With the steepest global yield curve in history it appeared in mid 2009 as though we were going to go on the credit binge to end all credit binges.  We were going to see inflation of eight gazillion percent and gold was headed to $50,000 as we went back to the gold standard.  As we now know that is not what happened. Instead banks bought Treasuries and there has been a massive contraction in lending as borrowing.  Instead of massive amounts of real growth the record steep yield curve instead brought with it a credit contraction that appears to be slowly but steadily sapping the energy from this so-called recovery.

Looking at the global GDP weighted yield curve right now you can see that since April of 2010 long term government rates have been steadily coming down as the short term rates are close to zero percent in many developed nations, which of course make up the bulk of a GDP weighted yield curve.

Global GDP Weighted Yield Curve

What is obvious to us when looking at this chart is that we are in a slow to negative growth environment for the foreseeable future.  We see this in both the economic data as well as in the markets themselves with stocks showing increased volatility and bond yields of all maturities hitting new lows or close to near lows. Until we start to see signs of real growth we expect the curve to continue to flatten, primarily on the long end.   One potential trade to take advantage of declining long bond yields is to either buy the long bond or buy TLT the 20+ year Treasury ETF. While we expect pullbacks and corrections, we expect long term Treasuries to continue to do well as an investment over the coming several months and maybe even the next few years.  Yes, yields are low but they can go lower.

Happy Trading,

Dave@TheMacroTrader.com

Disclaimer-In our model portfolio we are long TLT

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While we have been long various risk assets over the past several months we have been very cautious and have had some short positions the entire time.  We have been very defensive due to the plethora of indicators pointing to an economy that at best was going nowhere for the majority of 2010.  The reality is that as time has gone on we have seen more and more indicators deteriorate showing that money for the real economy is tight, employment is worsening, risk assets are overpriced, demand is not there, etc.   This basic outlook has served us well as our newsletter model portfolio has generated positive returns with very low drawdowns so far this year.

Here are two indicators that show that their is a very high likelihood that we are headed for not just a slowdown but a recession.  The two indicators are the PMI and the ECRI WLI growth rate.  As much as the ECRI has been trying to say that they aren’t calling for a recession we and several other analysts find a lot of use in looking at it.  We think that the main reason for some of this controversy is that the folks at ECRI think that Hussman and Rosenberg are using it as a mechanical model and that if it does X then Y will happen.  Instead we are confident that most analysts look at it as another tool in the toolbox, albeit a very good one.  Like inflation, interest rates, industrial production, etc.  it is but a piece in the puzzle. At least that is how we use it.

Looking at the ECRI WLI growth rate and the PMI on the same chart you can see that the WLI tends to lead the PMI by roughly three months.  Not only does it tend to lead but with a few exceptions it does a pretty good job of showing the magnitude of the future move of the PMI.  Looking at the chart right now it appears as though the PMI is headed to a level below 50 and we would not be surprised to see it down to 40.  These levels tend to be not just slowdowns but recessionary.

ECRI WLI Growth and PMI

Happy Trading,

Dave@TheMacroTrader.com

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One of the many reasons why markets have been falling is due to the fact that the money supply has not kept up with the economy.  After stoking the fire in a big way during the crisis with bailout money, stimulus, and QE the economy finally started to take off.  At first the different forms of stimuli were doing enough but over the past few months it appears as though they have stopped keeping up with demand.  Now instead of enough, and arguable too much money in the streets the situation has reversed and now there is not nearly enough money out there to make up for the surge in economic output let alone to find its way into the markets.

In the chart below we have an indicator that measures the real money supply growth against economic output to determine if there is adequate money to sustain current economic growth and for the markets (This indicator came from a NDR chart we saw somewhere several years ago).  What we have done is take the year to year change in industrial production and subtract it from the year to year change of the real money supply using M3* data.  As you can see in the chart, money supply relative to industrial production has taken a huge dive indicating that we either need more QE, more government spending, or we will likely see a dip in output.

Real Money Supply (M3) minus Industrial Production (Year-to-Year Changes)

Happy Trading,

Dave@TheMacroTrader.com

P.S.-Since M3 has been discontinued by the Fed we are now using the M3 data from NowandFutures which has reproduced it with a correlation of .99999 to the old M3 data.

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What historically is one of the major drivers of construction and the housing market?  If you answered interest rates you are correct.  So lets look at housing rates right now.  Here is a chart of the 30-Year fixed rate.

30-Year Fixed Rate

What about real yields?  After all a few months back we showed how real rates were at multi year highs.  Well that time has passed as rates are once again close to 30 year lows.

Real 30-Year Fixed Rate

With interest rates this low you would think that we would at least be seeing decent sales growth if not record breaking.  And yet as the numbers showed today the sales are not coming.  Look at the chart below.  The red line is the all time low which happens to be from the most recent release.  Fewer homes were sold in April then in any other time in at least the last 50 years.

New Home Sales

Right now it seems as though our long held deflationary beliefs are correct and that the economy still has too large of a gap to be expecting any real inflation.  We will of course see how this all turns out but anytime you have near record low interest rates and new record lows in housing sales it definitely does not bode well for the economy.  Double dip here we come.

Happy Trading,

Dave@TheMacroTrader.com

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Today while looking at the exhaustion rate the thought occurred to me that five or six months ago everyone and their dog (including me) were talking about the exhaustion rate.  Of course this was because in normal times no one looks at it as it rarely is at an extreme.  This time however it was hitting new highs.  After getting a lot of press for a few weeks the exhaustion rate kind of faded back into the depths of the Department of Labor stats department.

Why did it fade from glory?  As best I can tell it faded because it kept telling the same story month after month.  That story is the fact that the exhaustion rate has remained at its all time high levels for the past 10 months staying above 50 the whole time.  (Click on chart to enlarge)

Exhaustion Rate

After looking at the exhaustion rate I went over to the BLS stats that show how many people are unemployed and for how long.  First off  of course is the unemployment rate.  As you can see it is at 9.7% slightly down from the cycle high of 10.2%.  (Click on chart to enlarge)

Unemployment Rate

Next up is the number of people who have been unemployed for 15 weeks or more.  As you can likely guess from the exhaustion rate the number is quite high.  We took this number a step further and calculated the number of people unemployed for 15 weeks or more as a percentage of the labor force. As you can see in the chart below 5.78% of the labor force has been unemployed for 15 weeks or more.  (Click on chart to enlarge)

Unemployed 15+ Weeks Or More As A Percentage Of The Labor Force

Finally lets look at the number of people unemployed for 27 weeks or more as a percentage of the labor force.  As you can imagine by the previous charts, most notably the exhaustion rate, this number is quite high and is at all time highs almost double the previous peak. (Click on chart to enlarge)

Unemployed 27 Weeks Or More As A Percentage Of The Labor Force

So why aren’t these numbers with the exception of the unemployment rate getting much press lately?  Well there are likely a variety of reasons but the most likely reason I could come up with is that they have not changed.  The employment situation has been bad and getting worse for over a year now. So while they can try and spin the weekly initial claims number any way they want the underlying problems are not improving.  If this recovery is real, meaning we don’t fall into a double dip recession, then we are going to need to see more than just a token improvement in the employment numbers.

Happy Trading,

Dave@TheMacroTrader.com

P.S. The idea for weeks unemployed as a percentage of the labor force was from a chart we saw at EconomPic.  If you like mainstream and obscure economic numbers as well as different ways to look at them then you should mark Jakes site as a daily read.

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Some of the more useful liquidity indicators are the different money market spreads.  Typically when the financial system is feeling stress  we will see spreads rise as banks become hesitant to even lend to each other due to counter party risk and general uncertainty.  We saw this in the 1987 crash, in the 90-92 recession, in the bond market route of 94, in the .com crash, and then in the crash of 2008.  A rise in spreads does not guarantee a crisis or crash but we have seen higher spreads during each crisis.

Right now we are seeing what could be the beginnings of a new liquidity crisis or maybe just the second leg of the last crisis.  If spreads were rising just due to a weakening economy then we would not be overly concerned as these events take some time to really move lower.  Right now however we have a huge mess that goes by the name of the EU.  We are not necessarily saying that 2008 part 2 is upon us but we are saying that this is a real cause for concern, basically the rise in spreads is anything but bullish and as it reinforces our view that this is not just a normal correction but instead could be the start of something a lot worse.

Money Market Spreads

Happy Trading,

Dave@TheMacroTrader.com

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One of the strongest inflation/deflation indicators is the bond market.  When inflation is expected to be high yields tend to go up and when the market expects deflation/disinflation yields tend to be low.  So what are the markets telling us right now?

First lets look at the two year yield.  After all if hyper inflation is right around the corner it would make sense that we might see some of that in the short end of the curve.  As you can see in the chart below the 2-Year is not signaling higher inflation anytime soon.

2-Year Treasury Yield

Maybe looking at the long end of the yield curve would give a signal.  After all if gold is climbing inflation must be almost here, right?  Looking at the chart it would appear as though the market is not expecting much.

30-Year Treasury Yield

Lets give this all one more chance.  What are TIPS showing us?  Surely if hyper inflation is upon us inflation protected bonds would give us a sign.  Looking at the 10-Year breakeven rate it appears as though inflation expectations are in fact dropping instead of rising.

10-Year Breakeven Rate

Apparently many investors are reading things a bit wrong.  Gold is not going higher due to fears of imminent inflation.  Right now gold is almost purely a currency trade right now.  With the problems in Europe investors are scared of government and instead have been going to the shiny stuff as a perceived safe asset.

Inflation will come at some point down the road but it is not right around the corner.  Whether you are looking at bond yields, commodity prices, the CPI, housing, or Fed statements we are seeing the same signals, and they are almost all pointing towards deflation/disinflation and not inflation.

Happy Trading,

Dave@TheMacroTrader.com

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With the recent rise in LIBOR we have been reading a lot of concerns over what it all means.  The two main arguments that we have seen is that either it is due to liquidity concerns or it is due to the supposed recovery in the United States economy.  For many reasons we obviously fall on the side of this being led by fear and liquidity rather than due to a recovery and an expectation of the Fed raising rates anytime soon.

3-Month LIBOR

The first thing that would lead us to assume that this is due to panic and not recovery is the way in which LIBOR is rising.  What we mean is that if you compare it to T-Bills it usually trades very much in line except in times of fear.  Looking at the chart below you can see that the last three times that it has diverged was also when we had banking system fears.  The top in the summer of 2007 which kind of started off the whole mess, fall of 2008 when the world seemed to be falling apart in front of us, and then in late winter 2009 when we already had the ZIRP in place but it looked like things might be getting even worse.  Of course once things got back on track and the end of the world as we know it was at least postponed the relationship got back in line with LIBOR at a slight premium to T-Bills like regular times.  Another thing that we find odd is that if LIBOR is rising on a recovery then why aren’t T-Bill or  2-Year Treasury yields climbing?  Would bond investors not drive yields higher if they thought this recovery had legs?

3-Month LIBOR and T-Bills

Looking at other money market spreads shows much of the same thing.  Namely that spreads are going up, this by the way is usually not a good thing.  Looking at the TED spread, LIBOR-OIS spread, and 90-day commercial paper-T-Bill spread you can see that they have all been climbing since the Greece and EU problems really started to gain some attention.

Money Market Spreads

Now lets look at some spreads in other nations.  It should come as no surprise that they are also on the rise.  In the first chart we have the EURIBOR-OIS spread, after spiking higher it has continued to inch its way basis point by basis point wider and wider.

EURIBOR-OIS

Next up is the TIBOR-OIS spread.  As you can see it is also rising although a lot slower then in the US or in the EU.  As we will see in a few charts however that is how it always is.

TIBOR-OIS

Finally we have the UK LIBOR-OIS spread. Again it should not be much a surprise that it too has been climbing quite a bit.  The UK is weak and its nearest mega-economy the EU is weaker.  Banks are and should be scared.

UK LIBOR-OIS

Looking at the three spreads over the last few years you can see in the chart below that the global banking crisis affects them all.  Another thing worth noting is that Japans spread (the yellow line) may be rising slower but the swings have been far more muted the whole time.  Of course Japan has been dealing with a broken banking system for almost two decades now.

EURIBOR-OIS  TIBOR-OIS  UK LIBOR-OIS

We will end this post with one last indicator that we follow closely and that is the VIX.  This volatility index is simply an average of stock, bond, currency, and commodity volatility indexes.  If most asset classes are seeing an increase in volatility it rises and if most are declining it goes down.  As you can see in the chart below it has been going up the last few months as many market participants are once again focusing on risks.

Average VIX

In closing we have many concerns in our current situation.  Some pundits claim that markets are headed higher and that we are under estimating the recovery.  They say that everyone is too worried and that the fundamentals are strong.  We apparently are looking through an entirely different lens.  With the EU continuing to deteriorate we cant help but wonder how investors can look at the rise in LIBOR as anything but bad.  While Greece is indeed a small nation the Euro is what is at stake.  Yes, the same Euro which is probably the biggest economic experiment of the last 30+ years.  In addition to the EU we have “regular” geo-political concerns as well like Iran, the Korea’s, and our future energy supply.  So while we could of course go higher we definitely should be concerned.

Happy Trading,

Dave@TheMacroTrader.com

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In the investment world it should be no surprise to anyone anymore that outlying events actually happen with a decent amount of regularity. Looking at the past 12 years we have had the Asian Contagion, Russian Default, LTCM, .Com crash, housing crash, and the subsequent crash of everything else. Most of these are one in a gazillion year type events and yet they all happened inside of 12 years. Statistics while useful, are not able to perfectly model the real world.

So mixing stats with history let us look at the MOVE Index. The MOVE Index, essentially the bond markets VIX, typically trades between 128 and 79. Anything outside of those two lines is at least one standard deviation from the mean. As you can see in the chart below we are currently more than one standard deviation below the mean and look to be headed lower. (Click on chart to enlarge)

MOVE Index

Of course the interesting thing about the MOVE Index is not what level it is at but what tends to happen when it reaches certain levels.  Essentially whenever the MOVE Index drops below one standard deviation something blows up. Apparently bond market investor complacency is a better gauge of “too complacent” than other volatility gauges.

Drops below the lower one standard deviation have preceded the following events

-First Gulf War

-Asian Contagion

-LTCM bailout/Russian Default

-.Com tech crash

-Housing/Credit crisis

While it is not a crystal ball, see the extended period below one standard deviation preceding the credit crisis, the MOVE index is still a good risk gauge with a solid track record of saying investors are too risk averse or that we are too complacent and therefore not really aware of the risks on the horizon.  Consider this the yellow light, its not saying stop but its not saying go either.

Happy Trading,

Dave@TheMacroTrader.com

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One of the many indicators that we track is that of the Los Angeles and Long Beach port data.  Combined these two ports handle almost 50% of the shipping traffic for the United States so they are obvioulsy useful in order to follow global trade.  As you can see in the chart port data s very seasonal.  You can see that total trade (the green line) typically peaks in October and typically bottoms in February.  Sometimes this cycle is off by a month in either direction but for the most part it’s very consistent. (Click on chart to enlarge)

LA and Long Beach Port Data

While total shipping volume, outbound plus inbound containers, is down over 25% from the peak back in September of 2007 it is important to look at the same month due to seasonality.  Looking at shipping volume from Feb 2010 against the peak Feb in 2007 shipping is down -13.7% or 118,562 containers.

So is trade improving or getting worse?  By breaking the data down into performance by month we can see if this January and February are better or worse than other years.  In the chart below you can see that for 2010 Jan and Feb were both actually slightly above their historical averages.  The average January sees traffic shrink by -3.10% and this year it only shrank by -3.05%.  February sees an average decline of -4.42% and for 2010 it only declined -2.89%. (Click on chart to enlarge)

Port Data Seasonality For Jan And Feb

Frankly right now the data isn’t screaming at us.  Numbers are coming in close to the historical norms but overall there is little to get too worked up about. Basically port data is currently telling us that the recovery is still in progress but that nothing is really improving or declining.  What would be a constructive sign would be to see March where we have a historical average increase of 10.69%.  A large miss would be a bad sign while an average or even slightly higher number would be considered by us to be very bullish.

Happy Trading,

Dave@TheMacroTrader.com

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