Global economy: No surprises

The global economy faces deflationary pressures as the vast credit expansion of the last 4 decades comes to an end.

$60 Trillion Global Credit

Commodity prices test their 2009 lows. Breach of support at 100 on the Dow Jones UBS Commodity Index would warn of further price falls.

Dow Jones UBS Commodity Index

The dramatic fall in bulk commodity prices confirms the end of China’s massive infrastructure boom.

Bulk Commodity Prices

Crude oil, through a combination of increased production and slack demand has fallen to around $60/barrel.

Crude Oil

Falling prices have had a sharp impact on global Resources and Energy stocks….

DJ Global Energy

But in the longer term, will act as a stimulus to the global economy. Already we can see an up-turn in the Harpex index of container vessel shipping rates, signaling an increase in international trade in finished goods.


The latest OECD export statistics show who the likely beneficiaries will be. Primary producers like Brazil and Russia have suffered the most, while finished goods manufacturers like China and the European Union display growth in exports. The US experienced a drop in the first quarter of 2015, but should rebound provided the Dollar does not strengthen further.

OECD Exports

Australia and Japan offer a similar contrast.

OECD Exports

Oil-rich Norway (-5.8%,-13.3%) has also been hard hit. Primary producers are only likely to recover much later in the economic cycle.

Gold, silver and the Dollar

A long-term chart of silver shows strong support at $15/ounce. Recovery above $18 and 13-week Twiggs Momentum above zero would suggest that the precious metal has bottomed. A bullish sign for gold.


The picture for gold is less clear, with further tests of primary support at $1140/ounce expected. 13-Week Twiggs Momentum is also rising and recovery above zero would be a bullish sign. But breakout above $1300 is unlikely at present. Breach of support at $1140 would offer a target of $1000*.

Spot Gold

* Target calculation: 1200 – ( 1400 – 1200 ) = 1000

Stocks of major gold producers like Barrick Gold remain bearish.

Barrick Gold

The Dollar Index respected its declining trendline, warning of another test of primary support at 93. Breach of support would signal a primary down-trend. A weaker Dollar would boost demand for gold and lift the US economy, enhancing the competitiveness of exporters and local manufacturers facing competition in domestic markets.

Dollar Index

Long-term interest rates are rising, however, and provide support for the Dollar. 10-Year Treasury yields respected their new support level at 2.25% and are likely to test long-term resistance at 3.0 percent. Rising 13-week Twiggs Momentum above zero, strengthens the signal.

10-Year Treasury Yields

John Williams: Sakura variations

Sakura is a traditional Japanese folk song depicting spring, the season of cherry blossoms.

Gold suggests no “Grexit”

Gold reversed the gains of the last two weeks, anticipating a resolution to the eurozone’s “Grexit” crisis. Follow-though below $1170/ounce would warn of a test of primary support at $1140/$1150. Repeated peaks below zero on 13-week Twiggs Momentum signal a primary down-trend. Breach of primary support would offer a long-term target of $1000/ounce*.

Spot Gold

* Target calculation: 1200 – ( 1400 – 1200 ) = 1000

Are US stocks really over-valued?

Stock Market Capitalization

Let us start with Warren Buffet’s favorite market valuation ratio: stock market capitalization to GDP. I have modified this slightly, replacing GDP with GNP, because the former excludes offshore earnings — a significant factor for multinationals.

US stock market capitalization to GNP

The ratio of stock market capitalization to GNP now exceeds the highs of 2005/2006, suggesting that stocks are over-valued — approaching the heady days of the Dotcom era.

Corporate Profits

If we dig a bit deeper, however, while the ratio of market cap to sales is also high, market cap to corporate profits remains low.

US stock market capitalization to Business Sales and Corporate Profits

Clearly profit margins have widened, with corporate profits increasing at a faster rate than sales. The critical question: is this sustainable?

Sustainability of Profits

At some point profit margins must narrow in response to rising costs. Increases in aggregate demand may lift employment and sales, but also drive up labor costs.

Profits and Labor Costs as a percentage of Net Value Added

The brown line above depicts labor costs as a percentage of net value added, compared to corporate profits (blue) as a percentage of net value added. There is a clear inverse relationship: when labor costs rise, profit margins fall (and vice versa). At first the effect of narrower margins is masked by rising sales, but eventually aggregate profits contract when sales growth slows (gray stripes indicate past recessions).

Interest Rates and Taxes

Other contributing factors to high corporate profits are interest rates and taxes. Corporate profits (% of GNP) have soared over the last 30 years as bond yields have fallen. The benefit is two-fold, with lower interest rates reducing the cost of corporate debt and lower finance costs boosting sales of consumer durables.

Corporate Profits as % of GNP and AAA Bond Yields

Lower effective corporate tax rates (gray) have also contributed to the surge in profits as a percentage of GNP.

US stock market capitalization to GNP

The most enduring of these three factors (labor costs, interest rates, and tax rates) is likely to be taxes. Corporate tax rates have fallen in most jurisdictions and US rates are high by comparison. Even if a long-overdue overhaul of corporate taxation is achieved in the next decade (don’t hold your breath), the overall tax rate is likely to remain low.

If Not Now, When?

The other two factors (labor costs and interest rates) may not be sustainable in the long-term but it will take time for them to normalize.

Treasury yields are rising, with the 10-year at 2.37 percent. Breakout above 3.0 percent still appears some way off, but would confirm the end of the 35-year secular down-trend.

10-Year Treasury Yields Secular Trend

Interest rates are likely to remain low until rising labor costs force the Fed to adopt a restrictive stance.

Labor Costs as a percentage of Net Value Added

Labor markets have tightened to some extent, as indicated by the higher trough on the right of the above graph. But this is likely to be slowed by the low participation rate, with potential employees returning to the workforce, and a strong dollar enhancing the attraction of cheap labor in emerging markets.

Hourly earnings growth in the manufacturing sector remains comfortably below the Fed’s 2.0 percent inflation target. Any breakout above this level, however, would be cause for concern. Not only would the Fed be likely to raise interest rates, but profit margins are likely to shrink.

Manufacturing: Hourly Earnings Growth

For the present

None of the macroeconomic and volatility filters that we monitor indicate elevated market risk. I expect them to rise over the next two to three years as the labor market tightens and interest rates increase, but for the present we maintain full exposure to equities.

Miloš Karadaglić: Granada

Miloš Karadaglić: Albeniz No.1 Granada from his debut album The Guitar.

David Gilmour: Shine on you crazy diamond (acoustic)

David Gilmour at the Royal Festival Hall, London in June 2001

Dollar decline

A declining dollar is the one measure supporting demand for gold. The Dollar Index broke support at 95, warning of a test of the primary level at 93. Decline of 13-Week Twiggs Momentum below zero would warn of a primary down-trend. Breach of primary support would confirm, offering a target of 88*.

Dollar Index

* Target calculation: 93 – ( 98 – 93 ) = 88

A declining dollar would be good news for the US economy, improving the competitiveness of exporters in global markets and local manufacturers competing against imports in domestic markets.

Interest rates and inflation hurt gold prices

Where is inflation headed? The five-year breakeven rate (5-Year Treasury Yield minus 5-year TIPS) is hovering around 1.80 percent, close to the latest readings for core CPI. The market is anticipating low inflation for the next few years.

Five-year Breakeven Rate and Core CPI

Long-term interest rates are rising in anticipation of Fed tightening. 10-Year Treasury yields, in a primary up-trend, are retracing to test their new support level at 2.25%. Respect is likely and would signal an advance to long-term resistance at 3.0 percent. Rising 13-week Twiggs Momentum crossed above zero, strengthening the signal.

10-Year Treasury Yields


Low inflation reduces demand for gold as an inflation-hedge, while rising interest rates increase its carrying cost for speculators and the opportunity cost for investors. These factors are exerting downward pressure on gold prices. The spot price recovered above medium-term support at $1180/ounce, but the breach continues to warn of a test of the primary level at $1140. 13-Week Twiggs Momentum peaking below zero also suggests continuation of the primary down-trend. Failure of $1140 would offer a long-term target of $1000*.

Spot Gold

* Target calculation: 1200 – ( 1400 – 1200 ) = 1000

The Gold Bugs Index, representing un-hedged gold stocks, is testing primary support at 155. Breach of support would strengthen the warning.

Gold Bugs Index

Crude: Where next?

Nymex Light Crude plotted against CPI gives an historical perspective on current crude prices: high prior to China’s entry into the global energy market, but low relative to prices since then. Expect strong support at the 2008 low.

Nymex WTI Light Crude and Brent Crude

Has fracking permanently suppressed oil prices, or will production dwindle over time in response to lower prices? Oil well efficiency is rising as marginal wells are mothballed.


Production forecasts are rising.


Causing oil futures to fall. June 2020 Light Crude broke support at $70/barrel, offering a target of $55/barrel.

June 2020 Light Crude

* Target calculation: 70 – ( 85 – 70 ) = 55

Spot prices (Nymex Light Crude) continue to range between $58 and $61 per barrel. Reversal below $58 would signal retracement to test medium-term support at $54. Breakout above $61 is unlikely at present, but would signal a rally to $68/barrel.

Nymex WTI Light Crude and Brent Crude

India threatens reversal

India’s Sensex is testing primary support at 26500. Breach would signal a primary down-trend, confirming the signals from 13-week Twiggs Momentum & Money Flow, both of which have crossed below zero. Twiggs Momentum has been warning of a reversal with a bearish divergence since late 2014, while Twiggs Money Flow chimed in from March 2015. Breach of support would offer a target of 23000. Recovery above the descending trendline is unlikely, but would suggest another rally.



* Target calculation: 26500 – ( 30000 – 26500 ) = 23000

The S&P/NSE Nifty index tells a similar story, testing primary support at 8000. Breach would offer a target of 7000*.


* Target calculation: 8000 – ( 9000 – 8000 ) = 7000

The key to economic prosperity is good governance

Podcast: Francis Fukuyama on the importance of good governance [05:23].

It is time we started raising the bar for our own political system.

Why Fixed Investment is Critical to the US Recovery

The financial sector normally acts as a conduit, channeling savings from private investors to the corporate sector. When the conduit works effectively, the injection of demand from corporate Investment is sufficient to offset the ‘leakage’ from demand caused by Savings. Savings patterns alter during a financial crisis, however, with concerned households cutting back on expenditure and using any surplus to pay down debt, rather than depositing with the bank or buying stocks. Household Savings rise but corporate Investment contracts. The resulting ‘leakage’ from demand causes GDP to spiral downward.

When Investment contracts, unemployment rises. The relationship is evident on the graph below, but it could also be said that Investment rises when employment grows — businesses invest in anticipation of rising demand. Either way, it is safe to conclude that rising investment and job growth go hand-in-hand.

Employment Growth and Private Nonresidential Fixed Investment

Fixed Investment and Corporate Profits

Rising corporate profits also lead to increased investment. The lag on the graph below — investment growth follows profit growth — clearly illustrates the causative relationship.

Employment Growth and Private Nonresidential Fixed Investment

This is an encouraging sign, as the current surge in corporate profits is likely to be followed by rising investment — and further job growth.

Weekly Earnings and GDP

Rising weekly earnings already point to improving aggregate demand and consequent investment growth.

Weekly Earnings Growth

All that is missing is for the federal government to increase investment in productive* infrastructure to further boost job growth.

*Infrastructure investment needs to generate a sufficient return to repay debt incurred to fund the spending. Something many politicians seem to forget when preoccupied with buying votes for the next election.

The Long War [podcast]

Excellent insight into the long-term implications of conflict between Russia and the West. Hosted by Brian Whitmore (RFE/Power Vertical) and co-host Mark Galeotti, New York University professor and expert on Russia's security services, with guest James Sherr, an associate fellow with Chatham House's Russia and Eurasia program.

Podcast: The Long War

The Long War

It's going to be a protracted conflict and Ukraine is just the first major battle.

It's going to be fought in different ways and on multiple fronts: on NATO's eastern frontier; over the countries of former Soviet Union, in the energy market, over the airwaves, and in cyberspace.

We should have no illusions. The West's conflict with Russia is not going away anytime soon, regardless of how the current standoff in Ukraine is resolved.

And what is at stake is nothing short of the future of the international order.

This ain't no Cold War. Russia isn't strong enough for that.

But according to The Russia Challenge, a widely read and highly influential report issued by Chatham House last week, it is shaping up to be a Long War. A protracted looking-glass conflict with a weakening, but still very dangerous, Russia.

On the latest Power Vertical Podcast, we discuss the new Chatham House report and its recommendations.


The panel make some important points:

  • The post-Soviet transition to a modern democracy was poorly handled by the West and left Russians with a deep distrust of their motives.
  • The most important response to asymmetric warfare is good governance. The last 15 years shows a series of unmitigated blunders that would leave an independent observer with serious questions as to the competence of Western democracies. The West, Ukraine and Baltic States all need to get their house in order.
  • Conventional weapons are important, but the primary response should focus on improved intelligence and policing.

The Impunity Trap by Jeffrey D. Sachs | Project Syndicate

Jeffrey D. Sachs, Professor of Sustainable Development, Professor of Health Policy and Management, and Director of the Earth Institute at Columbia University, highlights one of the great challenges to modern society: public indifference to dishonest and unethical behavior.

The ability of those who wield great public and private power to flout the law and ethical norms for personal gain is one of the more glaring manifestations of inequality. The poor get life sentences for petty crimes, while bankers who fleece the public of billions get invitations to White House state dinners…..

In some societies and economic sectors, impunity is now so pervasive that it is viewed as inevitable. When unethical behavior by political and business leaders becomes widely viewed as “normal,” it then goes unpunished by public opinion, and is reinforced as normal – creating an “impunity trap.” For example, with politicians in the United States now so flagrantly and relentlessly on the take from wealthy donors, much of the public accepts new revelations of financial impropriety (such as the Clinton Foundation’s morally dubious financial dealings) with a cynical yawn.

The situation in the global banking sector is especially alarming. A recent careful study of ethical attitudes in the financial-services industry in the US and the United Kingdom showed that unethical and illegal behavior is indeed now viewed as pervasive…..

Yet not all societies or sectors are caught in an impunity trap. Some societies, most notably in Scandinavia, maintain the expectation that their public officials and business leaders should and will act ethically and honestly. In these countries, ministers are forced to resign for petty infractions that would seem trivial in other countries.

What is needed is a two-pronged approach. Firstly, a “broken window pane” strategy, where strict enforcement against minor infringements will reduce the occurrence of major violations. Second, ensure that penalties imposed on major transgressors in the banking industry, politics, sports administration (FIFA), and other public areas are sufficient to act as a visible deterrent to others.

Imposing a billion dollar fine on a bank for illegal behavior penalizes shareholders not the perpetrators who generally get away scot-free. A two-year jail sentence for senior executives involved would be a far more effective deterrent.

Read more at The Impunity Trap by Jeffrey D. Sachs – Project Syndicate.


From Marc Seidner:

At this point, the evidence is close to overwhelming that the Federal Reserve will embark on a tightening cycle this year. The base case for markets should be a move in September. While the pace of tightening should be very shallow and the ultimate destination for interest rates considerably lower than historical experience, investors should not underestimate the potential volatility emanating from the first interest rate increase in nine years and the first move off of the zero bound in six years….

Read more at RIP ZIRP | PIMCO Blog.