China's taxing problem

Although China gave us both its full December data-release as well as its 4Q GDP results, we learned only a very limited amount. For years now, the rule governing China's monthly data is 'no drama please'.  And so it was again today: industrial production up 4.3%, electricity down 2.1%, retail sales 1.7%, urban investment 4.9% ytd. These are all weak, but also all quite tightly in line with consensus. None of them featured in my shocks & surprises index for China. My momentum indicators barely flickered: my aggregate consumption momentum indicator down 0.1SD, industrial momentum up 0.2SDs, monetary conditions up 0.1SD. 

And it's much the same with the GDP result: the 4% yoy rise claimed for 4Q means the quarterly movement was almost exactly in line with historic patterns. Nominal growth of 8.2% yoy confirmed the quarterly growth is still sinking below trend; the more so when you ex-out the 14.2% yoy rise in trade surplus to find domestic demand  up 7.9% and slowing; and when you further ex-out the fiscal deficit of 4.1% fo GDP, you get private domestic demand rising only 7.6% yoy.  

But none of this matters much compared to the real problem rising to confront China, and worsened again in 2021. That is simply that the government has never been able to raise enough taxes to satisfy their ambitions.  

This is not immediately obvious, because the central government certainly does look munificently funded.  But the thing to remember is that the fiscal revenues all run up to central level, rather like what happens in the Sopranos. Below the boss,  there are pyramids of levels of government, all of them kicking upwards. So provinces are less well financed than central govt, but are better off than those in the prefectures that answer to them, and so on down to county and township/village level, where things can get quite desperate. 

All those further down the fiscal food chain must find their own finances, and selling land development rights is, of course the most lucrative way of doing it, which is a big reason why China's real estate sector grew so wildly, and why the real estate bankruptcies really matter.  

What's clear from 2021's numbers is that the situation is getting worse. We have all the fiscal data until November, so have a very good idea about what going on. Revenues will have risen by about 10% in 2021, whilst nominal GDP 12.6%. This means revenues/GDP shrank to 17.6%, the lowest since 2006, and continuing a decline which has been underway continuously since the high point in 2016 of 22.4%. 

The real estate industry is bust for the foreseeable future,  so China's provincial and local governments urgently need to find a new source of finance. As China's government works out how to cope with the Evergrande & related bankruptcies, that's the next question that will be being asked in Zhongnanhai.

US Retail Sales

No doubt about what's grabbing the attention today - it's US retail sales value, which fell 1.9% mom, or, if you ex-out vehicle sales, fell 2.3% mom. That's the worst since February 2021, and since these are value numbers, worse than they look, since the US was running CPI inflation at 7% yoy in December. 

The immediate reaction is to blame it on the resurgence of covid, but that won't wash. First, the  most recent covid surge in the US kicked off around 18th December,  by which time I guess most Christmas shopping decisions would already have been made. 

And  if it was covid doing the damage, you'd expect to see restaurants deserted, and internet sales soaring. But that's not what happened: cafes & restaurant sales fell 0.8% mom only, whilst non-store sales dropped 9.5%. Conclusion? Covid ain't responsible. 

Inflation almost certainly is.  There are two contradictory  reactions to inflation: the first is 'well, I'm not paying that much for it' and the other is 'better grab it now before the price goes up again.' The US consumer is in the first state - holding back as sticker shock kicks in.

Earlier this week, I talked about how confidence surveys showed the US consumer with  a 'decent scepticism' about economic prospects, and worried about financial markets. 

The Uni of Michigan consumer sentiment survey showed the same today, with the index down a further 1.8pts, with current conditions down 1pt and outlook down 2.4pts.  Not panic, but certainly worry. 

Nonetheless, the retail fall suggests things may be a bit tighter than that. 

The details of the  Uni of Michigan survey  describe how inflation is eroding confidence.  Three quarters citing inflation as the worst problem, and 33% reporting their finances weaker than a year ago. And inflation is hurting the lower paid the most: the index fell 9.4% mom for those with incomes below $100k, but rose 5.7% for those earning more than that.   

I suspect there's another thing at work too: the rise in bond yields is shrinking the opportunity to raise disposable income by refinancing your house. Last week average 30yr fixed rates were running at 3.52%, compared with 3.24% at the beginning of December. Refinancing activity is down about 15% from the end of November, and this still accounts for 64% of all applications.

To re-iterate: there's no more 'catch-up' spending to be done in the US; and if the US is at or near full employment, continued demand growth will be sustained only if workers shift from low productivity to higher-productivity sectors to secure non-inflationary wage growth. That's the challenge for 2022.  

Fading Investment Signals

Spare a moment to think about  Japan's Dec machine tool orders, which were on the weak side in December. True, they rose 40.5% yoy, but the monthly movt was 1.3SDs below historic seasonal trends. The weakness was mainly foreign: export orders, which usually make up about two-thirds of orders, rose only 30.6% yoy and were 1.2SDs below trend, whilst domestic orders were still up 6.12% yoy (and were 0.7SDs below trend). 

What's going on? Two things are worth considering. First, this might be about China and, incidentally, the auto industry. Or maybe specifically China'[s auto industry, which is a mess. China's car sales fell 4.3% in 2018, fell 9.4% in 2019, fell 2.1% in 2020 and managed a rise of 6.6% in 2021. 2021's car sales remained 13.2% below levels seen in 2017.  They're still under pressure: China's auto industry is almost alone in being unable to raise prices: although China's PPI iron & steel prices were up 21.4% yoy in Dec, auto prices managed only a 0.3% rise. So they won't be  in the mood for heavy investment: in fact, auto-industry investment fell 3.2% during Jan-Nov.  

More broadly, the switch from internal combustion engines to electric cars means a dramatic cut in demand for machine tools by the auto industry. As electric cars take over, demand for auto-industry machine-tools will actually fall - with the tipping point probably arriving around 2026-27.

If it were just Japan's machine tool orders, it would be one thing. But the investment-spending signals are deteriorating all over the world. My shocks & surprises index for capital goods sector fell into negative territory early in December, and is now the most negative since August last year. The 12m average is also just about to turn negative for the first time since September 2020, snuffing out a short-lived recovery which had in turn overturned a negative trend which had been running since mid-2018.

Fading investment spending is obviously discouraging news for the global recovery cycle, and also for profits: after all, the Kaleckian profits equation gives substance to the neo-Keynesian observation that whilst household spend what they earn, the corporate sector earns what they spend . . .  For Japan, net investment spending is the source for 47% of total profits.

Today I talk about US inflation and Eurozone industrial production numbers. 

US December inflation: headline, up 0.5% mom sa, but the real headline is that unadjusted, the index was up 7% yoy, with a monthly rise 0.9SDs above historic seasonal trends. That's actually a bit of a relief from the 1.7SD deflection in November, and the 2.1SD deflection in October. But hold the celebrations: this is is probably not yet, quite, the peak of likely yoy: that's probably coming in February, when we can expect it at around 7.1% to 7.3% yoy.  

Ex-out food and inflation, and core CPI rose 0.6% mom sa, and before adjustments was up 5.5% yoy, with a monthly movt also 0.9SDs above trend.  Sequential inflation pressure has moved out from energy and food into the broader inflation this core index this measures. If current trends continue, its another three months before this peaks, and in the meantime we can expect to see it flirting with 6%.

Its now unrealistic to expect CPI to really retreat very much on its own: if the break above trend of the last six months is continued, you can expect 1Q at 7.2%, 2Q at 6.3%, 3Q at 5.9% and 4Q at 5.4%. There's no likely scenario which would take CPI back to the 2% level which was the average of the last 10yrs. In the meantime, although bond yields have risen to the dizzying heights of 1.75%, that's still 3.7pps below what we can reasonably expect inflation to be showing in 4Q22.

On to Eurozone industrial production. Around the turn of the year, you can expect index series to get rebased every so often, using new weighting of items, sectors or countries. But if the index is rebased from, say, 2015 to 2020 weightings, you get told. There was no such explanation for what happened to the Eurozone's industrial production series today. Rather, what we got from Eurostat was a completely unexplained, and sharply material, revision of an absolutely central series.  

For the record, it showed November's output up 2.3% mom, which was way better than one could expect from what we already knew (Germany had already reported production down 0.2% mom and France down 0.4% mom).  What appears to have swung it was Ireland,  where output was reported up 37.3% mom but down 30.4% yoy. Really. 

But the whole series was made anew - all new numbers - and this new series materially alters what we thought we knew. To give simply the latest number: the new series says output fell 1.3% mom in October, whilst the old series reported a 1.1% rise. Overall, between Nov 2020 and Oct 2021, we used to be told that output rose 0.6%; the new series tells us it actually fell by 3.4%.  You can't just slip that sort of revision in without explaining what happened.  So I've asked Eurostat about it, but have no answers yet.

We've had four sets of  confidence indicators out of the US in the last couple of days. They tell a story of sustained main-street economic confidence contrasted with a sudden gap-down in financial market confidence. This seems to me to be eminently reasonable, given near=full employment and the prospect of monetary tightening. 

The NFIB small business optimism index really did nothing, rising 0.5pts to 98.9, which extends the modest recovery of the last couple of months. Expectations for the coming six months remain sharply negative despite rising 3pts to minus 35. 

But for me, it's the NY Fed's monthly survey which is the king of US sentiment surveys. What get's advertised is the movt in inflation expectations, and there was little to report from Dec's survey: 12m expectations were almost unchanged at 5.99% and so were 3yr expectations at 4%.  House price inflation expectations rose slightly to 5.5%, and chances of moving home down slightly at 16.7% 

But the survey doesn't end there: it looks at the full spectrum of household attitudes and expectations: employment, chances of getting a new job, expected earning, expected spending, expected taxes; difficulty of getting credit. There's almost too much to take in. What did it tell us in Dec? I think overall, the Fed will be pleased - US households seem both basically confident but decently sceptical of their good fortune. 

Compared to November, expected wages  were up a bit 2.97%, and h'hold income up a bit at 3.37%, but spending down a bit at 5.53% and taxes down a bit at 4.4%. Credit availability slightly less difficult than in November.  Likelihood of losing a job retreated to the lowest on record, and the chances of finding a new job quickly rose to the highest since Feb 2020.

And what do people think about financial markets? Well, 28% expect interest rates on savings accounts will rise this year, which is 0.7SDs below the l/t average. Meanwhile, 38.9% expect the stockmarket will rise this year, but that's 0.8SDs below the l/t average. This looks basically not encouraging.  

And so on to direct measurements of stockmarket confidence. 

Today we had the IBD/TIPP index, which tracks economic optimism among investors, sank 7.6% mom to the weakest since July 2020.  That's what they say, but what are investors doing? 

Yesterday we had the December investor movement index, which tracks actual behaviour  of Ameritrade clients. That dropped 9.6% mom in December, to the weakest since February, coming off a plateau it has enjoyed since last March last year. 

Ameritrade's results are similar to what we heard out of State street on 29th December, when its investor confidence index - also calculated by looking at what people are actually doing with their money  - dropped no less than 25.9pts to 85.6, which was the worst since October 2020. The US fell 14 pts to 96.4, which again is a drop-off from a plateau its held since July. But the real killer came from European investors, with the index down 27.8pts to 67.6, which is lower than at any time during the pandemic. 

Loads of data today, of which the most commented will be the US labour market surveys. I see loads of commentary about how the 199k rise in non-farm payrolls was a 'big miss'. I don't see it that way, and I don't fell like arguing about it much  - when you're near full-employment - which I think functionally the US is now - you don't expect to see big gains.  Rather, focus on the fall in unemployment rate (3.9% on the U3 score, 7.3% on the broadest U6 score) both now way below the l/t average.

Instead I want to ask: How was it for you? How bad did 2021 feel from an economic point of view? Was the soaring US stockmarket enough to offset the inflation, the supply chain ruins, the on-again-off-again medically induced coma etc?

If journalism is the first sketch of history, the SF Fed's Daily News Sentiment Index tells us how these proto-historians are feeling. The index scans US economic news stories from 24 daily US papers, scoring them for optimism or pessimism. The higher the score, the more upbeat the press is about the US economy. It's been tracking this score, daily, since 1980. 

How about 2021? If you think last year was an unprecedentedly grim year for the US, you'd be wrong: it registered as very slightly positive year, coming in at #21 out of the 40yr sample. Only averagely bad, then. Score one for the S&P.

Its a good parlour game to guess when the public presses were happiest and most optimistic about the economy.  The happiest years were, in this order .  . . 2006, 1997, and 2005 (closely followed by 2004). 

The most miserable years were . . . . 1980 (inflation, Paul Volcker using interest rates to smash inflation), 2020 (covid, obviously) and 2008 (financial crisis, obviously). 

Which was the most optimistic decade, which the most pessimistic? Well, by some distance the best decade was the 1990s, followed by the noughties. Worst decade, it turns out, was the 1980s - which I rather enjoyed.  The last decade - the 20teens were also mildly negative. 

There's some interesting re-writing of history going on as well. Presidents remembered fondly generally got a bad economic press: Ronald Reagan's economy was almost uninterruptedly negative according to press sentiment. But this is probably not political bias, since President Obama got very similar treatment.  

Meanwhile, the happy recipients of sustained optimistic press were Clinton 2 and George W Bush. Generally speaking, the US press was most upbeat between 1993 and 2006, with only a brief dip into pessimism in 2002 (by which time the recession was already well in the review mirror). 

So maybe we could amend the saying: Journalism may be the first draft of history, but its judgements get scrubbed and forgotten very quickly. 

The most important thing we're seeing today is the uprising in Kazakhstan, which has seen riots and protests throughout this vast country, with govt buildings fired in Almaty. And now we've got Russian paratroops involved. Dozens of deaths are reported, but we don't really know, since the internet has been cut off. 

Where to start with Kazakhstan? It's the size of Western Europe with the population of the Netherlands. It's vast empty steppes are almost certainly teeming with every kind of commodity the world needs - including uranium and oil. It's a giant chemistry set. It is neighbour to Russia, China, Kyrgyzstan (China's Central Asian best friend), Uzbekistan. On the other shore from the Caspian Sea, it neighbours Russia (again) Iran and Azerbaijan.  In other words, it's strategically the one Central Asian country that really matters.

A few years ago I spent a couple of weeks in Almaty being paid to frame an obviously futile, indeed crazy, investment trust based on the Kazakhstani consumer sector. (Truth is stranger than fiction.) I left with a few thoughts: the mountains outside Almaty are dazzlingly beautiful; the Russians are in a minority; and the Kazakhs themselves the toughest scariest bunch I've ever met.  Ethnically, I think they are first cousins to the Koreans, with significant Mongol and Turkish input. Among them, the resident Russians felt, with good reason, felt pretty jumpy.  

My driver there, though, had something to say. His highly credentialled mother used to work as chief admin to the wife of someone very very, very, senior in the government. (In today's situation, I'm naming no names.) One day, he turned to me, and just said: 'I tell you, these people are wolves'.      

Because of its size and its immense commodities potential, whoever is leading Kazakhstan can do pretty much whatever he likes with the economy and with the financial system - it's just one of those places that can never really go bust, such is its hidden natural wealth.  And that in turn has meant it has an absolutely appalling record of corruption and bad governance at the top that has gone on for decades - with the family of former president/strongman Nazarbayef outstanding in this respect.  My driver again: 'These people are wolves'.

All these years ago, this was already obvious, the resentment was everywhere, and the people the toughest I've ever met. So don't be fooled into thinking what's going on is just about fuel prices. There are decades of resentments coming out now. 

Distinctly mixed news from the US.  Good news from the labour market front, with the ADP total of private payrolls rising 807k - that's up 5.2% yoy. The demographics are good too - small cos adding 204k, medium-sized 214k and large cos +389k. No real sign then either that large cos are pulling in their horns, or that smaller companies are finding it impossible to hire. A genuinely encouraging result, then, and one which helps offset yesterday's slightly disappointing JOLTS job openings number when openings fell 529k to 10.562mn. After all, if you've got hiring accelerating in the way ADP is reporting,  you'd expect some of those openings to be getting filled. 

If you remember what I was talking about yesterday, there's no more 'catch-up spending' to be expected, and domestic demand will depend therefore a lot on healthy labour markets. Which is what we have got.  

On the other hand, the news from December's vehicle sales were truly dreadful: car sales fell 3.6% mom and fell 23.% yoy, with domestic producers down 3.8% whilst foreign makers rose 7.2%.  Not much better for the light truck market - it fell 4.2% mom with domestic down 5.2% and foreign up 0.1%. 

But the worst news came from the heavy truck market. The US is meant to be dealing with its supply-chain issues, and you'd think that this would absolutely mandate rising heavy truck sales. Not so: Dec's heavy truck sales fell 17.1% mom and fell 1.96.% yoy, with the total number sold the lowest since June 2020. What's more, November's sales were also revised down sharply.  Why does this matter? Well, collapsing sales of heavy trucks have been early signals of approaching recession in each of the last four recessions since 1980, with no false signals either.  So here's hoping that the weakness in Nov and Dec were merely end-of-year jitters.  Definitely one to keep watching. 

Throughout the last two years, the suspension of normal economic and financial relations has resulted in wild swings in money flows to households which in turn have resulted in extreme volatility in such basics as spending and saving. The reasons are fairly obvious: lockdowns cut the opportunity for plenty of the usual spending, whilst governments' furlough payments kept income flowing into your account.  

In 2020 we got the collapse, and then much of 2021 was taken up watching the rebound. Catching  up on that deferred spending made for spectacular year-on-year retail numbers. To take just one example, in the US, personal spending on goods and services fell 3.2% in 2020, but in the first 11 months of 2021 rebounded by 11%. And that in turn was met by supply chains only just waking up from the medically induced coma.

2022 is the year when this first wave of volatility gets dialled down, because household finances are settling back to 'normal' patterns.  

Again, the US illustrates the point.  Back in early 2020, the personal saving rose to an astonishing 33.7% of disposable income.  That came down throughout 2020 and 2021, but by November last year it was down to 6.9%, which was actually below the pre-covid long term average of 7.4%. Moral - the 'catch-up' spending has been done. 

Today's UK mortgage data shows something similar. In the UK, housing investment is the mainstay of personal saving efforts, so throughout the pandemic the housing economy  was supported by a swathe of tax incentives and debt holidays. And so mortgage lending for new purchases rose 12.3% yoy in 2020, but has been falling since July 2021, and was down 32.7% yoy in November.  

But it's the change in refinancing behaviour which is revealing. This is, after all, how households take cashflow from the rising equity value of their homes. With household finances underwritten by the government during the pandemic, the value of remortgaging a record low of 22% of the value of new mortgages.  But those days are over, and by November, whilst new mortgages fell 32.7% yoy, the value of remortages rose by 43.5%.  The proportion of new remortgage debt to new mortgages has now risen to 37%, which is roughly back to the pre-covid l't average of 39%. 

Just like the US saving rate returning to normal, so the rise in UK remortaging relative to new mortgaging tells us we're back in the realm of 'normal' activity. So don't expect rebound spending in the US to have legs much longer, and ditto in UK demand markets, including housing. 

Welcome back to 2022.

Christmas and the New Year holidays are marked by a relative absence of important economic data, and also, of course, thin markets. 

Thin markets are a mixed blessing: they can thrown up anomalies, and can be unusually sensitive to people with strong views trading early and aggressively. Right now, they are throwing a number of curve balls in currency, commodity and bond markets.  

I put a number of currencies, commodities and bond signals through a technical filter, with the aim not of catching the first 5% of a movement, but rather giving me consistently accurate picture of the way the world is developing, These are not  trading signals, more a bunch of 'reality' signals. 

And over the holidays, they have been flashing all over the place. Just today, the dollar is on the cusp of falling into a weakening trend, thanks to the Euro, which is on the cusp of generating a strengthening trend vs the dollar.  Add to that, gold broke through to a strengthening trend (which helps explain why the C$ is also today breaking through), and natural gas re-asserted a rising trend. In bond markets the inflation risk premium on 10yr treasuries also started a rising trend.  

What's the moral?  The key is the dollar: a weakening dollar is a generally inflationary signal, which we're seeing echoing in commodity markets and bond yields. If inflation is bad for equity markets, then so is a weakening dollar. 

As for over-the-holiday data, there is not much to report. Today is dominated by Markit's monthly PMIs: all you need to know about them is they bear no interesting statistical relationship to eventually surveyed reality.   

The one thing which really caught my eye over the holidays, though, was the collapse in State Street's Global investor confidence indexes. These are interesting, because they are not the result of asking investors 'how ya feeling?' but rather looking at what they are actually doing with their money. And in December, the global index dropped 25.9pts to the weakest since Oct 2020, led by Europe down 27.8pts to 67.6, which is weaker than at any stage during the pandemic so far. That got to be the omicron virus taking its toll.  But US also fell to the weakest since June, and Asia to the weakest since July. 

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