The economic calendar is a big one, including the major employment reports and the ISM indexes. In normal times, this would be the theme. But these are not normal times. Fed Speakers will be on the trail with every casual utterance parsed by algorithms and traders. The debate over the most recent tariff announcement will grab headlines. And who knows what the next tweet might be?
The punditry will operate with advocacy in mind. Instead, we should all be asking:
Can investors make any sense out of the conflicting market messages?
Last Week Recap
In last week’s installment of WTWA, I said that a “sputtering economic engine” would be a big theme during the holiday-shortened week. That was pretty accurate, as was my comment that “any tweet or Pres. Trump’s visit to Japan might spark a trading move.”
The Story in One Chart
I always start my personal review of the week by looking at a great chart. This week I am featuring Jill Mislinski’s chart, which shows several key variables at a single glance.
The chart shows a decline of 2.6% on the week. The trading range of 3.2% is at the high end of recent weekly results. A key feature is the rebound from the low on Thursday and a continuation Friday morning. That rally did not last long. Our weekly Indicator Snapshot provides a handy history of both actual and implied volatility.
After the recent losing stretch for stocks, let’s also check out Jill’s history of drawdowns since the market low in 2009.
One cause of misleading messages is media coverage. Hannah Ritchie (Our World in Data) demonstrates this in Does the News Reflect What We Die From? This chart gives a hint but read the entire piece for more charts and analysis.
Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!
When relevant, I include expectations (E) and the prior reading (P).
New Deal Democrat’s high frequency indicators are an important part of our regular research. In his post this week he again reports an inconsistency between yield curve signals and the housing revival boost from lower interest rates. The long-term indicators remain positive, while short-term and nowcasts are about neutral. He remains concerned about the effects of tariff policies.
- Consumer confidence for May remained strong. The Conference Board Index registered 134.1 (E 130 and P 129.2). The University of Michigan Sentiment Index final for May came in at 100.0. Expectations were a touch higher at 101.5 and the prior reading was 97.2. Jill Mislinski provides an excellent chart of the long-term history.
- Personal income for April increased by 0.5%, better than expectations of 0.3% and March’s 0.1%. Brian Wesbury (First Trust) has the income and spending story, along with his analysis of the implications. Hint: Don’t look for a rate cut in the near future.
- Personal spending for April increase 0.3. While lower than the upwardly revised 1.1% for March, it beat expectations of 0.2%.
- Core PCE prices increased 0.2%. This is good news because it is the Fed’s favorite inflation indicator and remains in line with expectations.
- Hotel occupancy continues to increase. (Calculated Risk).
- Truck tonnage is bullish reports Scott Grannis. He also views this as a reliable indicator of underlying economic activity.
- Mortgage delinquencies continue to move lower, now the lowest since August of 2007. (Calculated Risk).
- Q2 earnings are being revised lower, but at a lower than average pace for this time of the quarter. (FactSet). It is typical for estimates to start out high and get revised lower.
- Home prices for March increased only 0.1% on the FHFA Index. This is down from February’s upwardly revised 0.4% gain and lower than expectations of 0.3%. These are monthly figures on repeat mortgage transactions. The Case-Shiller Index (seasonally adjusted YoY) was up only 2.7% versus the consensus of 2.9% and the February gain of 3.0%.
- The Justice Department is preparing for an antitrust investigation of Google (NASDAQ:GOOGL). CNBC.
- Pending home sales for April declined by 1.5% versus expectations for a gain of 1.0% and a March gain of 3.9%. Calculated Risk sees the current level as “somewhat reasonable” and less important than new home sales. Bill also notes that inventory is low.
- Mortgage applications declined 3.3% last week compared to a gain of 2.4% the week before. Applications are still running ahead of last year, as we can see by this chart.
The farm story gets worse. Planting is far behind schedule, and danger of missing crop insurance deadlines. The subsidies supposedly drawn from tariff receipts already exceed those levels yet are not enough.
The Week Ahead
We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.
The calendar is one of the biggest and features the most important monthly reports – employment from ADP (NASDAQ:ADP) and the BLS, and ISM manufacturing and non-manufacturing indexes. There is plenty of FedSpeak on tap, providing plenty of chances for a stray comment for an algorithm and trader feast. And of course, we have the ongoing tweet-filled news environment.
The economic calendar should be especially important at this juncture, and maybe it will.
Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.
Next Week’s Theme
There is so much chaos and so little wisdom. Everything you hear or read reflects a strong and growing bias. Pundits won’t try to help on this one, but investors must ask:
Can we find meaning in the contradictory signals?
We cannot find meaning with a sound factual background. Current policy from the Fed, the President, and from foreign leaders is all part of this background. What I write is not an opinion about the merits of the policies but a description of the consequences. At the very start of the “trade war” I warned that most people were in for a real-time economics lesson. I also observed that one could support these policies for long-range political reasons, but the price would be felt in immediate economic impact.
For reference, the original posture was that “trade wars are good, and easy to win.” The objective was to reduce trade imbalances, which were used as a measure of loss for the U.S. These Presidential tweets were from fifteen months ago. What has happened since?
- The costs to US consumers have become obvious. (Econofact).
- The employment gains did not follow.
- The effects on agriculture are large and growing. (See today’s “ugly” section).
- The trade war has spread beyond China. While Mexico was the news of the week, India is about to lose preferential status.
- The issues with China now involve actions against specific companies on both sides. First Huawei and now Beijing targets FedEx (NYSE:FDX) for “damaging the rights of Chinese clients.” (CNBC). Rare earth minerals will be another battleground.
- Corporate earnings are very sensitive to tariffs.
- The Mexico Tariffs have a widespread effect on US industry, workers, and consumers.
- Economic uncertainty is raising the bar for business investment.
- The Mexico tariffs may jeopardize other trade deals.
- China – based on the loss of credibility re: Mexico.
- USMCA is jeopardized according to GOP Senators. (POLITICO)
- Opposition is coming from every direction without any apparent effect – so far.
Please note that I have used a wide range of sources and viewpoints about the factual economic effects.
The Mixed Signals
There are many sources of market messages, but I will emphasize three: the bond market, technical analysis, and economic data.
The bond market is sending a signal via low long-term rates and the inverted yield curve. The New York Times is now giving this warning front-page treatment (Neil Irwin) as well as an explanation of what the market is telling us.
In a sense, economists may have been analyzing the trade war too narrowly, merely by calculating the cost of tariffs and where those costs may show up.
The potential long-lasting consequences are harder to model.
This is followed by a list of other possible worries that could justify a bearish world view. These arguments are familiar to market watchers, but this is reaching into the mainstream, where average investors live. Nearly everyone commenting on the bond market concludes that it is “screaming” for the Fed to reduce rates to avoid a recession. And even that might not be enough.
The technical signals of all flavors are flashing warnings. Whether you rely on moving averages, patterns like a head-and-shoulders, or Elliott Wave Theory, there is cause for alarm. We took up the technical case in this week’s Stock Exchange, illustrating several of these approaches. Reuters focuses on the Dow Jones Transportation Index, and the Dow Theory non-confirmation of the highs in the DJIA. MarketWatch highlighted Avi Gilburt’s Elliott Wave analysis including his colorful “trap door” description. And finally, our own trading models are showing a higher risk level leading us to reduce positions. (See the Quant Corner below).
The economic data tell a very different story. The level-headed David Templeton points out that There Are Some Positive Data Points. He specifically considers the retail sales prospects and the encouragingly negative sentiment. Brian Wesbury, who has been on target for the entire rally (including noting the FAS 157 change as the turning point) explains why US growth remains solid in the face of foreign slowness. He credits tax and regulatory changes. And as usual, check out another viewpoint from Tim Duy, our go-to expert on the Fed. Scott Grannis highlights the trucking economic strength while the stocks are giving a negative signal. And last but certainly not least, Mike Williams (NYSE:WMB) provides a history of the “fear trade” and subsequent market results.
The Mexico tariff news hit at a time of market fragility on the sentiment and technical fronts. Those considering the economy are dismissing the current data in favor of the trading of bonds and commodities.
The week ahead will be special. The Mexico policy shift has the most widespread opposition of any policy in the current Administration. The normal channels of party support, key states needed for the election, and important contributors would normally stimulate a shift in direction. That will be the most important guide to finding order in the chaos.
I’ll describe some of my own expectations in today’s Final Thought.
Quant Corner and Risk Analysis
I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update, featuring the Indicator Snapshot.
Long-term technical conditions remain bullish, but the short-term technical health has declined to the neutral level.
The Featured Sources:
Bob Dieli: Business cycle analysis via the “C Score”.
Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.
RecessionAlert: Strong quantitative indicators for both economic and market analysis.
Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis, especially the regular updates of the Big Four indicators used by the NBER recession dating committee.
Timothy Taylor reminds us of something we know – correlations do not imply causation. But that is not enough! What about when they are completely without meaning? He explains how this can easily happen and provides some entertaining examples with accompanying charts.
Of course, at the more serious level of academic research, these types of issues can still arise. Imagine that a researcher is trying to look at the effects of a particular large-scale program. The researcher has lots of
data to divide people up into groups: by age, work status, family status, geographic location, education, health, race/ethnicity, gender, religion, and more. The researcher also has lots of possible outcomes for these people: income, marriage or divorce, childbearing, health, employment, retirement, and others. If a researcher looks at all the possible subcategories, it will inevitably be true that this program will seem to have major effects in a certain group: for example, the program may be correlated with a big change in the divorce behavior of white people in the 35-54 age bracket with low levels of religious observance in the state of New York. But if you (or your computer program) scanned through literally thousands of subgroups and possible effects to find this specific correlation, it’s fair to assume that the correlation is just as meaningless as any of the examples presented by Vigen.
James Picerno monitors the nowcasts for Q2 GDP growth.
Insight for Traders
Our weekly “Stock Exchange” series took up the hot topic for traders: The technical warning of a major stock decline. We drew upon various experts to discuss the head-and-shoulders pattern, moving averages, and other topics. Our models provided some interesting stocks for discussion. Felix ranked the top choices in the Nasdaq 100 and Oscar the most liquid ETFs. Pulling it all together was our series editor, Blue Harbinger.
Insight for Investors
Investors should understand and embrace volatility. They should join my delight in a well-documented list of worries. As the worries are addressed or even resolved, the investor who looks beyond the obvious can collect handsomely.
The day-to-day market is reflecting this pattern:
- Algorithms have learned keywords and respond to the news or tweet language.
- Human traders pile on, perhaps taking the other side from the computers which are already cashing out.
- The punditry, charged with imposing meaning on chaos, exaggerates the effect of minor news.
- Mainstream media picks up these “reasons” as the story of the day, even if markets move modestly.
- Investors who are observing casually become unduly frightened by the scary news and volatility.
Best of the Week
If I had to recommend a single, must-read article for this week, it would be Prof. James Hamilton’s analysis of the yield curve. This is tougher to follow than the NYT version, but worth the effort to read it carefully. He begins with the spread between the 10-year and three-month rates.
The picture is pretty scary. But the graph invites us to conclude that a positive spread between long-term and short-term rates is the normal condition, and that it’s an unusual situation if the spread disappears. The historical experience is certainly consistent with that conclusion; the spread has averaged nearly 150 basis points since 1952. A positive average spread means that investors will usually earn a higher return by holding long-term bonds rather than short-term bonds, presumably as compensation for some kind of risk.
He then discusses the role of risk premia, emphasizing the history of inflation in the 70’s. Since the bigger risk now is deflation, there is more willingness to “sacrifice some expected return in order to have insurance against a deflationary shock.”
After some data analysis and helpful charts, he points out:
In fact, if you used only the most recent observations, the coefficient is actually negative. Taken literally, it means that when the yield curve inverts you’d actually expect faster GDP growth. However, the effect is completely insignificant statistically.
Another way to express this visually is to subtract the term premium from the spread, as is done in the graph below. This measure reached negative territory before each of the last 6 recessions. But we still have another 80 basis points to go before we get there this time around.
He does not conclude that things are different this time – just more nuanced.
Let me emphasize that I do not believe the negative coefficient in the most recent data, and I think it would be imprudent to completely dismiss the evidence from the first graph and the full-sample regression. The current flat slope of the yield curve may well signal slower growth during 2019. But it is not as clear and not as dire a signal as some analysts might have you believe.