Today, Central Banks do “whatever it takes” to prevent “Disinflationary Bust.” If “whatever it takes” central bank policy wins, and I believe it will, then we shift up and to the right (red arrow next chart) and commodities and fixed assets such as real estate will do well.
Here’s the chart:
We have short-term debt cycles and long-term debt cycles. The last long-term debt cycle peaked in the 1930s. Our biggest challenge today is the massive level of debt accumulation.
Debt is a drag on growth. The conclusion that high levels of debt are correlated with lower growth is supported by studies from the Bank for International Settlements and the International Monetary Fund.
Reinhart and Rogoff looked at advanced economies going back to 1800. They concluded, with some controversy, that when debt-to-GDP exceeded 90%, economic growth declined from 2.8% per year to 1.8% per year. And if you look at growth globally from 1980 to 2000 and growth from 2000 to present, this is about what we see.
My point is that if 90% seemed to be the over/under the threshold, current readings of greater than 300% debt-to-GDP is crisis.
Here’s what it looks like globally (country on left, focus on red arrow):
Definitions: Total Domestic Debt is the total outstanding debt owed by all domestic sectors (households and non-profit institutions, financial and non-financial corporations, farms, state and local governments, federal government) and includes government bonds, corporate bonds, bank loans, other loans and advances, mortgages and consumer credit. Non-financial Corporate Debt is the total outstanding debt owed by all companies with the exception of financial companies. Household Debt is the total outstanding debt owed by the household sector, which includes households and non-profit organizations. (Source: Ned Davis Research.)
But wait, there’s more. The total IOU (add in pension obligations, Medicare, Social Security) in the U.S. is near 1000% of GDP.
High debt means slower growth. Slower growth means slower growth in income. The aged demographics in the developed world are not favorable to growth. Deflation has us in its grip. A “Paradigm Shift” takes time. We’ll see it coming.
This week the Federal Reserve cut rates a quarter point. Doug Noland, who blogs at Credit Bubble Bulletin, thinks it was a major mistake. US financial conditions are already extraordinarily loose and the stock market is roaring manically higher. The cut will likely generate inflation in all the wrong places and exacerbate social and geopolitical tensions. I am sure Jay Powell and the rest of the Federal Open Market Committee didn’t expect Thursday’s bond market action. They cut rates hoping to mitigate or even remove the inverted yield curve, which is a pretty reliable recession precursor. The opposite happened.
- The Federal Reserve has abandoned “data dependent.” No data justifies a rate cut at this time and even the Fed admits it. That’s why many call this an “insurance cut.”
- Nor should the Fed be worried about low inflation. There’s plenty of inflation, it’s just neither uniform nor is it necessarily in the places they prefer.
- Inflation exists mainly in securities and asset prices. Monetary stimulus will flow into these speculative bubbles, not consumer prices.
- Cheap credit for startups and new technologies may even aggravate disinflationary dynamics. It creates aggressive, cash-flush companies who are under no pressure to achieve profitability.
- The Fed is moving from accommodating the financial bubble to actively stimulating it.
- Monetary policy now presumes that the consequences of financial excess (i.e. debt and speculative Bubbles) can be remedied by inflating the general price level.
Here are three expert takes from Brian Wesbury, Bill Dunkelberg and Mark Grant.
- Wesbury: The Fed still claims it is “data dependent” but no one should believe it.
- If the Fed wanted to cut rates, it should have gone further and cut 50 bps or more to signal this was one-and-done. Instead they incentivized everyone to postpone buying decisions and hope for even lower rates.
- Dunkelberg: This rate cut will inflate the stock market, creating even more “wealth” that will buy less per dollar because output is growing slower than wealth (i.e., claims on that output).
- Dribbling out the cuts instead of one large one would have done far more to raise spending and maybe produce the higher inflation the Fed wants.
- Grant: The US is under financial assault by negative rate policies elsewhere and the Fed must cut rates to keep the dollar from strengthening too much.
- Lower rates will mean more stock buybacks, bond refinancing, lower mortgage rates, etc, but at the cost of leaving investors everywhere with almost no yield opportunities.
- This is negative for insurers, banks, pension funds, savers and retirees, all of who will be forced into riskier assets.
We can criticize the Fed’s action yesterday while also realizing it may have had little choice. The strong dollar, flat/inverted yield curve and weakening global growth is a deadly combination. I think they should have cut 50 bps in order to steepen the yield curve further. We are in a new environment now and will have to rethink many assumptions.
Noland says the Fed and other central banks are terrified at the possibility markets will lose confidence in their ability to inflate consumer prices. I think he’s right, and it matters because “a world where central bank reflationary measures are viewed as ineffective is a world with suddenly elevated fear of unsustainable debt levels and asset Bubbles.” The markets viewed this press conference as hawkish, sending risk assets down and the dollar higher (perhaps there was way too much easing already priced in).
This week’s Fed action was widely expected but we should realize its significance. This was the first time the Fed has loosened in over a decade. Exactly what they are thinking, and what the results will be, remains highly uncertain. With the new tariffs, the market is now convinced that a second Fed rate cut is coming next month.
Stocks sold off on today’s Fed announcement. Or, more accurately, during the press conference afterwards based on some confusing responses from Jerome Powell regarding the reasons for today’s rate cut, or whether more cuts are coming.
The 10-Year Treasury yield dropped 4 basis points to 1.84%. The flattening of the yield spread between those two maturities may explain why stock traders were disappointed by the rate cut. One major side effect of the Fed move was a stronger dollar
US Dollar Reaction
The most dramatic move of the day came from a new high in the dollar.
Gold and Silver Reaction
The rising dollar caused profit-taking in most commodities, and gold in particular.
Traders are now pricing in two more interest rate cuts by year’s end and increasing bets of further policy easing in 2020.
U.S. manufacturing PMI hits lowest since September 2009.
Jobs Report This Week
This time last month we got an unexpectedly strong jobs report. Today’s report downwardly revised that surprise and added more evidence that jobs growth is slowing. The prospect of new tariffs may be even more threatening to the economy.
- July payrolls grew by 164,000, about as expected, but the prior two months were revised down by a total of 41,000.
- Private sector hiring was weaker than expected. The government-dominated education and healthcare sectors added the most jobs.
- Average hourly earnings rose but average weekly earnings fell as employers reduced hours slightly.
- The participation rate and employment/population ratio both ticked up.
- In 2018 monthly job gains averaged 223,000. The last six months the average is 141,000, a significant slowdown.
There is a close connection between tariffs and jobs. As the number of affected businesses grows, more will cancel or delay major spending decisions, like hiring more workers. With interest rates already historically low, Fed rate cuts probably won’t help much.
This next round will have the most impact on consumer goods.
Stock Market Issues
The overbought condition, and near 9% extension above the 200-dma, suggests a pullback is in order.
Stocks have never been this expensive for how low the 10-year Treasury yield is today. It’s true that all else equal, low interest rates justify higher valuations. However, the lowest interest rates historically haven’t corresponded to the highest P/E markets because extremely depressed yields also signal fundamental problems in the economy. Ultra-low rate environments are often marked by highly leveraged economies where future growth is likely to be weak.
These valuations are occurring against a backdrop of deteriorating economic growth and corporate profits, the risk to investor capital is high.
While many US equity indices have marginally broken out to new highs recently, they have done so in the face of weakening market internals. Equity indices are being propped up by a narrowing group of leaders. The deteriorating breadth is most evident in the NASDAQ Composite, home to today’s leading growth stocks. While the overall index has reached record levels, the number of declining stocks has significantly outpaced the number of advancing stocks since last September.
Volume And Participation
Another warning sign is that volume and participation have also weakened markedly. These are all signs of a market advance nearing “exhaustion.”
Stocks are also rising in defiance of extremely low volume. On July 16th, the SPDR S&P 500 ETF (SPY) had its lowest daily volume in almost 2 years. In a 15-daily average terms, volume is now as low as it was at the peak of the housing bubble and prior to the last two selloffs in 2018. Unusual calmness and breadth deterioration are not a good set up for record overvalued stocks.
Deviation From The Uptrend
When prices deviate too far from the long-term trend they will eventually, and inevitably, “revert to the mean.” A “mean reverting” event would currently encompass a 53% decline from recent peaks.
Investor sentiment is a measure of how Bullish or Bearish investors are at the moment. When sentiment is heavily skewed toward those willing to “buy,” prices can rise rapidly and seemingly “climb a wall of worry.” However, the problem comes when that sentiment begins to change and those willing to “buy” disappear.
This “vacuum” of buyers leads to rapid reductions in prices as sellers are forced to lower their price to complete a transaction. The problem is magnified when prices decline rapidly. When sellers panic, and are willing to sell “at any price,” the buyers that remain gain almost absolute control over the price they will pay. This “lack of liquidity” for sellers leads to rapid and sharp declines in price, which further exacerbates the problem and escalates until “sellers” are exhausted.
Currently, there is a scarcity of “bears.”
The markets currently believe that when the Fed cuts rates this week, the bull market will continue higher. History suggests a different outcome.
Seattle Real Estate
After years of double-digit gains, Seattle’s housing market is cooling.
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