Morning Note: Diminishing Returns

Continued strong demand for goods — no doubt capturing no small amount of what would’ve been spent on services absent COVID — is keeping the manufacturing space humming along.

This morning’s release of the December ISM Manufacturing Survey results showed improvement in 8 of the 10 areas measured (new orders, production, employment, supplier deliveries, inventories, customer’s inventories, prices and backlog orders). The two that showed slightly worse month-on-month results were new export orders and imports.

Interesting how in a country where 19 million folks are still receiving some form of unemployment assistance, manufacturers cite difficulties getting folks back to work:

“The manufacturing economy continued its recovery in December. Survey Committee members reported that their companies and suppliers continue to operate in reconfigured factories, but absenteeism, short-term shutdowns to sanitize facilities and difficulties in returning and hiring workers are causing strains that are limiting manufacturing growth potential.”

While I suspect a good number would-be-manufacturing-workers are reluctant due to COVID-fear, I also suspect that unemployment benefits, in some cases, that meet or exceed (or perhaps come close to) their employment income has them less than eager.

Also worth noting is what the report implies about our inflation thesis going forward.

“Commodities Up in Price”

Aluminum (7); Aluminum Products (3); Brass Products (2); Copper (7); Corrugate (3); Corrugate Boxes (2); Crude Oil; Electrical Components; Electronic Components; Freight (2); Isocyanates; Labor — Temporary; Linerboard; Lumber (6); Ocean Freight; Oil-Base Lubricants; Packaging Supplies; Paper Products; Personal Protective Equipment (PPE) — Gloves; Phosphates; Plastic Resins (4); Polyethylene Resins (3); Polyurethane; Polypropylene (6); Polyvinyl Chloride (3); Solvents; Soybean Products (3); Steel (5); Steel — High Carbon; Steel — Cold Rolled (4); Steel — Hot Rolled (4); Steel Products (4); Steel — Scrap; Steel — Stainless (2); and Wood — Pallets.

Commodities Down in Price


For the second day in a row the Dow opened higher, only to give it back shortly in the session (although it’s still early in the session). 

While of course two days in no way whatsoever does a trend make, we pay close attention to the open-to-close action (daily, weekly and monthly) to get a feel for whether, let’s say, the institutional money, is in accumulation or distribution mode when it comes to stocks. Selling the rallies of course suggests distribution…

Asian stocks rallied overnight, with 13 of the 16 markets we track closing higher.

Europe’s mixed again this morning, with 10 of the 19 bourses we follow currently in the red.

In the time it took me to get from the top to here the Dow turned back into the green. Which is the case among all of the major U.S. averages at the moment: Dow up 23 points (0.07%), SP500 up 0.23%, Nasdaq up 0.50%, Russell 2000 up 1.08%.

The VIX (SP500 implied volatility) is flat. VXN (Nasdaq i.v.) is down 0.96%.

Oil futures are up 3.64%, gold’s up 0.21%, silver’s up 0.45%, copper futures are up 1.95% and the ag complex is up 0.52%.

The 10-year treasury is down (yield up) and the dollar is down 0.34%.

Led by oil services, energy, emerging market equities, materials and Asia Pac equities, our core portfolio is up 0.65% to start the day.

More stimulus on the way…

Yes, indeed, while we’ve seen an amount of “stimulus” over the past year that was previously unimaginable, there’ll be more to come, no doubt about it. The results of today’s Georgia runoffs — which will determine the power in the senate — will impact the degree.

The thing about throwing money on top of money at folks is that, eventually, we have to seriously consider the law of diminishing returns.

I.e., the incremental gain resulting from each additional stimulus virtually has to wane over time. I mean how much stuff can folks stuff into their garage? In fact, over time, this may present a bit of a headwind for our inflation outlook — as we should not be surprised to see a great number of used stuff for sale in the coming months.

In James Weatherall’s fascinating book The Physics of Wall Street, he explains the Weber-Fechner law, which puts physics to the law of diminishing returns:    emphasis mine…

The Weber-Fechner law was developed by nineteenth-century psychologists Ernst Weber and Gustav Fechner to explain how subjects react to different physical stimuli. In a series of experiments,

Weber asked blindfolded men to hold weights. He would gradually add more weight to the weights the men were already holding, and the men were supposed to say when they felt an increase.

It turned out that if a subject started out holding a small weight—just a few grams—he could tell when a few more grams were added.

But if the subject started out with a larger weight, a few more grams wouldn’t be noticed.

It turned out that the smallest noticeable change was proportional to the starting weight. In other words, the psychological effect of a change in stimulus isn’t determined by the absolute magnitude of the change, but rather by its change relative to the starting point.

Have a nice day!


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