Hiking Into a Slowdown
It becomes ever more tempting to conclude that the timing of the Fed’s rate hike was really quite odd, even from the perspective of the planners – even though the U3 unemployment rate has fallen to a mere 5% and they are probably correct about the transitory nature of the currently very low headline “inflation” rate (as we have recently pointed out, actual monetary inflation currently stands at almost 8% y/y).
Image credit: Fotolia
Recent economic reports have by and large not shown any noteworthy improvements – on the contrary. District manufacturing surveys are going from bad to worse, existing home sales just had another truly terrible month (this time bad weather can obviously not be blamed, but apparently there is a problem with filling in simplified forms) and even the Markit services PMI has suddenly undercut the entire range of economists’ expectations. Meanwhile, the growth rate in ECRI’s coincident index has just hit a 21-month low:
ECRI’s coincident index growth rate keeps falling. The weekly leading indicator has recovered from its lows (while remaining in negative territory), but we dislike the fact that this indicator is evidently strongly influenced by the stock market. In our opinion the stock market has long ceased to tell us anything about the economy.
In her press conference, Ms. Yellen inter alia went on about the “strong consumer” – as if one could consume oneself to prosperity. Both stronger employment and stronger consumption are a consequence of economic growth, not a cause of it. To believe otherwise, one needs to put the cart before the horse, based on the primitive Keynesian flow model of the economy (however, this model does not depict how the economy actually works).
A difficulty consists of the fact that capital consumption – i.e., a net loss of wealth – tends to masquerade as growing prosperity during a credit expansion. This is why the planners erroneously believe that growing the supply of money from thin air and artificially suppressing interest rates improves the economy. It is a bit like watching the erection of a Potemkin village and believing that there is actually something behind the facade.
Ms. Yellen always reminds us are that empirical data are the main guide informing Fed policy, but even those seem to contradict her point about consumers – to wit, growth in real personal consumption expenditures has just hit a 15 month low:
Annual growth in real personal consumption expenditures by sectors
We have to briefly interpose here that we are not about to suggest what the Fed should or shouldn’t do. We are not armchair central planners proposing “better plans” for interventionists. Our only plan with respect to central banks is to argue for the urgent need to abolish them and adopt a completely unhampered free market in money and banking.
We are mentioning this because we don’t want new readers to confuse us with the many would-be social engineers that can be found elsewhere on the intertubes. The reason why we discuss central bank policy is the fact that it exists and that we all have to live with its consequences.
With that out of the way, we want to show a collection of updated charts from our friend Michael Pollaro, on what we think are key economic data points. We also want to point readers to a recent critical discussion by Mish regarding an “economic snapshot” paper produced by the NY Fed (we agree with his counterarguments).
As we have stressed on previous occasions, our focus is primarily on the business side of the economy, and within that, on the part that produces the greatest share of gross economic output, namely manufacturing. This is of course in keeping with the cause-effect vector mentioned above. The charts below show a somewhat broader array of data, i.e. they are not only about manufacturing.
Economic Data Snapshot
The aggregate data on business sales, inventories, employment, etc. are mainly updated until the end of October, resp. November. This is simply due to the respective official update frequencies. However, we can already infer from recent more up-to-date data releases (such as the Fed district surveys), that the trends shown in these charts are so far persisting.
Obviously, the last time declining business sales and a rising inventory-to-sales ratio were considered good things was “never”.
Business sales by sector: y/Y change rate in overall sales (red), retail sales (green), wholesaler sales (purple), manufacturers sales (magenta) vs. the inventory-to-sales ratio (yellow area) – click to enlarge.
In typical business cycle fashion, industries in the higher stages of the production structure (further removed from the consumer) are showing the greatest volatility and are currently suffering the most due to the incipient downturn.
This chart shows overall business sales in the yellow area and disaggregates the inventory-to-sales ratio (I/S) by sector. Retail I/S (purple), overall business I/S (blue), wholesalers I/S (green), manufacturers I/S (red) – click to enlarge.
The next two charts show growth in total business sales and inventories relative to growth in employment:
What is noteworthy about the foregoing two charts is that a large gap has developed between employment growth and business sales – the last time such a gap was seen was when it occurred to the upside, as the recovery in business sales (not surprisingly) led the the recovery in official unemployment data after the GFC.
It is fair to assume that business sales haven’t lost their leading indicator qualities. Keep in mind though that employment data have become quite skewed though by the surge in part-time jobs (which leads to what used to be counted as one job being counted as two) and the sharp decline in the labor force.
Another comparison chart worth looking at is the following, which contrasts business sales with junk bond spreads. The negative correlation between these two data series is more direct, although slight leads and lags do of course happen as well:
Lastly, as an addendum to the data on retail sales, here is a chart of the Redbook Index (weekly y/y growth rate in same-store sales). Over the past year this indicator has weakened considerably:
Redbook Index: a sales-weighted index of year-over-year same-store sales growth in a sample of large US general merchandise retailers representing about 9,000 stores.
None of this looks particularly encouraging, but it needs to be stressed that there is no guarantee yet that this weakness will lead to an official recession in the near term. However, if a recession is indeed in store, we should expect more definitive signals to this effect to emerge quite early next year.
Additional Remarks – Production Structure and Yield Curve
The long period of ZIRP and historically strong money supply growth has kept our boom-bust index – the ratio of capital to consumer goods production – moving sideways at an extremely elevated level for an unusually long time. We can infer from this that there is probably more capital malinvestment in the economy than is superficially obvious.
The ratio of capital goods (business equipment) to consumer goods production, a rough indicator of the distribution of factors of production between the different/opposing stages of the capital structure. Typically it rises sharply during credit booms and contracts during bust periods – click to enlarge.
Finally, we wanted to briefly mention the yield curve. As a result of the Fed’s oddly timed rate hike, the yield curve has flattened quite rapidly recently. This brings us to the question whether it is necessary for the curve to invert before a recession can be forecast with confidence. As we have previously discussed (see The Yield Curve and Recessions), per experience this is actually not the case in ZIRP (zero interest rate policy) or near-ZIRP regimes.
Below we reproduce a chart from said article that shows the past six recessions in Japan contrasted to the Japanese yield curve (represented by very short and very long durations, i.e., 3 months vs. 10 years). Only one of them – the one that began immiediately after the major bubble of the 1980s had burst – was actually preceded by an inversion. We suspect that a mere flattenig of the curve must already be seen as a major warning sign during or on the heels of a ZIRP regime.
Japan: the yield curve and recessions – there have been five recessions in the past 2 decades that were not preceded by an inversion of the yield curve. What they all had in common was that they occurred during the ZIRP era – click to enlarge.
We are a bit worried that a consensus seems to be emerging lately that the Fed will soon “backtrack” from its rate hike. For the time being we believe so as well though, based on the data backdrop discussed above. It could however be that the Fed will get one or two more hikes in (even the BoJ once managed to implement two consecutive rate hikes – back when most of today’s stock market traders were still pimply teenagers).
This will largely depend on whether the above trends persist in the near term, as well as on asset prices, especially the stock market. All of this will in turn depend on whether the overarching downtrend in money supply growth rates continues (or perhaps even accelerates), or reverses again. So there are a great many moving parts, and we will have to wait and see how they develop. We would however say that it mainly comes down the question of whether the backtracking happens somewhat “sooner” or “later”.
Addendum: Modified Ned Davis Method Signal
We actually forgot to alert readers that according to Frank Roellinger, the Modified Ned Davis Method has gone 50% short the Russell 2000 as of Friday, December 11. However, net-net no major move has taken place yet since then (the RUT is actually a trifle higher as we write this). As always, the system’s signal to switch from flat to partly short represents an additional short to medium term warning signal for the stock market until it is rescinded again.
Charts by: ECRI, Michael Pollaro, St. Louis Federal Reserve Research, investing.com
It is that time of the year again – our semi-annual funding drive begins today. Give us a little hand in offsetting the costs of running this blog, as advertising revenue alone is insufficient. You can help us reach our modest funding goal by donating either via paypal or bitcoin. Those of you who have made a ton of money based on some of the things we have said in these pages (we actually made a few good calls lately!), please feel free to up your donations accordingly (we are sorry if you have followed one of our bad calls. This is of course your own fault). Other than that, we can only repeat that donations to this site are apt to secure many benefits. These range from sound sleep, to children including you in their songs, to the potential of obtaining privileges in the afterlife (the latter cannot be guaranteed, but it seems highly likely). As always, we are greatly honored by your readership and hope that our special mixture of entertainment and education is adding a little value to your life!
Bitcoin address: 1DRkVzUmkGaz9xAP81us86zzxh5VMEhNke
Most read in the last 20 days:
- Gold Price Skyrockets in India after Currency Ban – Part III
When Money Dies In part-I of the dispatch we talked about what happened during the first two days after Indian Prime Minister, Narendra Modi banned Rs 500 and Rs 1000 banknotes, comprising of 88% of the monetary value of cash in circulation. In part-II, we talked about the scenes, chaos, desperation, and massive loss of productive capacity that this ban had led to over the next few days. Indian prime minister Narendra Modi – another finger-wagger, as can be seen in this...
- Gold Price Skyrockets in India after Currency Ban – Part II
Chaos in the Wake of the Ban Here is a link to Part 1, about what happened in the first two days after India's government made Rs 500 (~$7.50) and Rs 1,000 (~$15) banknotes illegal. They can now only be converted to Rs 100 (~$1.50) or lower denomination notes, at bank branches or post offices. Banks were closed the first day after the decision. What follows is the crux of what has happened over the subsequent four days. India's prime minister Nahendra Modi, author of the...
- Gold Price Skyrockets in India after Currency Ban – Part IV
A Market Gripped by Fear The Indian Prime Minister announced on 8th November 2016 that Rs 500 and Rs 1,000 banknotes would no longer be legal tender. Linked are Part-I, Part-II and Part-III updates on the rapidly encroaching police state. The economic and social mess that Modi has created is unprecedented. It will go down in history as an epitome of naivety and arrogance due to Modi’s self-centered desire to increase tax-collection at any cost. Indian jewelry...
- A Note on Gold and India – What is Driving the Gold Price?
Hidden Motives It is well-known that India's government wants to coerce its population into “modernizing” its financial behavior and abandoning its traditions. The recent ban on large-denomination banknotes was not only meant to fight corruption. Obviously, this very bad Indian has way too much cash. Just look at him, he looks suspicious! Photo via thenewsminute.com In fact, as our friend Jayant Bhandari has pointed out, fresh avenues for corruption ...
- Will Trump Do What Reagan Couldn’t?
Depravity and Degeneration BALTIMORE – Finally, it’s over. We were both delighted and appalled by the news. A smile spread over our face... and our steps lightened... as we looked ahead to four years without Hillary Clinton’s know-it-all mug in the news. Praise be! This mug will be largely missing from the airwaves and the intertubes in coming years. And your caption scribbler PT won't have to look for a fall-out shelter! We thank the Lord and the American public for...
- India's Currency Debacle – An Interview with Jayant Bhandari
A Major Crisis Last week Jayant Bhandari related the story of the overnight ban of certain banknotes in India under cover of “stamping out corruption” (see Gold Price Skyrockets In India after Currency Ban Part 1 and Part 2 for the details). Banned 500 rupee banknotes The problem is inter alia that the sudden ban of these banknotes has hit the Indian economy quite hard, given that 97% of all transactions in the country are cash-based. Not only that, it has...
- Inflation Expectations Rise Sharply
Mini-Panic Over Inflation After Trump's Election Victory We have witnessed truly astonishing short term market conniptions following the Donald Trump's election victory. In this post we want to focus on one aspect that seems to be exercising people quite a bit at present, namely the recent surge in inflation expectations reflected in the markets. Will we have to get those WIN buttons out again? A 1970s “whip inflation now” button. The only thing that was actually needed...
- There Are Two Types of Credit — One of Them Leads to Booms and Busts
Stumped by the Bust In the slump of a cycle, businesses that were thriving begin to experience difficulties or go under. They do so not because of firm-specific entrepreneurial errors but rather in tandem with whole sectors of the economy. People who were wealthy yesterday have become poor today. Factories that were busy yesterday are shut down today, and workers are out of jobs. What has caused the bust? The modern-day economic orthodoxy continues to be unable to provide...
- Will the Swamp Swallow Trump?
Permanently Skewed TRUMP HOTEL, New York – Trump’s rambling army – professionals, amateurs, camp followers, and profiteers – is marching south, down the I-95 corridor. There, on the banks of the Potomac, it will fight its next big battle. Lieutenants in Trump's army: Bannon, Flynn & Sessions Photo credit: Drew Angerer / AFP Here at the Diary, we do not like to get involved in politics. But this is a special time in the history of our planet – a...
- Gold Bull Market Remains Intact – Long Term Fundamentals Outweigh Short Term Market Gyrations
A Strong First Half of the Year, Followed by Another Retreat In early 2016 gold had a big bull run. The precious metal rose close to 25% this year, pushed higher in a summer rally that peaked on July 10th. Gold experienced a bumpy ride over the remainder of the summer though, as investors became increasingly concerned about a potential rate hike by the Federal Reserve. Uncertainty returned to gold market and has intensified further since then. Initially, gold rallied sharply...
- Too Early for “Inflation Bets”?
The Trump Trade After 35 years of waiting... so many false signals... so often deceived... so often disappointed... bond bears gathered on rooftops as though awaiting the Second Coming. Many times, investors have said to themselves, “This is it! This is the end of the Great Bull Market in Bonds!” The long bond's long cycle – red rectangles indicate when the post 1980 bull market was held to be “over” or “over for sure” or “100% over”, etc. We have...
- All Aboard! Trump’s Express Train to the Future
Free Money! BALTIMORE – Last week, the Dow punched up above 19,000 – a new all-time record. And on Monday, the Dow, the S&P 500, the Nasdaq, and the small-cap Russell 2000 each hit new all-time highs. The last time that happened was on the last day of December 1999. Ironically, two events that were almost universally expected to trigger large stock market declines were followed by quite rapid and strong gains. Would the market have fallen if Hillary Clinton had won...