Monday, May 2, 2016

Still more encouraging developments

Markets continue to recover from the growth scare that set in beginning around the end of last year. Oil prices were plunging, creditors feared a wave of defaults, commodity prices were plunging, China was thought to be on the verge of a huge slowdown, and central banks appeared powerless to avoid another recession. What a difference a few months make. "Avoiding a recession is all it takes" has been a recurring theme of this blog for more than three years, and it's still relevant. Here are some more charts which suggest that instead of tipping over into a recession, the economy is more likely picking up a bit. Growth is still slow, but slow growth is a lot better than a recession, especially when cash yields almost nothing.

Here are some more charts updated with recent statistics that present an encouraging picture:

The April ISM manufacturing index was a bit lower than expectations (50.8 vs. 51.4), but it is still at levels which are consistent with overall growth in the economy of 2% or better. It's rebounded nicely from the lows of just a few months ago.

The export orders index has also rebounded nicely, and that's especially encouraging since the market has been very worried about slowdowns in overseas markets. 

The chart above shows the price of crude oil futures. Oil prices are no longer declining and have instead rebounded over 70% from their February lows.

With the plunge in oil prices a thing of the past, we see that prices of things other than oil are still rising. (The Core CPI has been rising at an annualized rate of 2% or so for many years.) A majority of companies in April reported paying higher prices, as the chart above shows. Deflation risk is vanishing.

Construction spending in March was up 8% from year-ago levels, and has been exceeding expectations in recent months.

Industrial metals prices are up over 25% in the past three months, a good sign that global manufacturing activity is improving.

Bank lending to small and medium-size businesses has been booming for the past five years. C&I Loans are up 11% in the past year, and have surged at an annualized rate of almost 20% in the past three months. This is an excellent indicator of rising confidence, since banks are evidently more willing to lend and businesses are more willing to borrow. Total Bank Credit outstanding has been rising at a 7-8% annual rate of late as lending has increased by $767 billion in the past year (for perspective, that's equivalent to 4.2% of GDP). 

It's ironic that radically cheaper energy prices in the past year or so have been seen by many to be a source of concern (because they threaten the health of energy producers), when they have been a boon to consumers everywhere. As the chart above shows, energy has never been a smaller part of consumers' budgets than it was last March (3.67%). High and rising energy prices have tended to precede recessions, and falling energy prices have tended to coincide with periods of very healthy economic growth (e.g., the mid-1980s). This is not an ironclad rule, but it's hard to see a recession developing when energy—an essential ingredient to all economic activity—becomes very cheap.

UPDATE: And here is the current menu of yields available on different types of assets:

The chart below shows the difference between the earnings yield on equities (i.e., after-tax profits per share) and the yield on 10-yr Treasuries. Note that the current equity risk premium (i.e., what you would earn if corporate profits were to continue at the same level relative to share prices and corporations paid out all profits in the form of dividends) is still quite a bit higher than its long-term average. You don't often get the chance to pick up so much extra yield on equities. The explanation for why this is so high today is that investors don't believe that corporations will be able to sustain their current level of profitability. In other words, bad news is still priced in:


Benjamin Cole said...

If you old enough, you can remember looking at the back of Business Week or Economist magazine to get some figures and commentary not quite as good as what Scott Grannis delivers regularly.

The core CPI may be at 2% and the PCE at 1.5% but my personal deflator must be at -5.9% or so!

Still, we see anemic global demand. Gluts of capacity in every industry and lots of capital.

We had an entire generation of the economists and central bankers, now in senior positions, who have devoted lifetimes to framing every argument in terms of inflation. They have prevailed---and how. The Swiss National Bank is now paying negative interest of 0.75% and contemplating rate cuts. I guess inflation is not a serious concern.

I think it may be time to frame many arguments in terms of demand.

QE (helicopter style) and unzone property.

And jump fast or a bulldozer or crane will mash you! America can work again, if we want it to.

Scott Grannis said...

Benjamin: one more time I will ask that you describe how it is that printing more money will stimulate the economy; how more money will result in greater productivity and higher living standards; how more money will result in more jobs and more risk-taking. You have yet to rise to this challenge.

Global demand can never exceed global supply; we can't consume if we don't produce. The idea that the world's problems center around a lack of demand and a surfeit of supply is nonsensical. The key to greater growth and rising prosperity is to stimulate supply, not demand.

Scott Grannis said...

Changing zoning codes would indeed contribute to growth, but only very marginally. We need a solution that is more global in nature.

The Dumb Money said...

Benjamin, I do not understand most of what the left and the right has said about monetary policy QE for the past few years. To me, the Fed's job has been and shall be to maintain stable prices, at or near 2%. "Helicopter money" for the sake of it would be ridiculous, and would (likely) cause excessive inflation. There is not such thing as a free lunch. At the same time, the army of conservative economists and commentators (I'm thinking of you, Larry Kudlow, and you, Niall Ferguson) who predicted hyper-inflation and a collapsing dollar in 2011-2012 or so, were equally ridiculous. People need to spend more time ignoring the Fed. It is but a ship captain, turning a monetary policy tiller to keep us on a near-2% course, as deflationary winds attempt to blow us left, or inflationary winds blow us right. Like any captain, it is not always perfect, but it has done a pretty darn good job since about early 2009.

Reducing zoning restrictions is needed in the largest and bluest cities, where greedy homeowners and greedy apartment owners collude to label developers "greedy developers," and cause the very unaffordability they then decry, and advocate trying to pass on the cost of their preferences to other people -- the smaller number of small business owners -- via calls for higher minimum wages. But zoning is not the problem in about 95% of the country, geographically.

Scott, to the extent you have a problem with what the Fed has done in the past few years -- I'm not a regular reader -- I hate the conflation of what the Fed does with "stimulus." It is true that Ben Bernanke spoke improvidently a few times using that word, or talking about supporting stocks. This was stupid, and harmed the Fed. It's not what the Fed is about. The Fed, per the above, is just a captain with a job to guide our ship towards the North Star of 2% inflation. It's employment mandate and its inflation mandate do not even conflict, except in times of high inflation (see, e.g., the Volcker years).

I am grateful for your recitation of actual (and by happenstance, good) economic news in this era of mindless pessimism.

The Dumb Money said...

(And I should note, re: zoning -- and the constant advocacy against development even when zoning allows it, that in these large, blue cities (SF, LA, NYC, Portland, etc.), the greedy homeowners and the greed apartment building owners are also colluding with economically-illiterate "renters advocates" who are like a serf army doing the bidding of the landed gentry, by fighting alongside them to restrict housing supply. Gentrification is decried, and nobody stops to examine the reality that it only happens in the first place because the large wealthy and middle class (and nominally liberal, but actually very reactionary/conservative) areas of these cities have put themselves completely off-limits for any development and densification. The whole situation is ridiculous and sad. But it's not the primary problem facing our country.)

Frozen in the North said...

I'm always a pessimist, but there are a few things that stand out: China has jacked its economy on a massive debt bubble, most of these loans will have to be forgiven -- since they are to SOEs. In America's backyard there is Puerto Rico, I am not clear what the impact of a default by PR would be on the rest of the economy. Things in Greece are back to "we're about to default". None of these things are new, overcapacity in China is an old story, the tension with PR could blow over, and Greece may again shovel the shit ahead... still these are three real problems.

Adding a fourth, would be the state of Europe's bank industry; SocGen and DB are having a hard time -- and the Italian banking sector is just one step away from life ending trouble with its massive bad debt problem.

None of these issues are terrible in their own, but the combination is worrying.

There's an old saying: “The market can stay irrational longer than you can stay solvent"

The Dumb Money said...

Frozen, just to be clear, to the extent you are responding at all to me, I'm neither a bull nor a bear. I don't care one way or the other. I simply look at individual companies, in every and any market, and select those that I think are most likely undervalued, based upon a combination of a roughly-estimated discounted free cash flow analysis, an evaluation of their ROIC, and their debt loads, and by employing "English major" analysis about their market prospects in the future. I also just put money in index funds every month, in good times and in bad. I am always saving, and always investing, and never timing, aside from a brief mind-fart in 2014, which I regret. There's another old saw, that the market always climbs a wall of worry. It has been climbing one for seven years now. Many who have missed out on that are desperate, absolutely desperate, to see things collapse. Careers depend upon it. (Poor John Hussman, poor ZeroHedge, poor hedge fund managers too numerous to count.) Economies being what they are, if the "bears" wait long enough, they will see the collapse they "foresaw," and proclaim themselves geniuses. But the gains they make at such time will likely not be enough to compensate for the gains they forwent from 2009-2016?, nor are most of them likely to time the market again on the other side of that inevitable recession/collapse, as the previous seven years have amply demonstrated already. In my view, there are only two acceptable options for plebes: invest for the long, long term, always, no matter what (subject to one's age); or, learn to do technical analysis well and trade for the very short term. Obviously I think the former is the better strategy.

Benjamin Cole said...

There are times when central bankers have maintained a money supply that is too tight, and indeed Milton Friedman blamed the Great Depression on Federal Reserve tight money.

Money is too tight now. I would like to see quantitative easing in combination with tax cuts. As I have said before, I would like to see tax cuts go to people who will spend the money. I do not say this because I like poor people or dislike rich people, I say this because I want spending to increase.

The globe is glutted with supply. The auto industry has 20% excess capacity globally, we have steel mills lacking for buyers, potash mines flooding the market, labor is everywhere. I can think of no industry in which demand is outstripping supply.

If you can name such an industry, please tell me so that I may invest in that industry!

BTW if we could reverse the 1926 Supreme Court decision upholding the abusive right of local governments to zone property, I think we would see a boom of our lifetimes, particularly along the Pacific Coast.

How many high-rise condos would be built in coastal cities such as San Clemente, Newport Beach, Santa Monica, Santa Barbara or Pacific Grove? Let alone Los Angeles to San Francisco.

Newport Beach could look like Miami Beach West on steroids. Toss in a few casinos, hotels, a rebuilt harbor, yacht club and that place could be cooking!

It is pinko socialist property zoning that is preventing development all along the Pacific Coast and suffocating the economy.

Okay, I got that out of my system.

Frozen in the North said...


I have zero issue with what you said! Frankly, I like you bottom up analysis methodology. My point was a macro one, the US economy has been growing for a while now, maybe not the growth of the '80/90s but steady growth nevertheless -- the quality of earnings in America has been declining, comparing adjusted returns and tax payments -- which in may cases indicates that real profits are a lot lower than what they imply in their press releases.

My issue was the macro factors are the issues; there are some major overhanging issues that could hurt the economy; PR is a local one, Greece is far away -- but still close, and China, China is the great unknown. The US markets are ripe of a fall, its even overdue -- this is now America's second longest expansion period (goes to show that Obama has not been bad for the markets.... if you think for one minute that Presidents have an impact on economic growth).

But to re-iterate no, not aimed at you

marcusbalbus said...

i demand more QE

Matthew Grech said...

The Fed will never do this but if they cared about realizing the long term potential of the economy (or at least the portion that they have some control over) they would announce, today, that they are targeting stable prices as defined by a broad basket of commodities and that gold has a significant place in said basket.

They would also recommend - because that's all they could do - that we rip up the thicket of rules that are choking the banks. In their place it would recommend a 20% reserve requirement on all banking assets.

It would further recommend that we significantly reduce income, corporate, and payroll taxes.

Side note: If you look at the price of gold over the last 14 months, you can readily see why this Fed has been subpar. Gold has been flat over 14 months but the path to flatness has been anything but calm. And that is the problem as it relates to the Fed. Crappy fiscal policy is choking the economy and that isn't the Fed's fault. But the volatility of the money supply in relation to the demand for money is doing absolutely nothing for the animal spirits of this country. This can be seen in the volatility of gold. I am slightly hopeful at the margin because, just looking at gold over the last four months or so, the Fed's policy can be said to be less bad. In fact, a lot less bad. But if they announced a sane policy of stable prices, the market and our economy would zoom. If fiscal policy ever improved, then so much the better.

This now concludes my midday fantasy.

Alain said...

Nice post as always scott

Benjamin Cole said...

BTW Scott:

Both John Taylor and Milton Friedman have advocated QE for Japan. Both are "right-wing" although I find these labels becoming meaningless.

(You have "right-wingers" defending the communist health program called the VA, and "left-wingers" like Obama calling for free-trade agreements. Reagan was a big protectionist.)

If QE does not work, what explains the viewpoints of such incisive monetary thinker as John Taylor and Milton Friedman?

QE does work when you are close to to ZLB and inflation is dead. It may be the only thing that does work.

The Federal Reserve famously tightened in the Great Depression. Then again tightened after 2006. The Fed never wavered btw, even in the Great Depression---ultimately the Fed was forced on board by WWII, when pinch-faced lectures about the perils of inflation and moral hazard were not very convincing. The printed money to accommodate a rapidly growing economy, but only at Nazi-Tojo gunpoint, so to speak.

Happily, today is not such a dramatic situation (but central bankers do not change). If you read FOMC minutes (I forgive the sin of not doing so) you will see hundreds of mentions of inflation, constantly.

This generation of central bankers can only think about inflation. The are asphyxiating the economy to pursue microscopic rates of inflation in a world with large structural impediments and institutional imperfections, not the least of which is pervasive and incredibly stipulative and suffocating local property zoning.

Hans said...

Well, Ben Jamin, those two fine economist blundered in their
assessment of QE.

A question to all, where did all that money go if the enitiy was
a non-bank? Let's example the volks at Goldman Sach. They are not
a bank in any sort of the name, even tho they are referred to as
an investment bank.

Did the FRS or FRB require them to place the funds from the Fed (QE) into
a lock box? Of course, there is little difference between the FRB and the
industry it SERVES.

When there is a turn in policy all the major money center banks will
be informed in advance. Billions in free money from market investors
under the auspice of a fully licenced monopoly and allegedly independent.

No one will have an answer and most certainly not the obtuse FRB.

Hans said...

Good news for auto sales.

Benjamin Cole said...


I share your concerns about industry capture at the Federal Reserve.

Hans said...

Ben Jamin, 'capture" is an interesting descriptive verb.

I am glad I am not alone in this opinion of this enitiy.

"Changing zoning codes would indeed contribute to growth, but only very marginally. We need a solution that is more global in nature."

Virtually every aspect of economic and social endeavor is controlled
by GUs. IMHO, it is more than marginal; it's impact is broad and debilitating
to growth and not readily apparent to the naked eye.

It has utterly destroyed the middle class housing "opportunities"
in San Francisco. In such a wealth urban center, only the UC and
rich can afford real estate.

That is not the American dream but the stratification of urban housing.

Hans said...

A new mandate for the FRS? Why not, no sense in constraining either
their actions nor choices.