Juggling Dynamite

This is just the beginning of a broader downturn for commodities, according to Lakshman Achuthan, co-founder of the Economic Cycle Research Institute. Achuthan said it all comes down to cycles and this point of the cycle indicates a move lower. Cycles in global industrial growth are closely linked to cycles in industrial commodity prices, including lumber,” Achuthan told CNBC’s Trading Nation on Wednesday. “While I know — lumber notwithstanding — people are still pretty bullish on commodities, with a cyclical downturn in global industrial growth getting underway things are going to shift the other way.”  Here is a direct video link.

Along with this cycle change in commodities, the USD has risen against the loonie since we added it back to our portfolios in June.  Now at 1.26USD, the next upside test is the 1.30 area as noted in my partner Cory Venable’s chart from June 30 shown below.

John Hussman’s July letter kicks off with a timeless John Galbraith quote:

And so on to the moment of mass disillusion and the crash. This last, it will now be sufficiently evident, never comes gently. It is always accompanied by a desperate and largely unsuccessful effort to get out. The least important questions are the ones most emphasized. What triggered the crash?

This is not very important, for it is in the nature of a speculative boom that almost anything can collapse it. Any serious shock to confidence can cause sales by those speculators who have always hoped to get out before the final collapse, but after all possible gains from rising prices have been reaped. Their pessimism will infect those simpler souls who had thought the market might go up forever but who now will change their minds and sell.

With the greenback and Treasuries surging while lumber futures slice below $500 a thousand board feet this afternoon, some big picture is worth a mull.  Read:  What Triggered The Crash?  Here’s a taste:

A market crash requires nothing more than a shift in investor psychology from careless speculation to even modest risk-aversion. A market crash requires nothing more than an increase in the risk premium demanded by investors, in an environment where risk premiums have become overly depressed.

At some point, enough investors stop basing their expectations for future returns on the mindless extrapolation of past returns, in a market where prices have become detached from fundamentals. At some point, investors discover a basic fact of equilibrium: it is impossible, in aggregate, for investors to “exit” the market. Every single share of stock that has been issued has to be held by some investor, at every moment in time, until it is retired.

Lost in the incoherent blather about “cash on the sidelines,” “money flowing into the market,” and liquidity needing to “find a home,” there is a basic fact of equilibrium: once a security has been issued, it has to be held by someone, exactly in the form it was issued, until it is retired. Every dollar bill. Every share of stock. Every bond certificate. All of them are already home. They can’t magically turn into something else. Not a single dollar comes “into” the stock market that does not simultaneously come “out.” Not a single share is purchased that is not simultaneously sold. Every eager buyer must find a seller. Every eager seller must find a buyer. Either way, the buying always equals the selling. It’s not “money flow” that moves prices around. It’s eagerness.

With valuations at the most extreme level in history, the one thing that the market simply cannot tolerate is the eager attempt of a substantial number of investors to exit. When the walls come down, investors will scavenge the news for “catalysts.” Don’t fall into this trap. Undoubtedly, some “catalyst” will be found, but the mistake will be in believing that the collapse is caused by that piece of “bad” news. The important question to ask is “What drove the bubble?” That’s where the lessons are. The root causes of a crash are always the factors that nurtured and encouraged the “happy” period of carefree and irresponsible speculation that led to the bubble extreme…

June’s US consumer price index (including clothes, groceries, restaurant meals, recreational activities and vehicles) increased 5.4% from a year ago, the highest 12-month rate since August 2008.  The so-called core price index, which excludes food and energy, rose 4.5% year over year.  The seasonally adjusted 0.9% rise in June from May was the largest one-month change since June 2008 (a price peak that cycle).

Accelerating prices for new and used cars (driven by a surge in demand and constricted supply during the pandemic) and gains in prices for lodging and transportation services, including car and truck rentals (reopening components), contributed to the vast majority of the core CPI increase.  As shown below, since 2018, core CPI (ex reopening and chip shortage components) has actually been declining since April (blue bars).   Lest anyone forget, vehicles are the largest ticket item in the durable goods category, and durable goods are so-named because they last longer than three years.  By definition, then, record durable goods demand over the last year is unlikely to be repeated for a few years, at least.

As David Rosenberg noted yesterday, the S&P 500 household durable goods stock composite has sagged nearly nine percent from the nearby highs as service spending picks up:

“…this is important since the former represents a US$2.4-trillion chunk of GDP, or four times the size of the latter. And within the “reopening” subsectors, only retailing and restaurants are behaving well, while office real estate investment trusts, airlines, hotels and casinos have rolled over considerably.”

According to the Conference Board, consumer plans to purchase a vehicle in the next six months remain down year-over-year, and the index of consumer sentiment from Morning Consult ended June (down 0.6% from May, which ended down 0.9% from April) 12.1% below Feb. 29, 2020 levels.  As shown on the left, auto auction data suggest that used vehicle prices are now likely to move lower in the months ahead, as pent-down appetite weighs.

Slowing demand is already evident in weakening economic surprise indices for the world’s largest economies since last summer, as shown below.  First-in and out of COVID-19 shutdowns, the weakening in China’s economy and price data year-to-date is noteworthy and prompted a surprise decision from China’s central bank (PBOC) last week to try and expand lending by lowering reserve requirements (RRR) for its banks effective July 15.  The PBOC is now expected to deliver further cuts in the RRR as pressure on the economy persists, and consumer inflation eases (latest Reuters poll).

As with North American Treasury yields, the 10-year yield in China has been falling again since March 2021, and at 2.92%, remains well below its 3.22% level before the global recession hit in early 2020 (shown on the left).

At the same time, lumber continues to deflate with futures at $558 per thousand board feet this morning, down 67% since early May, as demand cools and production expands.

The US dollar has been strengthening against the basket of its major trading partners since May.  A rising dollar is deflationary for America but inflationary for those importing its goods.  This adds to headwinds for developing economies like Russia, Brazil, Turkey and many others who then find they need to raise interest rates to support their currencies and combat a rising cost of goods–slowing the global economy in the process.

Central banks and record levels of debt have not arrested the economic/financial cycle–what magnified the up will also magnify the down.  Understanding this is essential risk management.