Night Of The Curling Laminates

Lumber Gets Liquidated

The rather violent demise of a former bubble darling may represent an interesting signal with respect to underlying economic growth in the US. We used to trade treasury bond futures and options back in the 1980s and we distinctly remember a piece of traditional trader wisdom handed down to us by one of the “old hands”: If you trade t-bonds, always keep an eye on lumber prices.

The idea was that lumber prices could be seen as a leading indicator of economic growth. Divergences in the trends of bonds and lumber prices could therefore be used as a signal helping one to avoid what might otherwise be surprising trend changes in bond prices. The manipulation of bond prices by central banks all over the world may have blunted this signal a bit, but lumber prices are presumably still a good leading indicator of economic growth.

Photo credit: Monty Python

Lumber Liquidators (LL), a company specialized in hardwood flooring, and therefore intimately connected with the housing market and the house renovation business, has been one of biggest high-fliers in the stock market until late 2013. The company faces a number of company-specific problems at the moment, but those were not evident yet at the time its stock price peaked. It is interesting that this peak occurred already in late 2013, at a time when market euphoria was just beginning to move from the slightly silly stage to the totally bizarre stage (we may yet get an opportunity to think up additional comparatives/superlatives).

What makes this interesting is that US economic data – with the exception of employment data, which are a lagging indicator – have become decidedly underwhelming in recent months. The decline of former bubble darling Lumber Liquidators can in hindsight probably be regarded as a leading indicator of this trend as well.

The stock has run into a buffer stop with enough momentum to make the laminates curl. Investors in LL probably feel like they’ve been debarked, de-limbed, re-sawed, crosscut and fine-grained in a sawmill. It is now too late for them to knock on wood:

Tiiiimbeeeerrrr! Lumber Liquidators turns into mill residue. It must have felt like standing in the way of a very determined caber toss when these green shoots turned into splinters. Note the divergences and correlations with t-note yields – this is probably no coincidence – click to enlarge.

Lumbering Economy

Lumber prices themselves also confirm the move in the stock of LL and the downtrend in treasury yields. The have declined to a new three year low last week, and the chart doesn’t exactly inspire a lot of confidence at the moment. Interestingly, lumber prices have also diverged from the price of Lumber Liquidators at the late 2013 peak:

Lumber stumbles – click to enlarge.

Meanwhile, Bloomberg’s “economic surprise” index has just declined to its lowest level since 2009. This index is so to speak “oversold” now. As a rule, the expectations of economists are adjusted downward after a string of disappointing data, which then allows the economic surprise index to move up again. This has e.g. just happened in Europe, where heavy monetary pumping has created more economic activity shortly after economists revised their expectations sharply lower.

The expectations of economists regarding the US economy have evidently been far too optimistic of late – click to enlarge.

Conclusion

The “tapering” and eventual end of QE 3&4 has apparently had a very similar effect on the economy to that experienced after QE1 and QE2 were discontinued. The main difference is that the slowdown in economic activity took a bit longer to arrive this time, presumably because the removal of QE was gradual rather than abrupt. Since a huge amount of additional money has entered the economy in recent years, very long lags are probably quite normal.

Recently commercial banks have been busy ramping up their inflationary lending, so it seems possible that activity will revive again with a certain lag. Much will depend on whether this recent trend in bank credit growth is maintained. Trends in commodity prices and bond yields all still point to economic growth being weaker than was hitherto widely assumed, so there is no guarantee bank credit growth will remain as brisk as it has recently been. If it slows down, money supply growth will falter – and that would spell the end of the asset bubble. In that case, other risk asset prices will catch up with LL.

Charts by: StockCharts, BarCharts, Bloomberg