Weekly Update: Command economy
Insofar as the 6% correction we just had is concerned, the proprietary data we have and the technical work I receive would indicate it’s not over. Ned Davis notes on the basis of past correction tendencies, the lows are likely to be tested. The tendency to rally has been strongest when the 200-day moving averages have been rising in most markets, as in 1997, 2006, 2010 and 2011. Currently, 82% of the moving averages are still rising. So I am not prepared to say, “That was it.” However, corrections can come by way of price or time, and any move of magnitude in the market should have a catalyst for it. So what might the catalyst be? In my talks this week with my CIO Steve Auth, who articulates very convincingly that we’re in a new secular bull, the question is what is there to worry about? The fundamentals look favorable. This week alone, we saw new and existing home sales hit five- and six-year highs, respectively (more below); home prices rise to their highest since 2004 (more below); and consumer confidence reach its highest level in more than five years (more below). What’s the best worry at this time? China.
China clearly is slowing, abetted in part of late by a big jump in its overnight bank lending rates. Credit Suisse says growth below 6% would be a problem for the global markets. Chinese authorities and its central bank appear to be engaged in a deliberate act of credit contraction to, in the view of The Institutional Strategist (TIS), clean up and create confidence in that country’s financial system so that it can achieve full currency convertibility by 2016. To ensure that capital wants to stay and invest in China, China’s government is willing to suffer bankruptcies, layoffs, market sell-offs and other short-term pain. When I travel and ask my audiences if they are getting bearish on the market now, I say it can’t be on valuations because they are not rich. It can’t be on fundamentals because they are improving. It can’t be on inflation because it is benign (more below). It can’t be because a recession is coming because all the indicators say there is no recession in sight. So if you have to be bearish, that leaves geopolitical risk, which is hard to get your arms around. Auth, who for years lived in Japan, noted China’s command economy has had about a half dozen leaders calling the shots for centuries. Do I want to bet on them to do something to derail their rise to the second-biggest economy in the world? I don’t think so.
I spent this week traveling in the Ann Arbor, Mich.-Toledo, Ohio area, where I met an advisor who was born in China, speaks and writes in Mandarin, and in his working life, has visited China 40 times. So I picked his brain about China. He gave me his take on the situation. China’s economy may be corrupt, but its half dozen leaders have on their cell phones the phone numbers of many billionaires they can call if cash is needed. TIS mocked reports that say China has a liquidity problem. Its monetary base jumped 16% year-over-year in May, well above the 13% target. There is no shortage of funds. To me, the words “Command Economy’’ sound strong and sure and nothing like something I really need to worry about. I think I’m going to go with the rest of what I can get my arms around, and much of that looks very good. I’m not prepared to say, “That was it.’’ But from a contrarian standpoint, the continued skepticism around U.S. stocks is encouraging. After a robust start to the year, flows into domestic equity mutual funds have rolled over. Command economy? Maybe it’s because I’m a lady, but that sounds “M’m, m’m, m’m” to me.
Housing recovery is undeniable April’s Case-Shiller gauge of home prices rose a 15th straight month and more than expected to its highest level since March 2004. May’s pending home sales index surprised, surging 6.7%, the most in more than three years vs. consensus expectations for a 1% gain, to put it at its highest level since December 2006. And May’s new and existing home sales also rose well above forecasts to their highest levels since July 2008 and May 2007, respectively. The National Association of Realtors (NAR) says real median prices jumped a record 11.2% year-over-year and are projected to increase to nearly $195,000, which would be the strongest gain since 2005. It also projects existing home sales to rise this year to 5.07 million units, the highest level in seven years. All of this suggests that even as mortgage rates rise (more below), housing should continue to be a key catalyst for growth.
Consumers more confident June’s third straight monthly increase surprised to the upside and put the Conference Board’s monthly gauge at its highest level since January 2008, while the University of Michigan’s sentiment gauge rose to a better-than-expected 84.1, a few ticks from May’s final six-year high of 84.5 and up from June’s preliminary 82.7. The Bloomberg Consumer Comfort Index also rose last week to its highest level since January 2008, boosted by rising home values and a better job market. Stronger job growth helped May personal income rise by the most in three months, which should support continued growth in consumer spending. May spending rose in line with forecasts, led by a 0.9% gain in durables, the most this year.
Manufacturing slowdown may be ending May durable goods orders rose more than expected, with nondefense capital goods orders—a proxy for capital expenditures (capex)—up a third straight month. Significantly, the capex book-to-bill ratio rose to its highest level in over a year, indicating factory activity is picking up. Several regional manufacturing gauges for June—the Richmond and Dallas Fed and Milwaukee PMI—sent similar signals. Chicago’s PMI pulled back significantly from May’s spike but remained entrenched in expansion territory with solid gains in new orders, production and employment. The Dallas Fed’s survey showed manufacturing production rising at its fastest pace in more than two years, with new orders climbing to their highest rate since July 2011.
Rising mortgage rates don’t seem to be hurting—yet The recent increase in the average 30-year mortgage rate by more than a point to 4.5% will likely spur “fence-sitters” into action, pushing individuals to buy a home sooner rather than incur a higher mortgage rate later. The question remains just how much of a rate increase the mortgage market can handle, especially with home prices moving upward. Some studies estimate rates above 6% are still conducive to buying rather than renting, but the problem is the continued lackluster job growth and stagnant incomes. The NAR says the participation of first-time homebuyers in May was only 29%—a five-year low. If housing is to sustain its recovery, the percentage should be expanding, not contracting; otherwise, the market will remain dependent on “investors” rather than “owner-occupiers.” This lack of first-time buyers goes hand-in-hand with the rising proportion of part-time workers, the rising number of college graduates working in low-skilled jobs and the fact there are still 4 million more unemployed than when the recession began in December 2007.
Q1 GDP growth a bigger downer than first thought It was revised sharply lower, to 1.8% from the previous 2.4%, reflecting the weak recovery and putting average annual growth after 15 consecutive quarterly increases at 2.1%, well below the historical mean of 3.2%. The biggest contributors to the downward revision were real personal consumption expenditures (PCE) and non-residential structures. PCE was revised down to a 2.6% annual rate, which is still the fastest PCE growth in two years, indicating consumers were unperturbed by higher payroll taxes.
There’s pain in the bond market but it’s way too early to worry about inflation Both the PCE price index and its core rose slightly in June, with the year-over-year core PCE index holding steady at a record low 1.1%. Inflation pressures were near the low end of the Fed’s projected ranges for 2013 and below the longer-term target of 2%, which argues for continued monetary accommodation.
Just give me a company whose business is steady no matter what is going on around it Then I don’t have to be glued to CNBC, or wondering what is happening in China or what Ben Bernanke has to say. When tobacco companies were under siege in the 1990s, Philip Morris raised dividends an average 15% a year. An adviser in Ann Arbor told me the story of a client who, back in World War II, used to fly a small supply plane from India to China as they fought the Japanese. Going through the Himalayas was dangerous—you had to fly through the clouds and if you came across a hill you couldn’t see, God forbid, your plane went down. And if that happened, you absolutely needed two things: 1) A good pair of boots in case you had to walk out of the mountainous terrain and 2) a couple of cartons of smokes. No matter who you met or what language they spoke, everybody understood that currency.
This is no fish tale Farmed fish production surpassed world beef production in 2011 for the first time and widened the gap last year, with output reaching a record 66 million tons vs. 63 million tons for beef. This year, the world may consume more farmed fish than fish caught in the wild, underscoring an historic shift in food output as meat production and the wild-fish catch approaches the Earth’s natural limits, according to the Earth Policy Institute. Annual world fish consumption of 42 pounds per person, up from 25 pounds in the ’70s, is poised to keep rising, lifting prices, too. Global fish prices hit a record in May on rising demand for salmon and falling supplies of tuna.
A refreshing take on the tired taper Following a presentation in Ann Arbor where we wondered who remembers hearing the word “taper’’ so much, an advisor presented me with a figurine of an animal—a tapir. It is a large (7-feet-long, 3-feet-high, 330 to 700 pounds) browsing animal similar in shape to the pig that can be found in the jungles of South America, Central America and Southeast Asia. Its coat is short, its color ranges from reddish brown to grey to black and it has a protruding rump and stubby tail with four toes on the front feet and three on the hind feet to help it walk in the mud. If you ever visit my office, you will find it displayed on my credenza.