Indicator Series Vol. 9 : Transports

As a bellwether indicator for economic health, the transportation sector of the equity market tends to foresee a downturn coming. When the transports start under performing the market as a whole, it is seen as a negative. This is likely because the shipping of intermediate and finished goods has dropped off and there is less overall demand being seen on the front lines of business.


As you can easily see, since the US election transports are hurting.They are under performing the S&P 500 by over 15%. This is surely not a good sign. Keeping an eye on this divergence would be wise.


Source: WSJ Daily Shot 11.13.17


Indicator Series Vol. 8: Market Cap to GDP

The so-called Buffett Indicator, aka Market Capitalization to GDP, is a useful metric for devising whether publicly listed equities are becoming frothy in relation to total output.

fredgraph (9).png

According to the graph above, this indicator has peaked and as of it’s last reading, has fallen. A keen eye is not necessary to see what happens next. This is one of the few data points that is flying in the face of the slow and steady recovery in macro-land at the moment. Unlike the turn of the century, we do not have an excess of valueless companies IPOing in the name of the world wide web. Unlike 2008, we do not seem to have reckless lending and borrowing practices propping up a particular market.

Unlike today, these two past recessions had little to no Central Bank intervention. Food for thought.


Source: St. Louis Fed

Indicator Series Vol. 7: Relative Interest Rates

Country GDP Rough % 10 Yr Yield Weighted Yield
Germany $3,754 37% 0.46% 0.002
France $2,489 25% 0.89% 0.002
Italy $1,852 18% 2.18% 0.004
Spain $1,252 12% 1.66% 0.002
Netherlands $770 8% 0.57% 0.000
Rough EuroZone 10 Yr Yield 1.04%
US Yield 2.35%

Using a rough estimate of Europe’s 10-yr interest rates, on a weighted basis, by GDP, we can compare similar, to some degree, economies. In terms of creditworthiness, most would argue that the US stands above the Euro area because it is the world’s reserve currency. Simply according to the yield differential, that does not seem to be the case. It is clear that, here in the US, we are further along in the business/interest rate cycle than across the pond, but should that still justify such a difference in yields on sovereigns?

In normal business cycles once a developed economy gets moving and inflation starts to pick up, a central bank will start to increase the cost of borrowing to slow down the expansion of credit, and this will effect business as a whole. This should bring capital into that economy due to the better yields on their bonds. Once investors bid up bonds to take advantage, the yield should start to fall, or at least stabilize. Of course, this is not a normal business cycle any way you look at it. Central banks around the globe have been buying fixed-income securities by the truck-load to keep yields depressed-and money easy.

Despite the fact that the European Central Bank is easing at a clip much more significant than the Fed, should the yield spread still be so wide? It seems as though two conflicting theories are at play while the Central banks are hard at work stabilizing the system.

While we are different nations, we do work, invest and do business in the same connected world. This means that disparities in the most fundamental price in the markets, the price of money via interest rates, can have widespread effects. As an example, if the US were to begin a less than tightening to money and our economy held strong, our interest rates would rise and our dollar should rise as well. As investors pour capital into our borders to take advantage of a better yield, the dollar would strengthen. A strengthening dollar would make imports cheaper than they once were.

One would think that this would not be especially great for the margins of exporting countries that do significant business with the US. To combat this, they may begin to tighten monetary policy as well, narrowing the relative yield differential. While this is all well and good in theory, it does not seem to be occurring today.

The difference, I think, lies in the place at which each country resides in the credit cycle. One year ago the US 10 Year Treasury was at 1.83%. That looks a lot closer to where the Euro Zone is today. Could it be that the Eurozone is about 1 year behind the US in it’s cycle?


The graph above shows the yield of the blended Eurozone and one of the US. It seems as though the Eurozone is a bit behind the US in the credit cycle, so while the Fed is now talking about normalization, across the pond the chatter is about another year plus of QE. This has worked out well for US investors sending funds overseas into equities because of the strengthening US dollar. (As you’ll know, US returns = Foreign Equity Performance X Foreign Exchange Performance)

As an indicator, how far along in the credit cycle, and how far along in extraordinary easing tend to be helpful. As some say, “Don’t fight the Fed”, I tend to think the same in terms of investment. Easy Money = Easy Money.


Source: ECB SDW

Indicator Series Vol. 8: Employment


In any economy where productivity is not exponentially and constantly increasing, human capital – labor -is important. In our economy in the US, employment is followed with keen eyes as a proxy for health. When most of the pool of eligible workers are on a payroll, there is reason to believe in a bright future. A reasonable way of observing a broad reading of unemployment is to track the rate against a long-term “Natural Rate”.

The natural rate of unemployment is the unemployment that comes from an expanding economy where creative destruction takes place to invoke structural job losses and also frictional unemployment, where the skills are available but not matched to the right positions. As the graph above shows, when current unemployment dips below the natural rate, a sharp spike higher in unemployment tends to follow some time after.

fredgraph (1)

Lately, many a talking head have been saying that bull markets (and economic expansions) do not die of old age. As the graph above illustrates, the Fed Funds Rate tends to increase during times of below-natural-unemployment. This could very well be the catalyst in past times and in the near future.

Indicator Series Vol. 7: ISM Surveys

The Institute of Supply Management reports monthly on both manufacturing activity and non-manufacturing (services) activity through a survey of “boots on the ground” purchasing managers. A reading over 50 implies business expansion, and one below implies contraction. Below is a graph of the manufacturing survey’s expansionary reading beating out those after 2004.


While this is important, the US economy can be characterized as a service economy because roughly 2/3 of GDP comes from non-manufacturing activities. The graph below shows a massive jump to nearly 60, creating a new high post-2005.


To get the most accurate picture of GDP, we can blend these two surveys, with a 33%/67% weighting. What is certain from the graph below is that since the mid 90’s the purchasing managers index tends to fall precipitously before a recession.

Blend w recessions.png

One important thing to note here is that this is considered “soft data”. Although the ISM survey is useful as a proxy for how the purchasing managers feel and view activity, it may not translate into economic growth for any number of reasons. The graph below from the WSJ shows this discrepancy.


With the GDP proxy at 60, it is safe to say that, using these surveys, the economy is on solid ground, but the hard data is something to keep an eye on as a persistent gap will prove this survey less useful going forward.

Source: Bloomberg, ISM, WSJ Daily Shot 10.18.17

Indicator Series Vol. 6: LEI v. MA


Many market watchers know the value of the Conference Board’s Leading Economic Indicator Index. When the current release is compared to it’s own moving average, the ability to indicate economic turmoil is scary. As you can see from the graph above, since the 1960’s, whenever this index has dipped below it’s moving average of 18 months, a recession soon followed. It’s uncanny. Today’s reading does not indicate we are at a large risk of economic downturn, although an exogenous shock or a failure of this index to continue to capture it’s intended data could send the needle spinning.

Although not a panacea, this has proven reliable and is certainly worth a hard look when forming an opinion on the stage of our economy in the business cycle.


Indicator Series Vol. 5: Closed-End Fund Discounts


A closed-end fund is much like an open-end fund, in that, it is a pool of assets managed to a specific strategy. Where is differs is in it’s structure. An open0end fund creates and redeems shares at will, changing the size of the fund daily. A closed-end fund, with a few exceptions, stays the same size. How is this possible? Closed-end funds trade on an exchange. This means that, as investor emotions and expectations rule the day, a closed-end fund can materially differ from it’s underlying portfolio value, or NAV.

Why are closed-end fund discounts an indicator? When discounts are wide, say 20% on equity funds for example, they are out of favor. When the come close to Net Asset Value, they are in demand. What can cause this swing is a reach for yield (most CEFs have an unusually high distrobution). Another reason, and perhaps more importantly, is that investors stop looking for a margin of safety. A closed-end fund at a 30% discount has a much better chance at beating it’s open-end cousin in terms of performance because of this built in margin of safety. Take care to compare a fund’s discount to it’s average, though,  as a fund trading at a 15% discount vs. an average of -35% may not be a value when judged against it’s flaws. 

When investors stop valuing this margin of safety appropriately, discounts narrow and they are willing to accept less benefit. When viewed in aggregate, closed-end fund discounts (and sometimes premiums) can tell you a lot about how investors as a whole view risk, because knowing how investors perceive risk can be influential in portfolio management. As Warren Buffet so famously said, “Be fearful when others are greedy, and greedy when others are fearful.”

Source: Bloomberg