Below is a round-up of Longview related views/research & trade ideas – the intention is to publish this most Fridays, updating key themes and highlighting key pieces of (often contrarian) research. Feedback, as always, is appreciated. Equally just ‘unsubscribe’ at the bottom if you don’t want to receive the email.
Fade the Davos consensus?
“Actual risk in the stock market is typically inversely proportional to perceived risk.”
Harry Lange, ex. Fidelity PM
Large gatherings, by definition, tend to represent the consensus. Often that’s the most useful information that investors can glean from these gatherings. The meetings that no one attends are where opportunities lie. The crowded, widely attended conferences typically point to investments that should be avoided, or even shorted. Consensus opinion, at these gatherings, works well as a contrarian because once something is widely known/acknowledged, then markets (as forward-looking discounting mechanisms) have already priced it in.
As such, the mood emanating out of Davos (characterised by many, with the following words: ‘a cause for concern') is troubling to market watchers like Longview (who anticipate at least one further leg lower in this pullback).
Naturally a mood of 'concern' at Davos, though, is not the same as a mood of widespread panic (i.e. which is more typical of the lows in fully-fledged bear markets). In that context it’s interesting to note that, in regular pullbacks, sentiment (and similar types of indicators) typically reach BUY/strong BUY after which the bull market then resumes. In full on bear markets those types of indicators reach strong BUY and then reiterate BUY/strong BUY multiple times over the course of the ensuing downtrend (e.g. see FIG 1).
FIG 1: Longview sentiment scoring system vs S&P500
It’s also interesting to note that the macro data (whilst blamed by many, including Draghi yesterday, on a series of one-off shocks) continues to mostly disappoint. Following on from last month’s sharp slowdown in the ISM headline and new orders series, US existing home sales (released this week) significantly disappointed expectations, reaching its lowest level since late 2015 (chart below). That marks a continuation of an expected housing slowdown (see HERE) caused by the back up in US bond yields into 2017/early 2018 (i.e. the natural effect of the bond market regulating the growth rate of the US housing market*).
FIG 2: US existing home sales chart (monthly, millions)
*and, important to note, nothing to do with the trade war or other geopolitical events.
Much of the other data out this week has also disappointed, including Germany’s IFO index – a good predictor of future German, and Eurozone, manufacturing trends (FIG 3). Expectations and current business condition indices both surprised to the downside. The message of German intermediate orders is consistent with that IFO reading.
FIG 3: German IFO (expectations less current conditions) vs. EZ IP (Y-o-Y %)
Those European data points continued the theme of weak Asian trade data earlier in the week. This included: Taiwanese new export orders, which were released on Monday (December data), and the first take on global trade in January (i.e. the South Korean January trade data for the first 20 days of the month – FIG 4). Both data points disappointed.
FIG 4: South Korean exports, first 20 days of month (1 & 6m, Y-o-Y %)
Meanwhile, whilst it’s fashionable to blame the manufacturing slowdown on trade wars, it’s hard to pin the slowdown in Eurozone services on that factor. This week’s flash PMI for the Eurozone fell again, to a level just above 50 (i.e. the ‘neutral level’ - FIG 5). Both the manufacturing and services PMIs have now been slowing throughout the past 12 months.
FIG 5: Eurozone manufacturing and services PMI indices (including Jan flash est.)
Interestingly in the context of globally soft economic data, on all occasions in the past 30 years, when the US’s manufacturing ISM new orders data has fallen below 50, there has been one of two outcomes: i) a US/global recession; and/or ii) the Fed (primarily), or another major central bank, engaging in stimulus measures.
In the summer of 1989, for example, the Fed was already cutting rates when ISM new orders moved below 50 (a recession then followed in 2H 1990); The Fed then cut in July 1995, after the move below 50 in June 1995; the Fed also cut in September 1998, as the index first dipped below 50; and so on (see FIG 6 below). Of note, in that respect, the only occasion when the new orders index has dipped below 50 and the Fed hasn’t stimulated is the last occasion that occurred in September & December 2015. On that occasion the PBOC/Chinese authorities (rather than the Fed) put a major stimulus program in place.
As such if the next 1 – 3 months leads to a move below 50 on that index**, a Fed rate cutting cycle (or significant Chinese stimulus, or plausibly both) is likely to follow.
FIG 6: ISM manufacturing new orders & the Fed funds rate (%)
**it’s also worth noting that whilst trade wars will have contributed to that ISM new orders weakness, housing softness, a fading fiscal stimulus as well as slowing shale/energy related activity are likely to be the key drivers of the index’s weakness. Much of which reflects the follow-on effects of tight money.
In that context, and as we outline in our analysis of the Chinese stimulus program published this week (see HERE), China’s recent stimulus measures are aimed at ensuring stability in the economy, and are designed to avoid creating excessive liquidity and a renewal of rapid credit growth. That view is neatly encapsulated by corporate sector borrowing growth which, despite shrinking shadow bank lending, has remained stable at low growth rates (i.e. as the traditional banking sector has stepped in and made up for the shrinking shadow bank lending channel, see FIG 7 below).
Fig 7: Growth in lending to the corporate sector (from all sources, Y-o-Y %)
At the moment, therefore, central banks are probably behind the curve: i) the Fed, whilst it is signalling an extended pause in rate hikes and despite the proximity of ISM new orders to the 50 level, still continues to tighten (i.e. via its balance sheet with QT); ii) the PBOC is seeking stability in policy (not stimulus), despite China’s own economic weakness; while iii) the ECB has just finished tapering (and has not yet ruled out a 2019 rate hike). Meanwhile, other, more minor central banks are still tightening (i.e. the Riksbank in December) or talking about the robust health of their economy (i.e. the BoC governor, Stephen Poloz, in Davos this week). In other words, despite increasing evidence of a slowing global economy and monetary policy that is too tight (FIG 8), central banks as of yet, haven’t shifted their outlooks enough. If history is any guide, therefore, those words of ‘caution’ and ‘causes for concern’, need to morph into something more marked and more fitting of the current global macro environment.
FIG 8: Global (GDP weighted) M1 money supply growth (Y-o-Y %)
In other words, Davos’ sentiment is, as always, likely wrong but this time not because of its ‘concern’ but more likely because it’s not concerned enough: Money is too tight (e.g. see FIG 8 below) and that’s an environment in which it typically pays to be cautious. It’s also an environment in which, if central banks aren’t careful, bubbles will burst and the full legacy of a decade of cheap money will finally emerge.
Have a great weekend.
Kind regards,
Longview
Longview Research Recently Published
This week:
Longview Letter No. 119, 24th January 2019:
" Chinese stimulus: Is it enough?" – see HERE
Last week:
LV on Friday, 18th January 2019:
"Relief Rallies & Sector Rotation" – see HERE
Macro Trade Recommendation No. 96, 17th January 2019:
"Move LONG UK rates & GBP" – see HERE
