Chemical Activity Indicates More Growth; The Fed Follows Market Rates

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“Davidson” submits:

The Chemical Activity Barometer (CAB) reaches a new high for the current economic cycle at 100.6. The previous high was 101.1 in May 2007-see chart.  As a measure of economic activity the CAB has been quite effective. While market prices are driven by the market psychology at the moment, the CAB is very good at helping investors visualize that markets follow economics over the long term. The recent acceleration in the CAB has been duplicated in the leading employment indicators, i.e. BLS Job Openings and The Conference Board Help Wanted Online indicators. An extract from today’s CAB report and link are below.

 

http://www.americanchemistry.com/Jobs/CAB#

“WASHINGTON (June 23, 2015) – The Chemical Activity Barometer (CAB), a leading economic indicator created by the American Chemistry Council (ACC), increased by 0.7 percent in June, followed by a similar gain in May, and an upwardly revised 0.5 percent gain in April. The pattern represents an acceleration of productivity not seen since the first quarter of 2011. Data is measured on a measured on a three-month moving average (3MMA). Accounting for adjustments, the CAB remains up 3.7 percent over this time last year, also an acceleration of annual growth as compared to the first half of 2015.”

Chemical Activity
Chemical Activity

While nothing lets us predict market prices with precision, indicators which reflect continued economic expansion have lead historically to higher equity prices. It is reasonable to expect the same this economic cycle in my opinion.

 

At this point in the investment cycle having already experienced rapid recoveries in Emerging Market, SmCap and REIT issues, the Reward/Risk favors a focus on US&Intl LgCap and Natural Resource assets. Fixed Income exposure should be kept to very short maturities with the lone exception being those fixed income investments which track the economy/SP500. Contact me for additional details.

 

Rate Hike or No Rate Hike? That is the question in every analyst presentation today!!

 

The belief that the Fed controls interest rates is so pervasive that markets shift on every nuance of every Fed Govenor relating to rates. But, history, as I have repeated many times, does not support this belief. History shows that the Fed has almost always followed T-Bill rates with up to a 6mo delay keeping Fed Funds higher. It is the market which historically has been the rate setter with the Fed following this lead. What the current Fed does is not an easy call. It is the current Fed under Bernanke and now Yellen which implemented Quantitative Easing(QE) and Operation Twist(OT) in an effort to lower mortgage rates believing that this would spur the housing market. The evidence is quite clear that this has been the slowest housing recovery in history. Low mortgage rates have resulted in tighter credit and a very slow recovery in housing. My observations lead me to believe that the Fed does not understand the results of their actions. Low mortgage rates mean lending institutions cannot finance new homebuyers as has been the historical pattern. Low rates do let lending institutions cover the necessary reserves required in case some new homebuyers default. This leaves lending mostly to those who already are Prime Borrowers. The majority of homebuyers are not Prime Borrowers. The Fed being the regulator of most lending institutions should get this, but surprisingly this point seems to have been missed.

 

If the Fed does act to raise Fed Funds rate before there has been a market driven rise in T-Bill rates, it will be a first. It will likely force 10yr Treasury rates to rise sharply. Since mortgage rates historically are priced 160bps (1.6%) higher than the 10yr Treasury, we should see mortgage rates to rise fairly rapidly to 5%+. If the spread between T-Bills vs. 10yr Treas widens, we should see broader mortgage lending and a more robust housing market which is in directly opposite to the consensus view.

 

No matter what the Fed does this time, lending spreads need to widen to spur the housing market. Equity markets, even though we may see a short period of nervousness associated with a Fed Funds hike, should continue to move with economic activity.

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