July 3rd 2012
Nick Hays
Dhaka, Bangladesh
Today - on The Long and the Short:
* Economic data dump: manufacturing takes a dive
* Bad news is good news
* Fed almighty
Risk assets rallying again today. Friday’s sharp relief rally (after the latest in an increasingly long string of supposedly “now-or-never” Euro-summits) faded on Monday but markets are resuming their move higher today, apparently on increased expectation of further Fed intervention.
Optimism that Bernanke et al will crank up the printing press once again appears to be founded on renewed signs of a weakening global economy. Yes it appears that once again bad news is good news – at least where risk assets are concerned.
Economic Data Dump
Central to the renewed sense of approaching economic doom was a raft of manufacturing data released on Monday. Firstly data from the ISM (Institute of Supply Management) showed a US economy in a state of deceleration verging on out-right contraction:
The data are negative almost without exception, but the standout data points in the above chart are:
· collapsing new orders (down 12.3 % pts MoM)
· prices down 10.5 %pts MoM
· Overall PMI composite down 3.8 % pts MoM -- and perhaps more significantly, for the first time since July 2009 it breached 50, the threshold which separates expansion from contraction.
Another closely followed indicator added to the gloom on Monday, with the PMI from Markit/HSBC registering negative MoM growth in manufacturing activity for 16 out of 26 surveyed economies. Notably, Japan, Korea, Taiwan, Norway and South Africa all slipped into contraction territory in June.
In summary, not a good day for economic news.
That said, an ISM PMI reading below 50 is far from a sure-fire indicator of a coming recession. Examining historical PMI data shows a number of ‘false negatives’ during the past 60 or so years where the PMI has breached 50 but no recession has followed:
(Interestingly, these PMI ‘false-negatives’ have been occurring more frequently since the mid-80’s, probably in part a reflection of the evolution of the US economy and the increasing importance of the non-manufacturing sectors).
Bad News is Good News
Unarguably, however, the data are poor and the trend is worse. With such a raft of negative data being released, one might reasonably expect a re-pricing of growth-hungry risk assets such as equities and commodities.
In fact, the opposite is happening: risk assets are rallying in the face of a slowing economy as expectations rise of future Central Bank intervention in order to prop up growth.
Yet again we are observing the ‘good news is bad news’ phenomenon as traders punt on another slosh of liquidity courtesy of Berkanke and his pals at the Fed.
What this reinforces is the fact that for some time now the markets have been progressively de-coupling from economic fundamentals and becoming increasingly dependent on Central Bank policy.
An effectively functioning capital markets system this is not.
I fear we are storing up major trouble for the future as a result of this breakdown: malinvestment, misallocation of capital, excessive leverage and risk taking...if it sounds familiar that’s because it is. My concern is that the burst mortgage and property bubble of 2003-2007 is in the process of being replaced by something new and more dangerous. Hydra-like, one head is lopped off only for two more to grow back in its place.
Fed Almighty...for now
I continue to fight my longer-term bearish instincts and maintain the short-term expectation of rising asset prices over the next 3-4 months.
Federal Reserve intervention will continue to play an outsized role in driving financial markets and the likelihood of further money printing in the coming few months is high as the economy slows to a crawl.
With both the Presidential election and the dreaded ‘fiscal cliff’ approaching at the end of this year, the window of opportunity for such Fed action is closing rapidly before political inertia sets in, and I expect Bernanke to hit the switch sooner rather than later.
While I don't expect further montary easing to have much impact on the real economy, it would provide a further boost for risk assets as at least part of the freshly printed money is likely to find a home in equities and commodities.
While I don't expect further montary easing to have much impact on the real economy, it would provide a further boost for risk assets as at least part of the freshly printed money is likely to find a home in equities and commodities.
It is wise not to stand in the way of this 'monetary freight train' but instead to either go with it or simply get out of the way. Longer term, however, ever-loosening monetary policy can surely not be immune to the law of diminishing returns and I expect that this fact will ultimately be exposed.
Once this occurs, and markets lose faith in the Fed Almighty, a major unravelling of confidence is possible and in that case -- watch out below. I suspect 2013 will bring us much closer to the endgame in this regard.
Hence looking beyond December 2012 I maintain a bearish outlook and am not committing long-term funds to risk assets. This increasingly feels like a market suitable only for short-term traders or investors with an ultra-long term time horizon. For those in between you have been warned.
Once this occurs, and markets lose faith in the Fed Almighty, a major unravelling of confidence is possible and in that case -- watch out below. I suspect 2013 will bring us much closer to the endgame in this regard.
Hence looking beyond December 2012 I maintain a bearish outlook and am not committing long-term funds to risk assets. This increasingly feels like a market suitable only for short-term traders or investors with an ultra-long term time horizon. For those in between you have been warned.
