The incoming data, both sentiment indexes and the actual hard numbers, continue to show growth deceleration in the U.S. and worldwide. In post-Fed meeting appearances, the Fed Chair and other FOMC members have walked back their hawkish positions taken in the immediate aftermath of the December 19 (rate hike) meeting. The oversold markets, having thrown the biggest December tantrum since 1931, responded positively and, at this writing, have recouped about half of their December losses.
Europe appears to be headed for recession, if not already there. This is significant since the Eurozone is a larger economy than that of the U.S. In November, Germany’s factory orders were -1% lower, and inflation receded in December, a sign of flagging demand. Prices also fell in Spain. Industrial Production in Italy was off a large -1.6% in December, and off -1.5% in Spain (-2.6% year over year (YoY)). In the U.K., Industrial Production was -0.4% weaker with YoY production down -1.5%. Brexit will only make things worse. A Wall Street Journal (WSJ) article in mid-January reported that 10,000 trucks/day cross the English Channel carrying parts that go directly to production lines. These currently move unfettered as there are no customs requirements. The Brexit date, March 29th, will usher in a huge headache for trade, as there are no customs facilities, trained staff, or parking/storage. That is on both sides of the Channel.
China’s Soft Data
China’s factory output appears to be at a four-year low. December’s PMI (both the official government number and the private Caixin-IHS Markit read) was below 50, the demarcation between growth and contraction. The official number is at a 28-year low. Retail isn’t doing much better. While still growing, the rate of growth is at a 15-year low. Chinese stocks remain in a bear market. In the rest of the world, most economies are struggling, including Japan, Australia, Canada, Mexico, Brazil, and most of the emerging markets.
In the U.S., both manufacturing and non-manufacturing PMIs slipped in December; still positive, but trending down. All of the capex surveys are showing softness. Ditto for the regional Fed surveys. For example, the Dallas Fed’s index fell to -5.1 in December, a huge decline from +17.6 in November. With both sentiment indexes and hard numbers now softening, all of the leading indicator indexes, composed of both, are likely to decelerate going forward.
It is never a good sign when major corporations issue warnings or walk back their guidance. Reporting season has just begun as of this writing, but already there is a large and growing list: Macy’s, Kohl’s, L Brands, JC Penney, Apple, Samsung, Amazon, Fed Ex, Delta Airlines, American Airlines, Lennar. The major banks (Citi, JPMorgan, Wells) all disappointed. I suspect the list will be much larger as reporting season progresses.
The Great December Employment Report
Part of the market’s recovery from the December disaster occurred on the first Friday in January. That was when Fed Chair Powell publicly turned dovish. But markets were up prior to his public appearance due to the seemingly ebullient employment report. “No Recession in Sight” read the headlines after the early morning employment report release.
A couple of comments here. First, employment is generally a lagging indicator. History tells us that recessions have begun within six months of such an upbeat employment report. Second, there were many anomalies in the report including the fact that in the Establishment Survey (+312,000 jobs), large job growth occurred in sectors that we know are soft including Retail and Construction. Other recent surveys, including the government JOLTS (Job Openings and Labor Turnover Survey) also contradict the growth shown in those sectors
The Household Employment Survey, which showed a positive, but much smaller, 142,000 jobs created, and is the survey used to calculate the unemployment rate, also gave cause for pause. Those holding college degrees actually lost jobs (-67,000); those in their prime working years (25-64) also lost jobs (-11,000 on top of the -48,000 lost in November), and the employment of adult males slipped -84,000. All of the job gains were concentrated among people without any college and those under 20 years of age. All in, December’s employment report, despite the Wall Street hype, does not inspire a lot of confidence, and investors would be wise to wait for confirmation in the next couple of reports.
Despite the overwhelming evidence of economic deceleration, markets rose in the first two weeks of January. Clearly, they rebounded from their significantly oversold condition on Christmas Eve. It appears that the market threw a tantrum at the Fed, and in the face of the biggest December selloff since 1931, in early January, the Fed blinked.
Volatility, the intraday percentage change between market highs and lows, is a good measure of market concern; the higher the volatility, the higher the market uncertainty and worry. In September, that measure of volatility was 0.67%. It rose in October and November to the 1.5% level. December’s average was 2.5% with some days over 3.2% and one over 5.3%. Through the first two weeks of January, volatility fell back to 1.6%, and, after the Fed’s about face in early January, to 1.2% in the week ending January 11. While still relatively jumpy, it does appear that markets have calmed a bit.
The market rally began in early January with Chairman Powell, sitting with former Fed Chairs Bernanke and Yellen at an American Economic Association conference, walking back his hawkish post-Fed press conference comments. No longer were the two 2019 rate hikes discussed at the December 19th press conference baked in. And Powell has let it be known that the reduction in the Fed’s balance sheet (known as Quantitative Tightening) was, in fact, not on auto-pilot as he had indicated in his December 19 presser. [Recently released data indicate that the planned balance sheet reduction in 2019 is now $442 billion, significantly less than the $600 billion reduction in 2018.] To date, Powell, Fed Vice-Chair Clarida, and some formerly hawkish Fed members (Ballard: St. Louis; Evans: Chicago) have indicated that the Fed will likely “pause” its rate hiking agenda and allow incoming data to determine its next move. As indicated above, markets have reversed course since then. Some may call me cynical, but it does appear that even the Powell Fed is not immune to a market tantrum, if it is big enough.
The Fed Minutes
During the second week of January, the minutes of the December Fed meeting were released. A reading of those minutes by any ardent Fed watcher with no knowledge of the Fed’s policy decisions (i.e., to raise rates) would have concluded that the Fed had lowered rates (or, at a minimum “paused” its rate hiking) because those minutes were replete with comments about heightened economic risks and worries about the future impacts of past Fed actions. Here is some typical language found throughout those minutes:
…assess factors such as how the risks that had become more pronounced in recent months might unfold…and the effects of past actions to remove policy accommodation which were likely still working their way through the economy…
Participants commented…greater-than-anticipated negative effects from the monetary policy tightening to date
Participants also reported hearing more frequent concerns about the global economic outlook from business contacts
In my view, the tone of the minutes vs. the post-meeting written statement, together with Powell’s hawkish comments in the presser, don’t jive. Was Powell originally sending President Trump a “back-off” message? Were the minutes written in the aftermath of the market tantrum and the clear decision of Powell and Co. to walk back the hawkish message in favor of signaling an upcoming “pause?”
Forward Guidance is “Pause”
The markets are relieved that the Fed is now “pausing,” and have rebounded off their Christmas Eve lows. But, that doesn’t help an investor decide on portfolio allocations. The question to be answered is: Has the Fed already over-tightened (policy mistake) and what impact could that have on the economy?
As outlined above, the mildest characterization of the U.S. and world economies is “deceleration.” The January 11th WSJ reported that 25% of polled economists see a 2019 recession and more than 56% see one in 2020. This is the highest level of concern since the Fall of 2011. No recession occurred then, so that is some comfort that recession is not inevitable. However, back then, the Fed was in the middle of its Quantitative Easing (QE) programs (between QE2 and QE3) and interest rates were at their 0% boundary. Those are not the conditions today as we have the world’s four major central banks (Fed, ECB, BOJ, and BOE) all in some stage of tightening. There is a big difference between QE with 0% interest in 2011 and a “pause” today with previous policy tightening moves still working their way through the economy.
- December’s market plunge told us that markets are worried about growth, both at home and abroad. Analysts have significantly reduced Q4 expected profits, currently being reported;
- The PBOC, China’s central bank, is moving quickly to large scale ease; that tells us something about the slowdown there;
- Fed Guidance is “pause,” not “ease;”
- All of the leading indicator indexes are now negative;
- Government shutdown is impacting travel (TSA sick-out has a large impact on major airports which do not have sufficient screening capacity); private sector government contractors have been impacted; White House estimates a negative -0.1% per week impact on GDP;
- The SEC isn’t processing private sector requests; the SBA isn’t processing small business and farm loans.
Could it be that the government shutdown becomes the triggering device for a recession?
For investors, caution is still warranted.
Robert Barone, Ph.D.
Robert Barone, Ph.D. is a Georgetown educated economist. He is a financial advisor at Fieldstone Financial. www.FieldstoneFinancial.com .
He is nationally known for his writings and Robert’s storied career includes his having served as a Professor of Finance, a community bank CEO and a Director and Chairman of the Federal Home Loan Bank of San Francisco. Robert is currently a Director of CSAA Insurance Company (a AAA company) where he chairs the Finance and Investment Committee. Robert leads the investment governance program at Fieldstone Financial, is the head of Fieldstone Research www.FieldstoneResearch.com, and is co-portfolio manager of the Fieldstone Financial Unconstrained Medium-Term Fixed Income ETF (FFIU).
Statistics and other information have been compiled from various sources. The facts and information are believed to be accurate and credible, but there is no guarantee as to the complete accuracy of this information.