Stepping on the Monetary Accelerator and Regulatory Brakes (excerpt)

Expectations that the ECB will provide more monetary stimulus next Thursday continue to push bond yields lower in the Eurozone. That’s been pushing US bond yields down as well, especially since ECB President Mario Draghi has said he will do whatever it takes to weaken the euro. That’s made US government bond yields especially attractive relative to yields available on comparable bonds in the Eurozone.

Draghi hopes to boost the region’s CPI inflation rate, which is only 0.7%, by weakening the euro. I’m not convinced that doing so will boost inflation in the Eurozone. The problem is that the region’s banks aren’t lending, which is also depressing monetary growth. Here’s the most recent key developments:

(1) Slow money. M2 growth was only 2.0% y/y during April. That’s down from a recent peak of 4.8% last April, and the lowest since December 2011. The recent slowdown coincides with the decline in the CPI inflation rate.

(2) Weak lending. Banks are starting to lend in the Eurozone, but to each other rather than to nonfinancial businesses. Over the past three months through April, Eurozone lenders provided a measly €13.6 billion (saar) in credit, with €142.8 billion extended mostly to financial institutions. Lending to nonfinancial corporations declined by €169.6 billion over this same period.

(3) Bad loans. The 5/13 FT reported that, according to Fitch, bad loans at Europe’s banks rose 8.1% in 2013 to slightly more than €1 trillion compared with the year before. Fitch surveyed a hundred banks due to be assessed by the European Banking Authority. Twenty-nine saw the number of impaired loans rise by more than 20% as their asset quality deteriorated, while one-third of banks saw their bad loan volumes fall or stay the same. European regulators are preparing a strict classification system, which should eliminate national differences over what constitutes a problem loan.

So European monetary and banking authorities are stepping on the monetary accelerator and the regulatory brakes at the same time. They are providing ultra-easy monetary policy hoping that banks will increase their lending. At the same time, they are toughening loan standards and subjecting the banks to stress tests. As a result, they are driving global bond yields into the ditch.

Today's Morning Briefing: Dancing With the Bull. (1) Morphing from cyclical to secular. (2) Bull market in earnings. (3) 50% jump in P/E since 2011. (4) Secular bull’s favorite sectors mostly the same as the ones during cyclical bull. (5) Eurozone yields driving US yields lower. (6) Will weaker euro boost Eurozone CPI inflation? (7) Draghi blows off Krugman. (8) Eurozone’s problem is lack of bank lending and weak monetary growth. (9) Stepping on the monetary accelerator and the regulatory brakes. (More for subscribers.)

Profits Drive Capital Spending (excerpt)

Profitable companies tend to expand by hiring more workers and investing in capital equipment and structures. They’ve been more cautious about doing so during the current economic expansion. That’s because they were traumatized by the financial crisis of 2008. However, that was five years ago, and they should be getting over it by now. That means that if their profits remain strong, payrolls and capacity will continue to grow, which is why the current expansion is likely to be longer than average.

The profits outlook remains bright according to the S&P 500 forward earnings. This series has been highly correlated with capital spending in real GDP and with nondefense capital goods orders.

Comparing capital spending in real GDP during the current expansion to the previous six shows that it has also been growing at a subpar pace. Spending on structures, on information processing equipment, and on intellectual property products (including software and R&D) have been especially weak. On the strong side have been industrial and transportation equipment.

I believe that as a result of the IT revolution, companies may be getting more bang for their capital-spending bucks now than in the past. They can spend less on IT hardware and software in current dollars and get much more computing and communicating power. The industrial equipment they buy comes with powerful embedded IT capabilities. Nevertheless, if profits remain strong, their capital spending should grow.

Today's Morning Briefing: Durable Economy. (1) Slow, but steady. (2) Below-average expansion could last longer than average. (3) Forward earnings is a very upbeat leading indicator. (4) Other good omens. (5) Regional business surveys and flash PMIs are strong. (6) Young adults are more optimistic. (7) Profits driving capital spending higher. (8) IT revolution increases bang per capital-spending buck. (9) Transportation stocks outperforming ytd. (10) Focus on overweight-rated S&P 500 Industrials. (More for subscribers.)

Great Crashes and Taper Tantrums (excerpt)

Earlier this year, a few technicians warned that the DJIA seemed to be tracking a similar trajectory to the one during 1928-29, and this could be the year for another Great Crash. I first questioned the apparent parallel in our 1/28 Morning Briefing: “Of course, to make the chart work, the September 3, 1929 pre-crash peak has to be superimposed on this year’s peak, and the scales have to be manipulated to maximize the fear factor.” When the scales are indexed to 100, the parallel virtually disappears.

Mark Hulbert touted the 1928-1929 “scary parallel” in his 2/11 MarketWatch column. While he did note that there is a scaling issue in comparing the current DJIA to the frightening parallel, he nonetheless opined that “[i]f the market follows the same script, trouble lies directly ahead.” That omen is a tautology, of course.

In the 2/18 Morning Briefing, I wrote: “What would it take to repeat the grim fundamental underpinnings of the scary scenario of 1928-1933? Another Lehman moment would do the trick, and make Hulbert and the other promoters of this grim scenario right on the money. Of course, there have been several variations of this ‘endgame’ scenario provoking anxiety attacks and corrections since the start of the current bull market. But Godot has yet to show on stage.” He remains a no-show.

Other bears noted that there has been a very high correlation between the S&P 500 and the Fed’s holdings of bonds. They continue to warn that the Fed’s tapering of QE, which is on track to be terminated by the end of the year, will terminate the bull market in stocks as well.

This week’s Barron’s includes an interview with Stephanie Pomboy, the thought-provoking proprietor of MacroMavens. She argues that QE has propped up the economy, which hasn’t achieved self-sustaining growth. So she believes that “the Fed is going to have to taper the taper” because “the economy can't handle a reduction of stimulus.” I disagree. We won’t have to wait much longer to see who is right given that the Fed is on course to terminate QE by the end of the year.

Today's Morning Briefing: Trekky Bull. (1) Star trekky bull tramples “Clingons.” (2) Will Godot arrive before next great crash? (3) Maven says Fed will have to taper the taper. (4) The problem with going away in May. (5) Great Moderation 2.0 could be bullish or bearish. (6) Will risky assets get riskier? (7) CLO 2.0, and CMBS 2.0 too. (8) Analysts turning more upbeat on earnings. (9) Nitpicking Picketty’s data. (10) The flaw in the neo-Marxist formula. (11) Italy adds vice to GDP. (13) “Godzilla” (- - -). (More for subscribers.)

Anatomy of an Internal Correction (excerpt)

Investors experienced a few hair-raising stock market corrections during the current bull market. From 2010 through 2012, there were five significant ones. The first one was during the spring of 2010 when the S&P dropped 16.0%. The worst hair-raiser was during the summer of 2012 when the S&P 500 plunged 19.4%, near the 20% drop that marks a bear market. That was followed during the fall of that year by a 9.8% decline, just short of the 10% that marks an “official” correction. There was another borderline correction of 9.9% during the summer of 2012, which was followed by a mini-correction of 7.7% during the fall.

The five corrections lasted from 27-154 days. Subsequent selloffs have been shorter and shallower, hardly meriting being called "corrections." All of these five corrections were triggered by macroeconomic events that threatened to precipitate a recession. When those threats dissipated, the bull market resumed. The anxiety attacks that caused the corrections were followed by relief rallies.

This year’s correction is unique so far. The S&P 500 is down just 0.5% from its record high on May 13. However, lots of stocks are down 10%-20% since March. They tend to be SmallCaps, as evidenced by the 8.7% decline in the Russell 2000, and the 12.2% drop in its Growth component. The Nasdaq is down 5.2% from its recent high. However, some LargeCap stocks have also taken big hits. In the S&P 500, Biotechnology, Internet Software & Services, and Consumer Discretionary Retail are down 13.5%, 12.0%, and 9.4% from their recent peaks.

I have characterized the recent selloff as an “internal correction.” Scrambling to avoid giving back the fabulous gains from last year’s melt-up rally, institutional investors have been rebalancing their portfolios away from high-P/E to low-P/E stocks. They’ve moved some of their portfolios out of Growth into Value stocks. Stocks with predictable earnings are outperforming the more cyclical ones. Among the losers have been lots of “innocent bystanders” that have been pummeled mostly because they are included in out-of-favor ETFs.

Today's Morning Briefing: Exit & Entry Strategies. (1) Hair-raising corrections. (2) Internal vs. external corrections. (3) Innocent bystanders. (4) Will Congress invert corporate inversions? (5) Too many bulls again. (6) Central banks: coming or going? (7) ECB set to do more of whatever it takes next month. (8) Janet Yellen and John Wayne. (9) New Fedspeak word: "Normalization." (10) Dudley is ready to raise rates eventually, but not by much. (11) Surprisingly weak earnings in UK and Eurozone. (12) Not all sectors in Japan getting a lift from Abenomics. (More for subscribers.)

Global Oil Demand Showing Slower Growth (excerpt)

According to Oil Market Intelligence (OMI), world crude oil supply rose to a record 90.2mbd on average over the past 12 months through April. The price of a barrel of Brent crude oil has been remarkably flat (with some volatility) around $110 since early 2011. World oil supply has been well balanced with world oil demand at this price.

Let’s review some of the highlights of the latest demand data compiled by OMI through April using 12-month averages to smooth out seasonal volatility:

(1) World. World crude oil demand rose to a record 91.7mbd last month. However, the growth rate has slowed from a recent high of 1.5% y/y during September 2013 to 1.0% during April. This suggests that the global economy is growing, but at a relatively slow pace.

(2) Emerging countries. Most of the recent slowdown is attributable to emerging economies. The OMI data show that the growth rate among non-OECD countries is down from 3.7% a year ago to 1.9% currently. Among the 34 advanced economies of the OECD, oil demand growth is close to zero on a y/y basis, but that’s an improvement from negative readings during 2012 and 2013.

(3) China & India. Oil demand rose sharply in China from 2009 through mid-2013. Since then, it’s been flat around a record 10mbd, confirming that the country’s economy is in the midst of a significant slowdown. On the other hand, India’s oil demand rose to a record high of 3.8mbd last month, up 3.8% y/y.

(4) Europe. I have often shown that oil demand is a useful indicator of economic growth. In addition to suggesting a significant slowdown in China, it is confirming that the Eurozone’s economic recovery is very weak. Oil demand in Germany has been flat around 2.4mbd since 2010. Demand in France, Italy, and Spain remains on a downtrend that’s been going on for over five years.

Today's Morning Briefing: The Oil Story. (1) Regina and Saskatoon. (2) Bigger than Saudi Arabia. (3) Counting rigs. (4) National oil companies seeking experienced Western partners. (5) $110 a barrel remains the right price for now. (6) Global oil demand at record high, but growing slowly. (7) Emerging economies are slowing. (8) China’s oil demand has been flat for a year at record high. (9) Eurozone oil demand confirms weak economic recovery. (10) Focus on underweight-rated S&P 500 Energy sector. (More for subscribers.)