Market Ignores Weak Economic Reports; Huge Fund Outflows; Victor’s Analysis

By the Curmudgeon with Victor Sperandeo

Introduction:

The Curmudgeon has never – in over 56 years of market watching and investing – seen such a disconnect between stock prices and the real economy! Hence, there will be no opinions from me on the current market action, which is baffling to say the least. Please refer to Curmudgeon Notes (especially data from BoA Merrill Lynch) and Victor’s comments below.

Economic Report Recap from 2/15/19 Business Insider:

There are lots of red flags for the US economy right now. Here are just a few:

· Retail sales collapsed by the most since 2009 in December: The Commerce Department said Thursday meanwhile that retail sales sank 1.2% to $505.8 billion, marking the biggest drop since 2009, as receipts fell in nearly every major category. The results were well below economist expectations for a 0.1% increase. Please see Victor’s comments and analysis of this shell shocking report.

· American household debt just hit a new record high, meanwhile. Overall debt rose by $32 billion to $13.5 trillion in the fourth quarter, the Federal Reserve Bank of New York said in a report out Tuesday, bringing it to a fresh high. Total household debt was nearly 7% higher than a previous peak of $12.68 trillion seen in the third quarter of 2008, underscoring potentially vulnerable spots in an otherwise humming economy.

· A record 7 million Americans have stopped paying their car loans. According to a recent Fed report, a record number of Americans were three months or more late on making car payments. At the end of 2018, auto loans facing serious delinquency rose 2.4% to more than 7 million.

· "The overall performance of auto loans has been slowly worsening, despite an increasing share of prime loans in the stock," New York Fed economists wrote in a subsequent report. "The substantial and growing number of distressed borrowers suggests that not all Americans have benefitted from the strong labor market and warrants continued monitoring and analysis of this sector."

· Industrial production declined 0.6% in January from a month earlier, the Federal Reserve said in a report Friday, well below expectations for a 0.1% increase.

· Manufacturing production slid 0.9%, seen as the result of rising protectionism and decelerating economic growth around the world. American manufacturing is in danger of entering a recession this year. "Manufacturing is under real pressure from the slowdown in China and the trade war, and we expect output to drift down over the first half of the year, putting the sector into a mild recession," said Ian Shepherdson, the chief economist at Pantheon Macroeconomics.

· A steep fall in auto production helped pull the sector lower, with the index falling 8.8% from a two-year high a month earlier. Motor vehicle assemblies fell from 12.3 million units at an annual rate in December to 10.6 million units in January, their lowest reading in nearly a year.

· "The large drop in the output of motor vehicles and parts contributed significantly to sizable decreases posted by consumer durable goods, transit equipment, and durable materials," the Fed said.

More on Retail Sales:

US retail trade fell by 1.2 percent from a month earlier in December 2018, following a revised 0.1 percent growth in November and missing market expectations of 0.2 percent gain. It was the steepest decline in trade since September 2009, as sales fell in almost all categories. Excluding automobiles, gasoline, building materials and food services, retail sales dropped 1.7 percent in December after an increase of 1 percent in November. Retail Sales MoM in the United States averaged 0.35 percent from 1992 until 2018, reaching an all-time high of 6.70 percent in October of 2001 and a record low of -3.90 percent in November of 2008.

Economists are keeping an eye on potential risks under the surface of the economy, but nothing (yet) has stopped the stock market rally off its 12/24/18 closing lows.

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Victor’s Comments and Analysis:

I’m of the belief we are (still) in a bear market with a recession occurring this year. The rally from 12/26/18 in extent and duration is in the median scope of historical bear market rallies, even though the V shaped market recovery is quite unusual (at least to the Curmudgeon).

The stock market rally indicates that interest rate increases have not only stopped, but conversely that the Fed will have to lower rates, as the economy weakens.

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Curmudgeon Note 1: The CME Fed Funds watch tool currently indicates that at the January 29, 2020 Fed meeting, there is a 78.1% probability that the Fed Funds rate will be unchanged (225-250 bps) and a 17.3% probability that rate will be lower by 25 bps.

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CPI headline inflation rate is now 1.5% year over year - the lowest since November of 2016. It is worth mentioning that on 12/19/19, when the Fed last raised rates, crude oil had dropped -37.3% from its 10/3/19 high. Why would the Fed again raise rates, when inflation (due to a huge decline in oil) was going to decline? In two days after the rate increase oil dropped another 10%!

àI have to conclude that Fed rate increase was a great deal about politics, but I don’t have any evidence to support that speculation.

An update on the markets is relevant because of the astonishing report on Retails Sales last week (please refer to detailed numbers and graph above). The surprising -1.2% decline in this report during December 2018 (the Christmas shopping season) was the largest decline in 9 years! Consensus estimates were for +0.1% increase! That and other weak economic reports caused the closely watched Atlanta Fed estimates for 4th quarter GDP to be revised sharply downward to +1.5% from +2.7%. That would be a major decline from the 3^rd and 4^th quarter GDP growth rates of 3.4% and 4.2%, respectively.

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Curmudgeon Note 2:

In a research note last week, BoA Merrill Lynch economists said its tracking of internal debit and credit - card data showed consumer spending at its lowest level since 2016, when the U.S. economy flirted with recession.

Astonishingly, BoA Merrill Lynch also reported that U.S. Equities had net outflows of $6.9bn this week ($2.3bn ETF inflows, -$9.2bn equity mutual fund outflows) and -$37.864bn this year (-$7,085bn ETFs and -$30.774 bn equity mutual fund outflows).

“No one loves equities: buyers' strike in equities continues…2nd biggest outflows ever from European equities ($5.9bn, chart 5), $0.6bn out of US & $0.9bn out of financials.”

So if that’s the case, where is the buying power coming from to propel stock prices higher? Historically, buying power is exhausted several years into a bull market and the current bull move will be 10 years old next month! Is Victor’s seminal interview with Jack Schwager, “Markets Get Old Too” now a thing of the past?

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Ironically, the equity markets response to weak economic reports and slower growth (and thereby reduced corporate profit forecasts) was bullish! This strange market reaction to surprisingly weak economic numbers implies to me that the Fed had known, in advance of the retail sales decline, as the report was delayed for over three weeks due to the U.S. government shutdown.

The Fed flipped monetary policy 180 degrees in Powell’s speech on 1/4/19 which was later confirmed at the Fed’s 1/30/19 meeting when Powell said during a press conference: “The current level of interest rates is appropriate for the state of the economy.” That reaffirmed the Fed’s new dovish view that it was “going to be patient about the further raising of rates.” That means they are done with rate increases for this economic cycle, unless they indicate a new change in direction based on a stronger economy.

Currently, the market is focused on the trade deal with China, as its assumed there will be a deal? Yet reports on Friday said that two days of U.S. trade talks with China had shown no discernable progress. What the deal is will not matter. The key is a deal is baked into stock prices, i.e. it’s been discounted. When a deal (or no deal) is announced, it will likely signal the end of the stock market rally. In my view, it will be a “sell on the news” type of event. Meanwhile, the Fed is doing all it can to signal the “Powell Put” is in effect... as the global economy is weakening across the board.

In a syndicated 2/12/19 editorial titled “Europe is Sleepwalking Into Oblivion, Will Go The Way of the Soviet Union,” Hedge Fund and Philanthropist George Soros (see Curmudgeon Note 3. Below) wrote:

Europe is sleepwalking into oblivion, and the people of Europe need to wake up before it is too late. If they don’t, the European Union will go the way of the Soviet Union in 1991. Neither our leaders nor ordinary citizens seem to understand that we are experiencing a revolutionary moment, that the range of possibilities is very broad, and that the eventual outcome is thus highly uncertain.

Most of us assume that the future will more or less resemble the present, but this is not necessarily so. In a long and eventful life, I have witnessed many periods of what I call radical disequilibrium. We are living in such a period today.

The next inflection point will be the elections for the European Parliament in May 2019.

Not heeding Soros is perilous. The EU elections on May 26th will be a disaster for the globalists and elites.

Curmudgeon Note 3.

Victor was hired as an independent trader by George Soros to manage a short portfolio for the Quantum Fund during the declining U.S. stock market from December 1981 to July 1982. The market bottomed on August 11, 1982 with DJI closing low of 776. The Curmudgeon was 200% long at that point but exited most of his long positions prematurely in late September 1982.

End Quote-Remember History:

“Bulls don’t read. Bears read financial history. As markets fall to bits, the bears dust off the Dutch tulip mania of 1637, the Banque Royale of 1719-20, the railway speculation of the 1840s, the great crash of 1929.”— James Buchan

Good luck and till next time…………………………………………………..

The Curmudgeon
ajwdct@gmail.com

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional. He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996. He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies. Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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