Global Economy – Investing In The Eye Of The Storm by Worth Wray STA Wealth Management
On Friday, we saw headline U.S. Retail sales surged 1.3% to give us the strongest reading in nearly two years.
A CNBC article entitled “US April Retail Sales Post Largest Gain in a Year” went on to say, “U.S. retail sales surged, suggesting the economy was regaining momentum after growth almost stalled in the first quarter”.
ValueWalk's Raul Panganiban interviews Joseph Cioffi, Author of Credit Chronometer and Partner at Davis + Gilbert where he is Chair of the Insolvency, Creditor’s Rights & Financial Products Practice Group. In the interview, we discuss the findings of the 3rd Annual report. Q2 2021 hedge fund letters, conferences and more The following is a computer Read More
The stock market did not seem to care. In fact, the worst performing sector on Friday was the sector that one would have thought should have benefited most from Friday’s data flow – the Consumer Discretionary sector which lost 1.4% on Friday; Wal-Mart alone was off 2.9% per share. So why the negative market reaction to seemingly good consumer news?
Investors seemingly bought more into the downbeat consumer views stemming from dismal earnings performances and forecast cutbacks coming from the likes of Macy’s, Kohl’s, Nordstrom, and J.C. Penney (to name a few). Collectively, their revenue numbers left something to be desired. Revenue for these four companies came in at $15.8 billion for the quarter. Unfortunately, this was 2.9% below expectations and 3.8% below last year’s levels. The department store stock index was down 16% last week, and in some sense, this was reflected in the retail sales data insofar as the strength was centered in online activity. Online retailers’ sales are up 10.2% YoY while department store sales have edged up only 1.7%.
Hard to imagine a week that saw such a great sales report from the U.S. Commerce Department would also see Macy’s stock price hit a four –year low and Kohl’s dive to a seven year low.
Is the consumer back? A further analysis suggests caution instead of optimism. The reason is seasonal adjustments. The seasonally adjusted number in the headlines suggests retail sales jumped an admirable $5.6 billion in April. However, the real (seasonally unadjusted) number shows a decline of $9.2 billion.
We still find the market expensively priced. One report, Shiller’s Cyclically Adjusted Price to Earnings (CAPE), finds stocks have only traded at more expensive levels 6% of the time throughout history. We certainly are not at the highest CAPE levels, but the air is getting a bit thin at these lofty levels.
This isn’t a good timing indicator, but it does point to the market’s vulnerability to outside events.
Overall our leading indicators have deteriorated from their strong February readings. We have previously suggested lowering equity levels where appropriate. Without the largess of the Fed’s Quantitative Easing program, stocks are beginning to trade on their individual merits.
The Market is Seeking Direction
The S&P 500 is now down three weeks in a row and down 2.2% over this period – bringing the year-to-date performance to roughly flat and marking the longest weekly losing streak since mid-January.
It has been a year since the S&P 500 made a new high and it is no higher today than it was in November 2014. Utilities and Consumer Staples stocks have taken on a leadership role, which is the stock market’s way of predicting a lingering stuck-in-the-mud economic backdrop.
This also reflects the ongoing thirst for yield in a world starved for it due to the lack of supply of stable income flows. Not only is 20% of the world’s sovereign bond market trading below zero, but even within the confines of the equity market, dividend cuts in the face of eroding profit growth are quickly becoming the norm – there have been 213 such cuts in total for the first four months of the year, up from 169 a year ago and the most in seven years.
Global Economy – Investing In The Eye Of The Storm
- Though central banks have bought some time and pulled the global economy back from the brink of an earthshaking crisis over the last several months, the fragile ceasefire between central banks is a fundamentally unstable situation that can easily collapse into chaos.
- While the trade weighted US dollar needs to stay in a reasonable range to balance global economic growth and revive inflation in our highly leveraged, highly interconnected world, I see a number of risks in China, Japan, Europe, and the United States that could easily blow the dollar out of bounds.
- I’m not saying that global markets are going to collapse in the next few weeks or even the next few months, but – in the absence of aggressive international monetary reform or a global infrastructure boom – everything I know about game theory and global macroeconomics suggests that we are still in the eye of the strong dollar hurricane.
- While the storm may be back upon us before the year is through, investors still have time to reassess their portfolios, diversify their risks away from richly-valued US equities, and buy some additional insurance in the form of managed futures, gold, and long-dated US Treasury bonds.
If you could buy insurance in the eye of a hurricane, would you?
hat’s been the central theme in our STA Investment Committee meetings in recent weeks and it’s something I think every investor needs to consider at this point in the global business cycle.
As you may know, I’ve spent the last few years warning about a powerful series of shifts in the world economy and financial markets:
- The insidious, bubble-blowing effect of ultra-low interest rates & quantitative easing
- Fed tapering/tightening, the policy divergence among the world’s most important central banks (namely the Fed, the European Central Bank, and the Bank of Japan), and the resulting rise in the US dollar
- China’s economic slowdown and the high probability of an earthshaking RMB shock
- A collapse in oil and other commodity prices as a function of oversupply and weakening global demand
- An investor exodus from emerging markets & the vicious slide in their currencies
- A violent blow-out in credit spreads and resulting wave of corporate bankruptcies
- And the growing risk of contagion in our highly leveraged, highly interconnected global financial system
Thus far, all but one of these risks have come to fruition… although not necessarily to climax.
The dollar has melted up as commodity prices and emerging market assets have melted down. China’s slowdown has shaken the world. And global corporate defaults are piling higher than any time since 2009 just as the world’s largest economies flirt with recession.
Over the last two years, global markets sold off in violent and synchronous fashion on two occasions: (i) once in August 2015 when the People’s Bank of China “reformed” its currency peg ahead of the Fed’s expected September interest rate hike, (ii) and again in January 2016 after the Fed followed through with its first rate hike a month earlier, geopolitical tensions began to flare with global oil prices falling below $27 per barrel, and China started to lose control of capital outflows.
Precisely as I outlined in my 2015 outlook (“On the Verge of a Disaster… or a Miracle”), the world economy was reaching a breaking point as all these forces came together like a Category 5 hurricane crashing into the Louisiana coastline.
But just when it looked like we were heading into a global financial crisis, a global recession, and maybe even a 1930s-style trade war, the storm clouds unexpectedly began to part.
As I’ve been writing for the last couple months (“Did Central Banks Just Save the World?” & “You Can’t Blame Them for Trying”), it’s now pretty obvious that policy elites from the United States, China, Europe, and Japan struck some kind of a deal at the end of February when they met on the sidelines of the G-20 gathering in Shanghai.
Perhaps China threatened to free-float the RMB and unleash hell if major central banks continued to drive the US dollar higher. Maybe Beijing pleaded for an opportunity to mobilize a massive stimulus effort and get back in control of its slowing economy.
We still don’t know all the details; but since this “Shanghai Accord” came into play in late February, we’ve seen a distinct shift in central bank behavior that has effectively taken the wind out of the US dollar’s sails, fueled a recovery in crude oil and other commodity markets, and supported a reflation in stillfragile emerging market assets.
Of course, blue skies can be deceiving when a hurricane is blowing through.
Though central banks have bought some time and pulled the global economy back from the brink, it’s a fundamentally unstable situation that can easily collapse into chaos.
There’s basically a reasonable range for the greenback in our highly leveraged, highly interconnected world which can balance global economic growth and revive inflation to some extent.
Any movements above or below that goldilocks range start to expose system-wide risks; and I see a number of risks in China, Japan, Europe, and the United States that could easily blow the dollar out of bounds.
For starters, the latest round of data from the People’s Republic of China shows that credit growth is losing its effectiveness in the world’s second largest economy and suggests Beijing may be forced to free float its currency sooner rather than later.
While industrial production, retail sales, and fixed asset investment all fell short of expectations in April, this chart from GaveKal Capital says it all.
The largest rise in government-led investment since 2009 – together with the largest burst in month-over-month credit growth since 2009 – is barely offsetting the ongoing private sector decline.
Moreover, it appears that Beijing knows the juice is no longer worth the squeeze.
After pushing more than $1 trillion into the system during the first quarter, the latest total social financing numbers show economy-wide credit growth falling abruptly in April.
This comes as both good news and bad news for the global economy.
The good news is that Beijing may have finally realized that massive credit growth against the backdrop of dismal capacity utilization only exacerbates its problems with almost zero short-term payoff.
The bad news is that China’s economic slowdown may start to pick-up steam in the coming months as Beijing grapples with the social, political, and financial fallout of its unprecedented credit bubble and “deliquified” banking system.
It’s from that shaky foundation that Beijing continues to dictate terms to the rest of the world by allowing its currency to fall every time the US dollar moves even modestly higher.
On that front, we’ve been watching two troubling developments around China’s currency over the last few weeks.
First, the RMB has been broadly weakening versus the US dollar in both the market-driven offshore yuan (CNH) and the government-controlled onshore-yuan (CNY) markets.
Second, the spread between the USD/CNH exchange rate and the USD/CNY exchange rate has been widening, suggesting that depreciation expectations are growing once again.
If these trends continue, it could easily spark another violent sell-off in global financial markets as we saw in both August 2015 and January 2016.
While the path to a June rate hike looks relatively clear today with oil prices trading just shy of $50 per barrel and consumer inflation set to reach 2% by the end of the year if crude remains above $45 per barrel…
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