Unusually high volatility and widespread nervousness continue to plague the markets, but there is still little or no evidence of any significant deterioration in the economic and financial fundamentals. On the contrary, recent releases show that the construction sector is booming and auto sales are at a 10-year high. Moreover, swap spreads—a key current and leading indicator of economic and financial market health—remain quite low, suggesting systemic risk is de minimus.
The Vix index (implied equity volatility) jumped to 32 today. Even though that is substantially elevated from the 12-ish value that prevails during periods of "normality," it is nevertheless much less than the panic high of 53 that was briefly reached last week. A similar result holds for the ratio of the Vix to the 10-yr yield (a ratio I prefer since the 10-yr yield is a good indicator of the market's outlook for economic growth; thus, a high level of the Vix/10-yr yield is indicative of a lot of nervousness and a lot of pessimism). A high Vix/10-yr ratio tells us that the market is pricing in some pretty awful stuff. If the reality subsequently proves to be less awful than the expectation, that forms a solid basis for a rally. I think we'll see this once again.
The ISM manufacturing index has been a little soft of late, but it is still suggesting that overall economic growth is 2-3%, which is what the economy has been averaging throughout the current expansion. Although soft, the ISM index is not even close to predicting a recession.
July construction activity was much stronger than expected, and it came on top of substantial upward revisions to prior months' data. Construction activity is booming, growing at strong double-digit rates. This is a very positive development.
Export orders were the weakest component of the August ISM indices. It's clear that the market is worrying more about developments overseas—notably a slowdown in the Chinese economy—than it is about anything going on in the U.S. economy. In that regard, I note once again that U.S. exports to China represent only 0.7% of our GDP. China is undoubtedly slowing down, but this is not a significant threat to the U.S. economy. On the contrary, the recent weakness in the yuan will ensure that Chinese goods reach our shores with low and very attractive prices. That is an ongoing boon for U.S. consumers.
Donald Trump needs to take a refresher course in the dynamics of international trade. If anyone is taking advantage of anyone else, it's the U.S. taking advantage of China, and we would be crazy to complain about our ability to buy incredible Chinese-manufactured goods at incredible prices (e.g., iPhones).
August vehicle sales were stronger than expected, and they now stand at a 10-yr high. This chart is a classic V-shaped recovery chart. Consumers are doing just fine.
The prices of gold and 5-yr TIPS continue to follow a slowly declining trend. This means that the world's demand for "safe" assets continues to moderate, and that dilutes the message coming from the elevated Vix/10-yr ratio. If things were really falling apart, the world would be much more anxious to seek out the safety of gold and TIPS.
Swap spreads have been excellent forward-looking indicators of economic distress. At current levels, they are telling us that the U.S. and Eurozone economies remain healthy.
High-yield spreads are a bit elevated, but still far below the level which would signal a substantial weakening of the economy. Most of the spread widening is coming from the energy sector, and spreads there have backed off of late, thanks to a significant bounce in oil prices. Swap spreads are very low, and that suggests that the recent bout of nerves in the corporate bond market is likely to pass.
Bloomberg's measure of financial conditions has deteriorated somewhat over the past year, but it is still far above the super-distressed levels of 2008. Conditions were much worse in 2011, around the time of the PIIGS crisis, than they are today.
Declining crude oil prices explain most of the decline in near-term inflation expectations. Nothing unusual at all about this. Lower energy prices put downward pressure on inflation, while at the same time enabling an increase in global economic activity. Lower inflation and stronger growth are a great combination!
Gold and commodity prices continue to trend lower, but they are still very high relative to their 2001 lows. This is not so much a "collapse" in prices as it is a return to more normal levels. As with energy, cheaper commodity prices make it easier for the global economy to grow, especially when lower commodity prices are the result of big increases in commodity supplies and production. For proof of the latter, look no further than the 85% increase in U.S. crude oil production over the past 5 years:
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