• "Kee" Points with Jim Kee, Ph.D.

    • What’s Ahead for US Stocks?
    • China Trade Points 

    What’s Ahead for US Stocks?

    The US stock market’s strong first quarter performance has prompted an obvious question: “Given the strongest quarter in almost 10 years, what are the odds that the market continues to rise through year’s end?” I asked one of our analysts, Josh Taenzler, to run the numbers on this, and what he found is pretty interesting. It turns out there have been 8 years since 1928 that had strong first quarters similar to the one we just experienced. Following those quarters, the market continued upward to finish higher seventy-five percent of the time. If you take out 1930, which began strongly with a bounce following the 1929 stock market crash and then declined sharply (the onset of the Great Depression), that number of strong finishes increases to 7 out of the 8 years, or 88 percent of the time.

    China Trade Points

    US-China trade negotiations continue to take center stage (just ahead of Brexit) as the key focal point for global equity markets. Business capital spending has been noticeably weak during this economic expansion, even after President Trump’s corporate tax cut that reduced rates from 35% to 21%. Non-defense capital goods orders have fallen since mid-2018, and many economists attribute this to US-China trade strife. Specifically, large global companies have put off capital spending plans until they get more clarity on trade rules and the implications for international supply-chains (Asian Times). Apparently, some progress was made over the weekend, which is good not only for China and for the US, but also for Europe and peripheral economies that trade with China (e.g. South Korea, Taiwan). In fact, economist David Goldman asserts that China’s ability to weather an export decline from trade uncertainty is actually better than many of these other exporters, including Germany. That is because China has a greater ability to compensate for export declines by stimulating domestic demand through tax-cuts, monetary policy and fiscal spending. That’s called “policy flexibility,” and China’s is considered to be higher than many other economies.

  • "Kee" Points with Jim Kee, Ph.D.

    • US and China
    • Europe and Brexit


    US and China

    “Green shoots” seems to be the theme this week regarding data coming out of the US and China, the world’s largest and second largest economies respectively. In the US, last Friday’s jobs report (196,000 non-farm jobs created for the month of March) has generated some skepticism over the recession concerns created by the recent, albeit temporary, inversion of the US treasury yield curve. In China, there is a growing consensus that last year’s slowing has given way to a bottoming and reacceleration of economic growth there (Financial Times). Of course, the key issue continues to be the ongoing US-China trade talks. Asked about whether a de-escalation of trade discussions between the US and China (and Europe) would be bullish for stocks, respected Leuthold Group economist Jim Paulson suggested that such a de-escalation was probably already baked-in to current equity prices. Given the strong, double-digit performance of global equities this year, I agree with Paulson. But I also agree with his assertion that valuation levels don’t rule out further gains by year’s end.


    Europe and Brexit

    As for Europe, UK Prime Minister Theresa May is pushing for a few month’s delay to Brexit (i.e., the United Kingdom exiting the European Union), while European Council President Donald Tusk is pushing for a longer delay, perhaps a one-year extension (WSJ). My understanding is that this would provide more time for reasoned negotiations versus multiple time extension requests. The best line I have heard regarding Brexit comes from a British academic, “The more someone says they know what will happen with Brexit, the less you should trust them.” I have a more generalized version of this statement, which is, “The more conviction someone has about a particular market or asset class, the less experience they have.” People with 20+ years of experience in the investment business are much fonder of diversification, because you can’t know with certainty, than concentration, which requires a higher degree of certainty than is plausible.

  • "Kee" Points with Jim Kee, Ph.D.

    • A strong year so far
    • Another yield curve story?


    A strong year so far

    You have probably heard by now that the first quarter of this year was the best quarter for the U.S. stock market (S&P 500) since 2009, which is kind of remarkable given the doom-and-gloom talk of Brexit, China trade deals, and a possible U.S. recession. Of course, a lot of the market’s move was probably just a rebound from the deep sell-off that occurred during the fourth quarter of last year. Nevertheless, it reinforces the caution against being out of the market during volatile times. I think it is a mistake to get too hung up over the media’s obsessions with pullbacks, corrections, bear-markets, and recessions. Plunges tend to be followed by rebounds, but you never know how long a decline will last, which means you never know when a rebound will begin or how long it will last. In my opinion, it is much more helpful just to remember that, “the market goes up and down.” As flippant as that sounds, people tend to temporarily forget the normality of ups and downs during sell-offs. Try this: the next time there is a big market sell-off (it won’t be long), instead of thinking about it in terms of some ominous sign, say to yourself instead, “Well, the market goes up and down.” I am confident that it will make it much easier to stay with your investment plan, which in-turn will make it much more likely that you reach your investment goals.

    Another yield curve story?

    I think I had promised that there would be no more commentary on inverted yield curves, but I came across a study that I think Kee Points readers will find interesting. In the most recent issue of Business Economics, which is the journal of the National Association of Business Economists (NABE), a new framework was proposed to predict recessions using short-term rates (the federal funds rate) and 10-year Treasury yields. The federal funds rate is the rate targeted by the Federal Reserve (specifically, the Federal Open Market Committee or FOMC), and it is the interest rate at which depository institutions charge one-another for funds they hold on reserve at the Fed (i.e., “federal funds”). The rate that the borrowing institution pays to the lending institution is negotiated between the two banks, and the federal funds rate is the weighted average of all of these types of negotiations (Federal Reserve Bank of St. Louis). The NABE article discusses a “fed funds rate/10-year threshold” as follows:

    “In a rising fed funds rate period, the fed funds rate crossing/touching the lowest level of the 10-year yield in that cycle is a prediction of an upcoming recession.”

    According to the authors, the average lead time between this signal and the onset of recession is 17 months. For example, the current rate hike regime started in December, 2015. If you look at the 10-year Treasury yield from that time on, it follows somewhat of a U-shaped pattern, with the bottom being 1.36% on July 5, 2016. So the question is, when did the fed funds rate, which was zero for seven years, rise above 1.36%? It occurred after the December, 2017 FOMC meeting. That would put the next recession sometime this year (2019). The authors felt that the 2018 tax cut would not affect this call, but that the ongoing tariff/trade war will, primarily by disturbing global supply chains. I think the research is clever, but there is also a tint of Nobel Laureate George Stigler’s assertion that, “If you torture the data long enough, it will confess to anything.” So, as I summarized last week, better to just take a front row seat and wait and see.

  • "Kee" Points with Jim Kee, Ph.D.

    • Last Week’s Inverted Yield Curve
    • The Economic Data

    Last Week’s Inverted Yield Curve

    Last week, the 10-year Treasury yield dipped below the 3-month Treasury bill yield, a true “inverted yield curve” with long rates below short rates. Since that is widely considered to be a recession signal, it is worth a closer look. In prior Kee Points I have mentioned a distinction between a “bearish flattening,” driven primarily by short rates coming up, and a “bullish flattening,” driven primarily by long rates coming down. This inversion appears to be driven by both, but with long rates coming down due to global growth concerns (e.g. Germany’s poor manufacturing numbers reported last week) and a flight into longer-term treasuries, driving up their prices and lowering yields (that’s bearish). So, in my opinion the signal flashed by last week’s inverted curve is unambiguously bearish, but the question is, does it portend a recession? I still do not think so, but it certainly reflects the near-term slowdown abroad, and in the US we see that in the economic numbers. Looking at the two big global issues at the moment - US trade negotiations (with China and Europe) and Brexit - one wonders whether or not we actually have more clarity now than we did six months ago. They’re both very fluid situations, but I would say the answer to both is "not really" and that’s why we’re seeing what the press is starting to call a synchronized slowdown, as opposed to the synchronized expansion observed a year ago.


    The Economic Data

    Looking at US data, the Atlanta Fed’s GDPNow model actually increased slightly to 1.3% for first quarter 2019 GDP growth, driven primarily by a surprising bounce in existing home sales for the month of February. Kevin Hassett, Chairman of the Council of Economic Advisors, made the case over the weekend that the government shutdown probably took away .3 percentage points, so he argued that the economy is actually growing closer to two percent and should accelerate from here. Hassett obviously has a bias (being nominated by President Trump), but he was accurate in forecasting last year’s US GDP growth and has a pretty good forecasting record. Less biased would be UCLA’s Anderson Forecasting Center, which stated that “There is not much in the GDP data on which to base an alarm of a soon-to-come recession.” My sense is that we are somewhere between the two. That is, we’ve hit a slow patch for sure, but two consecutive quarters of negative growth (i.e. recession) is not baked in the cake at this point. What makes forecasting tricky here is housing’s “failure to launch” during the current expansion, as housing and autos have traditionally been the early movers in signaling both expansion and decline. The Anderson center points out, however, that investments in intangible assets like intellectual property, software and development, and other corporate research and development have expanded faster than the economy. This should offset the weak performance of housing investments somewhat, and it should weaken the confidence in last week’s inverted yield curve forecasting a recession. One more point, made this morning by Bloomberg’s Mohamed A. El-Erian is that we still see tight credit or quality spreads, which typically widen prior to recession. So, spreads aren’t forecasting recession either. This is history in the making: we’ve had a legitimate yield curve inversion, and what remains is to track how the economy behaves going forward.

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