I continue following my folly of trying to divine the outcome of the fiscal cliff “talks” by observing the price action of certain stocks and sectors. Today we’ll examine the price action of two large commercial banks (Wells Fargo and US Bancorp) and two large investment banks (Goldman Sachs and Morgan Stanley). The first chart below shows the cumulative returns to WFC and USB since September:
WFC’s price action is encouraging, but USB’s is less so. Checking in with GS and MS below . . .
. . . provides more encouraging results. Over the weekend someone allegedly “in the know” mentioned that Goldman Sachs contributed more to the Obama campaign than to Romney’s — interesting. Wonder if this entitles the Giant Squid to a “sneak peak” at the fiscal cliff “negotiations?”
Draw your own conclusions from the above. I’m sticking with my call that we’re all given a long, hard look at the view from the precipice of the cliff for maximum theatrical effect. Then we’ll be dramatically snatched from the fictitious brink, so that our political leaders (?) can lay claim to actually accomplishing something.
Wouldn’t it be nice to get back to fundamental analysis and chart-reading in 2013? Does anyone else miss having real markets to play and trade? I know I do. Happy New Year, everyone.
One tenet of stock market wisdom — usually referred to as “sector rotation” — holds that we can discern the market’s mood by studying the relative price changes of stocks in different sectors. The chart below depicts this idea. The financial cycle is thought to lead the business cycle by 6-9 months. When certain sectors surge ahead — like Financial and Technology stocks — the business cycle is believed to be in early to full stage recession. On the other hand, when stocks in Cyclical sectors, like Industrials, surge ahead, the business cycle should be in the early stages of expansion.
Examining US stock returns by sector from the past 90 days in the chart below, we see that Financial and Industrial stocks both held up well and recovered the best since the November 2012 market malaise. Note the mixed message — when Financials surge ahead, we’re supposed to be in the early stages of a recession. But when Industrials lead the market, we’re supposed to be in the early stages of expansion.
When markets are functioning properly, we should to be able to glean a little wisdom from studying the price changes of the lagging sectors as well. As the above chart shows, classic risk-on sectors like Energy and Technology continue to exert a drag on the market — another sign that traders believe the economy is expected to weaken somewhat in early 2013. Overall, traders are probably having a difficult time processing the irrational signals coming out of Washington regarding the fiscal cliff. The market is not sending clear signals whether the big trade in early 2013 will be risk-on or risk-off.
My most recent Economic Outlook called for continued sluggish business conditions in early 2013: what used to be called a “growth recession.” Growth should remain positive, but too tepid to create enough jobs to really move the needle on underemployment. Let’s corroborate that view with some wisdom from the stock sectors. Below I’ve graphed the return to the top and bottom 2 stock sectors over the last 90 days.
It was basically a risk-off story, as technology and energy stocks tanked, and health care and materials led — both up about 2.0%. Materials stocks’ advances were driven by more of an oversold rebound, not a big shift in expectations regarding the global business cycle.
Relating to my call for continued sluggish conditions, financial markets also appear to be braced for continued risk-off. Best near-term rally point I can foresee is a little volatility burst around some last-minute fiscal cliff heroics. The market’s already leaning towards the “we don’t fall off the cliff” outcome, but my view is that traders are going to indulge in a faux good news rally when the word is “officially” announced.
If it’s December, it’s time for a year-end economic outlook. To my knowledge, this is the only blog where you can view all the Conference Board’s Leading, Coincident and Lagging Indicators. I will review each indicator and comment on the outlook for economic growth in 2013. Each indicator is scored -1 (for negative), zero (for neutral or not applicable), or +1 (for positive or superior) and merged into my own diffusion index. (The y-axis of the first graph below represents an index of economic conditions: 100% would be the most robust economic conditions possible, and -100% would be the worst of economic times — a depression. Data sources include the St. Louis Fed’s FRED2 database, Zerohedge and Gallup.)
Previewing the results of the analysis, the graph suggests that, looking back (lagging, in blue), the economy grew tepidly. Recent (coincident, in red) economic conditions have been more encouraging, but, as was the case in 2012, the leading indicators (in green) suggest the economy is expected to slow down slightly in the first half of 2013. The US economy remains surprisingly resilient in the face of slowing global growth and the deepening recession in Europe, but US growth will still be affected, and will most likely remain below trend for another 6-9 months, and possibly longer.
We’ll start with the Leading Indicators. The most heavily-weighted component is the Average Length of the Manufacturing Workweek (weight = 0.2781), shown below with the average length of the construction workweek. Both workweeks have regained their pre-recession levels, which is typically interpreted as a positive signal. Also notice that neither indictor “led” the previous recession, but instead behaved more like lagging indicators.
The chart below presents the Manufacturing Workweek (shaded area) with Total Manufacturing Employment. Although the length of the workweek is back up, since 2001 five million fewer manufacturing workers are putting in 41.5 hours per week. With the workweek back up, but the manufacturing sector continuing to shed jobs, I’ll rate the Manufacturing Workweek indicator zero.
The second leading indicator is the ISM’s New Manufacturing Orders Index (weight = 0.1651). The index has been in a clear downtrend, and has fallen below the key 50 level (suggesting contraction). Notice how previous recessions have been preceded by similar downtrends. I will rate this indicator -1.
The University of Michigan’s Consumer Sentiment Index (weight = 0.1551) has rebounded recently. Although sentiment is generally lower than it’s been in the last 3 expansions, the uptrend merits a score of +1.
Interest Rate Spread Between the 10-year T-Note and the Fed Funds Rate (weight = 0.1069). This indicator is really a proxy for the slope of the yield curve. A steeply sloped yield curve indicates economic expansion, while a flat or inverted yield curve indicates slowdown or contraction. The curve has been flattening for quite a while, but it is not yet at pre-recession levels, so I’ll rate the indicator zero.
Manufacturers’ New Orders for Consumer Goods (weight = 0.0811). Durable Goods orders deflated by the Personal Consumption Expenditure Index (PCE) are shown below. Although the indicator rebounds sharply following the last recession, Durable Goods orders are growing more slowly than the rate of inflation over the long term, and exhibits a troubling downturn in mid-2012. This indicator therefore merits a score of zero.
The Conference Board’s proprietary Leading Credit Index is replaced by Total Borrowing by Consumers and Businesses (weight = 0.0794). Borrowing continues increasing, so I’ll rate this indicator +1.
Inflation-Adjusted Level of the S&P 500 (weight = 0.0381). Despite recent advances in stock prices, on an inflation-adjusted basis, the US stock market remains mired in a secular bear phase. I will therefore rate this indicator zero.
Manufacturers’ New Orders for Capital Goods (weight = 0.0356). Similar to the pattern observed in Durable Goods, manufacturing indexes such as these continue making lower highs. Orders have tailed off in recent months, so I’ll rate this indicator -1.
Initial Unemployment Claims (weight = 0.0334). Unemployment claims have dropped precipitously since the recession, but most recently are heading back towards the recessionary level of 400,000 per week. This indicator therefore rates a score of zero.
Building Permits for New Private Housing Units (weight = 0.0272). This indicator continues advancing, but only to levels associated with the depths of the 1982 and 1991 recessions. I will therefore rate the indicator zero.
Next we’ll consider the Conference Board’s 4 Coincident Economic Indicators. Manufacturing and Trade Sales (weight = 0.5318) have risen steadily since the last recession, earning this indicator a score of +1.
Total Nonfarm Payrolls (weight = 0.2597). The US economy is producing jobs, but total employment still lags the levels of the mid-2000s, which earns this indicator a score of zero.
Personal Income Less Transfer Payments (weight = 0.1357). Personal income in the US is at an all-time high, which is definitely a positive. Examining the next graph below, however . . .
. . . I also compare Personal Income to Transfer Payments and Personal Consumption Expenditures. Notice how the upward trend in income and spending is strongly supported by an above-trend sruge in Transfer Payments (Social Security, Medicare, Welfare, etc.). Although I have strong concerns about future reductions in Transfer Payments and the effect on spending, I’ll rate this indicator a cautious +1.
Industrial Production (weight = 0.0728). Until this year, Industrial Production was the most heavily-weighted coincident indicator. The nominal series looks encouraging, but the inflation-adjusted series is in a downtrend, similar to the trend for Real Durable and Capital Goods. Long-term contraction in a number this vital to an economy suggests a rating of -1.
Merging the above -1, 0, or +1 ratings into a simple diffusion index provides a score of -10% if all indicators are equally-weighted, and -24% if we use the Conference Board weights. The implication is that growth and economic activity will slow slightly over the next 6-9 months.
Next we’ll move on to the Conference Board’s 7 Lagging Indicators. Average Prime Rate (weight = 0.2815), also shown with Total Commercial and Industrial Loans. The rate could hardly be lower, and as pointed out previously, business loans are increasing, so this indicator merits a score of +1.
Ratio of Consumer Credit to Personal Income (weight = 0.2101). It strikes me that this ratio is a sort of “goldilocks” number, where we don’t want it to be too low or too high. As of now, it’s only 1% lower than its all-time pre-recession high, which tells me consumers still have old debts to pay off before a new cycle of consumer borrowing can begin, so I’ll rate this indicator zero.
Consumer Price Index for Services (weight = 0.1955). The US is supposed to have recently completed the transition from a manufacturing economy to a service economy — just in time for service providers to lose the last of their pricing power, as the Fed prints money to avert deflation. Zero is a generous score for this indicator, but hey, we’re optimists around here.
Ratio of Inventory to Sales (weight = 0.1211). With the prevalence of just-in-time inventory management, this ratio has trended downwards for decades. There’s no sign of a recessionary inventory buildup, so this indicator earns a score of +1.
Commercial and Industrial Loans (weight = 0.0970) were considered previously, and earned a score of +1. Unit Labor Costs (weight = 0.0587) are shown in the graph below. Sluggish job creation has helped businesses keep labor costs capped — good for business, bad for working class consumers — so I’ll rate this indicator zero.
Median Duration of Unemployment (weight = 0.0361) is shown below, along with the Civilian Labor Force Participation Rate. I cannot discern a shred of good news from this indicator, thus I’ll rank it -1.
That concludes our tour of the Conference Board’s official indicators. Examining an alternative summary diagram below (this one using the Conference Board’s weighting system) confirms that a repeat of the below-trend growth from 2012 is the best we can hope for in 2013.
A few more charts to wrap up. Zerohedge recently posted the chart below, which ranks world governments by their cumulative budget deficit as a percentage of GDP. Yes, that’s the US, ranking just below Ireland and Greece, and only slightly ahead of Spain, Japan and the U.K. Can’t keep borrowing, folks. The principle of mean reversion suggests that after several decades of living above our means, it’s time for US citizens to . . .
. . . tighten their belts, shall we say? The last chart below is reproduced from Gallup, whose pollsters were silly enough to ask Americans what their ideal weight was.
Since 1991, US men have gradually decided it’s okay to be 16 pounds heavier on average, and US women have decided it’s okay to be 13 pounds heavier. Draw your own conclusions re: human nature. And good luck in the markets in 2013.