Friday, January 4, 2019

The Fed apologizes, and the outlook improves

Two weeks ago I noted that the Fed had screwed up badly. But all was not lost: "all it takes is a few words to put things right. The damage done to date is not significant or permanent, and it is reversible." Today we got those words: according to Powell, the Fed is "listening carefully to the markets." The threat of an overly-tight Fed has now all but vanished. The Fed and the market are dancing together again, with both participants expecting no further Fed tightening moves for the foreseeable future, but with a possibility of an ease later this year (i.e., the market is relieved, but still cautious).

Prior to this welcome Fed news, the Labor Dept. earlier today released a surprisingly strong December jobs number which was way above expectations (+312K vs +184K). This put the kibosh on concerns the US economy was slowing down, at least for the foreseeable future. Credit spreads have rallied from their highs, though they are still somewhat elevated.

For the time being some of the market's worst fears are being calmed. What remains to be seen is the result of the ongoing negotiations with China, which get underway next week (and in which my good friend and excellent economist David Malpass will be participating). If Trump can turn down the tariff-war heat, the entire world will be breathing a huge sigh of relief, and risk markets will move decisively higher. Already, the Brazilian and Argentine stock markets are up some 15% in just the past week in dollar terms, though they remain deeply depressed.

It bears repeating that what Trump hopes to achieve is NOT higher tariffs, but rather lower or zero tariffs, lower or reduced export subsidies on the part of China, and a reduced likelihood that China will continue to expropriate US intellectual property. Any move in this direction will be a direct benefit to global trade, and that in turn will benefit all concerned. Trump is putting at risk US prosperity (by raising tariffs as a negotiating tactic) in order to force China to do something that in the end will be of great benefit to both China and the US. It's a risky gambit, to be sure, but the potential rewards are Yuge. It's also worth repeating that it seems China must be threatened in order to do the right thing, and the threat must be not only palpable but terrifying. And China won't feel that kind of pressure unless you and I (and the market) also get to the point that we are terrified of the consequences of a tariff/trade war. With luck, we may have seen the worst of this deal-making process.

Chart #1

Chart #2 

Long-time readers know that I routinely focus on more than just one month's worth of job statistics and on just the private sector job numbers. The monthly numbers are so volatile as to be almost worthless, and private sector jobs are the only ones that matter. But a six- or twelve-month average of the numbers can give us valid insights into the broad trends of the labor market. Charts #1 and #2 show that today's number, however surprisingly strong it was, was not out of line with past experience. Yes, monthly jobs growth was at the high end of its range, but as Chart #2 shows, the trend growth rate of jobs has been only slowly picking up over the past year or so. Both the 6- and 12-month growth rates of private sector jobs are now slightly above 2.0%, but that's up from a low of 1.6% in September 2017. The economy really is getting stronger, albeit slowly. The momentum of a gradual strengthening of the mighty US economy is much more significant than the ongoing marginal slowdown in the Chinese economy.

In addition to a pickup in US jobs growth, we also are seeing a pickup in the growth of the labor force, which increased 1.6% last year—up significantly from 0.5% growth in 2017. It's also welcome news that the unemployment rate ticked up to 3.9%, since that means that despite the outsized growth in jobs, the number of people entering the labor force was even greater (i.e., many of the new entrants to the labor force are still looking for a job). A stronger economy and rising wages are attracting people who were formerly on the sidelines of the jobs market. This is terrific news, since it means the economy has plenty of untapped upside potential. (Doomsayers had been insisting that the low rate of unemployment meant that it would be difficult if not impossible for the economy to grow at a 3% or better pace.)

Chart #3

News of a stronger economy has contributed to a meaningful reduction in credit spreads, as Chart #3 shows.  High-yield, 5-yr credit default swap spreads (arguably the most liquid and meaningful indicator of the outlook for corporate profits) have tightened by some 60 bps in the past week or so, thanks to perceptions of a stronger economy coupled with rising commodity prices and a reduced threat of an overly-tight Fed. Swap spreads remain very low and firmly in "healthy" territory. So not only is the outlook for corporate profits improving (as indicated by declining credit spreads), but also it is the case that liquidity remains abundant in the financial markets and systemic risk remains quite low. In other words, we are most likely on the recovery side of another case of "panic attack."

Chart #4

As Chart #4 shows, the market is now much less worried (as measured by the ratio of the Vix index to the 10-yr Treasury yield) than it was just a week or so ago (the ratio has declined from a high of 13.2 just before Christmas to now 8). Last week we had the threats of 1) an overly-tight Fed, 2) a slumping economy, plus sundry other worries: China slump, trade wars, Eurozone weakness, collapsing oil prices, and the federal government shutdown. We can now scratch the first two off this list. There are still a lot of concerns out there, but we are moving in a positive direction.

Happy New Year!

41 comments:

Brian Murphy said...

I feel I should lead with Dr. Grannis. How does residential RE weakness fit into this and is that a canary in the coal mine for you?

Johnny Bee Dawg said...

Outstanding summary, Scott.

Let it be noted that Don John Trump put in the bottom on Christmas Day with his prescient exhortation that stocks were cheap enough, and all those of good cheer should BUY.

It’s literally the only thing that changed between the worst Christmas Eve stock market performance in US history on Monday, and the best ever post-Christmas Day performance in history on Wednesday.

Higher lows since then with bullish percents reversing up from extreme low levels. Yesterday’s huge sell-off (thankfully with no volume) saw more buy signals than sell signals. Positive divergence at the exact right time. Today’s rally brought 10:1 buys vs sells. 30:1 reversals up on charts vs. reversals down. It’s continues. The Don John Rally. It appears that Trump won the battle with Powell for now.

Don’t doubt Don John and MAGA. He is telling us that Chinese negotiations are proceeding well. Markets love MAGA, and markets love Trump. They blasted off the morning after he was elected, and paused only during Fed incompetence. Markets went to all time highs after the tariffs. Only Jay Powell could smash stocks. They can proceed cautiously higher as long as the Fed follows market signals. It was almost as if Yellen and Bernanke were there today by Powell’s side to tell him to STFU. And he did.

Only bad thing in today’s rally was lack of volume.
We will have to see how it goes. Forth North!!

Scott Grannis said...

Re: “How does residential RE weakness fit into this and is that a canary in the coal mine for you?“

I don’t see a problem with residential real estate. Price gains have gone to near-zero, that’s for sure, but not because of an over-supply or excessive government subsidies, as was the case in 2005-6. One fact was the increase in borrowing costs, which in turn was driven by rising mortgage rates. But those have reversed dramatically in recent weeks. So housing affordability has already been restored. Meanwhile, the supply of homes for sale is at relatively low levels, and new housing construction is still far below the rates we saw during prior boom times for housing. I think it’s just a temporary problem of affordability. Not an excess of supply or a lack of demand or economic weakness. Prices obviously cannot keep increasing forever, especially when mortgage rates are also increasing. Something has to give, and it has given, in the form of a pause or slowdown in price gains, and a decline in mortgage rates. This is all healthy.

marcusbalbus said...

the fed and the market are dancing again? pangloss, a new low in your self respect?

Fred Flinstone said...

I really don't understand this analysis. Back in 2010-11 you were arguing that the Fed didn't need to implement QE and should in fact tighten to avoid inflation. How can you now say, in light of arguably much stronger growth and hourly wage increases, that the Fed should pause and give in to a market correction? If the market rose from 2009-2017 due in large part to zero interest rates and QE, as your current view of the Fed seems to imply, it seems to me we are in big trouble. Of course it doesn't help that China's growth over the past 10 years also appears to have been a mirage, as evidenced by the vast number of empty high rise apartment buildings that were built with borrowed funds.

Scott Grannis said...

Fred: I misdiagnosed QE in its early stages I thought it would lead to higher inflation but I was wrong. Once I realized my mistake, which I think happened in late 2009, I came to understand that QE was a necessary response to a big increase in risk aversion. For most of the past year I have argued that QE should be unwound due to the rise in confidence and the increase in risk appetites. But with the onset of fears sparked by tariff wars and slowing growth in Europe and China, I have argued that the Fed should pause. The fed has an obligation to respond to changes in the worlds demand for mone. To ignore that is dangerous.

Benjamin Cole said...

Great wrap up.

Scott Grannis is more circumspect than me, but I will celebrate the last month's job figures. Wow!

Americans are going back to work, thanks to the strong demand for labor. Wages are rising, which is a good thing.

I want to see full-tilt boogie boom times in Fat City.

On China? The Communist Party of China does not see trade and commerce the way Westerners do. Hey, they do not even see human rights the way we do. I am not so sure that disengaging from China is the worst course. Trump may be crazy, but he also may be right.

sgt.red.blue.red said...

I love these faux fear bouts. It gives me the opportunity to buy equity securities at a discount from what they were recently selling for. I, for the life of me, don't understand the panic selling. Warren Buffett says, 'be greedy when others are fearful'. Investors like Warren aren't DUMPING stocks willy nilly during these selloffs. They deploy cash. Following his example, I have been adding equity securities via domestic ETF's and mutual funds on down days all fall and winter.

marcusbalbus said...

fred: to restate pangloss's answer: the fed needs to support the stock market and risk assets, or so to speak embed and advance income inequality. at least that's what he thinks right now, maybe. sometimes. on further reflection.....

randy said...

JBD and Benjamin,

Trump gets credit for focusing on China's unfair trade practices. But we shouldn't give him ANY credit for smart policy moves to combat that. He's still a hack deal maker, but he's not playing with family money anymore. The stakes are not his to gamble. That cannot be over-stated. He's not smart, much less strategic. He's just very lucky to be leading the strongest hand in history - which greatly increases his chances of winning even though he is an ill-informed undisciplined
lazy SOB. But we are all rooting for him at this point. MAGA.

steve said...

So now a cartoon character and anti-pangloss are beating up on an economist who is writing a FREE blog-the information of which is for anyone's perusal to do with what they want.

I don't believe Scott has ever held himself out as an investment adviser-not that any are worth a damn.

I find Scott's perspective perspicacious (don't give me grief those two words, ok?) and make my OWN investment decisions after gleaning much more information.

You should all so the same.

Fred Flinstone said...

I'm not criticizing his investment advice; just the inconsistency in his analysis of fed policy. Moreover, although I'm just a lawyer, I did get an A+ in economics my first year at Cornell back in 1980. 😀

Larry said...

Hello Scott,
I love reading your blog, it is educational and informative about current conditions in the market. Some of the comments are disturbing in a ridiculous sort of way, as to question the commenters mindset.

So anyway I see you like, "Wealth and Poverty" -George Gilder. Have you read his book,"Knowledge and Power"? If so, any comments?

Thank You for your BLOG!

Clinton Condo said...

Dr. Grannis, thank you for your detailed information and professional understanding. It is always so helpful.

But I subscribe to Flinstone's view. Hard not to see a dramatic slowdown in UK/Germany and even China and how this won't impact the US. Also, hard not to see RE as a harbinger of things to come. Even harder not to pay attention to CEOs 30,000 feet overview of the landscape (ie., Fedex, Apple and others).

The Yellens of the world won't say it, it is always goldilocks somewhere. More looking like an attempt to stabilize markets. Don't forget, people kept buying the market even after Bear Stearns in 08! And in 1929 the top financial caciques not just recommended buying stock after the crash, they got a ton for themselves too! A nice gain 2 quarters after that. We know the rest.

Ron T said...

Scott, thank you for your economic analysis and commentary. I appreciate the effort and find it very helpful.

WealthMony said...

So, Fred, you responded to Steve, but you've made no comment regarding Scott's answer to your question. Do you have one to share with the rest of us?

Fred Flinstone said...

I am concerned that Scott would endorse a change in Fed policy whenever the market has a tantrum. If the facts support raising rates so be it. Perhaps inflation is not a threat and rates should remain where they are but they are certainly very low by historical measures. I do not see how Scott can use his charts to argue that the economy is very strong on the one hand and then say the markets can't handle a modest increase in interest rates on the other. It would seem to me that the market is saying the only thing holding the economy up is artificially low interest rates and that is unsettling. I certainly defer to others who study these issues for a living and hope I am wrong (but I hold a substantial amount of cash outside of retirement accounts just in case I'm not!)

sgt.red.blue.red said...

Fred, Scott is seeing worldwide slowing dragging down a relatively strong US corporate outlook. The recent weakness in the US dollar means foreigners are seeing the next move down in interest US rates may be not far off. That’s also is what the ‘market’ is seeing. Of course there’ll b a lag between lower rates and the benefits the lower rates will provide the US economy.

If your investment horizon is 3-5 years or longer, you’ll be amply rewarded in deploying cash when markets give you the chance to buy at 10-20 percent discounts from recent highs, as it recently has.

I’m sure Warren Buffett has been using the selloff to his (and BH shareholders) advantage.

Disclosure: Long BrkA since 1995, BrkB.

Atul Davda said...
This comment has been removed by the author.
steve said...

I used to do business with Rusty Olsen, the pension director at Eastman Kodak-literally an icon in the biz. He used to say that cash was anathema-and this was back in the late 80's and 90's when cash earned very respectable returns! He wanted to 100% invested in stocks all the time. His perspective was that A) you could not time the market and B) over the long run, stocks outperform all other assets. He was right of course. This is the main reason investors under perform the S&P 500. They tend to sell when stocks are lower and buy when they are higher. Rusty used to say that if stocks do NOT out perform all other assets over 95% of rolling 20 year time frames we have much bigger problems. If you study the data closely you will see Rusty was 100% correct; there are few to zero 20 year rolling time frames when stocks to not out perform all major assets. So are you investing for the long run or are you "market timing"?

Good luck with the latter.

marcusbalbus said...

FRED; YOU ARE NOT WRONG. THIS IS WHY I HAVE BEEN TELLING PANGLOSS TO STOP GIVING INVESTMENT ADVICE.

Ron T said...

Perhaps the FED is actually getting around to seeing/acknowledging weakening data, widening spreads and tightening financial conditions and NOT reacting to a "tantrum." The market was already doing the same. They're both focused on the same catalysts.

Scott Grannis said...

Fred: I am not endorsing "a change in Fed policy whenever the market has a tantrum." Here's my position: The US economy is fundamentally strong, and likely the strongest of all global economies. But the Eurozone economy is much less strong and appears to be weakening on the margin. The Chinese economy is definitely weakening on the margin, as reflected in the huge decline in Chinese equities this past year. Markets are concerned that trade/tariff wars will make things even worse, particularly for China, and that a very weak China might well prove to be a serious drag on the US economy. Concerns about the health of the global economy abound, and those fears translate into strong demand for the safety of cash. Rising demand for money, particularly of the dollar variety, is something the Fed must take into consideration. (The job of any central bank is to balance the supply of money relative to the demand for money, otherwise deflation or inflation will result.) The Chinese are not throwing a tantrum and neither are the Europeans, but they are concerned. With global tensions on the rise and demand for money on the rise, against a backdrop of low and declining inflation, it makes no sense at all for the Fed to raise interest rates.

Johnny Bee Dawg said...

Market timing has worked out great, especially for those of us investing for the long term. Buffett has always done it. It’s worked out great for him, too. Be less aggressive when risk measures are high and companies are dear. Be more aggressive when risk measures are low and stocks are cheap. Greedy when others are fearful, and fearful when others are greedy.

Get out of the way when the Fed speaks politically, disregards data, and tries to make markets fall. Get back in when they stop that, or at least announce a pause.

Time tested. Price matters. In what other world would you buy things regardless of price??

steve said...

"Market timing has worked out great, especially for those of us investing for the long term."

Am oxymoron if I ever saw one. Virtually every piece of research shows market timing is a costly waste of time-especially "over the long run."

marcusbalbus said...

JBD should change to JBG: replacing dog with golem.

Johnny Bee Dawg said...

LOL at the hubris. “Virtually every piece of research” forgot to evaluate millions of anonymous investors. And they definitely forgot to include Warren Buffett in their research...the grand daddy of all market timers.

Price matters, but not to Steve!

damien said...

I think your crystal ball needs batteries, I have love CBP for years, but not really seeing the bold assertions like used to, CBP is becoming a 900 year old chart yoda with the same VIX, treasury..etc tea leaves ...get some of the Mendoza porteno spice going and throw us some bones we can cash in on....

steve said...

In the past 11 trading days the S&P 500 has gained 10.5%. So if you were unfortunate enough to "time" the market by selling sometime during the December swoon you have missed out on one of the fastest 10%+ moves EVER. Moreover, you must be asking yourself "what now"?

Of course if you're JBD, the koolaid drinking Trumpite, you have perfect fore knowledge so you must have bought on 12/24...

Johnny Bee Dawg said...

No, I sold in OCT and bought the day after Christmas.
Gave all the reasons in this very comments section. But you said "we just cant know".
Markets tell you what to do. If you listen.
Didn't catch the top or the bottom. And didn't need to. Im ahead.

Price matters to everybody but Steve. Hubris.
Powell gave us the top, and Trump gave us the bottom.
We will just have to see how it goes.

Al said...

Can we block Marcus and Steve?

These guys are majorly annoying.

marcusbalbus said...

AI: pure brilliance. silence dissent. extrapolating, when does it stuff a sock your pie hole?

steve said...

Well for once I have to agree with Marcus on this one. Aside from an outright churlish comment, I see no reason you can't just gloss over anything you disagree with.

Kenneth said...

Scott,
I want to express my appreciation for your blog. I have been reading it for ten years and feel very fortunate that I stumbled upon it in September 2008. Your work is terrific in so many ways but if I were to summarize I would say you are really good at zeroing in on what is really going on and explaining it clearly. And your track record is outstanding. I hope you continue to publish. I hope you and your family have a great year.
Kenneth

Al said...

Steve your okay usually, although this round you and Marcus were on the annoying bandwagon together being negative towards Scott who does this out of his free time. This information is so good that you guys ruin it with your crap.

Usually its just Marcus. Marcus is just negative and annoying. Would be nice to block his IP.

Fred Flinstone said...

While I'm sure Scott would prefer civilized debate over insults, I also doubt he is a snowflake who melts when someone either disagrees with him or slings a little mud his way. I think it comes with the territory when you blog. Absent a comment truly beyond the pale, I prefer freedom of expression. The repartee between JBD and Marcus is hilarious.

steve said...

If you back at my comments I have nothing negative to say about Scott. Quite the opposite. I DO have negative things to say about "market timing" but we'll let that one go.

I agree that Marcus can be annoying but this is a public forum and unless someone writes something particularly offensive I think we should just smirk and move on.

Obviously that is Scott's position also otherwise we'd see less comments from Marcus.

marcusbalbus said...

AI: 1. pangloss does not blog "for free"; he harvests repetitive mostly affirmative comments that increase his endorphin levels. 2. pangloss is pangloss, QED re why criticize. 3. the fundamental flaw beyond being pangloss in panlgoss's writings and knowledge base is he has never managed money, only charts. AI, your fundamental flaw is probably chromosomal.

Scott Grannis said...

Marcus: When I retired over 11 years ago, I was Chief Economist of Western Asset Management. At the time, Western was managing roughly $900 billion, and I was part of the investment strategy team. Since my retirement I have been managing money for numerous family members and friends, as well as my own portfolio.

DownSouth said...

marcus: Please do us all a favor and share with us a link for your blog. By doing so, you will allow each reader of CBP to decide on our own if we want read anything you care to share.

In the meantime, please recognize that the vast majority of readers of CBP do not care for your tone and your acidic words, and they we find value in what Scott has to say - that's why we're here on his site.

We can surely disagree about interpreting the world of economics without resorting to 2nd grade rantings - of course, I am confident that you'll find fault in my comments as well.

Harry said...

Scott: I am a huge Nick Murray disciple, and he raves about your blog. I started following it in November, and find it hugely entertaining, informative, and helpful. After reading a few of the knuckleheads on this COMMENTS section, I'll stay away from this nonsense and stick to reading your blog only. The world is full of people who need an audience; I stick to and listen to positive, reasonable, rational, mature folks--you are definitely one, as are Murray, Peter Diamandis, and others.

Keep up the good work, and thank you for your research, time, and expertise. It is invaluable to some folks.