Thursday, April 20, 2017
The Economy: “Imminent Signs of Market Collapse?”
“Imminent Signs of Market Collapse?”
by Brian Maher
“We have it on high authority - Reuters - that “the ‘reflation’ trades of 2016 that were supposed to mark a turning point in global markets are fading. Fast.” And CNBC senior markets commentator Michael Santoli sees the scribbling on the wall: "The question now is how it ends - with a whimper or a bang."
David Stockman has his answer. And it’s of the combustible variety: "The sweeping Trump tax cuts and fiscal stimulus are dead as far as the eye can see… So now comes the fiscal bloodbath and the day of monetary and fiscal reckoning."
One sign that something has to give - and probably soon - is the widening chasm between stocks and bonds. Bond yields are at historical lows. Yet stock prices are at historical highs. And therein lies a tale indeed. Low bond yields suggest an uncertain future… subdued growth expectations… and low inflation. High stock prices suggest faith in the future… elevated growth… “healthy” inflation. Since peaking at 2.6% in mid-March, yields on the bellwether 10-year Treasury bond have slipped to 2.2%.
Shyam Rajan, strategist at Bank of America Merrill Lynch, says the interest rate market reflects the increasing likelihood that Trump’s tax reforms might never see dawn: "The rates market is pricing in the death of tax reform and dimming 2018 economic prospects." Scott Minerd, global chief investment officer at Guggenheim, now projects that the 10-year yield could plummet to a dour 1.50% by summer.
Meanwhile, stocks bounce right along, merry as a wedding bell. The Dow weighs in at 20,578 today, up another 174 points. The S&P’s also up 18 today, and the Nasdaq a cheery 54. Thus, we have two seemingly incompatible market narratives locked in a bitter combat. Stocks versus bonds. Hope versus fear. In this great tug of war, the market seems to pull on both ends of the rope… pitted against itself.
It can’t last. Which side is the “real” economy throwing its weight behind? Bonds, apparently... As most recently as Feb. 1 the Atlanta Fed's closely watched GDPNow had first-quarter growth around 3.4%. But its latest estimate, out this week, weighed in at just 0.5%. And Gallup reports that confidence in the economy is at its lowest in five months.
More rain: The March jobs report came in about 82,000 short of expectations, retail bankruptcies are rising, auto sales dropped sharply in the first quarter. Meanwhile, commercial and industrial (C&I) credit growth has slowed to 5.4%... down from 10.3% a year ago. That’s a rate of decline not seen since December 2008, according to The Telegraph’s Ambrose Evans-Pritchard - the onset of the Lehman Bros. crisis. He says that’s “hard to square with the exuberant view of investors that the world is on the cusp of an accelerating economic boom.”
We’re inclined to agree. So are Elga Bartsch and Chetan Ahya of Morgan Stanley, apparently: "We have not seen such a sharp deceleration in bank lending to U.S. corporates since the Great Financial Crisis. Historically, credit downturns have led recessions."
Rather disturbing for a global financial system more leveraged than at any time in history. And if you’d like more evidence that the stock market is impossibly at odds with the real economy - deep in the dingles of bubble land, that is - consider the following:
Household net worth relative to GDP has never been higher. As independent investment adviser J. Lawrence Manley reports: "Since 1950, private-sector net worth (real estate and financial assets) has averaged 377% of GDP. Currently, private-sector net worth is 492% of GDP, which is 2.8 standard deviations above the mean." In all its graphic detail:
It was John Maynard Keynes who said the market can remain irrational longer than investors can remain solvent. Many would argue the past eight years affirm Keynes in spades. But if the bond market wins its tug of war with the stock market, reason could soon make its inevitable return - and with a vengeance too.
Below, David Stockman draws parallels between today’s stock bubble, the dot-com crash of 2000 and the Dutch “tulip mania” of 1637. Can today’s bubble possibly continue? Read on."
"Tulips and Stocks: A Study in Mania"
By David Stockman
"At the peak of the Dutch tulip mania, bulbs sold for more than 10 times the annual income of a skilled craftsman and a single rare specimen bulb (Semper Augustus) purportedly changed hands for the equivalent of 12 acres of prime land. But after rising 8X in a few months, the reckoning came in early 1637. The tulip bulb price index came crashing back to where it had started in, well, November of the prior year!
So it might be wondered whether this most recent November to April mania is “there” yet. Stocks haven’t quite risen quite as dramatically since November, but they’re still up a completely unjustified 12%. And I believe we’re not only seeing the end of the vaunted Trump Stimulus, but quite possibly the entire 30-year era of Bubble Finance.
Let’s revisit a later bubble, the dot com bust, for some more recent instruction... Between October 24, 1999 and March 22, 2000, the NASDAQ 100 rose from 2,460 to 4,600 or 87%. After that parabolic climb, however, it soon plunged back to where it had started in October. Nor was the year 2000 collapse close to done - it plunged a further 67% through October 2002.
Like the NASDAQ blow-off of 2000, the current Trump-O-Mania rally started on November 2. As it happened back then, however, the NASDAQ 100 peaked shortly after the Fed raised interest rates (again) on March 21. Yet as CNN reported that day, the Fed’s action was considered to be no big threat to a then unstoppable bull: "For financial markets, the rate increase and the short announcement that followed was a non-event, mostly because Wall Street had widely expected the Fed to do exactly what it did. There wasn’t a black swan in the sky, it seemed - until there suddenly began a dizzying two-year plunge of almost 85% from the nosebleed peak. This time there is an Orange Swan hovering above the market, but it appears equally unrecognized by today’s punters. I am referring to the fact that the headline reading algos have totally misread the Trump Stimulus.
The robo-machines - and the remaining troop of day-trading carbon units that mimic them - can only read words, not the political tea leaves. Accordingly, when the Donald promised a “big, big” corporate cut and a “massive tax reduction for the middle class” and also a $1 trillion infrastructure bill to rebuild “America’s roads, bridges, airports, hospitals and schools,” the machines dutifully “priced it in.”
Well, as of today none of these promises are even on the horizon. It is almost impossible to overstate the level of unhinged mania in the stock market, but still the robo-machines and knucklehead day traders just can’t seem to let go. They have been indulged by the Fed and other central banks so long that they surely have come to believe flying blind is completely safe. After all, we can count at least 60 “dips” since March 2009 that resolved to the upside over and again.
Altogether the S&P 500 now stands about 3.5X its post-crisis low, having generated an 18% annual return (including dividends) for nearly eight years running. To be sure, in an honest free market that very fact would be a flashing red light, warning that exceptionally high gains over an extended period necessitate a regression to the mean in the period ahead. But we have a central bank medicated market, not a free or honest one, so at the end of the day fundamentals don’t count. Instead, on the margin the stock market is driven by momentum, central bank liquidity and trader presumption that it will never be withdrawn.
The reflexive dip buyers have ratcheted the market higher 45% without any plausible or sustainable case for it. Economic growth rates are deflating, productivity has slumped and corporate earnings have been sinking for nearly eight quarters. Even the central banks themselves concede interest rates are intended to eventually normalize. Their radical experiment in zero interest rates (ZIRP) and bond yield repression of the last nine years was designed to force interest rates temporarily to unnatural lows in order to jump start the economy.
The implied channel of monetary policy transmission, therefore, would have been a temporary spurt of GDP expansion (back to the “potential” GDP path) and earnings growth. That didn’t happen, of course, because quantitative easing (QE) stimulus never got outside the canyons of Wall Street. It did nothing for main street. In so doing, the Fed has destroyed honest price discovery, and therefore the market has no braking or correction mechanism. It will drift higher on pure buy-the-dips momentum until it hits a sharp object.
Stated differently, this is the most dangerous market mutation to have ever been confected by state policy. It has destroyed two-way trade, short-sellers and the other mechanisms of free market discipline. What is left is robo-machines that all buy the dips together, but will also sell the coming crash just as quickly. Which I think is imminent.
So never mind the fact that the ostensible reason for the post-election Sucker’s Rally - the mythical Trump Stimulus - has already bitten the dust on Capitol Hill. Now Treasury Secretary Steven Mnuchin says tax reform by August is “highly aggressive to not realistic at this point.” Ain’t that the truth! Likewise, any corporate tax reform that does happen will be done on a roughly deficit neutral basis, meaning that the average effective corporate tax rate is not going to change much at all. Therefore, there will be no growth coming from corporate tax reform.
And don’t take my word for it. Here is what one of the most outspoken fiscal responsibility champions in the House GOP had to say: “You’re not going to be able to grow your way out of this one. It’s too big,” says Rep. Tom Cole (R., Okla.). He expresses worry about relying on rosy growth projections, through the use of so-called dynamic scoring, to assume tax cuts would stimulate the economy to materially offset upfront revenue losses. I worry we’re so in love with dynamic scoring, and it never works out the way the tax gurus tell us it’s going to.”
The bottom line is that the sweeping Trump tax cuts and Fiscal Stimulus is dead as far as the eye can see. Meanwhile, the economy is saddled down by declining real wages, collapsing GDP estimates, sinking retail and auto sales and contracting business credit. But after last month’s rate hike, Janet Yellen defended the third rate hike in 11 years by saying that the “data is noisy.”
What isn’t noisy is the data on the stock market’s bubble of a lifetime. And the rumblings of a financial earthquake are now audible. When it erupts Yellen and her posse of Keynesian money printers will be incoherent, speechless and finished. And that eruption could be days away. So now comes the Fiscal Bloodbath and the day of monetary and fiscal reckoning. Also, now comes your last chance to get out of the casino with the shirt on your back.”