On Civil Disobedience and improving prospects for growth

Everyone by now has heard about my governor's politically incorrect faux pas at The French Laundry restaurant in Napa. To make matters worse, LA County on Monday decreed that in-person dining (outdoor only had been the rule so far) at all county restaurants would no longer be acceptable starting Thanksgiving Day. Wow! Think of all the restaurants that booked tables and bought food in preparation for this! They are hurting, and not a few have already announced they are closing for good. Who wants to run a restaurant these days, when one day they encourage you to invest in outdoor patio dining and the next day they change their mind? 

Under Gavin Newsom's execrable leadership, California is really struggling. Fortunately, it seems that a number of police departments have decided not to enforce Newsom's limits on Thanksgiving family dinners, and a number of restaurants have decided to remain open on Thanksgiving. Thank goodness. Civil Disobedience is on the rise!

My friend Hector Cademartori has memorialized Newsom's latest foolishness with a new cartoon:

A few days ago, Zero Hedge caught my eye with this comment: "More than 1 million people traveled through American airports on Friday, according to data from the Transportation Security Administration, fueling fears of even greater spread of the virus." So I updated my charts to see whether this was a big deal or not. Turns out there has been only a modest uptick in air travel in the past month.

Chart #1

Chart #2

Chart #1 shows the daily and 7-day moving average of the number of people passing through TSA airport checkpoints. Chart #2 compares the 7-day moving average from this year with the same days from last year. On a 7-day moving average basis, the latest datapoint is only slightly higher than the previous high witnessed in mid-October. Comparing this year to last year at the same time, the percentage decline lessened a bit, rising from a previous high of -62% at the end of October to -60% as of yesterday.

Chart #3

As Chart #3 shows, there has been a modest decline in the Vix "fear index" since the end of October, and a correspondingly modest rise in equity prices, which is probably due to the market breathing a sigh of relief that the uncertainties surrounding the US elections have declined. In any event, the stock market is not greatly concerned about the "second wave" Covid flareup, most likely because we now know there are at least two vaccines that will be available shortly, with more likely on the way. The electorate seems to be regaining some tolerance for risk these days, as witnessed by rising equity prices and increasing cases of civil disobedience around the country. Hooray!

Chart #4

Increased tolerance for risk might explain why gold—almost alone among commodities—has dropped rather precipitously in the past month or so. As Chart #4 shows, gold prices had probably soared a bit too high and are now coming back to semblance of reason. Both gold and TIPS prices had benefited in recent years from the perception that the economic outlook was being threatened by political instability, Covid, and a weaker global economy. Those worries are now slowly fading. Why pay a huge price for a safe haven asset when the outlook is slowly brightening?

Chart #5

Chart #6

Chart #5 confirms that gold had become super expensive relative to crude prices, and crude, for that matter had become super cheap. Meanwhile crude remains historically very cheap compared to the value of the dollar, as Chart #6 suggests. Among the commodity universe, gold stands out as very expensive, while crude stands out as still very cheap. Expect these prices to normalize further in the months ahead.

Chart #7

Today's release of updated GDP data for Q3 brought with it the very welcome news that corporate profits surged. As Chart #7 shows, corporate profits have completely recovered to their previous highs, and remain very strong relative to GDP. This provides good fundamental support for the current level of equity prices.

Chart #8

Chart #8 is also encouraging: capital goods orders have increased meaningfully in recent months. This counts as more than a V-shaped recovery since it is a very important predictor of future economic strength.

Liquid global bond and equity market cap now totals $160 trillion

There's a lot of wealth out there. The global market capitalization of large and liquid stocks and bonds has reached the impressive sum of almost $160 trillion. (Note that this number excludes the market cap of ETFs and ADRs, to avoid double-counting.) Since late 2003, when they first started keeping track of this, the annualized rate of growth of US and global equities has been approximately 7%, which is very much in the same ballpark as the long-term total annualized return rate of US equities (not counting dividends). Which is to say there is no prima facie evidence here of any equity "bubble." The world has prospered, and we are all richer and more prosperous.

Chart #1

Bank of America/Merrill Lynch publish extensive statistics covering global bond markets, which now total about $32 trillion. They only include issues which are relative large and liquid (i.e., marketable). Bloomberg publishes the market cap of marketable global equities, and that now totals about $97 trillion. Chart #1 compares the relative sizes of these markets.

Chart #2

Global equity market cap has certainly had its ups and downs, but over time the annualized growth rate of this statistic is about 7%, as shown in Chart #2. Those who were fortunate—or smart enough—to have purchased equities at the bottom in early 2009 have since enjoyed a total return (not counting dividends) of about 270%. Similarly, the market cap of global equities today is about 60% higher than it was in late March at the height of the Covid panic. Needless to say, selling during times of panic is not a winning strategy over the long haul. Buying is. 

Chart #3

Chart #3 compares the market cap of US and non-US equities. Note how both markets have grown by about the same amount over the past 17 years. 

Chart #4

Chart #4 shows the ratio of US to non-US equity market cap. Note how the US drastically underperformed the rest of the world from late 2003 through late 2007. The US then went on to recover most of that underperformance from 2012 through today. 

NOTE TO READERS: In reaction to the very troubling and increasing spread of politically biased censorship on major social networks (e.g., Twitter, YouTube, FaceBook) I have established a presence on the rapidly-growing Parler network. Parler was established with the explicit aim of promoting free speech by avoiding all censorship, something I heartily embrace. I can be followed on Parler as @Sgrannis.

More V-shaped signs

The latest economic data available continue to show signs of a strong recovery from very-depressed lockdown levels. Economists have known for a long time that, in general terms, the deeper the recession the stronger the recovery. This axiom was disproved, however, when the recovery following the Great Recession of 2008-09 proved to be quite sub-par. I've commented on that many times over the years.

Chart #1

Today's release of the November Homebuilders' Sentiment Index (red line in Chart #1) was almost literally off the charts. We've known for some time that the housing market was doing exceptionally well since mid-year, but this makes it clear. It also suggests that housing (and related industries) is going to be doing gangbusters in the months to come. Lots of upside potential in the housing market, helped to no small degree by super-low mortgage rates and an abundance of available credit. 

Chart #2

Industrial production in the US surged from its lows, but gains in recent months have been more tempered. But as Chart #2 shows, industrial production in the US has enjoyed a much stronger recovery than in the Eurozone. Still lots of room on the upside in both regions.

Chart #3

World trade, shown in Chart #3 (but with a regrettably long lag) has clearly rebounded strongly. This is critical for nearly every country, since global trade has been a very important engine for growth and prosperity. 

Chart #4

The outlook for China has been improving for most of the past year, as reflected in the strength of the Chinese currency (blue line in Chart #4). It's important to compare the yuan's strength and weakness to the level of China's foreign exchange reserves, since this can tell us what is driving the yuan's value. In this case we see that forex reserves have been relatively steady for about the last four years. Meanwhile, the yuan's value has fluctuated considerably. What this shows is the China's central bank has not been manipulating its currency. It's maintained a relatively neutral policy stance, allowing net capital flows to drive the currency higher or lower. In the past year, capital inflows have apparently been quite strong, and since the central bank was not trying to absorb these flows (by creating more yuan and thus expanding forex reserves), the inflows resulted in a stronger yuan. In other words, strong demand for the yuan coupled with a relatively fixed supply of yuan caused the value of the yuan to rise. This most likely means that people have been more inclined to invest in China and/or less inclined to disinvest in China. 

Chart #5

Capital inflows and increased confidence have also driven the value of Chinese equities higher, as we seen in Chart #5 (blue line). A Biden presidency is much more likely to be friendly and supportive of China than Trump's has been, and the market has picked up on that. Whether this is a positive long-term development for the US remains to be seen, but in general terms whatever is good for China is good for the world. At the very least this is yet another sign of the market's "risk-on" behavior of late.

With all this good news, it pays to keep an eye on what might go wrong. My #1 pick for a nasty surprise would be the Democrats gaining control of the Senate by capturing both of Georgia's Senate seats in an early January runoff election. That would strongly tilt the balance of power to the left, whereas the current state of affairs equates to a rather benign "divided government." Government is sometime best when it governs least, as the old saying goes.

I don't expect the Democrats to regain control of the Senate (hardly anyone does, it seems), so for the time being I remain an optimist. The Fed is not about to do anything that might harm the recovery, and the federal government is not going to try to implement a Green New Deal (which would be a futile and hugely expensive undertaking that would only harm US competitiveness while doing virtually nothing to address climate change). A divided government is quite likely to avoid economy-killing tax increases, but Biden will probably manage to reverse some of Trump's beneficial de-regulation policies. I think this paints a picture of an economy that will continue to flourish in the short-term (think V-shaped), but over the longer haul will follow the same sub-par growth path established during the Obama years.

Recovery on track, politics is no longer a threat

The economic news continues to be favorable, and thus supportive of an ongoing V-shaped recovery. Now that the election dust has settled, the political news is also supportive.

Although I'm disappointed that Biden won, I am pleased to note that the much-expected "blue wave" did not materialize. Instead, we have the makings of a classic "divided government,", and that is very good news. The Republicans have substantially narrowed the Democrats' margin in the House (which in turn greatly weakens Speaker Pelosi's hand), and the Republicans are very likely to retain control of the Senate. Biden does not walk into the White House with a mandate to radically transform the American economy or to significantly raise income taxes. With luck he will prove to be a stabilizing and calming influence on the nation's nerves, rather than an existential threat to capitalism. In my view, the economy is quite able to take care of itself and prosper if it is just left alone, without any disturbing "stimulus" measures from either Washington or the Fed.

Trump's legacy can be summed up in lower taxes, greatly reduced regulatory burdens, a less-activist judicial system, and a Mid-East peace accord. Biden's legacy will be measured by how much or how little he squanders Trump's legacy.

 

Chart #1

I've been featuring Chart #1 in recent posts, because I think it's an excellent leading indicator of the global economy's health and outlook. The ratio of copper to gold prices is almost always driven by the perceived strength of the economy, since a stronger economy boosts demand for copper but depresses the demand for gold, which is a refuge from uncertainty. As the blue line shows, this ratio has turned up in recent months in convincing fashion. The 10-yr Treasury yield (red) is also quite sensitive to the market's outlook for the economy, since the expectation of a stronger economy implies that the Fed is likely to begin raising short-term rates early, rather than keeping them low in order to "support" a weak economy. Higher short-term rates in the future, coming from extremely low levels, is a good predictor of higher long-term rates. All in all, if these recent trends continue both the US and the global economic outlook will be brightening considerably.

Of course, a significant "tightening" of monetary policy and a commensurate rise in long-term rates could pose problems for the economy and thus might not be comforting news. I'm sure that higher rates at some point will be problematic, but I would argue that they are still so incredibly low (which normally would be symptomatic of a very weak economy) that they will have to rise considerably before they pose an obstacle to growth. 

Indeed, given the increasing signs of higher prices, the Fed risks allowing inflation to become endemic, and that would be very bad since ultimately it would assure us of a period of aggressive Fed tightening, which has been the proximate cause of almost every recession in the past half century.

Chart #2

Chart #2 compares the level of the dollar (blue, inverted) to the level of non-energy commodity prices. They tend to track each other pretty well over the years: a weaker dollar corresponds to higher commodity prices and vice versa. The strength of commodity prices this past year is almost certainly related to the weakness of the dollar, which in turn is a function of the Fed's "easy" monetary policy. The Fed has taken rather extreme measures to ensure that there is no shortage of dollar supply given the intense demand for dollars during the Covid recession. Dollars are abundant, and that supports higher commodity prices.

Chart #3

Chart #4

However, as Chart #3 suggests, the price of oil has responded only minimally to a weaker dollar. Oil alone stands out for its very weak response to easy money and a weaker dollar. It's therefore not hard to argue that oil is especially cheap these days. That conclusion is also supported by Chart #4, which shows that, relative to gold prices (a universal standard against which to measure all currencies), oil is quite cheap at current levels. This further suggests that betting against the prevailing wisdom that says that global warming demands a huge reduction in the world's consumption of petroleum-based energy—and the fact that oil-related stocks are very weak—might prove profitable.

Chart #5

Chart #6 updates the level of Credit Default Swap spreads, which are once again at very low levels. This is good evidence that a) liquidity is abundant, b) the outlook for corporate profits is very healthy, and c) the outlook for the economy is also quite healthy.

Chart #6

Chart #6 shows the level of 5-yr real and nominal Treasury yields, and the difference between the two (green) which is the market's expectation for what the CPI will average over the next 5 years. Inflation expectations today are around 1.6-1.7%, which is rather low compared to some past periods, but rather high considering (as the conventional wisdom would ordinarily suggest) that the economy is still plagued by a huge amount of excess capacity. I think that this confirms my hypothesis that the Fed risks remaining super-easy for too long. At the very least it suggests that the Fed is almost certainly not too tight, and that interest rates need not remain at current, extremely low levels. 

To be fair, I must note that the current level of real yields on 5-yr TIPS (-1.2%) would by itself suggest that the economic outlook is extremely weak. That's a fair characterization, but it's also true that extremely low real yields could reflect a very high degree of risk aversion: the market is obviously willing to pay a very high price for the safety of TIPS and Treasuries. 

Chart #7

Chart #7 backs up my assertion above, namely that the market is still full of risk aversion. The price of gold and the price of TIPS are trading at very elevated levels. Note, however, the early signs of a "top" in both prices. If the economy continues to improve over the course of the next year, which I think will happen, then watch for gold prices and TIPS prices to tumble.

Chart #8

Chart #9

Charts #8 and #9 compare the level and ratio US stock prices to Eurozone stock prices. US equities have very strongly outperformed their Eurozone counterparts. As the lower portion of Chart #9 shows, US equities have risen by almost 120% in the past 10 years. I'm pretty sure this is unprecedented. I hesitate to call a top to this ratio, since I have done so before and been proven wrong. But it certainly bears watching.

Chart #10

Finally, Chart #10 shows how the market is becoming less worried about the future, and that is driving equity prices higher. The Vix is still significantly above what might be considered "normal" (~12) and that is good evidence that risk aversion is still alive and well in the world.

The outlook for growth continues to improve

On the eve of our historic election, here's a collection of charts with the latest data and some brief commentary:

Chart #1

Chart #1 compares the US ISM manufacturing survey with that of the Europe. Conditions in both areas have improved dramatically in the past several months, but the US outlook is even brighter—almost as strong as it was a few years ago.

Chart #2

Chart #2 shows strong improvement in export orders for US manufacturers. This is a good sign that the global economic outlook is improving.

Chart #3

Chart #3 tells us there has been a much, much-needed improvement in manufacturers' outlook for new hiring. That also implies a new willingness to invest and expand operations.

Chart #4

Chart #4 shows that a majority of manufacturing firms are seeing price increases in the things they buy. This confirms that monetary policy is accommodative, and at the very least it means that liquidity is abundant. The Fed poses no threat to the outlook for improved growth.

Chart #5

Chart #5 compares the ratio of copper to gold prices (blue) to the level of 10-yr Treasury yields (red). Both appear to have bottomed out; that in turn is strongly suggestive of a nascent rebound in growth expectations both in the US and around the world. 10-yr Treasury yields today reached 0.9%, which is their highest post-Covid level. Yields are still extremely low from an historical perspective, which is consistent with their being still a lot of risk aversion priced into the market (i.e., people are still willing to pay extremely high prices for the safety of Treasuries). Optimism is returning, but only by a little.

Chart #6

As Chart #6 shows, the PE ratio of the S&P 500 Index is quite high (a bit over 26 as I write this). Does this mean the market is over-valued and primed for a crash? Not necessarily. The market understands that corporate profits have plenty of room to grow, being still depressed after the huge Covid-induced economic crash we are still recovering from, so an elevated PE ratio today only means that the market is pricing in an increase in future corporate profits. Today, the market expects profits (EPS) over the next year to grow by about 8% from current levels; that would leave next year's earnings per share about 12% higher than they were last year. 

Chart #7

Stocks don't exist in a vacuum, however. Investors have a choice between the expected returns on stocks or the guaranteed returns on Treasury bonds. The higher the price one pays for a security, the lower the expected return. Today, Treasuries (and their close cousin cash) are trading at very high prices historically, though they have dropped a bit of late. 

Cash is more "expensive" to own than every before: it yields either zero if held in the form of currency or in some savings deposits, and a minuscule 0.09% if held in the form of ultra-safe and extremely liquid T-bills. Meanwhile, inflation is running at least 1.5% per year. So the real return on cash is negative: holding cash implies losing about 1.5% of your purchasing power every year.

Holding cash is a losing strategy, and even holding 10-yr Treasuries (0.9% yield) is a loser in terms of purchasing power. But stocks have an earnings yield (the inverse of their PE ratio, which is the dividend yield an investor would receive if companies paid out all their earnings in the form of dividends) of about 3.8%. That represents a "risk premium" over 10-yr Treasuries of almost 2%. As Chart #7 shows, stocks today are not at all expensive relative to Treasuries (e.g., when the risk premium is negative, they are expensive). The reason stocks are "cheap" relative to Treasuries can be easily explained by the prevailing preference among investors to pay up for safety. Risk aversion is alive and well.

Chart #8

Chart #8 shows Credit Default Swap spreads, which is a measure of the cost of hedging oneself against the risk that corporate bonds default. That cost today is pretty low from an historical perspective, which means the market—despite the prevailing mood of risk aversion which makes stocks relative cheap—is fairly confident in the outlook for corporate profits and, by inference, for the health of the economy. It also indicates that liquidity is plentiful.

Chart #9

Chart #9 sums it all up. The Vix (fear) index is still quite elevated, and the stock market is trading today at about the same level as before the Covid crisis struck. The stock market is priced to some bad news (according to the Vix index), so it is not necessarily vulnerable to a negative news shock.

And with that I'm going to sit back and watch the election returns. Biden has been leading strongly in the polls until recently, and now it's possible Trump could snatch a victory from the impending jaws of defeat. It's going to be a wild ride no matter what. My fingers are crossed for Trump, mainly because I am sure his policies would be much more likely to deliver a prosperous economy than Biden's.