Tuesday, September 1, 2015

Chart updates III

Unusually high volatility and widespread nervousness continue to plague the markets, but there is still little or no evidence of any significant deterioration in the economic and financial fundamentals. On the contrary, recent releases show that the construction sector is booming and auto sales are at a 10-year high. Moreover, swap spreads—a key current and leading indicator of economic and financial market health—remain quite low, suggesting systemic risk is de minimus.

The Vix index (implied equity volatility) jumped to 32 today. Even though that is substantially elevated from the 12-ish value that prevails during periods of "normality," it is nevertheless much less than the panic high of 53 that was briefly reached last week. A similar result holds for the ratio of the Vix to the 10-yr yield (a ratio I prefer since the 10-yr yield is a good indicator of the market's outlook for economic growth; thus, a high level of the Vix/10-yr yield is indicative of a lot of nervousness and a lot of pessimism). A high Vix/10-yr ratio tells us that the market is pricing in some pretty awful stuff. If the reality subsequently proves to be less awful than the expectation, that forms a solid basis for a rally. I think we'll see this once again.

The ISM manufacturing index has been a little soft of late, but it is still suggesting that overall economic growth is 2-3%, which is what the economy has been averaging throughout the current expansion. Although soft, the ISM index is not even close to predicting a recession.

July construction activity was much stronger than expected, and it came on top of substantial upward revisions to prior months' data. Construction activity is booming, growing at strong double-digit rates. This is a very positive development.

Export orders were the weakest component of the August ISM indices. It's clear that the market is worrying more about developments overseas—notably a slowdown in the Chinese economy—than it is about anything going on in the U.S. economy. In that regard, I note once again that U.S. exports to China represent only 0.7% of our GDP. China is undoubtedly slowing down, but this is not a significant threat to the U.S. economy. On the contrary, the recent weakness in the yuan will ensure that Chinese goods reach our shores with low and very attractive prices. That is an ongoing boon for U.S. consumers.

Donald Trump needs to take a refresher course in the dynamics of international trade. If anyone is taking advantage of anyone else, it's the U.S. taking advantage of China, and we would be crazy to complain about our ability to buy incredible Chinese-manufactured goods at incredible prices (e.g., iPhones).

August vehicle sales were stronger than expected, and they now stand at a 10-yr high. This chart is a classic V-shaped recovery chart. Consumers are doing just fine.

The prices of gold and 5-yr TIPS continue to follow a slowly declining trend. This means that the world's demand for "safe" assets continues to moderate, and that dilutes the message coming from the elevated Vix/10-yr ratio. If things were really falling apart, the world would be much more anxious to seek out the safety of gold and TIPS.

Swap spreads have been excellent forward-looking indicators of economic distress. At current levels, they are telling us that the U.S. and Eurozone economies remain healthy.

High-yield spreads are a bit elevated, but still far below the level which would signal a substantial weakening of the economy. Most of the spread widening is coming from the energy sector, and spreads there have backed off of late, thanks to a significant bounce in oil prices. Swap spreads are very low, and that suggests that the recent bout of nerves in the corporate bond market is likely to pass.

Bloomberg's measure of financial conditions has deteriorated somewhat over the past year, but it is still far above the super-distressed levels of 2008. Conditions were much worse in 2011, around the time of the PIIGS crisis, than they are today.

Declining crude oil prices explain most of the decline in near-term inflation expectations. Nothing unusual at all about this. Lower energy prices put downward pressure on inflation, while at the same time enabling an increase in global economic activity. Lower inflation and stronger growth are a great combination!

Gold and commodity prices continue to trend lower, but they are still very high relative to their 2001 lows. This is not so much a "collapse" in prices as it is a return to more normal levels. As with energy, cheaper commodity prices make it easier for the global economy to grow, especially when lower commodity prices are the result of big increases in commodity supplies and production. For proof of the latter, look no further than the 85% increase in U.S. crude oil production over the past 5 years:


Benjamin Cole said...

Great charts, great post.

However, I think Scott Grannis is unfortunately right: we will see low growth, low inflation and very low interest rates for a long, long time.

If that is a good outcome, then good.

I would prefer more robust growth and I would be willing to tolerate moderate rates of inflation to get it.

Donald Trump?

The guy made $10 billion dollars and wears a hat that says "Make America Great Again". The other GOP candidates look pint-sized in comparison, by GOP standards.

Maybe Trump will be good for America. Time will tell.

marcusbalbus said...

we get it. you are an optimist; even if somewhat blinkered, you are an optimist. but really, just post new info/views. really detracts from this blog that you update continually the same view/data. btw, it's "de minimis"

Roy said...

"If anyone is taking advantage of anyone else, it's the U.S. taking advantage of China, and we would be crazy to complain about our ability to buy incredible Chinese-manufactured goods at incredible prices "

Absolutely. The U.S. is also taking advantage of the Eurozone, now that it has depreciated its currency everything is so much cheaper to import for US household!

How wonderful it would be if all foreign countries immediately depreciate their currencies against the USD and financially repress their households to reduce local wages and reduce local consumption. After all, consumption outside the U.S. does not matter, does it?

The U.S. should also be greatly thankful to the Chines for putting trillions of dollars (which they got thanks to the oh so great cheap products) into U.S. treasuries instead of spending it in the real world economy. But that would be awful for sure, lets hope they get more US dollars from US consumers and stick them straight into treasuries.

Thank you!

William said...

From what I have been able to read, it is not just an issue of China's economy slowing and US minimal exports to China. The slowing Chinese economy, especially the manufacturing and construction sides, are having a profound effect on other economies not only in Asia but also in Africa and South America. It is also affecting German auto manufacturers whose sales in China have slowed dramatically.

Korean's exports fell 15%, primarily because of China. Macau’s GDP Plunged 26% Last Quarter. I don't immediately have the specific numbers but commodity producing nation have taken significant hits to their GDPs: Canada has reported two consecutive quarters of negative GDP growth - recession? Similar stories in Australia, Indonesia, Brazil, etc. Further many companies in these commodity countries have borrowed large amount of debt in US dollars. Meanwhile their nations' currencies have already fallen against the US dollar making repayment more expensive at a time when their revenues are falling.

Finally, China may have large national reserves due to decades of trade surpluses but internally China for 3 decades produced rapid growth by encouraging provinces, cites and state owned corporations to borrow and spend. There are entire cities built out in some provinces with few occupants. Too many manufacturing plants were built. High speed rail rushed to completion. Etc. Etc. The result was that debt in China has grown even faster than their rapid GDP. Its now 200% of GDP and growing. There are bad loans galore at the nation's banks. China is at a turning point where encouraging borrowing to build more doesn't work any more.

It is becoming a vicious cycle: China's ponsi / borrowing scheme is coming to an end; causing a slowdown in other nations around the world; causing less demand for Chinese goods;; causing a further slowing of Chinese factories, etc. AND CAUSING LESS DEMAND FOR US GOODS!!

It's not just about US exports to China. It's a further global slowdown when global growth was already weak.

William said...

Correction: Just read China's debt is 280% of gross domestic product.

Johnny Bee Dawg said...

Many thanks for updating these most important charts during volatile markets. Very helpful for those of us who are profiting from the info. And thanks for being a realist and pointing out the most pertinent data and evidence of the underlying fundamental picture. Your timely updates are extremely helpful.

Benjamin Cole said...

Re China debt: funny thing about government debt. The Bank of Japan has purchased about one third of Japanese bonds outstanding.

People used to talk about how much the Japanese government owed, although they owed it to the Japanese public not foreigners.

Now one third of Japanese national debt has been eliminated. By the way, the Bank of Japan does not pay interest on excess reserves. Basically the Bank of Japan has swapped freshly digitized cash for bonds.

This is a very uncomfortable topic for many. But evidently a central bank has the power to monetize debt and without inflationary consequences.

PS. do not tell Congress

Unknown said...

Who owns the China debt? Just ignorant but curious as to who is holding the bag.

William said...
This comment has been removed by the author.
William said...

Wall Street Journal late this afternoon

"Airports from Seattle to Amsterdam are reporting a fall-off in cargo traffic to and from Asia, in what transportation executives and analysts say is a worrying sign for the health of global trade.

The data, released in recent days by individual airport authorities, brought to an end a months-long stretch of rapid growth in air freight volumes across the U.S. and Europe. The abrupt reversal demonstrated how rapidly economic problems in China and other emerging markets have already reduced the flow of goods around the world."


"South Korean trade sinks, manufacturing softens in Malaysia and Vietnam, while Australia is expected to report a rare quarterly contraction.

A startling plunge in South Korean exports sharpened the picture on Tuesday of how China’s economic slowdown is rippling across Asia. The 14.7% decline in August from a year earlier, driven in part by slack demand from South Korea’s largest trading partner, China, amounts to the first statistical evidence of regional trade’s decline...

Resource-rich Australia, among the biggest dependents on China’s commodities appetite, is now ripe for a recession after 24 years without one, some economists warn. These people predict Australia will report a contraction in the second quarter....

Japan’s economy contracted in the second quarter and concerns are growing it will do so again in the third, as businesses grapple with falling demand from China. Japan’s exports to China fell 10.8% from January to June and are expected to remain weak for the rest of the year....

Two other regional economies, Malaysia and Vietnam, on Tuesday announced manufacturing declines for August, after Beijing’s yuan depreciation cut the cost of Chinese goods....


Mark said...

Thanks Scott -I really enjoy the analysis you do. I wonder how anybody learns such things. Nonetheless, have you ever done a chart that overlays swap spreads with SP500 for US or Eurozone swap spread with Europeaon Stoxx 50?

Mark Eames

Scott Grannis said...

Mark: swap spreads are good predictors of economic and financial market health, and thus of recessions. But we don't have a very long history of swap spreads, so we can't say they are bulletproof indicators. Their correlation to stock prices is much weaker than their correlation to the business cycle. But that is of course just another way of saying that the stock market has forecast 10 of the past 5 recessions.