Minyan Mailbag:Jordi Visser
Note: Our goal in Minyanville is to remove intimidation from the financial markets and encourage an interactive dialogue among the Minyanship. Jordi Visser is a long time Minyan and a trusted friend and he pinged me late Friday with his take on the tape. We share his vibe with educational intents and it is by no means offered as advice.
Market & Economic Summary
There is much to discuss this week. Last week, in a letter to our peers, we expressed concerns about the global economy based on the early data releases for the month, alarming quantitative signals and relentlessly rising oil prices. Since then, we have observed more weak data points, even more alarming quantitative signs, and oil is up another 4%. In addition, corporate governance issues have returned to the forefront in the US this week and the US Presidential election remains an uncertainty. Accordingly, we continue to believe there are increasing risks to global growth and feel the market sentiment and positioning are not prepared for a surprisingly sharp slowdown.
The last two weeks have continued to show signs of weakness in the US Economy. On the manufacturing side, Industrial Production, Empire Manufacturing and the Philadelphia Fed Manufacturing all showed weakness. Inside the Philly Fed and Empire readings, new orders, employment, average workweek, and unfilled orders were all down. The Michigan Consumer Confidence headline number fell to its lowest level since September 2003. The expectations number dropped eight points to 79, the lowest reading since May 2003. The only other times we have seen readings below 80 over the last eight years were after September 11th, during the market collapse in 2002 and at the beginning of the War in Iraq. Finally, the Conference Board's Index of Leading Economic Indicators fell for the fourth month in a row (third time in 14 years). Chart 1 shows the extreme levels of the falloff in the diffusion component. Looking back to the 1990's we will see a comparable pattern reflected in the most recent quarterly GDP readings of +.7%, -.5%, +.9% and
-3.0% (-.475 average). Clearly the economy is weakening.
Last week, we mentioned our worries about negative signals in the housing sector led by weakness in homebuilder stocks and lumber. Lumber was down again last week and is currently down 4% this week, marking the eighth consecutive weekly decline. The importance of this drop is shown in Chart 2, which highlights the high correlation between US manufacturing (ISM headline number) and lumber futures. Despite lumber's fall, we had been optimistic since metals were making new highs. That also changed last week. Chart 3 shows the daily and weekly sigma moves in copper. Nickel, aluminum, lead, and zinc had similar moves during the week. The distressing part of the fall in lumber and metals is that they occur during a large post hurricane rebuild phase. Not all commodities are falling, though, as oil and gas continue to move higher at an incredibly rapid pace. Crude oil has been up 14 of the last 16 weeks and shows no sign of letting up. As we enter the winter season, crude oil and heating oil are both up over 50% in four months, much of that move occurring in the last six weeks.
Economic and commodity data are beginning to confirm stress building in our quantitative research that suggests risks are increasing for a possible shock. Chart 4 illustrates an alarming number of 10 standard deviation daily moves in stocks this week. We are also concerned that the ratio of 5 sigma moves to 3 sigma moves has been very high recently. Add in the high sigma moves in homebuilding stocks, Fannie Mae, lumber and the metals, and market stress is clearly evident. One of our favorite stress indicators has also risen lately. We use the ratio of Gold to the Bank Index (BKX) to look for signs of fear and it is beginning to break higher, out of a 17 month range.
Chart 5 shows the high correlation between this ratio and the CBOE Index Volatility (VIX), suggesting volatility will increase. On the currency side, the Swiss Franc has outperformed the Euro 12 days in a row. Due to the high historical correlation, we see this as another sign of stress. Finally, we began to see some problems in credit with high yield and emerging market debt showing some weakness early in the week. By the end of the week, things had calmed, but these metrics need to be watched closely. The most bullish argument to offset all of the weak economic fears is the strength of the corporate and emerging market balance sheets. Any sustained weakness in these groups will be a troubling sign.
Put everything together and we believe the evidence is overwhelming that there will be a slowdown in global economic growth based on the data over the last three weeks. The US consumer is responsible for about 20% of global growth and their cash flow is strained. Home refinancing is down, tax cuts are gone, short rates are higher, stocks are down, crude oil is up 50% in four months and property taxes are rising. House prices remain firm but are showing signs of weakness (lumber, homebuilders, and mortgage companies) and hiring has slowed. The remaining balance of global growth has been related to the fixed investment and manufacturing buildup. The information above suggests that this too is beginning to weaken. Although we believe in the long term Asia growth story, the Asian consumer is not ready to pick up the slack right now. Over the last two weeks many of the Dow Industrial companies have cited weakness in China demand and a lack of pricing power.
From a portfolio perspective, the market does not seem prepared for a sharp weakening of global growth and we are concerned about the risks of a high correlation unwind. We believe that most overweight positions are focused on Asia as a region, the industrial, cyclical, and materials as sectors, and corporate and emerging market debt on the bond side. These all seem correlated to us, being driven by global growth and strong balance sheet stories. Accordingly, we will continue to watch for stress in the financial system and a sign of high sigma unwinds. Purely from an equity sentiment perspective, Chart 6 and Chart 7 show equity sentiment from two separate works at similarly high levels to the period following the post September 11th equity rally and economic bounce. Our portfolio will be focused on being short the dollar and short equities until we see some signs of economic traction or signs that the market is already prepared for the weakness. Again, this isn't intended as advice to act, it's simply sharing our process with the hope it adds to yours.
Jordi Visser & Alex Seiler
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