Gavekal Capital: 2015-02-01

Friday, February 6, 2015

A Few Signs Are Pointing To A Lower US Savings Rate In 2015

Since the depths of the financial crisis, the rebound in consumer credit has been polarized. On the one hand you have non-revolving consumer credit (i.e. car loans, student loans, etc.), which briefly declined on a year-over-year basis in 2009 and early 2010 before violently rebounding in 2011. Over the past two years, non-revolving consumer credit has consistently grown at an approximately 8% year-over-year rate. On the other hand, you have revolving consumer credit (i.e. credit cards) which plunged in 2009 and continued to decline on a year-over-year basis until the end of 2011. In 2012 and 2013 revolving credit stopped declining but only grew at approximately a 1% rate. However, finally in 2014, revolving credit  bounced back and steadily increased all year long. It finished the year growing at a 3.5% year-over-year rate, the highest such rate since 2008. It should be noted that this is still well below the 8% year-over-year growth rate that revolving credit has averaged over the past 30 years. Combined together, consumer credit grew by 6.9% in 2014.

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However, this increase in consumer credit may be a negative sign for the personal savings rate in the US. Consumer credit as a percentage of disposable income reached an all-time high in 2014. At the end of December, consumer credit equaled 25.1% of annualized disposable personal income. This has had a highly negative correlation to the savings rate (-0.85) since 1960 and we would not be surprised to see the savings rate decline further.  In addition, the highest percentage of consumers are confident that they will receive a raise in the next six months since December 2007. Over the past decade, the more consumers that expect a raise the lower the savings rate tends to be.

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A Contrary Opinion On The US Employment Report

One of the main features of the current recovery is the drop in the potential growth rate.  In every other recovery since WW2, real GDP has risen back to potential as the recovery got going, thereby closing the output gap.  This time around, the output gap has narrowed because potential GDP has been revised down.  This is an important point to understand when looking at today's jobs report.

Real GDP, Potential GDP and Long-term GDP Trend
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GDP has basically two ingredients: 1) productivity and 2) labor force growth.  Estimates of potential growth are a function of estimates of these two variables.  In mid-January the CBO released its latest projections of real GDP for 2015-2025.  They estimate potential real GDP over the next decade at 2.1%, with .5% coming from labor force growth and 1.6% coming from labor productivity.  

With this framework in mind, one of the interesting features of the recent GDP report and labor market reports, is the recent stagnation in productivity.  For the private sector, productivity was basically flat last year while aggregate hours worked by private sector employees rose by almost 3.5%. Of that 3.5%, roughly 2.3% came from new jobs...and hence the excitement surrounding today's job numbers.  Looking back at private sector productivity, hours worked and total real GDP since 2009, we can see an interesting pattern emerge.  The first phase of the recovery--from 2009 through 2010--productivity surged and represented more than 100% of total economic growth.  But then productivity slowed in 2011-2013, and in 2014 it flat lined. Will it decline in 2015?

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In 2014, the entirety of real GDP growth came from more hours worked rather than greater productivity.  While it is good news that the labor force grew by 1.1% year over year in January, in December the one year growth rate was .7%.  So, looking back at 2014 and using the annual performance of the US economy, we can see that potential growth was really running closer to .7% (productivity + labor force growth).  There are least four conclusions to draw from this:
1) With real GDP running closer to a 3% rate in 2014, the economy is growing beyond potential right now.  This raises the spectre of inflationary pressures building and helps explain the sharp sell-off in US Treasury bonds.
2) This also should get the Federal Reserve's attention and helps explain the big drop in December 2015 fed funds futures.  This should bring fed fund increases sooner.
3) If this stagnation in productivity continues, it may pose a challenge for corporate profits and capital investment.
4) If this productivity stagnation continues, long-term estimates of the speed limit of the US economy need to be adjusted down again.

It is great news that the US is creating more jobs, but it is much worse news for the economy that productivity is stagnating.  As Paul Krugman once said, "Productivity isn't everything, but it is nearly everything."

Inflation Expectations Have Increased Since Mid-January

Since January 15th, 5-year TIPS derived breakeven inflation has increased 23 basis points from 105 basis points to 138 basis points. 10-year TIPS derived breakeven inflation has increased 16 basis points during this time and 30-year TIPS derived breakeven inflation has increased 8 basis points since the beginning of February.

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It will be worth watching whether or not today's widening of spreads (currently the 5-year treasury yield is 16 basis points wider and the 10-year is 12 basis points wider) will push inflation expectations higher. If inflation expectations move higher, the odds that the first rate increase by the Fed happens in June will most likely increase as well.

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A Deep Dive on Our Point-and-Figure Methodology

Familiar readers are aware that we use point-and-figure methodology as a technical complement to our extensive fundamental analysis.  For a brief discussion of how it works, you may watch a video blog on the subject here.  For more details, read on.

Generally speaking, a column of x’s denotes a gain in price while a column of o’s represents a decline in price.  In our proprietary model, we selected a ‘box size’ of 2.5%-- this means that each ‘x’ or ‘o’ is equivalent to a 2.5% gain or 2.5% loss, respectively.  Most of the time, we look at a stock (or an ETF, or a sector, etc) relative to an index.  In this case, each ‘x’ (or ‘o’) represents a relative outperformance (or underperformance) compared to the selected index.  In order for a ‘reversal’—or a change from one ascending (‘x’)/ descending (‘o’) column to the opposite—to occur, a certain threshold must be met.  For our purposes, we have selected a three box reversal.  This means that, in order to reverse from an ascending column of x’s to a descending column of o’s, the stock must decline 7.5% relative to the selected benchmark index.  No ‘o’ will be marked until the full 7.5% decline is registered at which point all three o’s are recorded (more, if the total decline is greater than 7.5%).  This is important to note because it is the means by which a great deal of day-to-day volatility, or noise, is eliminated—leaving us with a more clear picture of the true signal in the price trend of the stock.

With respect to the alpha numeric labels on the x- and y-axes, these are simply used as coordinates to identify positions on the chart.  In addition, while we have noted years across the top of the chart, time is not a variable here and they are only meant for reference.  Each chart plots the (relative) performance versus the variability of that (relative) performance or, said another way, return against risk over the last 1008 trading days.  So, though we have included time in order to orient the viewer, it is noteworthy that the position of the dates vary a great deal from chart to chart precisely because it is not a component of the actual plot.

There are a number of different lines that we draw on the charts, in order to highlight areas of support and/or resistance.  The light blue, horizontal line is said to act as resistance when the formation of x’s and o’s cannot move above it.  Conversely, it is referred to as support when the formation remains above the line.  When the formation is bound by two light blue lines, it is said to be in a trading range.
























The medium blue line is called the 45-degree bullish support line (BSL) and is an important indicator of the health of an uptrend.


























When this line is definitively violated by a descending column of o’s, there is a significant likelihood that the uptrend is over and that the stock in question is headed for a trading range (at best) or an outright decline.


























In some cases, the slope of an uptrend is steeper than the 45-degree BSL.  In these instances, we mark support with the dark blue, high performance support line.


























Finally, persistent downtrends are indicated by the red line (with a slope of -1).


























Stocks that are able to decisively overcome the resistance indicated by the red downtrend line—and particularly those that have managed to form a base of support (indicated by a light blue, horizontal line)—typically exhibit a greater likelihood of reversing the long-term downtrend in favor of a more constructive uptrend.


Thursday, February 5, 2015

Realized Equity Volatility Is Creeping Higher

Equity volatility looks like it made a low last fall. The 20-day moving average of the standard deviation of daily price changes for the MSCI World Index made a low on September 18th, 2014. Since that day, the average standard deviation for the MSCI World Index has increased by over 80%. However, from a historical perspective realized volatility is still relatively restrained.

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We have a noticed a pickup in volatility over the past 15 trading days in the developed markets. In the tables below, we look at the 20-day moving average of the standard deviation of daily price changes sorted by country index. The overall theme in the developed markets is that volatility has risen (cell color has moved from red to green). The exception is Israel, where volatility has decreased over the past 15 trading days. The same goes for Australia but to a lesser extent. Portugal and Canada have had the highest volatility of late while Belgium and Singapore have had the lowest.

Developed Markets Realized 20-day Volatility by Country
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In the emerging markets, in general volatility has also increased over the past 15 trading days but not quite as uniform as in the developed markets. China, UAE, Colombia and Qatar have experienced decreases in realized volatility. Greece and Russia, not surprisingly, have had the highest realized volatility. Meanwhile, the Philippines and Taiwan have had the lowest. 

Emerging Markets Realized 20-day Volatility by Country
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Wednesday, February 4, 2015

Regional Winners And Losers In The US From The Drop in Oil Prices

The drop in oil prices has brought up a few questions with respect to who will benefit and who will be negatively impacted.  There are regional PMI surveys and Federal Reserve surveys that can help fill in some of the gaps.  For example, below is the Dallas Fed New Orders index and the Houston PMI.  Both have turned down lately likely reflecting weakening of the weekly rig count.

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The Philadelphia Fed General Business Conditions Index has hit the wall sine November.

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At the same time, things are ripping in Milwaukee and look solid in Michigan.

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We calculate a diffusion index based on the regional PMI surveys.  The latest reading is -10, the worst going back a decade.  On net, it has dropped 28 points since July 2014.

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Looking at our 3-month diffusion index of the PMI surveys, we can see why the ISM has dropped by over 2.5 points since August reflecting the weak breadth.

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So far, on balance, the drop in oil seems to have had a negative impact on US production survey data, creating more losers than winners.

The Keep It Simple, Stupid (KISS) Guide To Asset Allocation

Let's say you have portfolio that invests in four asset classes: stocks, bonds, cash, and alternatives. The goal of the portfolio is simply to outperform the broad, global equity market (MSCI All Country World Index) over a multiple year time frame. With the proliferation of ETFs in the marketplace, the average investor can now effectively create a diversified global portfolio with just a few trades.

Equities:

  • The US continues to outperform (including all cap sizes)
  • China, India, and Indonesia look intriguing if one wants to add global exposure
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Bonds:
  • We said it last week and we will say it again, long duration government plays seem like the only option at the moment
  • Credit doesn't look compelling; same goes for munis
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Cash:
  • Keep it VERY simple here
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Alternatives:
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Real Trade-Weighted Dollar At A 141-Month High

The real trade-weighted exchange rate index against major currencies has reached its highest level at the end of January since April 2003. The broader index is currently at a 69-month high. The major currency index includes six currencies (Euro, Yen, Canadian Dollar, Pound Sterling, Swedish Krona, and Swiss Franc). The broader definition includes 26 different currencies. The currency weights are based on yearly trade data. In order to calculate a "real" (i.e inflation-adjusted) exchange rate, the nominal exchange is multiplied by the ratio of US CPI index to the foreign currency CPI index.

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The nominal trade-weighted exchange rate index by major currencies is at its highest level since May 2004, while the broader index is at its highest level since March 9th, 2009 (the infamous start to the current bull market).

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Lastly, our purchasing power parity diffusion index has fallen to 0 for the first time since 2009. This means that on a purchasing power parity basis, nine currencies are currently overvalued versus the USD and nine currencies are undervalued versus the USD.

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