What a Strange World We Live In

Imagine a bank that pays negative interest. Yup, that means depositors are actually charged to keep money in their accounts. I was always taught the borrower was supposed to pay interest, not the lender. As crazy as it sounds, many European central banks have cut key interest rates below zero. For some, it’s a bid to reinvigorate an economy with other options being exhausted. Others want to push foreigners to move their money somewhere else. Either way it’s an unconventional, unproven choice that distorts the financial markets and could have deleterious economic effects if it backfires. In order to keep this post brief I will limit my discussion on the “why’s” but if you want to learn more there is a good article in “The Economist” here

In a world of beggar thy neighbor and a race to see who can devalue their currency the fastest in an attempt to invigorate growth, the US dollar is king. For now, there is little reason to see it abdicating its throne any time in the near future. As such, it continues to play a prominent role in our investment strategy.  How about yours?

Housing Starts - Lumber’s Message

The abbreviated Thanksgiving holiday trading week (US equity markets closed Thursday & ½ day on Friday) are notoriously plagued with erratic price swings that tend to trigger false buy & sell signals so instead of talking about them I will turn your attention to the latest free post from McLellan Financial. This week Tom writes an excellent analysis on lumber prices being a leading indicator and what they are currently saying about the economy. I have sung the praises on Tom (and before him, his parents) work in the past and would recommend anyone to check his site out as his work is both unique, compelling and a great resource from which to learn.

There are a lot of leading economic indicators in use these days, but the one I like the best is lumber futures prices.  Perhaps this is because almost no one else seems to pay attention to them as an economic gauge.  Lumber prices tell us pretty reliably and ahead of time about what is going to happen to real estate prices and activity, plus interest rates.  They can even tell us about what unemployment is going to do.

This week we got the latest update on U.S. housing starts, data which are gathered and published by the Bureau of the Census.  The latest numbers are for October 2015, and they are showing the lowest rate of activity in 7 months.  This is a downturn which I have been expecting to see arrive now, based on the message from lumber prices.

This week’s chart shows how the movements in lumber prices tend to be echoed about 10 months later in the housing starts data.  It is not a perfect relationship; it is merely very good.  10 months ago, lumber prices were rolling over and heading downward, and so the message going forward from here is that we should expect to see a continued stair-step down move in the housing starts data.  Lumber prices appear to have made some type of bottom back in September 2015, and so counting forward 10 months from there, that says we might see a bottom for the housing starts data around July 2016.  But it is far from clear right now what sort of lumber price bottom that was in September, a temporary one or a more permanent one. 

Lumber also tells us about what the data on weekly jobless claims are going to do:

This chart looks at the seasonally adjusted data on weekly jobless claims, compared to lumber prices but with a twist.  In order to see the correlation better, I have inverted the data plot for lumber prices.  And it is also shifted forward by 42 weeks, which is about the same as the 10-month forward shift in the first chart on housing starts. 

The downturn in lumber prices is reflected in this second chart as an upturn for the green line.  We have not yet seen much response in the weekly jobless claims data, but it is hard to imagine the jobs data refusing to show some sort of reaction to the dramatic action in lumber prices. 

I have never heard a Fed official make reference to lumber prices as a leading indication.  Maybe it is something that they just don’t follow (but should).  Maybe it is not a glamorous topic to talk about. 

Here we are, facing a likely start to Fed rate hikes at the Dec. 15-16, just as lumber is saying that a downturn in economic activity is coming.  We know from watching the 2-year T-Note yield that the Fed should have started this process a long time ago.  So now they appear to be finally getting around to doing the right thing, at the wrong time

Have a great Thanksgiving!

Is This Why the FED Did Not Raise Interest Rates?

While the Fed has a dual mandate, there is no question they look at a plethora of data not just inflation and employment to determine what to do with interest rates. We are bombarded with so many regular reports but there is so much more going on behind the scenes that give insight into the shape of our economy that we aren’t necessarily privy to.  The good thing is the FED does not hide this information, in fact they publish it and make it available to everyone. Why it is not reported by the mainstream media is anyone’s guess but I thought the graphic below fills in some noteworthy voids.

While we may not have agreed with the FED’s decision to keep interest rates where they were, clearly these charts show areas of definite underlying economic weakness and concern in spite of positive unemployment and inflation data.

(As much as I would like, I cannot give proper recognition to the person who put this chart together as I was unable to find the author)

A Fundamental View

As a market technician my investment decisions are driven mostly by technical analysis.  That is not to say I do not use fundamental analysis, because I do. For me fundamentals reinforce rather than drive investment decisions. With that being said, I want to provide a rare fundamental chart that I am watching closely, that of stock prices and earnings. Investors have been told and conditioned to invest in stocks as long as earnings keep rising. The chart below illustrates how powerful the correlation is.

What should jump out at you is the path of corporate earnings (purple line).  Since the oversold 2009 bottom and the subsequent parabolic rise of both off their bottoms, earnings have followed a stair-step path higher. They step higher, level off, step higher, then level off. Wash, rinse, repeat. What should also be evident is that stocks lead earnings meaning stocks find tops and bottoms first. Since the beginning of this year when earnings took their last step up, stocks and earnings have gone in opposite directions. Earnings have declined slightly while stocks have gone (ever so) slightly higher.  

The bottom line here is we have a short term divergence in stocks and earnings which indicates the increased likelihood a correction for one of the two is in our future if this correlation is to hold. The question is which one?  Will stocks fall to synch with earnings or will earning beat estimates and confirm stock prices? Without question,n now that much of the uncertainties have been resolved (at least temporarily) surrounding Russia, China, Greece and the FED hiking rates, you have to believe this is an extremely important metric investors are now concentrating on.

What do you think?

New Credit Cards are Coming

For something a little different -

After years of use in other countries around the world, chip-enabled credit cards are coming to the USA. Credit cards with only magnetic strips are being phased out ahead of an October 1, 2015 deadline.

If you have a credit card, you’ll probably get a replacement with a chip at some point soon if you have not already. The entire country won’t switch to chip cards by October 1, but retailers and banks that don’t will assume more financial liability.

How to Use a Chip Card

To use a chip-enabled credit card, you insert it in the bottom of a payment terminal and leave it there for the duration of the transaction. Importantly, the card needs to remain in the reader until the transaction finishes, not swiped like a magnetic strip.

While you’ll encounter payment terminals with support for both the magnetic strip and chip on modern credit cards, you can’t necessarily just use the magnetic strip. Try to swipe a chip-enabled card on such terminals and you’ll probably be asked to insert the card and pay via the chip method.

EMV Card Basics

Credit cards with chips use the EMV standard, which stands for “Europay, Mastercard, and Visa.” EMV is a global standard allowing chip cards to interoperate at point-of-sale systems and automated banking machines. (Despite the name, American Express and Discover are also participating.)

Know that the old magnetic strip isn’t going anywhere anytime soon. A chip-enabled credit card has an EMV chip as well as a magnetic strip. If you ever find yourself somewhere that only accepts magnetic strips — either in the USA or elsewhere in the world — you’ll still be able to use your card.

The magnetic strip can easily be cloned by swiping it, and that magnetic strip data can be copied to another card and used to make fraudulent purchases. A chip card works differently — it has a small computer chip in it. When the chip card is inserted into a payment terminal, it creates a one-time transaction code that can only be used once. In other words, chips can’t be duplicated as easily as magnetic strips. Any payment details would be stored with the one-time code. If the USA had transitioned to chip cards earlier, the disastrous Target breach could have likely been averted.

The October 1 Liability Shift

US banks have been issuing chip cards over the past year ahead of an October 1, 2015 deadline. After this date, a “liability shift” will take place. Any retailers that choose to accept payments made via a chip card’s magnetic strip can continue doing so, but they’ll accept liability for any fraudulent purchases. Any credit card issuers that don’t issue EMV credit cards will be on the hook for any fraudulent purchases, too.

In effect, Visa and Mastercard are telling banks and retailers that they can continue using the old system at their own financial risk. Not everyone will be transitioned over by October 1, but everyone who hasn’t will assume additional liability — that will encourage them to migrate as soon as possible.

This doesn’t affect your own personal liability — if your bank doesn’t issue you a credit card with a PIN before October 1, they’re assuming liability. That’s their problem, not yours. These details are all between retailers, banks, Visa, and Mastercard. But they explain why chip cards are getting rolled out so quickly.

EMV Cards Don’t Eliminate Fraud

Chip cards don’t eliminate the problem of fraud. In particular, these cards still have numbers, expiry dates, and three-digit codes on their backs. Someone could copy this information and use it to make purchases online. A chip-and-signature card could be used at a point-of-sale terminal along with a forged signature. The magnetic strip can still be used in the old way at many terminals around the world.

But, although chip cards won’t eliminate all fraud, they will make fraud more difficult. This will also help prevent future breaches of payment systems — like the one that happened at Target — from being so damaging.