2016/09/07 Commentary: Goldie’s Back!
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COMMENTARY (Non-Video): Wednesday, September 7, 2016
Goldie’s Back!
What a ‘beautiful’ US Employment report for the US equities bulls, just like the metaphorical beauty of Goldilocks in the fable. There was reason for some trepidation on the part of the equities bulls coming into Friday’s US Employment report after a week of sharply divergent US and global economic data. Rather than review the full gamut of those influences, suffice to say Thursday’s much weaker than expected US Construction Spending and ISM Manufacturing Index (which unexpectedly dropped back below 50.0) were preceded by still firm US Income and Spending figures at the top of last week. And so it was for the offshore economic data as well everywhere from Asia across into Europe.
This made Friday’s US Employment report even more critical than usual after somewhat more hawkish missives from the Federal Reserve’s minions at the annual Jackson Hole Policy Symposium the previous Friday. And that even included the typically more dovish Chair Yellen. As such, there was real risk if last Friday’s Employment report’s major Nonfarm Payrolls (NFP) component was too strong it would encourage a Fed rate hike sooner than not after the previous two month’s job gains in the upper 200,000 area.
While it seemed less likely, the US equities bulls were also concerned about the potential for a real failure in this sometimes erratic data. Any weakness in the NFP back down to or below 100,000 job gains might raise concerns over the previous two strong numbers not being very reliable. There was also a matter of the previous two month’s Hourly Earnings improvement into the 0.30% area after being a restraint on the Fed throughout 2015 due to languishing in the 0.00%-0.20% range. Might any real strength there also encourage a more aggressive stance by already numerous Fed hawks that could weigh on equities?
Yet last Friday’s US Employment report was in fact neither too hot nor too cold, just like Goldie’s favorite Baby Bear porridge at the bear’s home. And that didn’t leave any home for the bears in the equity markets, as was apparent in the strong rally from the very moment the report was released. The NFP 151,000 gain was well below a 180,000 estimate. That seemed enough to cool off the Fed psychology while still leaving a 3-month 232,000 average jobs gain. And the bonus for the bulls was the monthly Hourly Earnings drop to just 0.10%, once again raising Fed-stifling concerns about the quality of the jobs.
In other words, this was about as perfect a US Employment report as the bulls could have imagined: Still strong enough to indicate continued growth, yet with enough weakness (like Manufacturing and Construction job losses as well) to restrain the Fed’s hawks.
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NOTE: Back on the evening of December 8th we posted our major Extended Perspective Commentary. That reviews a broad array of factors to consider Will 2016 be 2007 Redux? For many who believe that the US economy is really strengthening and can once again lead the rest of the world to more extensive recoveries, this may seem a bit odd.
Yet there are combined factors from many areas we have been focused on since the early part of last year which are less than constructive for the global economy and equity markets. We suggest a read if you have not done so already.
We pointed out in December in the face of another likely Santa Claus Rally this was not an actionable view during the year-end equities rally. Yet it was (and remains) important background to utilize into 2016. This is much like our major late 2006 perspective on Smooth Rebalancing? …or… The Crash of ‘07? In that instance the economic factors built up, but the actual crash was deferred into 2008. It is starting to feel this one may be deferred as well.
▪ The Fed’s ‘normalcy bias’ was back on clear display over the past several weeks. First there was a spate of somewhat improved data. That led to the predictably more hawkish Fed minions’ opinions at the Jackson Hole Policy Symposium two weeks ago, and in other venues. Yet, key data points in the wake of all that weakened enough to once again cast doubt on the Fed’s ability to raise rates. It is reminiscent of Ronald Reagan’s quip in his 1980 debate with Jimmy Carter (after Carter cited some oft-repeated social statistics)…
“There you go again.” And here was the Fed once again pushing the ‘normalcy bias’ on the improved economy needing further rate hikes, and being wrong-footed once again by the subsequent weaker data. This has been a regular cycle since the FOMC raised rates last December, and predicted there would be four more in 2016. The interesting permutation of this dynamic is not just that the equities go back to a “bad news is good news” psychology rally (on the expectation the Fed will not actually hike), but that the govvies also rally on the weak data.
The only instrument that doesn’t seem to like the weaker rates outlook is of course the US dollar. It has weakened against the other developed currencies (even weak sister British pound), and has surrendered a major portion of its recent significant (US rate hike anticipation) rally against emerging currencies as well.
As recent weak data is also apparent elsewhere, it leaves the global central bank accommodation ‘risk-on’ psychology in place. While this will likely continue to be a ‘hated’ equities rally in light of weakening fundamentals (especially corporate earnings and international trade), as long as central banks are willing to keep the liquidity flowing it will likely continue in the short-to-intermediate term.
▪ And just because the equities ‘risk-on’ central bank-driven rally may continue for now, it doesn’t mean we are dedicated bulls. There comes a time when the broader background factors point toward major risks, yet the sheer technical momentum and passingly acceptable economic influences keep the rally going. This is very similar to what transpired into the first half of 2007. In fact, after posting our concerns noted above in the late 2006 Smooth Rebalancing? …or… The Crash of ‘07?, we had to allow that the technical up trend remained intact.
We even warned folks involved in short-term trend positioning or those attempting to establish a more bearish portfolio view that there was only one thing to do while the rally maintained: Learn to love the bubble. While we had been counseling that through all of early 2007, it was important enough to spell out the specifics of the psychology in mid-June in a post accepted by the well-regarded Financial Times Lex column blog…
Learn to love the bubble. The link is to our marked-up iteration of it, and we hope you enjoy the read. In essence, it is about not getting ‘married’ to any psychology, no matter how reliable in recent history, that does not appear to be the sustainable path for the long term trend. While premature anticipation of a major trend reversal is a big mistake, it is important to consider what signals might reinforce the actual reversal of a longstanding trend.
As noted at the end of that post: (regarding participation in the highly distended up trend) “…one should enjoy it while it lasts, in the same way a young person comes to realize their current significant other may not be Mister or Miss Right, yet is a fantastic Mister or Miss Right Now.” Possibly a bit crass regarding interpersonal relationships, yet anyone with any experience knows that can be the way it is. And serious market participants have to realize when it is alright to still profit from a major trend even as doubts mount.
▪ And speaking of doubts mounting, we have noted for some time that the central banks cannot restore robust growth on their own. Even the additional boost from fiscal stimulus that governments can provide is not adequate to effect ‘structural’ growth. It is no surprise that this would require the sort of structural reform which we have noted for some time major developed economy governments seem incapable of providing.
That just this past week US Treasury Secretary Jack Lew was crowing about the US winning the ‘austerity’ versus ‘fiscal stimulus’ debate is more so troubling than encouraging. Without the necessary structural reforms neither the massive central bank accommodation nor occasional fiscal stimuli of the past seven years have managed to restore strong growth.
▪ The problems with this, and the degree to which central banks are not dealing with the distortions which ‘forced’ (necessary due to the lack of political action) accommodation policies have created, were reviewed last Friday by one of our very favorite financial observers: the Financial Times’ Gillian Tett. For those of you not familiar with Ms. Tett’s credentials, she is an anthropologist by training, and was the FT’s Credit Market analyst in the early part of this century.
She was also one of the most vocal critics of the major loosening of credit covenants and all of the other shenanigans that led to the 2008 Credit and Housing Bubble bursting. She was our favorite “canary in the coal mine” noting all of the underlying weakness that was developing. The difference is that the canary dies, and she lives to analyze another day. Her FT Comment page Finance observations in Friday’s Echoes of 2008 as danger signs are ignored (once again our marked-up version) is a must read.
We say this because of the well-considered tendency for the markets to rhyme rather than exactly repeat. Along that same line as generals always being fully prepared for the last war, central bankers now seem very much prepared for the last crisis. As such, in Ms. Tett’s view (and we concur) they are not paying enough attention to the variations on critical developments that are in part related to their own efforts.
They are instead back to debating their influence on the “real” economy (much like 2006), and less concerned about how the international finance landscape they have so significantly distorted might evolve into a new type of crisis. She does not provide any definitive answers. Yet her questions on the impact of negative interest rates, the Bank of Japan’s massive direct purchases of equities and other factors are worth a read. She questions why central bankers aren’t asking what that all means, and how to return to a real ‘normal’ instead being content with this very distorted ‘new normal’.
▪ As our regular readers know, we suspect that would require the central banks to become much more aggressive in their criticism of the political class’ failure to provide meaningful structural reform. While central banks are often criticized by politicians for the problems stemming from low or negative interest rates, central bankers outside of the ECB’s Mario Draghi rarely bite back.
He has noted that the if the politicians had structured the right growth policies, he would much rather be fighting inflation; and regularly requests more structural reform at the ECB post-rate decision press conferences. We expect to hear more of the same this Thursday. While many of the politicians are clueless on their role in the weakness of the global economic recovery, a few enlightened souls come to the rescue of the Fed and other central banks from time to time.
It is not surprising especially in the US Senate that folks like Robert Corker (who is also a very successful businessman), Patrick Toomey (a very successful currency trader prior to his political career) and Robert Menendez (a Democrat who has stood up to Barack Obama’s more outlandish positions) have defended the Fed. When Janet Yellen was under attack for low wage growth at her February testimony, they all (especially Sen. Corker) shared views that Congress and not the Fed was responsible to create conditions of greater productivity that facilitates higher wages, and it had failed.
And this somewhat isolated support for the central bank is not limited to the US. This past weekend’s FT Weekend’ Person in the News is German SPD (Social Democratic Party) leader Sigmar Gabriel. His current profile raising move is to challenge coalition partner Chancellor Merkel’s CDU on her refugee policy and the TTIP EU-US free trade agreement.
Yet he has also been critical in the past of the role of ECB in trying to stimulate the German and EU economy on its own instead of leaving that to the political class. It is clearly more so the responsibility of governments to deliver economic progress beyond what the central banks have done under emergency conditions.
We recall his previous view that we cited in our early Thursday, April 28th Commentary: Special Alert: Equities Critical. We referenced the April 21st Financial Times’ article on recent criticism titled Will the ECB fend off German criticism? To wit, “Sigmar Gabriel, the leader of the centre left SPD, said on Wednesday it was wrong to blame the ECB for Europe’s weak economy, blaming austerity policies instead. But he criticised the way the ECB had taken on the role of trying to stimulate growth, describing it as an ‘ersatz economy ministry.’”
▪ The bottom line in the wake of the Fed’s short-term disastrous experience after last December’s first hike in almost a decade remains obvious. As noted prior to the Jackson Hole Policy Symposium, the Fed’s appetite for actually raising rates further will remain ‘data dependent’. Ergo the extreme importance of last Friday’s somewhat weaker than expected US Employment report, and other weak US and international data since.
Extended Trend Assessment is available below.
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