Aug 11, 2017 - too that the tension between Trump and McConnell can take a toll on confidence ... On a related topic, wh
Bullish Edge in Range Context Title August 11, 2017 By David Ader, Chief Macro Strategist for Informa Financial Intelligence
Ader’s Musings… * Lots of recent data point to non-inflationary muddling. CPI YoY dips to 1.7%, Real Hourly Earnings YoY sag to 0.7%. No wonder people are borrowing more, dipping into savings. * ‘Good’ vs. ‘bad’ news on JOLTS, NFIB, ULC and Productivity (see charts). Muddling is the operative word. Hiking expectations diminish further – 35% odds for move in Dec. * Sideways trading ranges remain entrenched. * Another correlation, 10s vs. copper/silver, flips a coin. * BIS vs. PIMCO on whether aging demographics point to higher or lower rates. I suppose that in the week just passed the big story that kept yields from doing anything major (other than edging lower sans drama) was the rhetoric between Trump and Kim Jong Un which is notable in itself. This hints that the domestic data was worthy of a yawn, which it was, even though my take was that it points to ongoing slow-mo growth that doesn’t do a thing to threaten more intense Fed action or provide solace to the bond bears out there. Nor, for that matter, does it do all that much for the bulls. Fence sitters rejoice. I’m de-emphasizing the bond rally. I’m not ignoring the gains or the data and have, for now, a somewhat bullish bias. The thing is it still looks like a range containment for the most part. In other words, if geopolitics, low inflation figures, softish data and dovish Fed comments can’t break these narrow trading ranges, I don’t know what will. Still, in the context of the range, the latter influences give a bullish bias perhaps exacerbated by the reduced liquidity given the calendar. “Out of office” responses are rife... Fedspeak sounded rather dovish (though I concede I may be listening too hard). Dudley spoke of the weaker dollar boosting import prices but that it will take ‘some time’ for inflation to rise to 2%. “Some time” in Fed parlance (6-12 months from Dudley) is longer than ‘some time’ in market parlance. He also said sluggish productivity was dampening wage gains which net net sounds a bit more dovish than he has been. Bullard meanwhile opined that 2% GDP may hold for the next couple of years and that inflation expectations, already low, have come off with Fed hikes. Hence there’s risk the Fed may be too aggressive on rates. Also, dovish. Evans said inflation weakness questions outlook and soft wages signal there’s some room for jobs market to run. He adds 2% inflation in the next few years is reasonable. Next few years? Really? The Fed takes a longer view of things than the market does, for sure. None of this did much to change either Fed Funds futures or any expectations for when the Fed will start its glacial balance sheet reduction. Getting back to the geopolitical stuff, I find it telling (and surprising) that markets have not responded more to the frightening exchange between Trump and Kim Jong Un. Perhaps we’ve grown accustomed to the hubristic and narcissistic egotism of these two and simply don’t take it all that seriously. Certainly, market behavior would suggest that. I don’t know if that’s particularly comforting as these two haven’t had much experience facing off each other, but China’s recent willingness to countenance sanctions does change the paradigm. We have little option but to watch how this unfolds, but I don’t trust complacency; I suppose, per tradition, that means buy gold and the VIX. Note too that the tension between Trump and McConnell can take a toll on confidence as well – tax breaks, infrastructure, etc. – but continues the narrative of this particular Administration at odds with the world. 1
Title On a related topic, while much of this last week’s data was somewhat second tier compared with NFP or CPI, there were some disappointments to note. Consumer credit, for instance, dipped in June. NFIB’s optimism was up, but compensation plans came off as did plans to increase capital spending and, at a reading of 2, Inflation remains tied with Interest Rates as small business’s least most important problem. JOLTS Openings were up (see the chart at the end) but Hires and Quits were lower (odd, no?) while the Layoffs were up a smidgen. Further, Non-Farm Productivity continues along a very muddling path while Unit Labor Costs do nothing threatening on that front. Indeed, Productivity was such that it warranted a WSJ front page story saying, “Workers’ Pace Dents Growth.’ Real Compensation actually fell on a YoY basis. Again, see the charts at the very end of this week’s Musings. PPI came in weaker-than-forecast and negative on a MoM basis. That sort of speaks for itself. In short, for the most part the most recent set of data doesn’t do much to enhance anyone’s bearish views nor is it quite weak enough to inspire a major bullish bias. The sideways range dominates a while longer. You may recall that last week I offered up some charts on things that correlate with 10-yr yields, such as the DJ Transports/Utilities ratio, JPY, Bunds.. all of which hinted at a lower yield trajectory. A reader suggested I look at the copper/gold ratio as another one of those closely correlated relationships that recently shows a rare divergence. He noted that Jeff Gundlach of DoubleLine referenced this ‘obscure’ chart as a signal for higher rates. The idea works like this. Copper is an industrial metal whose price reflects economic demand such that higher prices suggest better economic growth. Gold tends to be, like the dollar perhaps, more of a riskaversion, safe-haven, commodity. As copper outperforms, i.e. the ratio rises, it potentially signals a better economy. Simple as that. The correlation with rising yields reflects better economic conditions and all that implies for the Treasury market and monetary policy.
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Title Do note, however, that all those other correlated instruments I wrote about last week suggest 10-yr yields are more likely to go down than up. Toss in the very neutral Daily Sentiment Index and you get a sideways, neutral, implication. I don’t like to argue too much with people smarter, richer, bigger, stronger and potentially a future employer (joke) like Gundlach, but the chart could suggest that copper is set to underperform gold, no? The correlation between 10s and this ratio is strong over the last couple of years, I grant you, but I don’t really see which one leads or lags. Anyway, FYI. CHARTS AND THEMATICS: Trump is right; Obama really screwed things up. However, per the chart below, what he screwed up was the correlation between a low Presidential Approval Rating and gains to the stock market. Trump’s remarkably low Approval rating this early in his term (or at any point in a term for that matter) tends to be a harbinger of stress vis a vis equity returns. In fact, the correlation has been historically very good.
Exceptions are there. For example, after Nixon resigned, Ford’s approval soared even as stocks soured. Likewise, George Bush the younger did very well after 9/11 while stocks sold off. Obama’s approval rating held pretty much between 40-50% from 2010 onwards while the S&P 500 maintained quite solid gains YoY, generally north of 10%. And then there’s Trump. Here at 37 on the U California poll, you would think we’re on the cusp of a breakdown in stocks, especially so early in his term. I’ll offer up the cheap phrase ‘time will tell’ to suggest that time will tell. A rating of 37 is, like it or not, very low. While the chart shows that stocks CAN do okay, make gains, when the rating has been low in the past, generally it appears to come after a prior plunge (think NASDAQ bubble or the global crisis) or towards the evident end of a President’s stay at the big house. I mean White House. In short, this looks quite different which is to say unprecedented. At least for the time being anyway. IN OTHER NEWS: I’ve done my share of work on changing demographics and how those will lead to (as they seem to be doing already) a slower pace of GDP relative to the bulk of the post war era and keep upward pressure on interest rates at the margin as those looking to retire save more, in more conservative investments, and those that are retired spend less as they envision a long retirement. Note that I have included concerns that benefits (such as Social Security or pensions) may diminish, but that’s there as well.
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Title I came across to recent reports on the matter that come to very different conclusions. One from the BIS (https://goo.gl/LYzGHq) argues that “Demographics will reverse three multi-decade global trends.” Its 47 pages are nicely synopsized in a Bloomberg piece, “New Study Says Aging Populations Will Drive Higher Interest Rates.” (https://goo.gl/x5ubp5 ). The upshot differs from most things I’ve read on the topic, concluding, in essence, that the addition of cheap labor from China, EM and Eastern Europe effectively brought about a stagnation in real wages, deflationary pressures and lower interest rates. That ‘shock’, the authors contend, is reversing. (They say the hardest part to unwind will be that of low interest rates due to the high level of debt out there enforcing such a regime, making inflation that much harder to bear economically.) Read it yourself, but keep a lot of coffee in the pot. The other piece argues that it’s demographics which will sustain a low interest rate scenario for at least a decade more. From PIMCO we have, “70 is the New 65: Demographics Still Support 'Lower Rates for Longer'. (https://goo.gl/Uy5ehq). If I did PIMCO justice, their angles are: 1) The ability of older people to work and save later in life will continue to rise as jobs become less physically demanding and better health technology lifts the functional age. 2) With Social Security’s full-benefit age rising, the government is telling people to stay in their jobs, 3) while years of low rates have left impending retirees with a need to catch up on savings. 4) Labor force participation for the older cohorts is rising in the US, EZ, UK and Japan. China will join. And these are particularly compelling in my view: 5) The top quintile of US households control 75% of the wealth and 80% of household financial assets and is the cohort seeing the biggest rise in participation. In other words, they can ‘afford’ to save and data proves that’s exactly what they do. The ‘peak saver’ cohort is aging dynamically. 6) As people age they ‘de-risk’ away from stocks to bonds, and aggressively so once they hit their 60s, “The lion’s share of the $31 trillion in US household financial assets is held within – or over the next 10 years will be held within – age cohorts that typically need to grow their fixed income allocation.” 7) People in the top income quintile do not even start selling stuff (i.e. reduce their portfolios) they have until they’re about 80. In other words, the richest of us, those with 80% of the household financial assets, are NOT selling their bonds or shares until very late in life. The authors refer to all this as a ‘demographic tailwind’ for bonds over the next decade, especially munis. By the way, while I didn’t construct all the data they offered, I’m in full agreement with their conclusions. While they focus on the demand side for bonds, I tend to emphasize that the aging population will spend less – they’ve done their household formation – and so contribute less to the consumption side of the economy as they save more to fund, generally, an uncertain length of retirement and the support (entitlements, low interest income) that goes with it. And finally, the WSJ delivers a backhanded compliment to public pension funds with the story, “It was a Great Year for America’s Pensions, but Many are Still in Crisis” followed by the subheading, ‘Large public pensions are facing a funding shortfall of as much as $4 trillion because their liabilities are so large.’ (https://goo.gl/USLMwZ ).
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Title This is a big deal, of course. Even with equities reaching new highs this article makes note that large public pensions plans have just 70% of what they need to fulfill obligations, i.e. assets vs. liabilities, according to work by Wilshire Consulting. This is something I wrote about in the July 21 Musings. The mismatch is going to be a problem at some point and I presume the shortfall will be made up for by: 1) higher taxes for greater contribution, 2) reduced benefits, or 3) a combination of the two. The article made note that Connecticut, my state, earned a whopping 14.3% in the last fiscal year, an impressive achievement but one that can’t be made without market risk attached to it. Still, the fund that oversees pensions for state workers had just, gulp, 35.5% of assets against future liabilities. At least the teachers’ fund was in better shape with all of 56% of what it needs. The state’s Treasurer suggested that the latter reduce its goal of 8%. The state already did that for other workers from 8% to 6.9%. NEAR-TERM MARKET THOUGHTS: Not for nothing, as the saying goes, but I’ve come across a lot of talk about the Fed’s Jackson Hole Conference where the ECB’s Draghi is slated to speak for the first time in three years. There’s anticipation that he’ll say something about the ECB’s QE program given improved confidence in the European recovery. I note this because the Conference isn’t until the 24th and his participation is getting more attention than speculation about the Fed’s own content or message. I think that underscores the domestic uncertainty or complacency with the Fed and data, which reinforces my view that we remain in a range. This is not to say that Draghi’s message isn’t important, but that the market in general has low expectations for the Fed’s message and, perhaps, isn’t getting more excited by the ongoing nature of our low domestic inflation story.
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Title Take a look at the chart above and then the 2-yr chart towards the end. They both show similarly range (channel) bound price action and those respective ranges are quite narrow. The dominant one in 10s is 2.11 to 2.38%. Momentum measures look pretty neutral though the move below the 200-day MA at 2.26+% and the flattish lows near 2.21% do look at least a bit bullish. Still, this effort is splitting hairs – simply, not much is happening and I’m not sure what it will take, given what we know, to take us to either extreme. Recent daily ranges of about 6bp don’t seem worth chasing hard especially when, oh, 75% of those ranges are due to corporate hedges and rate locks... Likewise, 2s are not precisely inspirational. I’ve drawn two channels that show the action, the larger one sloping up and the smaller, most recent, edging lower. There’s resistance at 1.30% there and support at the 21- and 40-day MAs near 1.36%. A series of lows near 1.26% come to mind as doable, but I suspect that 2s will underperform in the event they rally to that level. The logic is that the market has so convincingly priced out another hike this year (Dec Fed Funds at 1.21% are the lowest they’ve been in three months, and give about 37% odds of hike that month) that 2s don’t have that much room to run. A flight to quality I would expect to benefit longer maturities in an asset allocation shift. It’s really not awe-inspiring and I prefer 10s against 2s and 10s vs. 5s. By the way, 30s don’t look vastly more inspirational though on the margin look as if they’ll break their recent channel boding for a probe to 2.70-ish. A descending triangle, bullish pattern, helps that call. And here, finally, are those charts:
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Bringing 30 years of investment strategy experience to his role at Informa Financial Intelligence, David Ader has held senior positions at major investment banks and financial information firms as well as serving on investment policy committees and management teams. Most recently Partner, Head of Government Bond Strategy for CRT Capital, he headed the team voted #1 in U.S. Rates Strategy for 11 years and #1 in Technical Analysis for five years in Institutional Investor’s annual survey.
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David Ader is Chief Macro Strategist for Informa Financial Intelligence. For further information on our products and services, please see: https://financialintelligence.informa.com/
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