Merk Research: Axel's Take

Data developments since last month’s report have been mixed, but overall the economic expansion looks set to continue over the next few months, and in general until further notice. All of these charts or concepts are somewhat inter-related, as is the economy in general, so the idea is to have some different data points to cross-reference- in my view no one indicator can be looked at in isolation. That being said, most indicators are still positive, with the exception of some longer term indicators that look negative- suggesting that we are in the late part of the cycle.

The LEI Index still looks strong and the yield curve still has not yet inverted- it’s worth keeping in mind that yield curve inversion is historically a medium term indicator (6-24 months) with respect to the beginning of a subsequent recession. Regarding the global backdrop, I’m concerned about the weakness in the Chinese data, which needs continued monitoring for further deterioration. Recession risk over roughly the 1-5 year period is elevated with measures suggesting the economy is potentially operating above capacity, namely with respect to the output gap and labor force capacity utilization. Operating above capacity can persist for some time but is by definition unsustainable over the longer term, however there are uncertainties with regards to the estimates for potential GDP and the natural rate of unemployment. Also, some longer leading indicators such as auto sales and building permits appear to be rolling over, which adds to the evidence that the economy is in a late cycle phase. However, for the time being, there seems to be some slack remaining in the labor market, which suggests that the economic cycle can continue for a little while longer. Also notable, the NY Fed household credit report shows an uptick in the household delinquency rate, which might become a bigger concern in the coming months if that trend continues, but too early to say at this stage.

In general the data suggests classic late-upswing business cycle behavior. According to the CFA text, a late upswing means “at this stage of the business cycle, the output gap has closed and the economy is in danger of overheating. Confidence is high; unemployment is low. The economy may grow rapidly. Inflation starts to pick up, with wages accelerating as shortages of labor develop.” (See the Fed chart books for analysis on inflation and wages.)

To reiterate, taken together I think the U.S. business cycle picture is still positive. On balance, based on the charts and framework presented (which inevitably may not capture all possible risk factors in real-time), it seems likely the U.S. economic expansion continues until further notice.

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The Merk Hard Currency Fund is a no-load mutual fund that invests in a basket of hard currencies from countries with strong monetary policies assembled to protect against the depreciation of the U.S. dollar relative to other currencies. The Fund may serve as a valuable diversification component as it seeks to protect against a decline in the dollar while potentially mitigating stock market, credit and interest riskswith the ease of investing in a mutual fund. The Fund may be appropriate for you if you are pursuing a long-term goal with a hard currency component to your portfolio; are willing to tolerate the risks associated with investments in foreign currencies; or are looking for a way to potentially mitigate downside risk in or profit from a secular bear market. For more information on the Fund and to download a prospectus, please visit www.merkfund.com. Investors should consider the investment objectives, risks and charges and expenses of the Merk Hard Currency Fund carefully before investing. This and other information is in the prospectus, a copy of which may be obtained by visiting the Fund's website at www.merkfund.com or calling 866-MERK FUND. Please read the prospectus carefully before you invest. The Fund primarily invests in foreign currencies and as such, changes in currency exchange rates will affect the value of what the Fund owns and the price of the Funds shares. Investing in foreign instruments bears a greater risk than investing in domestic instruments for reasons such as volatility of currency exchange rates and, in some cases, limited geographic focus, political and economic instability, and relatively illiquid markets. The Fund is subject to interest rate risk which is the risk that debt securities in the Funds portfolio will decline in value because of increases in market interest rates. As a non-diversified fund, the Fund will be subject to more investment risk and potential for volatility than a diversified fund because its portfolio may, at times, focus on a limited number of issuers. The Fund may also invest in derivative securities which can be volatile and involve various types and degrees of risk. For a more complete discussion of these and other Fund risks please refer to the Funds prospectus. The views in this article were those of Axel Merk as of the newsletter's publication date and may not reflect his views at any time thereafter. These views and opinions should not be construed as investment advice nor considered as an offer to sell or a solicitation of an offer to buy shares of any securities mentioned herein. Mr. Merk is the founder and president of Merk Investments LLC and is the portfolio manager for the Merk Hard Currency Fund. Foreside Fund Services, LLC, distributor.