Recession Fears Drive Equities Lower… The inverted yield curve and heightened trade war rhetoric raised investor fears of a recession, leading to losses on Wall Street.
What it means – There aren’t many good indicators of bad economic times. One that has been reliable is an inverted yield curve, where long interest rates fall below short interest rates. The last time this happened was 2007, and before that was 1999, and 1990, and the early 1980s. See a pattern? Other people do, and they don’t like it. Add to that Trump’s exemption of a few products from tariffs, which President Xi brushed off, and you get a lot of nervous stockholders.
The market sold off hard before retail sales came to the rescue with a better than expected result.
But the yield curve, that’s something we should watch. Either central bankers have so manipulated interest rates that none of it matters, or bond investors are telling the world that they see exceptionally little growth for years to come. Typically, inversions happen when the Fed isn’t lowering rates fast enough, say from 5% to 3%. But today, we have the 30-year Treasury bond trading at 2%, the lowest level in history. We’re not starting at high, or even mid-range, numbers.
Either scenario is worrisome.
Globally some economies are already in recession. European Central Bank is considering dropping interest rates even lower than the current MINUS 0.4%! Apparently, the ECB economic model shows that what has not worked in the past will if tried when magnified. HMMM! Considering the pressure on the Fed to lower rates, we think the concept is getting much too close to home.
Inflation Jumps a Bit – Up 0.3% in July… Consumer prices expanded a bit faster than expected last month and are up 1.8% over last year. Excluding food and energy, core inflation rose 0.3% as well, and is up 2.2% over last year.
What it means – It won’t surprise anyone to find that the biggest contributors to higher prices were medical costs and housing. Medical costs increased 0.5% in July, and are now up 3.3% for the year, whereas housing rose 0.3% for the second straight month, and is up 3% for the year. Energy prices rose in July but will definitely retrench when the August numbers are reported. Prices may be rising though investors with diversified portfolios have not benefitted. The energy sector has deteriorated for more than a year and illustrates the struggle of a trading range market.
Overall, inflation remains right where the Fed wants it to be, so it doesn’t give the central bank any reason to change rates. Another reason for disappointed investors seeking lower interest rates.
Retail Sales Up 0.7% in July, Boosted by Amazon Prime Days… Continuing a streak of gains, retail sales jumped last month, following a 0.3% gain in June.
What it means – The gains were widespread and led by a 2.8% gain in non-store sales, which includes e-commerce. Even department store sales improved 1.2%, although several retailers have since reported earnings and guided lower. Autos were one of the few areas that showed weakness, along with sporting goods. The robust report bolstered estimates for third-quarter GDP and, along with solid inflation data, take away another reason that the Fed might use for lowering interest rates. Another reason for disappointed investors seeking lower interest rates.
Housing Starts Down 4% in July, Permits Up 8.5%… In another frustrating report for the real estate market, housing starts disappointed, missing estimates of a slight gain.
What it means – Multi-family starts dropped significantly in July, and now sit 2.8% lower than last year. Single-family starts inched up a bit and are 1.9% higher than last year. Single-family starts are more important because they are a bigger driver of employment in the sector.
Housing permits popped 8.5% last month, but that brought multi-family permits to an 11.9% annual gain and single-family permits to a 3.8% annual loss. The market remains muddled. Until the earnings of home buyers catch up with the prices of homes, we’ll remain in this no-man’s land with little growth.
Investors have opted for real estate investment trusts (REITs) and the related dividends to escape stock market volatility. The sector’s risk profile is unusually high. Residential and mortgage REITs should be given careful scrutiny for leverage and credit quality of holdings. Office building REITs may offer better risk reward.
Industrial Production Falls 0.2% in July, Missing Expectations for a 0.1% Gain… Heat waves sweeping the nation drove utility gains, but it wasn’t enough to keep industrial production in the green.
What it means – Manufacturing and mining drove the report lower. Manufacturing dipped 0.4%, taking away most of the 0.6% gain from June, and manufacturing, which includes oil and gas, dropped 1.8% in July. The Fed is likely to focus on business equipment spending, which dropped by 0.4% in July and shows a lack of investment. Industrial utilization fell to 77.5%, well below the long-run average of 80%.
Comparing the industrial production numbers and retail sales highlights the problem for the Fed. The business sector appears to be slowing down even as consumers remain steady.
For diversified investors, the industrial sector has been a drag on their portfolios since the peak in January 2018. While volatile as the market, it clearly illustrates the persistent trading range of nearly two years. An economic catalyst could easily drop the market to last December’s lows or beyond.
European GDP Expanded 0.2% in the Second Quarter, and 1.1% Over Last Year… The Euro zone is struggling with weak growth as its economy expanded at the slowest rate since the first quarter of 2013.
What it means – We don’t have details, but headline numbers from countries across the zone paint a bleak picture. French GDP increased slightly, up 0.2% in the second quarter after rising 0.3% in the first, while German GDP dipped 0.1% after rising 0.4% in the first quarter. Trade is an issue, but so is the lingering emissions scandal for German automakers and the looming Brexit.
Interest Rates Sink Around the World… The U.S. 30-year Treasury traded at the lowest level in history, barely above 2%, as German and Swiss 10-year bonds sunk further into negative territory. As of this writing, Bloomberg reports the 10-year Swiss bond yields MINUS 1.10%!
What it means – It’s all about the currency. With the global economy slowing down, countries around the world are eager to balance their economies by selling more to foreigners. To do so, they cheapen their currency, which makes their goods less expensive on the global market. By lowering interest rates, central banks try to make it less attractive for foreign capital to move into their currency, and even drive out some currency, which lowers the exchange rate.
The problem is that if everyone does it, nothing changes in the currency markets. But that doesn’t mean there isn’t any effect. Savers get crushed as they watch their fixed income returns dive toward zero and, in some cases, fall into negative territory.
Even with Population Gains, the World Has More Food Than Ever… In a blow to scarce resource alarmists everywhere, the group Human Progress reports that the population-weighted food supply increased 30% from 1961 through 2013 in the world’s poorest region, sub-Saharan Africa. Today, the region has the same access to food as measured by calories as Portugal did in 1961. The researchers attribute this to better farming, increased productivity, increased wealth, cheaper food, better transport, and better communications. They also point out that, with greater democracy and more free press, it’s harder for governments to starve their populations. “Who’da thunk it?”
Data supplied by Dent Research/Delray Beach Publishing
“When the facts change, I change my mind.
What do you do, sir?” ~ John Maynard Keynes
Our plan is “the plan will change.”
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