By Robert Seawright, Proprietor, Above the Market
By Robert Seawright, Proprietor, Above the Market
This morning’s CPI showed another very low reading at 0.9% on the headline and 1.7% at the core. It’s interesting to note that food and energy are now dragging down the index substantially. As I previously mentioned, food and gas are both down 7-10% so there’s your big headline drag. But the Fed and bond markets focus more on core CPI so we don’t want to overemphasize the headline reading anyhow. On the whole, this is all still very consistent with a weak economy.
The Housing Adjusted CPI is up 4% due to the big surge in housing. I think this is probably overstating the current pace of consumer price inflation, but provides a bit of perspective on the frothiness of broader consumer trends since housing is a big piece of the consumer balance sheet puzzle. This index also shows the increasing volatility of the consumer balance sheet as a result of monetary policy that has been geared specifically towards bolstering the housing market to a large degree.
(Chart via Orcam Financial Group)
The more interesting data is not US centric, but from all around the globe. The trend in the USA is indeed a global trend as inflation rates are falling just about everywhere. The latest from the UK showed a decline from 2.7% to 2.2% and Europe down to 0.7% from 1.1%. China has seen a small uptick from 3.1% to 3.2% and Japan is still in the inflation doldrums at 1%. The low inflation is becoming a global phenomenon.
(Chart via Orcam Financial Group)
Great chart here via Bob Seawright (H/T: The Big Picture/Bloomberg View). The chart shows Dow Jones Industrial Average gains off of 5 year lows. I don’t know if this chart should scare the daylights out of us or give us the impression that there’s a lot more room to run. Feel free to let me know what you think….
By Walter Kurtz, Sober Look
Weak inflation readings in the US continue provide the Fed with the rationale to maintain securities purchases in what amounts to a “QE trap”. With the PCE inflation measure once again below one percent, the FOMC doves fear that “taper” could bring about deflationary pressures. The risk of course is that inflation measures remain benign and what was meant to be a short-term policy measure extends beyond anyone’s expectations.
Scotiabank: – The Fed’s preferred measure of inflation — the price deflator for total personal consumer expenditures — came in at +0.9% y/y in September. We feel that markets are underestimating the importance of this observation to the Fed. That is tied with April for the softest inflation reading since October 2009 when the US economy was just beginning to emerge from recession.
The forward looking inflation measure derived from TIPS yield (breakeven), has now also turned lower after a recent upward movement.
Similarly, we’ve seen a slump in commodity prices (see discussion), which is another signal of weak inflation readings.
With inflation measures remaining this low, many argue (see story) that there is no rush to begin exiting the current monetary policy. The fact that the US monetary base is now 4.5 times greater than it was 5 years ago and capital markets are now fully addicted to ongoing stimulus does not seem add any urgency for these economists. The longer this goes on, the more difficult will be the exit, making it harder for the Fed to pull the trigger. Welcome to the QE trap.
Rail traffic continues to tell an optimistic economic story as the AAR reported a 10.8% surge in weekly intermodal traffic. This reading brings the 12 week average to 4.9% which is the highest reading in seven months.
(Chart via Orcam Financial Group)
Here’s more via the AAR:
“AAR today also reported increased rail traffic for the week ending Nov. 2, 2013. U.S. railroads originated 292,398 carloads last week, up 5.1 percent compared with the same week last year, while intermodal volume for the week totaled 264,264 units, up 17.7 percent compared with the same week last year. Total U.S. rail traffic last week was 556,662 carloads and intermodal units, up 10.8 percent compared with the same week last year. Rail traffic in the comparable week of 2012 was affected by Hurricane Sandy.
Eight of the 10 carload commodity groups tracked on a weekly basis posted increases compared with the same week in 2012, including nonmetallic minerals and products, up 18.6 percent; motor vehicles and parts, up 15.9 percent; and petroleum and petroleum products, up 12.6 percent. The groups showing a decrease in weekly traffic compared with the same week last year included farm and food products, excluding grain, down 3.3 percent; and coal, down 1.2 percent.
For the first 44 weeks of 2013, U.S. railroads reported cumulative volume of 12,384,147 carloads, down 0.7 percent from the same point last year, and 10,865,365 intermodal units, up 4.0 percent from last year. Total U.S. traffic for the first 44 weeks of 2013 was 23,249,512 carloads and intermodal units, up 1.5 percent from last year.”
Remember all that chatter earlier this year about the “great rotation” and how bonds were going to get crushed because everyone was “rotating” into stocks? That seems to have died down quite a bit in recent months, but just to put a nail in that coffin I wanted to point to the actual data.
But first, let’s remember a basic macro lesson – all securities issued are always held by someone. If you sell your stocks to “rotate” into bonds then someone else is selling their bonds to “rotate” into stocks. In the aggregate, people don’t “rotate” out of existing financial assets and into other financial assets. They simply exchange financial assets and the value of those assets may or may not change in the process. That’s simple enough, right?
But that’s only the secondary market. What about the primary market where actual issuance is occurring? Well, the “great rotation” myth looks even more ridiculous if you look at the data there because the issuance of debt in the USA has massively dwarfed the issuance of equity in recent years. And it not’s just government related debt. Corporate debt has outpaced equity issuance by a huge margin (roughly 10:1 per month over the last 2 years).
Here’s the chart showing monthly issuance of corporate debt, corporate equity and total bond market issuance. As you can see, this one pretty much puts the nail in the “great rotation” coffin.
I liked the way John Mauldin described the anatomy of a bubble in his latest letter:
Anatomy of Bubbles and Crashes
There is no standard definition of a bubble, but all bubbles look alike because they all go through similar phases. The bible on bubbles is Manias, Panics and Crashes, by Charles Kindleberger. In the book, Kindleberger outlined the five phases of a bubble. He borrowed heavily from the work of the great economist Hyman Minsky. If you look at Figures 9.7 and 9.8 (below), you can see the classic bubble pattern.
(As an aside, all you need to know about the Nobel Prize in Economics is that Minsky, Kindleberger, and Schumpeter did not get one and that Paul Krugman did.)
Stage 1: Displacement
All bubbles start with some basis in reality. Often, it is a new disruptive technology that gets everyone excited, although Kindleberger says it doesn’t need to involve technological progress. It could come through a fundamental change in an economy; for example, the opening up of Russia in the 1990s led to the 1998 bubble or in the 2000s interest rates were low and mortgage lenders were able to fund themselves cheaply. In this displacement phase, smart investors notice the changes that are happening and start investing in the industry or country.
Stage 2: Boom
Once a bubble starts, a convincing narrative gains traction and the narrative becomes self-reinforcing. As George Soros observed, fundamental analysis seeks to establish how underlying values are reflected in stock prices, whereas the theory of reflexivity shows how stock prices can influence underlying values. For example, in the 1920s people believed that technology like refrigerators, cars, planes, and the radio would change the world (and they did!). In the 1990s, it was the Internet. One of the keys to any bubble is usually loose credit and lending. To finance all the new consumer goods, in the 1920s installment lending was widely adopted, allowing people to buy more than they would have previously. In the 1990s, Internet companies resorted to vendor financing with cheap money that financial markets were throwing at Internet companies. In the housing boom in the 2000s, rising house prices and looser credit allowed more and more people access to credit. And a new financial innovation called securitization developed in the 1990s as a good way to allocate risk and share good returns was perversely twisted into making subprime mortgages acceptable as safe AAA investments.
Stage 3: Euphoria
In the euphoria phase, everyone becomes aware that they can make money by buying stocks in a certain industry or buying houses in certain places. The early investors have made a lot of money, and, in the words of Kindleberger, “there is nothing so disturbing to one’s well-being and judgment as to see a friend get rich.” Even people who had been on the sidelines start speculating. Shoeshine boys in the 1920s were buying stocks. In the 1990s, doctors and lawyers were day-trading Internet stocks between appointments. In the subprime boom, dozens of channels had programs about people who became house flippers. At the height of the tech bubble, Internet stocks changed hands three times as frequently as other shares.
The euphoria phase of a bubble tends to be steep but so brief that it gives investors almost no chance get out of their positions. As prices rise exponentially, the lopsided speculation leads to a frantic effort of speculators to all sell at the same time.
We know of one hedge fund in 1999 that had made fortunes for its clients investing in legitimate tech stocks. They decided it was a bubble and elected to close down the fund and return the money in the latter part of 1999. It took a year of concerted effort to close all their positions out. While their investors had fabulous returns, this just illustrates that exiting a bubble can be hard even for professionals. And in illiquid markets? Forget about it.
Stage 4: Crisis
In the crisis phase, the insiders originally involved start to sell. For example, loads of dot-com insiders dumped their stocks while retail investors piled into companies that went bust. In the subprime bubble, CEOs of homebuilding companies, executives of mortgage lenders like Angelo Mozillo, and CEOs of Lehman Brothers like Dick Fuld dumped hundreds of millions of dollars of stock. The selling starts to gain momentum, as speculators realize that they need to sell, too. However, once prices start to fall, the stocks or house prices start to crash. The only way to sell is to offer prices at a much lower level. The bubble bursts, and euphoric buying is replaced by panic selling. The panic selling in a bubble is like the Roadrunner cartoons. The coyote runs over a cliff, keeps running, and suddenly finds that there is nothing under his feet. Crashes are always a reflection of illiquidity in two-sided trading—the inability of sellers to find eager buyers at nearby prices.
Stage 5: Revulsion
Just as prices became wildly out of line during the early stages of a bubble, in the final stage of revulsion, prices overshoot their fundamental values. Where the press used to write only positive stories about the bubble, suddenly journalists uncover fraud, embezzlement, and abuse. Investors who have lost money look for scapegoats and blame others rather than themselves for participating in bubbles. (Who didn’t speculate with Internet stocks or houses?) As investors stay away from the bubble, prices can fall to irrationally low levels.
Just chugging along here. Intermodal was up 3.2% on the week bringing the 12 week moving average to 4.2%. That’s the highest 12 week average in 6 months. If the economy is slowing at all it’s sure not showing up much in this data. Here’s more from AAR:
“The Association of American Railroads (AAR) reported increased weekly rail traffic for the week ending October 26, 2013 with total U.S. weekly carloads of 297,455 carloads, up 3.6 percent compared with the same week last year. Intermodal volume for the week totaled 261,231 units, up 3.2 percent compared with the same week last year, and up for the 17th straight week in a row. Total U.S. rail traffic for the week was 558,686 combined carloads and intermodal units, up 3.4 percent compared with the same week last year.
Eight of the 10 carload commodity groups posted increases compared with the same week in 2012, including grain, with 25,101 carloads, up 29.6 percent; and petroleum and petroleum products with 14,152 carloads, up 20.1 percent. Commodities showing a decrease compared with the same week last year included farm and food products, excluding grain, with 17,759 carloads, down 3.9 percent.
For the first 43 weeks of 2013, U.S. railroads reported cumulative volume of 12,091,749 carloads, down 0.8 percent from the same point last year, and 10,601,101 intermodal units, up 3.7 percent from last year. Total U.S. traffic for the first 43 weeks of 2013 was 22,692,850 carloads and intermodal units, up 1.3 percent from last year.”
Chart via Orcam Research:
By Lance Roberts, CEO, STA Wealth
This past weekend I was at a party in my neighborhood. As a money manager, I like parties as they are a rather insightful indicator of the current psychology of the “average investor.” The great thing is that I do not have to do much other than stand in the middle of the room, have a drink in my hand and wait. It does not take long to find out where we are within the current investment cycle as one of three things will happen; 1) no one wants to talk about their investments; 2) a comment about investing might arise, or 3) they tell you everything about their latest investment success. The chart below explains the concept.
The party this weekend was an example of the third stage. Wives were walking around with freshly injected lips and other “augmented” body parts. Men were brandishing new Rolex watches while bragging about their other latest acquisitions. I now know more about their personal stock portfolios than I do about their children’s latest successes.
As I have discussed many times in the past – Bob Farrell’s Rule #9 states: “When all experts and forecasts agree; something else is bound to happen”
By the time, the sentiment of both individuals and professionals have become universally “bullish,” the markets are generally near a peak. The only issue is being able to know, with certainty, whether a particular peak will lead to a correction within an uptrend; or potentially something far more dangerous.us.
The chart below shows the Net Bullish Sentiment (bullish less bearish) of both professional and indivdual investors.
Historically, when net bullish sentiment has been above 20 markets have been close to a short term peak. When the index has risen above 30; such levels have typically been associated with deeper corrections. Currently, at 31, the net bullish sentiment is exceedingly high.
While this does not mean that the market is about to crash; it does suggest that investors are “all in” at this point with no real concern of the inherent risk. Of course, I can confirm this by the number of individuals that asked my opinion about every “high flier” stock in the market with a P/E with greater than 100x or did not have one because they lose money. Of course, when I made the fundamental argument the conversation quickly ended with “yes, but I am making so much money.”
While I will probably not be invited to any more parties for suggesting that investing in stocks is getting very risky; the reality is that investor “greed” is back. While this does not mean that a “market crash” is imminent, it does suggest that investors should be aware that the risk/reward ratio is no longer tilted in their favor.
While there are some minor signs of broader economic slowing, it’s certainly not showing up in rail traffic data. This week’s traffic trends showed a continued improvement off the June lows. We’re not at a new 6 month high in the 12 week average rate of year over year growth. This week’s reading on intermodal came in at 4.3% which brings the 12 week average up to 4.2%.
(Chart via Orcam Research)
Here’s more from AAR:
“The Association of American Railroads (AAR) reported increased weekly rail traffic for the week ending October 19, 2013 with total U.S. weekly carloads of 289,256 carloads, up 0.2 percent compared with the same week last year. Intermodal volume for the week totaled 264,687 units, up 4.3 percent compared with the same week last year, and up for the 16th straight week in a row. Total U.S. rail traffic for the week was 553,943 combined carloads and intermodal units, up 2.1 percent compared with the same week last year.
Eight of the 10 carload commodity groups posted increases compared with the same week in 2012, including petroleum and petroleum products with 13,644 carloads, up 15.5 percent; and grain, with 22,360 carloads, up 9.6 percent. Commodities showing a decrease compared with the same week last year included coal with 108,469 carloads, down 6.0 percent.
For the first 42 weeks of 2013, U.S. railroads reported cumulative volume of 11,794,294 carloads, down 0.9 percent from the same point last year, and 10,339,870 intermodal units, up 3.7 percent from last year. Total U.S. traffic for the first 42 weeks of 2013 was 22,134,164 carloads and intermodal units, up 1.2 percent from last year.”