Bob’s Journal for 7/3/19
Several interesting and important data points caught my attention this week and merit your attention.
You might have seen reports noting that this month, the U.S. economy set a new record. The 121-month recovery since June 2009 is the longest period the economy has gone without a recession. The previous record was set from March 1991 to March 2001.
Despite the beliefs of many people, bull markets and expansions don’t die of old age. While the economic cycle, on average, lasts five to seven years, it’s not a mechanical cycle. Each cycle has its own characteristics.
There are two events that end expansions. One event is a crisis that freezes economic activity, such as the housing crisis and its collateral effects. Increased trade conflicts also could have this effect. The other event is a withdrawal of liquidity from the economy that usually is caused by a central bank.
A reason this expansion lasted so long is that the growth rate has been well below average. Slower growth prevented the buildup of excesses that, in the past, caused the central bank to tighten monetary policy. At this point, inflation isn’t rising and banks aren’t overextended. There isn’t much reason for the Federal Reserve to tighten monetary policy.
The returns of stocks and bonds are another interesting data point. Stocks have had great returns so far in 2019. In fact, returns for the first half of the year were the highest since 1997. But bonds also have done well.
In fact, during the last 12 months, long-term bonds generated higher returns than U.S. stocks. The S&P 500 returned 11.15% over the last 12 months. But long-term treasuries returned 11.82% as of the July 1 close. The difference was even more significant just a day earlier.
The S&P 500 has outperformed long-term treasuries over most other time periods. But over the last 20 years, long-term treasuries have an annualized return of 6.9% compared to the S&P 500 5.9% annualized return.
The cumulative impact of that outperformance is significant. The total return of long-term treasuries over the last 20 years is 283.1%, compared to 214.8% for the S&P 500.
Long-term treasuries reached their peak in July 2016, and their long bull market dating back to 1982 seemed to be over. But the trade conflicts and fear of a recession gave them new life in the last 12 months. They are nearing the high reached in July 2016.
U.S. long-term treasuries are not the only bonds with high returns because of falling interest rates. In fact, this is a global phenomenon. Interest rates are so low elsewhere that U.S. bonds have some of the highest interest rates in the developed world.
There now are $13 trillion of bonds around the world that have negative interest rates, according to the Institute for International Finance. The number of negative-yielding bonds had peaked in 2016. But interest rates throughout Europe declined sharply after European Central Bank (ECB) President Mario Draghi announced last month that the central bank he heads might resume monetary expansion.
Europe now has more bonds with negative yields than it did in 2016. Japan has almost as many as in 2016.
Most bonds with negative yields are government bonds, but more than $1.5 trillion of corporate bonds and securitized debt have negative yields.
Negative interest rates are a sign the economy is weak. We see evidence of that in the latest global manufacturing data.
The global purchasing manager indexes from IHS Markit tumbled in June. The IHS Markit gauge that consolidates the PMI indexes from many countries this month reached its lowest level since October 2012. This is the first time since November 2012 that the gauge was negative for two consecutive months.
Developed countries, especially in Europe, had the steepest recent declines. But PMIs in China and the United States also declined.
That’s why central banks now are talking about easier monetary policy instead of the tighter policies they were discussing in 2018. It also is a major reason the United States and China reached a truce in their trade conflicts.
The Data
Personal Income and Outlays were strong in May. Income increased 0.5% for the month, though wages and salaries increased only 0.2%. Proprietor’s income and asset transfers were major factors in the personal income rise.
Consumer spending increased 0.4%, and April’s spending was revised higher to 0.6% from 0.3%.
The PCE Price Index continues to be stable. Both the headline number and core price index climbed 0.2% for the month. Over 12 months, the headline price index rose 1.5% and the core index increased 1.6%.
The service sector perked up a bit, according to the PMI Service Index. The index increased to 51.5 from 50.9, which was a 39-month low. The gain means there was only a marginal increase in growth. Expectations for future growth reached a three-year low.
The ISM Non-Manufacturing Index, on the other hand, declined to 55.1 from 56.9. But 55.1 still is considered a healthy growth level. Taken together with the PMI Service Index, the ISM Non-Manufacturing Index indicates the non-manufacturing sector of the economy continues at a sustainable level of growth, though it is lower than a few months ago.
The Kansas City Fed Manufacturing Index tumbled to 0 from 4 in May. That’s the lowest level since 2016. Most components of the index declined, but the worst declines were in export sales and in production of computers and electronic products.
The Chicago Purchasing Managers Index declined to 49.7 from 54.2. That’s a sizeable one-month decline and is the first reading below 50 in two-and-one-half years. A reading below 50 indicates the economy is contracting. This index is more volatile than most others, so we shouldn’t read too much into one month’s number.
But the PMI Manufacturing Index improved a little to 50.6 from 50.5. This still is the second-lowest level in 10 years, with May’s reading still the lowest. New orders and production were at or near three-year lows.
The ISM Manufacturing Index declined to 51.7 from 52.1. The decline was less than most analysts expected. Most components of the index were flat or down. Respondents to the survey blamed tariffs and fallout from the grounding of the Boeing 737 MAX for much of the decline.
Weakness in manufacturing was reflected in Factory Orders. The Factory Orders fell 0.7% in May, and April’s orders were revised lower to a 1.2% decline from an initially reported 0.8% dip. Orders declined three of the last four months. Excluding transportation, orders increased 0.1%.
Consumer Sentiment, as measured by the University of Michigan, declined to 98.2 from 100.0 in May. Current conditions improved, but expectations for the next six months declined.
The ADP Employment Report was well below expectations for the second straight month. Only 102,000 new private sector jobs were created in June. May’s new private sector jobs were revised higher to 41,000 from 27,000. The two-month total of new jobs created is the lowest since April 2010. We’ll have to wait a few months to determine if this is the beginning of a weaker labor market and economy or if it is only a pause.
New unemployment claims declined by 8,000 to 221,000. The four-week average increased marginally to 222,250.
The Markets
The S&P 500 rose 1.95% for the week ended with Tuesday’s close. The Dow Jones Industrial Average increased 0.90%. The Russell 2000 jumped 2.65%. The All-Country World Index (excluding U.S. stocks) added 1.77%. Emerging market equities grew 2.46%.
Long-term treasuries rose 0.53% for the week. Investment-grade bonds increased 1.10%. Treasury Inflation-Protected Securities (TIPS) declined 0.02%, while high-yield bonds added 0.51%.
In the currency arena, the U.S. dollar increased 0.65%.
Energy-based commodities declined 2.17%. Broader-based commodities fell 2.33% and gold lost 0.66%.
Bob’s News & Updates
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