This morning the Empire State Manufacturing Survey was released for the January period. Economists expected a bounce from last month’s terrible -19.37. However instead of the forecasted -10.00, January’s activity came in at -16.64.
At first glance it is easy to see how traders interpreted this result pessimistically. This Empire State Manufacturing survey release is not some fluke outlier event. Most economic releases keep disappointing. Many economic releases have been screaming recession is just around the corner.
Yet there seems to be two distinct camps arguing about the economy’s direction. This tweet from the always insightful (yet a little scary looking) @TheEuchre sums up the situation perfectly:
The two camps
I would put all the Federal Reserve economic optimists in the group seeing conditions through rose coloured glasses. But it’s not just government officials who are too optimistic. Have a look at the recent comment from Citigroup’s head economist William Lee:
I have this sneaking suspicion we might be pulling this image out of the archives to laugh about in the coming months…
Hedge fund heretics
Contrast all that optimism to the gloomy prognostications coming from the likes of Bill Gross, Jeffrey Gundlach and Kyle Bass. Many of these smart hedge fund managers are positioning themselves for an imminent economic slowdown.
This camp (of which I am a card carrying member) believes the Federal Reserve has tightened into an economic slowdown, and threatens to make it multiples worse through their continued hawkish path setting.
Why are there these diverse difference of opinions?
It is easy to shout your opinion from the rooftops with the internet echo chamber reflecting back all the like minded individuals confirming your bias. But isn’t it more productive to understand why the other side feels you are wrong? It is always a good habit to understand where your opponent has made his mistake. In trying to understand his opinion, sometimes you instead learn where you have made yours.
I have written extensively on the reasons the Federal Reserve is making a mistake with their premature tightening, so I won’t bore you with more of my end of the world musings. Rather let’s try to figure out why the Federal Reserve board members and all the other economic optimists believe the economy can handle the higher rates.
The devil is in the details
The perfect place to start with our analysis is today’s Empire State Manufacturing survey. At first blush it seems hard to garner any optimism from the report. It disappointed against expectations while also staying firmly below the 0 mark. Yet with a little digging, the picture is not so clear cut.
This detail was brought to my attention by George Pearkes from Bespoke Research:
He argues the report’s internals were actually quite strong, with only the prices component dragging down the index. Starting with the stronger than expected internals, here are George’s “teardowns”:
George does indeed have a point. These numbers are all solid. So where is the bad news?
Ahhh…. there it is. All of the price components are collapsing.
Do you trust the market or not?
These opposing results exemplify the difference between the economic optimists and the morbid macro traders.
The economists look at the data and do not see any immediate economic weakness on the horizon. Therefore they assume continued economic growth. In the absence of something to derail the recovery, they look past the price weakness. In fact some of them even forecast greater economic growth due to the consumer’s increasing purchasing power due to the deflation.
The macro traders instead look at the collapsing prices and assume the market sees something the economists are missing. The sheer scale of the price declines in a whole host of commodities, coupled with the collapse in world trade, scream something big and bad for these traders.
The question boils down to whether the markets are correct, or whether the economists are right to ignore the signals they are sending.
You can probably guess which side of the question I come down on. I am skeptical of looking past one of the greatest commodity price declines in history. I expect the Fed has made one of the biggest economic blunders in quite some time.
But as usual I suspect the truth lies somewhere in the middle. The economy is not nearly as strong as the economic optimists believe, but the end of the world is nowhere near as close as the macro traders have priced in.
Wouldn’t it be just like the Market Gods to trade to levels that makes them both lose?
Thanks for reading,