Well Dell spoiled the fun afterall. The S&P ended down 1.4% on Friday failing to hold onto Thursday's momentum. The Chicago PMI was stronger than expected, while US personal income and expenditure data came in pretty much in line, with the notable exception of income, which was materially worse than expected at -0.7% on the month as the tax rebate effect unwound, compared to expectations of -0.2%. The surprising strength of Q2 GDP now looks to be on even shakier ground than previously thought because as everyone knows, the US savings ratio must rise. That will be far more painful against a backdrop of falling income.
Crude and NatGas are slightly lower in a trading session convened especially (its Labour Day in the US today so all other markets are closed). Gustav is expected to make landfall today. It has the potential to wreak as much damage as Katrina and has already shut three-quarterss of oil output in the GOM. Yet crude and ng have been and are relatively calm? The IEA have already said that the SPR would be tapped if required while Thursday's NG storgage figures were merely the latest in a summer's worth of bumper numbers. In other words, inventory for each looks adequate - rightly or wrongly, there is appears little fear of supply disruption.
PMIs out in Europe today, the US tomorrow. The Chinese one this morning showed manufacturing to have contracted again in August. How seriously should this be taken? The Chinese economy is about the only engine firing the global economy right now and weakness there will have serious consequences indeed, not least in the commodity markets.
The truth, however, is that we just don't know. Is the PMI a reliable guide to activity? Probably not. It's difficult to find a correlation with any activity data. But suppose it was. To what extent does this weakness reflect the Olympics shut down? Again, we have no idea. We'll just have to wait for September's release, and beyond to see if China has avoided the "Olympic curse" (Morgan Stanley have shown that 10 of the last 11 Olympic hosts saw slumping activity in the year after the Games). Finally, if we accept that there is actually a slowdown going on, as evidenced by the authorities loosening lending standards and mulling fiscal stimulus, is any slowing caused by a weakening external sector likely to have the same devastating effect on overall activity and the domestic economy as it would in otherwise moribund economies such as Japan or Germany? I suspect not. Retail sales are now growing at a faster pace than exports, while all that infrastructure - water network, power plants and rail roads to name just a few - is as important as ever to the long run objectives of the government. But again - who knows? FAI of 50% of GDP is hardly "balanced." Is it disconcerting to be so utterly dependent on the part of the global economy we seem to know the least about? Yes, it is.
Where do the stock markets go from here? The end game for the financial system - nationalisation of credit - isn't even in sight yet and anyone thinking the July 15th was THE "capitulation" marking the bottom is thinking wishfully indeed. The peak to trough decline of the SS&P500 that day was 20%, buy the way, putting the US market in an "official bear market" according to the talking heads on TV.
But consider this: the entire model of Western (certainly Anglo-Saxon) economic growth over the past two decades has been based on the leveraging of activity. As private sector debt levels rose to 160% of GDP in the US (230% in the UK) the financial share of Amerian private sector business output rose to 25%, despite employing only 7% of its employees. As the conventional wisdom grew that one should never bet against the US consumer, growth and activity were significantly higher than they otherwise would despite real income growth going nowhere during those decades. It was more alchemy than wealth creation, but the magic required ever decreasing interest rates. Now, the secular fall in yields that took them from double digits in the early 80s to close to zero in the early part of this decade is over.
The GSEs can no longer afford to support the housing market. Banks remain unwilling to lend to one another. US Bank Credit is now 3.7% lower for the first time in 50 years. And US incomes are contracting. The machine is broken. Indeed, with a slow motion energy crisis likely to take yeilds higher on a secular basis over the next ten years or so, it will be impossible to fix it. Deleveraging - selling what you can to pay down debt, or simply defaulting - is the new leveraging. Does anyone really think that in such a context, 20% off most major indices is as bad as bad as it gets?
I'd been expecting a bounce to take us up to just shy of 1400 on the SPX, giving us a bear-market rally of 15% or so from the 1200 low reached on July 15th. Not that there's anything magical about 15%, or about 1400, but we had a rally of similar magnitude after Bear Stearns was bailed out ... also, the July 15th felt sufficiently panic-like to engender a commensurately impressive opposite response. But it has felt anything but. The stuttering 9% rally we've seen from that 1200 low to the recent high of 1320ish has been on low and declining volume ... meanwhile, banks have hundreds of billions of financing to arrange at rates which will be be at levels hundreds of basis points higher than they are paying now, while the lagged effect of the recent withdrawl of the last guys playing the mortgage game - Fannie and Freddie - ensures a second leg down in the housing market awaits.
Is there light at the end of the tunnel? No. But there will be some succour as central bank cuts policy rates as inflation peaks for this cycle. One of the worst inflation problems in EM land has been that of Vietnam, yet signs there are that the worst is over (for now) helped the mkt there rise by 19% in August. The inflation we've seen so far, at least in developed markets, has been entirely food and energy related. In July, depending on which index you look at, food and energy prices were 75-100% higher YoY. That means that anything less that 75-100% higher YoY will bring down the rate of headline inflation. Oil is likley to go materially lower near term, and while I'm more bullish of agriculture, we're already so far off the March highs it's unlikely we'll see food inflation at those rates for some time yet.
On the grains ... Western Australia received fantastic rains in the parts of the wheat belt which needed it most. I wonder if the same prayer group who have taken credit for the recent fall in oil prices turned their attention to the Australian farmers plight? http://news.bbc.co.uk/1/hi/business/7566566.stm
The IGC, meanwhile, upped their forecast global grain harvests and inventory levels for end May 2009.
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