes, and a set of square and round pegs, recounted Bloomberg in a 9/2 special feature. BRETT, a child-like robot, even takes pauses to think as he discovers the world!

(3) Winning games. Google’s DeepMind AI team has invented a computer that can learn to play and beat humans at video games, as they presented in a 2/26 Nature science journal letter. So robots now are capable of engaging in reinforcement learning, i.e., using cognitive functions to determine how to act in specific environments. In other words, they can program and train themselves.

(4) Walk in the woods. Google’s Boston Dynamics has a robot named “Atlas” that’s mastered the balance and other abilities required to take a stroll through the woods. Though not perfectly nimble yet, Atlas is undergoing training similar to military boot camp. “Researchers kick the robot, throw weights at it or make it walk over rock beds to observe how well it adapts to challenges,” reported the 8/18 NYT.

(5) Hazardous work. The earlier-mentioned Baxter robot has undergone testing in a simulation as lab assistant for Ebola workers, thereby reducing the risk of contagion. PackBots were utilized to search for victims in places where humans couldn’t go at the 9/11 disaster zone. Just last week, the WSJ reported that new robots have been deployed at the scene of Japan’s Fukushima nuclear meltdown to aid in the decontamination process.

Saturday, November 14, 2015

Global Economy: At Your Service (excerpt)

The evolution of national economies tends to follow a well established pattern. They all start out as mostly agricultural economies. They evolve into manufacturing economies. In the next stage of development, services increasingly predominate. In the final stage, economies become knowledge-based. Most emerging economies are currently based on labor-intensive agricultural and manufacturing businesses, but moving towards more services. On balance, most developed nations around the world are in the third stage, with services outpacing manufacturing.

While the recent batch of weak industrial production indexes for Germany (down 1.1% in September), the US (-0.2), the UK (-0.2), Brazil (-1.3), Taiwan, and Singapore (both little changed after big declines) suggests that a global manufacturing downturn may be underway, the increasingly services-led global economy isn’t falling into a recession. Indeed, it seems that services industries are creating enough jobs to boost some of the demand for what factories make, especially autos. Let’s have a closer look:

(1) Global perspective. All this is increasingly evident in the JP Morgan Global PMIs for manufacturing (M-PMI) and non-manufacturing (NM-PMI). The available data we have since 2010 show that the global NM-PMI has generally exceeded the global M-PMI. The spread between the two has actually widened since early 2014. During October, the NM-PMI was 53.7, while the M-PMI was 51.4.

(2) Country perspective. Not surprisingly, these trends--which admittedly are still relatively new and therefore open to debate--can be seen in most of the major economies of the world, since they must add up to the totals compiled by JP Morgan. During October, the spread between the NM-PMI and M-PMI in the US was 9.0ppts, the most since February 2001, and the fourth highest in the history of the series going back to July 1997.

In the Eurozone, the two were nearly identical from 2010 through 2013; but since then, the region’s NM-PMI has been consistently higher than the M-PMI. In China, the NM-PMI has exceeded the M-PMI every month since the start of 2010, with an average spread of 4.4ppts. Interestingly, over the past two years since October 2013, NM-PMIs among emerging market economies have averaged 51.3, while the comparable measure for developed countries has averaged 54.7.

(3) Third-stage economies. Of course, this is all circumstantial evidence of a global transformation from manufacturing to services. However, there is plenty of evidence showing that the major “industrial” economies--including the US, the UK, Canada, Australia, Japan, and the Eurozone countries--have evolved into “services” economies. That’s easiest to see by comparing employment in the services-producing and goods-producing sectors of these economies. The former has been outpacing the latter for at least three decades. A similar conclusion can be deduced by comparing real GDP of goods versus services.

So, for example, in the US, payroll employment in goods-producing industries accounts for only 14% of total payroll employment, down from 44% during 1943. During Q3, services accounted for $9.9 trillion (saar) of real GDP, while goods accounted for $5.3 trillion of real GDP. Since services-producing businesses tend to be less cyclical than goods-producing ones, this transformation should moderate the business cycle.

(4) Know-it-alls. On the other hand, the transformation of the US economy from services-producing industries to knowledge-producing ones may increase the problem of structural unemployment for some workers. That’s because knowledge workers spend their entire workday trying to figure out how to put the rest of us out of work.

They’ve already figured out how to replace factory workers with robots. Indeed, robots are even starting to displace workers in China’s factories. Last year, China was the single largest market for industrial robot sales, according to the International Federation of Robotics (IFR), and within two years there will be more industrial robots in Chinese factories than in either the European Union or the United States.

This is just the start. There are only 30 robots for every 10,000 manufacturing workers in China, compared with 323 per 10,000 in Japan and 437 per 10,000 in South Korea, IFR data show. Automation is also coming to the services sector. San Francisco start-up company Momentum Machines, Inc. has set out to fully automate the production of gourmet-quality hamburgers. McDonald’s is well on the way to offering self-serve kiosks at a majority of their stores instead of paying employees to ask, “Do you want fries with that?”

Thursday, November 5, 2015

The Grand Delusion (excerpt)

Is it possible that monetary policy can’t fix all of our economic problems? That was one of my main discussion points with our accounts in Boston last week. In recent years, the major central banks have been taken over by macroeconomists who believe that they have the power to tame the business cycle. Since the financial crisis of 2008, they’ve led us to believe that they can revive self-sustaining economic growth and stabilize inflation around 2%. That’s because they strongly believe in their powers--even though they’ve been providing abnormally easy monetary policy since the crisis yet economic growth remains subpar with inflation below 2%.

I believe that the macroeconomists at the central banks (a.k.a. central monetary planners) have failed to achieve their goals because they are blindly fighting very powerful economic forces that are microeconomic in origin. They are also fighting the forces of technology and demography. Technological innovation, one of the primary drivers of “creative destruction,” disrupts and displaces the old ways of doing things with better goods and services at lower prices (BGSALP). Demographic trends are disruptive too, as people are living longer while baby creation is tanking, as evidenced by plunging fertility rates around the world, with deflationary consequences.

By ignoring these forces, the macroeconomists are unknowingly disrupting the microeconomic adjustment mechanisms that automatically eliminate economic and financial excesses on a regular basis. In other words, their obsession with moderating the business cycle is actually contributing to the problems they are trying to fix, because they won’t let Mother Nature--who is a microeconomist--manage the business cycle. Consider the following:

(1) Tolstoy. Last Thursday, we learned that real GDP rose just 1.5% (saar) during Q3. That was widely reported. Not as widely reported was that the GDP deflator rose just 0.9% y/y. Excluding food and energy, it was up just 1.1% y/y, the lowest since Q1-2010. The deflator for personal consumption expenditures excluding food and energy rose only 1.3% y/y, with the comparable market-based core inflation rate at just 1.1%.

Why has the Fed’s ultra-easy monetary policy failed to boost inflation? The answer may be in Leo Tolstoy’s War and Peace. A chart of the US CPI since 1800 shows very clearly that inflationary periods have been associated with wartime conditions during the War of 1812, the Civil War, World War I, and World War II through the Cold War. The restoration of peace is associated with outright deflation, i.e., falling prices after each one of these wars with only one exception. There has been no deflation since the end of the Cold War, though the CPI inflation rate has declined from 4.7% y/y during November 1989, when the Berlin Wall was toppled, to zero today.

During wartime, government takes command of the economy since all resources must be mobilized to win the war. Global trade is disrupted since there can be no trade among combatants, and it can be hard to trade with allies. In other words, wars are trade barriers. During peacetime, globalization occurs. There is more free trade even among former adversaries, and markets become freer from government controls and also more competitive.

The end of the Cold War in 1989 was the end of biggest trade barrier of all time. It led to China joining the World Trade Organization during December 2001. So far, it has been different this time because there has been no deflation. That’s because so far the central banks have succeeded in averting it with ultra-easy monetary policy. But that doesn’t mean that there won’t be adverse consequences.

Macroeconomists don’t spend much time thinking about markets, especially competitive ones. These markets tend to be very deflationary because having fewer barriers to entry during peacetime means that established, profitable producers are constantly under attack from startups hoping to take some if not all of their profits by providing BGSALP. It’s one of Mother Nature’s great wonders because it greatly benefits the one and only economic class that should matter--that is, the Consuming Class!

Competition exists in nature for only one reason, which is to improve the standard of living of consumers. It is not designed to enrich companies, shareholders, trade unions, or workers. The protagonist in this natural narrative is the entrepreneurial capitalist. (Along the way, those who succeed among them have a tendency to turn into crony capitalists, but that’s a subject for a book that I will write someday.)

(2) Turing. These days, the hero of entrepreneurial capitalists is Alan Turing, the British mathematician who is widely credited with having invented the computer. As a result of the IT revolution, entrepreneurs are able to disrupt business models in every industry with innovations that provide consumers with BGSALP. Steve Jobs, who was a big fan of Turing, was the entrepreneurial capitalist who started the personal computing revolution by inventing operating systems that could run PCs, laptops, smartphones, and iPads. All these devices have become increasingly affordable, compact, portable, and powerful thanks to the Cloud and other innovations.

In the GDP accounts, the price deflator for IT capital equipment spending has declined 79% since 1977 when Apple introduced the Apple II, a color computer with expansion slots and floppy drive support. Capital spending, in current dollars, on IT equipment, software, and R&D now accounts for over 40% of the total of such spending, up from just 23% during 1977.

(3) Bismarck. The welfare state originated in Germany during 19th century with the policies implemented by German Chancellor Otto von Bismarck. The welfare system in the United States began in the 1930s, during the Great Depression. After the Great Society legislation of the 1960s, for the first time a person who was not elderly or disabled could receive need-based aid from the federal government. The notion that government has an obligation to provide a social welfare safety net is now widely accepted in all developed nations.

The good news is that people are living longer and more comfortably in their old age. The problem is that government deficits have swelled to finance entitlement spending rather than public investments in infrastructure. It’s conceivable that the plunge in fertility rates might be partly attributable to the perception that raising children is expensive and not a good investment if the government will support us in our old age, obviating the need for adult children to do that.

The result is that the number of social welfare beneficiaries are increasing faster than workers who can support them. In the US, the ratio of 65-year-olds who are not in the labor force rose to a record 24% of the civilian labor force during September, up from 20% only 10 years ago.

In any event, these demographic trends are likely to be deflationary, since older people tend to consume less than younger people with children. This might explain the strong secular correlation between the inflation rate in the US and the Age Wave, which is the percent of the labor force that is 16 to 34 years old. The Age Wave has dropped from a record 51.2% during January 1981 to only 35.4% currently. Over that same period, the CPI inflation rate has plunged from over 10% to under 2%.

Last week, the Chinese government abandoned its one-child policy, which over the past 35 years has led to a myriad of social and economic ills in China. All Chinese couples will be allowed to have two children. The move is most likely too little too late, as China already faces a declining, graying population without the workers it needs for its vast economy.

(4) Bernanke. The macroeconomists who are running the major central banks seem oblivious to these secular forces of deflation. Nonetheless, they can be credited with successfully countering the natural forces of deflation, so far, with ultra-easy monetary policy. Perhaps they eventually will be proven right in their belief that if they persist, then self-sustaining growth will make a comeback and inflation will stabilize around 2%.

More likely, in my view, is that easy money has lost its effectiveness and won’t boost demand as still widely expected by the demand-side macroeconomists who steer the central banks. Meanwhile, on the supply side, easy money has disrupted the economic laws of nature by propping up ““zombie” producers, who would have been buried for good, and for the good of the economy, in a competitive market. The living-dead companies exacerbate deflation with their excess capacity and weaken profits for healthy companies, thus depressing the overall economy.

As I’ve often noted, no one has been as committed to moderating the business cycle with monetary policy as former Fed Chairman Ben Bernanke. He reiterated this view in a 10/4 WSJ op-ed titled “How the Fed Saved the Economy,” timed to coincide with the release of his new book, The Courage to Act: A Memoir of a Crisis and Its Aftermath:

“What the Fed can do is two things: First, by mitigating recessions, monetary policy can try to ensure that the economy makes full use of its resources, especially the workforce. High unemployment is a tragedy for the jobless, but it is also costly for taxpayers, investors and anyone interested in the health of the economy. Second, by keeping inflation low and stable, the Fed can help the market-based system function better and make it easier for people to plan for the future. Considering the economic risks posed by deflation, as well as the probability that interest rates will approach zero when inflation is very low, the Fed sets an inflation target of 2%, similar to that of most other central banks around the world.”

In his memoir, Bernanke does acknowledge that the “experience of the Great Moderation had led both banks and regulators to underestimate the probabilities of a large economic or financial shock.” In my opinion, attempts by the central banks to moderate the business cycle make the economy more vulnerable to financial instability and deeper recessions. Consider this: After so many years of attempting to revive economic growth and stabilize the financial system, Fed officials have hesitated to hike the federal funds rate by a measly 25bps, fearing the consequences. By the way, I looked in the index of Bernanke’s book for the word “capitalism.” It isn’t there.

Wednesday, September 30, 2015

Lower Oil Prices Boosting Oil Demand & Global Growth (excerpt)

Repeat after me: “The best cure for low commodity prices is low commodity prices.” This mantra isn’t very comforting if that’s mostly because producers are forced to slash their output of commodities to match the world’s depressed demand for commodities, which is depressed by the economic and financial repercussions of the producers’ retrenchment.

Cheer up! There is already some evidence that low oil prices are boosting global oil demand, which also strongly suggests that low oil prices are boosting global economic growth. The flood of global liquidity provided by central banks is now being supplemented with a flood of cheap oil. I am a big fan of the monthly demand and supply data compiled by Oil Market Intelligence (OMI). I track the 12-month averages to smooth out seasonality. Consider the latest data through August:

(1) World oil demand rose 2.0% y/y to a new record high last month. That’s the best growth rate since August 2011.

(2) Developed and developing oil demand are both growing faster with gains of 0.9% and 3.1%, respectively.

(3) World oil supply, however, continues to outpace demand. I use OMI data to calculate a ratio of demand to supply. It fell last month to the lowest reading since January 1999.

There are plenty of other global economic indicators suggesting that the global economy is growing, and benefitting, on balance, from the drop in commodity prices.

Today's Morning Briefing: Commodity Bubble Pops. (1) Not so superlative. (2) When bubbles burst, bad things happen. (3) Is it different this time? (4) A bubble pops with more winners than losers, maybe. (5) A brief (and proud) review of our commodity bubble forecast. (6) Still falling. (7) CAT & GLEN marked the top in commodities during 2010 & 2011. (8) Marking the bottom now? (9) EME stock prices still tied more to commodity prices than to their emerging middle classes. (10) The best cure for low commodity prices. (11) World oil demand growth is picking up! (12) No recession in US and Europe confidence measures. (13) Focus on market-weight rated S&P 500 Energy. (More for subscribers.)

Tuesday, September 29, 2015

What Will It Take to Revive the Bull? (excerpt)

In the past few days, I’m being asked more frequently: “What will it take to revive the bull market?” Yesterday’s decline was the fifth consecutive daily drop. The S&P 500 may very well retest its August 25 correction low, which was 12.4% below the record high on May 21. The recent low nearly matched last year’s mini-correction low on October 15, which was attributable to fears about the termination of QE4 at the end of that month. There were also concerns about the impact of plunging oil prices and the soaring dollar on earnings.

Yet stocks managed to rally 14.4% from last October’s low through this year’s record high on May 21. It was yet another relief rally as investors concluded that outside of the Energy sector, earnings were holding up surprisingly well. Nevertheless, here we are again, right where we were about a year ago. The correlation between the S&P 500 and the Fed’s holdings of bonds is working all too well.

During the current bull market, many of the relief rallies were triggered by central bank moves to provide more liquidity into financial markets. As I observed yesterday, the central bankers may be starting to lose their credibility. In my opinion, investors would have favorably greeted the widely expected Fed rate hike following the September 16-17 meeting of the FOMC. It would have demonstrated the Fed’s confidence in the strength and resilience of the US economy.

Instead, the FOMC passed on doing so, emphasizing for the first time concerns about the global economy and financial system. Yet on Thursday, Fed Chair Janet Yellen said that she still expected a rate hike before the end of the year. Yesterday, FRB-NY President Bill Dudley said the same. The Fed’s transparency makes it transparently clear that Fed officials are clueless. That’s not good for investor confidence.

Yesterday, Dudley said that the US economy is “doing pretty well.” Notwithstanding the recent puzzling hawkishness of the Fed’s two leading doves, they and their colleagues on the FOMC will continue to confront a weak global economy when the committee meets on October 27-28 and December 15-16. They will have to be concerned that combined with the strong dollar, the US economy won’t continue to do so well.

That’s what’s unnerving investors right now. Yesterday’s implosion in Glencore’s stock price was the latest confirmation that the global commodity industry is in a major bust, which is also depressing capital goods producers of mining equipment. In addition, yesterday we learned that profits at Chinese industrial companies plunged 8.8% y/y in August, with losses deepening even after five interest-rate cuts since November and government efforts to accelerate projects. Leading the losers were Chinese coal companies.

I am starting to think that getting a relief rally this time might be more challenging than in the past, when central banks had more ammo and more credibility. If the market’s main concern is the slowdown in global economic growth, there’s not much reason to expect any upside surprise anytime soon. If the US economy remains strong, it is unlikely to be strong enough to lift global growth. Meanwhile, investors may continue to fear that the poor economic performance of the rest of the world will increasingly weigh on the US.

So what will it take to revive the bull given this assessment of the global economic situation? As long as it doesn’t all add up to a global recession, the bull should find comfort in good companies that can continue to find growth in a world of secular stagnation. Commodity users should continue to benefit from the woes of the commodity producers. Valuation multiples are also more attractive now than they were earlier this year. Needless to say, earnings have to keep growing and US consumers have to keep consuming for the secular bull to survive this latest challenge.

Today's Morning Briefing: What Will It Take? (1) The fourth FAQ. (2) No bull with stocks basically flat y/y. (3) No bull since end of QE. (4) Fed is transparently clueless. (5) Hawkish doves. (6) A sensible message from the trenches. (7) “Doing pretty well.” (8) Glencore’s meltdown. (9) China’s profits are MIA. (10) Seeking growth in a world of stagnation. (11) Forward revenues and earnings remain on bull market’s uptrends. (12) Buybacks and M&A will likely continue to shrink supply of equities. (13) Stocks are cheaper. (14) Consumers of last resort. (More for subscribers.)

Monday, September 28, 2015

The Canaries in China’s Coal Mine (excerpt)

The most frequently asked question in my meetings with accounts in recent weeks has been: “What’s your take on China’s economy?” I have been pessimistic on China’s economy for well over a year, mostly because of the producer price deflation. However, pessimism may be too widespread and excessive now.

Since the yuan was devalued on August 11, the US stock market has been much more sensitive to any indicator coming out of China. The latest one, released on 9/23 by Markit, showed that September’s flash M-PMI fell to 47.0, with the output component down to 45.7--both at 78-month lows.

Commodity prices remain under downward pressure, confirming the weakness in China’s factory sector. Also confirming China’s weakness are production indexes among its major trading partners. Industrial production indexes are falling in both Taiwan and Singapore, with the average of the two down 8.3% over the past five months through August. Brazil’s factory output is down 8.3% y/y to the lowest since May 2009.

Today's Morning Briefing: What’s the Matter? (1) Just another normal correction? (2) An ugly technical picture. (3) More Death Crosses. (4) Dow Theory looking bearish. (5) Fallen leaders. (6) Advance/decline lines in retreat. (7) Bearish sentiment, volatility, and junk spreads all elevated. (8) Three FAQs while waiting for Godot. (9) China’s canaries may be Brazil, Taiwan, and Singapore. (10) Draghi is waiting for lenders to lend more. (11) Abenomics 2.0 has three new darts. (12) US looking good, regional business surveys aside. (13) Resigned to more congressional partisanship. (14) “Pawn Sacrifice” (+ + +). (More for subscribers.)

Thursday, September 24, 2015

On a Relative Basis, US is Outperforming Again (excerpt)

During the current bull market, I have favored a “Stay Home” investment strategy over the “Go Global” alternative. That’s worked quite well, though I’ve missed some opportunities to outperform overseas, particularly in Japan, where stocks have soared since late 2012 when Abenomics was introduced. Of course, to benefit, dollar-based portfolio managers had to short the yen at the same time. Let’s have a closer look at some of the performance stats so far this year and since the start of the bull market:

(1) Major markets giving back gains. The US MSCI stock price index is down 5.3% ytd (through Tuesday), and has underperformed since the start of the year. The All Country World MSCI and All Country World ex-US MSCI are down 4.7% and 4.0% ytd in local currencies. However, the UK MSCI is down 10.3% ytd, while the Emerging Markets MSCI is down 7.4% since the start of the year. Japan (2.6%) and the EMU (0.6%) have been outperforming all year, but have recently given back most of their strong gains earlier this year.

(2) Shining city on the hill. Since the start of the current bull market on March 9, 2009, the US MSCI is up 188%, while the All Country World ex-US is up 77% in dollar terms and 83% in local currencies. The ratio of the US index to the world local-currency index charted over time shows that the US underperformed briefly in late 2012 and earlier this year. The US has been outperforming since late 2010 according to this ratio.

(3) Reversal of fortune for MEI sectors. During the bull market of the previous decade, I favored overweighting the Materials, Energy, and Industrials (MEI) sectors of the S&P 500. They were up 154%, 223%, and 125%, well ahead of the S&P 500’s gain of 96% from March 11, 2003 through October 9, 2007.

Since the start of the current bull market, they’ve mostly underperformed, especially this year, with gains of 138%, 48%, and 228% versus 187% for the S&P 500. These sectors tend to do best when Go Global is outperforming Stay Home, which it did during the previous bull market, but not during the current bull market. The performances of Energy and Materials in particular have suffered this year as commodity prices plunged. The outperformance of the Industrials sector during the current bull market is mostly attributable to transportation stocks.

(4) Weak currencies less bullish for EMU and Japan. Stock prices rose in both the Eurozone and Japan in recent years despite lackluster economic growth. Investors turned bullish on both after the ECB and BOJ stated their commitments to do whatever it takes to revive growth. The two central banks implemented QE programs aimed at depreciating their currencies to boost exports. So far, the results have been disappointing, which may be reflected in the 18.1% decline in the EMU MSCI (in euros) since April 13, and the 13.8% decline in the Japan MSCI (in yen) since June 1.

(5) Emerging markets submerging again. The Emerging Markets MSCI (in local currencies) performed relatively well during the current bull market until the recent selloff. However, it underperformed in US dollar terms since 2012, and especially this year. The dollar-denominated index is highly correlated with the CRB raw industrials spot price index. This isn’t surprising since the strength or weakness of the global economy has a big influence on both. The bottom line, though, is that the EM MSCI is really just a proxy for commodity prices.

Today's Morning Briefing: Homebodies. (1) Home sweet home. (2) Avoiding cabin fever. (3) Major global equity markets giveth and taketh away. (4) It’s all relative: US outperforming again. (5) “Go Global” was a great theme for previous bull market, not this one. (6) Currency depreciation hasn’t done much for economies of EMU and Japan. (7) Emerging Markets MSCI is just a commodities proxy. (8) Losses for commodity producers provide some material gains for homebuilders. (9) Will Millennials ever leave the nest (or dorm room)? (10) Getting tougher to rent. (11) Some wet blankets. (12) A positive feedback loop if homebuilders can find construction workers. (More for subscribers.)

Wednesday, September 23, 2015

Are Stocks Rolling Over? (excerpt)

Chart technicians are turning increasingly bearish. That’s largely because the S&P 500 was losing its upward momentum earlier this year and mostly moving sideways as its leadership narrowed. If it continues to move sideways following the latest correction, the 200-day moving averages of the S&P 500 and its 10 sectors might start to roll over. A few technicians are already saying the market is making a major top and entering a bear market.

I am a meat-and-potatoes fundamentalist with a drizzle of quant to enhance my meals. However, I will stay for dessert to chat with technicians. In any event, I am monitoring the 200-dmas of the S&P 500 and its 10 sectors more closely. There certainly is some rolling over going on, especially for the two most globally sensitive sectors, namely Energy and Materials. The interest-rate sensitive sectors are also looking a bit toppy, particularly Telecom Services and Utilities. On the other hand, the sectors with most of the market capitalization in the S&P 500 remain on 200-dma uptrends, particularly Consumer Discretionary, Consumer Staples, Health Care, and IT.

Today's Morning Briefing: Sand Castle. (1) Sand on sale. (2) Some things are different about latest bubble. (3) Circle of Life: Bubbles inflate and burst, triggering financial calamity and recession. (4) Endgame beginning or nearing an end? (5) Lower depths? (6) Supply and demand in the oil market. (7) Currencies on the run. (8) Lots of demand for autos. (9) Can stocks decouple from commodities? (10) Some 200-dmas are rolling over, others are not. (More for subscribers.)

Tuesday, September 22, 2015

Go USA! (excerpt)

S&P 500 forward earnings is highly correlated with the US index of coincident economic indicators (CEI). The latter rose to another new record high during August. Previously, I have observed that based on the past five cycles in the CEI, the next recession should start during March 2019. That’s not based on science, but rather on a simple average of the length of the previous expansions once the CEI had rebounded back to its previous cyclical peak. So it’s a benchmark of what could happen based on what happened in the past on average.

In any event, I’ve circled March 2019 as the possible date for the next recession. Given the Fed’s latest decision to do nothing, it’s safe to bet that the next recession won’t be caused by the tightening of monetary policy anytime soon. It could be caused by a severe downturn abroad, I suppose. More likely is that the US will continue to grow fast enough to keep the global economy growing as well, albeit at a pace that is best described as “secular stagnation.”

Today's Morning Briefing: NZIRP Forever. (1) Stock investors facing conundrum. (2) Fed upgrades Global Secular Stagnation scenario. (3) Long-term earnings growth (LTEG) forecasts remain remarkably high and stable. (4) STEG forecasts more volatile. (5) PEG ratio may be misleading now. (6) Investors curbing enthusiasm for growth, for now. (7) Flash crashes come and go. (8) Do Q3 and Q4 earnings matter? (9) Heady earnings estimates for 2016 and 2017. (10) Revenues growth rebound expected for next year. (11) Back to the future: The recession of 2019. (12) Yellen’s like-minded friends. (13) Yellen says that Fed doesn’t need to tighten if markets do so. (14) Bounded to the zero bound. (More for subscribers.)

Monday, September 21, 2015

US Flow of Funds: Net Equity Issuance (excerpt)

The Fed released its Q2 Flow of Funds (FOF) report on Friday. There's always plenty of interesting developments that are chronicled by this voluminous data dump. I was particularly struck by the data on net equity issuance by US nonfinancial corporations, US financial corporations, and foreign issuers. On balance, the data somewhat diminish the bullish share buyback story that I have been telling since early on during the current bull market. Consider the following:

(1) Three players. Corporate buybacks along with M&A activity have most noticeably reduced the supply of shares issued by nonfinancial corporations in the FOF tally. Over the past four quarters, their net equity issuance was minus $490 billion. This is the most negative this series has been since Q2-2008, and it has been in negative territory since the mid-1990s.

On the other hand, US financial corporations had net equity issuance of $250 billion over the past year. This series has been in positive territory since the beginning of the previous decade. There’s been a significant increase in net equity issuance by foreign corporations, which rose to a record $549 billion over the past four quarters.

(2) Grand total. The sum of these three series adds up to $309 billion over the past four quarters. While the S&P 500 data show that buybacks have been increasing throughout the current bull market, the FOF data on total net equity issuance was positive during 2009 and 2010, when financials had to raise lots of capital. Then it turned negative during 2011 and 2012 as financials significantly reduced their issuance. Since 2013, it has been increasingly positive as foreign equity issuers raised record sums in the US stock market.

Today's Morning Briefing: Coming Home to Roost. (1) Not suitable for a family publication. (2) Fearing a measly 25bps. (3) Strutting around the yard. (4) Giving more weight to foreign developments. (5) Central Bank of the World. (6) Yellen’s fairy dust losing its magic. (7) Losing touch. (8) It all depends on everything and nothing. (9) Transparency reveals cluelessness. (10) More chapters to the buyback story. (11) Foreigners are big issuers of stocks in US. (12) Record corporate bond crop. (13) “Black Mass” and “Narcos” (+ + +). (More for subscribers.)

Thursday, September 17, 2015

Canadian Perspective (excerpt)

Greetings from Toronto! I am visiting our accounts here on Wednesday and Thursday, and going to see our accounts in Cleveland on Friday. I guess I should have stayed home to watch Yellen’s press conference today. However, I figured I might learn more on the road. Yesterday, the chief investment officer of one of our accounts observed that today’s FOMC meeting might be one of the most important in history. Then again, what if they decide to do nothing? That could be important too!

I had lunch with my CIO friend yesterday in a restaurant with a spectacular panoramic view of downtown Toronto. I observed lots of building cranes, as were just as plentiful during my previous visits over the past few years. I asked whether they were all being used to construct more condominium towers with apartments that are purchased mostly by Chinese investors who leave them mostly vacant. Interestingly, he said that may be partly an urban legend and that more likely residents are young Canadian professionals, who prefer to live in town near their jobs. No houses, no cars, no kids for them.

Toronto is bustling. The finance industry continues to prosper. The annual Toronto film festival is thriving. The rest of Canada is facing some challenges. Consider the following:

(1) Technically in a recession. Canada has been hard hit by the bursting of the commodity super-cycle bubble. Real GDP fell -0.5% (saar) during Q2 following a -0.8% drop during Q1. Just yesterday, the OECD cut its forecasts for the country’s economic growth by -0.4ppts to 1.1% for 2015 and by -0.2ppts to 2.1% for 2016. Canada received the second-largest haircut for 2015 next to Brazil in the lineup of economies included in the OECD’s forecasts.

There is some debate about whether Canada is in a recession. Weighing on real GDP have been commodity-related gross fixed capital formation and exports. On the other hand, household consumption in real GDP has remained relatively strong.

By the way, the OECD also lowered its world forecast for real GDP by 0.1ppt to 3.0% for 2015 and by 0.2ppt to 3.6% for 2016. The OECD is concerned that the slowdown in China’s trade is depressing many emerging market economies (EMEs). On the bright side, the OECD noted the strength of the US, but also suggested that a US rate hike could worsen the prospects for EMEs.

(2) Another commodity currency. The Canadian dollar, which is down 20% y/y, is highly correlated with the CRB raw industrials spot price index. That should boost Canada’s exports, which account for 31% of the country’s nominal GDP versus 13% in the US. The problem is that manufacturing accounts for only 10% of Canada’s economy. So commodities account for a much bigger share of exports than do manufactured goods. As a result, the weaker currency isn’t likely to stimulate Canada’s economy.

Today's Morning Briefing: North of the Border. (1) 100% sure thing. (2) The Fed will do nothing or something. (3) Sentiment remains very bearish, which is bullish. (4) Misery Index is depressed. (5) Urban legend in Toronto. (6) Canada is in a recession, technically speaking. (7) Canadian dollar is a commodity currency. (8) Canada is rich with less valuable resources. (More for subscribers.)

Wednesday, September 16, 2015

Liftoff Scenario (excerpt)

If the FOMC doesn’t start raising interest rates tomorrow, that wouldn’t surprise me. I have been anticipating either one-and-done or none-and-done for 2015 since September 2014. If it’s none-and-done tomorrow, there could be a significant liftoff in the prices of commodities, bonds, stocks, and currencies around the world.

It might have started yesterday when the S&P 500 rose 1.3% to 1978.09. The index is up 5.9% from 1867.61 on Tuesday, August 25, which I predicted might be the low for the latest correction. It is down only 7.2% from the May 21 record high. The rally in recent days is especially impressive given that the latest batch of Chinese economic indicators was weak, as I discussed yesterday. This suggests that yet another relief rally is underway, this time following the panic attack that followed the depreciation of the yuan.

What if the FOMC votes to hike rates by 25bps on Thursday? Odds are that Fed Chair Janet Yellen will spend most of her press conference that day reassuring the markets that further rate hikes are unlikely for some time. So there could still be a liftoff in the financial markets, but a more gradual one.

Today's Morning Briefing: A Fine Mess. (1) A mess is a mess. (2) The Fed’s bad joke. (3) Ultra-easy policies aimed at increasing financial stability have decreased it. (4) Hard to normalize monetary policy without causing financial instability. (5) Capital markets taking the hits rather than the banks this time. (6) Lots of headlines warning Fed not to do it. (7) Liftoff for stocks, if not for interest rates? (8) US consumers doing what they do best. (9) Gasoline windfall boosting vehicle miles traveled. (10) Forward revenues and forward earnings providing support to S&P 500. (11) Q3 earnings season should result in small gain for earnings. (More for subscribers.)

Tuesday, September 15, 2015

The Great Stall of China (excerpt)

China has developed a serious capital outflow problem which has developed and gotten progressively worse over the past year. It most likely reflects the significant slowdown in the country’s exports growth, reducing the incentives for foreigners to invest in Chinese manufacturing capacity. In addition, the end of the property boom in China, combined with the anti-corruption campaign, may be causing more Chinese to invest abroad. Let’s have a look at the most recent data:

(1) Exports & imports. Merchandise exports have stalled around $2.3 trillion (saar) since early 2013). Imports also stalled starting in early 2013 and turned weaker this year.

(2) PPI, profits, & output. The trade surplus (in dollars) has widened to a record high because imports have been weaker than exports. However, both suggest that foreign investors are finding fewer good opportunities in China, especially since there has been a glut of manufacturing capacity, as evidenced by the 42 consecutive months of declines in the PPI. This pervasive deflation suggests that profits are hard to come by in China, which explains why the growth rate in industrial production has plunged from a record high of 20.7% y/y during February 2010 to only 6.2% during August.

(3) Retail sales & stock prices. Inflation-adjusted retail sales rose 8.8% y/y during August. The days of double-digit growth seem to be over. The recent boom and bust in the stock market probably didn’t directly impact very many Chinese, but it can’t be good for consumer confidence.

(4) Social financing. Over the past 12 months through August, China’s bank loans are up 15.7% (Fig. 13). A year ago, when the Chinese government was hoping to make the economy less dependent on debt, this growth rate was 13.3%. Over the same period, total social financing, which includes bank loans, rose $2.5 trillion.

China’s economy seems to getting a lot less bang per yuan for all this debt partly because of the worsening of its international capital account.

Today's Morning Briefing: China: Warning Label. (1) International reserves data: Use with caution. (2) Soaring dollar depressing dollar value of international reserves, exports, and lots of other global indicators. (3) Practice what you preach. (4) Capital flow proxy for China, adjusted for strong dollar, still showing big net outflows. (5) The Great Stall of China. (6) China’s exports have lost their mojo. (7) Foreigners see less reason to invest in China, while Chinese see more opportunities abroad. (8) China is getting much less bang per yuan of social financing as a result of capital outflows. (More for subscribers.)

Monday, September 14, 2015

The US Is on the Fast Track (excerpt)

Notwithstanding the slow pace of global economic activity, we expect enough strength in the US to drive earnings higher. While the S&P 500 Transportation index is down 19.3% from its record high on January 22, measures of actual transportation activity are very strong in the US. Railcar loadings of intermodal containers rose to a record high in early September, up 5.3% y/y based on the 26-week moving average of the data.

The ATA Truck Tonnage Index rebounded 2.8% m/m during July, remaining on its solid upward trend with a y/y gain of 3.7%. It’s just shy of its all-time high reached in January of this year.

The plunge in gasoline prices has supercharged gasoline usage, which is up 3.2% y/y through early September. Vehicle miles traveled rose to a record high during June. It’s hard to do all that driving without stopping along the way to do some shopping.

Today's Morning Briefing: Towers of Babel. (1) Kenny Rogers’ advice to investors. (2) Updating the case for a correction in a secular bull market. (3) Valuation is more reasonable and sustainable given low inflation. (4) Revenues and earnings remain on 7% uptrend line. (5) S&P 500 Transportation index is down big, while transportation indicators are up big. (6) Americans are driving more, probably to go shopping. (7) Temporary factors depressing inflation might not be so temporary. (8) Import prices are deflationary. (9) New towers reaching for the sky tend to be bearish. (10) Tower of Basel. (11) Lots of babel about stock market outlook, FOMC vote this week, and oil prices. (12) “Straight Outta Compton” (+ +). (More for subscribers.)

Thursday, September 10, 2015

Sentiment Is So Bearish That Maybe It’s Bullish (excerpt)

The 9/8 Business Insider website included an article titled “I just got back from Burning Man and here’s what I saw.” The author recounts that this annual festival at Burning Man in the Black Rock Desert, a remote part of Nevada, attracted 70,000 people and “was as wild as ever.” The stock market also seems to have turned wild as ever over the past few weeks. However, it hasn’t been a festive development for many other than high-frequency traders.

The S&P 500 was listlessly trading in a very narrow 110-point range between 2020 and 2130 from the beginning of February through mid-August. Then the wildness started following the devaluation of the yuan. As I wrote on Tuesday, “Arguably, the stage was set for the Monday, August 24 flash crash on Tuesday, August 11, when the Chinese devalued the yuan. That heightened fears that China’s economy was in much worse shape than widely perceived. Those fears were confirmed on the morning of Friday, August 21 with the release of a very weak reading for the Caixin Flash M-PMI. The S&P 500 plunged 11.2% from August 10 through August 25.”

The range for the S&P 500 is now much wider, spanning 263 points between the record high of 2130 on May 21 and the August 25 low of 1861. The daily swings certainly have become wild.

The flash-crash correction and all the volatility have depressed the Investors Intelligence Bull/Bear Ratio, which fell to 0.92 this week. That’s the lowest since October 2011. It’s so bearish that it’s bullish, at least from a contrarian perspective. Readings below 1.00 have provided strong buy signals in the past.

From a fundamental perspective, investors are fretting over lots of known unknowns. China’s economy is slowing, but is it a bumpy, soft, or hard landing? Might it be hard enough to cause a global recession? The plunge in commodity prices might be good for consumers, but bonds issued by commodity producers are at risk of default, as evidenced by the rising yield spread between corporate high-yield debt and 10-year Treasury bonds. The currencies of emerging market economies (EMEs) have been in freefalls this year as a result of capital flight. Won’t that put them into recessions, and might there be some sort of EME crisis? If the Fed does start raising rates, might that cause a massive unraveling of global carry trades?

We all know what the issues are. We just don’t know how they will actually play out. No wonder that investors aren’t in a festive mood. Nevertheless, stocks may be set up for yet another relief rally if all the worst-case possibilities of the known unknowns don’t unfold. Just as important for the bull case is that no matter what happens, the US economy remains resilient and strong. So far, that seems to be a known known. I see plenty of evidence of that in the latest survey of small businesses and the JOLTS report.

Today's Morning Briefing: Big Jolt. (1) A wild festival in the desert. (2) Stock market has also gone wild, but without the festivities. (3) From tight range to wide-open range. (4) Buy signal: Bull/Bear Ratio drops under 1.00. (5) Lots of known unknowns could be setting stage for yet another relief rally. (6) Small businesses are big employers in the US. (7) Upbeat trends in NFIB survey data. (8) Buddy, can you spare a worker? (9) In the past, rising job openings tended to boost wages. (10) It has been and may continue to be different this time. (11) Known known: US economy doing just fine. (More for subscribers.)

Wednesday, September 9, 2015

International Reserves: Another Sign of Global Slowdown (excerpt)

Not surprisingly, there is a strong inverse correlation between the yearly percent change in total non-gold international reserves (in dollars) and the trade-weighted dollar. The former is down -4.5% y/y through June, while the latter is up 12.3% over the same period. That’s because roughly 35% of these reserves are held in non-dollar currencies.

It turns out that the yearly percent changes in the CRB raw industrials spot price index and in total non-gold international reserves are also highly correlated. The index is down -13.2% y/y. This suggests that some of the weakness in reserves is directly related to the end of the relatively short-lived commodity super-cycle, which wasn’t so super and turned out to be the latest speculative bubble that has burst.

Commodity-producing countries, especially among the EMEs, are obviously taking big revenue hits in dollars, though those dollars are worth more in their local currencies. In any event, they are earning fewer dollars than can be accumulated in the local central bank’s reserve account.

In other words, causality runs both ways between global economic activity and international reserves. The recent weakness in reserves growth reflects some drying up of global liquidity. However, it also reflects the slowdown in world economic growth attributable to the forces of secular stagnation that I have previously discussed. They include the untimely death of the commodity super-cycle caused by excess supply, which has been facilitated by ultra-easy monetary policies, as well as the burden of heavy debt loads weighing on demand around the world, geriatric demographic trends, and disruptive technologies (automation and robotics).

The bottom line is that the IMF’s international reserves data are yet another measure of global economic activity showing a significant slowdown. Sure enough, the value of world exports was down -5.5% y/y during June, close to the decline in international reserves. But again, keep in mind that both of these IMF-compiled series are denominated in dollars, and have been depressed by its strength over the past year

Today's Morning Briefing: Global Liquidity Drying Up? (1) Short and long answers to liquidity question. (2) International reserves falling since July 2014. (3) Dollar remains the major international reserve currency, though less so than a few years ago. (4) Strong dollar depressing dollar value of euro and yen reserves. (5) Drop in reserves is a two-way street reflecting drying liquidity and secular stagnation. (6) Tiny tightening prospects already triggering tightening tantrum and unwinding of carry trades. (7) Bad for EMEs, but maybe good for USA. (8) China has a little less of lots of cash. (9) US labor market revisited and revised. (More for subscribers.)

Tuesday, September 8, 2015

Bull Case Hinges on US (excerpt)

The bear case is fairly compelling right now. However, it seems always to be compelling because it plays to our basic instinct of fear, which can often trump greed--the other basic instinct driving stock prices--fairly quickly and unexpectedly. This could turn out to be a good year for bearishly inclined chart technicians, but that’s after getting it mostly wrong for the past six years. I track Death Crosses and other technical indicators, but I don’t give them as much weight as I do the economic and earnings fundamentals.

The bull case hinges on whether the US economy and earnings can continue to grow even if global economic activity continues to weaken. Of course, that’s the bull case for US stocks, and consistent with our Stay Home investment theme. It might even be bullish for Eurozone stocks as long as the region continues to muddle along. However, it’s hard to make a bullish case for the stocks, bonds, and currencies of emerging markets, especially given the fairly convincing case for the unwinding of the global carry trade, particularly if the Fed does start to raise interest rates.

Here are the highlights of the latest economic indicators out of the US and the Eurozone:

(1) Boom in US labor market. Believe it or not, there still are economists arguing that the US labor market needs to make more progress before the FOMC starts to raise interest rates. Indeed, some of them are members of the FOMC, and one of them heads up the IMF. However, Friday’s employment report for August was overwhelmingly strong, on balance, in my opinion.

My Earned Income Proxy, which closely tracks the trend in private wages and salaries, rose 0.7% m/m last month, and 4.9% y/y. Granted, August’s payroll gain was only 173,000, but it is bound to be revised higher as were the previous two months in Friday’s report. In the household survey, August’s full-time employment exceeded the previous record high, set in November 2007. The unemployment rate was 5.1% last month, the lowest since April 2008.

(2) Crawling along in the Eurozone. The volume of retail sales in the Eurozone rose 0.4% m/m during July to the best level since February 2011. The bad news is that German factory orders declined sharply during July. However, German industrial production (including construction) rose 0.7% that month.

(3) China is the muddle kingdom. China may be slowing, but it isn’t falling into a recession, in my opinion. The plunge in China’s share prices since June 9 may be an ominous leading indicator of a worsening economic situation. More likely, it is the bursting of a bubble that has been inflating for a very short time, i.e., since November of last year.

I suppose we can all breathe easier knowing that Nouriel Roubini is optimistic about China. The 4/9 Telegraph reported: “Nouriel Roubini has cast aside his mantle as the lugubrious ‘Dr Doom’ of the global economy, scathingly dismissing market panic over China as ‘manic depressive’ behaviour by ill-informed investors. ‘China is not in free-fall,’ he told the Ambrosetti forum of world leaders on Lake Como. Mr Roubini, a professor at New York University, described the alarmist reaction to the Shanghai stock market rout as ‘excessive, unreasonable and irrational’.”

Today's Morning Briefing: Quant Guys: Fair-Weather Friends? (1) The Omega Man. (2) Risk-parity strategy didn’t pare losses for All Weather Fund. (3) Blaming “price-insensitive” traders. (4) Flash crashes now and then. (5) Spike peaks in VIX. (6) September curse played out in August? (7) Bull/Bear Ratio so bearish, it’s bullish. (8) Five fears on the Bear List. (9) The bulls need the US to do well--so far, so good. (10) Earned Income Proxy at another record high. (11) Roubini says China is okay. (12) “No Escape” (- -). (More for subscribers.)

Wednesday, September 2, 2015

US Economy: Homeward Bound (excerpt)

There are clearly enough recessionary indicators around the world to feed investors’ concerns about a global recession. While they were fretting about this scenario yesterday, they ignored solid numbers coming out of the US suggesting that real GDP, which rose 3.7% during Q2, could be revised higher and followed by another solid gain during Q3. Consider the following:

(1) The value of construction put in place rose 0.7% m/m during July, and 13.7% y/y, to the highest pace since May 2008. Leading the way over the past year has been nonresidential construction (up 18%), with particular strength in manufacturing (73), amusement & recreation (60), and lodging (41). Construction of factories has been soaring into new record-high territory since January of this year.

(2) Motor vehicle sales jumped to a new cyclical high of 17.8 million units (saar) during August. Leading the way have been light truck sales. The former is up 2.8% y/y, while the latter is up 9.0%.

Today's Morning Briefing: Breaking China. (1) Looking for support. (2) “Dudley Bounce” has petered out. (3) Good times for pessimists and bears. (4) The decoupling question. (5) No question that commodity producers can’t decouple from China. (6) China is weighing down global M-PMI. (7) Manufacturers in Canada, Brazil, Indonesia, and South Korea are in a world of pain. (8) China’s service economy isn’t serving as well as it should. (9) US and Eurozone M-PMIs remain solid, with just a few tiny cracks. (10) Let’s go home to the USA. (11) Construction spending on factories, lodging, amusement & recreation is booming. (12) Pickup trucks are on the fast track. (More for subscribers.)