Lately I’ve been focusing on the bond market and the dollar more because the stock market simply is not doing much. I sometimes joke that the stock market isn’t on or is broken because there have been so many days where it closes nearly unchanged. In Q1 2017, the Dow had 15 days where it moved less than 0.1%. That is the highest amount since Q4 2006. Obviously, any comparison to a time right before the financial crisis is an ominous sign. This signal alone doesn’t necessarily mean that the market is in for more volatility, but because of my analysis, I do think a replay of 2008 is probable.
Getting into the final totals of the quarter, the average move for the S&P 500 was 0.317% per day which is the lowest since Q3 1967. I find it amazing that at a time when the economy has had such low productivity growth and there has been such high political tumult, that stocks are reacting in such a complacent manner. It’s like a slinky which is coiled to its base. These low movements beget further mild moves because of human psychology. If you think the stock market will never fall 20%, when it falls 3%, you buy in. At first the meme was buy the dip, but after every successful investor started to do that, the dips disappeared.
The volatility index is more of the same as the VIX’s average for Q1 was the second lowest ever. Risk has been taken out of the market temporarily. The million-dollar question is what will cause fear to be brought back to the market. Even sages with decades of experience will have a tough time answering that question because it’s been decades since we’ve such a lack of movement. I point to uncertainty with monetary policy as a principal concern. My two main questions which remain unanswered are: 1. Who will be the Fed chairperson next year? 2. What effect will the declining ECB purchases have on the weak Italian banks and economy?
One reference point to support my claim that the economy is overleveraged and ready for a 2008 style crash is seen in the chart below. The chart is slightly confusing because the stats in the box aren’t in the correct font color. The green bar is household net worth and the red bar is nominal GDP. Household net worth increased 67% from Q2 2009 to Q4 2016, while nominal GDP only increased 32%. Household net worth as a percent of GDP is high because of the bubble in financial assets. Those Americans who are older and have money saved in a 401K are sitting pretty. If you talk to some people who have their savings in stocks, they will tell you exactly how much money they made this year in the market. Unfortunately, they have no clue how much risk they are taking. This is how bubbles are formed. If everyone understood the basics on valuations and business cycles, there wouldn’t be such a wide disparity between median valuations and current ones.
Moving over to the economic data, the ISM manufacturing report showed deceleration, but still had its second highest reading in the past 12 months. The March reading came in at 57.2 which was 0.2 higher than expectations and 0.5 lower than February. In the segment of miscellaneous manufacturing, one business owner said his/her business did well because of orders related to the winter storm. It will be interesting to see which businesses were helped and hurt by the storm. The need to buy items to prevent damage would help a manufacturer, but retailers were probably hurt by the lack of shopping. Apparel sellers were probably the worst hit as cold weather doesn’t encourage buying spring clothes. Home improvement is already expected to be one of the best areas of retail and teen apparel is already expected to be one of the worst. These trends will be amplified by the weather effect. In the ISM survey, a furniture manufacturer stated “business is strong and looking up.” Home improvement and interior design are clear winners at this point in the cycle.
The chart below is a summary of the ISM Manufacturing report. The PMI report for March is consistent with 4.4% GDP growth. The total quarter’s results are consistent with 4.3% growth. Clearly these estimates are way off base. With low productivity growth, decelerating lending growth, low population growth, hawkish monetary policy, and no fiscal stimulus, the chance of above 3% GDP growth is slim to none.
The chart below shows the latest Atlanta Fed GDP Now forecast which sees 1.2% GDP growth in Q1. Part of why the forecast increased by 0.3% was because of the ISM report. The other reasons were the improvement in the forecasts for real consumer spending growth and real nonresidential equipment investment growth. The blue-chip consensus is down notably as it’s now at 1.7%. The ISM report being in the estimate may make the Atlanta Fed’s forecast too optimistic since survey data appears to be off the mark lately. Speaking of off the mark, the NY Fed’s Q1 forecast of 2.9% growth appears to be way outside the mainstream.
The difference between the hard and soft data continues to present itself. As you can see in the chart below, the survey data’s positive surprises are at about the highest level in 17 years, but the hard data is barely showing any positivity. The optimism has always waned quickly in the past 17 years. I expect that to happen again in the next few months. Then we will be left with an economy growing at sub-2% and a stock market which is expecting a return to 1990s era growth rates. The market may fall along with the survey reports, but that didn’t happen in 2016, so I’m not banking on it. I’m still considering weakness in the labor market as the best potential catalyst for a correction. Even with the high level of retail bankruptcies and low restaurant same store sales growth, we’re still not there yet.
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