This note was originally published at 8am on April 15, 2014 for Hedgeye subscribers.
“In the long history of humankind (and animal kind, too) those who learned to collaborate most effectively have prevailed.”
In his 1936 book, “The General Theory of Employment, Interest and Money”, John Maynard Keynes used the term animal spirits to “describe the instincts, proclivities and emotions that ostensibly influence and guide human behavior.” He goes on to use consumer confidence as an example of how animal spirits can be measured economically.
In our Q2 Themes presentation, we did a lot of work on the median consumer and took a detailed look at his / her income statement and balance sheet. Currently, there are a number of major headwinds for the median consumer. The obvious first one is the rampant acceleration in food costs in the year-to-date, the second is the anemic interest rate that they get on their savings, and, finally, the last headwind is the softening in the housing market.
For many average consumers, the house is in effect the balance sheet, so as home prices go up so too does net worth. The two points that bode most negatively in our models for future home prices are the dual facts that pending home sales are down -14.5% from their peak and mortgage applications for purchase are down more than -20%. Ultimately, home prices follow demand on a lag (as shown in the Chart of the Day), so we should expect that home price growth softens from here.
As it relates to the consumer, late last week the Bloomberg Consumer Confidence slipped to -31.9 from -30.0. This is well below the long run average of -16.5 and normally a number above -30 is the level at which the economy is considered to be in recovery mode. More alarmingly was the personal finance sub-index which fell to -2.9, the worst level in five months.
On a higher level, last week Michigan Consumer confidence came in at 82.6. This was better than the expected 81.0 and an increase from the prior month. So the animal spirits of consumer confidence appear to be intact . . . at least for now, but keep your eye on those home prices.
Back to the Global Macro Grind . . .
Yesterday was a slow grind in global macro land and today seems to be similar in tenor. As it relates to the pin action of stock markets, the Shanghai Composite today is -1.36%. The punditry is attributing this downward move as front running China’s GDP tomorrow, albeit the positive move in Chinese equities yesterday was considered a precursor to positive GDP, so the question of course is: which is it?
At a minimum, it seems that the government may be trying to talk down economic growth and the timing of the following report is suspect coming out one day ahead of GDP:
“Researcher with State Information Center said in Shanghai Securities News that efforts to address overcapacity, deleverage the economy and curb property bubbles could push GDP below 7%, something that would trigger massive unemployment.”
My colleague and our Asia Analyst Darius Dale had some detailed thoughts on the topic:
“In the 15 quarters since Chinese real GDP growth hit a cycle-peak of +11.9% YoY in 1Q10, Chinese economic growth has accelerated sequentially only three times. It’s basically been a straight leg down for four consecutive years – so much so that on a trailing 3Y basis, the current z-score for this series is (0.6x), which is actually up from trough of (1.6x) in 2Q12. In non-statistical speak, this implies that the “surprise factor” of Chinese #GrowthSlowing is burning off.
That isn’t to say that Chinese economic growth is not still slowing. In fact, the broad swath of high-frequency economic data points to a continued slowdown. The current risk range in our predictive tracking algorithm has probable downside to +7.3% YoY for Chinese real GDP growth here in 1Q14, which would: A) be the slowest growth rate since 1Q09; and B) imply that the Chinese economy is not taking advantage of extremely favorable base effect tailwinds – a sign that sequential momentum is indeed decelerating (as evidenced by the MAR PMI data).
One thing that investors should be aware of, however, is that Chinese policymakers are content to stand pat for now. Expectations for big stimulus has been dramatically tempered in recent weeks, most recently by Premier Li Keqiang’s prepared remarks at the Boao Forum for Asia Annual Conference. Perhaps they are storing up their fiscal and monetary “gun powder” to arrest any potential deceleration through the low +7% range in real GDP.
Or perhaps China’s intermediate-term growth trajectory isn’t really isn’t as dour as it has appeared in recent months and their superior visibility into the state-run Chinese economy leads them to believe that a large stimulus is simply not warranted. Time will tell; next up: tonight’s releases of 1Q GDP and MAR high-frequency growth data…”
The Hedgeye team will never be confused of being supportive of the interventionist nature of the world’s central bank. A key critique we often held is that as a result of activist monetary policy, the markets tend to get manipulated. We aren’t sure yet whether the Fed is more evil than those dastardly high frequency traders, but recent data on correlations emphasize our concern.
Specifically, according to ConvergEx, since 2009, the 10 industry sectors in the SP500 have averaged 85% correlation to the index. In the past thirty days, correlations have dropped markedly to 77.5%. Most interestingly though is the fact that long run correlations, before Fed intervention, have averaged 50%. (Hint: Michael Lewis, there is a book here somewhere.)
The most challenging part of dealing with central banks may be in discerning whether they mean what they say. The most recent example of course is the jawboning from ECB head Mario Draghi, who specifically indicated that the ECB was ready and willing to take monetary policy to an extreme level. The Euro, despite a down move yesterday, has by and large shrugged Draghi off and is up 0.6% on the year-to-date. Credibility anyone ?
Our immediate-term Global Macro Risk Ranges are now:
Daryl G. Jones
Director of Research