The following is a guest commentary from my friend, economist James Padinha. James and I have known each other since 1998, when James was a columnist for TheStreet.com. Since then we have been corresponding on a regular basis, as a check and balance to each others’ own analysis. James and I provide each other with a look at “the other side of the elephant”, so to speak, as I supply the technical backdrop while he counters with the fundamental / economic part of the equation.
James is the best economist I know. Unlike some more well-known economists, political bias does not taint James’ analysis. He objectively and intelligently tries to extract the meaning and directional implications of the latest economic data, which is precisely what I try to do every day for Asbury Research. I can tell you this: when James’ macro-economic analysis and my technical/quantitative analysis agree, we generally have a very good handle on what to expect from US financial asset prices one to to several quarters in advance.
This “guest perspective” is something new for our blog. Hope you like it.
John Kosar, CMT
Director of Research
The Lay of the Land
On November 17 Spain sold about $4.8 billion in 10-year government notes. The auction proved extremely sloppy. It drew a bid/cover of 1.54, much weaker than 1.76 last month. The yield clocked in at 6.975%, not only much higher than 5.433% in October but also the loftiest level in 14 years.
Tape bombs from Europe might continue to shell U.S. shares. But domestic macro data does not paint a picture of doom. Coincident indicators show that the economy is strengthening and leading indicators reveal an upbeat message.
Aggregate hours are up 3.1% from a year ago, while the establishment measure of non-farm payrolls is up 1.1% and the household measure of employment is up 0.9%. All three increases mark the largest or second-largest in more than 16 quarters. Final sales to domestic purchasers increased at a rate of 3.2% in Q3, the second-largest gain in more than four years. GDP has posted a larger increase for two straight quarters, and core retail sales data for October puts it on track to do so again in Q4.
Leading indicators suggest that the improvement in coincident indicators will persist. The 10-year/three-month yield curve (the yield on the 10-year Treasury note less the yield on the three-month Treasury bill) increased to 213 basis points in October, the first steepening since April. Our baseline forecast has never included a double dip and will not include a recession if this curve does not sink to at least 150 basis points and remain there for a month or two. The yield curve boasts a rich history of accurate prediction.
A recession started in Q3 1990.
- One year earlier—in Q3 1989—the 10-year/three month gap averaged nil (zero basis points).
A recession started in Q1 2001.
- One year earlier—in Q1 2000—the 10-year/three-month gap averaged 78 basis points.
A recession started in Q4 2007.
- One year earlier—in Q4 2006—the 10-year/three-month gap averaged negative 40 basis points.
In contrast, the smallest gap of the past year clocks in at 172 basis points.
Meantime nominal M2 growth has accelerated for five straight quarters, and the average year-ago increase in the past three months (10.0%) is more than twice as large as the increase in Q1 (4.5%). Additionally, the nominal M2-GDP gap has increased for four straight quarters. Also, key six-months-ahead indices from the Philly Fed have soared since August. < http://www.philadelphiafed.org/research-and-data/regional-economy/business-outlook-survey/2011/bos1111.pdf >
Price action is speaking clearly—at the moment stocks do not care about solid U.S macro data—and market participants are enamored of the plague that is Europe (note that the gap between 10-year and three-month government yields in Germany clocks in at 157 basis points). Meantime the yield on the 10-year Treasury stands at 2.01%, 29 basis points north of the recent low (the record close of 1.72% on September 22), and EUR/USD stands at 1.35, 4.7% higher than the lowest level of 2011 (1.29 in January).
It would not surprise us at all to see lower levels for the S&P 500 (1160 or less), the 10-year note (1.70% or less), and EUR/USD (1.29 or less) in the near term. We do however believe that the fear is much likelier to owe to exogenous shocks (Europe, the Super Committee, a dirty picture of Gentle Ben) than an endogenous macro event. Moreover, we think the downleg/washout can birth a landscape that includes a sharper focus on the improved U.S. economy and the higher interest rates and stock prices it warrants.
James Padinha has been forecasting and writing about the economy for 19 years. He has two degrees in economics (Cal State Chico, U.C. Santa Barbara) and his past employers include Arnhold and S. Bleichroeder, Standard & Poor’s, and Jim Cramer/TheStreet.com.