Negative Macro versus Positive Micro Continues
05/31/11
The linkage between dollar strength and US stock market weakness continues. Bad news from Europe in the morning means Euro down and Dollar up, leading to "risk off" behavior, the decrease of leverage and the selling of stocks and commodities. Good news out of Europe means rising Euro, falling dollar leading to "risk on" behavior, the increase of leverage and the purchases of stocks and commodities. In short: Dollar up - stocks down and vice versa. The hedge funds will continue to play this game until it stops working. The markets frequently even ignore domestic economic numbers if they contradict the days "risk on" or "risk off" theme. Markets for example did not react as negatively to Friday's crash in pending home sales than one might have anticipated because everyone focused more on the declining dollar to determine that it was "risk on" time and therefore time to buy stocks (not sell them). Of course, the housing market no longer plays the pivotal role that it used to play even two years ago. But even weaker than expected GDP numbers or regional Fed Indices like the Chicago Fed National Activity Index are not moving the markets as they used to even one year ago. I am sure that this is going to change. By the time everyone has figured out a pattern, it will be discounted immediately and thus loses its significance. Until that time comes however, we probably should assume that economic factors exert only limited influence on markets unless they also influence currency movements. Nevertheless it behooves us to follow the economy, because the voting mechanism that is the stock market becomes a weighing mechanism long term, exactly because (not despite) of the economy.
The Philadelphia Fed Index measures changes in business growth. The index is constructed from a survey of managers who voluntarily answer questions regarding the direction of change in their overall manufacturing activities. From the over 20 sub-categories I have picked four that deal with future expectations. You can see that expectations are not (yet) negative but are barely staying in positive territory. The second indicator, called the Chicago Fed Index (second chart) measures real time, very broad, economic activity on a monthly basis. The zero line, however, does not divide expansion and contraction, but represents the dividing line between growth above or below "trend growth", which means that the economy expands more or less in line with its long term potential. The economy's long term potential growth rate is assumed to come in at around 3%. Therefore a positive reading represents economic expansion above 3%, a negative reading means it's growing slower than 3%. A reading of -0.70 or below indicates the economy might be heading into recession. The index fell to -0.45 in April, from an upwardly revised 0.32 in March (previously 0.26). This was the lowest reading since August 2010, when fears of a double-dip recession lead to the second quantitative easing effort. The three-month moving average of the index slipped to -0.12 in April from an upwardly revised 0.8 in March. The three-month moving average turned negative for the first time since December. (Note that recession concerns aren't an issue until the three-month moving average falls below -0.7. A negative reading above -0.7 indicates growth, just less than "normal".) The biggest contributor to this decline was a fall in industrial output that was at least partly related to the earthquake in Japan, as auto production (as well as other manufacturing) was crimped by parts shortages. This may seem extreme, but consider that you can't build a car without, say, a fuel pump, even if you have the rest of the parts on hand. Once those parts begin to move freely again, auto production may snap back and might get the recovery back on track. But then again, it might not. One influential voice is predicting a worldwide slowdown in the coming months. The coming economic slowdown, according to the Economic Cycle Research Institute's (ECRI) Long Leading Index of global industrial growth will affect the US economy also. A look at the institute's chart here reveals that the downturn follows in lock-step with the decline in short-term indicators like ISM survey and the ECRI's Industrial Commodity Inflation index. Lakshman Achuthan, co-founder of the institute, stated during the interview that he does not believe that we are headed into another recession, just a mid-cycle slowdown. Last year we had the same problem, where a seasonal slowdown felt awfully similar to a double dip recession. This year I hope we can avoid the severity of last year's stall. Some indicators have improved since then and give me hope that the US economy can march to its own drummer at least a little bit more than before. Take a look at the charts below and see if you can share my cautious optimism.
The first chart reminds us that the vast majority of people in this country are working and paying taxes. The red line shows government employees, the blue line shows private industries. Incomes from private industries have continued in a strong upward trend through April. This is the first strong positive. The second is the fact that tax receipts (second chart) are also strongly rising. The Treasury Department said it collected about $155 billion in individual income taxes alone last month, pushing up year-to-date individual receipts to $631 billion. So far for the government's fiscal year, individual receipts are up 26% compared to the same period last year. Expanding payrolls from private industry and expanding tax receipts are strong signs that the economy continues to strengthen, becoming ever more resilient against outside shocks. Of course we would be foolish to assume that we can live in splendid isolation. Every morning the first order of the day continues to be the reading of headlines from Europe such as "Greek debt fears weigh on euro, curb world stocks". The markets remain hostage to systemic challenges from Europe, no matter how attractive US stocks may be.
Hermann Vohs
"Optimism doesn't wait on facts. It deals with prospects. Pessimism is a waste of time."
Norman Cousins
Hermann Vohs is president of Cales Investments, Inc., a registered Broker-Dealer. All material presented herein is believed to be reliable but we cannot attest to its accuracy. Investment recommendations may change and readers are urged to check with their investment counselors before making any investment decisions. Opinions expressed in these reports may change without prior notice. Hermann Vohs and/or the staff at Cales Investments, inc. may or may not have investments in any of the markets cited above. Hermann Vohs can be reached at 303-765-5600.
This information is not to be construed as an offer to sell or the solicitation of an offer to buy any securities.
