The Bank of Japan did something Friday that took the market by surprise, something the bank’s own governor had repeatedly rejected as a potential course of action. Yes, the BOJ joined the ECB and put a minus sign in front of its main policy rate, cutting interest rates into negative territory. Markets reacted as we’ve come to expect when central banks do unconventional things. The yen dropped, bonds rallied and stocks rose. Not just Japanese bonds and stocks either; basically the world was up Friday, enough to turn a negative week into a positive one, the S&P 500 up 2.5% Friday and 1.75% for the week.
The falling yen was, of course, applauded by those who think impoverishment is a pre-requisite for its opposite. And certainly negative interest rates would seem to logically reduce the demand for yen and there surely isn’t a dearth of supply so the falling yen makes perfect sense even if one doubts its efficacy. JGBs rallied on the premise that the BOJ buying more is a positive although I’ve yet to figure out how this policy would be positive for bonds if it were successful. Presumably success would include a plus sign in front of Japan’s inflation rate which last I checked wasn’t generally positive for bonds with yields trading in small fractions. The effect on US bonds was also positive with the 10 year Treasury yield ending firmly below 2%, a level it had been trading around for most of the last week.
Interesting though is that a rally in bonds is not exactly a bullish sign for the US, Japanese or global economy. If the BOJ’s policy was expected to succeed shouldn’t we have seen a rise in bond yields as higher nominal growth – real growth or inflation – is priced into the market? The bond market reaction was either a nod to the depth of the global economy’s problems, an acknowledgement that things are worse than we thought or a vote of no confidence in the new policy itself. The yield curve flattened after the BOJ’s action while a steepening would have been an indication that the bond markets expected a positive boost to nominal GDP.
Even more interesting was the movement in the TIPs market which was already in rally mode before the move by the BOJ. Rising TIPS prices – or to put it another way, falling real interest rates – reflect falling real growth expectations, a trend that persisted even Friday. For the week, TIPs were outperformed only by the longest duration Treasuries and there by only a little. In other words, the TIPs market was already sniffing out weak real growth and the BOJ’s action did nothing to change that verdict of slow growth.
Is it any wonder that real growth expectations are falling? The economic data has recently been pretty downbeat as the industrial/manufacturing/energy recession rolls on. When you take a look at our economic scorecard below you’ll find that the worse than expected reports (in red) outnumber the better than expected ones (in green) by a 2 to 1 margin. And when you tally up the negative reports versus the positive ones – not just better or worse than expected – the economy just isn’t looking very healthy right now.
| Economic Growth & Investment | Prior | Consensus | Actual | Year Over Year % Change |
| Industrial Production | -0.9% | -0.2% | -0.4% | -1.75% |
| Manufacturing | -0.1% | 0.0% | -0.1% | |
| Capacity Utilization | 76.9% | 76.9% | 76.5% | -3.2% |
| Chicago Fed Nat’l Activity Index | -0.36 | -0.22 | ||
| Existing Home Sales | 4.76M | 5.2M | 5.46M | |
| Personal Income | 0.4% | 0.2% | 0.3% | 4.40% |
| GDP | 2.0% | 0.9% | 0.7% | |
| Leading Economic Indicators | 0.5% | -0.1% | -0.2% | |
| Production | ||||
| Empire State Mfg Survey | -4.59 | -4.00 | -19.37 | |
| Philly Fed Survey | -10.2 | -4.0 | -3.5 | |
| ISM Non-Mfg Survey | 55.9 | 56.2 | 55.3 | |
| ISM Manufacturing Index | 48.6 | 49.2 | 48.2 | |
| Chicago PMI | 42.9 | 45.5 | 55.6 | |
| Dallas Fed Mfg Index | -21.6 | -14.0 | -34.6 | |
| Richmond Fed Mfg Index | 6 | 2 | ||
| Kansas City Fed Mfg Index | -9 | -9 | ||
| Consumption & Distribution | ||||
| Retail Sales | 0.4% | 0.0% | -0.1% | 2.20% |
| Less Autos | 0.3% | 0.2% | -0.1% | |
| Less Autos & Gas | 0.5% | 0.3% | 0.0% | |
| Wholesale Sales | -1.0% | -4.60% | ||
| Motor Vehical Sales | 18.2M | 18.1M | 17.3M | 2.50% |
| Consumer Spending | 0.0% | 0.3% | 0.3% | 2.90% |
| Inventories | ||||
| Business Inventories | -0.1% | 0.0% | -0.2% | |
| Inventor/Sales | 1.38 | 4.55% | ||
| Wholesale Inventories | -0.3% | 0.0% | -0.3% | |
| Inventory/Sales | 1.32 | 7.32% | ||
| Orders | ||||
| Factory Orders | 1.3% | -0.2% | -0.2% | -4.2% |
| Durable Goods | -0.5% | 0.2% | -5.1% | -0.6% |
| Ex-Transportation | -0.5% | 0.0% | -1.2% | -3.2% |
| Core Capital Goods | -1.1% | -4.3% | -7.5% | |
| Trade | ||||
| Trade Balance | $-60.3B | $-60.1B | $-61.5B | |
| Exports | -1.6% | -1.0% | ||
| Imports | -1.9% | 0.0% | ||
| Inflation | ||||
| CPI | 0.0% | 0.0% | -0.1% | 0.7% |
| less food & energy | 0.2% | 0.2% | 0.1% | 2.1% |
| GDP Price Index | 1.3% | 0.9% | 0.8% | |
| Import Prices | -0.5% | -1.4% | -1.2% | -8.2% |
| Export Prices | -0.7% | -0.5% | -1.1% | -6.5% |
| Employment Cost Index | 0.6% | 0.6% | 0.6% | 2.0% |
| PCE Price Index | 0.1% | 0.0% | 0.0% | 0.4% |
| PCE Core | 0.0% | 0.1% | 0.1% | 1.3% |
| FHFA House Price Index | 0.5% | 0.5% | 0.5% | 5.9% |
| Case Shiller HPI | 0.8% | 0.7% | 0.9% | 5.8% |
| Farm Prices | 3.4% | -2.2% | -11.0% | |
| Employment | ||||
| New Jobless Claims | 294K | 285K | 278K | -2.70% |
| Job Openings | 5.349M | 5.431M | ||
| Labor Market Conditions Index | 2.7 | 2.9 | -58.57% | |
| Non Farm Payrolls | 252K | 200K | 292K | -11.25% |
| Unemployment Rate | 5.0% | 5.0% | 5.0% | |
| Challenger Job Cuts Report | 30953 | 23622 | ||
| ADP Employment | 211K | 190K | 257K | |
| Construction | ||||
| Housing Market Index | 60 | 62 | 60 | 5.3% |
| Housing Starts | 1.179M | 1.200M | 1.149M | 6.40% |
| Housing Permits | 1.282M | 1.217M | 1.232M | 14.40% |
| Construction Spending | 0.3% | 0.7% | -0.4% | 10.50% |
| New Home Sales | 491K | 500K | 544K | 14.70% |
| Other | ||||
| Consumer Sentiment U of Mich. | 93.3 | 93 | 92 | -6.20% |
| NFIB Small Business Optimism | 94.8 | 95 | 95.2 | -5.18% |
| Consumer Confidence Conference Bd. | 96.3 | 96.0 | 98.1 |
Which all makes the reaction of the world’s stock markets more than a bit mysterious. Why would stocks rally if the economic data and the bond markets are both pointing to weaker growth? Why would stocks rally if the yield curve is flattening? The best answer I have for that is that stocks and the economy are not very well correlated in the short term. Stock prices may reflect fundamentals in the long run but they reflect all kinds of things in the short term, sometimes in a fun house mirror sort of way. It could also be as simple as the bond rally and the stock correction produced a large enough imbalance between dividend and bond yields that stocks appeared the more attractive at the moment. I’m not a fan of that theory – the S&P dividend yield is only 2% – but I heard it put forth as an excuse….er….justification….um…rationale for buying stocks last week. I guess that analyst doesn’t care for that “margin of safety” some of us demand when buying riskier equities.
It could also be that the stock market – but not the bond market – is looking through the recent economic weakness to better times on the horizon and the BOJ action was just a catalyst. We did see a few reports last week that offered some encouragement. The Dallas and KC Fed surveys were still weak but Richmond was positive if down from last month and the Chicago PMI jumped back up to the mid-50s. Durable goods orders were…well okay let’s skip that one if we’re concentrating on positives. New home sales were up 10.8% as prices eased a bit and pending home sales were up a bit. Consumer confidence was pretty good and jobless claims backed away from the 300K level. The drop in exports is moderating and imports were flat on the month.
Unfortunately, that’s about it for the positive stuff. Stocks may be trying to look through the weakness but you need some rose colored specs to bring that into focus. Bond traders are probably more clear-eyed and headed. The GDP report Friday was weak and I don’t see much reason to think the 1st quarter will improve much. Inventories were a drag in the 4th quarter and still need to be worked down. The outlook for other investment – non-residential – is not yet improving as energy and related companies continue to cut and international weakness holds back other industries. We may still avoid recession but year over year GDP growth is now down to 1.8% and falling. For now, the risks are still to the downside with some hint – or maybe hope – of a stabilization.
With no improvement in the economic outlook yet – the yield curve is still flattening, credit spreads still moving wider – the move in stocks last week may last a bit longer but I wouldn’t get too excited about it unless you still have some stock to unload. We are still in the transition period I wrote about two years ago and the strong dollar positives are not yet apparent. Intermediate and long term momentum is still negative; only short term indicators are turning higher and those only feebly. More monetary stimulus, wherever it is in the world, isn’t the answer for a global economy still trying to find a new growth path. Pay attention to bonds and ignore the sirens of the stock market.