A Few Quick Comments About The Market, Interest Rates, Economic Activity and Interpretation Of Data
Unfortunately, I am unable to get as many posts up as I'd like and there are some I've promised that are in the backlog but I wanted to get some general comments about recent market events yet this week.
First off, the market. Internals remain strong yet this cycle has given no warning of impending corrections if one relies on generally available data. On an intermediate term, we are now more overbought by some measurements than we were in January of 2000 and much more so than at any time this cycle. That includes 2003 where we had returns on some indices approaching triple digits. With the many macro factors unfolding, we now get to see how the market digests its meal. One of the sectors I have said represents extremely serious risk, the utilities, has recently completed one of, if not the biggest blow offs in the history of the utilities averages. Is the utilities bull over? Well, that's hard to predict. I surely wouldn't be buying on the dips regardless of what happens. I would expect those seeking yield have pushed about as far as they can. The air is so thin for the utilities averages that only those with no concept of risk management would be buying utilities here.
Let's hit this economic re-acceleration topic. I see people talking about the Beige Book and ISM numbers as support of the Goldilocks' environment. That is again quite interesting. I guess it depends on how you want to slice the data. Today we get the Philly Fed survey but regardless of what the data points are, order data in the U.S., Europe and Japan remains very weak. It's not falling off of a cliff but the weakness is spreading. Some of the ISM data is expectational and some is based on quantifiable data. The order data is very soft and trending in the wrong direction in all three economic regions. Other hard data points are invalidating any noticeable pickup in manufacturing that many are expecting. China's industrial investment is still booming and that might be propping up global output to an extent, but since the supply chain is circular, ie industrial exports to China end up as consumption in the U.S. and Europe, that will likely be a lagging indicator unless China implodes first.
The recent interest rate move is really a blip. There appears to be two main points of interpretation, neither accurate in my estimation. One is that the 2-10 year bond spread is turning more positive therefore growth is re-igniting and the other commonly stated response is that inflation is rearing its ugly head again regardless of growth prospects. Again, look at the data. Bond yields of all sorts are rising. Bonds that have nothing to do with positive economic or inflationary prospects are moving briskly. Additionally, bank stocks are not responding to rate spreads so if economic conditions were improving, banks would likely be anticipating increased economic activity parallel to positive rate spreads. If the concern of inflation was rising due to economic output improving, then why are manufacturers reporting continued drops in employment hours? And, if employment hours are decreasing, then how is the economy and inflation picking up? Then why would companies be increasing their factory order rates? Additionally, if the bond market were worried about inflation, why did commodities have substantial short term moves to do the downside as rates rose? Commodities would have taken a jaunt north on the expectation of additional demand, improved economic conditions and/or subsequent inflation. I could go on and on but I won't. The market is more plausibly looking at risk and realizing it is mispriced in my estimation. Or there are undercurrents in the bond market caused by rejiggering or some anomalous event.
Let's take a moment and talk about the interpretation of data as that is some of what this post is about. Here's a little story about lies, damn lies and statistics as Mark Twain used to put it. We used to use an urban legend when talking to retail clients about data mining as a tool. Market basket analysis is a method retailers use to determine what items are purchased together or in baskets as the term states. These and other patterns may affect product placement or marketing programs to increase sales. Simple enough.
The story starts with a supermarket chain that noticed a large number of transactions where beer and diapers were purchased together. What do you conclude from this? The most obvious conclusion at face value is that babies were buying beer. The accurate conclusion was that dads were picking up diapers and a six pack. In other words, my point is that interpreting the data is much more important than the face value of the data. Anyone can tell you X data point has a value of Y. That's great. I can read too.
In psychology, confirmation bias is our innate desire to interpret data in support of our beliefs. This is especially true with successful people. More commonly you have a disagreement over facts and hear people say, "You believe what you want to believe.". Well, that is indeed scientifically true. Since most people aren't even aware of their predisposition to do so, do they even take the time to contemplate other possible interpretations? That's a little of "you don't know what you don't know." more commonly referred to as "ignorance is bliss.".
It's not always about being right. It's about being thoughtful in your process and considering perspectives you may be prone to discount. You might even practice defending a view you disagree with. I try to do that with most perspectives. It helps one create a defendable position. To wash out false positions. There might be truths one was heretofore blind to in doing so. The next time you have a disagreement with a friend, a spouse or your children, before you discount their point of view, consider that they might have a valid position or valid points.
While I have a strong view on the risks associated with today's environment, is it plausible there may be a solution that doesn't negatively impact financial markets? Sure. Have we been in similar situations in the past where positive events have come together and managed to have a positive outcome? Not in any historical data I have looked at. As I've said before, it's all about risk management. And, since financial markets don't seem to be doing it for you.........
Update with the release of the Philadelphia Fed manufacturing survey:
.......most future indicators fell from their readings in May
First off, the market. Internals remain strong yet this cycle has given no warning of impending corrections if one relies on generally available data. On an intermediate term, we are now more overbought by some measurements than we were in January of 2000 and much more so than at any time this cycle. That includes 2003 where we had returns on some indices approaching triple digits. With the many macro factors unfolding, we now get to see how the market digests its meal. One of the sectors I have said represents extremely serious risk, the utilities, has recently completed one of, if not the biggest blow offs in the history of the utilities averages. Is the utilities bull over? Well, that's hard to predict. I surely wouldn't be buying on the dips regardless of what happens. I would expect those seeking yield have pushed about as far as they can. The air is so thin for the utilities averages that only those with no concept of risk management would be buying utilities here.
Let's hit this economic re-acceleration topic. I see people talking about the Beige Book and ISM numbers as support of the Goldilocks' environment. That is again quite interesting. I guess it depends on how you want to slice the data. Today we get the Philly Fed survey but regardless of what the data points are, order data in the U.S., Europe and Japan remains very weak. It's not falling off of a cliff but the weakness is spreading. Some of the ISM data is expectational and some is based on quantifiable data. The order data is very soft and trending in the wrong direction in all three economic regions. Other hard data points are invalidating any noticeable pickup in manufacturing that many are expecting. China's industrial investment is still booming and that might be propping up global output to an extent, but since the supply chain is circular, ie industrial exports to China end up as consumption in the U.S. and Europe, that will likely be a lagging indicator unless China implodes first.
The recent interest rate move is really a blip. There appears to be two main points of interpretation, neither accurate in my estimation. One is that the 2-10 year bond spread is turning more positive therefore growth is re-igniting and the other commonly stated response is that inflation is rearing its ugly head again regardless of growth prospects. Again, look at the data. Bond yields of all sorts are rising. Bonds that have nothing to do with positive economic or inflationary prospects are moving briskly. Additionally, bank stocks are not responding to rate spreads so if economic conditions were improving, banks would likely be anticipating increased economic activity parallel to positive rate spreads. If the concern of inflation was rising due to economic output improving, then why are manufacturers reporting continued drops in employment hours? And, if employment hours are decreasing, then how is the economy and inflation picking up? Then why would companies be increasing their factory order rates? Additionally, if the bond market were worried about inflation, why did commodities have substantial short term moves to do the downside as rates rose? Commodities would have taken a jaunt north on the expectation of additional demand, improved economic conditions and/or subsequent inflation. I could go on and on but I won't. The market is more plausibly looking at risk and realizing it is mispriced in my estimation. Or there are undercurrents in the bond market caused by rejiggering or some anomalous event.
Let's take a moment and talk about the interpretation of data as that is some of what this post is about. Here's a little story about lies, damn lies and statistics as Mark Twain used to put it. We used to use an urban legend when talking to retail clients about data mining as a tool. Market basket analysis is a method retailers use to determine what items are purchased together or in baskets as the term states. These and other patterns may affect product placement or marketing programs to increase sales. Simple enough.
The story starts with a supermarket chain that noticed a large number of transactions where beer and diapers were purchased together. What do you conclude from this? The most obvious conclusion at face value is that babies were buying beer. The accurate conclusion was that dads were picking up diapers and a six pack. In other words, my point is that interpreting the data is much more important than the face value of the data. Anyone can tell you X data point has a value of Y. That's great. I can read too.
In psychology, confirmation bias is our innate desire to interpret data in support of our beliefs. This is especially true with successful people. More commonly you have a disagreement over facts and hear people say, "You believe what you want to believe.". Well, that is indeed scientifically true. Since most people aren't even aware of their predisposition to do so, do they even take the time to contemplate other possible interpretations? That's a little of "you don't know what you don't know." more commonly referred to as "ignorance is bliss.".
It's not always about being right. It's about being thoughtful in your process and considering perspectives you may be prone to discount. You might even practice defending a view you disagree with. I try to do that with most perspectives. It helps one create a defendable position. To wash out false positions. There might be truths one was heretofore blind to in doing so. The next time you have a disagreement with a friend, a spouse or your children, before you discount their point of view, consider that they might have a valid position or valid points.
While I have a strong view on the risks associated with today's environment, is it plausible there may be a solution that doesn't negatively impact financial markets? Sure. Have we been in similar situations in the past where positive events have come together and managed to have a positive outcome? Not in any historical data I have looked at. As I've said before, it's all about risk management. And, since financial markets don't seem to be doing it for you.........
Update with the release of the Philadelphia Fed manufacturing survey:
.......most future indicators fell from their readings in May
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