Surging high quality bonds and sinking commodities are still expressing quite clearly that the central bankers have thus far failed to ignite a sustainable recovery and, in fact, global growth expectations are heading south. Copper and iron ore markets reflect the same pessimism as that for crude. Because so much of the economic activity of the last few years was commodity-intensive, pricing in these markets serves as even more of a barometer than it has historically. The U.S. currency is displaying enormous strength as “the best house in a bad neighborhood,” causing significant pain for issuers of dollar debt outside the U.S.
Equity markets are banking on their next QE “fix” from Europe, while worrying that Greece may leave the Euro community. At the same time, certainty over the Fed raising short rates sometime this year is waning due to growth worries. Equity bulls attempt to spin discussions around this topic into the thought that if the Fed tightens, then growth must be strong. If the Fed does not raise rates, then the free money environment continues. Both are a win for stocks according to those camps and bullish sentiment is at historic extremes along with valuations as a result. In spite of equity indices residing near record highs, the average stock is down about 20% from its high, so even the world of stocks is not as euphoric as many pundits seem to indicate. Credit spreads are moving wider in another indication that all is not well.
The employment report for December was just more of the same. Strong headline job gains masked weak wage growth and an alarming number of people leaving the labor force. It seems that part-time and lower quality jobs are continuing to be the driving factor. The headline 5% GDP number for the third quarter contained an inordinate amount of spending on Obamacare and national defense but provided very little reason to raise future growth expectations, particularly when spending on goods actually slowed. A slump in imports was another major element of the revision higher. Moving onto the fourth quarter, based on what we have heard so far from retailers themselves, Christmas sales look to be in line with the soft performance we have seen in recent years with no clear impact from lower gas prices. December retail sales were just reported at -0.9% in an apparent surprise to those that seemed to think that printing money helped the average person spend a ton this holiday season.
As we have discussed previously, the two biggest sources of growth in the U.S. have been shale fracking and auto production. However, because crude prices have cratered, energy production and employment will be a drag on growth this year with some offset from the beneficial effect of lower gas prices. We have been surprised by the speed of the historic collapse in energy markets, and though we need no reminding, it is a testament to just how quickly a belief system can come apart at the seams. In addition, a recent big spike in auto loan delinquencies centered on the major growth engine of sub-prime debt creation will likely weigh as the year progresses. That leaves us with new attempts to crank up sub-prime lending in housing in 2015 as the latest growth gimmick in spite of all the drama such past efforts have already caused. Memories are indeed short! Clearly the powers that be want to continue to hope that high debt growth will lead to high economic growth despite the fact that the trillions of new debt created since 2009 has not produced escape velocity.
At some point, the disconnect between equity indices and reality will have to be resolved. With more participants having come to the conclusion that U.S. equities are at historic extreme valuations, we wonder who will be the next “greater fools” to do the buying when the exit doors become crowded. Corporations buying back their own equity in huge amounts while the insiders sell in their personal accounts will only go on for so long because the marginal ability to improve EPS per dollar spent decreases as the stock price moves higher.
The collapse in commodity prices to multi-year lows, wider credit spreads, and the huge rally in global high quality bonds indicate that many markets do not agree with the central banker assurances that sustainable growth is here to stay. Is it really such a huge leap of faith to go from realizing that QE has not helped the real economy based on these renewed growth concerns to worrying that if that is the case then stock prices at bubble extremes are quite risky? Perhaps stock investors should have a chat with a group of oil traders who have learned the hard way that fact and fiction eventually converge in markets.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.