Category: Economy

Analysis of the global economy

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Luke Gromen: Bitcoin alarm

“We do not think BTC is a bubble; we think BTC is the last remaining functioning fire alarm that has not been disabled by policymakers, and it is issuing an increasingly shrill alarm about the USD and fiat currencies more broadly. We have little doubt that policymakers will attempt to disable BTC as a functioning fire alarm as well, but its traits make that far more difficult to do to BTC than they have thus far done with gold.”

~ Luke Gromen, Treerings.com

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Danielle DiMartino Booth On The Future Of The Federal Reserve

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Jim Bianco forecasts higher inflation in 2021

Jim Bianco from Bianco Research:

“The problem the stock market has in 2021 is by most standard metrics (P/E, Market Cap/GDP, etc.) it’s overvalued. Now a lot of people expect it to stay that way for another year. If we don’t get inflation, that can actually happen and you could actually have the market stay at these elevated levels. But if you do get rising interest rates on inflation……that will frip earnings, make mortgage rates go up and lift interest rates. That has historically not been good for risk assets….”

The problem if we don’t get inflation will be far worse. MMT theorists will take this as validation and we are likely to see more calls for far higher stimulus checks. Why not $200,000 stimulus checks someone on Twitter asked. The bubble will keep expanding without any visible effect …..until it bursts.

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Stock prices: Jay Powell is talking through his hat

Daily COVID-19 cases in the US continue to climb, reaching 236,211 on Thursday 17th.

USA: COVID19 Daily Cases

Unemployment claims jumped by 1.6 million in the week ending November 28, exceeding more than 1 in 8 of the total workforce (Feb 2020).

DOL: Total Unemployment Claims, 28Nov2020

Initial claims under state programs climbed to 935,138 (unadjusted) by week ending December 12, compared to 718,522 for w/e November 28, while initial claims under pandemic assistance programs run by the federal government jumped to 455,037 compared to 288,234 for w/e November 28.

Further escalation of both daily COVID-19 cases and unemployment claims is likely before vaccine distribution achieves a wide enough reach to make a difference. A major obstacle will be public reluctance to get the vaccine shot:

As states frantically prepare to begin months of vaccinations that could end the pandemic, a new poll finds only about half of Americans are ready to roll up their sleeves when their turn comes.

The survey from The Associated Press-NORC Center for Public Affairs Research shows about a quarter of U.S. adults aren’t sure if they want to get vaccinated against the coronavirus. Roughly another quarter say they won’t. (Associated Press, December 10, 2020)

Federal assistance

Further federal assistance may soften the impact of rising unemployment on the economy but Senate leaders are yet to conclude a deal. Both sides claim to want a deal but it seems unlikely that agreement will be reached before the Georgia run-off elections on January 5th. If the Democrats win both seats, and a Senate majority, they will not need to compromise. Unfortunately, large numbers of the least fortunate will suffer before then. Real leadership from the White House, needed to break the logjam, is sadly absent.

Jay Powell and stock prices

Jay Powell says he is relaxed about stock prices:

Stocks at record highs and bond yields not far from their historic lows are telling two different stories, but Federal Reserve Chairman Jerome Powell said he isn’t worried about the disparity.

In fact, the central bank chief said during a news conference Wednesday, the low rates are helping justify an equity surge that has gone on largely unabated since the March pandemic crisis lows.

“The broad financial stability picture is kind of mixed I would say,” Powell said in response to a CNBC question at the post-meeting media Q&A. “Asset prices are a little high in that metric in my view, but overall you have a mixed picture. You don’t have a lot of red flags on that.” (CNBC, December 16, 2020)

There is just one problem: bond yields are distorted by the Fed and do not reflect market forces.

S&P 500 PEmax

If we take the S&P 500 Price-Earnings ratio based on the highest trailing earnings (PEmax), this eliminates distortions from sharp falls in earnings during a recession. The current multiple of 26.69 is the second highest peak in the past 120 years, exceeded only by the Dotcom bubble. By comparison, peaks for the 1929 stock market crash (Black Friday) and 1987 (Black Monday) both had earnings multiples below 20.

S&P 500 PE of Maximum Trailing Earnings (PEmax)

Payback model

If we use our payback model, we arrive at a fair value estimate of 2169.50 for the S&P 500 based on:

  • projected earnings for the next four quarters as provided by S&P;
  • a long-term growth rate of 5%, equal to nominal GDP growth in recent years; and
  • a payback period of 12 years, normally used for the most stable companies (with a strong defensive market position).

The LT growth rate required to match the current index value (3709.41) is 14.0%. The only time such a growth rate was achieved, post WWII, is in the 1980s, when inflation was spiraling out of control.

Nominal GDP & Inflation (CPI)

Conclusion

Stock prices are in a bubble of epic proportions. Risk is elevated and we are likely to witness a major collapse in prices in 2021 unless inflation spikes upwards as in the 1970s to early 1980s.

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To infinity and beyond Part II

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.”

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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.

Wilshire 5000 Index/Profits

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.

Wilshire 5000 Index/Profits & 3-Month T-Bill Yield

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.

Wilshire 5000 Index/Profits & Bank Credit

There may be three possible causes of slowing credit growth:

  1. Inflation surges, forcing the Fed to raise interest rates;
  2. Low interest rates cause investment misallocation, as in the Dotcom and subprime bubbles, leading to rising defaults and tighter bank credit; or
  3. 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.

Initial Claims

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.

Bank Credit Standards

Conclusion

Keep a close watch on bank credit growth. If this falls to zero, then stock prices are likely to tumble.

Bank Loans & Leases

Commercial paper often acts as the canary in the coal mine, giving advance warning of a credit contraction.

Commercial Paper Outstanding

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US healthcare killing the host

This chart sums up the size of the challenge facing President-elect Joe Biden.

Health Care Costs

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.

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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.

USA: Daily COVID-19 cases

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.

Payrolls Annual Change

Hours worked are slightly more encouraging, down 4.68% on an annual basis, compared to -2.9% change in real GDP.

Real GDP & Hours Worked

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)

Now This News

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.

S&P 500 SPDR (SPY)

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.

AAPL, AMZN, GOOGL, MSFT, FB

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.

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Why Today’s Fiscal Stimulus Is Not Like WWII | Eric Basmajian

https://youtu.be/Rq5aBHsz0V0

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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.

Nasdaq 100

Even retail sales (ex food) have recovered sharply, from -15.3% in April to -1.4% in May (annual % gain).

Retail Sales (ex Food)

Light vehicle sales are more sluggish but June sales of 13.05 million are still a sizable bounce.

Light Vehicle Sales

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.

COVID19 Daily Cases

Source JHU CSSE

Let’s look at where the money is coming from.

Federal Debt

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.

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