Thursday, March 3, 2016

Progress report on climbing

The main concern that markets are grappling with these days is the possibility that weakness in China and in the oil patch, coupled with escalating debt defaults, could conspire to produce another recession in the U.S. I've argued that these fears are probably overblown, that the U.S. economy is inherently resilient, that most of the damage so far has been contained to the oil patch, that financial markets are fundamentally healthy, and that therefore all it takes to alleviate the market's concerns is the absence of recession, which is the most likely outcome in any event. I don't expect strong growth, merely a continuation of the modest 2 - 2½% growth we've seen for the past 6-7 years. Here are a few charts which document the progress towards climbing the latest wall of worry:

As the chart above shows, the price of oil has jumped by one-third in the past three weeks. This takes a lot of pressure off the oil patch.

Higher oil prices have helped spreads on HY energy debt to narrow by almost 500 bps! This is a clear sign that panic is receding. 

A major contributing factor to the bounce in oil prices is the huge drop in the number of active drilling rigs in the U.S., which has plunged by 75% in the past 14 months. The cure for low oil prices is low oil prices, which have sent the message to producers to shut down production and exploration.

This same dynamic (supply and demand coming into balance) is playing out in the metals markets. The CRB Metals index (see above chart) is up 10% in the past two months. This suggests that the Chinese and global economies are not going down a black hole. Producers are cutting back and consumers are ramping up demand in response to lower prices. Markets work!

The service sector is also not going down a black hole. Although the readings from the ISM surveys show the service sector is relatively weak, it is still growing. The Business Activity index, shown above, bounced quite a bit from its January low, which suggests that sentiment (e.g., everyone's worried these days, but the worry index is going down of late) could be playing a role in the relatively weak readings. It's also the case that most of the weakness can be traced to the energy sector, which contributed an additional 25K layoffs last month, according to the Challenger survey of announced corporate layoffs.

Weekly claims for unemployment have probably fallen as much as they are going to. The recent uptick is minor, and likely reflects a final round of energy-sector layoffs. 

The ADP estimate of February private sector payrolls (blue line in the chart above) suggests that jobs growth continues at the rate which has prevailed for the past several years. No deterioration, no improvement. Steady as she goes may be boring, but it is good news when the market is worried about a recession.

 With the news coming in better than feared, the market has managed to rally.

But as the chart above suggests, there is still a lot of concern out there. Gold and TIPS prices have jumped as the world worries that central banks will try once more to goose their economies with more QE and negative interest rates.

With the bounce in oil prices, we've also seen a bounce in inflation expectations. Breakeven spreads on 5-yr TIPS have jumped almost 45 bps in the past three weeks. Now at 1.44%, they are a bit below their long-term average of 1.9%, but not seriously below. In essence, the threat of deflation has almost gone up in smoke, according to the bond market.


Benjamin Cole said...

Gold is funny. China's central bank is a major buyer of gold, as are buyers of jewelry in India and China---a market of 3 billion increasingly prosperous people.

Alain said...

Your the man scott! Love the positivity in your posts. It's nice. Plus it's backed by nice data as well. Always look forward to reading your blogs. Thank you for sharing your knowledge!

Johnny Bee Dawg said...

Excellent updates and succinct comments. I think it's a big deal that as the market tested its Jan 20 intraday lows on Feb 11, the Vix/10 yr ratio faded way below it's Jan 20 peak. Big divergence there set up this recent rally.

Meanwhile, all kinds of market indicators held their Jan 20 lows during the Feb test, further making a case for a far. The percent of stocks trading above 50 day and 200 day moving averages both held their Jan 20 lows, and have soared. Still waiting for the percent of equity funds in an uptrend to reach 50% to think we are coming out of the woods.

Interestingly, precious metals stocks have skyrocketed past every other sector in relative strength. From last place to first place. I hate being in those things, but the miners are up over 40% year to date. (With more to go.) Not sure what that is telling us, but can't help wishing it was some "normal" sector zooming up, instead, like Financials, Retailing, Autos, or Technology, etc.

William McKibbin said...

The good news about a Trump presidency would be that stiff tariffs on consumer electronics, oil, clothing, and automobiles will create vast opportunities for manufacturing and energy growth in the coming 30 years -- the recession that would ensue along with the concomitant trade wars would be survivable for those that work -- however, Social Security, Medicare, and Obamacare would not survive the savage cuts in government spending that would be required -- the US would suddenly have a new economy as a result of zero deficit spending and balanced trade, albeit less trade -- I tend to agree with Trump that trade that leads to a negative trade balance should be cancelled using tariffs to ensure balanced trade going forward in the 21st century -- long-term investors with a 30-40 year investment horizon would win big as manufacturing and energy are reborn in America -- sadly, retirees living on Social Security would have to rejoin the workforce in order to survive once entitlements were repealed -- we live in exciting times!

Scott Grannis said...

WMK: I completely disagree. What sense does it make for us to turn away cheap Chinese imports, in order to pay more for stuff produced in the US? Would your family be better off if you bought a car with a sticker price of $40K but gave the dealer $60K because you thought $40K was too cheap? Trade is a two-way street: if we buy more goods and services from the Chinese than they buy from us we have what is termed a "trade deficit." But—and this is the point most folks miss—that trade deficit is ALWAYS offset by a capital surplus. At the end of the day, the Chinese must spend the dollars they receive from us on something in the US, namely on stocks, bonds, or real estate. They must reinvest their trade surplus in the US. That's just simply double-entry accounting. We get cheap goods, they buy our stocks and bonds. There is absolutely nothing wrong with a trade surplus. In fact, it can be a great thing, because it means that foreigners are investing lots of money here.

And when foreigners decide to take their money back, just consider what happens: they have to sell their stocks, bonds, and real estate, and spend the proceeds on goods and services that they take home with them. You can't spend dollars in China.

Trade is a win-win for all parties. Of course, it can be very disruptive for some industries that can't compete. But overall, it is in our best interests as a country to have lots of free trade. That is one of the laws of economics that simply can't be repealed or refuted.

Frozen in the North said...


Considering WMK's past comments...maybe he was trying to be sarcastic?

Don't know but anyone who starts his comment with "The good news about Trump" 'got to be yanking your chain, don't you think?

Just saying -- Oh and happy Friday, and thanks for you positive thoughts.

Johnny Bee Dawg said...

And there is no way that a President Trump would convince Congress to vote for Smoot-Hawley tariffs. He would not really try. Trump is setting a posture for dealing with China. There is NO support for any such trade war in Congress or among Trump's advisors, despite how loud Meg Whitman squeals. Trump wants to set a "tough" tone with the new thugs who now run China. I think that's smart in a weird Trump way.

If a President Trump pressures China to stabilize their currency, the new leadership there may actually have to start treating their citizens better in order to stop the real reason for their capital flight.

Plus, the Chinese will be very respectful to The Donald once they hear the news about his weener. Not sure Hillary can beat him in that department, but you never know.

Johnny Bee Dawg said...

Aaaaand...Gold Miners are up almost 5% more this morning.

Lawyer in NJ said...

Meg Whitman has earned my respect.

steve said...

JBD, so you support Trump on the supposition that has MAIN platform idea will be blocked by congress. Brilliant.

Johnny Bee Dawg said...

Not at all. Trump's main platform, in my opinion is immigration reform and stopping terrorists from coming across our borders. That's my number one concern, and the main topic he talks about in his rallies. Next comes tax reform and ObamaCare reform. His website has great programs laid out for those. I couldn't care less about tariff bluster that will never occur. Not worth crying over.

After those, I'm leaning to Trump because he pulls in more Democrat voters than the other PUB candidates. And has been getting twice as many primary votes as Romney got. He's expanding the Party. Big tent.

Barack is the first Prez in US history to win a second term with less votes than he got the first term. Hillary's turnout has plummeted even from His weaker numbers, while Trump's turnout is surging.

I like that he wins at things. A Trump government will have my back in productivity and success. It will be America First. A Hillary government is out to hobble and punish me for succeeding while redistributing my wealth. She takes bribes from foreign governments.

I'm tired of the worst recovery in history, and don't want 8 more years of it. Im ready opportunity for everyone. Im ready for America's first CEO President, not another damn SENATOR with zero accomplishments. Trump actually gets things done. The others dont except for Kasich....who has no voyer appeal. Im tired of all the risk aversion caused by the misguided establishment ignoring and subverting the will of the people. Im ready to win again.

Lawyer in NJ said...

Trump's health care plan, or whatever you want it, doesn't protect against pre-existing conditions. That's that's just cruel. I'll stick with premium support and the individual mandate, similar to the plan the heritage foundation initially formulated. It was the Republican plan until Obama proposed it. It has slowed the rate of growth of healthcare costs, and increased coverage. Republicans should be taking credit for it rather than smearing it.

Trump is an isn't even well-rounded businessman; all he does is license his name. So unless the US wants to sell it's national monuments to corporate sponsors, he is uniquely unqualified to be president.

Lawyer in NJ said...

As far as the worst recovery in history, this is what the recovery from a financial crisis looks like. See Rogoff.

Lawyer in NJ said...

Let's also recall that many Republicans, like Paul Ryan, wanted the Fed to raise interest rates for years, warning of a debased dollar and runaway inflation. How did that call work out?

Benjamin Cole said...

I am so pro-business I make GOP'ers look like shrinking violets. No property zoning for example.

Trump? I love him for saying that Iraq was a 5 trillion dollar mistake.

Until the GOP recognizes errors, and also recognizes that the federal government will always spend more money in every department worthlessly, I cannot support anybody except Trump.

A non-PC topic: the US Naval Institute says stealth airplanes are not stealthy. No worries, the contractors and Congress will build them anyway.

Maybe Trump is better.

Johnny Bee Dawg said...

Heathcare costs have not slowed. Medical Care CPI is soaring. Some spending has actually stopped, though. People can't afford to have procedures under ObamaCare's combination of high premiums and high deductibles so they simply forego the needed care. Ask the working poor if their growth in healthcare costs has shrunk. And it gets worse when subsidies to insurers start to phase out in 2017.

Oh Lawyer, tell us of all those "recoveries from financial crisis" we've had that we can compare to.

This recovery is the worst in history because of high tax rates, redistributive policies, and onerous regulations. Too much government. Unconstitutional government has created massive risk aversion...the most weve seen since the Great Depression. That was another period of massive unConstitutional government, too. In other words, the Obama agenda is simply bad for prosperity. Sand in the gears. Low low GDP ever since DEMs took over Congress in 2006 election. Why take risks with a hostile government??

Ryan has nothing to do with monetary policy, fwiw.

Johnny Bee Dawg said...

Read the WSJ editorial today by Christopher Press...."Slammed By ObamaCare" find out about the LIE of slowing health costs. If this doesn't help people understand why our recovery is anemic, then nothing will.

Here's how it starts:

"This year my family joined millions of others whose health-insurance premium has become their biggest annual expense. More than our mortgage. More than our property taxes. More than our state income tax. More than our annual food or energy costs. With this year’s $194-a-month premium increase, I could roughly buy a Chevy Sonic or Ford Fiesta. Since 1999 our premiums are up 350%. Bad as this is, the story gets worse..."

Thanks, Obama.

Scott Grannis said...

JBD: it's even worse. If you didn't have a job, healthcare would be free. Obamacare is a boon for those who don't work or don't want to work, and a nightmare for those that do work.

Bob said...

Lawyer said: "As far as the worst recovery in history, this is what the recovery from a financial crisis looks like."

Just understand that the financial crises has it's root cause in government manipulation in the private sector. Don't blame fire for burning the forest, blame what starts the fire.

Scott Grannis said...

Re spending dollars in China: you can't spend dollars in China, but you can exchange dollars for yuan. But the person who gave you the yuan now has the dollars, and he or she can't spend them in China either. At the end of the day the dollars will be exchanged with someone who will then use them to buy something in the U.S.

All the dollars that "leave" the U.S. to purchase Chinese goods will, one way or another, find their way back to the U.S. where they will be spent on something. Our trade deficit with China, in other words, is the result of a one-way net movement of Chinese goods to the U.S. that is offset by an equal flow of dollars to the U.S. that end up being invested in real estate, bank deposits, stocks, and/or bonds.

This is the math of how international trade works. Dollars out always match dollars coming back in.

There is nothing wrong with this at all, contrary to what Trump erroneously claims.