ADER’S MUSINGS – A LOT OF NOISE, NOT SO MUCH ACTION
Aug 17, 2018
* Data dearth puts attention (overly much?) on Turkey and EM, Italy. -- markets need to fill the information void. * Import Prices ex petroleum slip in July, downward revised, -- disinflationary impact of stronger dollar at hand, -- agricultural export prices down 5.3%; reflects trade policies. * St. Louis Fed economist Chris Waller gives yield curve its due (https://goo.gl/C71fYt), -- cautions it’s a useful recession indicator, * Eight reasons for stock-market caution. * Heads up; Fed’s Jackson Hole symposium, “Changing Market Structure and Implications for Monetary Policy. * Pension fund post tax-break date fears offset by many other factors
It is rare, I admit, for me to find the silver lining in a given cloud, but I managed to in the recent week. Perhaps I was inspired in this search by the approaching 10th anniversary of the Lehman bankruptcy and the differences and similarities between now and then but I’ll save those thoughts for now. In any event, the silver lining I refer to comes in the form of household debt. The Quarterly Report on Household Debt & Credit from the New York Fed showed a relatively modest rise in overall debt to $13.3 trillion, a gain of $82 billion. I suppose that is the ‘bad’ news if you consider debt a bad thing for households.
The good news is that delinquencies fell and the proportion of people facing third-party collections fell to their lowest level since 2003. I suppose this shouldn’t be much of a surprise; a lot of people simply couldn’t borrow and past-due accounts from 10 years ago have worked their way through the system. And, of course, lending standards are not what they were back in the bad old days. I’ll add in the demographic story, too, whereby younger people have student loans to deal with and are not borrowing as much through the traditional spending categories and older folks learned their lesson the hard way.
None the less, we owe credit where credit is due albeit not in the financial sense. Households have gotten themselves into better shape and seem to want to stay that way. I won’t overly quibble or challenge this sort of success. Alas, the same cannot be said for other areas of the economy.
I refer to Federal and corporate debt once again. The Federal debt is and will remain a problematic thing for decades to come but I’ve been over that and nothing in the past few weeks has really added or detracted to the story other than supply itself. Corporate debt, too, isn’t a new thing though at 45.2% of GDP, pretty much at a record high, and should maintain raised eyebrows. A piece in the NYT, titled “The Big, Dangerous Bubble in Corporate Debt” by William Cohan, outlined this from a pretty basic perspective.
That’s not an insult or condescension. Rather, it’s basic because it was a rather long Op-Ed piece reaching to a broad audience, maybe more Mother and Father than Mom and Pop, but still to a public that doesn’t typically follow the corporate market. He outlined the impact of monetary policy on keeping spreads tight and paving the way for weaker credit creation a la ‘covenant-lite’ loans. He could just as easily have mentioned how much of the IG market is made up BBB and so the construct is of lower quality than a few years back. He concludes with the cautionary note that we’ve never unwound QE before and that it’s prudent to ‘inure ourselves to the inevitable.’
I think the next two sections will resonate with that view.
Before we get to those I have to mention why it is that I read some people all of the time. I refer to the analysis of the Retail Sales report, strong at the headline levels, offered by the folks at The Liscio Report. In the good old days, before everyone had the ability and urge to superficially relay the obvious via messages and tweet-like alerts, we relied on sages for depth. To wit, TLR makes note that a given Retail Sales report isn’t always something to hang your hat on even if, like in the most recent release, apparel was a strong element, so you might have an extra had or two needing to be hung.
Anyway, they point out that the revisions are so often enormous that one specific report’s analysis is dubious. June Retail Sales saw a 60% downward revision, with Autos revised down by 90%! Gas went down with a 70% revision and even some signs turned from positive to negative and ‘not by trivial amount.’ Electronics, for instance, went to -0.4% from +0.4%. The initial report seems to overstate gain in growth periods and the second release takes the edge off of that.
Says TLR,” Retail sales are an important indicator, but these preliminary monthly reports leave a lot to be desired. That’s a sharp contrast with the monthly employment numbers, which, though revised, are much less so, and rarely does the entire picture change from one telling to the next. Sometimes we wonder why the Census Bureau even publishes the preliminary retail report, or why anyone pays much attention to them.”
CHARTS AND THEMATICS: I do write a lot about demographics, the impact of an aging population on everything from spending to employment to wage demands to investment habits. Maybe it’s because with the crossing of 60, I find myself pondering all that from a rather personal perspective. Let me add that I read a lot on the topic, both academic literature and the popular press and have started to tire over the ‘advice’ proffered. I mean, who doesn’t know the way to retire securely from is to 1) save more, 2) spend less, 3) pay down debt, 4) work longer, 5) postpone Social Security to the last possible moment, 6) exercise, and 7) eat better?
I suppose along with all that obvious advice comes the caution that people should invest more conservatively in their golden years. Thing is, there’s a lot of exposure out there and older households tend to have a greater exposure than younger ones. Overall, equity amounts to over 25% of Household Financial assets, a level surpassed only once and that in Q1 2000. Overall Net Worth as a % of Disposable Income is a record 683%. The takeaway from this is that the security households have that, presumably, helps fuel consumption habits is at least a partial function of this visualization of the wealth effect.
It’s the age thing to consider; at what point does this demographic shift to a higher bond allocation? I bring this up with a perspective on that allocation in the context of interest rates having risen. Equities as a % of Household Financial Assets are nearly 22% -- the most since the mid 1997-2000. Meanwhile, bonds make up a tad under 6% of holdings, basically at the lows of the last 40 years. This doesn’t seem the most prudent allocation given the demographics or, I’d argue, valuations. When I’ve written about yields available in the bond market relative to the S&P 500 dividend yield, I anticipate that investors will too, and soon, see the prudence in taking some risk off the table.
Don’t laugh at me too much, but I have to reference an article in Kiplinger Magazine, which I read religiously. The article was about “10 Things You’ll Spend Less on in Retirement” and dovetails with my some of my own work and a recent interview with Ed Yardeni. The Kiplinger piece said what I’ve documented; retirees spend 25% less than the average household (https://goo.gl/DvEy3U). The 10 areas are interesting, but not earthshattering enough to repeat. The key point, however, is that people do spend less which makes the argument for a move into bonds from equities all the more reason to expect the risk-averting flow.
In an interview with CNBC, Yardeni made note that it’s not just about retirees but that several generations are moving towards a more minimalist lifestyle. Baby Boomers are obvious as they downsize, bought most of what they need (that reminds me I do need to resole those Clark Wallabees), and have reasonable angst over their financial futures which is maybe the downside of increased longevity. As evidenced by the boom in Brooklyn and elsewhere, millennials, too, are ‘minimalists,’ says Yardeni. We know they’ve got Uber, Zipcars, CityBikes, prefer urban living to the burbs, renting to buying, and are marrying later and having fewer kids.
That means slower consumption in the broadest sense compared with history and that’s notable given that consumption is a larger part of the economy at 69.4%. And you thought it was just 2/3rds of GDP; that’s so 1980s. Interestingly, Yardeni says that’s a bullish thing in that it means the economy can grow but not overheat and drive the Fed to hike us into a recession. (For what it’s worth, I disagree; I think the Fed’s tightening will get us to an inverted curve which presages a recession AND at a time when stocks are, arguably, rich as I outline in the subsequent section.)
IN OTHER NEWS: Sort of related to this was a recent piece in the WSJ that’s worth mentioning; “The Eight Best Predictors of the Long-Term Market” followed by a subtext that read, “Here are the stock indicators with the enviable track records—and the cautionary tale that they tell.” (https://goo.gl/E4QdaF).
The most bearish of these ‘projects’ a negative 3.9% annualized return under inflation and the most bullish just 3.6% over inflation. That bullish one is 300 bp below the real return for the last, oh, 200 years.
Author Mark Hulbert details these eight, with the charts I just showed presenting equity allocations as a % of household assets being one of them. The correlations with the stock market are rather compelling. I allow that the multitude of charts and, perhaps, the somewhat arcane nature of them are overwhelming and perhaps edge into the realm of nerdom. But when putting them together they do contribute to one’s angst over the pace of the equity market and, my goal, to offer more reason to expect the bond market to find support on relatively shallow pullbacks. Hulbert downplays the variations in the R-squares, which is fine with me, but it’s the charts themselves that are the relevant displays of the story.
An interesting angle was input from Jeremy Siegel of Wharton who among other challenges to these charts, asked “What is the replacement cost for a Google or Facebook?” the idea being that history has never been so dominated by info-tech firms. True, true and true. But those are not the only firms in the world (yet) and if you exclude a handful, equity performance this year doesn’t look quite so robust.
The seven others include the Q ratio and their R-squares (the proportion of the behavior for a dependent variable explained by the independent one) against the stock market. Next up is the Q ratio, the ratio between a physical asset’s market value and its replacement value.
A third is the prices/sales ratio, 44%, determined by dividing the S&P 500’s price by per share sales.
A fourth is the Buffet indicator, 39%, which looks at equity market capitalization relative to GDP.
A fifth is the Shiller/CAPE Index, which looks at the cyclically adjusted Price/Earnings ratio, 35% R-square. Umm, err, it’s high.
Sixth on this list is the S&P 500 Dividend Yields (R-square of 26%). I’ve flogged this dead horse amply, so suffice it to say bond yields look more enticing and the less defensive nature of the S&P 500 (defensive stocks make up 16.3% of the index vs. 40% in 1990) makes it highly unlikely to see the dividend yield increase to match bonds
Seventh and Eighth on one chart! show the P/E ratio and P/Book ratios (R-square 24% and 21%, respectively).
NEAR-TERM MARKET THOUGHTS: Risk on, risk off. It’s not about domestic events at the moment but domestic events will return to the fore to, I suspect, keep longer yields in this tight range and the curve responding to Fed anticipation, the dollar, and yield differentials in that order. I put a lot of emphasis on the calendar where the number of ‘out of office’ messages I get serves as a proxy for thin trading, relative illiquidity, and I think not a lot getting accomplished in a strategic sense. I’m not dismissing the action in Turkey and EM, or the excitement over China’s trade delegation, but it is noise for now. I’m not coming away with a grand strategic direction.
The next couple of weeks are slim on the data front so I see no reason there to get excitipated (a word I made up, but you should get its gist). I am impressed that despite generally healthy data in the last few weeks yields have come back into the late June/July range. I suspect there’s covering more than active buying going on, especially given the short base evidenced in the CoT data.
No one thinks the overseas stuff will impact the September FOMC, fully priced in, so maybe there’s some near-term urge to book those profits (on flatteners) simply because there’s nothing left to go for in the very near term. For 10s, I think the old channel bottom at 2.80% will be a strong resistance area with support near the 21-day MA at 2.94%. I’ll give the curve a very few bps of corrective steepening -- 29/30 bp on 2s/10s, something like that.
Three things crop up on my radar. One is the Fed’s Jackson Hole Conference which I won’t attend this year (blackballed again). The topic is “Changing Market Structure and Implications for Monetary Policy.” If experience is of any value, these tend to offer more hope for market-moving insights than delivery. I’ve heard that this will be more about the global economic structure than financial market structure, but that’s probably speculation.
Still, if it’s about the market structure let’s consider what they’d discuss. Certainly, it would include the Fed’s Balance Sheet and perhaps some detail on how large it might have to be in the future to deal with the larger deficits and system needs. I wouldn’t speculate that this will get people excited over an early suspension of the current balance sheet reduction, but it is out there so to speak.
Further, the use of the Balance Sheet as a tool seems a reasonable topic to talk about; did it work as expected, what are implications for its unwind, do the limits of fiscal stimulus mean the balance sheet will have to be employed aggressively in the next downturn, and, how do all those Treasuries coming to market change the supply/demand implications of the broader market. Of course, NONE of this may come up, but whether at Jackson Hole or some later date most definitely will be on the market’s, and Fed’s, agendas.
I mentioned three things. Another is growth vs. value stocks where the latter is getting more attention after it’s underperformance in recent years. It may be a short-term summer thing, but it’s gotten some press and I ponder if it’s the start of something more or, simply, a reflection of the last few weeks of some risk aversion.
A third thing is Italy. Italy’s 2-yr has gone up 80 bp or so in the last few weeks, to 1.34%. Part of that is about Turkey, but a good part, larger perhaps, is about Italy’s banking and budget woes. I mention this because others are following it with vastly more insight than I have. Marcus Ashworth, a BBG Opinion columnist, had a good piece ({NSN PDJCGD6S9729 <GO>}) that’s worth a read.
Finally, I want to mention the tax/pension thing that some have brought up as meaning the curve can resteepen and/or that long end yields will rise beyond the recent trading range highs. I refer to the tax break corporations get for contribution made before the middle of September based on the old, higher, tax rate. This undoubtedly has fueled more money going into pensions this year. Is it ‘bad’ for the long end?
Well, bear in mind both stocks and bonds have benefited, so both in theory will suffer less contributions post the date in question. However, I think bonds will suffer minimally. First, there’s the allocation story. The Milliman Pension Fund Index puts funding levels at 93.4% due to strong investment performance which is surely about stocks. That was just 85.8% a year ago and is at it highest level since 2007. I think it will prove prudent for such pensions to take some risk off the table given those sorts of funding levels. (The same is true for public pensions I suppose.) Second, there’s the curve angle; the Fed’s still hiking, the dollar is disinflationary and base effects will take the edge off of inflation figures in the coming months. Third, there’s the Fed’s balance sheet; the shrinking of asset purchases has had little bearish impact so far and given the liquidity needs there’s reason to think said shrinkage will run its course sooner than later. In any event, I think the tax benefit to contributions will have very little impact on the Treasury market given bigger issues just outlined.
David Ader, Chief Macro Strategist for Informa Financial Intelligence
Bringing 30 years of investment strategy experience to his role at Informa Financial Intelligence, David Ader has held senior positions at major investment banks and financial information firms as well as serving on investment policy committees and management teams. Most recently Partner, Head of Government Bond Strategy for CRT Capital, he headed the team voted #1 in U.S. Rates Strategy for 11 years and #1 in Technical Analysis for five years in Institutional Investor’s annual survey.
Informa Financial Intelligence obtains information for its analysis from sources it considers reliable, but does not guarantee the accuracy or completeness of its analysis or any information contained therein. Informa Financial Intelligence and its affiliates make no representation or warranty, either express or implied, with respect to the information or analysis supplied herein, including without limitation the implied warranties of fitness for a particular purpose and merchantability, and each specifically disclaims any such warranty. In no event shall Informa Financial Intelligence or its affiliates be liable to clients for any decision made or action taken by the client in reliance upon the information or analyses contained herein, for delays or interruptions in delivery for any reason, or loss of business revenues, lost profits or any indirect, consequential, special or incidental damages, whether in contract, tort or otherwise, even if advised of the possibility of such damages. This material is intended solely for the private use of Informa Financial Intelligence clients, and any unauthorized use, duplication or disclosure is prohibited. This material is not a comprehensive evaluation of the industry, the companies or the securities mentioned, and does not constitute an offer or a solicitation of an offer or a recommendation to buy or sell securities. All expressions of opinion are subject to change without notice.