Bloomberg Opinion, Bear Market, Danielle DiMartino Booth, Quill Intelligence

How to Identify a Bear Market Rally

History is replete with examples of major stock market recoveries following big sell-offs, many of which turn out to be head fakes.

This article originally appeared in Bloomberg Opinions — 2.24.19

 

The remarkable rebound in the U.S. stock market from the lows in late December has resulted in gains that the analysts at Goldman Sachs rightly point out already constitute banner returns for an entire calendar year. History is replete with examples of major recoveries following big sell-offs, many of which turn out to be head fakes otherwise known as bear market rallies. At the end of the trading day, it’s still fundamentals that should drive investing decisions.

If the economy is, in fact, slowing and that is what has sidelined the Federal Reserve, then what we are witnessing at the moment is a bear market rally. AdMacro Ltd head of research Patrick Perret-Green recently warned the firm’s clients that though the January employment jobs report might have looked good on paper with 304,000 jobs created, it nevertheless flashed a bright recession signal as the unemployment rate ticked up to 4 percent, the highest since June.

According to historic payroll data and the National Bureau of Economic Research, every time the three-month average unemployment rate exceeded its six-month average at cycle peaks over the past 50 years — like it did in January — the U.S. economy has experienced a recession. In a 2016 speech to the International Monetary Fund, then Federal Reserve Bank of New York President — and current Bloomberg Opinion contributor — William Dudley corroborated the historic pattern citing research first conducted earlier in his career at Goldman Sachs:

“History shows it is very difficult to push the unemployment rate back up just a little bit in order to contain inflation pressures. Looking at the post-war period, whenever the unemployment rate has increased by more than 0.3 to 0.4 percentage points, the economy has always ended up in a full-blown recession with the unemployment rate rising by at least 1.9 percentage points. This is an outcome to avoid, especially given that in an economic downturn the last to be hired are often the first to be fired.”

To Dudley’s point, the odds that layoffs will continue rising are high. As per January data from Challenger, Gray & Christmas, layoffs have risen over the prior year for six straight months. Economists would characterize that as an established trend. Retail and more recently, energy, have been some of the weakest sectors. Media is another sore spot.

Backing out to the broader economy, one of the fastest growing reasons for increased layoffs last year was mergers and acquisitions. There’s likely to be no letup in 2019 after last year’s record M&A activity, which is just one of the more creative avenues companies have pursued to reduce costs in recent years. The looming earnings recession will compel firms to be more direct in their approach, as in outright headcount reduction to protect profit margins.

Auto dealers are struggling to shoulder the weight of the most crowded lots in almost two years. As a result, auto production contracted in January, promising to pressure Midwest manufacturing, a stand out area of the economy in recent months as other regions faltered. As is the case with the earnings sudden stop, motor vehicle and parts swung from 8.4 percent year-on-year growth in December to a 0.7 percent contraction in January, according to Industrial production data from the Fed.

Although autos were a sweet spot in the delayed December retail sales release, that strength appears to be wavering as cumulative tax refunds disappoint. In the first 18 days of the tax season through Feb. 21, cumulative refunds totaled $36.3 billion, down $61.7 billion, or 63 percent, from the same period last year. This portends poorly for the seasonal surge in auto buying and consumer spending tied to households’ propensity to spend the majority of their tax refund proceeds. If anything, Fed data show households are hunkering down, with checking and savings account balances rising dramatically, moves generally associated with spending pullbacks.

It is the combination of an earnings recession and an economic slowdown that derail parallels with the 2015-16 stock swoon and rebound. As breathtaking as the rally off the Christmas Eve lows has been, it is not at all unusual to see protracted and magnificent surges punctuate bear markets. In the five months through August 1989, the S&P 500 rallied 19.2 percent before backsliding.

What makes the current run historically remarkable is the magnitude of the 10.5 percent rally in such a short time span, which belies the bottoming of the unemployment rate in the face of accelerating layoffs.

Bear Market Rallies can be Protracted and Pronounced

It was a bit curious to read in his recent Bloomberg Opinion commentary that Dudley thought it was “hard to see how the normalization of the Fed’s balance sheet tightened financial conditions in a way that would have weighed significantly on stock prices.” The current bear market rally was, after all, catalyzed by Chairman Jerome Powell’s assurances that quantitative tightening might be suspended soon, a stance since corroborated by both hawkish and dovish Fed officials.

Skeptical investors have been badly bruised if they were emboldened to fight both the Fed and the C-Suite at the same time. There is one force, however, that trumps both of these faith-based investing approaches and that is economic fundamentals. This may be a bear market rally for the ages, but that shouldn’t imply investors should do anything other than rent it. Owning it promises to end in tears.

This article originally appeared in Bloomberg Opinions — 2.24.19

Rising Credit-Card Use Shows Consumers Are Strapped

Americans are increasingly reaching for the plastic in their wallets to cover what their paychecks won’t.

 

Even though evidence is mounting that the U.S. economy may be soon heading into a recession, there are plenty of analysts who say that the surge in credit card borrowing is a sign of strong confidence among households. That’s hardly the case. In fact, households’ confidence in the future growth of their incomes has been cooling since late last summer, which means borrowers will only reach for what’s in their wallet to compensate for what their paychecks will not cover.

Many working adults have no recollection of credit card borrowing not being a mainstay among their financing options. But then, few would be able to identify a Diners Club card, which was a popular brand during the 1980s “yuppie” era when Americans first began to embrace credit card spending in earnest. These days, consumers are not keen to lean on credit cards, partly due to a cultural and financial shift in the industry.

The financial crisis arguably altered households’ views on charging beyond their means. It didn’t hurt that the availability of subprime credit all but disappeared for a few years or that the interest rate on credit cards remained in double-digit territory despite the Federal Reserve’s zero interest rate policy. That said, the idea of frugality re-entered many households’ thinking in the wake of the severe hardship the foreclosure crisis brought to bear on millions of working Americans. Debit cards became the predominant form of plastic used at the checkout.

And yet, consumer credit likely rounded out 2019 at a new $4 trillion milestone as runaway higher education and car-price inflation coupled with ridiculously looser lending standards pushed households to take on record levels of student loan and auto debt. At roughly $1 trillion, credit cards are but a co-star in a star-studded, full-length feature film. A long history of credit card borrowing suggests that we would have multiples of today’s $1.04 billion in outstanding balances had the growth rate of spending on plastic maintained the headier double-digit paces clocked in the 1980s and 1990s.

Credit Card Borrowing Decouples from Income Expectations in Current Cycle

Several factors worked to slow the rate of credit card usage, few of which were virtuous. The past several recoveries were characterized as “jobless” due to the prolonged period required to recapture prior cycle highs in the employment-to-population ratio and anemic wage growth that persisted in such environments. And while credit card spending certainly held up during the years the housing bubble was inflating, households didn’t have to lean near as hard on plastic when their homes had infamously become de facto ATM machines.

The question is where credit card borrowing goes from here in view of the deteriorating economic outlook. August marked the high in income expectations as measured by Conference Board data. If history is precedent, there will be a rush to tap available credit as households become increasingly aware that the economy is headed into recession.

Challenger, Gray & Christmas layoff announcements began rising on an annualized basis in August. And the quits rate, as measured by the Job Openings and Labor Turnover Survey, or JOLTS, peaked in August. Janet Yellen, a labor economist by training, was known to lean heavily on the quits rate, which rises as workers gain increased confidence in the availability of jobs. And finally, confidence among small businesses, which we know are the largest source of job creation, also peaked in August. There is a pattern.

You may note that the effective personal income tax rate — defined as the taxes paid on income, including realized net capital gains and on personal property — has tended to move up alongside credit card borrowing with two exceptions in the history depicted. The 1980s and the current episode are marked by falling income taxes, hence the decline in this tax rate ahead of recession. It’s intuitive that this holistic tax rate also rises as stocks rally throughout an expansion and declines into recession as the swing factor of capital gains drives the marginal moves.

Add it all up and it’s likely that any rush to “charge it” will be a last gasp as income expectations continue to decline and eventually cross lines with credit card borrowing. The closer we get to recession, the more desperate a sign credit card borrowing is anything but a reflection on strengthening in household finances. Households wouldn’t be reporting that they expect their incomes to rise less if that was the case.

 

 


This article originally appeared in Bloomberg Opinions — 1.18.19

 

Danielle DiMartino Booth, a former adviser to the president of the Dallas Fed, is the author of “Fed Up: An Insider’s Take on Why the Federal Reserve Is Bad for America,” and founder of Quill Intelligence.

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DiMartino Booth, Bloomberg Opinion October 18

Why Main Street Should Worry About Wall Street’s Bond Selloff

The potential for higher borrowing costs to inflict damage on household finances has grown in the era of extraordinarily easy monetary policy.

The recent leg lower in the bond market has pushed mortgage rates to the highest since the start of the decade. The glass half full people might say that’s not a problem since rates are less than half the levels seen during the bad old days of the 1980s when borrowing costs exceeded 10 percent. But that’s not the way to think about the potential fallout from higher rates. The real issue is what current mortgage rates represent to the current generation of home buyers. And by that measure, the outlook is rather dire.

According to the Mortgage Bankers Association, the average loan rate for a conforming 30-year mortgage was 5.10 percent in the week ended Oct. 12, the highest since early 2011. Back then, that level didn’t hold for long, as rates crashed to 3.5 percent by late 2012 and held at those low levels for years. As recently as July 2016, the 30-year rate was at 3.6 percent. Starting points matter, especially now with home prices at nosebleed levels. According to Black Knight’s August Mortgage Monitor, the monthly payment on the average home has jumped by 16 percent since the start of the year. That’s up from a 3 percent increase in 2017, illustrating the effect of rising rates on affordability.

The potential for rising rates to inflict damage on household finances has grown in the era of extraordinarily easy monetary policy. Yes, mortgage lending standards were tightened after the housing bubble burst in the financial crisis, but record low rates have nevertheless allowed buyers to afford pricier homes and homeowners to refinance to improve their cash flow via lower payments in order to augment stagnant income growth. But that was then. Refinancing activity is off by a third compared with last year, an effective drag on households.

Twice a month, the University of Michigan reports its Consumer Sentiment Index. In the preliminary October report, reported buying conditions for autos and homes fell. The last time both of these gauges were as low as they are today was the early 1980s as the economy was emerging from a grueling recession. If history is any guide, a sustained level of higher rates is the second nail in the coffin for housing followed by an upward turn in the unemployment rate and recession. We’re well on our way to the second stage.

Determined homebuyers are increasingly turning to adjustable-rate mortgages, or ARMs, which have low initial rates that adjust either higher or lower after some period depending on prevailing rates at the time. Currently, the average 5-year ARM charges a rate of 4.34 percent. As per the Mortgage Bankers Association, ARMs comprised 7.1 percent of new applications in the latest week, the most in a year.

To be clear, demand for ARMs is a shadow of what it was during the last boom when underqualified buyers did whatever it took to get into overpriced homes and lenders were happy to accommodate. At the apex of the housing bubble, ARMs were over half of mortgage activity. The drivers of ARM usage, however, have not changed. It’s still all about price. The average ARM today is $661,000, which are clearly being used to finance high-end homes. And just like when the last housing bubble burst, the risk is that ARMs taken out in recent years will reset at higher rates, leading to defaults and weighing on housing prices.

DiMartino Booth, Bloomberg Opinion October 18

And don’t forget that well-heeled home buyers are also likely to have a high concentration of stock market holdings. And given that eight of the top 10 markets with the largest monthly declines in home prices in July as measured by Black Knight were on the tech-heavy West coast, a month when technology stocks were headed to record highs, it’s not hard to imagine how fast home prices will fall once the air comes out of the tech bubble.

Black Knight highlighted San Jose in its latest report. The average home price in San Jose fell 1.4 percent in July, a sharper decline than any other market and the steepest drop for any month in any of the top 100 markets since the housing recovery began. Prices are down by 2 percent since May following a cumulative rise of 35 percent over the prior 20 months. Black Knight notes that “71 of the largest markets nationwide have seen the rate of home price appreciation slow in recent months.”

How bad things get may depend on supply. The housing market has been marked by low inventories placing ever greater upward pressure on home prices. There are two root causes. The first is that both small and institutional investors have scooped excess supply to flip or rent homes. And the second is the millions of owners who were able to hold onto their homes by modifying their mortgages through a government program through 2016. But after five years, their 2 percent interest-only payment period ends. At that point their loans will fully amortize and the mortgage rate will rise by one percentage point per year for five years. The payment shock will be enormous and could lead to an exorbitant number of homes being dumped on the market.

Two announcements in recent weeks suggest lenders have grown wise to the building risks. Home builder Lennar Corp. put Rialto Capital, its real estate lending group, up for sale. And Goldman Sachs Group Inc. said it will rein in the expansion of Marcus, its direct lending to consumers arm.

The outlook for households, and by extension the economy, is on shaky ground. Many households simply cannot weather a rising rate environment.


This article originally appeared in Bloomberg Opinions — 10.18.18

Danielle DiMartino Booth, a former adviser to the president of the Dallas Fed, is the author of “Fed Up: An Insider’s Take on Why the Federal Reserve Is Bad for America,” and founder of Quill Intelligence.

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Danielle DiMartino Booth is CEO and Director of Intelligence at Quill Intelligence LLC.

Visit QuillIntelligence.com to find out more. Click HERE to SUBSCRIBE.

For a full archive of my writing, please visit my website Money Strong LLC at www.DiMartinoBooth.com

Click Here to buy Fed Up:  An Insider’s Take on Why the Federal Reserve is Bad for America.

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The U.S. Economy Is on a Sugar High

The U.S. Economy Is on a Sugar High —

Many companies are rushing to secure products and materials before the trade war worsens

Across the U.S., companies are hitting the panic button. The Trump administration has levied 10 percent tariffs on $200 billion of Chinese goods, a charge that is expected to rise to 25 percent by 2019. This tops the tariffs on $50 billion of Chinese goods that were imposed in August, and is an effective tax on U.S. consumers, who will soon be paying more for everything from cosmetics to clothing to cars if they aren’t already.

Against that backdrop, it’s becoming clear that many companies are rushing to secure products and materials before prices rise regardless of current demand. You could say they are in panic-buying mode. The upside is that this behavior bolsters economic growth in the short term. The downside is that there is likely to be a nasty hangover. The noise in the economic data will be amplified by the rebuilding from Hurricane Florence. The estimates of the storm’s damage span from $20 billion to $50 billion.

Evidence that panic buying has set in was seen in the September Chicago Purchasing Managers Index report, which is a bellwether for the broader national manufacturing sector. While the results “disappointed,” with the index falling from 63.6 to a still high 60.4 and the new orders component sinking to a six-month low, the inventory component surged above the 60 mark. (In these diffusion indexes, readings above 50 denote expansion.) To put the stockpiling in context, inventories have only breached 60 twice this year. Such nosebleed readings are so rare that they rank in the 97th percentile over the last 30 years.

As per the Chicago PMI: “Firms continued to add to their stock levels, building on August’s marked rise. The scarce availability of inputs continued to encourage stockpiling while forecasts of higher future demand also contributed to the rise in inventories.”

There’s also been a pronounced increase in railcar volume. But the thing to know here is that data from the three biggest California ports, where the vast bulk of Chinese goods land on U.S. shores, arrives with a lag. We won’t have September data in hand until mid-October. Absent this port data, study the activity on BNSF and Union Pacific’s “Overland Route.” This old-school term begins at the West coast ports and ends at the railroads’ easternmost points. Take the number of rail cars in service and multiply it by how long these cars “dwell at terminal” to get a proxy of hours worked. That derivation roughly equates to aggregate hours worked in the employment report, due out Friday.

Indications that the tariffs will rise to 25 percent by year-end suggest the panic-buying mode will stay in effect for the next few months, making labor resources even more scarce. The latest Duke University CFO Survey reveals that those who set compensation budgets anticipate wages will rise by 4.8 percent over the next 12 months, the biggest increase in 18 years.

Artificial supply was evident in the August trade deficit, which came in at the widest in six months as exports slowed even as panic buying fueled imports. At the same time, wholesale inventories came in at nearly three times their expected rate while those of retail inventories came in stronger than their upwardly revised July levels.

The upshot is that economists have had to react in two ways. First, they’ve had to take down their third-quarter GDP estimates to account for weaker exports. On top of that, they’ve had to downgrade the quality of economic growth to account for the reasons behind the inventory build. Or, in the words of JPMorgan Chase & Co. chief economist Michael Feroli, the economy is looking “less boomy, more noisy.”

In the event you’re hoping the virtuosity of panic buying can become a permanent prop to the economy, you might want to rethink your thesis. To Feroli’s point, “less boomy” indicates a fundamentally weaker demand backdrop as the U.S. economy stretches into the final months to claim the trophy of the longest expansion in history.

Rather, artificial, tariff-driven panic buying pumps up GDP growth in the short term but ensures it will disappoint in the future. Look for fourth quarter estimates to be revised upwards and then look out below into the first of the year. And no, the first-quarter disappointment will not be the seasonal anomaly many economists typically ascribe to economic growth in the first three months of the year. In other words, it could be that much worse.


This article originally appeared in Bloomberg Opinions — 10.4.18

Danielle DiMartino Booth, a former adviser to the president of the Dallas Fed, is the author of “Fed Up: An Insider’s Take on Why the Federal Reserve Is Bad for America,” and founder of Quill Intelligence.

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Danielle DiMartino Booth is CEO and Director of Intelligence at Quill Intelligence LLC.

Visit QuillIntelligence.com to find out more. Click HERE to SUBSCRIBE.

For a full archive of my writing, please visit my website Money Strong LLC at www.DiMartinoBooth.com

Click Here to buy Fed Up:  An Insider’s Take on Why the Federal Reserve is Bad for America.

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Fed’s Inflation Focus Needs a Tuneup

Past errors by the central bank compel it to put less emphasis on consumer prices and more on financial stability.

What now? Continued Federal Reserve interest-rate increases for as far as the eye can see? Those are the primary questions with the last inflation target standing essentially hitting the central bank’s 2 percent bullseye.

The core personal-consumption-expenditures price index (PCE), a broad measure of inflation that excludes food and energy, rose 1.98 percent in July from a year earlier. The core PCE has long been the gentlest measure of inflation, so for many economists the evidence that it’s catching up to every other similar metric, such as the widely recognized consumer price index, that have long since pierced 2 percent is akin to the end of a vigil. (The government is expected to say Thursday that the consumer price index rose 2.4 percent in August from a year earlier when excluding food and energy.)

So, let’s get on with more rate hikes already — right? Perhaps, but such rigidity in the approach to monetary policy is a vestige of the past. Federal Reserve Bank of St. Louis President James Bullard has risen to the forefront of questioning the sanctity of relying solely on inflation in guiding policy. But it’s not because he feels inflation is too hot or too cold, but rather it is inappropriate.

Bullard can always be relied upon to strike a dovish tone — so much so that many consider him dovish for the sake of being dovish. He warned in a speech last week that Fed policy was already “neutral or somewhat restrictive” as reflected in a very flat yield curve, which is one of Wall Street’s most reliable indicators for forecasting recessions. He downplays inflation as a reliable metric given how the economy has evolved, with financial assets becoming a bigger part of the economy. “Neither low unemployment nor faster real GDP growth gives a reliable signal of inflationary pressure because those empirical relationships have broken down,” Bullard said.

9.5.18-us-private-sector-fin-assets

There’s some irony in markets branding Bullard as the most dovish member of the Federal Open Market Committee while placing Chairman Jerome Powell at the opposite end of the spectrum in the hawkish camp. The two are literally echoing one another’s views. Consider this from Powell’s Jackson Hole speech last month:

“Inflation may no longer be the first or best indicator of a tight labor market and rising pressures on resource utilization. Part of the reason inflation sends a weaker signal is undoubtedly the achievement of anchored inflation expectations and the related flattening of the Phillips curve. Whatever the cause, in the run-up to the past two recessions, destabilizing excesses appeared mainly in financial markets rather than in inflation. Thus, risk management suggests looking beyond inflation for signs of excesses.”

In an Aug. 15th interview with Central Banking, Bullard also said financial excesses should be monitored closely given the growth of the shadow banking system since the crisis a decade ago. Here, the Fed has always been handcuffed, limited to regulating bank holding companies and financial institutions with a bank charter. It has no jurisdiction over private equity or technology firms that have crept into the world of finance, entities Bullard said are in the business of avoiding regulatory overview:

“The whole game in Silicon Valley is to do regulatory arbitrage: ‘Let’s provide financial services in ways that are not covered by ordinary laws, and let’s build up a business, like Uber. Let’s build up a business and a constituency for that business outside of the normal legal framework, and then we will wait for the legal system to catch up, and then we’ll litigate at that point.’”

The geographic parallels with pre-2008 are striking. As the subprime mortgage lending apparatus was being built out in the housing boom years, then Fed Chairman Greenspan was repeatedly warned that the central bank would have to catch the falling knife when housing turned. To this, Greenspan’s stock reply was that the Fed only regulated a quarter of mortgage lending and therefore was not exposed to the mania building in Janet Yellen’s San Francisco Fed District, with Countrywide Financial at its epicenter. “It’s that shadow world where the next crisis will be brewing,” Bullard said, “and how is the regulatory apparatus going to handle that going forward?”

Bullard and Powell are both clearly looking back to the Fed’s past errors in judgment and questioning the efficacy of core PCE dictating monetary policy. They know that what started in the shadows of subprime lending ended with the fall of Lehman Brothers Holdings Inc. and the unleashing of systemic risk, the dangers of which were absent in a broken inflation metric. The question for the here and now is whether their shared perspective proves to be prescient, but at the same time, too late.


This article originally appeared in Bloomberg Opinions — 9.12.18

Danielle DiMartino Booth, a former adviser to the president of the Dallas Fed, is the author of “Fed Up: An Insider’s Take on Why the Federal Reserve Is Bad for America,” and founder of Quill Intelligence.

Read more opinion


Danielle DiMartino Booth is CEO and Director of Intelligence at Quill Intelligence LLC.

Visit QuillIntelligence.com to find out more. Click HERE to SUBSCRIBE.

For a full archive of my writing, please visit my website Money Strong LLC at www.DiMartinoBooth.com

Click Here to buy Fed Up:  An Insider’s Take on Why the Federal Reserve is Bad for America.

Amazon.com | Barnes & Noble.com | Indie Bound.com  |  Books•A•Million