National Post (National Edition)
U.S. bulls might need a reality check
Recent rally belies major indicators
Well, the bulls certainly are emboldened, there isn’ t any doubt about that. And this confidence, bordering on hubris, is proving very difficult to break. We are back to good news being good news and bad news also treated as good news.
The major averages are enjoying their fastest start to any year since 1991 (which was still a recession year, folks).
Amazingly, the S&P 500, after this 11 per cent January-february surge, is now within 4.3 per cent of reclaiming the cycle (all-time) highs. Virtually every commentator is bullish both on the market and macro outlook.
Odds of a rate cut by yearend in the U.S. have almost vanished to two per cent from 22 per cent a week ago, while market-based rate hike probabilities rose from just over one per cent to 7.7 per cent — ostensibly owing to what has been construed as some economic cheerleading during Jay Powell’s congressional testimony last week.
Let’s revisit some of the factors underpinning the relentless rally this year in risk assets, a number of which came to further light this past week:
❚ Trade tensions with China were already thawing out but last week we did hear U.S. Trade Representative Robert Lighthizer say that the plan to raise tariffs from 10 per cent to 25 per cent was being postponed.
❚ There is more and more talk of Modern Monetary Theory and this has caused investors to start pricing in fresh rounds of fiscal reflation, financed by the Federal Reserve, no less. MMT really should stand for Magical Money Tree (whoever heard of such nonsense, and yet this “theory” is gaining more adherents, and investors love it).
❚ The corporate bond market is back open for business and spreads have tightened dramatically. The same is true in the EM debt space. Fear is back in the broom closet — and the investor stretch for yield is back in the kitchen.
❚ The near-20 per cent surge in the price of oil this year has been a big surprise, thanks to Saudi-led OPEC compliance on the production curbs. The correlation between WTI and the S&P 500 is positive to the tune of 90 per cent, so the rebound in crude has helped out a lot with respect to the newly-found optimism in the stock market.
❚ Earnings season was mixed and guidance poor overall but was not an unmitigated disaster. The bar was lowered enough for most companies to beat their beaten-down estimates.
❚ Everyone seems to have been emboldened by the Q4 real GDP data in the USA — a “solid” 2.6 per cent annual rate. I remember the days when a number like this was referred to as sluggish.
❚ The prevailing view in China is that the data are stabilizing and fiscal and monetary stimulus efforts are going to turn growth back into acceleration mode. And the equity market rally there might lead one to believe that this is indeed the case.
❚ There’s even some renewed enthusiasm in the euro area, which is brand spank- ing new. Even though Italy’s macro numbers have remained abysmal, confidence seems to have returned in both France and Germany.
While these factors may be encouraging the bulls, it is nevertheless amazing that we could have a situation this past week where investors positively re-rated the economic outlook and repriced the Federal Reserve for a renewed tightening in policy.
After all, the Citigroup economic surprise index for the United States deteriorated to minus 43.4, which is the weakest it has been since August 2017; and the global index sagged to minus 32.4, a level we last saw in June 2013, which only begged for more monetary easing.
The Atlanta Fed took its Q1 real GDP growth estimate to a microscopic +0.3 per cent annual rate and the New York Fed is down to +0.9 per cent. Even the usually bullish Macroeconomic Advisers cut its Q1 view to +1.2 per cent from an already puny +1.6 per cent the week before. Be that as it may, the consensus is adamant that this is all related to temporary factors like the weather, the government shutdown and trade/tariff tensions.
Even if true, the reality is that despite this broad consensus that the data softness is temporary, the numbers are coming in surprisingly weak. The economists knew that this so-called transitory malaise was going to result in a decline in the ISM purchasing managers’ index in February — but why did the index fall so hard from 56.6 to 54.2 rather than to 55.9 as was widely expected? Why are the numbers surprising so much to the downside? This was, after all, the worst ISM reading since November 2016. In the past six months the headline has receded 6.6 points, which has not happened since the credit rating downgrade in August 2011. Each of the past three recessions were presaged by such a dive, and the only other “head fake” was in 1995.
Then there was the consumer spending data for December — a 0.6 per cent slump in real terms doesn’t happen every day, that’s for sure (only one economist polled by Bloomberg was calling for such a decline). Friday’s data on personal consumption expenditures (PCE) was a telltale that, no, sorry, the retail sales plunge that month was not due to any hasty reporting flaws. And while the consensus was looking for a decline, the slump was twice as much as what was generally expected, and it was right was across the board. The government shutdown happened too late to have any perceptible impact. The weather that month was just fine. The mantra by the experts was how great the holiday shopping season was going. The stock market decline had little to do with it because the “wealth effect” on spending occurs with lags; it is not contemporaneous (I can’t believe how many times I’ve heard this as a reason).
The next question is whether Canada is acting as a leading indicator, too. After all, look at the similarities — tensions with China, a national leader under pressure, an early-year stock market boom, a central bank that has been pushed to the sidelines after a rate-hiking cycle, signs of deleveraging in the household sector, and the benefits of the recovery in oil prices. Canada may be small for a country, but it’s economy is bigger than California’s and being so well integrated with the United States, it may be serving up a wake-up call here (keeping in mind that California has been known to have been a leading indicator at times in the past as well).
So Americans should take note that their little brother north of the border saw real GDP growth throttle back to a mere +0.4 per cent annual rate in Q4, from +2 per cent in Q3 and +2.6 per cent in Q2 of last year. If not for an inventory boost, curiously at the same time as imports declined, the headline would have been much worse. Indeed, real final domestic demand contracted at a 1.5 per cent annual rate in Q4 and that followed a 0.5 per cent drop in Q3. Back-to-back declines in this metric, virtually all the time, are associated with official recessions.
The monthly series showed a 0.1 per cent GDP dip in December, and that sets the stage for another flat quarterly reading, at best, for Q1. One can kiss goodbye to the Bank of Canada’s efforts to keep market-based rate hike expectations alive (all the more so with core inflation still modestly below target), and to the early-year rally in the Canadian dollar as well.
The one thing Canada is showing us all is that: one, monetary policy does influence the economy with a lag ... this receives scant attention from U.S. economists; and two, ballyhooed infrastructure spending sounds great from a political “feel good” standpoint, but doesn’t do a very good job at affecting the business cycle (but won’t stop the big government spenders south of the border from clamouring for a big package financed by money printing out of the Fed). One final comment on the risk-on rally that has taken hold in the first two months of the year. I would hazard to say that if we hadn’t endured that Q4 meltdown, such a flashy rebound never would have occurred.
As things stand, the stock market is still more than four per cent off the highs and actually, despite all the euphoria of late, has really made no headway at all for the past fourteen months. It could be dangerous to extrapolate very good January-February stock market gains into the future, because if memory serves me correctly, the S&P in prior such years went on to post mediocre gains or outright declines in the ensuing ten months. I am thinking of 1987, 1988, 1993, 2004, 2011 and 2012 when I say that.
Word to the wise.
AS THINGS STAND, THE STOCK MARKET IS STILL MORE THAN FOUR PER CENT OFF THE HIGHS AND ACTUALLY, DESPITE ALL THE EUPHORIA OF LATE, HAS REALLY MADE NO HEADWAY AT ALL FOR THE PAST FOURTEEN MONTHS. — DAVID ROSENBERG, GLUSKIN SHEFF + ASSOCIATES INC.