What is ‘Animal Spirits’?
“Animal Spirits is a term used by the famous British economist, John Maynard Keynes, to explain financial and buying decisions in conditions of uncertainty. In Keynes’ 1936 publication, The General Theory of Employment, Interest and Money, animal spirits describes the human emotion that drives consumer confidence. In modern economic terms, animal spirits describes the psychological factors that drive investors to take action when faced with high volatility in the capital markets. The term is derived from the Latin spiritus animalis which means the breath that awakens the human mind.” (Investopedia.com)
Many speculate now that after the 9 year bull market and long term recovery, the cycle is coming to an end, we are at a peak! BUT what if, due to the nature of the mundane recovery, it is finally just getting started in the classic V shape–reflecting the release of “Animal Spirits”. It seems the recovery under Obama’s leadership was real and dynamic, but festered with fear and loathing of the financial world, of the political stalemate and facing the fast changing, disruptive challenges of new technology and the Internet. There was a genuine hesitation for companies to invest. That has changed, creating new perspectives and prospects.
The chart below measures US Industrial Production change yoy and if you look at the troughs, they are highly correlated with stock market troughs so what if a new economic growth cycle is in it’s infancy rather than its peak? The 2nd chart below indicates if Industrial Production goes sideways at current levels as in the few years after the DOT.COM bust and the Financial Crisis bust, the stock market will remain robust!
Did the US effectively undergo a recession in 2016 as a result of unusually tight financial conditions (strong dollar, rising credit spreads, etc.)?
Source: Stifel / WSJ The Daily Shot
US Industrial Production (Black) vs US GDP yoy (Orange) vs. S&P 500 Index (Blue)
What about the US-China Trade War?
Distribution of World Manufacturing (source: Nature):
UK, Russia, Western Europe, North America, China, East Asia, Indian Subcontinent, Rest of World
World Manufacturing 1750-2016 – look at the pattern! China is purple and was a dominant force from perhaps before 1750 for the next 100 years when Western Europe and the UK took over and then came the USA in the 20th century. In 2016, the Chinese recaptured it’s role together with East Asia squeezing both North America and Western Europe. If the current administration succeeds at bringing a greater portion of manufacturing back to the USA esp. from China, it will fuel industrial production further, fueling greater confidence in GDP growth and the stock market–those animal spirits!
Despite the manufacturing sector’s relatively small contribution to the (service-focused) US economy, factory earnings make up a significant portion of the total nonfinancial operating profits.
Source: TS Lombard / WSJ-The Daily Shot
Then there’s oil…
Oil has been a bone of contention for me as I thought the price should fall significantly as the world swims in the stuff and America becomes a net exporter. It has played out quite differently than I expected as major suppliers have been stymied, namely Iran and Venezuela. Demand is robust as global economic activity has yet to peak. Being a bull at heart, I should be happy.
Oil can still be vulnerable! CHARTS
Oil and the Sotheby’s Bubble Indicator: Sotheby shares are indicating a correction in both Equities and Oil
A stronger dollar is bad news for crude oil… not necessarily
Source: Stifel / WSJ The Daily Shot (21June2018)
Stronger USD could also hurt Gold, but here you can see Oil Prices remain resilient… (Equities – S&P500 just keeps on climbing) – The Power of the US Economy and its Animal Spirits!
European Outlook weakens…clearly a sign of non-existent Animal Spirits
Buyers of Gold look at the dangers of Italy (Equities) threatening to leave the EU (DAX) or the EURO…
This table shows the year-to-date changes in the manufacturing PMI (business activity) globally. The worst slowdown has been in Europe (shaded yellow). Turkey is the worst at -12.2 pts., then comes a number of Europeans including Germany (-9.7 to -5.5 pts), USA is no. 32 with +0.5pts from 38 and the best is Chile with +9.3 pts.
Source: WSJ-The Daily Shot
Unimaginable #3: European growth outpaces the USA turning negative interest rates positive, narrowing the differential keeping the EURO strong with little volatility.
Completely off this year as I thought in December 2017 that the momentum in Europe would keep up its pace. A start to normalization is 9-12 months down the road. Europe is not only dependent on a strong USA, but more apparently on a strong China and worried about Brexit and Italy.
It will be tricky for several European economies to exit the negative rate environment before the ECB does.
Additional Sources: WSJ-The Daily Shot
Food for Thought: The market is anxious about stock markets peaking and economic growth slowing or even going into reverse with an imminent recession just around the corner. High oil prices, rising interest rates, pending inflation, lower auto and home sales in the USA are worrisome signs, but what the market is not pricing in is firstly, the severity of the Great Recession which can mean a much longer than normal recovery and secondly, the release of Animal Spirits. Again these Animal Spirits reflect America’s history of embracing risk, going for it and something that the younger generations worldwide just might be learning.