Watch from 5:00
Luke Gromen: “Their game plan is to keep treasury yields below the GDP growth rate. The last time they did this was 1945 to 1980.”
A stock market bubble of epic proportions
A great deal has been written in recent years about real estate bubbles, stock market bubbles and even bond market bubbles. But there is really only one kind of bubble — that is a debt bubble. Without low interest rates fueling rapid debt growth, any form of bubble would wither on the vine.
The Wilshire 5000 broad market index, compared to profits before tax, recently peaked above 15.0 for only the second time in history before retreating to 13.97 in Q3. The fall in Q3 is attributable to recovering profits rather than falling stock prices, so a return to above 15.0 seems likely if the index rises in response.
The reason for the surge in stock prices is clear on the chart below: interest rates at close to zero for an extended period act like rocket fuel.
Anna Schwartz, co-author of A Monetary History of the United States (with Milton Friedman, 1963) once said:
If you investigate individually the manias that the market has so dubbed over the years, in every case, it was expansive monetary policy that generated the boom in an asset. The particular asset varied from one boom to another. But the basic underlying propagator was too-easy monetary policy and too-low interest rates.
That is particularly true of the current bubble.
When will it end?
The Fed seems unlikely to change course and is expected to keep interest rates near zero for an extended period, so when is the bubble likely to end?
If bank credit growth stalls, falling to zero (the red line) as it did before the last three recessions, stock prices are likely to tumble.
There may be three possible causes of slowing credit growth:
- Inflation surges, forcing the Fed to raise interest rates;
- Low interest rates cause investment misallocation, as in the Dotcom and subprime bubbles, leading to rising defaults and tighter bank credit; or
- An external shock causes falling aggregate demand and high unemployment, with banks tightening credit policies in anticipation of rising defaults.
Chairman Jay Powell has assured us that the Fed will tolerate higher inflation, with its new policy of inflation averaging, so higher interest rates do not seem to be a major risk. While there has been some investment misallocation, falling aggregate demand and high unemployment seem to be the greatest threat.
Initial claims for unemployment insurance jumped to 853,000 for the week ended December 5th, while initial claims for pandemic unemployment assistance surged to 427,600.
Latest Department of Labor figures (November 21) show total unemployment claims remain high at 19 million — or 1 in 8 people who had a job in February 2020.
Bank credit standards have tightened significantly.
Conclusion
Keep a close watch on bank credit growth. If this falls to zero, then stock prices are likely to tumble.
Commercial paper often acts as the canary in the coal mine, giving advance warning of a credit contraction.
US healthcare killing the host
This chart sums up the size of the challenge facing President-elect Joe Biden.
Mancur Olson (The Rise and Decline of Nations) identified special interest groups as one of the primary obstacles to efficient functioning of the economy, whether they be oil producers, banks, trade unions, or the medical profession. And the more powerful they grow, the greater the obstacle they become.
S&P 500: Leaders no longer leading
Daily new cases of COVID-19 continue to spike upwards, warning of further shutdowns as medical facilities are overrun.
Payrolls
The latest labor report disappointed, especially as the November survey came before the latest round of layoffs after states imposed tighter restrictions.
Payroll growth flattened, leaving total payroll down 5.99% compared to November last year.
Hours worked are slightly more encouraging, down 4.68% on an annual basis, compared to -2.9% change in real GDP.
Vaccines
Encouraging news on the vaccine front but “when you hear the cavalry is coming to your rescue, you don’t stop shooting. You redouble your efforts.” (Dr Anthony Fauci)
Stocks
Progress in manufacturing vaccines that will soon be widely available has buoyed stocks despite the dismal economic outlook. The S&P 500 made new highs, assisted by hopes of further stimulus and ultra-low interest rates. The large megaphone pattern is a poor indicator of future direction but does flag unusual volatility.
Growth in the big five technology stocks has slowed in recent months, with only Alphabet (GOOGL) breaking above its September high. Too early to tell, but failure of market leaders to make new highs is typical of the late stages of a bull market.
Conclusion
Vaccines should succeed in flattening the third wave and suppressing future outbreaks but are unlikely to succeed in restoring the economy to normalcy.
Federal debt is at a record 123% of GDP and growing. Further stimulus is required to support the still-fragile recovery.
The Fed will continue to expand its balance sheet to support Treasury issuance.
Ultra-low interest rates are likely to stay for a number of years.
If massive federal debt, QE and ultra-low interest rates does not cause a spike in inflation, that will encourage authorities to push the envelope even further (we fear this would have disastrous consequences).
Unemployment is expected to remain high and GDP growth likely to remain low.
Zombie corporations and commercial real estate with unsustainable debt levels will continue to be a drag on economic growth.
Growth stocks are expected to remain overpriced relative to current and future earnings.
George Orwell and the appeal of Fascism
George Orwell reviewed Hitler’s Mein Kampf in March 1940. His last paragraph is particularly revealing:
“Also he [Hitler] has grasped the falsity of the hedonistic attitude to life. Nearly all western thought since the last war, certainly all ‘progressive’ thought, has assumed tacitly that human beings desire nothing beyond ease, security and avoidance of pain. In such a view of life there is no room, for instance, for patriotism and the military virtues. The Socialist who finds his children playing with soldiers is usually upset, but he is never able to think of a substitute for the tin soldiers; tin pacifists somehow won’t do. Hitler, because in his own joyless mind he feels it with exceptional strength, knows that human beings don’t only want comfort, safety, short working-hours, hygiene, birth-control and, in general, common sense; they also, at least intermittently, want struggle and self-sacrifice, not to mention drums, flags and loyalty-parades. However they may be as economic theories, Fascism and Nazism are psychologically far sounder than any hedonistic conception of life. The same is probably true of Stalin’s militarised version of Socialism. All three of the great dictators have enhanced their power by imposing intolerable burdens on their peoples. Whereas Socialism, and even capitalism in a more grudging way, have said to people ‘I offer you a good time,’ Hitler has said to them ‘I offer you struggle, danger and death,’ and as a result a whole nation flings itself at his feet…..”
David Wood suggests that society may have eliminated many of the challenges that they faced 80 years ago but this makes us even more vulnerable today. If people don’t have real struggles to overcome, or enemies to fight, they will invent them…..
Time to get on with the serious business of beating COVID-19
Conservative news channel Fox News have called the election in favor of Joe Biden.
Trump and a few die-hard supporters insist that they will mount a legal challenge to overturn the election result. Here is a quick assessment of his chances by Neal Katyal, professor of National Security Law at Georgetown University and former US Acting Solicitor General (2010-2011):
There were 128,412 new COVID-19 cases on Saturday, November 7, bringing the total number of Americans infected to just under 10 million.
This has the potential to overload the health care system and shut down the economy. We need to ignore the sideshow and focus on what can be done to stop this. Before it’s too late.
Quote for the Week
Crisis does not change who you are.
Crisis reveals who you are.
~ Jakub Janda
Still counting…….and still rising!
Three days have passed since the election and there is still no clear result.
There are currently five states still in play: Alaska, Georgia, Nevada, North Carolina, and Pennsylvania. With 270 electoral votes needed to win, Biden needs 6 more electoral votes — any one of the last four (GA, NV, NC or PA) would do it. If conservative Fox News call the result in favor of Joe Biden, we will know it is all over for Donald Trump.
There are wild claims of missing ballots and vote rigging aimed at destroying credibility of the election result, plus conspiracy theories and fake videos alleging election fraud circulating on social media. We saw similar videos circulated after the 2014 Scottish independence referendum. Some were so amateurish as to be laughable — with looped video run in reverse in an attempt to portray an election official as counting the same ballot over and over again, complete with a voice-over with a heavy Russian accent — but some are now likely to be far more professional. Social media companies will need to crack down on organized disinformation campaigns.
Requests for recounts are fair enough in a hotly-contested race but are unlikely to change the outcome. Allegations of election fraud are far more malicious, especially when made in the mass media rather than in court. In the end, any such allegations will need to be tested in a court of law which will act as the final arbiter.
Still Rising!
The election is distracting us from an even more serious threat to the country: daily cases of COVID-19 in the US reached a new record high of 121,888. Failure to curb the current rate of transmission threatens to overwhelm the health care system and bring the economy to a standstill.
The last thing we need is to neglect the COVID-19 campaign while the election arm-wrestle descends into an all-in brawl.
Why Today’s Fiscal Stimulus Is Not Like WWII | Eric Basmajian
https://youtu.be/Rq5aBHsz0V0
Bearish divergence warns of tech stock retracement
The US recorded more than 75,000 new COVID19 cases on July 16th. The CCP must be smiling behind their masks after successfully containing last month’s outbreak in Beijing.
Source JHU CSSE
Technology stocks have screamed upwards despite the chaos, but bearish divergence on Twiggs Money Flow now warns of selling pressure. Expect retracement to test support at 2650 on the Dow Jones US Technology Index.
Dow Jones Banks Index is a more realistic representation of the broader US economy. The weak rally has fizzled out, with a Money Flow peak at zero now warning of strong selling pressure. Breach of short-term support at 320 would signal another test of primary support at 270/280.
Government support can only cushion the impact of a massive surge in unemployment for a limited time. Then we will witness the full extent of the damage.
Continued unemployment claims jumped to 17.355 million on July 4th, up by 840,000 from a week earlier. Judging by the rising virus count, further increases are likely.
But that is only the tip of the iceberg.
The latest Department of Labor update shows 32 million people claimed unemployment insurance benefits in all programs for the week ending June 27.
…..21% of the 152.4 million non-farm workforce in February 2020.
Pandemic Unemployment Assistance (PUA) under the CARES Act, signed into law on March 27, 2020 provides benefits to those individuals “not eligible for regular unemployment compensation or extended benefits under state or Federal law or pandemic emergency unemployment compensation (PEUC), including those who have exhausted all rights to such benefits.”
The S&P 500 is inching upwards, reflecting the tug-of-war between technology stocks and the broader market. We expect retracement of the Technology Index to cause another test of support at 3000 (on the S&P 500).
Nasdaq: Devil take the hindmost
I am fond off quoting Jesse Livermore’s maxim “You don’t argue with the tape” but Livermore was a keen student of market conditions and based his decisions on far more than just price action in the market.
We are witnessing a spectacular stock market rally, driven by retail investors and hedge funds piling into the market while institutional investors are sitting on the sidelines.
The Nasdaq 100 broke through resistance at 10,000, new highs signaling a fresh primary advance. Bearish divergence on Twiggs Money Flow index may warn of selling pressure but it is hard to argue with the tape. Only a fall below 9500 would signal another decline and that seems unlikely at present.
Even retail sales (ex food) have recovered sharply, from -15.3% in April to -1.4% in May (annual % gain).
Light vehicle sales are more sluggish but June sales of 13.05 million are still a sizable bounce.
So why are many old investment hands acting with such caution?
We know that the efforts to contain the COVID19 outbreak are struggling, with over 60,000 new cases per day, but the economy still seems in good shape.
Source JHU CSSE
Let’s look at where the money is coming from.
Treasury debt has expanded by more than $3 trillion in the last four months (March 9 – July 9) as the government does everything in its power to cushion the economy from an unprecedented shutdown. Rescuing airlines, bailing out Boeing, emergency business loans, job preservation schemes, and supporting Fed purchases of a wide variety of financial assets to keep the plumbing of financial markets open. Every way they can, government has been flooding the market with money and some of that has found its way to the stock market. Whether through boosting stock purchases, enabling companies to raise debt or boosting consumer spending to buoy up sales, the market is flying on borrowed money.
Steep up-trends like this typically end in a blow-off. A trend is self-reinforcing if rising prices attract more investors who in turn bid up prices even further. A steady influx of new investors is required to sustain the trend, else it dies.
Similar self-reinforcing cycles are evident in nature, where they expand violently outward at an exponential rate until they run out of fuel. The fuel driving the event may differ, from dry tinder in a forest fire, warm ocean temperatures in a hurricane, consumable vegetation in a locust plague, …..or exposed population in a virus outbreak. The cycle expands, feeding on itself, until the fuel is exhausted.
A stock market blow-off is no different. The up-trend will continue for as long as rising prices are able to attract new investors. It will stop when the source of new money dries up. In this case, when Treasury tries to slow the unsustainable growth in federal debt. Then it becomes a case of devil-take-the-hindmost as a preponderance of sellers attempt to offload their stocks on a rapidly shrinking pool of buyers.