Fear Storm Clearing?
Board: Macro Economics
After the little storm of Extreme Fear that blew through in early February, the Fear & Greed Index has risen back to neutral. Investors are shifting toward risk-on investments (stocks, high yield bonds) and away from risk-off investments, such as the USD and Treasuries. We have seen this pattern many times before. The next move is usually toward Greed.
Long-term Treasury yields are gradually rising again. The yield curve is not as steep as it was before the storm blew in about a month ago, but it is steepening. This is normal for an improving economy. If the economy strengthens in the spring as the unusually harsh winter weather mitigates, the yield curve will probably steepen further. It is normal for interest rates to rise in the spring as the demand for mortgage lending increases.
ECRI (the Economic Cycle Research Institute) says that the economy has "Failure To Launch." They write, "It is now quite clear that the economy is decelerating, not accelerating, with growth in ECRI's Weekly Coincident Index (see chart) falling rapidly." While the growth rate is still positive, it is only about half what it was in 11/2013. The LEI dropped, but that was within the noise of a generally climbing trend. For perspective, ECRI has been bearish since early 2013. Their predictions failed to jive with the consistently growing economy (or even with their own increasing Leading Economic Index) and especially with the bullish stock market. So it's hard to say whether their prediction of a slowdown will be correct this time. The Fed's data series are only current to the end of last year (e.g. New Factory Orders).
Commodities, such as gold, oil and corn, are rising our of their near-term channels. This could be the beginning of a sustained trend change but it is a little early to tell.
It is also early to tell whether the SPX has resumed its 2013 bullish trend since it has not made a new high. The last new high was 1848 on 1/15/2014, so the "mungofitch 99-day rule" is still bullish. The "mungofitch Lagged MA" is also strongly bullish. Several measures of market internals that deteriorated during the storm are now recovering. The SPX P/E ratio is high but not in bubble territory.
The money supply continues to grow. The Fed continues to pump money, as shown by the growth in their assets (despite the slight "taper").
As aleax pointed out, Velocity is important in determining economic activity in the "real economy." The velocity of money is the frequency at which one unit of currency is used to purchase domestically- produced goods and services within a given time period. Both Velocity and the Money Multiplier (the ratio of M1 to the St. Louis Adjusted Monetary Base) are very low. If these metrics grew faster than the increase in production, consumer price inflation would increase.
However, Velocity and the Money Multiplier refer to M1 (cash and very short-term equivalents). They do not apply to money invested in the asset markets. The Federal Reserve continues to pump money into the asset markets, which is inflating asset prices. The Fed is quite satisfied with its results -- low inflation in consumer prices with high inflation in asset prices.
In addition to Fed pumping, NYSE margin credit is at a record high. The WSJ is reporting that small investors are buying more stocks on margin. This is a driver for a bubble in the stock market that can burst with devastating effect, since margin calls can force selling of good assets to finance the debts on falling assets.
A large part of the U.S. economy depends upon real estate. The Bureau of Labor Statistics adjusted its Producer Price Index (PPI) last week to include construction and services in addition to goods.
The spring season for real estate begins in March in warmer areas of the country. The average 30-Year Fixed Rate Mortgage is still over 4%, as it has maintained since June 2013. The average sales price of a new home as high as it was in 2005. The Case-Schiller averages are rising. Housing permits and starts are rising, although still low on a historical basis.
Non-U.S. stock markets around the world have popped back up as the storm cleared. The USD and euro are stable within their channels as the CAD continues to fall.
Despite the unrest in the Ukraine, Venezuela, Syria, etc., there are no financially disturbing stories in the press, just the usual chit-chat.
The 2014 spring real estate season will tell whether higher mortgage rates will "bite" housing sales and whether higher real interest rates will "bite" consumer spending, which is 70% of GDP. So far, Personal Consumption Expenditures are increasing although Disposable Personal Income stagnated in the second half of 2013. Consumers are borrowing but keeping the Household Debt Service Payments as a Percent of Disposable Personal Income at the lowest level since 1980.
If ECRI is correct and the real economy is slowing significantly, the effect will be longer-term. The 2007 recession started many months after interest rates (including mortgages) began to rise in 2005.
The METAR for next week is bullish. The storm has blown out and the weather is clear.