By
StopAlerts
:
RECESSION CONCERNS
JP Morgan Asset Management published two interesting charts in
last week's "US Fixed Income Markets Weekly".
The first was a chart of the frequency of Google searches on the
word "recession", as an indication of how much recession concern
was on people's minds overtime. Here it is:
You can see the spikes that occurred in 2010 and 2011 that
correspond to the times when the Greece/Europe debt crisis flared.
The most recent concerns about Greece defaulting and Spain and
Italy coming under the microscope with rising bond rates are not
reflected in as large an interest in Google searches for
"recession".
Maybe that is just Europe fatigue, and maybe it is a reduced
sense of concern about a recession.
Whichever, in the short-term, expectations drive securities
prices, although in the long-term reality and experience determine
price levels.
ECONOMIC POLICY UNCERTAINTY
The second chart of interest is one about the level of economic
policy uncertainty. Uncertainty tends to be a negative for prices,
or at least rising uncertainty is a bad thing. Here is the chart
for that indicator:
The creators (Baker, Bloom and Davis) are academics from
Standford and the University of Chicago. They described their
uncertainty indicator this way in
their paper
on the topic:
Many commentators argue that uncertainty about taxes,
government spending and other policy matters deepened the
recession of 2007-2009 and slowed the recovery. To investigate
this issue we develop a new index of policy-related economic
uncertainty and estimate its dynamic relationship to output,
investment and employment.
Our index averages several components that reflect the
frequency of news media references to economic policy
uncertainty, the number of federal tax code provisions set to
expire in future years, and the extent of forecaster
disagreement over future inflation and federal government
purchases.
The spikes in uncertainty seem to occur at times when the stock
market is weakening, although there is not a proportional
relationship. You can see that the highest spike occurred in 2011
(around the time of the European debt crisis), but the deepest
stock market decline was in 2008, when the second highest
uncertainty spike occurred.
All we can gather from the chart at this point is that there
seems to be a directional significance to the indicator,
corresponding to the common sense view that more uncertainty is a
negative for stocks and less uncertainty is a positive for
stocks.
Uncertainty has been rising as of late with not only the
European issues, but the close US presidential race towards two
potentially very different futures, the US fiscal cliff
specifically (taxes and spending at the federal level), slowing GDP
growth in China, continuing tensions in the Middle East (with Syria
becoming the center of major diplomatic struggles between the major
military powers), recent territorial conflicts on the high seas
between China and its neighbors (Japan, Vietnam and the
Philippines).
FEDERAL RESERVE FINANCIAL STRESS INDEX
The Saint Louis Federal Reserve Bank calculates what they call
the "financial stress index". It takes into consideration 18
financial factors, as follows:
Interest Rates:
- Effective federal funds rate
- 2-year Treasury
- 10-year Treasury
- 30-year Treasury
- Baa-rated corporate
- Merrill Lynch High-Yield Corporate Master II Index
- Merrill Lynch Asset-Backed Master BBB-rated
Yield Spreads:
- Yield curve: 10-year Treasury minus 3-month Treasury
- Corporate Baa-rated bond minus 10-year Treasury
- Merrill Lynch High-Yield Corporate Master II Index minus
10-year Treasury
- 3-month London Interbank Offering Rate-Overnight Index Swap
(LIBOR-OIS) spread
- 3-month Treasury-Eurodollar ((TED)) spread
- 3-month commercial paper minus 3-month Treasury bill
Other Indicators:
- J.P. Morgan Emerging Markets Bond Index Plus
- Chicago Board Options Exchange Market Volatility Index
((VIX))
- Merrill Lynch Bond Market Volatility Index (1-month)
- 10-year nominal Treasury yield minus 10-year Treasury
Inflation Protected Security yield (breakeven inflation
rate)
- S&P 500 index (equities).
The index is not as elevated as it was in 2011 and 2010 when the
European debt crisis flared. It has risen slightly from its 2012
low, but is still subdued compared to the peaks since 2007.
However, it has not reached the lower levels of comfort seen during
the bull stock market from 2004 through 2007.
S&P 500 STOCK OPTIONS VOLATILITY INDEX (VIX)
One of the components of the St. Louis Stress index that we like
to view independently is the VIX. The VIX is not showing distress.
It is much lower than during the Europe crisis in 2011 and 2010,
and is in no way similar to the panic seen at the time of the 2008
crash. The current level is somewhat below the 10-year average
level (shown as blue line).
JUNK TO INVESTMENT GRADE CORPORATE BOND YIELD
SPREAD
Another indicator we like to look at is the yield spread between
the highest level of below investment grade corporate bonds (rated
BB), and the next to highest investment grade corporate bonds
(rated AA). As that spread rises, it correlates with economic
forecasts worsening (because investors demand relatively more yield
from weak companies than they do when things are going well with
the economy). When the spread declines, the forecasts are
improving.
The spread is much better than last year during the last Europe
debt crisis -- still not as good as in the 2004 through 2007 bull
market, but much improve from crash levels, and better than last
year.
CONSUMER SENTIMENT
The University of Michigan Consumer Sentiment index has improved
substantially this year, although not to levels seen at the peak
reached after the 2009 stock market bottom.
HOUSEHOLD DEBT SERVICE TO DISPOSABLE INCOME
Households have significantly reduced their debt service burden
from 14% of disposable income to 11%, through a combination of debt
repayment and refinancing at lower rates.
Consumer Debt to GDP
Debt Service to Disposable Income
EMPLOYMENT RATIO IMPROVING
Employment ratios are still not good, but they are
improving.
Total Jobs vs Civilian Population
Unemployed (U4) and Unemployed Plus Underemployed
(U6)
PURCHASING MANAGERS MANUFACTURING INDEX
Markit produces measures of the Purchasing Managers Index
("PMI"), which Investopedia describes this way:
An indicator of the economic health of the manufacturing
sector. The PMI index is based on five major indicators: new
orders, inventory levels, production, supplier deliveries and
the employment environment.
A PMI of more than 50 represents expansion of the
manufacturing sector, compared to the previous month. A reading
under 50 represents a contraction, while a reading at 50
indicates no change.
Here is a chart of the US PMI as of July 24, 2012:
The US is softening, but the index is still above 50 -- we're
still growing.
Here is some detail behind the sub-components of the index:
S&P 500 INDEX OF LARGE-CAP US STOCKS
Overall, the indicators above paint an OK picture, with some
ragged edges.
The S&P 500 stock index (1) is still in an up trend (the
gold line for the 200-day moving average), (2) is in the middle of
its 3 month price range (the upper and lower blue lines), (3) is
well above the bear market threshold (the read line 20% below the
trailing one year high), and (4) presents a price probability range
out to 12/31 2012 based on 6 months of historical volatility that
is above the bear market level at the lower end of the range.
The black line price probability cone is based on an 80%
probability, and the green line probability cone is based on a
90% probability. That is with 80% or 90% probability, based on
past volatility, the price is likely to remain within the
cones.
No reason to head for the hills at this time, but also no reason
to go whole hog into risk assets given the uncertainty and event
risk we face at this time.
Directly Relevant Broad US Market ETFs:
[[SPY]], [[IVV]], [[VTI]], [[IWB]], [[ISI]]
Disclosure:
QVM has positions in SPY as of the creation date of this article
(July 24, 2012).
Disclaimer:
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See also
Earnings Preview: Procter & Gamble
on seekingalpha.com