Last month we gave 6 reasons as to why the US economy is heading into recession. A lot can happen in a month and just like that, the commodity and equity markets have rallied and “Everything is AWESOME!!!” (For those of you who have small children, the theme song from “The Lego Movie” should be stuck in your heads right about now).
This last month has brought strong rallies and an auspicious start; “bull” news is slowly over-taking “bear” news in the media as many pundits have emerged to declare the bottom in oil and equities is behind us, and predict prosperous times ahead. Before we debunk a 2016 recession and do an election year “flip-flop,” we need to look at what, why, and how this rally started, and if everything really is awesome, or if the rally deserves a sarcastic “Yeah, right!”
Before we can look ahead, we must look back. What is it that started the bear market doom and gloom prediction that could cause the economy to succumb to a recession in 2016? Firstly, the business cycle is coming to a close across the globe as the economic engine of growth is slowing down. Commodity demand is soft, and prices have been in free fall. Corporate profits are weak and industrial production is contracting across the world and in America. Seeming most important to the American economic outlook is a paucity of jobs, despite research conveying that America is nearing “full” employment.
The question then becomes – what has changed? A slew of positive economic indicators surfaced for starters. GDP was revised upward to 1.0%, exceeding the consensus at 0.4%, the ISM manufacturing indices both came in above consensus at 49.5 and 53.4, respectively, and the employment indicator, nonfarm payrolls, exceeded the consensus at 242k vs 190k. This brought on the bulls and commodity prices have had massive rebounds in a short amount of time. It is not just oil that has been making big gains, but several others, including metals and agriculture. For example, look at the iron ore chart. In the last 60 days, iron has moved from about $34 to $59, before falling back to $50 in the blink of an eye. The move in the “sleepy” iron ore market is not a “normal” bull market rally.
As the old paradoxical riddle goes-what comes first, the chicken or the egg? Industrial metals rally, then energy rallies, and then the equity markets follows with oscillating swings. Rumors and stimulus seem to imbue the most influence on large swings in how traders and hedgers are preparing for the future. We constantly preach that fear and uncertainty drives markets. Despite commodity jumps, there are continued fears in Asia as China and Japan continue to produce weak economic data, only to be followed by moves of stimulus, or moves due to the lack of stimulus.
Speaking of fear and uncertainty, recent swings in precious metals bring a unique view to recent volatility in global markets. There are many factors that swing the gold and precious metal market as currencies rise and fall, and Central Banks enter and exit stimulus plans, and monetary and fiscal policy drive lending rates, but this following chart seems to defy logic, and is worth a second look.
The Gold “coverage ratio” that shows the total number of gold claims relative to the physical gold that “backs” potential delivery requests hit a record of 542 ounces earlier in the year in potential paper claims to every ounce of physical gold. The physical to paper gold story should not in and of itself cause alarm and in no way does it tell the story of the recession, or a bottom or top of any market, but it expounds on the story that fear and uncertainty are continuing to drive current market conditions.
The boom and bust of business cycles often overshoot and undershoot expectations. As we have previously reported, the commodity cycle is often a foreshadowing tool of predicting the future tide path of economic health. We are only a quarter of the way through this New Year, and for some, the tide has brought in fears of recession, and to some the tide has already washed away those fears.
Uncertainty remains, as Japan and China look to stimulate growth, emerging markets look to reverse hard times, oil producing countries yearn for higher energy prices, and Europe is faced with the possibility of a “Brexit.”
Recession has not reached America yet, but before you pop “The Lego Movie” in the DVD player and sing along to the theme song “Everything is AWSOME!!,” know that the world economy has not magically been ameliorated overnight. In the world of economics, tides come and go rapidly, lifeguards can save your life, but at the end of the day no one can control the force of the undertow that is waiting to sweep swimmers out to sea.