Markets doubt Carney’s claim to have saved 500k UK jobs

Brexit Oct16

Last week as the BBC reported, Bank of England Governor, Mark Carney, explained to an audience in Birmingham that the Bank had saved the UK economy after the Brexit vote in June:

Between 400,000 and 500,000 jobs could have been at risk if the Bank had not taken action after the referendum, he said.  ”We are willing to tolerate a bit of an overshoot [on inflation] to avoid unnecessary unemployment. We moved interest rates down to support the economy.”

Imagine that!  How wonderful, that one man and his Monetary Policy Committee could save “between 400,000 and 500,000 jobs“, just with a speech, an interest rate cut, and more money-printing.

There was only one problem, as the chart above shows.  Markets didn’t applaud by buying more UK government bonds and so reducing interest rates.  They sold off again (red line)*, panicked by the idea that debt was rising whilst growth was slowing and the currency falling (blue line):

  Interest rates had fallen after the June 23 vote, as traders bet that Carney would add more stimulus
  They fell to 1.09% on June 24, and then to 0.65% after his August confirmation that this was underway
  But then, in a departure from the Bank’s script, they bottomed at 0.53% a week later, and began to rise
  Premier Theresa May caused further alarm at the Conservative Conference, suggesting Brexit might be for real
  They closed on Friday after Carney’s speech at 1.1% – nearly twice the August level, and above the June 24 close

Over the weekend, traders were then able to read the previously unpublished comments of Foreign Secretary, Boris Johnson, on the implications of a Brexit vote:

There are some big questions that the “out” side need to answer. Almost everyone expects there to be some sort of economic shock as a result of a Brexit. How big would it be? I am sure that the doomsters are exaggerating the fallout — but are they completely wrong? And how can we know?

“And then there is the worry about Scotland, and the possibility that an English-only “leave” vote could lead to the break-up of the union. There is the Putin factor: we don’t want to do anything to encourage more shirtless swaggering from the Russian leader, not in the Middle East, not anywhere.

“And then there is the whole geostrategic anxiety. Britain is a great nation, a global force for good. It is surely a boon for the world and for Europe that she should be intimately engaged in the EU. This is a market on our doorstep, ready for further exploitation by British firms: the membership fee seems rather small for all that access.

“Why are we so determined to turn our back on it?”

Its just a pity that it was left until now for Johnson’s “alternative view” on Brexit to emerge.  It confirms my fear immediately after the Brexit vote, that Brexit will prove to be:

The canary in the coalmine.  It is the equivalent of the “Bear Stearns collapse” in March 2008, ahead of the financial crisis.    And as I have argued for some time, the global economy is in far worse shape today than in 2008, due to the debt created by the world’s major central banks.

The sad conclusion is that the world is now likely to suffer some very difficult years.  Markets will have to relearn their true role of price discovery, based on supply and demand fundamentals, rather than central bank money-printing.  On Wednesday, I will look at some of the wider implications for global interest rates.

* Bond prices move inversely to interest rates, so a higher rate means a lower price

My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments:
Brent crude oil, down 50%
Naphtha Europe, down 48%.“Petrochemical demand high despite margin drop”
Benzene Europe, down 53%. “Prices have ebbed and flowed with the crude oil/energy market as well as market developments in the US”
PTA China, down 40%. “Bottle chip producers in China have been staying away from purchasing import cargoes, with traders describing demand for PET producers as ‘soft”
HDPE US export, down 31%. “The depreciation of Chinese Yuan dampened buying interest for import cargoes”
S&P 500 stock market index, up 9%


Tokyo, Shanghai stock markets crash; yen rises 8% in 2 weeks

Nikkei v Shang Feb16Pity poor Janet Yellen, you might say.  The head of the US Federal Reserve told the Senate this week that she had been “quite surprised” by the collapse of oil prices since mid-2014.  And she added that the rise of the US$ was similarly “not something that we had expected” (you can see the testimony by clicking here).

But then you might wonder why she doesn’t have people on her staff whose job is to seek out different viewpoints?  Or, indeed, why she didn’t apologise for these critical mistakes and offer to review the Fed’s methodologies?

Instead, she claimed that the mistakes didn’t really matter, and that the Fed’s policy was still correct.  In other words, the Fed is still convinced that it is right, and anyone who disagrees with them is wrong.  This suggests it is still failing to learn the lessons of the past, as I discussed in July:

Previous chairs of the US Federal Reserve had a poor record when it came to forecasting key events:

  • Alan Greenspan, at the peak of the subprime housing bubble in 2005, published a detailed analysis that emphasised how house prices had never declined on a national basis
  • Ben Bernanke, at the start of the financial crisis in 2007, reassured everyone that at worst, the cost would be no more than $100bn

“So we must hope that current chair, Janet Yellen, has better luck with her forecast last week that: “Looking forward, prospects are favorable for further improvement in the U.S. labor market and the economy more broadly”

My concern is that markets are telling us that something is very definitely nor right in the Fed’s models. This is surely the message of the chart above, showing the performance of the Tokyo and Shanghai stock markets over the past 3 months. Suddenly, and quite unusually, both are moving downwards together, despite occasional rallies:

  • Somebody is doing a lot of selling, as both markets are down over 20% in this short space of time
  • The sellers desperately need cash, and they keep selling – Tokyo went into into freefall on Friday, falling 4.8%

Who might these people be?  In Shanghai, they are perhaps property developers, desperate for cash to support their investments.  In Tokyo – Asia’s largest market – they are perhaps oil-based Sovereign Wealth Funds responding to cash calls from governments with urgent bills to pay.

JPY Feb16And then we mustn’t forget that the yen has suddenly jumped by an astonishing 8% since the start of February. Somebody must really need a lot of yen in a hurry, to cause that jump in the currency.  Presumably the money came from selling stocks in the US and Europe – helping to cause the downturn these have seen since the start of the year.

We should all be very worried when moves of this size take place in major Asian stock markets in such a short space of time.  And the yen, after all, is the major currency in Asia after the dollar.

These moves are further evidence that the cracks are opening the the debt-fuelled ‘ring of fire’ created by the central banks with their stimulus programmes.  We can only guess where they will next appear.

My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments: 
Brent crude oil, down 70%
Naphtha Europe, down 66%. “Naphtha price volatility in line with Brent”
Benzene Europe, down 58%. “Trading was limited due to the IP Week event in London”
PTA China, down 46%. Market closed for Lunar New Year holiday”
HDPE US export, down 42%. “Domestic prices for export material remained stable this week”
¥:$, down 11%
S&P 500 stock market index, down 5%

Coppock, Farrell indicators suggest financial market downturn underway

Coppock Oct15

They don’t ring bells to warn of financial market tops and bottoms.  But there are 2 very good substitutes in terms of the Farrell and Coppock Indicators, as the above chart for the UK stock market since 1973 shows:

  • It is based on the Financial Times All-share Index (FTA), as the FTSE 100 only began in 1984
  • It shows the Coppock Indicator for buying moments on the left (black line) with BUY signals marked
  • It also shows the annual percentage change for the FTA on the right (green line)
  • This is overlaid with Bob Farrell’s 20% and 40% Indicators for market peaks in dotted red lines

The Coppock Indicator was developed to try and identify when markets were bottoming.  As Wikipedia describes, Erwin Coppock had the profound insight that people reacted emotionally to a financial market collapse, making it parallel the response to having a death in the family

Coppock, the founder of Trendex Research in San Antonio, Texas, was an economist. He had been asked by the Episcopal Church to identify buying opportunities for long-term investors. He thought market downturns were like bereavements and required a period of mourning. He asked the church bishops how long that normally took for people, their answer was 11 to 14 months and so he used those periods in his calculation”.

Coppock was clearly right with his insight, as the chart confirms.  It has given real-time BUY indicators for all the major rallies, and only 2002′s signal was relatively early.

Bob Farrell began his career studying famed value investors Graham & Dodd, and then analysed how sentiment could also move markets alongside the fundamentals of company earnings.  He developed 10 legendary rules for successful market investment.  One key insight was that markets that moved too quickly would normally correct.  As he described this:

“Exponential rapidly rising or falling markets usually go further than you think, but they do not correct by going sideways”

Working at Merrill Lynch, he became the leading “technical guru” on Wall Street, where he observed that market rallies of more than 20% in a year were normally followed by a major correction.  Those that rose by 40% would inevitably be quickly followed by a correction.  The chart confirms his insight.

If we look at recent history:

  • It shows a BUY signal in May 2009 for the Coppock Indicator, followed by a 48% Farrell peak in March 2010
  • After the correction, there was a new Coppock BUY signal in July 2012, and a 26% Farrell peak in May 2013
  • Since then the Coppock Indicator has been in steady decline, and went negative in September

Both indicators, of course, were developed in a world where the US Federal Reserve would never have dreamed of trying to boost the economy by pumping up financial market prices.  Instead, it saw its role as being “to take away the punchbowl, just as the party is getting going“:

  • We therefore cannot rule out the potential for “one last hurrah” in financial markets via a massive and globally co-ordinated central bank stimulus programme
  • But China seems unlikely to support such stimulusagain, as it focuses on its New Normal policy direction

Central bankers would, of course, deny that their activities have simply provided the stimulus for an exponential rise in financial markets, as defined by Bob Farrell’s Rule. We can only hope they are right, as the downside over the next few years – if they are wrong – could be considerable.

My weekly round-up of Benchmark prices since the Great Unwinding began is below, with ICIS pricing comments: 
Brent crude oil, down 54%
Naphtha Europe, down 49%. “Asian arbitrage volumes will be the main outlet for European naphtha in Q4 as other sources of demand dry up, including demand from the domestic petrochemical industry and the US gasoline sector”
Benzene Europe, down 57%. “Downstream markets have also seen some margin erosion, as prices start to weaken in the fourth quarter”
PTA China, down 41%. “Demand from the downstream polyester sector is still sluggish, especially in November and December, which is usually the lull demand season”
HDPE US export, down 35%. “Prices for domestic exports held steady”
¥:$, down 18%
S&P 500 stock market index, up 6%

Yellen offers hostage to fortune on US growth

US auto home Jul15Previous chairs of the US Federal Reserve had a poor record when it came to forecasting key events:

  • Alan Greenspan, at the peak of the subprime housing bubble in 2005, published a detailed analysis that emphasised how house prices had never declined on a national basis
  • Ben Bernanke, at the start of the financial crisis in 2007, reassured everyone that at worst, the cost would be no more than $100bn

So we must hope that current chair, Janet Yellen, has better luck with her forecast last week that:

“Looking forward, prospects are favorable for further improvement in the U.S. labor market and the economy more broadly”

The chart above will be key to the answer, as the outlook for the economy greatly depends on developments in the auto and housing markets:

Auto markets.  From the outside, these seem to have recovered well since the 2008 financial crisis.  But the National Auto Dealers Association suggested this month that sales have likely peaked, warning – “This is a cyclical industry, and there is no escaping the consumer cycle”.  Prices also look to have peaked, with JD Power reporting these averaged $30,452.  Buyers are only able to afford these prices due to the combination of low interest rates and extended loan terms, which now average a record 67.9 months.

A further threat to the market comes from increasing availability of used cars.  Around 40 million of these are normally sold each year, dwarfing the new car market.  But used cars have been in short short supply until recently, due to the post-Crisis collapse of new car sales in 2009-10.  Today, however, used car availability is booming after the bumper new car sales of recent years, as a major dealer told the Houston Chronicle:

Right now there are a substantial number of cars coming off lease, which is very good for us because at long last we have a nice supply of what we call lower-mileage pre-owned cars.

Housing.  As the chart confirms, home starts have not recovered to previous levels, but are less than half previous peaks.  The reason is demographics – the purple period from 1973 – 1984 saw vast numbers of BabyBoomers buying their first houses, having children, and then buying larger houses.  Greenspan’s ill-advised low interest rate policy in the 2000s failed to replicate this type of sustainable demand – instead, it simply allowed poorer people with poor credit ratings to buy houses they couldn’t afford, and ended up losing to foreclosure.

The latest data confirms that now a new trend is underway, where the Boomers downsize and move back into the cities from the suburbs.  41% of new home starts in June were multi-unit rather than single family, a near-record high, as Boomers and young people found condominium living more affordable.  Even worse from Ms Yellen’s viewpoint is that the home ownership rate continues to fall, and at 63.7% is back at levels last seen 20 years ago.  The rate for minorities is even lower at just 47.2%, and for Afro-Americans it is only 43.8%.

Ms Yellen’s problem is therefore two-fold:

  • She desperately needs to raise rates in September, to avoid becoming involved in the political debate when the Presidential primary season starts new year.  Yet both the IMF and World Bank have warned this would put the recovery at risk by causing the dollar to rise even further, thus reducing exports
  • Her underlying theories on the economy continue to take no account of demographic changes.  Common sense tells us that the arrival of a generation of 65-year-old Boomers with 20 years’ life expectancy must considerably change US growth potential.  Equally important is that US fertility rates have been below replacement level since 1970 – meaning there are now relatively few people in the peak spending 25 – 54 Wealth Creator generation.

It therefore seems very likely that Ms Yellen has offered a hostage to fortune when forecasting that the economy will now finally recover.

Past performance is not always a good guide to the future, but it is the best that we have.  Prudent companies and investors will therefore want to ensure they are not caught out a 3rd time if the Fed’s forecasts turn out to be wrong again.

Shiller warning suggests S&P 500 bubble coming to an end

SP500 Sept14Nobel Prizewinner Prof Robert Shiller correctly forecast the dot-com collapse in 2000, and the 2008 financial Crisis, using the chart above.  Now he is warning we risk a 3rd collapse.

The problem is that Western central banks have undertaken the largest financial experiment in history.  Their policy has been to boost financial markets, particularly the US S&P 500 – the world’s most important equity market index.

This policy has failed twice before in 2000 and 2007, and Shiller fears we will now see a further collapse.  This is a major risk as today’s Great Unwinding of policymaker stimulus gets underway.

Shiller’s original insight was that it was possible to recognise when investors had become over-enthusiastic:

  • Traditional values for the P/E ratio simply divide the daily market price by current earnings
  • But Shiller’s CAPE version instead uses average earnings across the 10-year business cycle*

Using a 10-year average for earnings enables his CAPE Index to highlight peaks and troughs in investor enthusiasm.

The ratio shot to fame in 2000, when published in Shiller’s book Irrational Exuberance, where Shiller correctly argued that markets were about to collapse:

  • 1929 had been the only previous example when markets had traded above a CAPE ratio of 25 (red line)
  • But in 2000, the ratio surged to nearly 45, as central banks allowed the dot-com mania to develop
  • Until then, they had seen their role as being “to take away the punch-bowl as the party develops
  • Instead, under Fed Chairman Alan Greenspan, they came to believe their role was to support the stock market

Over the past 15 years, stock markets have become more and more dependent on central bank support.  As we noted in chapter 2 of Boom, Gloom and the New Normal, Bank of England Governor Eddie George explained the policy to the UK Parliament in 2007 as follows:

When we were in an environment of global economic weakness at the beginning of the decade it meant that external demand was declining… we knew that we had to stimulate consumer spending.   We knew that we had pushed it up to levels that could not possibly be sustained in the medium and longer term…That pushed up house prices and increased household debt. That problem has been a legacy to my successors; they have to sort it out.”              

But central banks have since refused to remove this ‘life-support’ and have instead increased it to all-time record levels, whilst taking interest rates to all-time record lows.  As then US Fed chairman Ben Bernanke boasted in January 2011:

Policies have contributed to a stronger stock market just as they did in March 2009, when we did the last iteration of this. The S&P 500 is up 20%-plus and the Russell 2000, which is about small cap stocks, is up 30%-plus.”

Shiller, like Warren Buffett and the blog, is a follower of Ben Graham’s work.  Known as the ‘Father of Security Analysis’, Graham developed a simple formula to explain the importance of the Price/Earnings ratio:

  • He showed that a P/E ratio of 8.5 meant markets were expecting zero earnings growth over the next 10 years
  • Each 2 point change, up or down, meant they expected earnings to rise or fall by 1% a year for the next 10 years

Thus today’s CAPE ratio of 26.5 means investors are expecting S&P 500 earnings to rise by 9%/year till 2024.  Yet earnings are already at near-record levels, so this is clearly impossible.  Hence Shiller’s concern that the market is heading for a collapse.

For a fuller analysis by the Harvard Business Review of Graham’s pioneering work, and its triumphant confirmation during the 1987 stock market crash, please click here.

Despite all their efforts, it is clear today that the central banks’ policy has failed.  The main US Consumer Confidence Index remains well below Boomer-led SuperCycle peaks.  Instead, we are moving into the Boomer-led New Normal, where spending will be much lower due to the impact of globally ageing populations.

Sensible central banks would have celebrated the fact that life expectancy has increased by 50% since 1950 across the world.  They would have accepted that demand must slow as a result – particularly as fertility rates had fallen by 50% over the same period.  After all, only people can create demand.

Instead of increasing debt levels, they would have ensured that the budget surpluses of the late-1990s were maintained, in order to pay the bills for pensions and healthcare spending.

But they chose to deny the impact of this demographic change, and so have instead created a ‘debt-fuelled ring of fire’.  China’s reversal of its stimulus policy is the initial earthquake that is now opening up the fault-lines they have created.

Thus it seems that the Great Unwinding of these failed policies is now underway.  We can have no idea how it will end.

As Shiller’s chart shows, the modern world has never seen such an experiment in monetary policy carried out on such a scale, and for so long.  It highlights how policy has become entirely focused on the progress of the S&P 500:

  • Policymakers believe that as long as it continues to climb, everything must be going well in the wider economy
  • Thus they are ignoring China’s reverse-course, just as they ignored early signs of collapse in sub-prime housing
  • Fed Chairman Bernanke at first said in July 2007 that losses would be no more than $100bn

They are also completely ignoring even the major changes now underway in oil, currency and interest rate markets.

Yet any impartial observer would see these as a clear warning sign that market direction was changing.

And when an informed observer such as Shiller, with a proven track record, gives the following warning, the blog feels we need to listen very carefully:

I am definitely concerned. When was [the cyclically adjusted P/E ratio or CAPE] higher than it is now? I can tell you: 1929, 2000 and 2007. … We don’t know what it’s going to do. There could be a massive crash, like we saw in 2000 and 2007, the last two times it looked like this. But I don’t know. …

“One thing though, I don’t know how many people look at plots of the market. If you just look at a plot of one of the major averages in the U.S., you’ll see what look like three peaks – 2000, 2007 and now – it just looks to me like a peak. I’m not saying it is. I would think that there are people thinking that way – it’s gone way up since 2009. It’s likely to turn down again, just like it did the last two times.”


*The detailed calculation for the CAPE 10 year ratio is as follows:  (1) calculate annual Earnings Per Share for the S&P 500 over the past 10 years. Adjust these earnings for inflation using the Consumer Price Index and average these adjusted figures over the 10-year period.  Then divide the current level of the S&P 500 by this 10-year average number to get the P/E 10 ratio, or CAPE ratio.

Boom/Gloom Index tumbles as S&P 500 hits record

Index Sept14aThe stock market used to be a good leading indicator for the economy.  But that was before the central banks decided to manipulate it for their own purposes.  As then US Federal Reserve Chairman boasted 3 years ago on launching their second round of money-printing:

Policies have contributed to a stronger stock market just as they did in March 2009, when we did the last iteration of this. The S&P 500 is up 20%-plus and the Russell 2000, which is about small cap stocks, is up 30%-plus.”

Of course, the Fed launched their QE low-cost money policy with the best of intentions.  They genuinely thought that a higher stock market would boost consumer spending by creating a new ‘wealth effect’, and that this would then encourage companies to invest in new capacity, thus boosting employment.

Unfortunately, the data shows that fewer Americans own stocks than own houses – only 52% versus 65%.  So the impact of higher stock prices hasn’t actually helped to boost spending, particularly as real household incomes remain well below pre-Crisis levels.

Instead we have seen a growing divergence between the performance of the stock market and the wider economy – the opposite of the Fed’s intention.

So the question now is very simple.  Will the economy suddenly start to respond to the Fed’s policy?  That, of course, would be very welcome, if it happened.  Or will the Great Unwinding now underway in oil and currency markets start to impact equity markets as well?

Worryingly, the IeC Boom/Gloom Index is giving us its own answer – and it is not positive.  As the chart above shows:

  • The S&P 500 Index has hit a record 2000 level for the first time (red line)
  • But the Boom/Gloom Index of sentiment actually fell sharply (blue column)
  • It is now bordering levels which have always seen stock market losses in the past

The chemical industry is also, of course, also a good leading indicator.  It tends to pick up around 6 months before the wider economy, and to turn down in advance as well.  And its Q2 downturn was a clear signal that H2 would be more difficult that expected.

Now the the Boom/Gloom Index is reinforcing that message.  Both indicators may be wrong, and the stock market right.  But the blog certainly wouldn’t plan ahead on that basis, if it was still running a major chemical business today.