Weighing the Week Ahead: Will Slowing Chinese Growth Spark a Global Recession?
We have a big economic calendar with some reporting still catching up from the government shutdown. Inflation data, small business and consumer confidence, and retail sales lead the list. In addition to the U.S. economic data, there is increasing concern about China. Pundits are wondering:
Will weakening Chinese growth drag the world into a recession?
Last Week Recap
In last week’s installment of WTWA I suggested renewed attention to what was “baked into” current market prices. While the topic attracted frequent mention, the daily market declines and political news attracted more attention.
The Story in One Chart
I always start my personal review of the week by looking at a great chart. This week I am featuring Investing.com. In addition to several choices of index, they include versions for both cash and futures. The interactive charts are very flexible and highlight key news events.
Stocks lost 2.2% in the week and the trading range increased to 3.5%. You can see volatility comparisons in our Quant Corner.
Of special interest is the pre-market trading on Friday. For this we need to see the futures chart. The horizontal red line represents Thursday’s close. Futures fell to the 2736 range, apparently in reaction to China news. After the employment report release the decline was another 8 or 9 handles – 30 to 40 bps. The Friday close was actually higher than prices when the employment news was announced. I have a more complete discussion of the weak employment report below, but we should take note of the market impact of the news.
Puzzles often illustrate the critical thinking required of investors. Try out the two in this short video. Learning two spot these two tricks will inoculate you against much of the misleading noise about the economy and markets.
Each week I break down events into good and bad. For our purposes, “good” has two components. The news must be market friendly and better than expectations. I avoid using my personal preferences in evaluating news – and you should, too!
When relevant, I include expectations (E) and the prior reading (P).
New Deal Democrat’s high frequency indicators are an important part of our regular research. He is observing improvement as the effects of the government shutdown fade. Only the short-term indicators remain negative, but he is still watchful. NDD gets credit both for sticking to his indicators and for noting the likely shutdown effects.
- Mortgage delinquencies are lower. Black Knight (via Calculated Risk) reports January’s rate as 3.75%, down from 4.31% a year ago.
- The ISM Non-Manufacturing Index registered 59.7, a healthy increase from January’s 56.7 and beating expectations of 57.2. ISM spokesman Anthony Nieves states’ “The past relationship between the NMI® and the overall economy indicates that the NMI® for February (59.7 percent) corresponds to a 3.9-percent increase in real gross domestic product (GDP) on an annualized basis.” The ISM data page provides excellent context, including comments from respondents. Bespoke charts both services and the combination with manufacturing.
- Bloomberg’s consumer comfort index made a new recent high (Daily Shot).
- New home sales for December were 621K (SAAR) beating expectations of 572K. November’s report however was revised lower from 657K to 599K. Calculated Risk notes the revisions as well as the reporting delay, advising that we continue a close watch on inventory.
- Housing starts for January were 1230K (SAAR) beating expectations of 1180K and December’s 1037K (downwardly revised from 1078K). (Calculated Risk).
- Building permits significantly beat expectations – 1345K versus 1280K and December’s 1326K.
- ADP’s report on private employment showed a solid gain of 183K for February, beating expectations of 175K, but lower than January’s 300K (upwardly revised from 213K). Amazingly, some of those on my “reliably bearish commentary” Twitter list (publicly available – just follow me via @dashofinsight) scoured the report to discover a decline of .02% in one subgroup, businesses with fewer than twenty workers. This was touted as an early “canary” warning of recession. Here is ADP’s own summary.
- Construction spending for December declined by 0.6%, worse than the expected drop of 0.3% and much worse than November’s gain of 0.8%.
We review this data set to understand the economy. The intuitive sectors (total carloads removing coal, grain and petroleum) contracted 4.8 % year-over-year for this week. We primarily use rolling averages to analyze the intuitive data due to weekly volatility – and the 4 week rolling year-over-year average for the intuitive sectors improved from -3.2 % to -2.9 %.
When rail contracts, it suggests a slowing of the economy.
US-China trade talks reports the WSJ
A week ago, the sides appeared to be closing in on a draft accord. But Chinese leaders were taken aback by President Trump’s failed meeting in Vietnam with North Korean leader Kim Jong Un, the people said.
Mr. Trump’s decision to break off those talks and walk away sparked concern that China’s President Xi Jinping could be pressured with take-it-or-leave-it demands at a potential summit at Mr. Trump’s Mar-a-Lago estate in Florida late this month, these people said.
As a result, China wants a summit to be more of a signing ceremony than a final negotiating session that could break down, the people familiar with the leadership’s thinking said.
- The trade imbalance for December was -$59.8 billion worse than expectations of -$57.8 B. It was much worse than November’s deficit of -$50.3 B.
- The employment report was weak, showing a net gain of only 20,000 jobs. The report contrasted sharply with January’s strong report, causing most economists to conclude that it was noise rather than signal. Investing.com sources noted the effects of weather and the inconsistency with other data for the period. This was the most common conclusion among economists (TIME), and the market seemed to shrug off the report. (See introductory week review above). Business cycle expert Dr. Robert Dieli, in his excellent monthly report on employment, smooths via a six-month moving average of change from the prior year.
By contrast, many sources focus on subgroups without noting either the variations or the sampling error. Here is the WSJ version:
Compare this with the BLS representation of the confidence interval for the same data. Check out the BLS site to see how the confidence interval gets smaller for longer periods.
Increasing chances of a nuclear war. From the Council on Foreign Relations:
Nuclear anxieties have returned in force. They have been front and center in media coverage of, among other things: the recent armed confrontation between India and Pakistan, President Trump’s negotiations with North Korean leader Kim Jong-un, the U.S. repudiation of the Iran nuclear deal, Washington’s intention to withdraw from the Intermediate-Range Nuclear Forces (INF) Treaty with Russia, and U.S. plans to modernize its nuclear arsenal. If a nuclear sword of Damocles continues to hang over humanity’s collective head, it is now joined by a proverbial axe, mace, and spear.
The article reviews some of the near misses, which occur at a rate of one per year. The India/Pakistan conflict brings this to mind, as well as the apparent rebuilding of North Korean nuclear facilities.
The Week Ahead
We would all like to know the direction of the market in advance. Good luck with that! Second best is planning what to look for and how to react.
We have a big economic calendar with a focus on inflation. There is a lot of catching up in reports delayed by the partial shutdown. Of special interest will be retail sales and new home sales for January. (Yes, we just had that report, but it was for December). Small business optimism is important as well as the Michigan Consumer Sentiment index. The much-misunderstood JOLTS report will augment what we learned Friday about labor markets.
FedSpeak features Chairman Powell, accompanied by his two predecessors, in a 60 Minutes interview.
Briefing.com has a good U.S. economic calendar for the week. Here are the main U.S. releases.
Next Week’s Theme
The never-ending quest for new worries has lost the government shutdown and the recession signaled by December stock market action. The economic data is still “rolling over” in some series, but other indicators have stabilized or made new highs. The quest has moved abroad. There are many countries for us to worry about, but attention is focused on the biggest. Pundits are urging investors to consider:
Will slowing growth in China drag the entire world into a recession?
This topic is too big to be a summary theme for WTWA, but let’s give it a try. It is important and at the forefront of concern. I cannot provide all the answers of course, but I can discuss what I am watching. I hope that readers will join in with their ideas as well.
The Popular Summary
The main thesis for this worry goes something like this:
Chinese economic growth is rolling over according to many indicators. This weakness could lead to a recession. China is a major economic force in the world. The weakness will inevitably spread to Europe, emerging countries, and even the U.S. Chinese debt forestalls some of the options for policy stimulus. The trade war is making things worse.
We have all heard some variant of that theme – a challenge to evaluate. I will review some evidence, adding my own take in italics on each point. Then we will see what conclusion, if any, is justified.
Pieces of the Puzzle
- Knoema takes note of the shift in official reporting by the Chinese government, acknowledging a pattern of slowing growth. Their conclusion is that “recession seems inevitable, and that might trigger major problems globally. Read the full article for the complete argument, including a note or two of hope in the conclusion. It also includes a helpful collection of charts, including these.
[6.4% growth looks pretty good, despite the decline. “Inevitable” seems a strong conclusion, given the time to continue reforms].
While the United States has a weight of 54.53% in the MSCI All Country World Index, China only has a weight of 3.71%3. MSCI is incrementally realigning China’s overall weight in their Global Standard Indexes through the inclusion process, and upon completion, China A-Shares are predicted to account for about 16% of the MSCI Emerging Market (EM) Index4 which is tracked by $1.8 trillion in assets5. This will gradually increase China’s overall weight, including Hong Kong and US listed Chinese companies, from 30% to over 40% of the MSCI Emerging Market Index.4
[The author ascribes the downgrade as a policy shift by Chinese leaders, wishing to dampen the surge in these stocks. The conclusion that insider trading is most important is also useful].
It’s too early to be saying things like “overall trade data come in much weaker” or “Chinese exports slump as slowdown deepens.” When minimally adjusted (January+February), things don’t look much different from December (exports down 4.4%).
The huge 20.7% drop in Chinese exports is massively misleading. Moreover, although any drop in exports would end up punishing China’s production base, it would actually be much more indicative of weakness elsewhere than in China.
- Early estimates suggest a Q1 growth slowdown in the U.S. (James Picerno). The median “nowcast” is only 1.4%.
Global economic slowdown looms, exposing outgunned central banks
[The article, citing many of the leading economic bears, acknowledges that the Fed and the People’s Bank of China are in relatively better shape. There is then some mention of other tools. The article is written with a strong viewpoint, and still, it does not support “looming” or “outgunned” banks.]
[This conclusion is just wrong. I like economists, but do not rely upon them to forecast the outcome of international negotiations. Regardless of the exact agreement, we will have less uncertainty, and that is important.]
Fears of Softer Global Growth Hurt Oil the WSJ
[Oil traders worry about economic data and stock traders point to commodity prices. If your job is writing an article, you have to blame something]
reports the WSJ
[The real-time economics lesson continues. Tariffs reduce imports and increase costs for consumers. There is also retaliation and other second-order effects left out of the studies].
The Industrial Recession is Ending
[The analysis rests too strongly on the historical length of industrial downturns – 18 months – and admits there is nothing magical about that. The author believes that the trade dispute is nearing resolution].
Putting the Pieces Together
I took only important articles and tried to organize them a bit. There is plenty of debate over each point. Is the Chinese economy weakening or plunging into recession? Are stocks due to rise from access to a world market, or to fall from government pressure? Is the trade war hurting China, or U.S. businesses, or U.S. consumers? Does it require a big agreement to improve policy chances?
No wonder market perceptions are confused!
I don’t have the answers, beyond the opinions included, but I will add a bit in today’s Final Thought.
We follow some regular featured sources and the best other quant news from the week.
Risk Analysis –The Indicator Snapshot
I have a rule for my investment clients. Think first about your risk. Only then should you consider possible rewards. I monitor many quantitative reports and highlight the best methods in this weekly update.
Short-term and long-term technical conditions are back at the most favorable level. Our fundamental indicators have remained bullish throughout the December decline and rebound.
The Featured Sources:
Bob Dieli: Business cycle analysis via the “C Score.
Brian Gilmartin: All things earnings, for the overall market as well as many individual companies.
RecessionAlert: Strong quantitative indicators for both economic and market analysis.
Doug Short and Jill Mislinski: Regular updating of an array of indicators. Great charts and analysis.
James Bullard, President and CEO of the Federal Reserve Bank of St. Louis has an excellent discussion that goes to the heart of a current market worry, the Fed balance sheet unwind. When Quantitative Tightening Is Not Quantitative Tightening
carefully explains how balance sheet effects differ when interest rates are at the zero lower bound. He reviews the history of the policy and the background research. The argument is straightforward, but you need to read the article and examine the charts to see the logic.
I will now turn to the case for relatively small macroeconomic effects of balance sheet reduction. My argument has three parts:
- A baseline neutrality theory suggests that temporarily increasing the Fed’s balance sheet size beyond the minimal level needed to implement monetary policy has no macroeconomic effect at all when the policy rate is well above the zero lower bound.
- When the policy rate was near zero, the Fed’s balance sheet policy nevertheless had an important macroeconomic impact through a signaling channel. In particular, bond purchases signaled “lower for longer” for the policy rate.
- With the policy rate now well above zero, this signaling channel is no longer operative, and the baseline neutrality theory again applies.
The result is an asymmetric effect that hardly anyone understands.
“Davidson” (via Todd Sullivan) looks at a variety of indicators in questioning the persistent media fears. He writes:
The media feeds fears that current conditions are leading to the next Great Depression. While some of this talk has abated, predictions of imminent recession continue to fly about at a fast and furious pace. Fundamental Investors have to question what is it advisors use to make these predictions. The conditions which preceded previous recessions are not present today. Most forecasts for recession are based on single economic reports and very much out of context with recent financial history.
Check out his run through several leading indicators and excellent charts. His conclusion is the recession odds are low for the next several years. One factor is the absence of euphoria.
Insight for Traders
Check out our weekly “Stock Exchange.” We combine links to important posts about trading, themes of current interest, and ideas from our trading models. Last week we played upon a popular book from decades ago, Who Moved My Cheese?, to illustrate the need to adapt in your trading. Our trading models have edged back into the market, with Holmes and Athena fully committed. As always we included some recent model picks as well as DJIA from Felix and ETF ratings from Oscar. Pulling this altogether was our regular editor, Blue Harbinger.
Insight for Investors
Investors should embrace volatility. They should join my delight in a well-documented list of worries. As the worries (shutdown, Fed policy, trade) are addressed or even resolved, the investor who looks beyond the obvious can collect handsomely.
Best of the Week
If I had to recommend a single, must-read article for this week, it would be Mike Williams (Truvestments) recounting of the last ten years.
Happy Birthday! – to the most hated, most fought over, most under-reported, most disliked market recovery in the economic history of mankind.
And I have some news for you.
If you did not like the last 10 years – or if you got lost in politics or news and in-fighting – then you are really, really, really going to hate the next 10 years.
He proceeds to recount many examples of misleading reporting. Enjoy reading the list of headlines and quotes and spotting the surprises – usually the most important point, buried in “all that hogwash.”
It is a delight to read someone who takes the critical look at reporting that I so strongly advocate. He even explains how data gets a bearish interpretation, regardless of the result. How else can we explain this?
“The masses hate stocks at 16 times earnings and then love bonds for a locked in, never rise in your life – shot at 38 times earnings….guaranteed. : )”
And finally, he urges what we really should all be watching. Read the entire article to get the answer, but here is a hint: Think ahead – and beyond the short-term.
Chuck Carnevale turns his sector-by-sector review of the market to the finance sector. He does his typical masterly job of providing a lesson along with the ideas, noting that the difference among stocks in some sectors is relatively small. It is important to limit the sector weighting, but there is no shortage of ideas. He writes:
I found more value in the Finance Sector than I did in any other sector that I screened. All in all, I identified 131 attractively valued companies out of the 1,888 companies in the Finance Sector. This is approximately 10 times as many as I found in any other sector. Stated succinctly, there is a lot of value in the Finance Sector but a lot of redundancy as well.
The Rose Portfolio is both successful and transparent, explaining why there are many followers. The update for February is now available.
D.M Martins Research likes Target (TGT) with a $90 price (ahem) target.
Barron’s calls Delta the “best-managed U.S. Airline.
Seeking Alpha Senior Editor Gil Weinreich’s Asset Allocation Daily is consistently both interesting and informative. Each week he highlights stories of interest for both advisors and investors. His consistent creativity highlights new angles and familiar problems. This week I especially appreciated his discussion of debt. After citing some good data sources he describes what should not concern us.
People tend to get excited by headlines such as Bloomberg’s recent “U.S. Credit Card Debt Closed 2018 at a Record $870 Billion.” Our cultural knowledge that the U.S. consumer is awash in debt is what gives stories like this their edge.
But the fact that U.S. consumer revolving debt hit an all-time record does not in itself frighten me. It might as well say: “Record Profits For U.S. Consumer Finance Companies,” which has a positive spin. A growing economy will see all kinds of new records broken, and the positive aspects usually compensate for the negative ones.
Then he turns to a genuine concern, the shifting demographics of debt toward older Americans. This is an excellent observation for social policy, financial advisors, and those on the “wrong path.”
Abnormal Returns is an important daily source for all of us following investment news. I read it daily, finding many good ideas. His Wednesday personal finance theme is of special interest for investors. Among the usual collection of excellent choices, I especially liked Mark Rioboli’s timely post, There’s Still Time to Contribute to an IRA for 2018. There is crucial information on dates, limits, and changes in the law.
Watch out for…
Exxon Mobil (XOM). Stone Fox Capital is concerned about “crazy spending” and oil prices.
CBS. Valuentum notes that the shares are “cheap” on standard metrics, but supported by the reduced corporate income tax.
Kroger (KR). D.M. Martins Research opines that the poor performance is no surprise.
The China story is important, but the threat is not imminent. Careful reading is required to make sense of a complex and confusing picture.
One point I did not cover is the challenge in interpreting data. Like many, I do not trust the “official” data. I especially don’t like those who say that it used to be distorted but now it is accurate. More likely the leadership objectives have changed. Private data is not better. The widely-followed China PMI is based upon a survey of 800 purchasing managers. How is the sample drawn? What is the confidence interval? Are the 800 respondents immune to influence?
U.S. economic indicators are also affected. The ten-year note is in an arbitrage relationship with European equivalents. This has kept rates lower and flattened the yield curve. We should insist on data and accept no substitutes, but flawed data does not help much.
What does this mean for our investments? Paul Schatz writes The Pullback to Buy is Here. But the Pundits Will Worry.
I think a low is coming sooner than later and the big post-Christmas rally ain’t over yet. All those people who have been waiting and waiting for the pullback to buy will probably miss the boat in here as they always do. Now, they will worry that stocks are about to collapse. I am certainly ready to commit the dry powder I have.
Paul is more willing than I to forecast short-term moves, but I endorse the overall sentiment. I did some personal buying last week, as well as for clients.
Readers sometimes complain that I do not answer the title question. This is often true, but not a valid criticism. We must know what to watch.
If you wait until you know all the answers, you will be too late in reaching conclusions.
I’m more worried about:
- The India-Pakistan conflict.
- US/China trade matters. (Yes, a switch from last week).
I’m less worried about
- The Fed balance sheet unwind.
- Slowing economy, which still seems consistent with a 2.5% real growth. This is a little below trend, but good enouh to make stocks attractive.