Breakfast with Dave

John Mauldin | Jun 03, 2014


While you were sleeping

Where Americans are shopping (and where they are not)
Update on the Commitment of Traders report
Third time’s the charm for the May ISM
Construction spending solid to start Q2

Bank lending gaining more momentum


In stark contrast to yesterday at this time, global equities are under some selling pressure. Most of Europe is down anywhere from 0.2% to 0.4% (a whole lot of ECB easing ostensibly was priced in with the 2% jump in May), though Asia was more mixed to positive — the Japanese Nikkei index was up again (+98 points or 0.7% to 15,034), the Hang Seng rallied 0.9%, the Korean Kospi index rose 0.3% to a five-month high, and the Indian Sensex index firmed 0.7% to a new record high (the central bank cut the liquidity ratio for banks today), but China was flat (though the H-shares spiked 1.2%) and Australia and Singapore were in the red column. Overall, the Asia-Pac region closed higher to its best level in seven months today, with eight of 10 industry groupings in the green column.

There is some relief stemming from the latest data-flow out of China showing the slowdown turning to growth stability — the non- manufacturing PMI rose to 55.5 in May from 54.8 in April, as an example (and follows the news that the official manufacturing PMI edged up to a five-month high of 50.8 in May). As such, the hedge funds are now reportedly closing their short bets on Emerging Market equities (as per Bears Pull Out of Emerging Markets Amid Four-Month Gain in today’s Bloomberg News).

Core sovereign bond markets are stable — not benefitting from the slippage in euro area equities — even though we got news that inflation in the Eurozone slipped last month to a five-year low of +0.5% from +0.7% in April (consensus was +0.6%). The core rate plunged from +0.9% to a shockingly low +0.6% rate.

U.K. gilt yields have actually jumped four basis points to 2.65% — and now trade about a full 10 basis points above comparable U.S. Treasuries — on reports that U.K. home prices are spiraling upwards as per the just-released Nationwide data for May: +0.7% MoM and +11.2% on a YoY basis to record-high levels (not even the U.S. is close to that just yet) in what is the hottest real estate market since the bubble peak of June 2007 (Mark Carney left one housing bubble in Canada to help create another one in Britain). Sterling is rallying on this news — can a 0.5% policy rate really be sustained in this asset inflation backdrop?

The challenge for the ECB is how to take the edge off a still-overvalued euro — it is already down about four full figures on the ‘talk’, but at 1.36 versus the U.S. dollar it still has at least 15 figures to go the downside just to hit its fair-value line (this will need a Draghi ‘walk’ which would finally quash the deflation pressure … this worked in Japan and Canada, as an aside). The fact that the euro has just broken below its 200-day moving average for the first time in ten months — now at a three-month low against the greenback — is a step in the right direction and the fact that the 50-day moving average is rolling over provides added technical confirmation that the euro is on the down-escalator for some time to come.

Not all is lost, however, as German new car registrations were just released and showed a decent +5.2% YoY growth rate; and the euro area jobless rate fell to 11.7% on April from 11.8% and 12% a year ago, which may be painfully slow progress but at the same time at the lowest level since November 2012 (5.2% in Germany but 10.4% in France, 12.6% in Italy and 25.2% in Spain so the divergences are super-wide).

The Reserve Bank of Australia was among the first of several central banks to hold a policy meeting today, leaving rates on hold and signaling a completely neutral stance going forward. The Bank of Canada meets tomorrow and likely to do much the same.

Yesterday’s ISM manufacturing index finally came in at a respectable 55.4 reading — the high-water mark for the year and the fourth straight increase. In the past, this level was consistent with 4% annualized real GDP growth, a rate that Q2 seems on track to meet (the Markit estimate was sitting even prettier at 56.4, a three-month high). Of the 18 industries responding, 17 reported expanding factory activity and just one said conditions were flat — so it’s not just the depth but the breadth of the report that was impressive.

The ISM prices-paid index moved further out of disinflation terrain, rising to a three-month high of 60 in May from 56.5 in April. For every company seeing declines in input costs, three are seeing increases. That is either a margin squeeze, a source of cost-push inflation, or both. The “nominal” ISM that takes into account both volumes and pricing, hit its best level in four years last month. Something for the growth bears and bond bulls to possibly consider.

Bonds have benefitted of late from massive short covering, portfolio rebalancing after last year’s huge S&P 500-Treasury relative return gap, the nouveau talk of a lower post-crisis “terminal” Fed funds rate and huge institutional investor appetite for duration for pure liability matching purposes — powerful fund flow sources of strength for the bond market. But I simply cannot see the economic case for an ongoing rally in U.S. Treasuries from here.

The first quarter GDP setback was clearly the outlier, influenced by one- off effects from the severe weather, an auto inventory unwind, the end to emergency jobless benefits and the new mortgage qualification rules. These shocks, in terms of influencing incremental growth rates, are over. Few pundits mention that total labor input, measured by aggregate hours worked, rose at a 2% annual rate in Q1. Dow Transports meanwhile, have made gains in seven of the past eight sessions, are at a record high and up 30% from year-ago levels, and are signaling better economic times ahead. The recent decline in mortgage rates is a much- welcome source of relief for the homebuilders.

Don’t see wage inflation? Well, we shall see whether Seattle turns to be a leading indicator because the city council there just unanimously voted in a $15 per hour minimum wage. That is a 60% hike. It will be interesting to see if the price of that Big Mac and grande latte stay where they are (if you’re a Fed dove, not to worry, these don’t affect the ‘core’) — have a look at Seattle Approves $15 Minimum Wage, Setting a New Standard for Big Cities on page A15 of today’s NYT. U.S. consumer spending power is coming back too — Gallup’s survey for May showed that shoppers’ average daily spending jumped $10 to $98 — the highest this has been in six years.

Back to bonds for a second. Interestingly, Larry Kudlow pens a column on page A13 of the Investor’s Business Daily titled Bernanke’s Bullish Bravado and concludes that “we’relooking at 1950s-style interest rates and we may be looking at this for a long time”.Indeed, what is not commonly

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