Photo: AFP / Jewel Samad

The consensus view of the brokerage house commentariat boils down to “growth disappoints, central banks don’t,” as Barclay’s strategists Ajay Rajadhyaksha and Aziz Sunderji wrote in a February 25 report.

All sectors of the world economy showed a significant slowdown during the fourth quarter and the beginning of 2019, and Europe and Japan are in or close to recession. Fears of a significant slowdown in China evaporated earlier this week after China reported robust credit growth for January and the RMB stabilized at well below the 7-to-the-dollar level.

Meanwhile, the US consumer, the only significant source of demand in the industrial world, seemed to falter. Consumer behavior in the US is the great unknown in the equation, and available data are inconclusive. Color me pessimistic about US household spending, though. The modest wage gains of the past year aren’t enough to requite the income backlog of US households after two decades of unusually low wage growth.

The price of risk assets depends on this question more than on any other. I never took seriously Western warnings about China’s debt bubble and a prospective slowdown in the Chinese economy. But American households are finicky, and still hurting from the financial crisis.

Consumer balance sheets look strong, but that is because credit is hard to obtain for consumers without the highest credit rating. The analyst consensus already foresees a year-on-year drop in per-share earnings and profit margins for the S&P 500 during the 1st quarter, followed by a recovery later in the year. If households turn defensive, US equities won’t like this at all.

The most compelling measure of global economic slowdown in my view remains the year-on-year decline in world trade volume as of December, as I wrote yesterday. Collapsing capital goods orders in the midst of a tariff war are the evident driver of the trade decline, which hit major cap goods exporters like Japan and South Korea harder than anyone else.

A resolution of the US-China trade war would occasion some recovery over time, but it’s hard to un-ring this particular bell. Low levels of trade and CapEx leave the consumer as the only source of growth.

Another data series went pear-shaped on Tuesday when the Commerce Department reported an unexpectedly large decline in housing starts. On February 21 the National Association of Realtors reported a drop in new home sales, unusual after a fall in mortgage lending rates.

Later in the US morning session, equities recovered from a modest loss after the University of Michigan released a surprisingly buoyant report on consumer sentiment. Soft survey data of this sort are not a good predictor of future economic behavior. As the chart below indicates, the Consumer Expectations survey frequently moves opposite to retail sales. The trouble with surveys is that people lie.

The poor retail sales data are supported by Bank of America’s credit card transaction data, which shows a decline in activity continuing through January, by the tightening of credit standards for consumer loans, and by the weak housing and auto markets. Some major retailers, including bellwether Home Depot, missed sales expectations during the fourth quarter. I think we have to color the consumer worried – and finicky.

The University of Michigan survey cheered the US stock market, which recovered from a modest decline in the morning to end virtually unchanged.

But the facts do not look encouraging for US household spending. Debt service, to be sure, takes up the lowest share of household disposable income since the series was first calculated, but that is due in part to the inability of many households to obtain credit. Credit card interest rates are at an all-time high – a form of rationing – while a record number of credit card accounts are being closed by banks. There is a distinct upward trend in the percentage of banks that are tightening credit conditions for consumers and small businesses.

I see the US stock market moving sideways for the foreseeable future and prefer credit to equities.

A note to institutional investors: Options on the CBOE VIX Index, or VVIX, express the volatility of S&P volatility. Typically VVIX and VIX move in tandem. On rare occasions, they diverge, and this is one of them. Out-of-the-money options on VIX futures offer a cheap way to hedge credit portfolios. If credit markets blow up, so will VIX, and a cheap option on VIX is a form of insurance worth considering.

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