EORUM CLARITATEM VESTIG ATIONES !
10. JULI 2012
A&O Insights July 2012
Inside: What to do
The Economy
Demographics
We are at a maximum equity exposure as of June 29, 2012. Bonds are a „hold“ to us. Support from yen exchange rate looks iffy.
There is steady progress in our indicators. Our Composite Economic Indicator suggests GER GDP bottom for SEP 2012.
U.S. June labor market data positive surprise. ,Broad improvement. - European CDI dips into negative late 2013.
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EORUM CLARITATEM VESTIG ATIONES !
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The analysis presented in this publication is based on the conviction that major economic trends are rooted in demographic forces, which are the main drivers of consumption. Notably, household formation by people seeking permanent employment after education and by those engaging in family formation is for a substantial portion of consumer expenditure. Eventually, consumption is followed by investment, employment, shifts in inflation and interest rates etc. Gradually, financial markets are affected by what is going on in the "real" economy regardless of whether or not these goings-on become apparent in the official statistics.
I
The DEMOGRAPHIC ROAD-MAP focusses on medium-term and long-term demographic trends and explains how they feed through to the financial markets.
ntroduction
Economic trends can be characterized by looking at new business orders and production, representing demand and supply. These data, however, are often not available on a timely basis and are sometimes subject to substantial revisions. Monetary data, on the other hand, are much more consistent. In our approach money serves as a proxy for demand in the economy and loan growth is usually a good approximation of the trend in supply. The interplay of these two forces is one of the cornerstones of our monetary analysis. Monetary analysis attempts to detect emerging monetary stress or ease reflecting the ever changing balance between demand and supply in the economy. Our proprietary indicators represent our operational "tool-box" for forecasting trend changes in bonds and equities. Equity prices are - last but not least - the result of an auction market at work. Market prices may deviate from the path set by any methodology. The analysis presented on the following pages is grounded on the conviction that market prices can over- and undershoot fundamental trends only for a relatively brief period of time. Emphasis is, therefore, placed on a disciplined yet flexible fundamental approach to market analysis. What is presented here is solely based on facts - objective data obtained from official sources - rather than more or less arbitrary estimates. Additional background information is available upon request. NOTE: Market trading can result in losses as well as profits. This statement is required by law. We strive for accuracy in our advice and info, but all conclusions and decisions based thereon are the sole responsibility of the reader.
Advice&Opinion Demographics & Markets Inh. Dipl.-Kfm. Rüdiger Braun Steinkaul 10 – D-40589 Düsseldorf – Germany Website: www.aodemographics.eu FON: +49-(0)211-6400113 Cell: +49-(0)1525-8705859 All rights reserved. No part of this publication may be reproduced without written consent. Copyright by Advice & Opinion Demographics & Markets, 2012.
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Where to Find ...
Page 4
The Investment Box - Just the results
Page 5
Summary - Most Important Observations Some brief explanations
Page 12 Page 17
Monetary and Economic Background - The Details Monetary Indicators Economic Indicators
Page 24 Page 28
The Demographic Road-Map How, where and when population shifts drive the economy and markets.
verview
O
The Demographic Chart-Book Charts to keep in mind
Timeline: A Possible Scenario For 2012 & 2013
4Q 2013: Stock Mkt. Top Begins to Form
3Q 2011: Recession Begins
! A&O Insights July 2012
Mid-2012: Equity Bear End
1Q 2013 Econo Bottom
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I. The Investment Box: Just The Results Stocks: Our demographics-based asset allocation model for the German market went bearish stocks in April 2011. The DAX then stood at 7,514 points. It went long stocks again as of June 209, 2012. The DAX was at 6,416 at the time. Following the model thus saved you a loss of 14.6%. Going long the REX total return index in April would have produced a gain of 11.9% for the whole portfolio. Well, now we are back at a balanced exposure: 50% long DAX and 50% long the REXP. Our demographics-based asset allocation model will be bullish equities until October 2013. --- World stock markets are doing much better than the European ones. The lingering euro crisis and the unknown policy responses are a major drag on equities. Stock selection is key to performance at present. Our new product TREND INSIGHTS is designed to help you master this challenge successfully. What to do: We are at a maximum equity exposure. A tactical stop level may be placed at a three day closing below DAX 5,800.
W
hat to do
Bonds: We continue to view bond markets as increasingly risky. In the U.S., for instance, the margin indicator shown on p. 23 is certainly still positive, but at levels which more often than not triggered a reversal. In addition, we are worried about the yen vs. euro rate. Our yen model shows a persistent loss of momentum. The euro re-cycling is at risk. Also, German banks are increasingly reluctant to buy bonds. In short: Profit protection is our top priority. What to do: We are still long Bunds, but use trailing stops. We let the market decide.
Gold/Commodities: Gold continues bullish. Industrial metals suffer from recession. The firm dollar has been depressing gold in past months. This may be changing now, though, as we are detecting early signs of the dollar losing momentum vs. the euro. What to do: Stay clear of mining stocks (AMEX Gold Bugs). If still long, sell into the current rebound. We will go long physical gold above 1700 USD and add to positions above 1800 USD.
Currencies: The Pacific currencies are signaling that the global economy is gaining pace. The Australian and NZ dollar are super strong versus the euro. The U.S. dollar is also re-gaining momentum vs. the euro but our monthly model is clearly getting tired. What to do: We are long U.S. dollars enjoying the ride. Adjust your stop to 1.2700 vs. euro. Economy: It is a mixed bag, but we think that the weight of the evidence is gradually improving. In the U.S. the unexpected weakness of the ISM index caused some dismay. On the other hand industrial production continues in a solid up trend. The labor market data was disappointing, too, as far as the Establishment Survey was concerned. Yet the Household Survey data came in amazing across the board. Most important: the first-time entrant labor force participation rate moved very close to a long-term trend change. --- In Europe, data remain rather confusing and contradictory. New business orders for Germany appear to stabilize and export orders from outside the EMU lead. Employment remains stable, but demand for labor is heading south. Input prices plunge, but sales prices are not affected. It is difficult to read anything consistent from the data. Yet there is one bullish development: In Germany, short-term business loans are turning down and this has been a classic indicator of rising cash flows/stock market.
Demographics: Our purely demographics-driven asset allocation model is long equities since June 30, 2012. The next exit point for equities is October 2013. --- The German economy will hit bottom in spring 2013 and peak in 4Q 2013.
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II. Summary II. 1. Where We Are: Most Important Observations which we analyze (amongst others) 130 German stocks (DAX, MDAX, and SDAX). The chart illustrates the extremely split nature of today‘s stock market. During the spring correction the percentage of stocks rated „favorable“ by our system fell to slightly above 50%. The percentage of vulnerable stocks climbed to about 25%. Now
Weekly "ALL DAX" Trend Survey (2011 to Date) 200
DAX Index & Long-Term Moving Average
Percent of Stocks
150
100
50
PC Favorable Stocks
PC Consolidating/ Topping
0 Jan 07, 2011
Apr 08, 2011
PC Vulnerable Stocks
July 08, 2011
Oct 07, 2011
Jan 06, 2012
APR 05, 2012
JUL 06, 2012
GER DAX (Top) vs. Inverted Call Money Rate (Advanced) 8.000
0,20
6.000
4.000
-0,50
2.000
0
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E
quity Summary
Stocks: Stocks are groping for a bottom. That should be a choppy affair going forward. The bottom chart illustrates a scenario based on past interest rate patterns. Eventually, beginning in the fourth quarter 2012, a broad rally should get underway. The top chart on this page is from TREND INSIGHTS, our new publication in
EORUM CLARITATEM VESTIG ATIONES !
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DAX vs. Relative Strength: DUAV/DAX
DAX vs. 10 & 30 Day OB/OS Oscillator 80
76
72
69
E
65
quity Summary
61
10211
90611
131011
170212
280612
have a look at the dotted line in the chart, which is the percentage of stocks in a pattern of „indecision“, consolidating or potentially topping (We call it Stage 3). It rose to a hefty 50%. It will be very important to track how this big chunk of Stage 3 stocks will proceed going forward. Currently, we think they will revert to an up trend (Stage 2). - Notice that our Stage Analysis for the MSCI Universe of stock markets and the U.S. could register healthy gains since our last writing. Both indicators are in the 75% vicinity. It is also positive that our unweighted German equity index DUAV continues to outperform the DAX. As of this writing, the OB/OS oscillator (top right) is displaying a small negative divergence, but the red 30-day-oscillator is moving into positive territory. In addition, the percentage of German stocks in medium-term uptrends has improved strongly in recent weeks, which is bullish. But in the short-run this indicator is over-extended so that a little rest would be no surprise. The bottom line is that the majority of indicators continue in o.k. shape, not great but not bad either. This is also true for the U.S. bullish percentage index. The trend is up and this is probably all we need to know. *****
57
20311
270511
190811
111111
60212
30512
USA Percent Stocks in Stage I & II vs. DAX
Mär 16,2007
Mär 14,2008
Mär 13,2009
Mär 12,2010
Mar 11, 2011
Mar 09, 2012
Percent Global Stock Markets (Euro based) in Stage I & II
Jun 21,2002
USA Bullish Percent Index vs. DJIA (2009 to date)
Jun 18,2004
Jun 16,2006
Jun 13,2008
Jun 11,2010
JUN 01, 2012
Percent GER Stocks in Medium-Term Uptrends 200
150
100
50
0 Mär 26,2010
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MAR 23, 2012
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moved. In our opinion there is now a negative divergence building. In the first half of 2012 the money was made in the bond market and this may well reverse in the second half. The momentum loss we register is the reflection of the fact that the underlying fundamentals do no longer look rosy, as we will demonstrate through the remainder of this report. This leaves the fear of a Eurozone meltdown as the main buying motive for German government bonds. Opposite to the German stock market investor sentiment for U.S. Treasuries is high AND rising, as the insert chart illustrates. This certainly does not raise our comfort level. We remain defensive.
GER 10-Yr.-REX vs. 10/5-Yr. REX Performance Ratio 155
150
B ond Summary
Bonds: In the bond markets the trend is still up. But it is a very mature trend. Similar to an aging gigolo it is trying to attract new buyers, easy meat, so to speak, with little experience, those who only see the seductive smile but not the missing tooth. Typically, the loss of momentum is an early warning of something being wrong. Notice the deterioration in our weekly and monthly models since last month. The rebound from the recent correction has done nothing to better the situation. The performance ration shown below is just another item to worry. The 10-yearREX index has retraced about half of its correction, but the performance ratio has barely
10. JULI 2012
140
135
10-Year REX Bond Index
145
130
125
19.06.2009
14.06.2010 REX Price Index vs. Weekly Model
03.06.2011
24.05.2012 REX Price Index vs. Monthly Model
120
A B
Jul 28,2006 Aug 24,2007 Aug 22,2008 Aug 21,2009 Aug 20,2010 Aug 19, 2011
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Chart theory has it that this reduces the likelihood of a downside breakout. So let us be patient and see what happens. The critical factor behind the gold price is, of course, the U.S. dollar. The dollar vs. euro exchange rate has hit long-term resistance and the monthly model is showing a massive bearish divergence vs. the previous peaks. Yet also in the short-run the model has failed to produce a new recovery high (arrow). The practical implication is that we should treat a short-term sell signal, let‘s say a trend line violation, as a signal with longterm implications.
Currencies/Commodities/Gold: Industrial metals continue dormant. Especially in euro terms they have ceased to go down. Nickel, our pet gauge for the strength of the global economy, has been going sideways for many months and is now shy of crossing its moving average on the upside. Message: Global demand and economic activity is bottoming. Precious metals are a different story. gold has been correcting for many months and a falling triangle has been developing. Notice that the long-term moving average is beginning to flatten out and that the gold price is running into the apex of the triangle.
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ommodity & Currency Summary
USD vs. Monthly Model
88 JAN
93 JAN
Gold USD/Unze
98 JAN
WPK: 999003
03 JAN
Rohstoff
08 JAN
13 JAN
ISIN: XC0009655157
vwd Rohstoffe
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US-$
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- SMA(30):1.596,07 - SMA(200):1.659,93 LOG
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(c) Tai-Pan
09.07.2012
(c) 1997-2004 Tai-Pan
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II. 2. Equities ther words, the bond markets continue to anticipate a devaluation of the „deficit euros“ vs. Germany, the Netherlands, Luxemburg and Finland. Capital flight is on and drains deposits from the southern European banks. The (negative) Target2 balance of Spain rose by 63 billion euros in June! How can a new rescue package for the Spanish banks of 100 billion euros help the banking system under such circumstances? Anyway, stock markets seem to turn a deaf ear on such
Percent
GER Equity Index vs. AUD Ann. %
88 JAN
91 JAN
94 JAN
97 JAN
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E quity Analysis
The main themes remain unchanged. There is increasing evidence that the global economy is gaining traction. On the other hand, there is increasing evidence that the Eurozone is facing a collapse. Despite all sorts of „rescue“ action (for Spain in particular) there is no indication that the markets are beginning to discount a turn for the better. Similar to the pre-euro period, bond yield spreads keep widening between the Eurozone surplus and deficit member states. In o!
15 JAN
GER Total Equity Holdings at Major German Banks (Ann. %) 150 125
Annual Percent Change
100 75 50 25 0 -25 -50 -75 90 JAN
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EORUM CLARITATEM VESTIG ATIONES ! looming scenarios of eurozone armageddon. The two charts on the preceding page are an attempt to illustrate these two factors. Notice that the Aussie dollar, which enjoys an almost immaculate track record of mirroring the state of the global economy, is gradually establishing a turnaround. Its annual rate-of-change is in the process of moving above the long-term moving average line. At the same time the pace at which German banks have been reducing equity holdings seems to slow. All of this takes place at historically low holdings anyway and leaves a lot of room for increasing positions
E
10. JULI 2012
quity Analysis
once sentiment vs. the stock market begins to improve. We believe that banks will only move into the market late, when the traditional fundamental indicators report about an improving economy. We like the fact that we get support from international (and the U.S. in particular) stock markets. The MSCI world equity index (in euro) is close to moving above long-trem resistance. Our monthly model for the Nikkei is making progress moving closer to positive territory. The DJIA (in euro) has already accomplished a long-term buy signal. This is an important step ahead compared to last month. The U.S. is the economic juggernaut.
Nikkei 225 (in Euro) vs. Monthly Model
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DJIA (in Euro) vs. Monthly Model
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II. 3. Bonds high vs. the euro, this pillar could crumble overnight. Notice on the bottom chart how incredibly tight the correlation between the yen and the Bund future (blue graph) has been! Also notice that there has been virtually nil support for the bond market stemming form the domestic side. Net mutual fund contributions have been negative despite the rally. Domestic demand is low, and foreign demand can turn on a dime.
GER Mutual Bond Funds: Net Contributions (% of Fund Volume) 10
6
A 2
B
B ond Analysis
We view the bond market with a jaundiced eye. It is holding well, the up trend is still intact, but it is hard to find a justification for that among the indicators we follow. One can hold bonds with tight and trailing stops, because capital flight out of southern Europe generates demand for safe haven investments. In addition, the trade surplus re-cycling out of Japan is another important factor propping up bond prices. Should the yen, however, fail to make a new !
-2
-6 78 JAN
83 JAN
88 JAN
100 Japan.Yen in Euro Euro
93 JAN
WPK: 000091
98 JAN
03 JAN
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Japan Forex
DE: BUND-Future (adj.)
Euro
1,0000
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- SMA(30):1,0060 - SMA(200):0,9663 LOG
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Kurs:1,0220 Q1'09
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01.01.2008
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1179 Kurse
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Q2
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Q1'12
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(c) Tai-Pan
06.07.2012
(c) 1997-2004 Tai-Pan
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III. Monetary & Economic Background III. 1. Bank Lending & Related Indicators III. 1. 1. Bank Lending
M onetary Analysis
! Cross border bank lending in the Eurozone has long come to a virtual standstill. The consequence is that lending is now done via the national central banks. As a result, the Target2 balances are ballooning. The below (top) chart shows the exponential rise in
the (positive) Target2 balance of the Deutsche Bundesbank. The source behind these balances is international trade needed ot be financed and, increasingly, capital flight. Ultimately, the Bundesbank (the German taxpayer) is financing the zombie banks of
Charts courtesy www.querschuesse.de
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longer. The Eurozone is close to breaking up. The economic strategy is untenable and the balance of (political) power is shifting away from Germany. Economic logic and common sense might be thrust upon the European elites or else the Eurozone will become a failed state altogether. In Germany, it is remarkable that growth in short-term business loans is finally subsiding. That is bullish for stocks since it is the precursor of rising cash flows and profits. In contrast to the Eurozone, inter-bank lending is healthy. There is no credit crunch and this is another sine qua for an economic recovery.
GER ST Business Loans (Ann. %; RS) vs. Job Offers (Ann. %) 150
25
120 10
-5
60
Job Offers 30
-20
Annual Percent Change
Annual Percent Change
90
M onetary Analysis
the deficit countries which lose deposits at a very heavy clip. It is quite unlikely that the claims of the Bundesbank on the central banks of the deficit countries will ever be settled. The bottom chart on the previous page shows why. It shows the annual rate-ofchange in outstanding loans to private households and businesses in the Eurozone, which turned negative in May. The Eurozone is in debt deflation. At the same time, public spending is slashed. Under these circumstances there will be no economic growth. It seems, however, increasingly likely that this situation will not continue for much
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0 -35 -30
-60 80 JAN
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GER Inter-Bank Lending (Ann. %) Advanced by 6 Months vs. GER Equity Index 45
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III. 1. 2. Liquidity Indicators Ten - That is the reading of our Composite Liquidity Indicator this month. It is the maximum rating last registered in 2009. It then lasted from January to June and provided a solid base for the rebound of the stock market after the Lehman slump. The important shift compared to last month was the trend break in short-term business loans (see p. 13). Slowing demand for short-term business loans has been a !
L iquidity Indicators
reliable clue to reduced financial stress and a precursor of falling business risk. Another major positive this month is the surge in real M1 growth in Germany and the Eurozone. M1 is a leading indicator of new business orders and we expect orders to improve in the third quarter 2012. If our assessment is correct, it would be very bullish for equities. There is nothing better than rising demand meeting a business sector that is retrenching and thus lean and mean.
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Annual Percent Change
Sum of Ratings (Range: +/- 10)
GER Composite Liquidity Indicator (Monetary Trend) vs. Real GDP (Ann. %) 30
-17 15 JAN
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GER NBO Goods-for-Further-Processing (Ann. %) Top vs. Real M1 (Ann. %) Bottom 50
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-10 92 JAN
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-115
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EORUM CLARITATEM VESTIG ATIONES ! That said, there is a little fly in the ointment, however. Notice that Bank Liquidity is treading water presently. German banks are again reluctant to buy government bonds so that the liquid asset ratio is barely changed compared to the previous month. Needless to say that this is a drag on the bond market. On the other hand Corporate Liquidity has surged. With bank lending stagnant this is entirely due to the rise in M1 growth. The
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implications for the stock market should be bullish going forward. Mind you that the concept of Corporate Liquidity is based on the composition of the consolidated banks‘ balance sheet in an economy. It monitors the change in the difference between private debt and deposits. This difference is the sum of all net savings by private households and retained profits of the corporate sector. A positive and expanding Corporate Liquidity indicator is thus the
iquidity Indicators
Annual Percent Change
GER Bank Liquidity (Liquid Assets Ratio Ann. %) vs. Inverted Bond Yield
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L
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GER Corporate Liquidity vs. Equity Index
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GER Bank Liquidity (Liquid Assets Ratio; Smoothed Ann. %) Advcd. by 6 Months
iquidity Indicators
Annual Percent Change
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creases the ability of the banks to incur higher business risks. It must not be forgotten that the German banks have practically no exposure to the stock market. Compared with historical standards the investment exposure in mutual equity funds is also very low. In other words, there is room to change and move once all the locked-up wallets are being opened. The bottom line is that monetary growth is accelerating and lending is very subdued. Bank reserves are abundant. The stage is set for the economy to grow.
sine qua of an economic upswing and rising profits. On the upper chart we note further progress in the smoothed and advanced version of Bank Liquidity. This indicator is not to be ignored and its message is bullish. It is also positive that bank reserves continue to grow at a healthy pace. Notice that both moving averages are now in bullish territory. A highly liquid banking system is essential to a healthy economy and stock market. Given the dire situation of the Eurozone it is even more important since it in-
Annual Percent Change
GER Bank Liquidity II (Central Bank Reserves - Ann. %)
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III. 2. Economic Indicators III. 2. 1. General Economic Indicators that its six-month moving average is close to becoming positive as well were it advanced and not centered! All the same we think that a bullish crossover is n the cards. September is the likely month unless we see an uptick in the ISM before or a return of life to the German job offers. Both constituents are still rated negative and depress our composite gauge.
GER Composite Economic Indicator (LS) vs. Real GDP (Ann. %) 45
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Annual Percent Change
Sum of Ratings (Range: +/- 14)
Real GDP (Ann. %)
E conomic Indicators
As we have argued so far, the technical situation of the German stock market is more or less satisfactory. The economy‘s liquidity situation is improving and the banking system is awash with reserves and liquidity. Does the real economy also look upbeat? Well, our Composite Economic Indicator remains in positive territory. It has been positive for four months in a row and this means !
-17 15 JAN
GER Exports to EMU Relative 65
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Percent of Total Exports
Percent of Total Europe
EMU as % of Total Europe (LS) EMU as % of Total (RS)
35 13 JAN
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EORUM CLARITATEM VESTIG ATIONES ! Last month we noted that the economies outside the EMU have taken the lead by looking at new business orders. The bottom chart on the preceding page delivers the same message. Since 2009 German exports to the Eurozone have lost importance relative to total exports and exports to Europe. This is the reflection of the austerity policy in Euroland and the beneficial impact of the strong U.S. dollar/weak euro. All of this, however, could not yet lift our „Real“ Corporate Liquidity Indicator into positive ground. In fact, it notched down this month. Industrial production is still outstripping the growth rate of new business orders.
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conomic Indicators
But that may change very soon as we have noted before, if orders recover on the back of strong monetary growth within the Eurozone. The bottom chart depicts the German current account balance. Export growth is the cornerstone of the German business model and so far Germany has managed to avoid a deterioration of its export surplus. In fact, there is a pattern of a rising triangle now and this means that intermittent downswings in the current account have become systematically smaller. De-emphasizing the Eurozone has certainly helped accomplishing this little wonder.
Annual Percent Change
GER "Real" Corporate Liquidity Ann. % (New Business Orders - Production)
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GER Current Account Balance (Mln Euro) vs. Equity Index 30.000
Millions of Euros
20.000 C/A in Mln EUR GER Equity Index
12 MMAVG
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EORUM CLARITATEM VESTIG ATIONES ! In the U.S. the ISM indexes fell in June. New orders were hit hardest, but the employment sub-index remained remarkably resilient. This is consistent with the data from the Household Survey we analyze in the demographics section. - Industrial production also dipped marginally in the durable consumer goods and business equipment area. Nothing special and no trend change in sight. - Most important to us, though hardly visible in the chart, is the uptick in the wholesale employment to a new recovery high. This is an ace coincident indicator of the U.S. economy and it is bullish!
10. JULI 2012
USA Balance of Payments Goods & Services (Millions of Dollars) vs. DJIA
U.S. E
-17500
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No new data -70000
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USA Wholesale Trade Employment (000) vs. Ann. % (Bottom)
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USA ISM Total Index vs. Ann. % (Bottom) 6250
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conomic Indicators
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USA ISM Employment Index vs. Ann. % (Bottom)
USA Industrial Production Consumer Durables: Index vs. Ann. %
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USA ISM New Orders Index vs. Ann. % (Bottom) 110
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III. 2.2. New Business Orders ! Isn‘t the stock market deemed to be a discounting mechanism? Its current pattern is one of diverging trends even within industry groups. We can make this observation in the U.S. as well as in Europe. And our new publication Trend Insights confirms this for the majority of markets under survey. That said, the obvious question is, what the market discounts at present? Will the negative camp win of the bullish one? Well, our demographic indicators provide a clear-cut answer. But how about other, fundamental indicators? The fact that the market itself can no longer be treated as a monolith teaches us that we cannot paste a straightforward label on today‘s economic background. We have to come up with a more complex answer, as unpleasant as the fact
N ew Business Orders
may be. Let us take a look at the index of new business orders first. The arrow in the chart marks the low of the index in September 2011. Since then the index managed to recover and is now above its moving average line. Barring any severe fit of weakness the annual rate-of-change of the index will recover soon above its moving average and the zero reference line. If so, it would be a classic buy signal for the stock market. The export vs. domestic order ratio exploded on the upside in May. Sure it was helped by base effects, too. Yet the nonEMU business is much stronger than the domestic one and may prove to be the White Knight for Europe and Germany in particular. In Germany, domestic orders for con-
GER Total New Business Orders Index vs. Ann. % 80
GER NBO Ratio Export vs. Domestic Orders (Ann. Change) 150
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GER NBO Domestic Consumer Non-Durables vs. Durables (Ann. %) 110 10
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marriages is in an up trend and this suggests a rise in big ticket consumer spending beginning soon. A brief glance at the below charts confirms why the economy and the stock market is so split: it is domestic growth vs. exports. Notice the huge jump in the machinery sector and the more modest rebound in the steel industry. Yes, there is life outside the Eurozone!
Annual Percent Change
GER New Business Orders: Machinery Relative to Total Orders (Ann. %)
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N ew Business Orders
sumer goods are falling sharply. This is the likely result of rising job insecurity. The official German labor market data show a steady decline in the jobless rate since April 2009 no matter how the economy is doing. We suspect that the official statistics have long become a political figure hiding the large degree of underemployment from the public. But help may be on the way for the domestic consumer sector. As we will show in the demographics section, the number of
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15 JAN
Annual Percent Change
GER New Business Orders: Steel Relative to Total Orders (Ann. %)
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III. 2. 3. Corporate Profit Gauges Isn‘t this funny? New business orders have been displaying large swings. Industrial production has sharply fallen in the recent past. The growth rate in the number of job offers has slumped. Yet somehow the jobless rate managed to decline through all of this. Does this make sense to you? Has the Bundesagentur managed a miracle? The jobless rate (seasonally adjusted) has remained at 6.8% for seven months in a row and de
P rofit Gauges
clined steadily since April 2009 when it stood at 8,3%. That said, it is unsurprising that proxy #1 largely fluctuates in sympathy with the new business orders component. There is no new message here. The German margin proxy at the bottom of this page is of course different but equally stuck in an uptrend with virtually zero volatility. Input prices have plunged speaking of weakness in the industrial sector. It did
GER Profit Proxy I: NBO (= Revenues) vs. Employment (= Costs) 60
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GER Profit Proxy II: Margins = Sales Prices vs. Input Prices Six minus twelve months moving average in percentage points
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certainly one development, which explains the extremely split nature of the market at present. Thank God, not all economies are run by the miracle concept. The U.S. margin proxy eked out another recovery high. It is now back at its historic highs and this may well mean that the U.S. bond market rally is close to being over, too. The stock market should follow the lead of this key indicator with a lag of about six months, which argues in favor of an exciting second half.
GER Profit Proxy III: Consumer vs. Capital Goods Ratio (Advcd by 6 Months) vs Equity Index
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P rofit Gauges
not have any effect on employment and it seemingly did not affect sales prices either. Consumer prices have barely responded to the dramatic change in input price inflation. Another miracle of economic management. Profit margins continue to expand relentlessly and this supports the stock market. Well, there has been change this month. It is proxy #3, the consumer vs. capital goods ratio. Somehow, the adjustment to lower levels of demand is afoot, which is positive, of course. Until now, however, it has not hurt the stock market and, as experience shows, does not have to. But it is
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U.S. Margin Proxy: Prices Received vs. Prices Paid vs. Inverted U.S. 10-Y-Bond Yield -1,50
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IV. The Demographic Road-Map The U.S. data continues to surprise us said, the bulk of the U.S. employees appears positively. It didi so last month too, but the to enjoy rather healthy labor market condiJune data looks even more compelling. Distions. guised by a surprisingly weak ISM index for Yet as you are aware of, we place a lot June the demographics-driven labor market of attention to the employment situation of data shows an upbeat picture of the U.S. women and first-time entrants. Both populaeconomy. At the core is a mildly up trending tion and labor family formation market segments US Male E/P Ratio (Ann. %) cycle and a firstare very sensitive time entrant pat- 3 to subtle shifts in tern, which is economic activity. groping for a bot- 1 As some would tom to be followed phrase it, they are by a modest up- -1 the last to be hired turn. Both should and the first to be also stimulate the fired. Therefore, global economy. -3 trend changes in As a consequence t h e l a b o r f o rc e w e a r e s e e i n g -5 participation rate growing opportuniof first-time enties in the stock -7 90 JAN trants have been 95 JAN 00 JAN 05 JAN 10 JAN market(s) and inan ace economic creasing risks for indicator with an bond investments. The dollar exchange rate almost immaculate track record. We simply may also benefit and the recent momentum cannot overemphasize the fact. Now, check loss made up. out the chart below. The first-time entrant The insert chart shows the annual ratelabor force participation rate „jumped“ to of-change in the employment/population 35% in June. This does not seem to be an rate for men. It gained in June and remains exciting event, but notice that it has crossed comfortably above its moving average line its moving average and now exceeds the as well as above the zero reference line. That previous high! In addition, the moving aver!
D emographics
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seen this since 2008. To remind all readers: In the past there has never been a solid economic recovery and equity bull market (in Germany) without this indicator traveling in positive territory. So we give it the benefit of the doubt for the time being and treat it as bullish. The same indicator for the first-time entrants is shown in the bottom chart (at the bottom) in comparison with the growth rate of German export orders. We showed the same graph here last month but we have to repeat it. The annual rate-of-change of the first-time entrant employment/population
U.S. Female E/P-Ratio (Ann. %) vs. GER Equity Index 10
8
5
D emographics
age line is beginning to flatten out. All of this sure looks encouraging though a whipsaw cannot be ruled out. There was a kind of false start in May 2008 (circle) when the participation rate jumped by 1,4 percentage points from April and fell back by 1,8 percentage points in June. Yet we do not anticipate a similar flash in the pan this time. One of the reasons is that the employment situation among women made progress. The employment/ population ratio remained flat at 53,2%, but compared to the year-ago level it notched into positive ground in June. We have not
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U.S. First-Time Entrant Employment/Population Ratio (Ann. %) vs. GER Export Orders (Ann. %) NBO Export RoC US FTE E/P Ann. %
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EORUM CLARITATEM VESTIG ATIONES ! ratio spurted to a new recovery high! Probably not so incidentally the export order graph violated its moving average line on the upside. The bottom line is that - with a bit of luck - the fresh U.S. labor market momentum is already beginning to spill over to Germany/Europe. After many months of delay, the Federal Statistics Office published new data And we like what we are seeing. For starters marriages are now showing a favorable upturn. Over the remainder of
D
10. JULI 2012
emographics
the year this will help push consumer demand, specifically big-ticket spending. The below chart illustrates that real GDP tends to respond positively to a rising trend in marriages and that marriages typically lead the general economy by roughly one year. So that‘s the good news. The bad news is that the end of the budding economic rebound is almost sure to occur in the third quarter of 2013. The bottom chart on this page depicts a European CDI dipping into the negative. This means that the preceding peak is an exit point for
GER Real GDP vs. Advanced Marriages Ann. % (6 MMAVG) 30
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Real GDP (Ann. %)
Marriages
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A lot will also depend on the capital flight movements, which have so far propped up the bond markets of the Eurozone surplus countries. One possible outcome of such a mess of conflicting and confusing crosscurrents may be that there won‘t be a clear trend for many months. We are seeing the same phenomenon in today‘s stock markets, which are terribly split in Europe and the U.S. Even though the indices are inching up they do not reflect a monolithic market trend any more even within individual industry groups. Given the current problems in Europe and the unknown policy responses, bonds may have to be treated on a country-bycountry basis rather than buying „the index“. Sounds pretty much old-fashioned, doesn‘t it? Diversity, not diversification, may be the key to performance in the next twelve months. *****
July 10, 2012
D emographics
the stock market investor. One year from now, in June 2013, our modified version of the CDI that is shown below and which we use as a proxy for the evolution of corporate costs will have topped out. As we have just shown, the demand side of the economy will turn sour as of October 2013. Finally, in November 2013, the German family formation cycle will embark on a fresh and steep down leg. No economic cycle or bull market has ever survived such an adverse combination of demographic patterns. As for the bond markets we are not so sure what will emerge from the above scenario. Typically, bonds tend to benefit from a growing economy because cash flows and tax revenues rise and thus reduce financial stress. But this time around the unresolved euro crisis remains the big imponderable. should the U.S. dollar surge in response to a lift of the U.S. economy then flow-of-funds may weigh on European bond prices.
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V. The Demographic Chart-Book Chart # I Demographic Asset Allocation (DEMAA) incl. 90% Floor b/o High Water Mark
D
180 160
emographic Chart-Book
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Chart # II Performance Compared - Percent Change (Base = JAN 2000) 180 150 120
Life-Cycle Investing DAX German Govt. Bonds
Percent Change
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Chart I, a 90%-Floor Fund concept, and chart II illustrate what demographics can do to your portfolio. The simulation is based on the employment of demographic data input only in order to demonstrate that it is possible to outperform by adding the demographic element to your investment process. To make demographics work for you instead of being at its mercy. please, contact us.
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Chart # III GER Annual Births 1900 - 2009 (West Germany) 1100000
GER Annual Births 1900 - 2009 (West Germany)
D
1100000
Baby Bust in WWII
Baby Bust b/o Anti-Baby Pill
887500
675000
Baby Bust Echo 675000
Post War Baby Boom
462500
Baby Boom Echo
462500
250000 250000 1900 1900 1910
1920 19201930 19301940 19401950 1950 1960 1960 1970 1970 19801980 19901990 2000 1910 2000
2010 2010
2020 2020
2030 2030
Chart III is key to understanding the implications of population shifts for the future course of our economies and financial markets. The births of the past will translate into equivalent variations in the number of young adult consumers who are the ultimate drivers of private consumption, the bulk of GDP. The rationale for this is the fact that first-time entrants and family founders enjoy the highest percentage rise in personal incomes and, therefore, consumer expenditures. Older people may have higher incomes but a large part of their spending is largely tied to the replacement of consumer goods like stereo systems, TV-sets, cars, refrigerators, furniture etc. Nothing can compete with the household formation spending among young adult consumers.
emographic Chart-Book
887500
While the economy as a whole benefits from a rising number of young adult consumers (because of rising births in the past) there are also specific industries which are affected more than others from demographic shifts. Evidently, residential construction and automobiles, two core areas of the economy, are very sensitive to population shifts. Chart IV depicts the consequences of the demographic pattern for these industries and the economy as a whole. It demonstrates that your future is indeed based on the past. Notice that the number of young adult consumers, the first-time entrants and family founders, will increase in the years ahead. This is very bullish news for equities in particular.
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Chart # IV
1100000
Baby Bust Echo Depresses Family Formation & Consumer Spending
D
950000
emographic Chart-Book
800000
650000
Demographic Tailwind 500000
1990
1992
1994
1996
1998
2000
2002
2004
2006
2008
2010
2012
2014
2016
2018
2020
The baby bust of the sixties and seventies caused a steep fall in the number of young adult consumers decades later and the result was a demographic headwind for the economy, which started in the early nineties and lasted until 2003. Since then, the demographic headwind has become a demographic tailwind, which is a major plus for the economy and the equity markets. Chart # V 15
6
GER Real GDP Ann. % (Ann. %) RS GER Young Adult Consumers (Ann. %) LS
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!
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This slump in the number of young adult consumers will be followed by an economic slump. 1970
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2020
Real GDP Annual Percent Change
Young Adult Consumers Annual Percent Change
12
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On chart V the red graph illustrates the change in the employment of the thirty-year old population segment, the typical family founders, based on the data from the micro-census. It follows the “forecast� of the red graph, the annual rate-of-change of the number of births advanced by thirty years. In other words, the actual employment pattern tracks the hypothetical pattern very closely. The practical relevance lies in the fact that economic growth rates (the blue line) follow the pattern of young adult consumers, in this case the thirty-year olds.
D
Chart # VI
50.000.000
2.125.000
43.750.000
1.750.000
37.500.000
1.375.000
31.250.000
Population Aged 21 - 60
Young Adult Consumers
Population aged 21 - 60 yrs. essentially the labour force
First-Time Entrants & Family Founders 1.000.000
1950
1960
1970
1980
1990
2000
2010
2020
2030
25.000.000
emographic Chart-Book
GER Population 1950 - 2030 2.500.000
Chart VI shows how powerful the demographic shift is. The combined number of first-time entrants and family founders is set to increase steadily until the year 2020. This pattern is in stark contrast to the decline in the size of the total labour force on the back of demographic ageing. There is no empirical evidence that the total size of the labour force is critical to economic growth. Notice that the first post WWII recession in the early seventies was triggered by the steep drop in the number of young adult consumers because of the drop in births during WWII some thirty years before. In the same period, from 1970 to 1974, the total labour force actually rose. Other European countries are subject to demographic patterns, which are very similar to the German one. The U.S., however, exhibit a different pattern, which has its roots in the Vietnam war. The modification of the Selective Service Act led to a brief baby boom and bust in the late sixties/ early seventies. Chart VII shows in which way this brief interlude created a very different pattern compared to other countries. The draft deferral baby bust has caused painful damage to the global economy (via a sudden drop in the number of young adult consumers) and will continue to do so in the future. The global slump in 2001 and 2002 is the most recent example of such an intermittent recession, which has demographic roots. The recession of the years 2011 to 2014 will be next.
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Chart # VII
USA Average of First-Time Entry & Family Formation 6
D
Vietnam War Legacy: The Echo Effect of the Draft Deferral Baby Boom & Bust
emographic Chart-Book
Annua Percent Change
3
0
-3
-6
1980
1985
1990
1995
2000
2005
2010
2015
2020
2025
Chart # VIII USA Young Adult Consumers Ann. % (4-Year Avg.) 7,50
10 Year Treasury Yield
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Young Adult Consumers
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US Young Adult Consumers Annual Percent Change
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The demographic shift, which has ended a dozen years of subdued growth in the Western industrialised countries a few years ago, will bring about a revival in the domestic economies. Beginning in 2003 this has lifted the equity markets, especially the small and mid-caps. The bill for this bullish reversal will, however, be eventually presented to and paid by the bond market. That’s yet another secular change being underway. (The bull market in commodities is the third one.) Chart VIII should give you an idea of how powerful the consequences of the demographic shift are for all investors. Whether these consequences will be pleasant or painful depends on how informed you are about these goings-on. You are invited to profit from our know-how. *****
D emographic Chart-Book
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