Weekly Update: 'Kiev is the mother of all Russian cities'
In recognizing Crimea’s vote to rejoin Russia, Vladimir Putin mentioned Kosovo several times in a 50-minute speech filled with Russian complaints about the West over the past 20 years. He touched on the downfall of the Soviet Union, Kosovo, NATO expansion, missile defense, Libya, Iraq and Syria. He also touched on Russians’ roots in Ukraine, in a way that a large number of Ukrainians may not have found to be reassuring. “We sympathize with the people of Ukraine,” Putin said. “We’re one nation. Kiev is the mother of all Russian cities.” While Crimea is now part of Russia, it is cut off from Russia by any land bridge. Eastern Ukraine lies between the newly annexed Crimea and mother Russia. How will Crimea obtain its gas supplies, food and other goods, unless the Ukrainian government agrees to allow those goods to pass or Russia seizes Eastern Ukraine? ISI says the threat of targeted sanctions on members of the Russian elite along with the sell-off in Russian equities and the ruble may not be enough to force Putin to back down. We overestimate at our peril the weight he puts on the stock market and the wealth of oligarchs relative to the historic opportunity to restore Russia's control of Crimea and compensate for the fact that he has lost Ukraine as a whole from Russia’s sphere of influence for good. I spent this week in California, and this was the biggest concern among several of the advisors I met.
The market seems less concerned by the Fed’s suggestion the benchmark funds rate could rise sooner than expected. After a sell-off following the policy-setting FOMC's post-meeting statement on Wednesday, the S&P 500 recovered and as of this writing was trading at new intraday highs. In its statement, the FOMC said it anticipates that, “even after employment and inflation are near mandate-consistent levels, economic conditions may, for some time, warrant keeping the target federal funds rate below levels the committee views as normal in the longer run.” When asked what a considerable time was, Fed Chair Yellen said, “Something on the order of around six months.’’ Our Wall Street research thinks she spoke off the cuff and probably regrets what she said in her inaugural press conference as the Fed’s head. But I am of the camp that finds it hard to believe she didn’t anticipate this question and had a prepared answer. Cornerstone Macro’s believes the FOMC has abandoned the idea it could tolerate somewhat higher-than-target inflation in order to boost employment, which means it could raise rates earlier than commonly believed, and that possibility needs to be priced in. At the same time, the intention to proceed at a gradual pace once rate hikes start was confirmed and made explicit in the statement. So the market probably has the right view of the pace of rate hikes (gradual) but is too dovish when it comes to timing.
Californians I met this week are keenly aware of food prices, which have been surging even as headline and core prices remain subdued (more below), and are very worried about their state’s severe drought. One person told me the next good chance for reasonable rainfall is not until the fall. Another said California used to have four seasons, now it seems to have only one. Their concerns centered on the poor, who suffer the most from rising food prices. This also matches a worry voiced frequently in my travels through San Francisco and Northern California, about the true unemployment rate and high underemployment, which is continuing to widen the difference between haves and have-nots. In one meeting the advisor opened the discussion not with, “Hello,’’ but asking, “Where do I get income?” (I can answer that one!) We visited an extremely impressive adviser who last year offered the notion that the turtle walks slowly because he has a wallet filled with dividends on his back. Her biggest concern is emerging-market weakness. A rare meeting in which the adviser brought handouts, we discussed the length and return of the current bull vs. the long-term average 68 months and 178% return, respectively, since 1946. And the likelihood that we may be in a period like the 1960s-70s, which featured bear-market corrections mostly in the 20% range, and then took less than two years to reach the previous peak. I like that. We ended the meeting agreeing that the market really needs a significant pullback, after which an excellent buying opportunity will present itself. There is always going to be something to worry about, and some things will be big. But, as an aging baby boomer who is going to live until 95, I still need to invest in order to not outlive my money. So when I visit with my adviser, I open our meeting not with “Hello’’’ but asking, “Where do I get income?
A pick-up in GDP is highly reliant on capex Bank loans are accelerating at an 8.7% annual rate, led by surging commercial & industrial loans, a good sign for capex. ISI says an unprecedented and stunning $2.4 trillion gap between bank deposits and bank loans leaves a huge amount of room for further acceleration. This comes as businesses’ improving assessment of economic conditions is boosting their willingness to spend: the Business Roundtable’s CEO Economic Outlook Index showed confidence at an eight-quarter high, with the percentage of respondents anticipating higher capital spending at its highest level since Q2 2011. Elsewhere, ISI’s proprietary truckers’ survey, which highly correlates with GDP, has jumped 7.5 points the past four weeks to an eight-year high, and the Conference Board’s leading indicators rose a much better-than-expected 0.5% in February.
Manufacturing moving past the weather February industrial production rose 0.6%, triple the consensus and driven by both durables and nondurables. March’s Philly Fed index also rose by triple consensus, with new orders, shipments and the average workweek all climbing and the forward-looking capex plans up to 31.3, its highest level since early 2011. The Empire State gauge’s increase was slightly below expectations but did move above its six-month average, with orders rising back into expansionary territory.
All roads lead to jobs The recent big downtrend in initial jobless claims adds to the case that there is a strong spring employment report in the wings. Supporting the view that employment was held back by the weather, the four-week average has dropped significantly since mid-February and could soon fall to levels last seen in late November—a month that saw nonfarm payrolls jump 274,000.
A pick-up in GDP is highly reliant on housing Existing home sales fell slightly in February for the sixth decline in seven months and are now down 7.1% year-over-year. Weather played a major role, and also impacted builder sentiment, which was up only a tick in March to 47, well below the consensus expectation of 50. February housing starts also fell to an annualized pace of 907,000, although permits unexpectedly surged 7.7% and the prior months’ starts were revised up (all in the multifamily, aka apartment rental, arena). Other housing headwinds include rising prices, high levels of student debt—the National Association of Realtors said 20 percent of buyers under the age of 33, the prime group of first-time buyers, delayed purchases because of outstanding debt—and still-tight bank-lending standards. About a quarter of the population have a FICO score below 600, making it virtually impossible to receive a mortgage. In contrast, about 85% of mortgage loans are to borrowers with FICO scores between 650 and 800, a cohort that only makes up 47% of the population.
China’s ability to engineer a soft landing remains one of our biggest concerns Its slowdown appears broad based. Industrial production, retail sales, housing and fixed investment are all declining; freight traffic is growing at its slowest pace since mid-2009; and monetary growth is expanding at its slowest pace since 2001. Moreover, Chinese bank stocks have fallen to 2009 lows and could decline further as more negative credit events seem likely. Bank stocks were the canary in the coal mine for the U.S. in 2007 and the eurozone in 2011. Deja vu? Like housing, it isn’t all bad. The MNI China Business Sentiment Indicator rose for the first time in three months in March to its highest level since December. The survey indicated credit availability is at its highest for two years, a sign the authorities have relaxed their firm grip on lending, and that yuan’s recent depreciation is boosting exports. Also, Prime Minister Li has indicated the need to accelerate some spending plans to keep growth in a “reasonable range,’’ the first step down the fiscal stimulus path. Growth is priority No. 1; deleveraging is not.
This week’s Fed statement raises inflation’s profile Headline CPI rose only 1.1% year-over-year in February, with a 0.4% jump in food prices—the sharpest one-month gain since September 2011—offset by a 0.5% decline in energy. Year-over-year core prices also held steady at 1.6%, and were 50 basis points higher than the PCE gauge the Fed prefers. A major difference is core PCE gives more weight to medical-care prices, which slowed sharply in 2013. But that has shown tentative signs of reaccelerating. Notably, the one-off effects of April 2013’s sequestration spending cuts, which prompted Medicare to cut the price it pays for many services and pushed year-over-year health-care inflation down from more than 1.9% to 1.1% within few months, is about to run its course. A move up in PCE would be one sign that the Fed may act sooner rather than later.
Obamacare’s unintended consequences The Heritage Foundation says the U.S. economy has yet to feel the full brunt of the Affordable Care Act. It counts 17 new taxes or penalties that will affect Americans; cites delays, exemptions, and changes which seem to come out of nowhere; and notes there are pending premium increases, which until recently, were not supposed to happen—in fact, falling premiums were the expectation. All of this also breeds uncertainty, it said. The over-arching concern is how much of an effect will Obamacare’s implementation ultimately have on risk-taking, investment, spending, savings and big-ticket purchase decisions such as home-buying.
I got this nugget from my fabulous California wholesaler Venture capitalist Tim Draper, saying recent social and economic changes have made California “nearly ungovernable,’’ has been cleared to collect signatures for a ballot initiative splitting California into six new states: San Diego and Orange County would make up "South California;" "West California" would include Los Angeles and Santa Barbara, while Bakersfield, Fresno and Stockton would make up the larger "Central California;" San Francisco and San Jose would be in the new "Silicon Valley;" "North California" would include the Sacramento area; and "Jefferson" would be home to the Redding and Eureka areas.
Not a bad way to spend one’s fortune During this week’s California sojourn, I did a large client presentation in the Sonoma Valley, which included a wine tasting hosted by a local winery. The owner spoke of the joys of owning a vineyard: "A small fortune turns into a smaller fortune." A great time was had by all—once I finished my talk.