Market/Economic Analysis: UK; Looking Better

From the Office of National Statistics:

• Gross domestic product (GDP) increased by 0.6% in Q2 2013 compared with Q1 2013.
• All four main industrial groupings within the economy (agriculture, production, construction and services) increased in Q2 2013 compared with Q1 2013.
• The largest contribution to Q2 2013 GDP growth came from services; these industries increased by 0.6% contributing 0.48 percentage points to the 0.6% increase in GDP.
• There was also an upward contribution (0.08 percentage points) from production; these industries rose by 0.6%, with manufacturing increasing by 0.4% following negative growth of 0.2% in Q1 2013.
• In Q2 2013, output in the construction industry was estimated to have increased by 0.9% compared with Q1 2013. In Q1 2013 construction output was at its lowest level since Q1 2001.

Here are relevant charts from the report:

The above chart shows two important points.  First, total GDP is still below pre-recession levels (the red line).  This was caused by an incredibly weak economy, which is caused by the weak growth in the Q/Q area.  The UK has had periods of negative growth since the end of the recession, highlighting how fragile their economy has been.

The above chart shows two important developments.  First, in the latest quarter production, construction and services all contributed to growth.  Additionally, each sector contributed in a meaningful way.  Compare the most recent quarters performance to the previous four quarters where at least one area contracted, leading to the slower growth.

In addition, the latest Markit indicators show an economy about to expand.

UK service sector growth accelerated to its highest level since March 2011 during June as incoming new business rose at a rate unmatched for six years. The sharp increase in new business led to a marked rise in backlogs of work, and encouraged companies to take on additional staff to the strongest degree since August 2007.

Confidence regarding future activity was also retained, with expectations at their highest for 14 months. However, margins remained under some pressure as strong competition prevented companies from fully passing on higher cost burdens. 

After accounting for seasonal factors, the headline Business Activity Index recorded 56.9 in June, up from May’s 54.9 and the highest reading for 27 months. Growth has now been recorded for six successive survey periods, and has continually improved throughout this sequence.

Here's the accompanying chart:

That's a strong rise, and one that indicates an economy with some momentum for growth.

And manufacturing appears to have the same bullish qualities:

The UK manufacturing sector maintained its solid second quarter performance into June, with levels of production and new business rising at the fastest rates since April 2011 and February 2011 respectively. Domestic market conditions improved further, while demand from overseas also strengthened.
 
At 52.5 in June, up from a revised reading of 51.5 in May, the seasonally adjusted Markit/CIPS Purchasing Manager’s Index® (PMI®) posted above the neutral mark of 50.0 for the third month running. Moreover, the rate of improvement signalled by the PMI was the steepest for 25 months. The average reading over the second quarter as a whole (51.4) was the highest since Q2 2011.
 
The latest expansion in UK manufacturing production was broad-based, with all of the sub-sectors covered by the survey signalling increases in June. The strongest rates of growth were recorded by the Textiles & Clothing and Food & Drink categories.

Here's a chart of the data:

Let's take a look at the ETF chart for the UK market:

 

Since early June of last year, prices have been rallying and have been using the 200 day EMA as technical support, hitting that level twice.  There have been several periods of consolidation.  The market recently hit a peak just below the mid-May peak.  I've drawn a red line connecting these peaks.  My guess is we're starting to see some consolidation from the year long rally. 

The pound is still trading at very low levels on the weekly chart; prices are just above three year lows, indicating traders still view the economy as weak.  Ultra-low interest rates are not helping in this matter.

Consumer prices in July likely up 0.2%

. - by New Deal democrat

One of my running themes for the last few years is how the engaging or loosening of the Oil choke collar explains the acceleration and deceleration of the economy in general, and the inflation rate in particular. In an era of paltry average wage gains, that makes the difference between households gaining or losing ground.

In fact, knowing what has happened to the price of gas is virtually all you need to know to figure out the inflation rate. Since underlying cor inflation is typically +0.1% or 0.2% a month, all you need to do is divide the percentage change in gas prices by 10 (or by 16 if you want to be more conservative), add that to core inflation, and you are almost always going to be within 0.1% of that month's non-seasonally adjusted inflation rate. Then all you need todo is make the seasonal adjustment.

We now know that the average price for gas in July was $3.59 vs. $3.62 in June (remember that June started at a high price and then declined). This is about a 0.7% decline or less tha 0.1% after we divide by 10. Adding in core inflation gives us roughly +0.1%. As you can see from the below graph of NSA vs. S A inflation each month beginning last July, the seasonal adjustment is +0.1%:

This gives us a July inflation rate of +0.2% +/-0.1% seasonally adjusted, or +2.0% YoY.

So you should expect to read in a couple of weeks at a lot of sources that inflation is worryingly picking up steam. Don't buy it. Note that in August and September of last year there was a big run-up in the price a gas, and inflation clocked in at +0.5% each month. Unless gas prices run up to $3.90 or so a gallon, that isn't going to be duplicated. If gas prices remain stable, in two months we will be right back down at about +1.2% YoY inflation. Then we can switch right back to worrying about deflation.

US Employment Preview: Employer Behavior

Let's continue looking at the US labor market by focusing on employer behavior:

The total number of establishment jobs indicates that employers have been hiring, and doing so consistently.  However, the total amount of establishment jobs is still 2 million below that highest level of the previous expansion -- and that's before we take population growth into account.

The above two charts are from the JOLTs survey and they highlight an interesting trend.  While the number of openings being advertised is at decent levels for this time in the expansion, the total number of hires is still very low.  Put in a different way, while employers are advertising job openings, they aren't hiring at a high rate.

This information tells us that while employers are advertising positions as open, they're just not filling them that quickly.  This ties in with the low level of employer confidence.

Market/Economic Analysis: Japan -- Still Looking Better

From Reuters:

Japan's consumer prices rose in June for the first time in more than a year, a positive sign for the government's battle against deflation, but the rises centered on higher electricity bills rather than stronger demand that could drive a durable recovery.


.....

Core consumer prices rose 0.4 percent in June from a year earlier, higher than a median market forecast for a 0.3 percent increase, largely due to higher electricity bills and gasoline prices.

Japan's energy prices have been rising as a weaker yen has boosted the cost of imported fuel needed to make up for the closure of almost all the nation's nuclear reactors after the March 2011 tsunami.

"Such cost-push inflation should not be taken as particularly positive," said Yasuo Yamamoto, senior economist at Mizuho Research Institute. Market participants "are skeptical about the prospects for a steady pickup in inflation, with service-sector firms struggling to pass on costs to consumers due to a persistent output gap."

.....

"If you look at a narrower basket of goods without energy, the clear rising trend isn't there yet and we can't say with great confidence that Japan is clearly on its way out of deflation," said Koichi Fujishiro, economist at Dai-ichi Life Research Institute in Tokyo.

Short version: it's a start. 

Here is a link to the Japanese CPI numbers from their statistical bureau.

Most importantly, the rise in inflation is a direct result of the BOJs plan to drop the yen's value.  Consider this long-term chart of the yen's ETF:

 
The yen was in a clear uptrend from 2007 until the end of 2011 -- this despite the obvious weakness of their economy.  The first reason is the yen was part of the carry trade -- people would borrow in yen because of their ultra low rates and then invest in another currency, pocketing the difference.  After the Great Recession, the yen became a safe haven.  But either way, a currency that should have been dropping in value because of the fundamental weakness of the underlying economy was rising. 

Now it appears the yen is probably closer to "fair value" given the weakness of the Japanese economy.

In addition, Abe's party swept the most recent elections, giving them a strong mandate to continue their policies:

Japanese Prime Minister Shinzo Abe, fresh from a strong election victory, vowed on Monday to stay focused on reviving the stagnant economy and sought to counter suspicions he might instead shift emphasis to his nationalist agenda.

The victory in parliament's upper house election on Sunday cemented Abe's hold on power and gave him a stronger mandate for his prescription for reviving the world's third-biggest economy.

At the same time, it could also give lawmakers in his Liberal Democratic Party (LDP), some with little appetite for painful but vital reforms, more clout to resist change.

"If we retreat from reforms and return to the old Liberal Democratic Party, we will lose the confidence of the people," Abe told a news conference on Monday.

He emphasized that his priority remains proceeding with his "Abenomics" program of hyper-easy monetary policy, government spending and economic reform, describing it as the cornerstone of other policy goals.

Let's take a look at the Japanese ETF to see how it's fared:

After peaking in late May, the ETF fell to the 200 day EMA and rallied again to just shy of the previous peak.  The ETF has dropped over the last few days in reaction to weak news coming out of China.  It still appears that the Japanese market is consolidating gains made in the post Abe run-up.

US Employment Preview; Leading Indicators

This week we get another employment report.  So let's place the upcoming data into perspective by using the Macroblog employment spider chart categories (leading indicators, employer behavior, confidence and utilization) to get a broad picture of the US employment situation, starting with leading indicators.

The top chart shows weekly initial claims and the 4-week average of claims and places the latest reading into a 20 year historical perspective.  Claims are currently at levels associated with the mid-point of an economic expansion.  The bottom chart shows a five year history of claims and demonstrates a clear downward trend which appears to be stabilizing around the 350,000 area.

Secondly, temporary services are at very high levels and are in a clear upward trend.

In short, the leading indicators for employment are very positive.

Market/Economic Analysis: US; More of the Same "Moderate" Recovery

Let's take a look at last week's economic news

The Good

The Kansas City Fed index rose to 6.  Most importantly, the internal numbers on production and shipments rose sharply.  Additionally, the Markit flash estimate increased from 51.9 to 53.2, which included some strong growth in internal numbers.

New home sales increased 8.3% from the previous month.  However, keep an eye toward the next 3-5 readings for this number.  The spike in this reading could reflect higher interest rates pulling sales forward, but we won't know until we see a few more months of data.

The Neutral 

From the Chicago Fed: The index’s three-month moving average, CFNAI-MA3, increased to –0.26 in June from –0.37 in May, marking its fourth consecutive reading below zero. June’s CFNAI-MA3 suggests that growth in national economic activity was below its historical trend. The economic growth reflected in this level of the CFNAI-MA3 suggests subdued inflationary pressure from economic activity over the coming year.

I've placed this reading in the neutral category because it indicates the economy is growing below its overall economic growth potential.

Existing home sales decreased 1.2% last month.  This is a neutral reading as it may indicate that higher interest rates area starting to slow the real estate recovery.  However, this is only one month of data, so we obviously can't be sure on that. 

The University of Michigan Consumer sentiment decreased a bit last month.

The Bad

The Richmond Fed's manufacturing index fell 18 points to -11.  Production and new orders also declined.  It should be noted the Richmond Fed's index has shown depressed readings relative to other Fed numbers for the last few years.

Conclusion: the best news came in the Markit report, which showed an improvement in the manufacturing environment.  But more importantly, the internals show a good possibility for a continued improvement in the coming months.  The housing numbers are a bit concerning as both may indicate we're starting to see higher rates impact purchases.   But we we don't have enough data to make a solid call in that area.  Finally, the Chicago Fed number merely concerns that regardless of the news we get, the economy is still operating below potential.

Let's turn to the markets, starting with a long-term view of the SPYs:

The monthly chart shows that we're clearly in new technical territory.  At the end of last year, the market hit resistance around the 139 level -- the previous high from the 2003-2007 rally.  After stalling there at the end of last year, prices have made a strong push higher.  The underlying MACD and CMF support a continued move higher.

The daily chart shows that prices may be consolidating.  The most recent push higher is characterized by weak candles (small bodies) on lower volume.  While the most recent peak is technically higher than the peak in late May, it's pretty insignificant technically.  Most importantly, the MACD is currently declining and close to giving a buy signal.  In addition, the MACD appears to be declining.

When the daily chart SPY analysis is combined with the above 60 minute chart, it shows that next week's most likely direction is consolidation or lower.  Prices above have broken trend from the June 24-July 23 rally and are tight at technical support established in mid-June.  The MACD is declining.

The belly of the treasury curve (the IEIs and IEFs) are consolidating their recent sell-off.  While both have a rising MACD, the indicator is still negative indicating weak momentum.  The key level for the IEIs is 119.5 and the IEFs 100.5.

The dollar is still trading in a tight range of 21.5 - 23. 

The week ahead: we're in the middle of the summer doldrums, so barring a cataclysmic event, trading will be weak.  While there is a Fed announcement this week, I'm not anticipating a major change in their statement.

A thought for Sunday: turning points

- by New Deal democrat

Why do I blog? Why should you read me? In the last week I've thought a lot about political end economic turning points. For example, Obama is touting a "middle [class] out" economic strategy. He always gives great speeches, but he wouldn't have to be giving them now if he hadn't ceded the narrative to the Tea Party all throughout 2010, telling one Georgia Congressman at the time that there wouldn't be a repeat of 1994 because, "This time, you've got me."

The news of late has been totally "blah." Everything seems either totally stuck in the doldrums or just shambling forward. Unless Washington seriously rattles markets and the economy by refusing to pay bills that it has already incurred this autumn in what looks like Debt Ceiling Debacle 2 - a serious possibility - the news is likely to remain "blah" through the end of the year. Almost nobody is calling for, or saying we are already in, a recession. And the use of the term "recovery" in scare quotes, minus Atrios and a few Doomers, has almost completely disappeared. Almost everybody seems to have accepted the narrative that the economy is improving, as it has for 4 years, but way too slowly compared with what was needed for average Americans.

Meanwhile the stock market continues to make new highs. In the blogosphere, that means that economic sites are losing readership while investing sites are gaining as the public, as always, arrives late to the stock market rally party.

Which means it's a "blah" time for me as well. While I have a strong political viewpoint, my thoughts are usually expressed about 1000 times better by Digby, David Atkins, Charlie Pierce, Riverdaughter, and Armando a/k/a Big Tent Democrat. Simply put, my forte is identifying and calling economic and market turning points - and debunking the false hysteria in between.

In 1994, I was schooled. There was a huge back-up in interest rates, for a couple of days the long end of the bond market inverted, and consumer confidence plummeted. The overwhelming consensus of the pundits, and of individual investors, was bearish. I agreed, but it turned out it was the absolute bottom.

I only needed to learn once. I dug deeply into historical data. I saw why business infrastructure investment in software and computer hardware, touted by raging bull Joe Battapaglia, was driving the economy. I realized that as long as interest rates were declining over the longer term, and businesses continued to invest, the historic bull market was likely to continue. Further, whenever any one or two indicators would roll over, but the important ones remained intact, there would be a "V" market correction, Elaine Garzarelli would announce that a crash was imminent, and that would be the bottom. This was a historic secular bull move, and I figured every individual indicator would give a false positive at least once. At the top, everyone would be ignoring all the signals, all of the late Louis Rukeyser's elves would be bullish (or at least neutral), and then the bottom would fall out.

And that's exactly what happened. After Rukeyser booted Gail Dudak in 1999, all his elves were afraid of being bearish. Marty Zweig looked like he was in agony, continuing to say that he was neutral, while looking as if he wanted to grab Rukeyser by the lapels, shake him like a ragdoll, and scream, "Game over, man. Game over!!!" All of the other leading indicators started to turn. The advance/decline line from 1998 through 2000 looked absolutely horrible. In March 2000, I sat down with a friend over lunch, went through all of the indicators, virtually all of which had turned negative, and announced that the great bull market that had started in 1982 was over.

In 2005 when I started writing diaries at Daily Kos, I figured progressives could use neutral economic commentary, written by somebody with no product to sell. I am always worrying, I am always cautious, and my disposition is pessimistic, but usually with the caveat "not yet," because the long and short term data simply don't support that any Day of Reckoning is nigh.

I was almost positive that we were in a housing bubble, and called its turn in real time. In November 2006, I wrote that a recession would probably start within a year. As the data deteriorated, I wrote "Are Hard Times Near?" the thesis of which was that we were entering a period of prolonged, well, Hard Times as the strugle of the middle class to stay afloat by taking on ever greater debt, and refinancing at lower and lower interest rates, was probably coming to an end (as it turned out, there was one more chance, post 2008, to refinance). In 2007, I wrote of the similarities to 1929 in the broader economy.

Then the deluge hit. My focus turned to whether it would be a self-negatively-reinforcing deflationary spiral, or whether it would avoid going over the precipice. The first clue was when retail sales stopped falling - or fell at a very slow rate - beginning in December 2008. With gas at $1.40 a gallon, it looked like consumers might actually start to rebound in a few months. In January 2009, I started to write that the recession might bottom out in the summer, a conviction which increased as housing permits and starts stopped falling in the spring, and other leading indicators started to turn. Even the horrific monthly payroll declines started to be a little less horrific each month. By early May, Bonddad and I parted company with the dominant Doomish narrative on Daily Kos, and dared to say that conditions were on the cusp of improving.

They did. Since then I have remained positive, with greater or lesser caution at times, seeing off double dippers and triple dippers and Doomish dippers. The data simply hasn't supported a return to economic contraction. In 2009 I was mocking the Pied Piper of Doom. By the end of 2011, I was challenging ECRI. In mid-2011 I also foresaw the bottom in housing prices in early 2012, and in 2012 I took the contrary position to Barry Ritholtz's thesis that housing prices hadn't bottomed. In 2010 and 2011 I called the bottom of corrections in the stock market within one day.

So, writing economic or political polemics is simply not my strong point. Telling you the direction of the data, and whether or not we are at a turning point, is.

At the moment, the news is "blah." Washington could make it dramatic, in a very bad way, shortly, but there is simply no way to know how that will play out. Barring that sort of intervention in the economy, here's how I think the next recession begins. It will look very much like right now, with a significant increase in interest rates. Housing starts and permits will take a spill. Refinancing will die. Wages will fail to keep up with inflation. Corporate profits will suffer. Eventually consumers will cut back on buying cars, and then there will be a more general cutback in consumer spending. The short leading indicators will have joined the long leading indicators in rollilng over. At that point we will be right back where we were at the end of 2008, hoping we can avoid an outright wage deflationary spiral.

The recent retreat in several of the long leading indicators may or may not be the start of that process. Stay tuned.

Weekly Indicators: a midsummer respite edition

 - by New Deal democrat

Monthly data reported in the last week included a 5 month high in the Michigan consumer confidence index. Almost all of this was due to the present conditions sub-index, while expectations for the future, a component of the LEI, gained only slightly. Durable goods were up, but only due to transportation. New home sales were up. Existing home sales were down.

Let's start this week's look at the high frequency weekly indicators again by looking at the Oil choke collar:

Oil prices and usage

• Oil $104.70 down -$3.35 w/w


• Gas $3.68 up +0.04 w/w


• Usage 4 week average YoY up +3.1%

The price of Oil retreated from its 52 week high. The price of a gallon of gas should follow (and already is on GasBuddy). The 4 week average for gas usage was, for the third time in a long time, up YoY.

Interest rates and credit spreads

•  5.29% BAA corporate bonds down -0.12%


• 2.54% 10 year treasury bonds down -0.10%


• 2.75% credit spread between corporates and treasuries down -0.02%

Interest rates for corporate bonds had been falling since being just above 6% in January 2011, hitting a low of 4.46% in November 2012. Treasuries previously were at a 2.4% high in late 2011, falling to a low of 1.47% in July 2012, but remain back above that high, although they have backed off the recent new high. Spreads have varied between a high over 3.4% in June 2011 to a low of 2.73% in October 2012, and are very close to that low again.

Housing metrics

Mortgage applications from the Mortgage Bankers Association:

• -2% w/w purchase applications


• +6% YoY purchase applications


• -1% w/w refinance applications

Refinancing applications have decreased sharply in the last 9 weeks due to higher interest rates to a two year low. Purchase applications have also declined from thier multiyear highs in April, and this week were again only slightly positive YoY.

Housing prices

• YoY this week +8.5%

Housing prices bottomed at the end of November 2011 on Housing Tracker, and averaged an increase of +2.0% to +2.5% YoY during 2012. This weeks's YoY increase remained close to its 6 year record.

Real estate loans, from the FRB H8 report:

• +0.3% w/w


• +0.5% YoY


• +2.4% from its bottom

Loans turned up at the end of 2011 and averaged about 1% gains YoY through most of 2012.  In the last several months the comparisons have completely stalled.

Money supply

M1

• +1.3% w/w


• +0.8% m/m


• +7.1% YoY Real M1

M2

• +0.5% w/w


• +0.8% m/m


• +5.0% YoY Real M2

Real M1 made a YoY high of about 20% in January 2012 and eased off thereafter. Earlier this year it increased again but has backed off its highs significantly.  Real M2 also made a YoY high of about 10.5% in January 2012.  Its subsequent low was 4.5% in August 2012. It increased slightly in the first few months of this year and has generally stabilized since, although it has declined slightly in the past few weeks.

Employment metrics

The American Staffing Association did not report an update to their Index this week.

Initial jobless claims

•   343,000 up +9,000


•   4 week average 345,250 down -750

Tax Withholding

• $137.4 B for the first 18 days of the month of July vs. $124.7 B last year, up +$12.7 B or +10.2%


• $147.4 B for the last 20 reporting days vs. $134.4 B last year, up +13.0 B or +9.7%

Daily tax withholding has improved to the middle part of its YoY range compared with its YoY average comparison in the last 7 months. Initial claims remain within their recent range of between 325,000 to 375,000, and have flattened out just as they have in the last 3 springs and summers.

Transport

Railroad transport from the AAR

• -3200 carloads down -3.0% YoY


• +6100 carloads or +3.8% ex-coal


• +6900 or +2.8% intermodal units


• -1600 or -0.3% YoY total loads

Shipping transport

• Harpex down -1 to 398


• Baltic Dry Index down -56 to 1082

Rail transport has been both positive and negative YoY in the last several months. This week it was negative once again. The Harpex index had been improving slowly from its January 1 low of 352, but has flattened out in the last 6 weeks. The Baltic Dry Index remained close to its 52 week high. In the larger picture, both the Baltic Dry Index and the Harpex declined sharply since the onset of the recession, and have been in a range near their bottom for about 2 years, but have stopped falling.

Consumer spending

• ICSC +1.4% w/w +2.1% YoY


• Johnson Redbook +3.3% YoY


• Gallup daily consumer spending 14 day average at $91 up $23 YoY

Gallup's YoY comparison was extremely positive this week. The ICSC varied between +1.5% and +4.5% YoY in 2012, while Johnson Redbook was generally below +3%. The ICSC has recently been relatively weak, but Johnson Redbook remains close to the high end of its range.

Bank lending rates

• 0.25 TED spread up +0.01% w/w


• 0.186 LIBOR down -0.005% w/w

The TED spread is still near the low end of its 3 year range, although it has risen slightly in the last month.  LIBOR has made another new 3 year low.

JoC ECRI Commodity prices

• up +0.89 to 123.77 w/w


• +5.70 YoY

This was a positive week, with the only outright negatives being mortgage applications, which are still declining, and energy prices, which are high enough to engage the Oil choke collar. YoY S&P 500 earnings also remain slightly negative.

Interest rates have subsided somewhat from their recent highs, and spreads are near 52 week lows. Other positives include bank rates, money supply, house prices, and commodities. Consumer spending is extremely positive as measured by Gallup, very positive as measured by Johnson Redbook, but only weakly positive as measured by the ICSC.

Neutrals to slight positives include real estate loans, jobless claims, withholding taxes paid, and shipping rates.

This week saw a respite in the recent negative turn in the long leading indicators of interest rates and mortgages, as well as a decline in the oil price spike. Short leading and coincident indicators remain positive.

Have a nice weekend.

Weekend Weimar, Beagle and Pit Bull

I'll be back on Monday; NDD will be here over the weekend.

China and Declinging Commodity Prices

The following graph is from the Financial Times:

China's export led manufacturing drive has been a boon to natural resourc companies and countries that are natural resource exporters (Australia, Canada and South America).  With China slowing, all of the countries will see a slowdown.  Consider the commodity ETFs from this mornings report on deflation; with the exception of oil, all are moving lower.

And it appears the slowdown is becoming a trend.  Consider this from the latest HSBC manufacturing report:

Financials Reassert Leadership Role

From the Financial Times:

A stark shift in investor sentiment in global equity markets has accelerated this year with a widening gulf between the market value of big US banks and commodity companies in emerging markets.

Five years ago, just ahead of the collapse of Lehman Brothers investment bank, the market capitalisation of US banks fell below the value of energy, materials and mining companies from the Bric countries – Brazil, Russia, India and China. 

The switch appeared to highlight a shift in global economic power and the rise of fast-growing economies beyond North America and western Europe.

But now investor sentiment has flipped again. At the end of last week the market capitalisation of US banks – which exceed $1tn for the first time since November 2007 – was more than twice that of Bric energy and material companies, which were valued at $432bn, according to calculations by the Financial Times.

Central to the economic growth model of the early 2000s was the South South trade: southern hemisphere countries with lots of raw materials to export sold massive quantities to China.  Now that China is slowing, that trend is far smaller.

This relationship is really apparent in the following chart that shows the relationship between the XLBx (basic materials ETF) and the XLFs (financial ETF):

The financial sector started to overtake basic materials at the beginning of the second quarter.

How Much Damage Will Rising Rates Do To the Housing Recovery?

From Marketwatch:

Even a spike in mortgage costs since late spring — interest rates have jumped nearly a full percentage point — doesn’t appear to have stanched the flow of would-be buyers. It’s possible some buyers moved up their purchases to lock in attractive rates before the rose, analysts say

Housing has been one bright spot in the US economy over the last year, as sales are now in uptrends for both new and existing homes.  However, over the last few months we've seen a drop in bond prices (and a corresponding increase in bond yields).  Consider this chart of the TLT -- the long end of the Treasury market:

Prices have fallen through the 113/114 price level which was providing short term support.  Now prices are in the 106-110 level and appear to be finding a short-term bottom.  There's an uptick in momentum and a newly positive CMF implying at least a stabilization.  In addition, consider the yield on the 10 year is now fluctuating around 2.5%, which isn't a bad rate of return in a low inflation environment.  Put another way, I think we've seen the big bump up in rates that would be expected after the recent Fed announcement regarding tapering its bond buying program.

However, consider this scenario.  Interest rates are clearly rising.  Rate increases will be contained to a certain extent as purchasers such as foreign central banks re-balance their portfolios to take into account the rising rate scenario.  But make no mistake; rates are clearly moving higher.  At the same time, US unemployment is still 7.6%, meaning there is little to no upward wage pressure.  This explains why median incomes have been stagnant for the last 10 years.  At the same time, we've seen a recent spike in oil prices that are also eating into incomes.  And then there is the increase in the median price of new homes:

At some point the combination of rising rates, higher oil prices, stagnant incomes and higher home prices may start to slow home sales. 

Slowing Global Economy Slowing International Exports

The Canadian economy has been hit over the last two quarters by slowing global demand.  The blue part of each quarter's section represents net exports, which have decreased the last two quarters.  These drops in growth coincide with a drop in GDP to just over 1%.

The export situation has been dropping for the last three years.

Singapore continues to see a drop in exports:

Singapore’s exports in June extended the longest run of declines since the global financial crisis, suggesting economic growth last quarter may have been less than the government initially estimated.

Non-oil domestic exports slid 8.8 percent from a year earlier, falling for a fifth month, the trade promotion agency said in a statement today. The median of 17 estimates in a Bloomberg News survey was for a 5.8 percent drop.

Here's a chart of exports from the latest exports release:

As I've noted before, a big reason for this slowdown is a slowing global economy; the EU is in a depression and China is re-balancing its economy.


Taiwan shares the same problem:

June export orders declined 3.5 per cent year on year, weighed down by weak demand from Asia and Europe. Sales to China alone dropped 1.9 per cent, while sales to the broader Asian region fell 3.8 per cent. The 10.4 per cent drop in orders from Europe accelerated the 0.4 per cent contraction seen in May. 

And this is a reason for the overall slowdown we've seen and a primary reason for the drop in the IMF's global forecast:

The global economy is growing more slowly than expected, with risks to that growth increasing especially in emerging markets, says the IMF in an update to its World Economic Outlook (WEO). Global growth is now projected at 3.1 for 2013 and 3.8 percent for 2014, a downward revision of ¼ percentage point each year compared with the forecasts in the April 2013 WEO.

Global growth increased only slightly in the first quarter of 2013, instead of accelerating further as expected at the time of the April 2013 WEO. The underperformance was due to continuing growth disappointments in major emerging market economies, a deeper recession in the euro area, and a slower U.S. expansion than expected. By contrast, growth was stronger than expected in Japan.

Looking ahead, the IMF expects the brakes behind the recent underperformance to ease, but only gradually. Growth in the United States is forecast to rise to rise from 1¾ percent in 2013 to 2¾ percent in 2014, as fiscal consolidation slows and private demand remains solid. In Japan, growth in 2013 is now expected to be 2 percent, up ½ percent from the last WEO, reflecting the boost to confidence and private demand from recent accommodative policies. The euro area is forecast to remain in recession in 2013 before growing again in 2014. Activity in the region continues to suffer from the combined effects of low demand, depressed confidence, financial market fragmentation, weak balance sheets, and fiscal consolidation.

Growth in emerging market and developing economies is expected to moderate to 5 percent in 2013 and about 5½ percent in 2014, some ¼ percentage point lower than projected in the April 2013 WEO. The weaker prospects reflect, to varying degrees, infrastructure bottlenecks and other capacity constraints, lower export growth, lower commodity prices, financial stability concerns, and, in some cases, weaker monetary policy support. In China, growth will average 7¾ percent in 2013–14, ¼ and ½ percentage point lower in 2013 and 2014, respectively, than in the April 2013 forecast.

Turkey Raises Key Rates 75 Basis Points To Stem Currency Slide And Slow Inflation

Count turkey as another developing country that has inflation problems:

Recently, several developments have affected inflation adversely. Surging unprocessed food prices, rising oil prices, and the increased exchange rate volatility may continue to have adverse impact on inflation in the short term. Although the Committee sees these developments as temporary to a large extent, a measured monetary tightening is deemed necessary in order to contain a deterioration in the pricing behavior.

In order to support the price and financial stability, the Committee has decided to raise the upper bound of the interest rate corridor. Cautious stance will be maintained until the inflation outlook is in line with the medium term targets. In this respect, additional monetary tightening will be implemented when necessary.
 
Due to ongoing uncertainties regarding the global economy and the volatility in capital flows, the Committee has decided to increase the flexibility of the liquidity management. To this end, developments regarding price stability and financial stability will be closely monitored and necessary adjustments will be made in the composition of Turkish lira liquidity provided by the Central Bank.

After moderating last fall and this spring, year over year rate of change in both the PPI and CPI has jumped in its most recent reading.

Increasing rates makes it more attractive to hold deposits and financial resources in Turkey, thereby increasing (hopefully) the stability of the country.

The Turkish ETF broke its upward trend (the red line), falling from 75.92 to 53.71 for a drop of about 30%.  Since then, prices have been fluctuating between the 38.2% and 61.8% Fib level, while also getting resistance from the 200 day EMA.

Deflation Is The Real Risk To the US Economy

The following is from Bernanke's speech to Congress last week:

Meanwhile, consumer price inflation has been running below the Committee's longer-run objective of 2 percent. The price index for personal consumption expenditures rose only 1 percent over the year ending in May. This softness reflects in part some factors that are likely to be transitory. Moreover, measures of longer-term inflation expectations have generally remained stable, which should help move inflation back up toward 2 percent. However, the Committee is certainly aware that very low inflation poses risks to economic performance--for example, by raising the real cost of capital investment--and increases the risk of outright deflation. Consequently, we will monitor this situation closely as well, and we will act as needed to ensure that inflation moves back toward our 2 percent objective over time. 

Over the last few months, the hyper-inflation calls of many have gone by the wayside as more and more evidence emerges that deflation may be the real potential problem we are facing.

Let's look at the data.

Total CPI has been running below 2% for most of the last year.

Core CPI's YOY rate has been declining since early 2012

Both the year over year percentage change in PCE and core PCE expenditures have been decreasing since mid-2011 (total) and early 2012 (core).

Perhaps most importantly, gold (which I use as a proxy for inflation expectations among traders) has dropped from very high level.  

And where would potential inflation come from?  Overall demand is low.  The US unemployment rate is still over 7% leading to low wage growth.  This prevents demand pull inflation from occurring.  Capacity utilization is at 77.8%, indicating factories have plenty of ability to ramp up current production to absorb increased demand.

Internationally, China is slowing and shifting to an economic model more focused on domestic demand.  That means the upward pressure on commodity prices doesn't exist in the same rate.  The EU is still in a depression, lowering demand from the second largest economic block in the world; the developing world is slowing  in tandem with China.

Overall commodity prices have been dropping consistently across asset classes.  Consider the following ETF charts:

Most of the agricultural complex has been dropping since 2012.  Grains (top chart) have been dropping since mid-2012 and softs (bottom chart) have been dropping since early 2011.

Copper is at important technical levels on the low side.

Oil is the one commodity that runs counter to this thesis.  However, it's recent rise has occurred in the summer (and therefore in the "summer driving season) and was originally caused by the political situation in Egypt. More importantly, as oil's price increase the oil choke collar tightens around the US economy, slowing growth and therefore inflationary pressure.

Commodity prices are declining, save for oil.  And oil's price increase will eventually slow growth decreasing inflationary pressure.  Unemployment is still too high to lead to meaningful wage increases and capacity utilization can still increase to absorb price pressures.  In this environment, inflation just isn't a major problem.

The long leading indicators - an update

- by New Deal democrat

In view of the recent interest rate spike, now is a good time to review the status of the long leading indicators, which typcially forecast the economy more than 12 months in advance. Last month I wrote that a 1% spike in interest rates was necessary but not sufficient to signal recession. At the time I considered adding housing permits, but I didn't. For a good reason: housing permits don't add much information to the signal given by interest rates.

Here's two graphs, split up from 1964 to 1983, and 1984 to the present. Both show the YoY% change in interest rates (red) and housing permits (blue):

OK, they're squiggles. But the important point is they are esssentially mirror images of one another. When interest rates go up 1% or more, YoY housing permits go down and even turn negative. Literally the only exception to this pattern was 2006-09 when the housing bust presaged the deflationary great recession, so interest rates went down as well. But notice that there are a number of occasions (9 to be exact) when interest rates increased, and housing permits decreased, but no recession occurred: 1966, 1968, 1972, 1978, 1984, 1987, 1994, 1996, and 2004.

Put another way, the sudden softness in housing permits and starts in June may have been a surprise in their quickness, but are an expected result of the interest rate increase and don't give us a lot more information about the economy.

That doesn't end the inquiry, because a third long indicator, corporate profits, looks like it is stalling. The actual series used has only been updated through the first quarter, but Barron's keeps track weekly of reported S&P 500 earnings. Here's what the 4 quarter trailing earnings look iike:

Corporate earnings, as measured by the S&P, have actually turned negative YoY. That doesn't mean that corporate profits as a whole have turned negative, and of course not all second quarter earnings are in. But here's what happens to recession risk when we add in corporate profits (green), again in the first graph from 1964-83, and in the second from 1984 to the present [note I've changed the scale for corporate profit YoY% changes during the 1984-2001 period, just to make them more visible. The change doesn't affect direction at all]:

OK, even more squiggles. But here's what you need to know: when we add in corporate profits as an indicator, all but two of the false positives for recession drop out, leaving only 1966 and 1984. In both cases, by the way, the economy came close to going into recession, but didn't.

Look to the most recent readings: while interest rates are up over 1% YoY, housing permits haven't quite yet turned negative YoY, and corporate profits after taxes are still slightly positive.

Finally, in the past real M2 has had to be less than +2.5% YoY to signal a recession in the near future. We're not close to crossing that threshhold. The graph below shows all four long leading indicators. Real M2 YoY is in red, and adjusted so that a reading of below 100 means real M2 has grown less than +2.5% YoY. Note that the reading remains above that point. The other three long leading indicators are normed to 100 in June 2009. Interest rates are inverted so that an increase in rates reads as a decrease in level:

Note that we actually had a small but actual downturn in 3 of the 4 long leading indicators (permits, corporate profits, and real M2) in parts of 2010 and in early 2011. Doubtless this was one of the things leading to ECRI's blown recession call almost two years ago. As of now, we don't have even that synchronized downturn.

To summarize: interest rates have risen sufficiently to cross a warning threshhold, but housing permits are still positive YoY (although I strongly suspect they'll turn negative within a few months if interest rates remain at their recent elevations). Corporate profits are also on the verge of crossing a negative threshold, but aren't there quite yet. Real money supply is still significantly positive.

Oil Still At Higher Levels; How Long Until The Oil Choke Collar Slows the Economy?

The daily chart of oil shows that the 98-99 price level held for five different advances this year. However, with the Egypt situation prices finally moved through resistance to hit the 108 level.  Also note that inventories have taken a sharp dive over the last few weeks:

The weekly chart really shows the new key levels.  The 110 and 114 price level are now key resistance ares for the market.

Oil is the only commodity market that is showing any meaningful price appreciation right now.

In case you were wondering, here's a chart of the relationship between oil prices and gas prices.  I've reduced both to a scale 100 to show the very tight relationship.