Straight Line GDP?

“You might not have thought you needed a professional mathematician to tell you that not all curves are straight lines.”

-Jordan Ellenberg

But, as Ellenberg goes on to remind us in How Not To Be Wrong – The Power of Mathematical Thinking, “linear reasoning is everywhere. You’re doing it every time you say that if something is good to have, having more of it is even better.” (pg 31)

For a long time that’s how most central market planners talked about “low interest rates.” Apparently, post non-linear outcomes in both economies and markets, that’s changing.

In a speech yesterday, the Federal Reserve’s Vice Chair, Stanley Fischer, openly admitted that “low rates may threaten financial stability.” May threaten? Unwinding them as the economy continues to slow would absolutely threaten financial complacency!

Back to the Global Macro Grind…

Not all curves are straight lines. Two dots aren’t an intermediate-term TREND @Hedgeye either.

If you wake up at the top of every risk management morning embracing the uncertainty associated with non-linearity, you won’t spend your life at the Fed, ECB, BOJ, etc. trying to prove to the world that you can bend and smooth economic gravity.

Yesterday, more economic reality was reported in the part of the economy that was supposed to “bottom” (but, when it’s not bottoming, it shouldn’t be considered a consequential part of the economy!) - US Industrial Production:

1. US Industrial Production for SEP was down -1.0% year-over-year
2. That’s negative year-over-year growth for the 13^th straight month
3. That also represents the longest non-recession losing streak ever

Ever, remains a long time. And when something like that happens, linear economists consider it an anomaly. But that certainly doesn’t make it go away. Why would someone living in fear of a rate hike (into this slow-down) start investing in capex?

As you can see in today’s Chart of The Day, US Capital Goods Orders (Capex) have been negative for 19 going on 20 of the last 21 months. Like Industrial Production, at -3.1% year-over-year, Capex remains in its worst non-recession run of negative growth ever.

“So”… as Janet Yellen likes to preface her prescient forecasting thoughts, what’s the catalyst for an inflection in Industrial Production, Factory Orders (negative for 22 consecutive months), or Capex?

1. Not Forward Capex Plans! (the Regional Fed Survey on “capital expenditure plans” is in serious retreat)
2. Not Supply (ISM Customer Inventory Level at their highs for #TheCycle)
3. Not Demand (classic Inventory-to-Sales ratios across the manufacturing supply chain are also at cycle highs)

Uh, you know what the Fed thought was going to be the catalyst for demand? A: More cheap credit! And, unfortunately, as the #ProfitCycle rudely interrupted their linear thinking, access to credit started to tighten.

Again, don’t take my word for it. This is all in the Fed’s own surveys and data:

1. Net % of Banks Tightening Standards for C&I loans tightened again in Q3
2. Net % of Banks Tightening Standards for CRE (commercial real estate) loans tightened in Q3

Obviously, the Fed and its pretend hawks (who will all turn-tail dovish on the next bad US jobs report) don’t like to talk about their capex or senior loan officer surveys. They’d rather cherry pick #LateCycle US employment and consumption data and call it “good.”

But “good” doesn’t mean anything in 2^nd derivative math…

Things aren’t good or bad – they’re either getting better or worse. Whether you look at stock market returns or cyclical data in the last 3 months (more than 2 dots), both the “market” and “data” have been worsening, not improving.

That’s why classic #LateCycle sectors of the US economy (Consumer Discretionary, Healthcare, Financials) have all reversed to negative returns for 2016 YTD (sorry, Consumer Discretionary (XLY) is up a whopping 0.10% vs. Healthcare (XLV) -3.7%).

And why the cyclicals (Industrials and Basic Materials) are down -2.3% (XLI) and -2.9% (XLB) for OCT to-date…

The straight line that consensus economists wanted to draw as a “bottom” at +1% year-over-year US GDP (after trying to call it a straight line of “3% growth” 10 months ago) evidently still has some rate-of-change curvature towards 0% in Q4.

Our immediate-term Global Macro Risk Ranges are now:

UST 10yr Yield 1.59-1.81%

SPX 2117-2143
RUT 1

NASDAQ 5160-5261

VIX 14.07-17.84
USD 95.79-98.60
EUR/USD 1.09-1.12

Gold 1

Best of luck out there today,

KM

Keith R. McCullough
Chief Executive Officer