This article was originally published on RealMoney Pro at 10:00am EDT on Feb 16th, 2016
I fully believe we are in the midst of a correction and not something worse (a recession/crash/depression/collapse). Apologies in advance; this is a long one.
1. Economic data do not support the recession story.
There are a lot of headlines suggesting we (both the US and the rest of the world) are heading into recession. But the headlines and data do not match up. At all.
In a recession, people are not quitting their jobs because they are afraid they won’t be able to find another one. Here is a chart from Bloomberg reflecting the “JOLTS quit rate” (the rate at which Americans are quitting their jobs):
Wages are up, too, as we found out last week. In fact, average hourly earnings growth in January was 2.5% year-over-year (yoy). The number for December was revised higher to 2.7%, marking the highest increase in yoy wage growth in more than six years.
Even Europe is now growing. The growth rate is not hugely expansionary, but it is growth—and growth is not recessionary.
2. US Dollar
Despite Quantitative Easing from 2010 to 2014—which many Americans and even industry professionals felt would cause an irreparable weakening of our currency—the US Dollar has essentially never been stronger (when compared against a basket of other major currencies). Taken on its face, that sounds like a good thing. After all, strongis good!
Except we are living in the most interconnected global economy in history (and that trend will only continue), and US-based large companies do an enormous amount of their business overseas. According to the data below from S&P Capital IQ, about a third of S&P 500 companies get more than 40% of their revenues from outside the United States.
A strong US Dollar means, by default, that the currencies of these foreign counterparts will be weaker—negatively impacting their purchasing power of USD-denominated goods and services.So, while it’s a good time for Americans to travel overseas (a gelato in Rome has rarely been cheaper) it’s not a great time for the owner of the gelato store to buy a US-made car.
The strong dollar has been a headwind for at least two years. We have pointed to this fact over and over; but the trend may be in the process of ending. Below is a chart of the US Dollar versus other major currencies (Euro, Yen, Swiss Franc).
3. Oil
It could easily, and correctly, be argued that the US Dollar and oil are inextricably, though inversely, linked. After all, oil (and all of the world’s most important commodities) are priced in US Dollar. The stronger the dollar, the fewer of them are needed to purchase a unit of said commodity.
There are other factors that weigh on how much a barrel of oil costs at any given moment, but the strong dollar finally breaking is a big one. Over the past two weeks we have seen Brent Crude—the international benchmark—doing a dance with the $30 level. In fact, it seems each time Brent breaks $30 to the downside we hear a rumor floated by an OPEC member about an emergency meeting or possible coordination on addressing the global glut (i.e. Production cut). This was unilaterally deemed impossible by many as recently as a month ago.
It’s possible. These countries and their currencies are in disarray. Our shale producers are not the only ones who spent recklessly while the “gettin’ was good.” OPEC nations got their populations used to lavish social spending and subsidies, and as a result their economic breakeven points for the price of oil is, on average, three times higher than where we are today. Yes they get oil out of the ground cheaper than we do, but they do not operate as private companies who report only to shareholders. Look at the breakeven prices and finances for the OPEC nations:
That Saudi Arabia can thrive, or even survive, with oil prices at current levels is a fallacy. Keep in mind also that their currency, the Riyal, is “pegged” to the US Dollar. The Riyal has come under fire by hedge funds of late as Saudi Arabia’s financial picture darkens; as such, the Kingdom is having to spend a small fortune each month in order to prop it up (to maintain the dollar peg).But doesn’t Saudi Arabia have a ton of US Dollar reserves? Yes, but the war chest is being depleted quite rapidly—and that will continue—with oil this low…
Oil stabilizing and rising a bit would be good for stocks, as it would provide a modicum of certainty in what’s become a most uncertain situation.
4. China
I’m not going to spend too much time here because we’ve addressed it very recently. The story we’re being sold is that China is “slowing.” Okay. The world’s second largest economy—a $10 trillion behemoth—is “only” growing at 6.9% annually. At least, that’s the data they’re reporting. We can go ahead and trim that by 30% and we still have a $10 trillion economy that’s growing at 5%. Compare that to the US, an $18 trillion economy that’s growing at….say, 1.5%? Where is the problem?
My opinion is that the “problem” is uncertainty about their currency and stock market, and not their economy—and I’ve pointed this out before. In August of last year the Peoples Bank of China decided to let the Renminbi (RMB) freely float against a basket of other currencies. There is no coincidence that two months after this decision the IMF announced that the Chinese currency would be included in its SDR (Special Drawing Rights) basket for the first time ever. Put simply, it seems the IMF was waiting for China to stop manipulating their currency before offering to include them in their basket of major currencies.
It took a few more months for the market to accept this reality, but below is a chart of the US Dollar against the Renminbi. The stabilization since the start of the year is clear:
5. The “powers that be”not about to lose control.
People seem to be writing off the Federal Reserve, and other Central Banks, as impotent with QE having been retired in late 2014. Either (a) they have no further policy tools to inspire growth, or (b) they are happy with where the economy is and willing to let things “cool off” for a bit.
Trouble with (b) is that nothing needs to cool off. If anything, the recovery has been lacking in size and scope, and the more reasonable argument is that further stimulus may actually be required—and coming.
As long as the global economy flirts with a substandard growth rate, I think it is reasonable to expect Central Banks worldwide to remain as accommodative as necessary to avoid a paralyzing recession or worse. Some might argue that the Europeans and Japanese have their pedals to the metal already, so to speak. And that may be true, but the Fed no longer does, and there is no question that the Federal Reserve is the most important Central Bank in the world. The Fed’s balance sheet is already north of $4 trillion, you might say. True, but there is no official “ceiling” on how large that number can get—to be sure, further QE is absolutely a possibility if deemed necessary.
6. The technical picture.
The technical picture for stocks (as represented by the S&P 500) has been tenuous for a while. We began the year with a cringe-inducing drop and bounced off the 1,812 level on January 20th with no relevant news to speak of. Since then we’ve seen US Treasury Bonds rally (and interest rates continue to plumb the lows of two years ago). The 25% downward move in interest rates in the first 6 weeks of 2016 has been breathtaking. But it is unlikely to continue unabated.
This week we retested that 1,812 level on the S&P and successfully bounced with some vigor on Friday, and we did so with bullish divergences forming on the chart below—a chart I’m calling “The War of 1,812”…
Naturally, there is no telling what this next week will bring, but I see more reasons for optimism—especially given today’s more attractive entry points—than I have in a long time.
It is always darkest before the dawn….
Have a great week and don’t hesitate to reach out if you have questions about your investments, whether or not they are held with our firm.
Adam B. Scott
Argyle Capital Partners, LLC
www.argylecapitalpartners.com
10100 Santa Monica Blvd, #300
Los Angeles, CA 90067
(310) 772-2201 – Main
Adam Scott’s profile on RealMoney can be found here.
