Leading indicators lagging?

Dallas FED came out today and it was decidedly negative:

The negative economic data is not surprising given the overall economic weakness combined with low oil prices hitting Texas especially hard. But the data is in odds with the leading index for Texas from FRED:

The leading indicator is showing upward sloping curve with no hint of weakness. One explanation for the divergence is that leading indicators use monetary signals such as credit spread and yield curve as their components and these monetary signals are now heavily manipulated by FED. It is possible the leading indicators will not be as useful as in the past in predicting the next recession. Proceed with caution. 

Coincident and leading data for US economy is weak

This week, we had update on durable goods and housing. With the latest data points, the "hard data" average for the US economy is weak:

This type of weakness is normally associated with recession. It is still early to make this conclusion: Recession is "pervasive weakness" and a few months of below average or negative growth is not yet pervasive. On the other hand, we have ECRI leading indicator also pointing to future weakness:

Finally, the US growth barometer has stabilized but is still divergent from stock market:

Stocks remain near all time high but the backdrop is negative. It will not take much the cause a waterfall declines.

OECD Leading Indicators for January

The OECD Composite Leading Indicators for January are out. Below are results for the world's four biggest economies. Notably, only US is growing but loosing steam.

This indicator is not telling us anything we don't already know. World economy is experiencing slowdown as has been signaled by commodities and Baltic Dry Index:

The current economic expansion has been artificially boosted by bringing future demand forward. This course may be reaching its limits. 

Credit spread is increasing again

After a counter rally, the credit spread has been increasing again:

While the stocks made new highs last week on FED euphoria, the worsening credit spread signals newly arisen risk aversion. Granted, the divergence between the credit spread and SP500 has persisted longer than I expected but eventually the correlation will be established. For more about why credit spread matters, see "Why credit spread matters".

Economy looks real bad for Q1 2015

Economic data has been weak in recent months. Figure below shows how coincident economic indicators are overwhelmingly deteriorating:

There is a lot of data in this figure - taking the average shows a clearer picture:

The acceleration has been fast. The effect is also seen in the FED forecast for Q1 GDP:

Market is sheering all these negative developments. There is not even a pretense that price movements are driven or related to fundamentals other than short term interest rate. But bulls have only price momentum only on their side, the price may quickly snap down.

Households still piling into stocks

The Q4 2014 flow of funds data is available from FRED and it shows that households are still moving from bonds into stocks at record pace:

Historically, households have been dumb money: For example, households sold stocks at 2009 bear market bottom and bought bonds. This time may not be any different. If economy continues to decelerate, bonds will outperform stocks. 

I was wrong

Its been obvious for a while: my call on market peak on 12/16/14 was wrong. Since then, all major indexes have made new highs.

I was early but tide may be turning. This week saw a modest sell-off but nothing resembling panic selling. That will surely follow as it becomes obvious that US economy is not immune to global slowdown. Signs are becoming more evident:

ECRI weakly growth is stuck at -4%

Inventories to sales ratio is at recessionary levels: 

The producer price index is at level that has only been seen in recessions: 

Finally, insiders are bailing out (source: Nautilus Research):

So although I was wrong in December, I still believe that a larger correction is coming and it may just be a few weeks away. 

BDI about to roll over?

Baltic Dry Index has bounced in the recent weeks. This has given some support to shippers’ stock prices but the lift may be short lived: As Figure 1 shows the bounce is seasonal and about to roll over.  I am bulk shippers as prices are low compared to book values; but with the industry bleeding money and China slowing fast, it is prudent to wait.

Figure 1: Seasonal variations of Baltic Dry Index

Correlation between ECRI leading index and stock market

The ECRI weekly leading index growth and SP500 change track each other as shown in the plot below.

Figure 1: Correlation between ECRI LEI and SP500

The correlation is good, nearly 80%. This is not a surprising given that

1. SP500 is a component of ECRI.

2. Stock market usually reacts to other components of ECRI. For example, higher unemployment claims indicates cooling economy which drives stocks prices lower.

What is surprising is that this correlation has been broken recently. Whereas the ECRI growth has been negative, the SP500 has been making new highs. Similar broken correlations are seen other historically reliable indicators such as credit spread and SP500.

There is combination of forces at play:

1. Investors are betting that current weak data is passing and will not affect longer term prospects of US economy.

2. We are in later stages of bull market where majority of investors are all in. By definition of all in, there are no sellers, just buyers, and price keeps going up.

3. Stocks bubble is being blown by the central bank narrative. In this narrative, fundamental analysis is not important and good news may actually be undesirable.

At the same time, the rally is running on fumes. As seen by the margin debt peaking (plot below), there is little fuel left for further rally. All that is needed for sell off is a slight change in psychology where minority of investors decides to hold cash rather than stocks yielding less than 2% dividends.

Figure 2: Margin debt has peaked and is in down trend.

All time highs with weak breath

February saw a powerful risk-on rally with stocks. Notably cyclical sectors and broad market rallied reversing some of the defensive posture that has been building. This has resolved some of the glaring divergences in market. I was expecting the divergences to be resolved by pull back in large caps but for now, it is still a bull market.

So divergences remain: The credit spread is still flashing red (HYG/TLT), 1/VIX is still in the downtrend, and new highs/lows signal weakness at ATH. The market is weaker than the headline number suggests.