Friday, September 6, 2019

Jobs growth continues to slow, but it's not a problem

For the past several months, I've observed that the growth rate of private sector jobs was slowing. Today's jobs report—which was much weaker than expected (96K vs 150K private sector jobs) only confirmed that. It's not a cause for concern or a precursor of a recession, however. Most likely it just reflects the fact that it's getting harder for employers to find new workers.

Chart #1

Chart #1 tracks the monthly change in private sector jobs. It's pretty clear from this that jobs growth has been decelerating since last January. It's also true that jobs growth has decelerated prior to the last two recession. This time, however, things look very different. Unlike the runup to prior recessions, to date the Fed has not restricted liquidity; real interest rates are very low; credit spreads are very low; and systemic risk is very low. The only other sign of a recession is the inverted yield curve, but as I explained in a prior post, today's inverted yield is a sign of risk aversion, not a sign of an economy struggling under the burden of tight money.

Chart #2 

Chart #2 shows the 6- and 12-month rate of change in private sector jobs. I think this is the only reliable way of judging whether jobs growth is accelerating or not. Monthly numbers are way to volatile—and subject to huge revisions—to come to meaningful conclusions. What we see now is that jobs are growing at something like a 1.3-1.6% annual rate. That's down quite a bit from the 2.0% rate which prevailed around the end of last year. But it doesn't condemn the economy to a recession or even to an uncomfortably slow rate of growth. For the first six months of this year, labor productivity surged to an almost 3% annual rate. Slower growth in jobs has been accompanied by faster growth in the average worker's value added. There's nothing wrong with that, especially since productivity has been rising for the past several years after having been dismally weak for most of the current expansion.

Over the past year, productivity rose by almost 2%. Thus, a relatively weak 1.6% growth in jobs in the past year generated real GDP growth of 2.3%. If productivity continues to pick up (thanks in no small part to Trump's deregulation efforts), then a measly 1.3% growth in jobs could deliver 3% real growth or more.

Chart #3

Chart #3 tracks first-time claims for unemployment, which typically begin to rise in advance of recessions as businesses sense a deterioration in their business outlook and attempt to shed workers and cut back on expenses. That's certainly not the case today! The worst that can be said about claims is that they have been flat for the past 12 months, averaging 217K per week.

Chart #4

Chart #4 divides unemployment claims by total payrolls. By this measure, unemployment claims are much lower than they have ever been before. This is a virtual "jobs nirvana" since it means that the chance of the average worker being fired is lower than ever before. And on top of that, wage growth has been accelerating: average hourly earnings rose 3.2% in the past year, and that's up significantly from the 2.0% pace that prevailed in 2014 and the 2.6% pace of 2016.

Chart #5

Chart #5 compares job openings with the number of persons unemployed but looking for work. There are more jobs available than people looking for jobs, and that's been the cast for over a year.

Slow jobs growth these days is not a sign of a deteriorating economy, it's a sign of a healthy labor market that continues to seek out new hires, only to find it difficult due to a shortage of people willing to work.

Tuesday, September 3, 2019

Tariffs are really beginning to hurt trade and manufacturing

It should not be surprising to learn that Trump's tariff war with China is having a negative impact on the US economy and global trade. Tariffs inhibit trade, and most of the tariff hikes to date have been directed at manufactured goods. The latest data show just how much this impact has been, and it is not insignificant.

Chart #1

Today's release of the August ISM manufacturing survey data showed a big drop in export orders (see Chart #1). The August reading of 43.3 was the second lowest in history of this data series, worse than the late 1998 reading, which was negatively impacted by the S.E. Asian currency devaluations in early 1998 and the Russia/LTCM implosion in late 1998. Only the Great Recession generated a weaker number, and that, in turn, reflected the worst collapse in global trade since the Depression. (As an aside, the collapse of trade that occurred in late 2008 was largely a function of the inability of exporters to get letters of credit from a global banking system that was in complete disarray.)
Chart #2

The overall ISM manufacturing survey began to weaken in late 2018, and by now, a slump in activity in the manufacturing sector has put considerable downward pressure on US GDP, as Chart #2 suggests. Though it's not likely enough to tip the economy into a recession, it is nevertheless of concern. The bond market has not been blind to this, however, as suggested by the significant decline in real yields since late last year. By my estimates, 0% real yields on TIPS most likely are priced to a slowdown in GDP growth to 2% or possibly less for the foreseeable future.

Chart #3

As Chart #3 shows, the volume of world trade has been declining since its Oct. '18 peak. (The latest datapoint is for June '19; undoubtedly the index has weakened more since then.)

Chart #4

Chart #4 reflects Chinese trade statistics through July of this year. China's exports to the US have not been greatly harmed by the imposition of tariffs, most likely because the yuan has fallen almost 13% since Trump first began slapping tariffs on Chinese imports. Chinese manufacturers effectively have absorbed the brunt of the US tariff costs by accepting a lower dollar price for their goods while receiving more yuan per dollar of sales. The decline in Chinese imports from the US can be attributed not only to China's imposition of retaliatory tariffs on US goods, but also to the fact that the weakness of the yuan has boosted the yuan cost of US imports by over 14%. 

Chinese imports from the US have suffered significantly of late. According to Chinese statistics, July'19 imports were 19% below the level of a year earlier. US statistics confirm this, showing that June '19 exports to China were down 17% from a year earlier.

Chart #5 

Tariff-related trade tensions have plagued the markets for most of the past month. 10-yr Treasury yields have fallen below 1.5%, driven by risk aversion (Treasuries are classic hedges against a weakening economy and they are the ultimate safe-haven asset) and declining growth expectations. Meanwhile, the Vix index has risen as fear and uncertainty drives demand for the risk-reducing properties of options in lieu of outright positions. 

UPDATE (9/5/19): The manufacturing sector is definitely hurting these days, but the much larger service sector—which accounts for over 70% of total private sector payroll employment—is doing just fine.


Chart #6 

Service sector business activity rebounded strongly in August (Chart #6). July's plunge was most likely a reflection of worried sentiment (this is all based on surveys of people's opinions) rather than an actual deterioration in business activity.

Chart #7 

The employment index (hiring intentions) softened a bit in August, but remains at a healthy level (Chart #7).

Chart #8

The Eurozone service sector survey reveals a continuing improvement, albeit modest, from the depressed levels of late last year. (Chart #8)

Chart #9

The service sector New Orders index rebounded in August from depressed July levels. Like Chart #6, this likely reflects improving sentiment (less worried sentiment) rather than any fundamental change in new order activity.

The service sector remains healthy, and that is a nice offset to obvious weakness in the manufacturing sector. The economy as a whole is thus likely to continue growing, albeit at a less-than-impressive pace (~2%). 

Sunday, September 1, 2019

Another look at corporate profits

A few days ago, the second revision to Q2 GDP gave us our first look at corporate profits for the quarter. My preferred measure of profits is after-tax, with adjustments for inventory valuation and capital consumption allowances, as calculated in the National Income and Product Accounts (NIPA). As Art Laffer is fond of saying, this represents "true economic profits,” and it is a consistent measure that goes back a long time. On that basis, second quarter profits rose 5.1% from first quarter profits, but for the year ended June '19, profits were up only a modest 2.7%. Over the past 5 years, profits have grown at an annualized pace of just 1.9%. Not very impressive, right? Well, not exactly. Here's some context which puts profits in a more attractive light:

Chart #1

Chart #1 shows 60 years of corporate profits compared to nominal GDP. Note that the y-axes are both plotted using a semi-log scale, and both are scaled identically (i.e., the top value is 150 times the bottom value). Lines plotted thusly have an identical slope if their growth rates are also identical. What stands out here is that corporate profits have handily outpaced nominal GDP growth since 2001.

Chart #2

Chart #2 uses the same data as #1, dividing profits by GDP. From 1959 through 2001, profits averaged a about 6.1% of GDP, and they were mean-reverting around that value. Since 2001, however, they have averaged 8.7%, with no signs of a mean reversion to 6%. In short, corporations these days are generating profits on a scale never seen before 2001: for the past 17 years corporate profits have averaged a higher percentage (about 40% higher) of GDP than they ever saw in prior years. That translates into a roughly 40% increase in profits when measured against GDP .

Chart #3

theorized over 6 years ago that, due to globalization, US corporations' ability to boost sales and profits had increased significantly, and this explained why we shouldn't expect to see a reversion to the old profits/GDP mean. In a rapidly-globalizing world, expanding foreign markets allowed US corporations to significantly and permanently expand their sales. As Chart #3 shows, corporate profits have averaged about 2% of World GDP since 1960, with some signs of mean reversion around that mean. In other words, while corporate profits are running strong relative to our economy, they are simply keeping pace with the much-faster growth of the world economy.

Chart #4

When profits surged to over 10% of GDP in the early years of the current expansion, most observers expected them to revert again, which is why PE ratios were depressed despite spectacular growth in profits (see Chart #4 and this post for more details). Today PE ratios are about 15% above their long-term average, but then again, profits continue to be a much larger percentage of GDP than they have been over the long term. I don't see any cause for concern over current PE ratios.

Chart #5

A few years ago, in a post entitled "A better PE ratio," I discussed an alternative way to measure PE ratios using the S&P 500 index (a good proxy for total market capitalization) and dividing it by NIPA profits (arguably the best measure of total corporate profits). I've done that in Chart #5. Note that the ratio is normalized so that its long-term average is equal to the long-term average of the standard measure of PE ratios (just under 17), which divides stock prices by trailing 12-mo. earnings per share (EPS). Both PE ratios today are running about 15% above average.

Chart #6

Chart #6 shows both measures of profits, again by using two y-axes with similar ratios and a semi-log scale. Note that the "gap" between NIPA profits and EPS profits has closed rather dramatically in recent years. Much of that came about thanks to a downward revision to past years' NIPA profits announced earlier this year. In any event, both measures of profits seem now to be tracking each other more closely, and both give rise to similar PE ratios. Neither measure suggests that equity valuations are excessive. PE ratios are above their long-term average, but profits are in general much more abundant, relative to GDP, than they have been over the long haul. What's not to like about this?

Wednesday, August 28, 2019

Risk aversion is the big story, not the yield curve

This blog has discussed the importance of an inverted yield curve numerous times over the past decade. As I've noted, an inverted yield curve has preceded every recession in modern times, so it bears watching, but it's not the only thing to watch. The yield curve is inverted now, but there are other important indicators which at this time fail to confirm the yield curve signal. Market-based indicators suggest the economy and financial markets are still in reasonably healthy condition.

The most significant development is the extraordinarily low level of real and nominal interest rates in the US and in most major developed economies. I believe that very low interest rates are not necessarily a sign of an impending recession, but instead likely reflect widespread risk aversion among market participants. Moreover, widespread risk aversion lessens the chance of negative surprises.

Chart #1

As Chart #1 shows, yield curve inversions (when the red line becomes negative) have preceded every recession since the 1950s. But there is one other variable which has also preceded every recession, and that is a real Fed funds rate (blue line) that is high and rising (e.g., at least 3-4%). Currently, the real funds rate is barely positive, which means that monetary policy is far from being so tight as to strangle the economy or to starve the market of much-needed liquidity.

Only one of these two classic recession indicators is flashing red. That the other is not is due to the fact that monetary policy since 2009 has functioned in a very different way than it did prior to 2009. Prior to 2009 Fed tightening involved draining reserves (which at the time paid no interest) from the banking system, which in turn pushed up the Fed funds rate and made borrowing more expensive. It also restricted liquidity in the banking system, which often exacerbated problems stemming from rising real borrowing costs. Since late 2008, monetary policy tightening has only involved a decision by the Fed to increase the rate of interest it pays on bank reserves (something it never did before); meanwhile, bank reserves have remained abundant, and liquidity has generally remained plentiful.

Chart #2

As Chart #2 shows, the recent decline in real yields on 5-yr TIPS (from just over 1% prior to late 2018 to now zero) suggests that the market expects the economy to slow to a 2% pace going forward. As the chart further suggests, real yields on TIPS have a tendency to track the real growth trend of the economy. Today's low and negative real yields do not necessarily imply that the market is expecting a recession, more likely simply a slowdown in the pace of growth. And to date, that appears to be exactly what is happening, thanks in large part to the uncertainty and disruption caused by Trump's tariff war with China.

Chart #3


Chart #3 shows 2-yr swap spreads, which are not only excellent indicators of financial market liquidity conditions, but also excellent predictors of economic health. Swap spreads are very low these days, both in the US and in the Eurozone. This is a strong indication that liquidity remains plentiful—let's not forget the almost $1.5 trillion in excess bank reserves—and systemic risk remains low. All positive for future growth prospects.

Chart #4

Chart #4 shows that small business owners are quite optimistic about current and future business conditions. That's important, because they are the main engine of jobs growth. Optimism is up significantly since Trump's election, and Trump's efforts to slash regulatory and tax burdens get a good portion of the credit for this in my book.

Chart #5

Consumers in general are also quite confident these days, as Chart #5 shows. Trump's election helped spark a surge in consumer optimism. Healthy business and consumer optimism at the very least suggests the absence of any deterioration in the health of the economy.

Chart #6

Chart #6 shows that rising inflation has typically preceded recessions. That makes perfect sense, since very tight monetary policy has been needed to bring inflation down, and as Chart #1 showed, tight monetary policy (marked by high real rates and an inverted curve) is the main reason recessions have occurred in the past. Today there is no problem at all with inflation, and thus no reason for the Fed to tighten. In fact, they are very likely to ease at the next FOMC meeting, if not before, as I argued earlier this month.

Chart #7

As Chart #7 shows, recessions have typically been preceded by rising unemployment claims. Claims are a high frequency statistic that is released with a lag of only a week or so, so they are timely indicators of the health of the labor market. Currently, claims are very low and show no sign of rising. Businesses are therefore quite happy with the size of their workforce. If anything, the main problem facing most businesses these days is the difficulty of finding new hires.

Chart 8

As Chart #8 shows, deteriorating financial conditions also precede recessions. So far there has been no significant deterioration in Bloomberg's measure of financial conditions, which is quite comprehensive.

Chart #9

Chart #10

As Charts #9 and #10 show, rising corporate credit spreads also precede recessions. Today, however, they are quite low. This means that financial market participants have little or no reason to fear a significant deterioration of corporate profitability. In fact, today's low credit spreads are a good indicator that the outlook for corporate profits (and, by inference, the economy in general) is healthy.

Chart #11

As Chart #11 shows, fixed-rate mortgages are about as cheap as they have ever been. That's one reason the housing market continues to hold up well. Consumers are not being squeezed by high rates.

Chart #12

Chart #12 is one measure of the shape of the yield curve that is looking just fine. The very long end of the curve is mostly immune to Fed policy and Fed policy expectations, unlike the front end of the curve, which is where all the inversion is happening. The long end is nicely positively-sloped, which means that the market's long-term expectations for the economy and the outlook for inflation remain healthy.

Chart #13

Chart #13 (a new chart making its first appearance on this blog) shows the 3-mo. annualized rate of growth of demand and savings deposits at U.S. banks. I consider this to be a proxy for money demand, since the interest rate paid on these deposits is very low. People hold them mainly because they want to keep their money safe. What stands out is the recent and significant increase in the amount of money being stashed in these safe havens. Not surprisingly, this coincides with the recent bout of nerves triggered by Trump's trade war with China. 

The big thing happening on the margin is a flight to quality/safety. (This shows up in the rising price of gold as well.) Strong money demand (and by inference strong risk aversion) is the driver behind the yield curve inversion, because the Fed has been slow to respond to an increased demand for money by reducing short-term interest rates. 

Chart #14

10-yr Treasury yields have plunged this year, and are now closing in on all-time lows. But it's a phenomenon that is happening all over the developed world. As Chart #14 shows, yields in Germany and Japan are much lower than ours. Strong foreign demand for Treasuries could well be one of the main drivers of lower yields, since our yields are still much higher than anything you can find in major overseas markets. In short, there is a lot of risk aversion globally, and that is creating exceptionally strong demand for government bonds.

Chart #15

Chart #15 highlights the behavior of 10-yr real yields in the U.S. and Germany (and by inference the entire Eurozone). Eurozone real yields are now at record lows, and far below their U.S. counterparts.

Chart #16

As Chart #16 suggests, the huge difference between real yields here and in overseas markets is being arbitraged by market forces. The spread between US and German real yields has been narrowing sharply so far this year, at the same time as the dollar has been rising against the Euro, because money is leaving Europe in search of higher returns in the US. 

Global risk aversion and a flight to safe havens is what's going on behind the scenes just about everywhere—not fears of recession. It shows up in very low and negative yields (because demand for sovereign bonds is extremely strong), and in rising gold prices. 

Chart #17

As Chart #17 shows, equity valuations are not out of line with the level of real yields. Both tend to move together. High real yields typically accompany strong economic growth and strong corporate profit growth, which drives PE ratios up. The equity market itself is displaying signs of risk aversion, even as PE ratios are above average; small caps are underperforming large caps, and that happens when people see slowing economic growth.

Risk aversion appears to be significant, but it's not necessarily something to worry about. A risk averse market is less prone to disappointments, and more able to withstand adverse shocks. 

Monday, August 26, 2019

The US has experienced very little warming since 2005

This post digresses from economics to dabble in the issue of "climate change." If, like me, you have read enough about the difficulties of measuring global temperatures to know that virtually all temperature datasets are and have been extensively "adjusted" after the fact to correct for a variety of factors, then you should welcome the news that our own NOAA (National Oceanic and Atmospheric Administration) has come up with a way to measure temperatures in the contiguous US that, beginning in 2005, generates data that require no adjustments, thanks to strategically placed and well thought-out monitoring stations. Here's a HT to James Taylor, who notes that:

In January 2005, NOAA began recording temperatures at its newly built U.S. Climate Reference Network (USCRN). USCRN includes 114 pristinely maintained temperature stations spaced relatively uniformly across the lower 48 states. NOAA selected locations that were far away from urban and land-development impacts that might artificially taint temperature readings. 
Prior to the USCRN going online, alarmists and skeptics sparred over the accuracy of reported temperature data. With most preexisting temperature stations located in or near urban settings that are subject to false temperature signals and create their own microclimates that change over time, government officials performed many often-controversial adjustments to the raw temperature data. Skeptics of an asserted climate crisis pointed out that most of the reported warming in the United States was non-existent in the raw temperature data, but was added to the record by government officials.

The USCRN has eliminated the need to rely on, and adjust the data from, outdated temperature stations.

What this new data show is that in the contiguous 48 states there has been a statistically insignificant amount of warming over the past 14 ½ years. Using NOAA's data, I created the following chart:

Chart #1

The green line is the best-fit trend line, and it shows that US temperatures have increased by about 0.6º F per decade, or roughly 0.06º per year. It's worth noting as well that US temperatures have been below average for most of the past year. This, at a time when headlines trumpet soaring global temperatures.

My intuition tells me that if US temperatures have barely increased at all over almost 15 years, then it is unlikely that global temperatures have increased by much more, if at all. After all, air does circulate around the globe. Climate skeptics have here one justification for being skeptical of those who warn that man-made global warming is an existential threat.


Tuesday, August 20, 2019

Another look at Truck Tonnage

Long-time readers will recall numerous posts on Truck Tonnage over the years. It's a good proxy for the physical size of the US economy, since it represents "70.2% of the tonnage carried by all modes of domestic freight transportation, including manufactured and retail goods," according to the American Trucking Association. It's been unusually volatile this year, but that could be explained at least in part by the disruptions caused by Trump's tariffs. In any event, the latest reading (July '19) shows tonnage to be still in a rising trend.

Chart #1

Chart #1 shows the Truck Tonnage Index, which is up 7.3% in the 12 months ending July '19, and up 23% since the Nov. '16 election. Using a four-month moving average to smooth out the recent volatility, the index is up almost 5% in the past year, which is a bit more than nominal GDP growth (4%) for the 12 months ending June '19. Nice.

Chart #2

Chart #2 shows the path of Retail Sales through July '19. Sales experienced a slump in late 2018 and early 2019, but now appear to have resumed a decent rate of growth (~5% over the past year). This has all the hallmarks of tariff- and uncertainty-induced disruptions which have since been absorbed.

Chart #3

Chart #3 compares Truck Tonnage to equity prices over the past 16 years. It's a pretty nice fit, and paints a bullish picture for equity prices today.

Chart #4

Chart #4 compares Truck Tonnage to the inflation-adjusted level of equity prices over the past 46 years. That they track so closely adds weight to the view that Truck Tonnage is a good proxy for the size and health of the economy. This fit supports the current level of equity prices.

Chart #5

So as not to be accused of cherry-picking the data, Chart #5 compares the much broader Dept. of Transportation's Freight Index to the nominal level of equity prices over the past 27 years (which is as far back as the Freight Index goes). Here again we see a remarkable correlation between the two over the years.

Chart #6

A closer look at the Freight Index (see Chart #6) shows that it is not as bullish as the Truck Tonnage chart (Chart #1), since it's been relatively flat for the 8 months ending in June '19. Still, it does show a rebound from the late-2018, early-2019 slump, just as truck tonnage does. I suspect the July reading will be up, considering the strong July reading for truck tonnage. Stay tuned.

UPDATE (9/13/19): The July reading for the Freight Index was indeed up, as I expected:


Monday, August 5, 2019

Round 3 of the tariff wars

The stock market hit an air pocket today, buffeted late last week by news that Trump had threatened to unleash a new round of tariffs on Chinese imports, and news today that the Chinese yuan had fallen below 7 to the dollar. For good measure, the Chinese government also announced it would retaliate by restricting imports of US agricultural products.

Yikes, thought the market, maybe this is going to turn into a full-fledged tariff war after all! Better sell now before the sh*t hits the fan!

I've mentioned before that if Trump's tariffs are going to have their intended effect, namely forcing China to lower its trade barriers and respect intellectual property rights, then the Chinese are going to have to be very worried that bad things are going to happen to their economy if they don't make a deal with Trump. It's also true that for the Chinese to take Trump seriously, just about everyone needs to be worried that Trump is out of control and the global economy is headed for a fall. If we aren't scared, the Chinese never will be.

Well, it's looking like we're getting closer to that point.

Chart #1

Chart #1 compares the level of China's forex reserves to the value of the yuan vis a vis the dollar. What this says is that the huge rise in the yuan's value leading up to 2014 was largely due to a huge influx of capital. The Bank of China was actively trying to suppress the yuan's value, since if it hadn't bought more dollars and sold more yuan, the yuan would have risen even further. But from mid-2014 to mid-2017, capital began to flee China. This forced the Bank of China to sell its forex reserves and buy yuan, otherwise the yuan would have depreciated even more against the dollar. Until recently, it seems that the Bank of China has been targeting a fixed level of reserves, and allowing the yuan to fluctuate with the winds of capital flows. The recent drop in the yuan virtually guarantees that capital is desperate to abandon China. At the same time, China's economy has been slowing. China is far more dependent on trade with the US than the US is with China. Trade disruptions are disrupting China's economy meaningfully, and that is putting increasing pressure on Chinas' leadership to make a deal. Further declines in the yuan's value will put tremendous pressure on China to make a deal, otherwise their economy could be crippled.

Chart #2

Chart #2 shows that the market's level of fear, uncertainty and doubt (as proxied by the ratio of the Vix Index to the 10-yr Treasury yield) is today as high as it has been in many years. We are in Panic Territory. Yet I note that the selloff in stocks has not been very deep so far. This could mean that the market is not really terrified, because the market realizes that although things look really bad today, they can be fixed with a simple Trump tweet or a Chinese capitulation. In any event, it's worth noting that FUD is high but stocks have not really suffered very much. But does that imply the market is over-confident? Not necessarily.

Chart #3

Chart #3 shows that the real yield curve today has inverted even more. The market is expecting the Fed to be forced into deep cuts, since otherwise an escalating trade war with China could cause serious damage to the Chinese economy, and that would inevitably be felt here at home as well. In any event, the market is sending a strong signal to the Fed that monetary conditions are too tight right now. That in turn is due to a sharp rise in risk aversion and a sharp increase in the demand for money and other safe havens, both of which have not been alleviated by offsetting Fed actions (e.g., lower rates, which have the effect of making cash and money less attractive).

Chart #4

Chart #4 shows the implied rate on Fed funds futures contracts that mature next June. The market fully expects the funds rate at that time to trade at around 1.6%, which would further imply three more 25 bps cuts to the current funds rate of 2.25%. That in turn means the market thinks the economy is going to be sucking pondwater pretty soon.

Correction: (9;28 pm PST) I need better reading glasses. This chart says that the market expects the funds rate to be 1.2% by next summer, not 1.6%. That implies four more 25 bps cuts to the current funds rate. HT: Mike Churchill

Chart #5

Chart #5 compares the price of gold to the price of 5-yr TIPS (proxied here by the inverse of their real yield). Both tend to rise in periods of uncertainty. Moreover, the recent rise could be attributed to the market thinking that the Fed has fallen so far "behind the curve" that in the end it will be forced to ease too much, and that will ignite an unwelcome rise in future inflation (gold and TIPS both promise protection from rising inflation). The market is getting pretty worried about the future, it's safe to say.

Chart #6

Chart #6 shows the spread between 10- and 30-yr Treasury bond yields. The long end of the Treasury curve has been steepening, even as the front end has been inverting. This reinforces the view that eventually the Fed is going to be forced to "reflate," and that would be bad for long-dated bond prices.

Chart #7

Chart #7 shows the yield on 10-yr Treasury bonds. Late last year it looked like bond yields had broken out of their long-term downtrend. Now it looks like that downtrend is still intact. I'm not a technical chart devotee, but there are a lot them out there, and this chart has gotten their attention, you can be sure. That US yields have fallen this low implies 1) great demand for equity hedges (which in turn implies a lot of bearish sentiment), 2 very low inflation expectations, and/or 3) a belief that the Fed is at risk of making a deflationary mistake.

Chart #8

Yet despite all the doom and gloom priced into the Treasury market, Chart #8 shows that the corporate market is only a tiny bit concerned about the outlook for corporate profits. Spreads on generic 5-yr Credit Default Swaps have only risen modestly from very low levels. Similarly, I note that swap spreads are extremely low (2-yr swap spreads have fallen to -7 bps), both here and in the Eurozone. This suggests both a dearth of safe-haven assets, and strong liquidity conditions. Investors are buying swap spreads instead of other high-quality bonds because they are trying to hedge their exposure to stocks and other risk assets—not because they are afraid the economy will collapse. As I argued in my last post, the low level of real yields and the abundance of bank reserves imply that financial conditions in the US are not deteriorating; money is not hard to come by, and therefore the economy is not at great risk of a Fed mistake.

This further suggests that the carnage being priced into assets today is still in the minds of investors, and is not yet to be found in the physical world.

Chart #9

With the rush to safe-haven assets, the PE ratio on the S&P 500 has fallen to 18.6, which gives the stock market an earnings yield of 5.4%, which is a whopping 370 bps above the yield on 10-yr Treasuries (see Chart #9). You have to go back to the scary days of the late 1970s to find an equity risk premium that high. One thing this chart says for sure: the market is quite pessimistic about the risks that the future holds.

If Trump and China figure out how to make a face-saving deal, the upside potential out there could be very impressive indeed.