Central Banks

Economic Insights – Week ahead 11/01/2016

Headlines:

  • First week hangover: don’t blame it all on China

  • Coming up: more slowdown evidence

  • L’Europe en danger! Et ses femmes!

  • Brexit is hard to do

  • Markets: sauve qui peut! Every stock for itself!

 

First week hangover

2016 has got off to what can only be described as a rather poor start but I am sticking to my headline last week that we may well all be ‘doomed but just not yet’.  China is currently getting most of the blame but, in fact, the real causes are problems carried over from last year:

  • The slowdown in growth is global and not only the fault of China’s manufacturing
  • The central bank with most clout remains the US Fed even if others are more deluded.
  • China has almost nothing to do with the Syrian crisis threatening Europe.
  • All markets have become fragile and exposed to stampedes

Alas, the hangover follows what was  not even that much of a party. Much of 2015 went by with the Fed’s signalling its desire to remove the proverbial punchbowl and finally doing so just as Santa was expected with his proverbial rally. So, it should really be no surprise that things look grim right now and, unfortunately, there appears to be no equivalent to PG Woodhouse’s ‘Jeeves famous hangover cure’. Hangovers are wretched but they do eventually fade and I remain convinced the major stock markets will end 2016 not so far away from where they started, albeit they are more likely to take a few nasty tumbles on the way and from which not all may recover fully by next December. Having said that, last week’s rout in equity markets included the worst ever start to the New Year in the US and has given new material to the soothsayers who routinely come out with such bonmots as ‘Santa Rallies’ and ‘Selling in May’. The latest sooth is ‘as the year starts, so it proceeds’ and this may well prolong the hangover for the more nervous. Why not take a look at Chart 1 and judge for yourself?

 Chart 1 S & P 500 in 2016?: Pick a number between -40% and +30%

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Source: Pension Partners via Financial Orbit

Coming up: more slowdown evidence

Two charts from last week highlight the current challenges to the global economy and  provide a framework for assessing data to be published in the coming weeks. Chart 2 from Caixin/Markit came out on Wednesday showing China’s Manufacturing, Services and the combined Composite PMIs for December. These surveys are widely regarded to be as close to being independent as any data from China.The shock was that the Services PMI had for the first time ever fallen below the 50 level that delineates expansion and contraction.Taken to extremes, which inevitably it was (especially by the new archetype gung-ho investor, Mrs Wong), this could mean that the whole Chinese economy was contracting in December. So, forget the official GDP growth rate of 7% and the switch to Consumption! It is going to become increasingly difficult for the authorities to massage the next batches of data and so this week we can expect further softening in both Exports and Imports. Later in the month Retail Sales and Industrial Production in December may also be reported as softer but the authorities will probably try to tough it out with reporting 7% GDP growth in 2015 as a whole.

Chart 2 Caixin China Output PMI: Services pooping the Party

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In contrast, at first sight the December US Labor Market numbers seemed very encouraging when they first came out on Friday: 292K new hires in the month, previous months revised higher, another nudge higher in the Participation Rate and also in Average Hourly Earnings. However, the doomsters have since been busy deconstructing the data. Chart 3 tells a similar story to the UK in so far as almost all recent new hires are in the Services sector, where many jobs are lower paid, unskilled and less productive. Indeed, average hourly earnings did not increase month on month from November. Perhaps even more worrying is that of the 292K incease in the December Non-Farm Payrolls 281K represent an annual adjustment because of the Festive Season that may or may not be accurate. This week Industrial Production is almost certain to be soft again but there may be some cheer in Retail Sales, which are due for a good month after struggling over the last few months. In other words, whether the US is even close to growing at 2% per annum depends almost entirely on shopping.

Chart 3 US cumulative new jobs by sector: low skill, lw pay

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Here in the UK, Industrial Production may actually be better as the ONS seems to report good and bad numbers in alternate months but the year on year headline for Manufacturing Output is still set to show a deterioration. Also due for an uplift are British Retail Consortium sales in December (shopping again!). The MPC meets this week but the only question is whether Ian McCafferty will fall back in line with his colleagues and vote to hold Base Rates (probably not). The most interesting announcement will be the NIESR’s rolling 3-monthly GDP estimate (not a forecast) which will cover Q4. The previous two rolling estimates came out at +0.6% which suggests an estimate for Q4 of no worse than +0.5%, which sets up a potential clash with the ONS’s first cut when it is published later this month.  Chancellor Osborne will have to put up with the latter’s numbers but will not welcome any further downward revisions for previous quarters. His downbeat ‘poisonous cocktail’ speech last week, however, should be seen as a political rather than economic warning. Protocol prevents his giving hints to the MPC but Tory MPs need a wake-up call on Brexit risk and, of course, he must ensure that he gets none of the blame if his upbeat message of only one month ago turns out too optimistic. It should always be remembered that Mr Osborne is usually (but not always!) at least two moves ahead of everyone else.

Meanwhile in the EZ, mixed data suggests that although its economy is no longer getting worse significant recovery remains elusive. This week, with Italy and Spain taking centre stage, should add to this picture following last week’s Unemployment (slightly better), CPI (under pressure again), Industrial Production (stalling) and PMIs (slightly better).

L’Europe en danger! Et ses femmes!

One thing that can be said for the EZ elite is that they take holidays very seriously. Sadly, there has been no avoiding the shocking accounts of muggings and sexual assaults in parts of Germany but who would guess that all the major problems are still festering. Greece is not and, to be fair, probably cannot, comply with the bail-out conditions, Italy and France are trying to neutralise the Stability and Growth Pact, Germany is still trying to block the Single Bank Resolution, Portugal and Spain are without stable governments, Denmark wants no more integration, there is a North-South dispute over gas pipelines from Russia, the Bundesbank is trying to subvert the ECB’s monetary policies und zo weiter. The Brexit negotiation is a minor irritant by comparison.

 

However, there is no doubt the Syria crisis represents the greatest threat to Europe and it has already undermined the Schengen agreement on free movement and returned high wire fences to Eastern frontiers. Migration generally brings direct economic benefits to all concerned: more jobs, more public spending but tax receipts taking over from initial social benefit outlays but this time the problem is so many migrants’ arriving at once. This point is made in a most civilised way in the following extract from an article by Klaus Brinkbäumer, Editor in Chief of DER SPIEGE:

9:26 p.m. – 25 Dec 2015 · Details

No migrant leaves his or her home casually, frivolously or even with any kind of pleasure at all. It is a far-reaching decision and all who pull up roots know it, even those who are still in their formative years. The migrants who come to us merit empathy — and what choice do those people have who come from war-torn Syria? What would we do in their situation?

There is proof for everything — for almost every thesis as well as for its antithesis. Regions that have integrated many migrants in the past are prosperous today, but integration only works if the state doesn’t lose control, and Germany at present has lost control. Of course there is a basic human right to asylum, but without an upper limit — enforced, if necessary, with border controls — it will be almost impossible to find a way out of the crisis.

The political and social disruption is only just beginning and it is hard to be optimistic. Much is being made of the rise of extremist political parties but I would suggest that the most sinister long-term threat is to the status of women unless ‘multiculturalism’ is made more sympathetic to them.

Chart 4 Brexit voting intentions

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Source: YouGov via The Times

Brexit is hard to do

Full disclosure: both my head and heart are in favour of the UK staying in the EU. Heart is easy to explain as my father was an immigrant, my wife and I between us have family and friends in 8 other EU countries and I spend up to 2 months every year in Italy and France. Head (from an economic stance) is slightly more difficult if the post-Brexit outcome is merely a ‘Swiss/Norway plus’ deal in a free-trade zone although I boggle at the logic of  still  being bound to most European Treaties without being able to participate in future decisions.  The extreme solution of joining some sort of ‘Anglo-Saxon’ English-speaking trade group (specifically with multiracial US, Canada, Australia and New Zealand) seems even more illogical as well as politically fanciful and economically reckless. At least our European partners value our trade!  Nevertheless, it may well be that fear of migrants from Syria, Somalia, Afghanistan and Pakistan rather than Europe itself will tilt the balance in favour of Brexit,  which would ironic in a number of ways, not least because we would need to increase trade with many such countries.

Chart 4 from pollsters YouGov shows referendum voting intentions to be very finely balanced with a narrow split between both men and women. The party political differences are as one might expect, which means people in London, the North and Scotland want to stay while those in the English shires want to leave. There is a more fundamental polarisation between those educated to ‘A’ Level and above (stay in) and those below (out) and also those aged under 30 (stay in) and over 50 (out). There is less polarisation by social class: AB and CI would prefer to stay while C2 DE want to leave. As with most referenda the onus will be on those who want a change and xenophobia as opposed to lofty superiority traditionally does not go down well in the UK. A sub-plot may well develop in which it becomes a matter of confidence in David Cameron personally, which should stay the hand of many Tory Eurosceptics. I would like to think the pointlessness of Brexit might swing the balance.

Markets: Sauve qui peut. Every stock for itself

OK, let’s get China and last week’s 10% belly flop out the way first. Foreigners are still not allowed to get much involved directly via the domestic stock exchanges and most are too smart to want to. With major shareholders subject to restrictive lock-in regulations, the wild swings are all about ‘Mrs Wong’ and the authorities clearly do not know what to do about her, given the absolute priority of keeping the Communist Party in power. The international repercussions are to undermine confidence in global growth and corporate earnings while the clumsy devaluation of the renminbi is more of an issue for China’s trading partners amongst the Developing Economies. It is all very unsettling but investors will just have to get used to it while Mr Xi decides how much he wants to ‘embrace the markets’ as The Economist mischievously put it back in July or, as now seems more likely, prop them up!

Chart 5. Xi ha!

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Source: Bloomberg

Some Emerging Markets are easier to get into than others but none look attractive right now and this highlights the problem of investing in broad asset classes and geographical markets. Where to get a positive return is proving increasingly hazardous for Japanese investors who are inclined to repatriate when risk is in the air but the resulting boost to the yen is counterproductive, especially for exports to China and other Developing Economies. European equities were fashionable last year but neither exports nor domestic demand are growing fast enough to encourage hopes for much further progress, albeit earnings multiples are still relatively modest compared to the US. In the UK the FTSE 100 looks a rather unhappy cocktail of beaten-up overseas resources companies and UK standard bearers in sectors facing margin squeezes and/or enforced structural change. The FTSE 250 has so far proved to be a more solid representative of UK plc and the wider economy but even it failed to escape last week’s sell-off.

Chart 6: M & A to the rescue?

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Inevitably, one has to look to the US for investment ideas but even this is not clear-cut. Valuations are historically very high especially when considering the prospects for future growth. After two soild years earnings of S & P 500 companies probably fell by at least 4% in 2015 and the outlook is still not encouraging. Share buy-backs no longer look so attractive to corporate executives nor does holding on to their stock options. There may be a silver lining in the form of M & A deals although even these may involve significant equity swap elements. It is only once one starts digging deeper that slightly more hopeful signs appear. If one strips out the energy and materials sectors, average corporate earnings turn positive with Consumer Dicretionary, Healthcare and IT topping the bill. This is yet another reason not to invest only in asset-classes and market indices.

Even better is to seek out individual companies that have a new story to tell and/or are temporarily off many investors’ radar screen. These stocks should be able to move independently of the general market or their sector but also be sufficiently liquid to enable short-term trades. This approach is applicable elsewhere but the US and the UK offer the most accessible opportunities. This ‘stockpicking plus’ strategy is the principle on which we recently launced our DAN-Trade equity product. Of course, there will always be great companies to buy and hold for the long-term but that too is becoming increasingly subjective-and risky!- in the current skittish markets.

Meanwhile some investors will continue, when all else fails, to rely on the Fed to bail us all out. Plus ça change …….

Chart 7 When you wish upon a star…….

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Source: WSJ Survey of Economists via WSJ

 

Once more unto the breach

I very much regret that I have to carry on with my recent themes with some new emphasis on the clouds gathering over the US economy, albeit that relatively little news is actually due from there this week. The latest FOMC minutes will no doubt confirm the growing gulf between hawks and doves amongst the regional Fed presidents but Chair Yellen and her fellow governors have probably again tried to say as little as possible. The April CPI is the other significant US announcement and it will likely remain close to zero but the FOMC still do not seem inclined to pay much attention to it.

US economy: not in the script

One of my acerbic correspondents in the US (@smaulgld) pointed out yesterday that ‘lowering GDP estimates is a national sport now’ and indeed he deems the economy already to be in recession. There is certainly plenty of recent data to encourage caution if not downright pessimism.  US economic headlines concentrate on monthly numbers and last week reported higher March retail sales but year on year growth’s falling further to a lowly 1.3% is rather ominous. Moreover, the monthly numbers have a history of being revised substantially lower as shown in the chart below.

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Source: Zerohedge

Even more worrying from last week was a fifth consecutive monthly drop in Industrial Production, which in April was just about chugging at 1.9% year on year. The great hope remains Employment but the weight attached to the headline Non-Farm Payroll numbers is exaggerated.  Currently, a debate is carrying on both as to whether US Q1 GDP is always low and also whether there were exceptional factors at work this year. Fresh from forecasting Q1 reasonably accurately, the Atlanta Fed Nowcast is predicting that Q2 is unlikely to be much better. Since these Nowcasts started in 2011 regular technical improvements are resulting in error margins of 0.7% annualised. Accordingly, for my part I am willing to accept that the latest Nowcast of 0.7% shown in the chart below means that US GDP in Q2 is running at somewhere between flat and +1.4%. Others, coyly described as ‘Blue Chip Consensus’, seem to be veering in the same direction. This is not a happy outlook and is still not in the script for many investors.

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More slow boating in China

Official China data has long been viewed, along with much else in China, as being managed to reflect Socialist Realism and conformity with Party Policy but somehow the numbers still keep getting worse. Last week it was New Loans, Fixed Asset Investment, Retail Sales, Industrial Production and even Inflation (too low). This chart courtesy of China-expert George Magnus highlights the trend in recent months, with no end in sight.

China Data 2007-15

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EMU: Better but don’t forget the deflator

Everyone loves a good headline and there plenty last week proclaiming that EZ GDP growth in Q1 outstripped that in both the US and the UK. There is no doubt that a solid recovery would represent good news for all concerned and maybe things really are looking up a bit but precious little mention was made of the boosting of the nominal numbers by the price deflator. This was negative throughout most of the EZ in Q1, notably so in Spain and Italy. Moreover, deflation persisted despite a fall in the EUR/USD exchange rate of 11.2% in Q1 and following a 12% drop in 2014 and while this previous euro weakness has certainly helped exports the sharp turnaround in Q2 will surely be a drag on each of GDP, Trade and Inflation. At the risk of seeming churlish, it should also be noted that both Industrial Production and Retail Sales are running at levels below 2% while Unemployment remains stubbornly above 11%. We must hope for more progress in Q2 but be prepared for some disappointment.

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Meanwhile, Grexit has somehow managed to sneak off the front pages but a leaked internal IMF memorandum suggests its return very soon. The main points are:

  • The negotiating process may have got easier, with Prime Minister Tsipras apparently taking more interest, but it remains ‘far from ideal’ with no direct access to ministers.
  • Major concerns are deposit withdrawals (increasing dependence on the ‘Eurosystem’), non-performing loans and a deteriorating ‘payment culture’
  • There has been progress on reforms to Vat, tax collection and insolvency law
  • Loan repayments to the IMF in June, July and August cannot be funded without help from the rest of EMU but there has been no agreement, even on partial disbursement
  • IMF staff appear to believe that debt relief is needed but they are not prepared to press other EMU countries to grant this
  • The Syriza government seem determined to press on with reversing measures agreed by its predecessor on pension and labour market reforms or on laying off public sector workers.

Significantly, the memorandum seems entirely consistent with Mr Tsipras’s latest pronouncements, in particular his ‘red lines’ on pensions, wages and rehiring of public sector employees.  He may or may not still believe that other EMU governments can be shamed into coughing up but they seem more interested in passing off the blame to the IMF, ECB or better still the Greeks themselves. The IMF reckons the cash will run out in June but it probably has already.

UK: Land of Hope……

….and maybe even a modest amount of economic glory as last week yet another set of strong Employment numbers and signs of renewed growth in Manufacturing and Construction after a dull Q1. Productivity is now seen as the UK’s Achilles Heel, although it is also a problem in most other advanced economies. Chancellor Osborne is likely to have something to say on the subject in his second Budget on July 8th with a major splurge on Supply Side stuff: apprenticeships, capital allowances, seed capital for new technologies and high value sectors, funding for small business, house building and Infrastructure. His Northern Powerhouse and other offers to local authorities are still not being taken sufficiently seriously but are of huge economic and social s as well as political ignificance. On the tax and welfare fronts Mr Osborne is likely to deliver his IHT pledge to ‘ordinary’ house owners while using higher CGT on the wealthiest to pay for it but both the main pain and jam are likely to be postponed.

Meanwhile, Mr Cameron seems to have plans of his own, including for the EU referendum. Having seen off UKIP with his pledge to hold it he has now while impressed his Tory Eurosceptics by being in a position to do so. Foreign Secretary Hammond, an erstwhile Eurosceptic is clearly on board with his newly emollient approach to EU Treaty changes while other ministers have at last admitted that many of the friction points can be dealt with internally. Also helpful is Andy Burnham’s offer of support, albeit with conditions, for the negotiations: a smart move by him, helpful to Mr Cameron and in the national interest.

Election post mortems are continuing and The Spectator has run two contrasting stories of quiet confidence at Tory HQ and manic delusion at Labour’s. Even with a generous pinch of salt it is hard to argue with the description of the professional expertise of the Tories’ Lynton Crosby and the smouldering divisions within Labour, which have now come to the surface. Peter Mandelson’s spoke for many in the party with the devastating comment that what Ed Miliband most lacked was an economic policy. It is hard not to sympathise personally with Mr Miliband while also remembering that those who live by the sword often die by it.

Central Banks: running out of ideas

Nobody could ever say that central banking was easy but those who try run an economy with an interventionist monetary policy end up reaping the whirlwind, as it were.

FOMC: They clearly want to raise rates not so much to tighten per se but to get some flexibility after six and a half years of near-zero rates and various QE programmes. They have, however boxed themselves by making any change ‘data dependent’ and, of course, the numbers are starting to go the wrong way. Various committee members keep sending out conflicting signals and have managed to confuse many economists, if not themselves. The Wall Street Journal has been tracking changings views on the date of the first rate hike so far in 2015 ,as shown in the chart below. Although I do not participate in the WSJ’s surveys, I would have gone with the June consensus (red) until the March FOMC but now am blue, most likely in December 2015.

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PBoC:  It has so far eschewed both ZIRP and ‘conventional’ QE but successive cuts to both lending and deposit rates and to the Reserve Requirement Ratio for banks do not seem to be having much effect. Bailouts of local authorities, state-owned enterprises and even private sector companies look to be the next step, which will look and feel very much like QE but only using vast accumulated reserves rather just printing money. In fact, the first bailouts have already been arranged via the state-owned banks. The PBoC is, of course, under the control of the Communist Party leadership, who seem to be willing to pursue high risk policies such as encouraging booms in real estate and shares. Sound familiar?

ECB: Never a shrinking violet, Mario Draghi is already boasting about the success of his QE programme, the mere rumour of which did indeed start the depreciation of the euro. However, in the last few weeks the euro has come roaring back, bond yields have soared and many European share prices have been hit as a consequence. Supermario is, in fact, assailed on two fronts:

  • The Bundesbank (and many others) saying that QE was unnecessary and competitive currency devaluations only work in the short-term and can rebound.
  • The various EMU governments creating a new existential challenge to the euro by refusing to hand over any more money to Greece despite pressure from him, the EU Commission and the IMF. Rubbing salt into the wound, the ECB itself is facing a multi-billion hit on Greek sovereign paper it holds.

MPC: It is hard to tell when Governor Carney decided doing nothing was the best monetary policy for the UK but he is surely right to leave well alone. In retrospect, he must be grateful that previous MPCs did not cut rates to zero and continue indefinitely on the QE treadmill. The election of a majority Conservative government committed to fiscal correctitude must suit him while he keeps monetary policy loose but he is also right to argue for an early resolution to continuing membership of the EU. This means that the worst criticism he faces is over poor economic forecasting. Below is the GDP chart from the latest Quarterly Inflation Report, which shows that the MPC believe growth will be in 2-3% range for the next three years but…..er….it could be as low zero or as high as 5%! The other non-shock forecast was that Inflation will eventually return to the target of 2%. Well, put like that it could just happen!

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Put not your trust in princes or central bankers (Psalm 146)

This may not be an exact quote from the King James Bible but it could well become increasingly appropriate advice for those investors who have come to believe, whether out of cynicism or naivety, that the various central banks both can and will ‘see them right’.  The People’s Bank of China still appears the most obliging as it is under political orders to ease monetary policy and provide bail-outs wherever needed. In the US,  while the FOMC does seem to have abandoned altogether renewing the notorious Greenspan and Bernanke ‘puts’ for investors it remains collectively ambiguous as to when the first interest rate hikes will start. The Bank of England has been much more restrained in deed but in word has indulged in occasional kite-flying about raising Base Rates and, most recently, in cutting them. In contrast, the ECB and Bank of Japan are still ‘gung ho’ on QE, ZIRP/NIRP and competitive currency devaluation.

Last week collywobbles in most equity markets further confirmed that some investors are losing confidence both in the global economy and the ability of central banks to do much about it. In fact, US markets have been flashing hot and cold for much of the last six months in response to FOMC ambiguity while those in Europe and Japan have been either awaiting or responding to ECB and BoJ QE programmes. Since Mr Draghi fired his starting gun investment flows have been complex with some US investors eager to exploit ECB as well as BoJ largesse while some European and Japanese investors have taken the opportunity to pile into the US. Mr Draghi, presumably deliberately, has set off a feeding frenzy for European sovereign bonds and shorting the euro in favour of the dollar.

Around the world, commentators with varying degrees of shrillness are ramping up talk of asset prices bubbles and surely there will soon be more frequent alarms over Ponzi schemes and Minsky moments. Market movements and economic fundamentals rarely coincide but it is worth saying that the latter are definitely not encouraging. Whatever monetary policy has been credited with in the past it appears now not to be doing much for global demand. Accordingly, putting trust in central banks is asking too much of them. Moreover, at the risk of ending with a banality, it should be noted that the ‘sell in May’ season is already upon us.

WIMPS

There are two contenders for Weekly Irrational Movements in Prices

Thirty-year German bund yields: 0.48%, down 17 pips on week and 90 pips in 2015 so far. OK, so you might end up being repaid in DMarks but less than half a per cent return for 30 years?

Shanghai Composite: up 6.7% last week, 32.5% in 2015 and 111% in 12 months. Even the Chinese authorities are rattled!