Friday, October 30, 2020

Timely indicators still quite positive

While we wait for the results of next week's election, here are just a few charts of timely economic indicators (all based on very recent daily and weekly data) that show continuing improvement in the economy:

Chart #1

Chart #1 is a very timely compilation of high-frequency weekly economic indicators designed by the NY Fed. It shows continued and rather dramatic improvement (aka a V-shaped recovery).

Chart #2

Chart #2 shows the amount of gasoline supplied, which as of last week was only 7.7% below the level of last year. 

Chart #3
Charer #4
Passenger air traffic (Chart #3) is up only modestly over the past month, but as Chart #4 shows, it continues to improve relative to the levels of last year at this time. This would probably be best described as a U-shaped or gradual recovery. It's going to have to improve significantly before we can conclude that economic activity is getting back to normal.

Chart #5

Chart #5 shows continuing claims for unemployment, which continue to decline rather dramatically. Lots of people are going back to work. My son, who has been furloughed since April, was recently notified that he is being called back to work starting November 9th.

Tuesday, October 27, 2020

Entering the home stretch with hugely mixed signals

As we enter the home stretch in what could prove to be a monumentally important election, I doubt that any honest observer has strong convictions regarding the election's outcome. The implications for the economy are potentially huge: a second term for Trump arguably could put the economy back on a stronger growth track, while a Biden presidency coupled with a Democratic Senate majority would likely give rise to significant obstacles to growth such as much higher tax rates, more regulatory burdens (e.g., an end to fracking and eventually the entire petroleum industry), enormous compliance costs for green energy initiatives, expanded income redistribution efforts, and a more activist industrial policy. If the market expected a Biden/Democrat sweep, I have to believe that stock prices would have been trending lower in recent months, instead of higher. Yet the polls appear to overwhelmingly support a Biden win, as do the betting markets. In any event, never in my lifetime have we had so personally polarizing a president as Trump, and never before have we seen the mainstream media so vociferously, overwhelmingly, and blatantly in support of the challenger—and so antagonistic to the incumbent. 

The personalities of Trump and Biden could not be more opposite. Trump is a hardscrabble billionaire businessman devoid of social graces, while Biden is the epitome of a career politician, albeit one with a checkered past and few if any significant accomplishments. It's not surprising that both have skeletons in their closets, but the Democrats and the press spent most of the last 4 years trying in vain to dig up evidence of Trump's malfeasances while ignoring Biden's. The Democrats went on to impeach Trump over a supposed quid pro quo phone call, but now evidence is surfacing of the Biden family's ties to Chinese business interests and apparent influence peddling. Trump is bursting with energy, while Biden is suffering from old age and the beginnings of dementia. Trump has shaken off the Covid virus while maintaining an active schedule, while Biden has been hunkered down in his basement for months in fear of that same virus. Trump's rallies are many and massive, while Biden's are few and subdued. The "enthusiasm gap" hugely favors Trump, while the polls and the pundits hugely favor Biden. Trump chose a competent and successful person to be his Vice President, while Biden gave the nod to an unliked and unimpressive woman because she ticked the politically correct race and gender boxes. In the end, Biden's strongest selling point is that he is not Trump.

To make matters worse, it's possible that we won't know the results of the election for an unbearably long time. Potential risks cloud the horizon in almost every direction, but the market is not ignoring this. Risk aversion is still abundant and visible, especially in the levels of the Vix index and Treasury yields. And yet the economic statistics of late paint a very promising picture of a V-shaped recovery. I'm cautiously optimistic, as I explain below.

Chart #1

Chart #1 shows how rising fears have accompanied market declines. The Vix index, currently just over 33, is significantly higher than what we have observed during times of relatively tranquility (i.e., 10-15), but substantially less than the panic levels we saw at the outset of the Covid crisis. The market is worried, but not in a panicked sense. 10-yr Treasury yields, however, are very near their lowest level in all of history, as are real yields on TIPS. Inflation expectations, in the meantime, are "normal," averaging about 1.7% for the foreseeable future. Low nominal and real yields are therefore not indicative of deflation fears—they are rather clear signs of a lack of confidence in future growth. I hasten to add that yields are low not because the Fed has made them so; they are low because the demand for Treasuries and safe cash equivalents is intense, and that demand, in turn, can only be driven by the market's strong preference for risk aversion. 

Chart #2

Chart #2 shows that new orders for capital goods—the seed corn of future productivity gains and a good barometer of business' confidence in the future—have rebounded strongly in recent months. This proxy for business investment is still relatively weak when viewed from an historical perspective (capex was much strong in previous economic expansions), but on the margin it has increased at an impressive pace of late. 

Chart #3

Chart #3 highlights the very strong increases in existing home sales in recent months. The housing market is on fire!

Chart #4

Chart #4 shows impressive strength as well in new home construction. Moreover, home builders have never been so optimistic about the future of residential construction. This foreshadows further impressive gains in housing starts and home sales in the months to come.

Chart #5

I don't normally pay much attention to the regional Fed manufacturing surveys, but as Chart #5 shows, conditions in the Richmond area are rather spectacular. Surely a V-shaped recovery of sorts.

Chart #6

Chart #6 shows a similar pattern—though not quite as strong—in the Dallas Fed manufacturing survey. Both Charts #5 and #6 contain data released yesterday and today. 

Chart #7

Chart #7 shows an index of non-energy industrial commodity prices. This also reflects a V-shaped recovery of impressive proportions, and it is driven not just by improving conditions in the U.S., but also in global economic activity. If nothing else, this is a good sign that there is no shortage of money in the world these days.

Chart #8

Third quarter GDP numbers will be released on Thursday, and the market is currently expecting a 32% annualized increase in real GDP. I've plotted that result in Chart #8. Even an impressive gain such as this is not enough, however, to erase the losses of the first half of the year. And compared to the long-term trend growth of real GDP (blue line), today's economy is about $4.5 trillion smaller than it otherwise might have been had we not had the slow-growth Obama recovery and the devastating Covid crisis. That translates into a "shortfall" of about 20%. Given our recent history of over a dozen years of sub-par growth mixed with two recessions, it's no wonder the market is having trouble getting optimistic about the future. 

I have not yet succumbed to pessimism, however. My hopes for the future are sustained by 1) the numerous and growing signs of a V-shaped recovery, 2) impressive progress in developing therapeutics and vaccines for Covid, 3) infection and case fatality rates for Covid that are coming in much lower than feared, 3) my enduring belief that the American public will invariably choose growth over redistributionist policies, and 4) the obvious signs of enthusiasm among Trump voters. 

Wednesday, October 14, 2020

The economic tea leaves look favorable

Here's my current reading of the economic tea leaves: 1) the September CPI inflation release confirms that ex-energy inflation continues on the 2% per year trend which has prevailed for almost two decades; 2) Small Business Optimism has rebounded strongly and confirms the presence of a V-shaped recovery; 3) very low real interest rates on Treasuries confirm that safety is extremely expensive, Treasuries are a bad deal for investors and a great deal for the federal government; 4) stock prices continue to drift higher, confirming an improving economic and favorable political environment; 5) commodity prices have staged a strong V-shaped recovery, which suggests the global economic outlook has improved dramatically; and 6) TSA throughput says air travel is recovering at only a modest pace (not everything is coming up roses).

Near and dear to my heart, meanwhile, was Apple's unveiling yesterday of its iPhone 12 models. I've been an investor in and a fan of AAPL for a very long time and have had optimistic posts on the company over the years. To my mind, the technological advances and capabilities of Apple's new models are breath-taking, not to mention beautiful to look at. This is one more of many examples of how advanced technology has enriched our lives by orders of magnitude while at the same time becoming accessible to just about anyone. Apple continues to impress, and I'll be ordering a new iPhone 12 Pro Friday morning.

Now for the charts:

Chart #1

Chart #1 plots the ex-energy version of the CPI on a log scale, superimposed on a line that increases at a 2% pace each year. I use ex-energy inflation because energy prices are by far the most volatile component of any inflation index—something the Fed cannot possibly offset or attempt to control. That inflation by this measure has averaged 2% per year for over 17 years is remarkable, although I would prefer to see inflation averaging closer to 1% or less.

Chart #2


Charts #2 and #3 show the impressive results of the September survey of small businesses. Overall optimism has surged in the past few months, as have hiring plans. Despite the still-existing legions of the unemployed, the majority of small businesses report having difficulty filling job vacancies with qualified people. Experience and education are still in demand.

Chart #4

Chart #4 shows the inflation-adjusted yield on 10-yr Treasuries. Nominal yields are a mere 0.7%, and the core rate of CPI inflation (CPI ex food and energy) is currently 1.7%. That leaves an investor with a loss of purchasing power of 1% every year for the next 10 years! (That means a real return of -1%.) This loss of purchasing power obviously hurts the investor, but it's a boon to the US Treasury, which gets to repay its obligations with cheaper dollars. Treasury has issued about $3.5 trillion of new debt since last March, so thanks to very low real interest rates (which are a function of very strong demand for the safety of Treasury notes and bonds) and ongoing inflation, the real burden of that debt will decline by about $35 billion every year for the foreseeable future. Those buying these bonds, of course, will suffer a $35 billion loss. 

Chart #5

Chart #5 shows the real and nominal yield on 10-yr Treasuries (blue and red lines) and the difference between the two (green), which is the market's expectation for what CPI inflation will average over the next 10 years: 1.75%. The bond market fully expects nominal yields to remain firmly below the rate of inflation for a very long time. That adds up to either a) tremendous respect for the prowess and power of the Fed, b) a huge amount of risk aversion on the part of the investing public, and/or c) a very negative view of the economy's ability to thrive for the foreseeable future. I'd say the latter two are the obvious choices: risk aversion is very strong and economic optimism is in short supply.  

Chart #6

Chart #7

Charts #6 and #7 show that air travel has picked up modestly in the past month to its highest pre-pandemic level. Yet it is still 65% below the levels which prevailed at this time last year. It's a slow takeoff for this industry.

Chart #8

Chart #8 shows the CRB Raw Industrials commodity index, which has staged a complete and V-shaped recovery over the past 5 months. This is a good indication that the global economic outlook has improved rather dramatically in the wake of the Covid shutdown fever which swept almost very country in the world (with a few notable exceptions like Sweden and Switzerland).

Chart #9

We finish with Chart #9, which by now is quite familiar to readers. On balance, stock prices have been edging higher over the past several years, but the Vix "fear index" is still elevated. The market is cautious, as it should be, because there still are plenty of unknowns in our future, the most obvious of which is next month's election, and the potentially huge changes in fiscal policy (most disturbing being higher taxes) that could be set in motion as a result. Bloomberg (alert: strong liberal bias) tells me the market is cheering Biden's lead in the polls, but I worry that his pledge to raise taxes and re-regulate the economy (e.g., Green New Deal) would deal a significant blow to our still-struggling economy and the present discounted value of future corporate profits (i.e., stock prices) if he wins.

If I were to guess the election result that is priced in to the market, I would say the market is discounting the polls—which show Biden with a strong lead—and betting that Trump's odds of winning are favorable: a replay of sorts of what happened 4 years ago. My confidence in this assessment is not high, but in my defense I note that 56% of Americans say they are better off today than they were 4 years ago. I also note that the NY Times' science reporter recently noted that "Experts are saying, with genuine confidence, that the pandemic in the United States will be over far sooner than they expected, possibly by the middle of next year." Moreover, the Trump administration's "Operation Warp Speed — the government’s agreement to subsidize vaccine companies’ clinical trials and manufacturing costs — appears to have been working with remarkable efficiency."

UPDATE (10/15/20): Just discovered this series produced by the NY Federal Reserve, which is a compilation of 10 indicators that are released on a weekly basis, so it's a pretty good coincident indictor of the economy's health. As you can see in Chart #10, things are improving in V-shaped fashion:

Chart #10