Taking stock of inventories

Another day, another new low in the euro.  Given the potential monetary fireworks that are driving the decline in EUR/USD (ECB QE!  Rate hike in the US!), the move has seemed strangely quiet.  The price action doesn't really seem consistent with large positions being put on...perhaps punters are reticent ahead of Friday's payroll figure.   Well, either that or they're just selling gold and buying bitcoin.  (That's a jest, of course...the daily volume in Bitcoin is equivalent to one modestly-sized FX ticket from a professional punter.)

Regardless, EUR/USD has broken down, and a fair amount of the volume that has gone through is probably from CTAs.   After largely stopping out of shorts (and perhaps flipping to long) over the summer, key thresholds have been breached to trigger model sell signals.

Yesterday also saw Janet Yellen re-iterate that if the economy performs well enough, the Fed will probably lift-off in December.   That's a bit like saying that if West Ham performs well enough, they might qualify for European competition next year; the proof, as the saying goes, will be in the pudding.

Yellen also made some remarks wherein she refused to rubbish the notion of negative interest rates, suggesting that it could spur bank lending.   One wonders if she has ever met Elizabeth Warren.  The lowlight of the testimony came when some congressman claimed that God wanted the Fed to wait until spring before raising rates.  It's hard to know if he was serious; either way, the comment was a total joke.

Anyhow, with fixed income continuing to roll over the 2nd vs 10th eurodollar calendar spread mentioned here a few weeks ago keeps on trucking.  It's now up 16 ticks since Macro Man first highlighted it, breaking its downtrend from the summer in the process.  Somewhere between 120 and 125 is where it's probably time to start letting a few go.


Yesterday also saw an excellent service PMI release which crushed expectations.  Did you know that this is the second largest gap between the services and manufacturing PMIs since the former survey began in 1997?  Macro Man performed a cursory analysis of the gap and could find no obvious signal for either future growth or market direction, so at this juncture it's just a statistical curiosity.  The composite ISM, meanwhile, remains in territory consistent with solid economic growth.

Obviously high frequency growth can deviate quite a bit from levels suggested by a blunt instrument such as the composite ISM, not least because of factors such as trade and inventories.  Speaking of which, US trade data was also released yesterday; the balance was largely in line, with both exports and imports declining modestly y/y.   While this might seem disappointing, the US actually doesn't look too bad in comparison with many other nations.


As for inventories, it's well known that the inventory to sales ratio has increased steadily over the past few years to levels last seen in the aftermath of the crisis.   It's hard to pin it just on things like oil; I/S ratios have increased across all three sectors tracked by the Census Bureau.

Macro Man is a big believer in the inventory cycle, so this is obviously cause for concern.  Yet the extent of the rise has been so big, dwarfing rises observed in several prior recessions, that it leads Macro Man to wonder if there is something else going on.   I/S ratios put in a secular decline for nearly two decades before the crisis, reflecting the improved information provided by the Internet and enterprise software, etc.  Perhaps firms found that inventories on the lows were just too lean?   It's hard to say, especially given the abrupt collapse in demand engendered by the crisis.   If any readers have a plausible explanation beyond "it's all a Ponzi scheme, innit", Macro Man would be glad to hear it.

As a sense check, he broke out one of his favourite indicators that he hadn't looked at in a few years, the production/inventory scatter.   This indicator generally does a nice job of capturing the economic cycle and providing insight into where we are; an expansion resides in the top-right corner, and the cycle typically progresses counter-clockwise.  Although the US is currently in expansion territory (Q3 is in red), it was flirting with a slowdown earlier this year.

Ultimately, the inventory cycle is likely to determine whether the Fed's decision on potential lift-off will be the right one.   Like so many other things in ZIRP-world, however, the fate of the cycle is not so clear cut.   Perhaps Rep. Sherman could ask God if he has a clue?
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Anonymous
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November 5, 2015 at 7:11 AM ×

Inventory ,possibles.
Price information in the internet age is now approaching close to 'perfect' therefore the new battle ground for competition is on service and at it's core ,immediacy of delivery ...higher inventory level to support that policy?
Cost of tying up capital in inventory can rarely have been lower and the paucity of alternatives by way of use is already highlighted by buybacks etc. Why not increased inventory levels also?

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Anonymous
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November 5, 2015 at 8:14 AM ×

Macro Man,

I strongly admire your dedication to conducting proper macro-economic analysis. But I am starting think analyzing economic metrics is now a waste of time.

I think many professionals in finance underestimated the socialist impulse of the political machinery. They mistakenly thought the CB/Gov were interfering the markets during the 2008 crises to help them and stabilize the situation. But they were wrong. CB/Gov agencies are replacing private capitalist finance with publicly managed socialist finance. We are currently in the early stages of this process. Joseph Schumpeter prophetically discussed this type of this thing happening in his chapter 'the slow march toward socialism'.

Yellen is not a central banker anymore...she is a super hedge fund manager! Her, and people like her (academics, politicians, public sector, etc ), will never relinquish the out sized power that was granted to them by the private sector. Power transfer from private sector -> public sector is a one-way function. Every 1 unit of power given to the public sector is permanently gone.

p.d in Cal

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Anonymous
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November 5, 2015 at 8:39 AM ×

@Anon 8:14 - V well put. I completely agree.

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Anonymous
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November 5, 2015 at 12:22 PM ×

BoE’s Carney: "QE Could Be Extended, Could Cut Rates If Down Risks Materialise..."
Who would have thought it? (lol).

Prediction for Dec 2015 FOMC:
Yellen: "QE Could Be Extended, Could Cut Rates If Down Risks Materialise..."

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washedup
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November 5, 2015 at 12:56 PM ×

MM - the culprit in I/S has been the denominator - sales have been disappointing starting from Q3 of last year, and I think businesses had planned their supply chains on, lets say, a more robust trajectory.
At this point I am taking it as a given that we will see NIRP in the US, but probably not more QE - weirdly enough, NIRP may get a better reception simply because they haven't tried it yet.
I kind of like it - charge foreign countries for displaying confidence in the United States - also, China's FX reserves would go back to all time highs on a MTM basis with the 2 yr at roughly -1.5% - problem solved.
Does anyone know of publicly traded short plays on NIRP (money market firms, for example)?

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Adrem
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November 5, 2015 at 1:17 PM ×

@anon 8:14
What an excellent comment! Clarifies and explains a lot.
But what are the investment implications? What if it hits a stop? Rising and unacceptable inequality that governments cannot resolve? Politics become even more fissiparous, with states and regions wanting to break away from centralised control and domination. Too many false policies that fail - the Euro, climatology. QE , Obamacare.

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washedup
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November 5, 2015 at 1:35 PM ×

@anon 8:14 - two comments:

1. The end point you are predicting may happen, but its a stretch to imagine its the result of a deliberate conspiracy - sure, its ironic that narrowly incentivized, capitalist, rational individuals take actions that slowly result in a socialist outcome - but, if Bernanke, Yellen's, and Carney's actions are motivated primarily to save their hides and secondarily to land a cushy assignment at Shaw or Goldman post Fed to line their pockets, thats hardly a socialist sentiment!
2. Its not clear to me why macro-economic trends should be ignored in the stated paradigm - a strong argument could be made for taking factors into consideration that you didn't before, but I for one happen to think it throws up more opportunities for good punters, not less - alas, I have found myself sorely lacking in that regard lately.

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Cityhunter
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November 5, 2015 at 1:37 PM ×

Oh yeah Carney, we all knew you have no gut even just to pretend to be serious. Next Yellen will do the same trick

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abee crombie
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November 5, 2015 at 1:38 PM ×

Nice analysis MM. Looking at the stock level, I feel now is important to focus on industrials. In the US, GE is leading the pack, along with large cap defense players. What has been dragging down industrials is Transports (ex Airlines). I'm looking for Europe and Japanese industrials to catch up if this rally is for real, as relying on more macro variables, like base metal prices or oil is not worth it at this point (well they are headed the other way, Dr Copper says). Still lots of dispersion in this sector so there is lots of room to run if things turn for real....

I am not a huge fan of PMI's even though ISM seems to be the most modeled economic statistic there is. I mean its just a survey which i believe now is even more influenced by the stock market than before....

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Nerk
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November 5, 2015 at 1:41 PM ×

How about a really simply explanation for higher inventory: ZIRP makes it cheap to hold.

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washedup
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November 5, 2015 at 2:13 PM ×

Nerk - that wouldn't explain the steep rise in the last 12-15 months - till q214 you could argue that the trend was more or less neutral in the context of past levels.
It does seem to correlate perfectly with the steep rise in the dollar, however, something i just thought of - MM would that explain anything directly or indirectly?

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Macro Man
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November 5, 2015 at 3:31 PM ×

I assume that energy inventories represent at least part of the issue; wholesale inventories have risen more notably than either retail or manufacturing inventories (which have also risen, 'tis true.)

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JohnL
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November 5, 2015 at 3:42 PM ×

Interesting, USCI & HYG start to roll over mid 2014 same time inventorys lift off.
$USD and energy effects at play?

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Nico G
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November 5, 2015 at 6:00 PM ×

@Anon 8:14 the Fed is mainly helping the most speculative, tiniest fraction of the working population (bankers, hedgies) to carry on punting with their put offered permanently just under and in ricochet, a couple of their friends and families to amount to just about 0.001% of American population. How the living heck is that socialist?

"The 12 regional Federal Reserve Banks, which were established by the Congress as the operating arms of the nation's central banking system, are organized similarly to private corporations--possibly leading to some confusion about "ownership." For example, the Reserve Banks issue shares of stock to member banks. However, owning Reserve Bank stock is quite different from owning stock in a private company. The Reserve Banks are not operated for profit, and ownership of a certain amount of stock is, by law, a condition of membership in the System. The stock may not be sold, traded, or pledged as security for a loan; dividends are, by law, 6 percent per year."

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abee crombie
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November 5, 2015 at 8:02 PM ×

NDX 100 about used up the earnings momentum? Only big one left is Cisco, which I wouldnt bet on. If we close tom on high volume to the downside that might be the bell everyone is looking for. Lets see

Mortgage reits being thrown out here, IMO.

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Anonymous
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November 5, 2015 at 10:37 PM ×

Watching Mr Druckenmiller at the deal book tells you what you need to know.
This is a generational change and a new attention at providing value to stakeholders at large instead of just the shareholder is emerging, so the consumer, the employee and hopefully the taxpayer. Now that we re at record profit as share of gdp and at the end of a road, This is the normal swing of the balance of power back to society now .you just need to wait for the right politician to articulate it as a coherent story to the public debate. All bullish really.

On the "socialist " comment above, we re are where are now partly because the previous model failed. Claiming conspiracy is not ok.
Another funny side in this dealbook video is to present the strategy as investing. Since when shorting currencies for a few month is called investing - in the sense of being a full part of the whole economy.
At uni, I used to learn that in the tank there are small fishes, big fishes, and the ones that clean the glass walls. The latter , albeit useful, shall not grow too big. The formulation of the first question in the audience was quite telling of the attitude: apr├Ęs moi le deluge.
So, out those 90s dinosaurs ;o) everthing needs to change so everything can stay the same .
Fantastic posts MM.

Travis

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Anonymous
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November 6, 2015 at 12:23 AM ×

The Economist suggests the logical endpoint of Japan's economic mess is debt-monetisation. It further suggest this is also the outcome of other developed countries.

http://www.economist.com/news/finance-and-economics/21677648-despite-shinzo-abes-best-efforts-japans-economic-future-will-be-leap

Thoughts?

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Anonymous
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November 6, 2015 at 12:29 AM ×

Following on from above, the IMF now also propose monetizing debt:

http://blogs.wsj.com/economics/2015/11/05/deflation-risks-may-warrant-radical-new-central-bank-thinking-the-imfs-chief-economist-says/?mod=e2tw

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Anonymous
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November 6, 2015 at 12:53 AM ×

Anon12:23

I like the opening sentences of your link:

"There are four kinds of countries in the world, the Nobel-prize-winning economist Simon Kuznets supposedly said: developed, undeveloped, Argentina and Japan. Yet much of the rich world now looks remarkably Japanese, with chronically low interest rates and inflation, and eye-watering levels of sovereign debt."

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washedup
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November 6, 2015 at 1:28 AM ×

of course fiscal stimulus/debt monetization is the end point, maybe after they've tried NIRP on in the fitting room for a few quarters - WTF were they thinking? That they would send equity prices to the moon and scumbag CEOs would happily dole out the largesse to the rank and file?
The next step will be a payroll tax holiday and/or massive infrastructure bill (or as I like to think of it, a 'commodity' put in addition to the existing equity put) that stops deflation in its tracks. If the next steps are also equity and asset inflation focused I think there may literally be blood on the streets - that said, I think it will take a much bigger global slowdown for the clowns in DC to get there, but boy do I see it coming in the next 2-3 years.

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Anonymous
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November 6, 2015 at 9:00 AM ×

"Following on from above, the IMF now also propose monetizing debt"
It's been said for a long time that trickle down policy isn't actually working that well. The velocity of each buck of such policy has been in a downtrend for decades now. Whilst the gap of wealth distribution has been steadily widening and yet who is signalling that the two are directly related?
In effect monetizing debt is just a fiscal policy rather than a monetary one. It recognises that there appears to be very limited options for intervening in the trend of the wealth distribution gap due to the free movement of capital that allows same to circumvent domestic policy. Even this policy though may be circumvented by capital. Afterall why do we think so many Chinese buyers are buying up property around the world if not to diversify away from such future policy?

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