Welcome to Rocktober! Longtime readers know that I call October, Rocktober. It’s a tradition that started at a radio station here in St. Louis back in the 1970s, and I carry it on to this day. Well, the Fed’s Federal Open Market Committee (FOMC) has met and left rates unchanged. I could go on and on about why they did it, and what excuse they used for not hiking rates in September, but that’s all been hashed out, raked over the coals and used to beat a dead horse, so I won’t go there. So for now, let’s take a look at U.S. economic numbers, how currencies and precious metals are holding up, and the economic state of China.
A Quick Review
Several months ago, the Fed told us they were “data dependent.” So, keeping that in mind, let’s start out with a quick review of the data in September that led up to the Fed meeting on 9/21/2016. It has not been a stellar month for economic data here in the U.S. Most recently we saw Retail Sales (which are very important given that personal consumption makes up 2/3 of GDP) fall 0.3% in August, which should have included back-to-school sales, and historically has been one of the better months for Retail Sales. We also saw Industrial Production decline 0.4%, and Capacity Utilization, one of the few forward looking pieces of data, was at 74.7%. That’s just 74.7%. When the U.S. economy was cooking with gas “back in the day,” this percentage was normally above 85%. And the indices that measure the pulse of manufacturing here in the U.S. saw the index number fall significantly to 49.2, below 50, which is the line in the sand that is used to differentiate between expansion (above 50) and contraction (below 50). This is the first time this index has fallen below 50 in some time. So, all in all, this is not a good showing of data, which leads me to believe that the Fed will not hike rates.
What Does This Mean for Currencies?
While one can’t shoot from the hip and say that a no-rate-hike scenario should be good for currencies—especially ones that currently enjoy positive interest rate differentials to the dollar like the Russian ruble, Brazilian real, S. African rand, Aussie dollar and New Zealand dollar to name a few—you can imagine that fundamentals should return in earnest, and the dollar gets sold. But, we haven’t lived and traded in a truly fundamentals rule environment since before the financial meltdown, so it’s not a layup that the dollar will get sold in a no-rate-hike environment. In fact, the press conference following the rate announcement will carry more weight than the actual rate announcement.
I’ve gone on record as saying that I believe Janet Yellen will announce no rate change, and then talk dovish about the economy. That, given what we’ve seen from the data prints, is not good. I do believe, however, that she will keep the door open for a rate hike to happen at some point in the future, just not now.
Speaking of Data…
I told my dear readers of the Daily Pfennig® blog, that in this edition of the Review & Focus I would include three graphs that pretty much “tell it like it is” with regards to the U.S. economy. And so, here they are. These are graphs taken from the Fed in St. Louis, so it’s not like I made this stuff up, folks.
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US. Department of the Treasury. Fiscal Service, Federal Debt Held by Federal Reserve Banks [FDHBFRBN] from Q2 2006 – Q2 2016, retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/FDHBFRBN, September 23, 2016.
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US. Bureau of Labor Statistics, Civilian Labor Force Participation Rate [CIVPART] from Q2 2006 – Q2 2016, retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/CIVPART, September 23, 2016.
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Board of Governors of the Federal Reserve System (US), Student Loans Owned and Securitized, Outstanding [SLOAS] from Q2 2006 – Q2 2016, retrieved from FRED, Federal Reserve Bank of St. Louis; https://fred.stlouisfed.org/series/SLOAS, September 23, 2016.
Now, you tell me, why on earth would the Fed want to hike rates, knowing and seeing these graphs? I know, they could point to the Labor Markets and pound their collective chests and proclaim that they are the saviors of the Labor Markets, and that’s what they’ll hang their hats on. Well, that is as long as they don’t look under the hood at all that so-called job creation.
In the past 16 years, 94% of the net jobs created were in education, healthcare, social assistance, bars, restaurants, and retail—even though those sectors only employed 36% of America’s workforce at the start of the millennium.
Average hourly pay in these sectors, weighted by their relative sizes, has consistently been about 30% lower than in the rest of the economy.
And since typical jobs in bars, restaurants, and retail involve far fewer hours than normal, weekly pay packets for workers in these growing industries were more than 40% lower than workers in the rest of the economy. Average weekly earnings are now 3% lower than they would have been if the distribution of employment had stayed the same as in January of 2000. And that, my friends, is a look under the hood of all this job creation that the Fed is so proud of.
Gold Can’t Find Terra Firma
Well, all the talk leading up to the Fed meeting highlighted the Fed members and their opinions about the need for rate hikes, and all that talk led to the backing off rally in gold that started in January of this year. But I do want to bring something to your attention that should be underpinning gold as we move along here. The Official Monetary and Financial Institution Forum (OMFIF) has recently issued a report titled: The Seven Ages of Gold. And in the report they highlight the fact that Central Bank buying of gold has been renewed, and this marks a new “rebuilding period.”
With Central Bank purchases of physical gold at 350 tonnes per year since 2008, Central Banks have returned to the 100-year average. The OMFIF research document, “The Seven Ages of Gold,” contains detailed statistics plotting long-run changes in central banks’ policies on buying and selling gold over seven distinct periods during the past two centuries, each lasting an average of around 30 years.
The report states, “The latest ‘Rebuilding’ Period VII has been underway since the financial crisis in 2008.” So, if the average time allotted for Central Bank buying of physical gold is 30 years, and we’re only 8 years into this new “period,” then that should mean that the price of gold should be underpinned for some time going forward. Of course historical trends don’t always mean that they will repeat themselves, but I like to think they could.
So, this is as good a time as any to revisit diversification. I recently did an interview with Dennis Miller on his radio program, Miller on the Money. (He’s also known as the “retirementor,” as he is the go-to guy when it comes to information and advice for retirees or those about to retire.) We centered on diversification in that interview, and for those of you who would like to read it in its entirety, I’ll provide a link below, but first I thought I would provide you with a snippet from the interview:
I have spent the last 25 years of my life emphasizing that diversifying your investment portfolio is of utmost importance.
When I began trading foreign bonds, my boss, Frank Trotter, suggested I look up Henry Markowitz. Markowitz was known as the Father of Modern Portfolio Theory (MPT). I’ve supported his viewpoint throughout my career.
He believed the more asset classes you hold, the further out on the efficient frontier you get, and that reduces the overall risk of your portfolio, and provides a great means of return.
Each asset class should have different pricing mechanisms and unique features; differentiating them from other asset classes in your portfolio. While you may get to the point of small incremental returns, the structure makes perfect sense because the goal is to avoid catastrophic losses and gain positive returns.
These two facts bring everything to the forefront when talking about diversification:
- 94% of portfolio return is based on asset class selection.
- Diversifying in currencies and metals reduces the overall risk to your investment portfolio.
The way to value a currency is the same as valuing a stock; a currency is the “stock of the country.” If you have a set of criteria that you use to value a stock before you buy it, then adapt those criteria to currencies.
I always look at the balance sheet. Is the country a debtor or a surplus country? I look at the leadership of the country. Is it stable? Are they going to tax and spend their way into debt that’s unsustainable?
What do they have to sell that other countries would want? Countries with raw materials will always have a flow of trade that helps their balance sheet. And finally do they pay a yield on deposits? Interest rate differentials have always been a key fundamental for currencies.
When you go through that criteria for a country that you’re interested in, you’ll find that you end up with a handful of currencies that qualify. Like stocks, diversify within that handful.
Well, what do you think? Did it whet your appetite to read more? If so, you can find the rest of the interview, titled The Sky Is Falling, here.
China Takes Another Step
Hey, did you hear the news about the MSCI? Well, I say that knowing all too well that you probably didn't (unless you read the Daily Pfennig), because they tried to run this announcement under the cover of darkness, and without fanfare. I'm talking about the MSCI; you know, the huge market indices that large institutions follow? Well, according to Steve Sjuggerud, in the second week of September the MSCI announced that they had created 20 new indices that will include Chinese A-Shares (stocks), the first such inclusion in any major index of Chinese stocks. Wow! Hasn't it been just like watching a baby roll over, then become a toddler, and crawl, pull itself up and take those first steps? Then run, fall, and get back up and run some more? And so on. That's what it's been like for me to watch China these past 13 years, a time over which we've followed China and offered a Chinese renminbi deposit account. They just got past those awkward middle school years, and are heading to high school now.
And by the time you read this, the IMF will have announced the inclusion of Chinese renminbi to their Special Drawing Rights (SDRs). This is going to be huge folks. Maybe not right at first, but it could mean that a huge chunk from the dollar’s reserve currency armor is taken away. Things in China economy-wise aren’t exactly all peaches and cream right now, but that’s what happens to economies as they mature—they have excesses, and then a cleaning out of the excesses, which is where China is right now. As long as they don’t fall into the Japan/U.S. trap of thinking they can mitigate the recession with monetary policies like ZIRP, NIRP and QE, then China will be okay.
In Conclusion: Strap In and Keep an Eye On the Markets
Historically, Rocktober has been a volatile month in the markets and this Rocktober is setting up to be no different. So here’s your warning to buckle up and make sure your arms and legs remain in the vehicle at all times!