Recap 2014-10-08: Are Growth Concerns Really the Driver? Also a note on Breadth


The concern over lower inflation expectations has become more mainstream. FT reported on it yesterday, and I’m seeing it from other well read sources. JPM noted that survey measures of inflation remained range bound, which is certainly true. But take a look at the long term chart – do you think the trend is up or down?

One of the more common interpretations of recent market moves is that equities are becoming more concerned about growth . An observation supporting that is that US equities appears to have become more correlated to growth surprises as of late, (chart 1 shows SPX PE ratio vs US eco surprise index)

However, a real downgrade of growth expectations should result in lower real yields, as the market will price in a more accommodative Fed. But note that US real yields have apparently become less correlated to data surprises: (second chart)

Again, maybe Pimco related selling of TIPS is a driver, but it’s an old story now by market standards, and real yields have not changed much. Anyway, the dichotomy in performances suggest that equities may not be reacting to growth risks per se, but lower inflation instead: (SPX PE in white, 10y ILBE in orange)

I’m really not sure if that’s the case – one can make the argument that since earnings tend to growth in line with inflation, a decrease in inflation expectations both decrease future nominal EPS growth but also decrease the appropriate discount rate, and the net effect should be something of a wash. Readers are welcome to comment!

Separately, many commentators have noted weakening breadth in the stock over the past few weeks and have used that as a reason for concern. A popular observation is that “the breadth is diverging from the price of the index, and is a reason to be cautious/bearish/whatever.” I thought I’d test the relationship between breadth and index performance relative to a moving average. Arguably, both are mean reverting measures and should be correlated. Below are charts of the breadth of the SPX, defined as the percentage of stocks above the 200 day moving average, and along with the SPX level relative to its historical 200 day moving average: (multiplied by 100)

There’s definitely a strong correlation as expected, but it’s interesting to note that breadth didn’t really drop below what the SPX price / 200dma ratio along would’ve predicted until yesterday. That is a phenomenon that seems quite common during selloffs – the last such observation was in mid 2012, which was just before the low was put in. Also interesting is that the recent print followed 2 year period when breadth was well above what SPX/200dma would’ve predicted.

Here’s a different way to look at the relationship – a scatter chart with the most recent print highlighted:

Again, the most recent print doesn’t seem much out of the ordinary, although here we can more clearly see that breadth is below what SPX/200dma implies.

I dug a little further and looked at the same charts using a 50 day moving average. Results:

Perhaps unsurprisingly, breadth (an equal weight measure) is more volatile than the index. The drop in breadth vs SPX/50dma is a bit more stark here, but again is not unprecedented.

Anyway, the point I want to make is, we can agree that breadth is weaker than what index levels would imply, but whether that means we are about to get a regime change is specious at best.

Separately, Pimco noted that retail HY mutual fund outflows actually peaked in July and has been declining, and is advocating increasing exposure in the space:

Very Interesting:

Macro Fund Performance in Sept:


  • Dudley made comments Tues afternoon and made an interesting remark regarding the jobs market: “While I still believe that the participation rate could move back up again as the demand for labor strengthens, I am less confident about this than earlier as the downward trend in participation rates has persisted even as the labor market has improved. What I can say with greater certainty is that there still is a significant underutilization of labor market resources”. h/t Jordan
  • FOMC Minutes
  1. longer-term inflation expectations were stable. Participants anticipated that inflation would move toward the Committee’s 2 percent goal in coming years, with several expressing concern that inflation might persist below the Committee’s objective for quite some time.
  2. a number of participants noted that economic growth over the medium term might be slower than they expected if foreign economic growth came in weaker than anticipated, structural productivity continued to increase only slowly, or the recovery in residential construction continued to lag.
  3. The recovery in housing activity remained slow in all but a few areas of the country despite relatively low mortgage rates, rising house prices, and improvements in household wealth… Households with relatively low credit scores continued to have difficulty obtaining mortgage loans. It was noted that this difficulty could be a factor restraining the demand for housing, particularly among younger households who have high levels of student loan debt or weak job prospects.
  4. Information from business contacts in most parts of the country indicated improvements in business conditions, rising confidence about the economic outlook, and increasing willingness to undertake new investment projects… Among the other industries cited as relatively strong in recent months were transportation, energy, and services.
  5. Some participants noted that expectations for the path of the federal funds rate implied by market quotes appeared to remain below most of the projections of the federal funds rate provided by Committee participants in the SEP, which represent each individual participant’s assessment of the appropriate path for the federal funds rate consistent with his or her economic outlook. However, it was pointed out that measures of financial market participants’ expectations incorporate their judgments regarding not only the most likely outcomes, but also the possible downside tail risks that might be associated with especially low paths for the federal funds rate. For example, respondents to the recent Survey of Primary Dealers placed considerable odds on the federal funds rate returning to the zero lower bound during the two years following the initial increase in that rate. The probability that investors attach to such low interest rate scenarios could pull the expected path of the federal funds rate computed from market quotes below most Committee participants’ assessments of appropriate policy as reported in the SEP.
  6. participants differed somewhat in their assessments of how quickly inflation would move up. Some cited the stability of longer-run inflation expectations at a level consistent with the Committee’s objective as an important factor in their forecasts that inflation would reach 2 percent in coming years.
  7. some participants saw the current forward guidance as appropriate in light of risk-management considerations, which suggested that it would be prudent to err on the side of patience while awaiting further evidence of sustained progress toward the Committee’s goals… A number of participants also noted that changes to the forward guidance might be misinterpreted as a signal of a fundamental shift in the stance of policy that could result in an unintended tightening of financial conditions.

Germany may rethink stimulus given slumping growth according to Reuters; right now Merkel is pressing ahead w/her balanced budget goal but economic weakness would cause her to reject that objective. "If the only way to achieve the balanced budget goal is to make cuts that would deepen a recession, it will be abandoned and we will see more spending," said one senior German official. Another official close to the chancellor said: "If the German economy weakens substantially, that would be a game changer” – Reuters Japan Eco Watchers Outlook Survey declined to 48.7 vs 50.4 prev Australia’s Bureau of Statistics announced significant revisions to employment data The Texas Ebola patient passed. Upcoming:

  • Wed: UK RICS House Price Balance, Australia Employment
  • Thu: German Current Account, BoE, US Jobless Claims, Williams Speaks
  • Fri: Canada Employment, USDA report
  • Mon: US Holiday, China Trade Balance, Australia Business Confidence
  • Tue: France CPI, UK CPI, German ZEW, US NFIB Survey,
  • Wed: Draghi Speaks, UK Employment, US Retail Sales, PPI, New Zealand PMI, Consumer Confidence, RBA FX Transactions