Edge and Odds

The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

Edge and Odds

Invest with smart knowledge and objective odds

NEW$ & VIEW$ (8 JUNE 2016): The Complacent Fed;

THE COMPLACENT FED

During her Monday speech, while using the words “uncertain” and “uncertainties” 20 times, even qualifying “uncertainties” as “considerable” and “sizeable”, Mrs. Yellen concluded that she is seeing

good reasons to expect that the positive forces supporting employment growth and higher inflation will continue to outweigh the negative ones”

Yet, the Labor Market Conditions Index which uses her own 19 datasets peaked in October 2015, 7 months ago, turned negative in January and has been falling for the last 5 months.

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Difficult to find “positive forces supporting employment growth” on her own dashboard. These are conditions to ease, not to tighten.

Maybe the Fed’s own Beige Book gives her comfort since the June 1st Beige Book described the economy as expanding at a “modest or moderate” pace in 7 of the 12 districts, about the same as in recent editions. In general, optimism regarding the economic outlook far outweighed pessimism throughout the Beige Book, as it has for the past two years or so…

But LPL Financial Research offers its own analysis of the Beige Book:

We believe the Beige Book is best interpreted by measuring how the descriptors change over time. (…) To evaluate the sentiment behind the entire Beige
Book collage of data, we created our proprietary Beige Book Barometer (BBB). The Beige Book Barometer is a diffusion index that measures the number of times the word “strong” or its variations appear in the Beige Book less the number of times the word “weak“ or its variations appear. When the Beige Book Barometer is declining, it suggests that the economy is deteriorating.

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Here in 2016, although oil prices have rebounded more than 80% off the February 2016 lows, oil production has continued to fall, and the continued weakness in the oil patch has weighed on the overall barometer.

Pointing up However, most of the decline in the BBB since its 2015 peak has come in the non-energy-producing districts of the U.S., suggesting that there has been some spillover from lower oil prices and lower oil production to other parts of the economy.

Mrs. Yellen must know that her staff is positively biased:

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Why the focus on tightening? Samuel Rines, Senior Economist and Portfolio Strategist at Avalon Advisors in Houston, TX​. shares his views on that:

Why the Fed Needs to Make a Policy Error

(…) By so consistently telegraphing interest-rate hikes, the Fed has backed itself into a corner. It may be a policy error to continue raising rates at this point, but backing away from higher rates could spark a crisis of confidence, which would be even worse. The Fed is setting up to commit a policy error, and an error may be the best possible outcome now. (…)

Fed presidents frequently reiterate the primacy of data dependency in their policy-determination process, while emphasizing the lack of a preset course for future policy. But the language is typically unidirectional—always focused on what data are needed to justify a rate hike. No one talks about what would constitute evidence for a reversal. And this creates complications for the Fed’s ability to prudently conduct both present and future monetary policy. (…)

The reasoning to normalize policy is more that “it must be done” than that “it needs to be done.”

The logic as to why the Fed must remain on a tightening path is that it cannot afford to lose credibility. More accurately, it cannot afford to lose credibility in that way. By committing the policy error of misreading the economy, and significantly slowing an economic expansion, the Fed risks less credibility than it would by backtracking on it policy path. The Fed must maintain faith in the execution of its commitments and policies. (…)

Unconventional policy relies heavily on Fed credibility. Credibility allows the Fed to commit to achieving a certain outcome, and have markets believe it will happen. (…)

At the pace of the Fed’s own dot plot, interest rates will rise on a trajectory that almost guarantees an error. But it is an error the Fed needs to commit. Regardless of whether the policies are good or bad, the Fed cannot risk its credibility—credibility is critical to the efficacy of the tools it will use in the next downturn. The Fed must commit an error.

Weak Productivity, Rising Wages Putting Pressure on U.S. Companies U.S. companies are facing a toxic combination of dismal productivity growth, accelerating wages and sluggish demand, raising the risk they will slow hiring, cut spending further and weaken an already-fragile economy.

Labor productivity, or the amount of goods and services employees produce per hour worked, fell at a 0.6% annual rate in the first quarter, the Labor Department said Tuesday. (…)

Hourly compensation, encompassing everything from salaries to retirement benefits and health care costs, surged at a 3.9% annual rate in the first quarter, Tuesday’s report showed. It rose 3.7% over the past year, marking the biggest annual gain in two years. (…)

When wage compensation outruns productivity, the result is an acceleration in labor costs per unit of output. In the first quarter, those costs rose 4.5% at a yearly rate and 3% from a year earlier. If companies can’t boost productivity, they must either absorb the costs in their profit margins or raise prices.

Corporate profits are being squeezed as a result, and the worry is that companies will slow hiring and further slash spending.

A different worry for the Fed is that firms will react to higher labor costs by raising prices, pushing inflation above the central bank’s 2% target. (…)

  large image (Haver Analytics) 

U.S. Consumer Credit Increased at 4.49% Pace in April

Outstanding consumer credit, a measure of nonmortgage debt, rose by a seasonally adjusted $13.42 billion in April from the prior month, the Federal Reserve said Tuesday. The 4.49% seasonally adjusted annual growth rate is a slowdown from March’s downwardly revised 9.57% pace.

Revolving credit outstanding, mostly credit cards, rose at a 2.08% annual pace in April, the slowest pace since January. That is a steep drop-off from a downwardly revised rate of 13.34% in March, its fastest pace since February 2001.

Nonrevolving credit outstanding, including student and auto loans, rose at a 5.35% annual pace in April compared with March’s downwardly revised 8.22% growth rate. (…)

large image(Haver Analytics)

Household Spending Spurs Eurozone Growth

(…) The European Union’s statistics agency said the combined gross domestic products of the eurozone’s 19 members was 0.6% higher in the first quarter than in the final three months of 2015, and 1.7% higher than the first three months of last year. Eurostat had previously estimated that the economy grew by 0.5% on the quarter, and 1.5% on the year. On an annualized basis, the economy grew by 2.2%.

Eurostat also raised its growth estimate for the fourth quarter of last year, and now calculates that GDP increased by 0.4% on the quarter and 1.7% on the year, having previously estimated growth at 0.3% and 1.6% respectively. (…)

The pickup in growth during the first quarter was driven by an increase in household spending, which was up 0.6% from the final three months of 2015, doubling its growth rate in that latter period and recording its fastest expansion since the final quarter of 2014.

Rising government and investment spending also contributed to growth, while weaker export growth was a drag on the recovery. (…)

  • Low Yields Go Lower in Europe Yields on the 10-year government debt of Germany and the U.K. fell to all-time lows, a stark demonstration of the modern era of scant inflation, weak growth and outsize monetary policy.
China central bank holds line on growth forecast but sees more pain to come

China’s central bank slashed its forecast for exports on Wednesday, predicting a second straight annual fall in shipments, but said the economy will still grow 6.8 percent this year.

The People’s Bank of China (PBOC) also warned in its mid-year work report that the government’s push to reduce debt levels and overcapacity could increase bond default risks and make it more difficult for companies to raise funds. (…)

The report was released shortly after monthly data showed China’s exports fell an annual 4.1 percent in May, more than expected and the 10th decline in the past 12 months.

Imports were more encouraging, declining only marginally and much less than expected, pointing to improving domestic demand and adding to views that the economy may be slowly stabilising. Preliminary commodity trade data showed sharp rises in imports of copper and iron ores.

However, some economists cautioned that imports from Hong Kong may have once again been inflated by fake trade invoicing to disguise speculation on the yuan, which came under renewed depreciation pressure last month as the U.S. dollar surged. (…)

Despite cutting its forecast for exports to minus 1 percent from growth of 3.1 percent, the PBOC saw a domestic recovery remaining on track.

It upgraded its forecast for fixed-asset investment growth to 11 percent, an increase of 0.2 percentage points from estimates it made late last year. (…)

World Bank Cuts Growth Outlook The World Bank cut its forecast for this year’s growth of the global economy, citing troubles in developed and developing nations alike.

The bank’s latest projection pegs global growth at 2.4%, down from the 2.9% forecast in January and slower than last year’s weak pace. The bank also cut its forecast for growth in 2017 to 2.8% from 3.1%.

“The global outlook faces pronounced risks of another stretch of muted growth,” said World Bank chief economist Kaushik Basu. “A wide range of risks threaten to derail the recovery.”

Commodity exporters such as Brazil, Russia, Nigeria and Angola suffered some of the largest downward revisions. Governments have been forced to cut spending due to the price collapse in metals, energy and other commodities.Weakening currencies also are forcing central banks to raise interest rates to curb rampant inflation. And higher borrowing costs are weighing on investment and putting many company balance sheets deep into the red.

The bank pared its projections for the world’s largest economy, the U.S. A wounded energy sector, strong dollar and anemic international demand contributed to a 0.8-percentage-point cut in growth expectations—to 1.9%—for the year. (…)

Policy makers’ room to maneuver is shrinking. Although debt levels have moderated in many advanced economies, central banks are starting to run out of monetary-policy options. And politicians are reluctant to use government balance sheets to fund major injections of stimulus.

Options are even fewer among emerging-market exporters. Debt levels are rising, budget deficits are deepening and central banks are having to raise rates instead of cutting them to temper rising prices as their currencies weaken. Those countries, such as Angola, Kazakhstan, Malaysia, South Africa and Venezuela, are running average budget deficits of 5% of gross domestic product.

One major indicator of global weakness—trade growth—remains muted at 3.1%, well below precrisis trends. (…)

One bright note in the outlook: Emerging-market importers aren’t suffering the same downturn as exporters. In countries such as India, Hungary, Thailand and Vietnam, government deficits are actually lower than the bank forecast two years ago and debt levels as a share of economic output are falling. 

OECD lead indicator flags first signs of growth stabilization

Signs are emerging that a downturn in the United States and China, the world’s two biggest economies, may have bottomed out, the OECD’s monthly leading indicator showed on Wednesday.

The Paris-based Organisation for Economic Cooperation and Development said its leading indicator (CLI) for the United States improved to 98.95 in April from 98.93 in March, the first increase in the reading since July 2014.

The index for China rose to 98.41 in April from 98.38 in March, its second consecutive monthly increase. The reading fell below the 100 mark in October 2014.

The OECD said its indicators showed stable growth momentum in the euro zone as a whole, including Germany and France, while the reading for Britain pointed to easing growth.

The index for the euro zone fell to 100.38 in April from 100.42 in March but has been above its long-term average of 100 since October 2013.

The OECD was also positive on the outlook for Brazil and Russia, which have suffered from a sharp downturn driven by a collapse in commodities prices.

“Amongst major emerging economies, CLIs for Brazil and Russia confirm the signs of positive change in growth momentum flagged in last month’s assessment,” the OECD said.  image

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HAVE A GOOD SUMMER!

image(Bluehawk Wealth Management)

Chinese Jets Intercept U.S. Spy Plane Over East China Sea The U.S. says one of two Chinese J-10 fighters intercepting a U.S. Air Force reconnaissance plane on routine patrol Tuesday closed on it at an “unsafe excessive rate.”

NEW$ & VIEW$ (7 JUNE 2016)

Yellen: No Rate Rise Until Economic Outlook Clears Janet Yellen affirmed the Federal Reserve won’t be raising interest rates until new uncertainties about the economic outlook are resolved, echoing conclusions investors drew Friday after weak jobs data.

(…) Her comments represented a shift from less than two weeks ago, when she confidently said a strengthening economy meant the Fed likely would move rates up again in the “coming months.” She dropped that time frame reference Monday. (…)

Ms. Yellen also said a number of “considerable and unavoidable” uncertainties could affect the economic outlook and the path of interest rates, including sluggish global growth, weak business investment, low U.S. productivity growth and uncertainty about the outlook for inflation.

“The uncertainties are sizable, and progress toward our goals and, by implication, the appropriate stance of monetary policy will depend on how these uncertainties evolve,” she said. (…)

On an upbeat note, Ms. Yellen said she expects the economic expansion to continue, noting that overall the labor market’s progress has “been quite positive,” household incomes have been rising, the housing sector is strong and fiscal policy is now providing a boost to the economy, rather than a drag. (…)

“Speaking for myself, although the economy recently has been affected by a mix of countervailing forces, I see good reasons to expect that the positive forces supporting employment growth and higher inflation will continue to outweigh the negative ones,” she said.

(…) and then went on to list a number of reasons she thinks that is so, including the low level of weekly jobless claims and the recent step up in consumer spending.

What she didn’t do, however, is give even a hazy indication of when the Fed might again raise interest rates. This was in contrast to last month when she said it would be probably be appropriate to raise rates “in the coming months.” And it was in contrast to the minutes of the Fed’s April meeting, which repeatedly mentioned the possibility of raising rates at next week’s meeting. (…)

FYI, in her speech yesterday, Mrs Yellen used the word “uncertain” 15 times and “uncertainties” 5 times. Is this really dovish?

Pointing up The WSJ’s James Mackintosh writes an interesting piece today: You Know Almost Nothing About the Economy; Get Used to It

(…) The payrolls figures have a huge margin of error, are subject to big revisions, and offer little in the way of guidance to the future. The Bureau of Labor Statistics is 90% sure that its conclusion of 38,000 jobs created is right to within 115,000 jobs, and so lies somewhere in the range of a loss of 77,000 to the creation of 153,000 jobs.

(…) payrolls are subject to big revisions, averaging 43,000 in either direction since 2003 and occasionally, as in November of 2012 and 2014, adding more than 100,000 jobs to the initial report. It is possible the bad May figures could be revised away. (…)

The hardest thing to do is to accept the uncertainty. With error margins, revisions and the shifting structure of the economy, it isn’t only jobs figures that might mislead. Paul Donovan, global economist at UBS Investment Bank, points out that many survey measures have become less reliable as fewer consumers fill them in, although this doesn’t apply to the corporate payrolls survey. The rise of self-employment means even company data, though, are less representative than before. (…)

Not only don’t we know where the economy is going. We don’t even know where it is, and after revisions we frequently find we were wrong about where the economy was, too. (…)

Investors who give up their pretensions to know where the economy is going can find ways to construct sensible portfolios. The first is to focus on the one thing you do know: how much you paid. Buy low, and there’s more chance of being able to sell high. The second is scenario planning. While you can’t reliably forecast the economy, you can look at possible extreme outcomes and invest accordingly. The final one is diversification. It may not help much in a crisis, when everything moves together, but in the absence of any other information, a spread of assets and countries is the best alternative to perfect foresight.

This is not a paid advertisement for Bearnobull, although it is what I advocate:

  • Accept that we don’t know the future.
  • Understand where we are on valuations to be able to calculate potential upside vs downside (reward vs risk) based on fundamentals.
  • Monitor trends in economic data and investor sentiment.
  • Assess scenarios from the above.
  • Set investments on probabilities, emphasizing valuations over trends. It is not as bad to be wrong on trends when valuations are low then when they are high. Buying low brings time on your side.
  • Be disciplined and patient.

Regarding economic uncertainty, one way to live with volatile and unreliable data is to focus on trends rather than on specific data points. Another way is to focus on the more solid data sets. Markit’s PMI surveys are the best sources. The data come from corporate purchasing managers whose job it is to monitor and understand what’s going on upstream and downstream, i.e. at the client level (demand) and at the production level (supply). These guys specialize in trend analysis, their data is accurate (within the limits of a survey), timely and never revised. Markit does the same surveys on manufacturing and services across the world simultaneously every month, even providing flash estimates three-quarters of the way. This is why I post them dutifully.

What air freight volumes tell us about global trade

Shipping volume is often used to track global trade, but air freight levels are even more closely tied to global production levels, an International Air Transport Association analysis shows. A softening in world trade demand in early 2016 is echoed in air freight volumes during that period, IATA says.

Trains too as this Raymond James chart shows:

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And trucks (RJ):

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China warned on hostile business climate US officials and EU executives feel increasingly unwelcome

Foreign multinationals feel increasingly unwelcome in China, American officials and European business executives said on Tuesday, at the start of a second day of high-level Sino-US talks.

“Concerns about the business climate have grown in recent years, with foreign businesses confronting a more complex regulatory environment and questioning whether they are welcome in China,” Jack Lew, US Treasury secretary, said ahead of a meeting with senior US and Chinese business executives. (…)

Only 47 per cent of European businesses plan to expand their China operations, according to the chamber’s annual business confidence survey, down from 56 per cent last year and 86 per cent in 2013. (…)

It said 41 per cent of its members planned to cut costs in China, led by the car industry.

European executives from the car, chemicals, transport and logistics, and IT and telecoms sectors reported the highest level of overcapacity among the companies surveyed, as well as the largest decreases in revenue in 2015 compared with the year before. (…)

China is not about to seriously attack is excess capacity problem:

China’s Real Unemployment Rate Is Three Times Higher Than The Official Number

(…) based on a new report by Fathom Consulting, it appears that China is also dramatically misreporting what may be the one most critical for social stability metric, its unemployment rate, which when stripped away of the political propaganda, is more than three times greater than the officially reported rate.

According to Fathom, China’s underemployment Indicator has tripled to 12.9% since 2012 even while the official jobless rate has hovered near 4% for five years. (…)

BTW, Markit’s China PMI surveys have been documenting the negative employment trends in China for quite a while, first in manufacturing, lately also in services.