Tag Archives: Sentiment

NFIB Survey Trips Economic Alarms

Last week, I wrote an article discussing the August employment report, which clearly showed a slowdown in employment activity and an overall deterioration the trend of the data. To wit:

“While the recent employment report was slightly below expectations, the annual rate of growth is slowing at a faster pace. Therefore, by applying a 3-month average of the seasonally-adjusted employment report, we see the slowdown more clearly.”

I want to follow that report up with analysis from the latest National Federation of Independent Businesses monthly Small Business Survey. While the mainstream media overlooks this data, it really shouldn’t be.

There are 28.8 million small businesses in the United States, according to the U.S. Small Business Administration, and they have 56.8 million employees. Small businesses (defined as businesses with fewer than 500 employees) account for 99.7% of all business in the U.S. The chart below shows the breakdown of firms and employment from the 2016 Census Bureau Data.

Simply, it is small businesses that drive the economy, employment, and wages. Therefore, what the NFIB says is extremely relevant to what is happening in the actual economy versus the headline economic data from Government sources.

In August, the survey declined 1.6 points to 103.1. While that may not sound like much, it is where the deterioration occurred that is most important.

As I discussed previously, when the index hit its record high:

Record levels of anything are records for a reason. It is where the point where previous limits were reached. Therefore, when a ‘record level’ is reached, it is NOT THE BEGINNING, but rather an indication of the MATURITY of a cycle.” 

That point of “exuberance” was the peak.

It is also important to note that small business confidence is highly correlated to changes in, not surprisingly, small-capitalization stocks.

The stock market, and the NFIB report, confirm risk is rising. As noted by the NFIB:

“The Uncertainty Index rose four points in August, suggesting that small business owners are reluctant to make major spending commitments.”

Before we dig into the details, let me remind you this is a “sentiment” based survey. This is a crucial concept to understand.

“Planning” to do something is a far different factor than actually “doing” it.

For example, the survey stated that 28% of business owners are “planning” capital outlays in the next few months. That’s sounds very positive until you look at the trend which has been negative. In other words, “plans” can change very quickly.

This is especially the case when you compare their “plans” to the outlook for economic growth.

The “Trump” boom appears to have run its course.

This has significant implications to the economy since “business investment” is an important component of the GDP calculation. Small business “plans” to make capital expenditures, which drives economic growth, has a high correlation with Real Gross Private Investment.

As I stated above, “expectations” are very fragile. The “uncertainty” arising from the ongoing trade war is weighing heavily on that previous exuberance.

If small businesses were convinced that the economy was “actually” improving over the longer term, they would be increasing capital expenditure plans rather than contracting their plans. The linkage between the economic outlook and CapEx plans is confirmation that business owners are concerned about committing capital in an uncertain environment.

In other words, they may “say” they are hopeful about the “economy,” they are just unwilling to ‘bet’ their capital on it.

This is easy to see when you compare business owner’s economic outlook as compared to economic growth. Not surprisingly, there is a high correlation between the two given the fact that business owners are the “boots on the ground” for the economy. Importantly, their current outlook does not support the ideas of stronger economic growth into the end of the year.

Of course, the Federal Reserve has been NO help in instilling confidence in small business owners to deploy capital into the economy. As NFIB’s Chief Economist Bill Dunkleberg stated:

“They are also quite unsure that cutting interest rates now will help the Federal Reserve to get more inflation or spur spending. On Main Street, inflation pressures are very low. Spending and hiring are strong, but a quarter-point reduction will not spur more borrowing and spending, especially when expectations for business conditions and sales are falling because of all the news about the coming recession. Cheap money is nice but not if there are fewer opportunities to invest it profitably.”

Fantasy Vs. Reality

The gap between those employers expecting to increase employment versus those that did has been widening. Currently, hiring has fallen back to the lower end of the range and contrasts the stats produced by the BLS showing large month gains every month in employment data. While those “expectations” should be “leading” actions, this has not been the case.

The divergence between expectations and reality can also be seen in actual sales versus expectations of increased sales. Employers do not hire just for the sake of hiring. Employees are one of the highest costs associated with any enterprise. Therefore, hiring takes place when there is an expectation of an increase in demand for a company’s product or services. 

This is also one of the great dichotomies the economic commentary which suggests retail consumption is “strong.” While business remain optimistic at the moment, actual weakness in retail sales is continuing to erode that exuberance.

Lastly, despite hopes of continued debt-driven consumption, business owners are still faced with actual sales that are at levels more normally associated with the onset of a recession.

With small business optimism waning currently, combined with many broader economic measures, it suggests the risk of a recession has risen in recent months.

Customers Are Cash Constrained

As I discussed previously, the gap between incomes and the cost of living is once again being filled by debt.

Record levels of consumer debt is a problem. There is simply a limit to how much “debt” each household can carry even at historically low interest rates. In turn, business owners remain on the defensive, reacting to increases in demand caused by population growth rather than building in anticipation of stronger economic activity. 

What this suggests is an inability for the current economy to gain traction as it takes increasing levels of debt just to sustain current levels of economic growth. However, that rate of growth is on the decline which we can see clearly in the RIA Economic Output Composite Index (EOCI). 

All of these surveys (both soft and hard data) are blended into one composite index which, when compared to GDP and LEI, has provided strong indications of turning points in economic activity. (See construction here)

As shown, the slowdown in economic activity has been broad enough to turn this very complex indicator lower.

No Recession In Sight

When you compare this data with last week’s employment data report, it is clear that “recession” risks are rising. One of the best leading indicators of a recession are “labor costs,” which as discussed in the report on “Cost & Consequences Of $15/hr Wages” is the highest cost to any business.

When those costs become onerous, businesses raise prices, consumers stop buying, and a recession sets in. So, what does this chart tell you?

Don’t ignore the data.

Today, we once again see many of the early warnings. If you have been paying attention to the trend of the economic data, and the yield curve, the warnings are becoming more pronounced.

In 2007, the market warned of a recession 14-months in advance of the recognition. 

Today, you may not have as long as the economy is running at one-half the rate of growth.

However, there are three lessons to be learned from this analysis:

  1. The economic “number” reported today will not be the same when it is revised in the future.
  2. The trend and deviation of the data are far more important than the number itself.
  3. “Record” highs and lows are records for a reason as they denote historical turning points in the data.

We do know, with absolute certainty, this cycle will end.

“Economic cycles are only sustainable for as long as excesses are being built. The natural law of reversions, while they can be suspended by artificial interventions, cannot be repealed.” 

Being optimistic about the economy and the markets currently is far more entertaining than doom and gloom. However, it is the honest assessment of the data, along with the underlying trends, which are useful in protecting one’s wealth longer-term.

The Dreaded “R” Word

In early July, Michael Lebowitz appeared on Real Vision’s, “Investment Ideas” (LINK), with Edward Harrison. In the interview, Michael stated that the window for a recession was open but that a recession was not necessarily imminent. He based this opinion on the premise that the benefits of increased government spending and recent tax reform are waning and economic headwinds such as China-U.S. trade discussions, slowing European growth, Iran, and a disorderly BREXIT are all serving to slow the growth of the economy. Importantly, he warned that historically the catalyst for recession is often something that is not easy to forecast or predict.

Over the last month, we have noted the “R” word increasingly bandied about by the media. This potential recession catalyst is in everyone’s face, literally, but few recognize it.

Consumers Drive the Bus

Almost 70% of U.S. GDP results from personal consumption. Since 1993, retail sales and GDP have a correlation of 78%, meaning that over three-quarters of the quarterly change in GDP is attributable to the change in retail sales.  

The table below shows the dominant role consumption plays in the GDP calculation. In this hypothetical example, 2.5% consumption growth more than offsets a 4% decline in every other GDP category (an increase in net exports negatively affects GDP). If in the same example consumption was 1% weaker at +1.5%, GDP would go from positive .12% to negative .58%.

Spending decisions, whether for low dollar items such as coffee or dinner or bigger ticket items like a new TV, vacation, or housing, are influenced by our economic outlooks. If we are confident in our job, financial situation, and the economy, we are likely to maintain the pace of consumption or even spend more. If we fear an economic slowdown with financial repercussions, we are likely to tighten our purse strings. Whether we skimp on a cup of Starbucks once a week or postpone the purchase of a car or house, these one-off decisions, when replicated by the masses, sway the economic barometer.

Our economic outlooks and spending habits are primarily based on gut analysis, essentially what we see and hear. Accordingly, print, television, and social media play a large role in molding our economic view.

Recession Fear Mongering

Increasingly, the media has been playing up the possibility of a recession. For example, on August 15, 2019, the day after the yield curve inverted for the first time in over a decade, the lead article on the Washington Post’s front page was entitled Markets Sink on Recession Signal. The signal, per the Washington Post, is the inverted curve. The New York Times followed a few days later with an article entitled How the Recession of 2020 Could Happen. Since mid-August, the number of articles mentioning recession has skyrocketed, as shown below. Furthermore, the number of Google searches for the “R” word has risen to levels not seen since the last recession.

Data Courtesy Google Trends

We have little doubt that the media airing recession warnings are partially politically motivated, but regardless of their motivation, these articles present a growing threat to the consumer psyche and economic growth. 

The more the media mentions “recession,” the higher the likelihood that consumers will retrench in response. Small decisions like not going out to dinner once a week may seem inconsequential, but when similar actions occur throughout a population of hundreds of millions of people, the result can be impactful.  To wit, in The Dog Whistle Heard Around the World, we personalized how our decisions play an important role in measuring economic activity:

Picture your favorite restaurant, one that is always packed and with a long waiting list. One Saturday night you arrive expecting to wait for a table, but to your delight, the hostess says you can sit immediately. The restaurant is crowded, but uncharacteristically there are a couple of empty tables. Those empty tables, while seemingly insignificant, may mean the restaurant’s sales that night will be down a few percent from the norm.

A few percent may not seem like a lot, but consider that the average annual recessionary GDP trough was only -1.88% for the last five recessions.

If economic growth is starting from a relatively weak point, as it is today, then it requires even smaller reductions in consumption habits than in the past to take the economy from expansion to contraction. GDP growth before the last three recessions peaked at 4.47%, 5.29%, and 4.32% respectively. The recent peak in GDP growth was 3.13%, leaving at least 25% less of a cushion than prior peaks.


Recessions are difficult to predict because they are usually borne out of slight changes in consumer behavior. Needless to say, changes in short term behavioral patterns are difficult to predict at best for a large population and likely impossible.  

Whether or not a recession is imminent is an open question, but the window for a recession is open, allowing a strong negative catalyst to push the economy into contraction. What if that catalyst is as simple as the media repeatedly using the dreaded “R” word?

Over the coming months, we will pay close attention to consumer confidence and expectations surveys for signs that consumer spending is slowing. We leave you with the most recent consumer sentiment and expectations surveys from the University of Michigan and the Conference Board. At this point, neither set of surveys are overly concerning, but we caution they can change quickly.

Data Courtesy Bloomberg

Technically Speaking: 5 Reasons To Be Bullish (or Not) On Stocks

Just recently, Tom Lee, head of Fundstrat Global Advisors, published a list of 5-bullish signs for the stock investors which he says you should “ignore at your own peril.” As he notes:

“In short, these signals are saying the S&P 500 is set up for a monster 2H rally. We are not ignoring the negative signal of a plunge in interest rates, nor saying that a full-blown trade war is negative for the World. But, we believe the trifecta of strong US corporates, positive White House (towards biz) and dovish Fed, are major supports for the US equity market.”

His view is that the short-term disruption of the market over “trade” issues is an opportunity for investors to increase equity exposure.

Over the last few weeks, we had discussed the excessive deviation to the market above the 200-dma, which suggested that a reversal of that extension was probable. The question now is whether Tom’s view is correct?

Are the markets set up for “monster second-half rally,” or is this just the continuation of the topping process that began last year.

While these are certainly reasons to be “hopeful” that stocks will continue to rise into the future, “hope”has rarely been a fruitful investment strategy longer term. Therefore, let’s analyze each of the arguments from both perspectives to eliminate “confirmation bias.” 

Economic Growth To Improve

No matter where you look as of late, economic growth has been pretty dismal. However, there is always hope for improvement that could support a recovery in asset prices.

“Still, many analysts remain optimistic that the U.S. economy can continue expanding even if growth slows down. The Citigroup Economic Surprise Index for the U.S., which measures broadly whether data points are meeting expectations, has risen sharply in recent weeks.” – WSJ

After a recent slate of feeble economic data points, the improvement should come as no real surprise. The quarterly, or annual comparisons, can certainly show some improvement. However, it should be noted the improvement is still within the context of a very negative environment, or rather, the data is just “less negative,” rather than “positive.” 

This can be seen more clearly in our economic composite index, which is a broad measure of the U.S. economy including both the service and manufacturing sectors.

The problem for the bullish case is that 10-years into the current advance, there is little lifting power for monetary policy at this juncture. Yes, lower rates from the Fed could indeed provide a short-term bump to markets based solely on momentum. However, the ability to pull-forward accelerated rates of consumption to increase economic growth is much less likely. Most likely, the short-term increase in “less negative” data will turn lower as we move further into the year.

Volatility Signals A Bottom?

Volatility, as measured by the volatility index, spiked up recently. For the bulls, the spike in volatility has been a “siren’s song,” to “buy the f***ing dip.” This has been a winning strategy for investors over the last 10-years.

Is this time different? Take a look at the chart below. The volatility index is inverted for clarity purposes. The red vertical dashed line is when the monthly sell signal was issued, suggesting a reduction in equity risk in portfolios. The blue vertical dashed line is when the volatility index bottomed with extreme complacency and volatility begin a regime of trending higher.

The change in the trend of the volatility, trending lower to trending higher, is a hallmark of previous bull market peaks. 

While the market is short-term oversold, combined with a surge in the VIX, the market will likely bounce short-term.  However, with volatility now trending higher, that rally could be short-lived if a larger corrective cycle is beginning to take hold.

Earnings Not That Bad

“For Q2 2019 (with 77% of the companies in the S&P 500 reporting actual results), 76% of S&P 500 companies have reported a positive EPS surprise and 59% of companies have reported a positive revenue surprise.” – FactSet

On an operating basis, corporate earnings are providing the bulls boost of optimism, as hopefully, the “trade war” impact is limited. Earnings are strong, so prices should be higher.

Here’s the problem with that analysis.

As shown, for 76% of companies to beat estimates, those estimates had to be dramatically lowered. More importantly, as shown in the chart below, if we look at corporate profits for all companies, a more dire picture emerges. (The chart below strips out the profits from the Federal Reserves balance sheet.)

Despite a near 300% increase in the financial markets over the last decade, corporate profits haven’t grown since 2011. Importantly, corporate profits, have turned lower in the first quarter and that slide is continuing into the second. I have compared corporate profits, less Federal Reserve, to the Wilshire 5000 for a more comparative index.

The slide in corporate profits suggests weaker asset prices in the future as the economy, and ultimately corporate profits, continue to slow.

Sentiment Is Bearish

As Tom Lee noted in his “plea” for investors to “buy equities,” investor sentiment, very short-term is indeed negative. As shown in the chart below, the spread between bullish and bearish investors (according to AAII) is currently at -26. This is indeed a pretty bearish tilt and does suggest a short-term bottom is likely.

While that statement is true, it is a VERY short-term indicator more useful for trading rather than investing.

However, on a longer-term basis, we see that investor confidence is just about as bullish as it can get with investors outlook for stock price increases over the next 12-months near the highest levels on record.

The same is true when we look at the Commitment of Traders (COT) report which shows that speculators are just about as long as they can be in the markets.

While short-term the market could indeed rally over the next couple of weeks, investor sentiment suggests that the topping process for the markets is set to continue for a while longer.

The Fed Is Cutting Rates

Another one of Tom Lee’s points is that when the Fed cuts rates, it has previously led to a positive return over the next 6-months.

That is a true statement.

The problem is that Tom Lee isn’t going to tell you to “sell” in 6-months. There will find another reason to tell you to be bullish. This is the problem with the mainstream media, the market is “always a buy” in order to keep you buying the “products” Wall Street is selling.

For investors, the outcome of the Fed cutting rates is not a function of stronger economic growth, but a response to weaker growth, declining profitability, and lower asset prices. As I wrote last week:

“This suggests that the Fed’s ability to stem the decline of the next recession, or offset a financial shock to the economy from falling asset prices, may be much more limited than the Fed, and most investors, currently believe.

The Fed has a long history of making policy mistakes which has led to negative outcomes, crisis, bear markets, and recessions.”

It is becomingly increasingly clear from a variety of inputs that deflationary pressures are mounting in the economy. Recent declines in manufacturing, and production reports, along with the collapse in commodity prices, all suggest that something is amiss in the production side of the economy.

The Fed is going to cut rates further. Unfortunately, those rate cuts are not going to lead to higher asset prices.

What Should You Do Next

With the current bull market already up more than 300% of the 2009 lows, valuations elevated, and signs of economic weakness on the rise, investors should be questioning the potential “reward” for accelerating “risk” exposure currently. \

Ultimately, stocks are not magical pieces of paper that provide double-digit returns, every single year, over long-term time frames. Just five periods in history account for almost all the returns of the markets over the last 120 years. The other periods wiped out a bulk of the previous advance.

Too often it is forgotten during that “thrill of the chase” that stocks are ownership units of businesses. While that seems banal, future equity returns are simply a function of the value you pay today for a share of future profits.

The chart below shows that rolling 20-year real total returns from current valuation levels have been substantially less optimistic. 

What is important for investors is to understand each argument and its relation to longer-term investment periods. In the short-term, Tom’s view may well be validated as current momentum and bullish “biases” persist in the markets.

However, for longer-term investors, it is worth considering the historical outcomes of the dynamics behind the financial markets currently. The is a huge difference between a short-term bullish prediction and longer-term bearish dynamics.

As Howard Ruff once stated:

“It wasn’t raining when Noah built the ark.”

The Smart Money Are Bullish On Volatility Again

At the end of 2018, the global financial markets were reeling, the S&P 500 briefly fell into official bear market territory, and fear gauges were spiking. Sure enough, the Fed started to panic and backpedal on its previously hawkish tone regarding future rate hikes and quantitative tightening. Around the same time, Treasury Secretary Steven Mnuchin summoned the “Plunge Protection Team” or PPT to help shore up the U.S. financial markets. Since then, the S&P 500 is up over 24% and mainstream investors naively think “everything is great again!”  

As a result of the Fed’s flip-flop and resulting market surge, investors are very complacent once again (“why worry? the Fed has our backs!”). For example, the Volatility Index or VIX – a popular investor fear gauge – has been below 15 for the past couple months. Unfortunately, that is a reason for concern because the VIX also hit similar low levels before the last two volatility spikes and stock market plunges in early-2018 and late-2018 (volatility spikes when the stock market falls). In addition, the “smart money” or commercial futures hedgers (who tend to be right at major market turning points), are building up another bullish position in VIX futures, just like they did before the last two spikes. At the same time, the “dumb money,” or large traders (who tend to be wrong at major turning points), have built up a large short position, like they did before the last two spikes.

Worrisome investor complacency can also been seen in SentimenTrader’s Dumb Money Confidence index, which shows that the “dumb money” in the stock market are the most confident in a decade:

Another indicator that supports the “higher volatility ahead” thesis is the 10-year/2-year Treasury spread. When this spread is inverted, it leads the Volatility Index by approximately three years. If this historic relationship is still valid, we should prepare for much higher volatility over the next few years. A volatility surge of the magnitude suggested by the 10-year/2-year Treasury spread would likely be the result of a recession and a bursting of the massive asset bubble created by the Fed in the past decade (please read my recent article about this).

As a result of the Fed’s aggressive inflation of the stock market in the past decade, the S&P 500 rose much faster than earnings and is now at 1929-like valuations, which means that a painful correction is inevitable one way or another:

While it’s tough to say for certain that a volatility spike is imminent because we’re in an artificial market that is manipulated by the Fed and other central banks, the warning signs I showed are certainly worth keeping an eye on. Undoubtedly, the conditions necessary for another market rout and volatility spike are already present – the only thing that is holding the market up is faith that the Fed will continue to guide it higher even though economic data continues to deteriorate. At some point, investors will be forced to face reality.