Saturday, September 21, 2019

Weekly Indicators for September 16 - 20 at Seeking Alpha


 - by New Deal democrat

My Weekly Indicators post is up at Seeking Alpha.

For all of the discussion about various iterations of the treasury bond yield curve, it is little noted that right now it is sending a different message than virtually every other long leading indicator for the economy.

As usual, clicking over and reading should bring you up to the moment on the economy, and bring me a penny or two for my efforts.

Friday, September 20, 2019

A closer look at the housing rebound


 -by New Deal democrat

On Wednesday we got some excellent new residential construction numbers. I went into a lot more detail, showing how - exactly as I forecast - the turn in interest rates led the turn in housing sales by about six months, over at Seeking Alpha.

As usual, clicking over and reading helps reward me with a penny or two for my efforts.

While I am at it, on the subject of housing, here is a chart I am working on (not completed yet!) for another post, showing the maximum percentage decline in total and single family housing permits from expansion peak until the onset of recession, ever since reports started in the early 1960s, plus the decline from peak between the beginning of 2018 to the present:


Recession onsetTotal housing
Permits
1 unit housing
Permits 
——
12/1969 -22.7% -20.7%
———
11/1973 -42.0 -40.1

 6/1980 -36.8 -43.7

 7/1981 -37.4 -38.4

 7/1990 -44.3 -35.1

 3/2001 -11.5 -12.5

12/2007 -49.2 -58.7

2018-19  -12.4 -11.9





































Note that in all cases but two (1969 and 2001), the declines were in excess of 30%. The recent  decline, at roughly 12%, is almost identical to the decline prior to the 2001 recession. Why the 2001 recession happened despite the relatively small decline is important (and a subject of that other post to come!).

Also while I am at it, last October I wrote that Barring the Fed Reversing Course, Housing Has Peaked For This Cycle. Obviously with Wednesday’s permits and starts data, housing has exceeded its prior peak.

So what happened? Obviously the Fed did recently - very tardily in my opinion - change course. But the primary driver was a 1.5% decrease in mortgage rates, assisted by a 10% decrease in median new home prices.

Here’s a graph of 30 year mortgage rates since January 2013:


The “taper tantrum” of summer 2013 caused mortgage rates to rise 1.2%. Over the next 3 years, culminating with the Brexit panic low of summer 2016, rates went back down to 3.4%. Between the election of Trump and the Fed raising rates, by last November mortgage rates had risen to 5%. But in the last 11 months they have declined 1.5% (I don’t think it is primarily due to US recession fears, but that is another story).

Now here is the median new home sales price:


There was a 10% decline that started right at the peak of new home sales at the beginning of 2018.

Here’s what the decline in mortgage rates plus the decline in median prices did to the typical mortgage payment.

In November 2018, if you made a $30,000 down payment and took out a $300,000 30 year mortgage at 5% on the $330,000 median-priced new house, your monthly payment was $1610. Earlier this month, if you made the same down payment and took out a $270,000 mortgage at 3.5% on the $300,000 median-priced new house, your monthly payment had declined to $1212. 

That’s almost a $400 difference per month. That is going to spark a lot of new demand — and it did!

Thursday, September 19, 2019

Initial claims increasingly foreclose 2019-early 2020 downturn


 - by New Deal democrat

I’ve been monitoring initial jobless claims closely for the past several months, to see if there are any signs of stress. This is because the long leading indicators were negative one year ago, and many - but not a majority - of the short leading indicators have recently turned negative as well. So I have been on “recession watch.” But no recession is going to begin unless and until layoffs increase.

To reiterate, my two thresholds are:

1. If the four week average on claims is more than 10% above its expansion low.
2. If the YoY% change in the monthly average turns higher.

As of this week, initial claims continue to be very close to their expansion lows. The 4 week moving average of claims as of this morning is 212,500, only 11,000, or 5.3%, above the lowest reading this expansion:


On a YoY% change basis, the 4 week average is 0.6% higher than one year ago:


But September claims so far are running -5000 less than the full month of September 2018.

The less volatile 4 week average of continuing claims is also running -1.3% below where it was a year ago:


Initial claims continue to be an important positive in the short term forecast. If a recession doesn’t happen within the next 6 months, it is hard to imagine it happening at all through 2020 (with usual caveat: *IF* the economy is left to its own devices). And initial claims increasingly suggest that a downturn will not happen within that 6 month window.

Wednesday, September 18, 2019

Housing: BOOM!


 - by New Deal democrat

Well, this is an easy post. This morning’s report on housing permits and starts showed new expansion highs in both overall permits and starts. The less volatile single family segment also recovered, with both single family permits and starts at one year highs, although slightly below their expansion peaks.

Here are total and single family permits:


And here are total and single family starts:


The housing downturn is over. As expected, lower interest rates for the past eight months have shown up in the housing data in spades.

This has major implications for the index of leading indicators this month, which can be expected to pop. And since housing permits are a long leading indicator, this, along with new expansion lows in corporate bond yields, new highs in per capita real retail sales, renewed increases in real money supply, and continuing looseness in credit conditions, means that the only negative long leading indicator is the partially inverted yield curve, and the only mixed or neutral indicator is corporate profits. In short, the latter part of next year is shaping up to be quite positive.

In the immediate term, I wonder if this takes the pressure off the Fed to lower interest rates. If you are a Democrat, don’t hang your hat on there being a recession on  Election Day next year (although “Tariff Man” may yet come through!).

Tuesday, September 17, 2019

Industrial production rebounds; another message of slowdown, no recession


 - by New Deal democrat

Industrial Production is the King of Coincident Indicators.  When industrial production peaks and troughs coincides more often than any other indicator to NBER’s recession dating. Let’s take a look at the report for August, which was pretty darn good, which was released this morning.

Production as a whole increased 0.6%, and last month’s report was revised upward by +0.1%. The manufacturing component also increased, by 0.5%. Both, however, are still below their peaks set last December (left scale in the graphs below). The other important component, mining (which includes oil production) increased 1.4%, reversing July’s decline, missing a new high by less than 0.1% (right scale):


Stepping back for a longer term look, here is the same graph including the “shallow industrial recession” of 2015-16:


The main difference between the two periods is that the more volatile mining (oil and gas) sector declined by almost 23% in 2015-16, but has continued to increase this year. Manufacturing, which declined about 3% in 2015-16, declined 2% at its worst point  this year. Overall industrial production declined by -5% in 2015-16, but only declined -1.4% at its worst point in April of this year.

Here is the update on all of the four monthly indicators that the NBER has said it pays particular attention to in deciding whether or not there is a recession:


As in 2015-16, industrial production is the only one of the four which has declined this year.

In sum, production had a much more shallow decline this year than in 2015-16, and — so far — looks to be recovering from its trough in April. Once again the message appears to be: slowdown, no recession.

Monday, September 16, 2019

Weekly Indicators for September 9 - 13 at Seeking Alpha


 - by New Deal democrat

I realized that I neglected to post a link to this Saturday’s Weekly Indicators post, which was up at Seeking Alpha.  So here it is.

The theme over the past few months has been that, despite worsening conditions in manufacturing, and almost singular forecaster attention to the yield curve, many of the short and long term indicators have been improving, or are starting to improve.

As always, clicking over and reading helps reward me a little bit for the efforts I put in.

Last week’s initial jobless claims still show slowdown, no recession


 - by New Deal democrat

A couple of weeks ago, I updated the entire list of short leading indicators. To cut to the chase, those that were negative or trending negative came out of the production sector, while those that were positive were mainly from the consumer sector. 

But, regardless of which sector’s weakness might give rise to a recession, at some point it would have to be reflected in increased layoffs. As last Thursday’s report of initial jobless claims showed, that isn’t happening. Since I didn’t get around to commenting on this last week, let’s take a look now.

At 204,000, last week’s number of initial claims is close to the bottom of the number of claims even in the past year. The four week moving average is only 5.5% above the low point set in April:


Before a recession, the YoY comparison of initial claims generally moves higher for at least two months in a row. Against very positive numbers in August last year, this year’s number was slightly negative, but as shown below (weekly YoY claims in blue, monthly average in red) we haven’t violated this rule, and September so far is positive YoY:


Continuing claims turn a little after initial claims, but are less volatile. The four week moving average of continuing claims is -2.1% below where it was last year:


The bottom line is that the trend in jobless claims remains very weakly positive. Like so many other data series I track, the message at this point is “slowdown, no recession.”

Friday, September 13, 2019

August retail sales confirm healthy consumer sector


 - by New Deal democrat

Retail sales are one of my favorite indicators, because in real terms they can tell us so much about the present, near term forecast, and longer term forecast for the economy.

This morning retail sales for August were reported up +0.4%, and July, which was already very good at +0.7%,  was revised upward by another +0.1% as well. Since consumer inflation increased by +0.4% over that two month period, real retail sales have risen +0.7% in the past two months. As a result, YoY real retail sales, which had been faltering earlier this year, are  now up +2.3%.

Here is what the last five years look like:


Others may use other deflators. I use overall CPI because:
1. I’ve been doing it this way for over 10 years. 
2. This is the deflator used by FRED.
3. It has a 70+ year history.
4. Over that 70+ year history, it has an excellent record as a short leading indicator for employment and recessions. That’s the kind of track record I like.

As I mentioned above, although the relationship is noisy, real retail sales measured YoY tend to lead employment (red in the graphs below) by about 4 to 8 months. here is that relationship for the past 70 years, measured quarterly to cut down on noise:


Now here is the monthly close-up of the last five years. You can see that it is much noisier, but helps us pick out the turning points:


The recent peak in YoY employment gains followed the recent peak in real retail sales by roughly 6 months, and the downturn in real retail sales at the end of last year has already shown up in weakness in the employment numbers this year. Similarly I expect the improvement in retail sales to show up in an improvement in the employment numbers by about next spring. 

Finally, real retail sales per capita is a long leading indicator. In particular it has turned down a full year before either of the past two recessions:



With the past several months setting new highs, this is evidence against a recession within the next year.  Further, in the last 70 years, this measure has always turned negative YoY at least shortly before a recession has begun. Although there have been some false positives, there are no false negatives. In other words, this is a very reliable positive indicator. 

To sum up, real retail sales are evidence against the current slowdown turning into a full-fledged recession, and argue for an improvement in employment and the economy as a whole starting about next spring — assuming the economy is left to its own devices, and Tariff Man does not hit American companies and households with further substantial stealth tax increases (currently standing at about $460 per household annualized).

Thursday, September 12, 2019

Real average and aggregate wage growth for August


 - by New Deal democrat

Now that we have the August inflation reading, let’s take a look at real wage growth.

First of all, nominal average hourly wages in June increased a strong +0.5%, while consumer prices increased +0.1%, meaning real average hourly wages for non-managerial personnel increased +0.4%. This translates into real wages of 97.5% of their all time high in January 1973, a new high following revisions to prior months:


On a YoY basis, real average wages were up +1.7%, still below their recent peak growth of 1.9% YoY in February:


Aggregate hours and payrolls were up strongly in August’s household jobs report, so real aggregate wages - the total amount of real pay taken home by the middle and working classes - are up 29.7%  from their October 2009 trough at the beginning of this expansion:


For total wage growth, this expansion remains in third place, behind the 1960s and 1990s, among all post-World War 2 expansions; while the *pace* of wage growth has been the slowest except for the 2000s expansion.

Finally,  several months ago I raised a concern that real aggregate wages had decelerated sharply this year. That is because, typically, real aggregate wage growth has decelerated by 1/2 or more from its 12 month peak just at the onset of recessions, although there have been 3 false positives during slowdowns that did not turn into recessions. As of August, YoY growth has declined to 2.6% vs. a revised 4.7% at the beginning of this year, although it rebounded from July:


Note that we have had two similar declines already during this expansion. For now, this is just confirming that we are in a slowdown.

Wednesday, September 11, 2019

An update on forecasts


 - by New Deal democrat

I have a new post up at Seeking Alpha, describing the order in which data has tended to deteriorate before consumer-led recessions. A few conditions have been met; most others have not.

I have previously written that if a recession is in the works over the next few quarters, it is more likely to be a producer-led recession, a la 2001. In that regard, a few weeks ago I said that Q2 corporate profits would be a crucial report.

Well, they were reported a couple of weeks ago. I hadn’t linked to that article before, but that too was posted at Seeking Alpha.

The bottom line is that both the nowcast and the long-term 12+ month forecast are reasonably clear. The short term, 3 - 9 month forecast, is a lot dicier, and depends greatly on whether Tariff Man can resist the impulse to keep adding on de facto tax increases on American producers and consumers.

As usual, clicking over to SA and reading the posts should be educational for you, and helps reward me with a little $$$ for the effort I put in.

Tuesday, September 10, 2019

July JOLTS report: m/m improvement, but slowing trend


 - by New Deal democrat

This morning’s JOLTS report for July was in general surprisingly positive on a monthly basis, but continued to show a slowing trend.

To review, because this series is only 20 years old, we only have one full business cycle to compare. During the 2000s expansion:


  • Hires peaked first, from December 2004 through September 2005
  • Quits peaked next, in September 2005
  • Layoffs and Discharges peaked next, from October 2005 through September 2006
  • Openings peaked last, in April 2007 
as shown in the below graph (quarterly, normed to 100 as of May 2018):



Here is the close-up on the past three years (monthly):


In today’s report, all of the above series improved month over month. But the only series that is meaningfully higher than it was one year ago, was voluntary quits.


Next, here is the history of the “hiring leads firing” (actually, total separations) metric:



As Is again apparent, both hires and fires have essentially gone sideways for the last twelve months. It is possible both are at a turning point, but it is impossible to know.

Finally, although I normally don’t bother with the “jobs openings” series because I consider it soft and unreliable data, it is the one series that declined in July, and it is the only series that is negative YoY:


Since it was the last series to turn south before the 2007 recession, this is noteworthy, although — again, because the JOLTS metrics are less than 20 years old — it is impossible to know what if anything at all this may portend.

In summary, while almost all the monthly changes were positive, this month’s report does little to show an improving jobs market. The main takeway is deceleration just barely above neutral levels.

Monday, September 9, 2019

Scenes from the August jobs report


 - by New Deal democrat

The August jobs report was the mirror image of most earlier reports this year: a lackluster Establishment report but a strong Household report. Let’s take a look.

By now the fact that there has been a jobs slowdown is pretty well established. In the last 7 months, only 964,000 jobs have been added, an average of 138,000 per month. If we subtract this month’s temporary census hiring of 25,000, those numbers drop to 939,000 and 134,000, respectively:


And keep in mind that the number of jobs added between March 2018 and March 2019 is going to be reduced from roughly 210,000 to 167,000 per month.

Since last December, of the leading employment sectors, only residential construction has continued to increase significantly. Manufacturing has added only 19,000 jobs in the last 6 months, and temporary jobs have actually declined since the end of last year:


Here’s what the month to month breakdown of all three leading sectors looks like compared with 2018, showing the slowdown this year - except, so far, for this past month:


Further, because even with August’s increase, the average manufacturing workweek is down almost 1 full hour per week YoY (blue in the graph below), we should expect actual losses in manufacturing jobs going forward:


Before 1980, manufacturing jobs’ growth or decline typically followed hours by roughly 2 months. Since then, the time period has lengthened to more like 6 months.

That being said, if a similar pattern is followed to what happened in 2016, by the end of next spring, we should expect *no* net YoY in manufacturing jobs, which means a decline of at least -25,000 jobs during roughly the next 9 months.

On a similarly granular level, it seems that each month in my jobs report write-up, I comment on a surprising *increase* in temp jobs, despite the worsening YoY decline in the American Staffing Association’s temporary jobs Index:


And yet, as you can see from the graphs above, temporary jobs have indeed declined this year. So I went back and compared the original numbers for temporary jobs in each jobs report this year (1st column) with the final number (2nd column), and as I suspected, the revisions have been very asymmetrical:

JAN +1500 -26,300
FEB +5800 +7000
MAR -5400 -10,500
APR +17,900 +4300
MAY +5100 -2000
JUN  +4300 -2900
JUL +2200 -7300*
AUG +15,400 ——
*1st revision only

As originally reported, every single month this year except for March was positive. But as finally revised, only two months have been positive so far. Given the worsening comparisons in the Staffing Association’s Index in August, I would be very surprised if the initial rosy number for temporary jobs in August’s jobs report holds up.  Needless to say, this is the kind of thing that happens at turning points.

Stepping back a bit to look at the goods-producing sector overall, this has also slowed down considerably, adding only 73,000 jobs in total since January, or 10,000 per month:


As shown in the graph below, goods producing jobs (red) are much more pro-cyclical compared with jobs overall (blue):



There have been YoY losses in goods-producing jobs before all of the past 3 recessions, and going back 70 years, counting 12 recessions, in all but 3 there has been steep deceleration before and actual losses no later than two months into the recession. We’re not quite there yet.

Turning to unemployment, labor force participation, and wages, let’s update the graph of how initial jobless claims slightly lead the unemployment rate:


Initial jobless claims have trended only slightly lower in the past 18 months, and are flat over the past 12. The unemployment rate has continued to trend slightly lower, but I expect that to end in the next several months, with no new lows, and more likely a drift sideways at 3.7% or even slightly higher to 3.8% or even 3.9%.

Finally, in the past 30 years, the unemployment rate has tended to start declining after recessions before the prime age employment to population ratio improves, and that in turn has turned higher before YoY wage growth finally turns higher (note: averaged quarterly to cut down on noise; unemployment rate inverted):


Similarly, at recent peaks, the unemployment rate may slightly lead prime age employment, which in turn declines before YoY wage growth does.

As the below close-up of recent monthly changes shows, gains in both the unemployment rate and the prime age participation rate seem to be slowing overall, and this year wage growth has as well:


We should expect the unemployment rate to turn up, and the E/P ratio to turn down, several months before any recession. Wage growth is a lagging indicator, however, and only turns up well into expansions, and can continue right into the next recession.

Saturday, September 7, 2019

Weekly Indicators for September 2 - 6 at Seeking Alpha


 - by New Deal democrat

My Weekly Indicators post is up at Seeking Alpha.

The nowcast and the long term forecast have been pretty stable, but the short term forecast has been volatile recently - and the monthly series (slightly negative) vs. the weekly data (more positive) are not in sync.

This is likely because there is much more monthly data (usually from the government) than weekly data (more often from private sources) about manufacturing.

Friday, September 6, 2019

August jobs report: for once, the underwhelming headline masked very good internals

 - by New Deal democrat

HEADLINES
  • +130,000 jobs added (+105,000 ex-Census)
  • U3 unemployment rate unchanged at 3.7%
  • U6 underemployment rate rose 0.2% to 7.2%
Leading employment indicators of a slowdown or recession

I am highlighting these because many leading indicators overall strongly suggest that an employment slowdown is coming. The following more leading numbers in the report tell us about where the economy is likely to be a few months from now. These were positive.
  • the average manufacturing workweek rose +0.2 from 40.4 hours to 40.6 hours. This is one of the 10 components of the LEI and is positive (note last month was -0.3 so on net this is still -0.1 hours from two months ago).
  • Manufacturing jobs rose by 3,000. YoY manufacturing is up 138,000, a deceleration from last summer’s pace.
  • construction jobs rose by 14,000. YoY construction jobs are up 177,000, also a deceleration from last summer. Residential construction jobs, which are even more leading, rose by 7,000.
  • temporary jobs rose by 15,400 (note this *may* reflect census hiring).
  • the number of people unemployed for 5 weeks or less rose by 6,000 from 2,201,000 to 2,207,000. The post-recession low was four months ago.

Wages and participation rates

Here are the headlines on wages and the broader measures of underemployment:
  • Not in Labor Force, but Want a Job Now: rose by 107,000 from 5.043 million to 5.150 million
  • Part time for economic reasons: rose by 397,000 from 3.984 million to 4.381 million 
  • Employment/population ratio ages 25-54: rose +0.5% from 79.5% to 80.0%. THIS IS A NEW EXPANSION HIGH.
  • Average Hourly Earnings for Production and Nonsupervisory Personnel: rose $.11 from  $23.48 to $23.59, up +3.5% YoY. This is still a slight decline from the recent YoY% change peak.  (Note: you may be reading different information about wages elsewhere. They are citing average wages for all private workers. I use wages for nonsupervisory personnel, to come closer to the situation for ordinary workers.)  

Holding Trump accountable on manufacturing and mining jobs

 Trump specifically campaigned on bringing back manufacturing and mining jobs.  Is he keeping this promise?  
  • Manufacturing jobs rose an average of +11,500/month in the past year vs. the last seven years of Obama's presidency in which an average of +10,300 manufacturing jobs were added each month.   
  • Coal mining jobs rose +1200, an average of +117 jobs/month in the past year vs. the last seven years of Obama's presidency in which an average of -300 jobs were lost each month
June was revised downward by -15,000. July was also revised downward by -5,000, for a net change of -20,000.

Other important coincident indicators help  us paint a more complete picture of the present:
  • Overtime fell -0.1 hours to 3.2  hours.
  • Professional and business employment (generally higher-paying jobs) rose by +37,000 and  is up +449,000 YoY. 
  • the index of aggregate hours worked for non-managerial workers rose by +0.3%
  •  the index of aggregate payrolls for non-managerial workers rose by +0.8%  
Other news included:            
  • the  alternate jobs number contained  in the more volatile household survey rose by 590,000  jobs.  This represents an increase of 2,274,000 jobs YoY vs. 2,074,000 in the establishment survey. 
  • Government jobs rose by 28,000 (up +3,000 ex-census).
  • the overall employment to population ratio for all ages 16 and up rose 0.9% to 60.9% m/m and is up 0.6% YoY.          
  • The labor force participation rate rose 0.2% to 63.2% m/m and is up 0.5% YoY.

SUMMARY

This report was the mirror image of most others we have seen this year: the establishment report was mediocre, while the household report was excellent.

The deceleration in jobs growth was well in evidence in the headline number. The last three months, ex-census hiring, has only been +147,000. But construction and manufacturing jobs both did increase. Non-supervisory wage gains increased to +3.5% YoY. On the other hand, if census hiring was included in the temporary jobs number, that decreased significantly.(UPDATE:  Census hiring was not included therefore the positive number is real, but temporary jobs remain significantly below their December 2018 peak.)  It is also concerning that the revisions to prior months continue to be downward. This is something that tends to happen near turning points.

The household survey, on the other hand, was generally very strong. Almost 600,000 new jobs were added in that report, and the YoY gains now exceed the establishment report. The prime age employment to population ratio increased to its highest level since January 2008. It is only because of this big addition to the labor force that the unemployment rate stayed steady (vs. going lower) and the underemployment rate increased. Aggregate hours and payrolls both jumped. 

So, despite the underwhelming headline number, this was overall a very good report.

Thursday, September 5, 2019

One marker of initial jobless claims turns (slightly) negative


 - by New Deal democrat
I’ve been monitoring initial jobless claims closely for the past several months, to see if there are any signs of stress. This is because the long leading indicators were negative one year ago, and many - but not a majority - of the short leading indicators have recently turned negative as well. So I am on “recession watch.” But no recession is going to begin unless and until layoffs increase.

To reiterate, my two thresholds are:

1. If the four week average on claims is more than 10% above its expansion low.
2. If the YoY% change in the monthly average turns higher.

This week the second measure turned negative. Let’s take a look.  
Initial jobless claims last week were 217,000. This is in the lower part of its range of 220,000 +/-12,000 for the past 19 months. As of this week, the four week average is 7.3% above its pre-Easter low:


The four week YoY change as well as the YoY change for the month of August as a whole (red) are 450 higher than last year (weekly YoY change is shown in blue):


The less leading but also less volatile 4 week average of continuing claims rose slightly and is now only -1.8% below its level of one year ago, which is the weakest comparison in this entire expansion:


Overall, jobless claims remain ever so weakly positive, against some very tough YoY comparisons. There is no imminent economic downturn so long as this remains the case.

Tuesday, September 3, 2019

Two sharply contrasting reports on the economy to start September


 - by New Deal democrat

We got two contrasting views of the economy this morning.

First, the good news: residential construction spending increased in July. Below I show it in comparison with single family permits:

Typically construction follows permits. In the past few years, it has been almost coincident with permits. This is more good news for the important and leading housing sector, indicating that the decline that started in early 2018 has ended. With the continued recent further decline in mortgage rates, I expect further advances, although possibly not strong.

Now, the bad news: the ISM manufacturing index fell below 50 to 49.1. Worse, the leading new orders component fell to 47.2, the worst reading since the Great Recession:

Typically it takes at least two readings below 48 for the ISM manufacturing index to indicate recession. But the new orders index is already at a level which has been consistent over the past 70 years with a recession in the very near future - although it is also consistent, as for example in 1966, with a slowdown only:

Nevertheless, it does tip the balance of short leading indicators from neutral to slightly negative.
The reports, combined, suggest that in Friday’s jobs report there should be a little improvement in residential construction jobs, but suggest a decline in manufacturing jobs - something that has been loudly telegraphed by the decline in the manufacturing work week in the past year.

Sunday, September 1, 2019

The Passive-Aggressive Investor for the Week of August 26-30

Before starting please note that I am not the reader's investment advisor or lawyer.  This information is not meant for a specific individual.  Please read and then consult with your adviser.  This is not investment advice for any specific person.


Let's start with a simple question: where are we in the economic cycle?  We're a lot closer to the end of the latest expansion.  I've got a 25% recession probability in the next 6-12 months, based on the yield curve and softness in several business related metrics.  While I don't think a recession is a foregone conclusion there is a broad enough swath of data to be concerned.   But as for the third quarter, the NY Fed's 3Q19 GDP prediction is 1.8%; the Atlanta Fed is predicting 2%; the blue-chip consensus is between 1.6%-2.4%.   

The markets have taken notice.  In my latest weekly Technically Speaking summation, I noted that the weekly charts are continuing to roll-over in a bearish formation.  I've also noted that the daily charts are trending weaker.  

Let's take a deeper look at the charts I follow for this column, starting with US equity indexes:



Click for a larger image

The ETFs that track larger indexes (the SPY, OEF, and QQQ) are still in decent shape.  All recently hit highs but have since sold-off due to weaker economic news and trade-related concerns.  As the size of the issue decreases, however, the chart becomes technically weaker.  Mid-caps (IJH) are in fair shape, small caps (IWM) are technically more precarious and the micro-caps (IWC) are hanging on by a technical thread.





Click for a larger image

Defensive sectors (the XLP, XLU, VNQ) are in solid uptrends.  The fourth defensive sector (the XLV) is under a great deal of political and legal weight right now.  The other more aggressive sectors range from fair (the XLK and XLY) to very weak (XLE). 

Let's now look at the international ETFs:

Click for a larger image

Latin America (the ILF) has dropped sharply thanks to Argentina's and Brazil's weak performance.  Europe (VGK) and Asia (VPL) have both sold-off recently thanks to weaker economic data and concerns over trade-related issues.  The broader ETFs (developed and developing markets) are also weaker for the same reasons.

But the dividend paying ETFs are in slightly better shape:




Click for a larger image

The international dividend ETF has sold-off with the markets.  But with a high yield (it's currently yielding 6.3%) it's reasonable to assume that it's hit a bottom for now.  Preferred shares continue to rally.  The broader market dividend ETF has sold-off a bit but is still trading at its 50-day EMA.

Now let's turn to the bond market ETFs, starting with the US:



Click for a larger image

The US bond market is on a tear.  Both the treasury and corporate markets are rallying very strongly.



Click for a larger image 

We see the same pattern in the international bond markets, although international treasury bonds (left) are stronger than international corporate (right).


 Click for a larger image

Junk bond markets are actually doing pretty well, thanks to investors reaching for yield.

Let's add all this up:
  1. The economic back-drop is fair.  But while there are clear signs of economic weakness, a recession isn't a foregone conclusion.  
  2. Larger cap indexes are still catching a bid.
  3. The smaller the underlying equity issue covered by the ETF, the more precarious its technical position. 
  4. Bonds are very strong. 
If we just forming a portfolio in this environment, we'd have to make the following assumptions:
  1. The possibility of massive capital gains is very small, which means
  2. We should look for assets that have, at minimum, a certain level of income.
    1. While I didn't cover them above, a number of Dividend Aristocrats are currently yielding far above the 10-year treasury, making them potential candidates in future issues.
  3. We should probably shy away from higher risk (higher beta) assets due to the modest possibility of a recession in the next 6-12 months.
And that leads to a discussion of one of the investment world's most basic portfolios: the broad market (S&P 500 represented by the SPY), long treasury bond (20+ year treasury represented by the TLT) combination.  This is about as simple as you can get -- you've only got two assets, after all.  And they're almost always negative correlation -- when one rises the other is likely to fall.  Here's their rolling 60-day correlation for the last 10-years:

 
Click for a larger image

Let's look the historical performance of three possible allocations:

portfolio 1: 25% stocks/75% bonds
portfolio 2: 50% stocks/50% bonds
portfolio 3: 75% stocks/25% bonds

Let's first look at the historical return of this portfolio (January 1978-August 1979)

Click for a larger image

There's not much difference between the standard deviation (risk) of portfolio 1 and 2.  But portfolio 3's risk increased a lot for a .55% increase in the compound annual growth rate.  In addition, the Sharpe and Sortino ratios decline a bit between portfolio 2 and 3.  There's also a large increase in the drop during the worst year between portfolio 2 and 3.  The bottom line is that portfolio 2 looks to be a decent mix for the risk, whereas somewhere between portfolio 2 and 3 the investor winds up on the losing end of the risk-reward trade-off.

Finally, let's run a monte carlo simulation of the 50% SPY/TLT allocation model:


Here's the end result of the analysis (emphasis added):
Monte Carlo simulation results for 10000 portfolios with $1,000,000 initial portfolio balance using available historical returns data from Jan 2003 to Dec 2018. The historical return for the selected portfolio for this period was 8.50% mean return (8.30% CAGR) with 8.03% standard deviation of annual returns. The simulated inflation model used historical inflation with 2.08% mean and 1.37% standard deviation based on the Consumer Price Index (CPI-U) data from Jan 2003 to Dec 2018. The generated inflation samples were correlated with simulated asset returns based on historical correlations. The available historical data for the simulation inputs was constrained by iShares 20+ Year Treasury Bond ETF (TLT) [Aug 2002 - Aug 2019]. 
Here are a few observations from the above data:

  • With the exception of one scenario, all returns are positive
  • By year 3, it's reasonable to assume an annual return of 5% 
  • By year 10, it's reasonable to assume an annual return between 5% and 7.5%