Sigh. I apologise for the ceaseless battery of bearish outlooks this morning but damn, that’s the way the world is going, and I’m not going to “pull a Yardney” and pretend it isn’t so that yours and my hard earned capital goes up in smoke.
However, I’m not going to talk about either because beyond both now looms a greater problem, the Western world is sliding towards recession.
Consider the following from Data Sword over the weekend:
After the release of the Chicago Fed National Activity Index earlier in the week we suggested that there was downside risk to the GDP outcome for Q2. While we suggested we could see an annualised rate of around 0.5% for the quarter which would result in the actual annual pace of growth dropping below 2%, the final outcome came in above that expectation at an annualised rate of 1.3%. However a substantial negative revision to the previous quarter which saw the annualised rate of 1.9% revised down to 0.4% means that the annual rate of growth has slowed in line with the pace that the CFNAI suggested. With the US government currently debating how to cut the country’s budget deficit which will ultimately provide a drag on growth and the Fed reluctant to embark on another round of quantitative easing, growth in the US will remain weak for some time.
Now, for perspective on how slow this is, let’s turn to Gavyn Davies:
According to the GDP statistics released on Friday, the US economy has grown at less than 1 per cent annualised in 2011 Q1 and Q2 combined, a rate which is well below its usual stall speed. This is very sharply lower than I expected at the start of the year. Previously, economists were puzzled by the “jobless recovery” in the past few months. Now the mystery has been solved: there was never much of a recovery in the first place. And the solution to the debt ceiling crisis which may emerge in coming days will, in all likelihood, do nothing to help matters.
A budget deal is now rumoured to be within reach in Congress…The most likely deal will see around $1 trillion of government spending reductions starting next year, along with an automatic trigger mechanism to ensure that the scale of tightening is increased in a second round of cuts before very long. Furthermore, these cuts may be legislated in advance to take effect whatever the state of the economy is at the time. This means that if the economy slides back into recession, any emergency fiscal action has been ruled out in advance.
According to JP Morgan, both the House and Senate fiscal packages, from which the compromise is likely to be forged, would involve a tightening in the budgetary stance of some 4 to 5 percentage points of GDP over the next two years. This tightening, however, is only about half of what would be required to ensure that the US attains a position of long term debt sustainability by the latter years of this decade. In other words, the economy seems likely to be hit by a sizeable, early fiscal tightening, while failing to achieve longer term debt sustainability. This seems to be precisely the wrong way round.
Let’s not beat around the bush, that’s ipso facto a US recession.
Over the pond, Europe too is slowing sharply. Also from Gavyn Davies recently, leading indicators are heading south:
Meanwhile, in the eurozone, there have also been some early activity indicators published for July. The flash PMI surveys for the entire eurozone were very weak. In addition, the IFO survey for Germany and the INSEE survey for France have also declined, suggesting that the slowdown has now begun to infect core Europe, which was previously immune from it. This was especially true for the forward-looking parts of the surveys, which are used to calculate the Fulcrum leading indicator shown in the third graph.
The leading indicator implies that the industrial sector of the eurozone economy is now stagnating, compared to the very healthy growth rates recorded earlier in the year. It is probable that the sovereign debt crisis has taken a toll on business confidence throughout the area, including, lately, in Germany and France. This is yet another sign of the economic costs which have followed from the failure of Europe’s leaders to get to grips with the debt crisis.
We can add to that, UK GDP which is also sliding sharply. From Data Sword over the weekend:
Despite monetary policy remaining extremely accommodative with the cash rate at a record low of 0.5% and £200bln in Quantitative Easing completed to date, economic growth in the UK continues to slow. Growth increased by 0.2% over the quarter with the annual pace of growth slowing from an already weak 1.6% to an anemic 0.7% with the economy only growing by 0.2% over the past 9 months. With the UK Government pursuing a rather rigorous austerity program to address the countries ailing public finances growth in the home country is likely to remain weak for some time.
So, we are protected here, right? Sadly, no. Whatever mix of growth you ascribe to the Chinese economy, there is one lesson from 2008 that is worth heeding. Exports to Western markets matter to Chinese growth. From Sean Corrigan via Zero Hedge:
Market participants should not lose sight of the fact that, far beyond the twin, transatlantic farces, a rather darker drama is beginning to play out in terms of world economic activity.
The first warning signs come from the freight industry, where US West Coast container traffic has slowed appreciably. Imports, indeed, have decelerated to an extent only exceeded—and then by the smallest of margins—a handful of times in the past 15 years, sending the growth rate plunging from August 2010’s chart topping 26.4% to a 17 month low of 2.2%.
We can add to this the experience of 2008, which was nicely captured recently in an Australian Treasury Working Paper:
While China’s relatively closed capital markets protected it from the financial fallout from the crisis, trade proved to be a key channel for transmitting the financial crisis to the Chinese economy. The growth rate of exports and imports declined in November 2008 and continued to be negative until November 2009. The USA, the EU, and Japan account for about half of China’s exports. China’s exports to these regions fell substantially as demand in these economies contracted.
Now, I don’t think we’ll see the kind of precipitous fall in trade we had in 2008, unless there is a new financial shock resulting from the policy freeze.
But, there’s is a big danger of a new inventory cycle commencing in Western economies as new waves of austerity shock consumers into further retrenchment and unemployment rises.
I know also that most of the data in this post is backward looking and is affected by both Japan and the oil price. But so what? A new austerity shock is about to pile in on top of already weak economies and there is no prospect of the oil price declining without significant economic weakness first. Fiscal and monetary stimulus is inhibited in Europe, the US and China. And a slowly recovering Japan can’t carry us all.
The array of potential reversals in markets outlined at Data Diary today is a pretty good guide to what’s to come in my view:
So what are the likely trends from here?
As the ‘sell USD’ meme has gone mainstream, the risk/reward probably favours a counter-trend move. Certainly, ‘safe haven’ sentiment is at extremes (here), capital flows are becoming concentrated in fewer stocks (here andhere), and the climbing interest in protecting the downside even as volatility remains subdued (here), all suggest that the weak side is one where the USD rallies hard.
On the assumption then that the market is vulnerable to a USD rally – whether it is the result of a ‘resolution’ or not – what are the trades to consider?
1) Short gold – When I look at the relative underperformance of the gold miners versus the metal, I get the feeling that the ‘alternative money’ is due for a nasty sell-off. Note that the gold miners (HUI – blue line) have failed to make a new high while gold (black line) has pushed on through. This view is number 1 for good reason.
2) Short ‘safe haven’ currencies – we’ve been positive on the CHF since the start of the year (“Trends you can trust“), but with the most recent move it has got just plain ridiculous. While the Swiss central bank may have given up fighting the trend, the current mood leaves USDCHF particularly vulnerable to a sharp correction.
3) Neutral Risk assets – If we take the defensive posturing of money managers as a guide, the argument could be made that there are willing buyers for risk assets (equities and/or lower grade bonds) on resolution of the debt ceiling. While I’m not a buyer down the risk curve from a longer run valuation perspective, it’s unclear to me as to which way these asset classes can run in the shorter term.
4) Neutral Commodities – On the face of it, a stronger USD should hang heavily on the commodity sector. Still, commodities are more inclined to follow the breezes coming out of China, so the sector may not be as susceptible to movements in the big dollar.
Obviously, I’m less sanguine about commodities.