The Month that Was: September 2013

In general, the U.S. economy remains in growth mode but vulnerable to an exogenous shock. There remains reason for optimism regarding continued expansion though. Leading indicators such as the Chemical Activity Barometer and the Conference Board's (CB) leading indicators index imply continued expansion over the remainder of the year and into next. Meanwhile, coincident highfrequency indicators, such as the American Association of Railroad's traffic indicator and jobless claims do not signal any deterioration. However, counterbalance the bullish news with the Chicago Fed's National Activity Index, which indicates persistent slack in the economy along with mention of the CB's leading indicators index growing at its weakest pace of the recovery and one arrives at the aforementioned general conclusion. Given the weak but still growing state of the economy, focus should be directed on potential exogenous shocks. The current critical ones facing investors are the political battles in Washington as well as the ongoing legislative drama in the Eurozone. In Europe: European economic activity seems to be stabilizing; however, political trends continue to deteriorate. With the latter said however, price action among periphery sovereign bonds continues to imply that investors believe that these tendencies will reverse in the future. The most prominent events have occurred in the latter half of the month. Pavlos Fyssas, a 34-yr old activist rapper, was killed at the hands of a Golden Dawn party sympathizer, a clear indication of the heavy social cost that austerity continues to impose on the Hellenic Republic. Furthermore, this past weekend marked a sudden turn of events in Italy. Silvio

| Rodrigo C. Serrano, CFA | SIPA | Columbia University Master of International Affairs 14 Candidate | New York City, NY | 01-305-510-0181 | rcs2164@columbia.edu

> In general, the economy remains in growth mode but vulnerable to an exogenous shock.

> Given its weak but still growing state, focus should be directed on potential exogenous shocks, particularly in Washington and Europe.

> European economic activity seems to be stabilizing; however, political trends continue to deteriorate.

 Berlusconi has pledged that 5 ministers of the Forza Italia party will quit their posts, potentially throwing the fragile Italian government into disarray. To be sure, Berlusconis gambit seems to be backfiring but in general, these events belie the notion that Europe is on the mend. In Germany, Merkel's resounding win could actually have a negative effect on confidence in the monetary union, given that she has stated that austerity will continue to be the primary prescription for Eurozone management. In my view, the situation across the Atlantic continues to worsen in combination with a strange sense of complacency among European officials. However, it is important to respect price action and indeed periphery sovereign bonds continue to recover, despite continued negative news. Perhaps this is because most believe that Mario Draghi's recent announcement of more LTROs will serve to buy more time. With that said, financial conditions continue to improve in the monetary union. In the economic arena, Eurozone Markit manufacturing and service PMIs have solidly entered into expansion territory (notwithstanding the persistent disparity among individual member countries). Furthermore, OECD leading indicators of periphery nations (Greece, Italy, and Spain in particular) remain in a bullish trajectory. Other leading indicators, such as New Industrial Orders for Spain and Italy show a potential carving of a bottom. In the case of Italy, New Industrial Orders coupled with bullish results from confidence surveys may be signaling a turning point for "Lo stivale" (the boot). In France, confirmation of an exit from recession in Q2 mirrors a more robust German GDP report for the same time period. Another meaningful note is that inflation is falling in Germany and may thus give Draghi more political cover for additional stimulus (perhaps this is the reason for his announcement of further LTROs). Unfortunately the green shoots of growth in Europe are not primarily related to resumption in growth of global trade flows. The critical question is whether this seemingly stabilizing environment will translate to a much needed growth phase for the periphery, in turn decreasing an already dangerously high level of political risk. So far, investors are voting in favor of this scenario. In summation, economic visibility in Europe remains clouded, which doesn't do much to decrease an already dangerously high level of political risk in the region. However, investors are voting that conditions are on the mend in the Eurozone.
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Chart: RCS Investments

 In Asia: Data from China continues to assert the bulls claims that the communist nation is set to reaccelerate, providing the global economy with a much-needed boost. Both HSBC and China's official PMI are straddling the 50 line after spending 2012 and a good bit of 2013 in contraction territory. Unfortunately, the exports orders sub-index for both the HSBC and official PMI indices is not confirming sturdiness in global trade flows (mirroring European data). Indeed, at YoY growth of just over 7%, Chinese exports remain far from the roughly 20% expansion rates that characterized the pre-financial crisis period. This phenomenon implies that the global economy is undergoing a significant shift in its internal structure. Given signs of renewed growth in the face of weak export indicators; one would surmise that strength is coming from within. Indeed, numerous reports of a "quiet stimulus" from Beijing to maintain the government's annual GDP target of 7.5% have been making the rounds. Energy consumption has spiked in August and supports this bullish thesis. Be that as it may, on the commodity front, we still don't see confirmation that a sustainable global growth phase has begun. Copper remains unable to break through heavy resistance at $335-336. Furthermore, prices for steel & iron produced a "shooting star" technical pattern, indicating a trend reversal has begun. Price action in these metals implies that the global economy remains weak; a sustainable growth phase has not yet begun. ---------------------------------In the U.S.: Manufacturing and Services: Near stagnant readings in the ISM survey along with weak performance within the Industrial Production indicator characterized the manufacturing sector throughout late 2012 and into 2013. However, it has recently shown signs of a renewed upturn. New orders have participated in the ISM's latest string of vigorous readings. Not all the news was rosy however. A negative divergence between Backlogs and New Orders implies that this recent growth spurt may lack staying
> Manufacturing has recently shown signs of a renewed upturn. Not all the news was rosy however. A negative divergence between backlogs and new orders implies that this recent growth spurt may lack staying power.
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> Data from China continues to assert the bulls claims that the communist nation is set to reaccelerate, providing the global economy with a much-needed boost. However, at YoY growth of just over 7%, Chinese exports remain far from the roughly 20% expansion rates that characterized the prefinancial crisis period. This phenomenon implies that the global economy is undergoing a significant shift in its internal structure.

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Source: Bloomberg

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 power. Meanwhile, the manufacturing sub-index within Industrial Production has turned higher, having notched its best reading of the year. Leading indicators, such as the Core Durable Goods orders remain mostly positive, but have shown increased volatility as of late. In sum, the manufacturing sector is poised to continue its growth, but the coast is not clear as to whether this upturn will strengthen considerably. The service sector, which accounts for close to 70% of the U.S. economy, continues to growth at a rather brisk pace according to the ISM's service sector index. Its results have been more bullish in nature than its manufacturing counterpart. In addition to improvement in the main index, new orders AND backlogs have participated. This buttresses the bullish case for continued growth in the U.S. economy over the coming months. Housing: Housing has become more of a growth contributor for the U.S. economy this year, evidenced by significant improvement in the National Association of Homebuilder's index as well as a higher growth rate in new and existing home sales. Nevertheless, recent higher interest rates have clearly weakened the sector's potential. Important barometers such as Building Permits and Housing Starts point to reduced rates of investment, while lackluster purchase mortgage applications imply that demand for housing has weakened. In general, the cross currents of higher interest rates combined with a cyclical recovery have affected the sector. Here and now, a sustained fall in interest rates should continue to act as a developing tailwind. Purchasing applications have begun to perk up and are indicative of strong underlying tailwinds, such as demographic trends [household formation] and a low base of home construction, at work. In point of fact, lumber prices signal that demand for raw materials consumed by the sector remains solid.
> Housing has become more of a growth contributor for the U.S. economy; nevertheless, recent higher interest rates have clearly weakened the sectors potential.

> The service sector, which accounts for close to 70% of the U.S. economy, continues to growth at a rather brisk pace. This buttresses the bullish case for continued growth in the U.S. economy over the coming months.

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 The Consumer: Consumption indicators have been a mixed bag. Tailwinds encouraging consumption, such as rising home prices (fastest pace in 7 years on a YoY basis) and falling gas prices have been offset by continued sluggish growth in wages and weakening confidence due to continued political deadlock in Congress over the budget negotiations and the upcoming debt ceiling standoff. Given this amalgamation of offsetting factors, it is difficult to pinpoint which side will ultimately win out. A solution on the budget negotiations and debt ceiling would lift the uncertainty; however, the longer this takes, the higher the possibility of reduced confidence tipping the economy into a negative feedback loop. It's important to note that growth in core retail sales is near the weakest its been in the recovery at 3.61%. When the economy tipped into recession in late 2007, core retail sales were running at remarkably similar rates. Therefore any worsening in the YoY rate at this point would be cause for alarm. For the time being, however, the consumer hasn't fallen out of bed. An assertion supported by a strong rate of growth in light vehicle sales.
> Over the past month, consumption indicators have been a mixed bag. > A solution on the budget negotiations and debt ceiling would lift the uncertainty; however, the longer this takes, the higher the possibility of reduced confidence tipping the economy into a negative feedback loop.

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