Equities broadly sold off on Brexit news and then rallied on central bank easing chatter, but the collapses in global bank stocks and sovereign yields are sending a powerful message that levitating equity indices are reflecting a world vastly different than reality. A number of real estate funds in the U.K. have had to halt redemptions as one initial consequence of the vote was to pour cold water on the ebullient London commercial property markets. These events have also made other trouble spots become more obvious. For instance, Italian banks have been “swimming” in bad loans for years, but in this new more cautionary environment, investors are not willing to look the other way. As a result, discussions about bailing out the banks there have come to the fore.
Economic growth in the U.S. and abroad only seems to look good when the central planners are given a chance to seasonally adjust the data. Closer to where the “rubber meets the road,” (pardon the pun) auto sales have rolled over meaningfully and that had been one of the only sources of strength, though it had been driven by reckless subprime lending practices.
We recently heard again from one of our favorite economic barometers, Fastenal. The large industrial supplier with a presence in so much of the real economy stated:
“While our customers value the capabilities we bring to the table, in the last eight quarters this group of customers has seen a contraction in its production and therefore its need for fasteners. During this time frame, our fastener product line has seen its daily growth decrease from about 10% growth in the last six months of 2014 to about 6% contraction in the fourth quarter of 2015 and about 2% contraction in the first half of 2016. Our market share gains continue to be strong, but the contraction in purchases from our existing customers, plus some price deflation, has eliminated our growth and led to contraction.”
Considering these comments in the context of rail traffic, which was down 8% in the first half of 2016 and it really is hard to comprehend where some of the official data and surveys are coming from. They just do not make sense. This matters when evaluating individual stocks because hanging one’s hat on rosy government data at cyclical inflection points has been a surefire way to lose considerable money.
For all the talk of supposed consumer strength, we have mentioned repeatedly how management teams at the retailers just do not see it that way. At the same time, Moody’s Investors Service just took down its estimates for 2016 retail spending and mentioned broad weakness in several subsectors. Additionally, we have recently come to find that restaurants saw quite a soft month in June. According to Knapp-Track, guest counts were down near 5%. That’s a lot! We reiterate that much of the growth showing up in consumer-related data is tied to mandatory healthcare spending related to Obamacare, which is likely choking off spending elsewhere.
Factory orders have now fallen for 19 consecutive months in the U.S and industrial production has fallen year-over-year for 10 months. Those are recessionary numbers. Inventories remain stubbornly high. The celebrated bounce in the June employment data from the establishment report still left us with a slowing jobs growth rate for this year and runs counter to both the household survey, income tax receipts, and the Fed’s own Labor Market Conditions Index which paint a much darker picture.
That yields are hitting record lows on major growth concerns while equities in the U.S. are at record highs, suggesting things are great, is quite unusual to say the least. To us, it appears that we have entered a new stage of the crisis that began in 2008. Having been caught off guard by events in the U.K., the deciders will redouble efforts to maintain the status quo. You can count on that.
As for the broader equity market, we expect that sooner or later the historic discrepancy between economic growth and valuations will narrow much like the aftermaths of the 2000 and 2007 bubbles. Equity markets were the last to realize trouble ahead in those periods as well. We remain patient and expect that we can continue to profit from our less exposed posture of recent months. We find that cash is not trash at all in the current environment because its optionality is much undervalued with so many securities so expensive and policy mistakes quite likely as the deciders grow desperate. After all, the historic record is not very good at all for central bankers who tried to prevent the inevitable or for investors who bet that they could.
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 relation.