Bi-Weekly Economic Review
Economic Reports Scorecard – 9/14/15 to 9/25/15
If you want a good explanation for why the Fed didn’t hike interest rates last week, just take a look at all the red in that chart. They might have cited international concerns but the reality is that the US economic data isn’t all that robust either. Okay, things aren’t as bad as they are in Brazil but unless there is a surge in economic activity in the last quarter of this year, 2015 growth will likely clock in even below the crummy 2 to 2.5% rate we’ve become accustomed to the last few years. No, it isn’t a recession and we are still growing but for Janet Yellen to be fretting about “full employment” with the economy performing this poorly is fairly ridiculous. That she’s guiding policy by a theory that has proven worthless again and again – the Phillips curve view of inflation – is disturbing on its own but she doesn’t even seem capable of interpreting the employment data within the concept of her chosen flawed theory. There may be a lot of reasons to hike interest rates but fear of a runaway boom that ignites inflation is not one of them. Not even close.
The data since the last update just confirms the trends we’ve been tracking all year. The manufacturing side of the economy is in contraction. That is confirmed by numerous regional Fed surveys, the industrial production numbers and durable goods orders. And that is despite a booming auto industry that continues to benefit from cheap financing. The service side of the economy, however, continues to expand and offset the weakness in manufacturing. Housing is also still in an uptrend although one that is frustratingly slow. Overall, growth is tracking at slightly less than 2%, a fragile situation that probably wouldn’t stand up to much of a shock.
Our main economic indicators show an economy that is experiencing a degree of stress but still advancing at a subdued pace. One of the main indicators – and causes – of stress is the dollar which has settled into a narrow range:
The broad dollar index has eased a bit as well but is still near its all time high. Gold, on the other hand, is offering a different view of the dollar recently. It started moving higher in late August and has traded in a bullish fashion since. A test of the 200 day MA appears imminent. The dollar remains fairly strong against other currencies but is starting to weaken against gold. Hint to Yellen: a weakening dollar is not a sign that the economy is booming.
Interestingly the Fed standing pat didn’t have any impact on inflation expectations:
The yield curve didn’t change much since the last update, still in the middle of its historic range providing little useful information.
Credit spreads resumed widening after moderating for a couple of weeks and are now over 6 and rising. Levels in excess of 7.5 for the HY index would probably put us very close to or in recession. In any case, spreads continue to be the indicator that worries us the most as they are inversely correlated with stock prices and highly so. The rate of change is frankly very concerning.
Momentum in markets continues to favor bonds. Over three and six month periods, bonds have outperformed stocks with Treasuries outperforming corporates. The Fed may think the economy is doing well enough to warrant a rate hike but the market disagrees. In fact, momentum has provided us with two recent buy signals that, if sustained to the end of the month, are fairly ominous for both the economy and stocks. Long term momentum is shifting to gold and Treasuries from stocks:
This momentum shift has economic as well as market implications. If investors are favoring gold and Treasury securities over more risky securities, that has an impact on the economy which may accelerate the momentum shift. Just as with credit spreads it may be that investor fears about recession create the very conditions that lead to recession. As investment capital is increasingly devoted to non productivity enhancing investments – gold and Treasuries – the economy suffers. We haven’t exactly had a boom in investment this cycle in any case so it may not take much of a pullback to have a big impact on the economy. It is still early in this trend though – and it can reverse – but it bears watching very closely. For now, I don’t have sufficient evidence to call for anything more than the slowdown we’re already tracking.
Note: I’ll be doing a Global Asset Allocation update in a couple of weeks but we shifted our allocation in early August before the recent stock market correction started. Our Momentum Asset Allocation portfolios also started shifting to bonds in early August. This Bi-Weekly Economic review is just one of several reports we produce each month. We consider these reports complementary (and complimentary) and they should be read consistently to get a feel for our process. You can access these reports here.