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The Market Isn’t The Economy: A Snapshot From The Depression

The Market Isn’t The Economy: A Snapshot From The Depression

“We gathered on porches; the moon rose; we were poor.

And time went by, drawn by slow horses.

Somewhere beyond our windows shone the world.

The Great Depression had entered our souls like fog.” – Pantoum of the Great Depression – Donald Justice.

Wall Street insiders relish market troughs.

They bask sanguine in their confidence of history. Tenured pros are comforted in the belief that monetary and fiscal stimulus triggers are cocked and at the ready, reinforced in the knowledge that taxpayers without choice in the matter, will again, be the bail-out solution.

In a last irony to turn the blade in the back slowly, this group confidently takes credit for saving a system they helped to bust in the first place.

They are the strong hands who patiently await to scoop up shares when markets falter. As the smart money, these players unload inflated shares to the ‘dumb’ money or retail investors at “FOMO” or fear-of-missing-out emotional peaks.

The masses are advised to blind buy and hold. Retail investors are cajoled as “brave” if they “ride it out.” And whatever “it” is can be counted in years, even decades. Time is precious to us mere mortals. Our lives are finite; Wall Street lives on forever. The precious time it takes to break-even is ignored. Not relevant.

One of my favorite Nashville-based songwriters Drew Holcomb begins a song with a seminal line:

“Time steals every paradise I’ve been looking for.”

When Wall Street prospers, Main Street doesn’t necessarily follow a similar, prosperous path.

For example, Pew Research Center outlines that overall, American Household wealth has not fully recovered from the Great Recession. As early as 2016, median wealth of all U.S. households was $97,300; well below median wealth of $139,700 before the recession began in 2007.

…click on the above link to read the rest of the article…

Yes, Something Broke

Yes, Something Broke

In this missive, we are just going to focus on the “WTF!” moment of this past week. In order to do this properly, I need to start with last week’s missive where we asked the question “Did Something Just Break?” In that article we addressed very specific concerns about interest rates and the problem they were going to cause.

Speaking of rates, each time rates have climbed towards 3%, the market has stumbled.”

Chart updated through Friday.

“If you note in the chart above, a short-term ‘warning signal’ has been triggered which suggests that if rates remain above 3%, stocks are going to continue to struggle. The last time this occurred was in May when rates popped above 3%, stocks struggled and bonds outperformed.”

We also updated the pathway analysis for the highest probability outcomes over the next couple of months.

Chart updated through Friday – pathways remain unchanged

While the majority of the pathway’s accounted for a continued corrective, consolidation, process through the end of the year. It was Pathway #3 which came to fruition.

“Pathway #3: The issue of rising interest combines with a break in the economic data, or another credit-related event, and sends the market heading back to test supports at 2800 and 2750. This would likely coincide with a more severe contraction in the economic data which is not an immediate threat. Nonetheless, we should always consider the risk of an unexpected, exogenous, event. (10%)”

The recent sell-off coincides with the rising concerns of higher rates coupled with deterioration in economic growth heading into 2019. To wit:

“As such, our best initial take is that yesterday’s repricing of US growth was an overdue gut-check following last week’s monetary and oil supply shocks.”

…click on the above link to read the rest of the article…

Debts & Deficits: A Slow Motion Train Wreck

Debts & Deficits: A Slow Motion Train Wreck

Last Friday, I discussed that without much fanfare or public discussion, Congress decided to push the U.S. into deeper fiscal irresponsibility with the passage of another Continuing Resolution (CR). To wit:

“The House on Wednesday passed an $854 billion spending bill to avert an October shutdown, funding large swaths of the government while pushing the funding deadline for others until Dec. 7.

The bill passed by 361-61, a week after the Senate passed an identical measure by a vote of 93-7.”

Without the passage of the C.R. the government was facing a “shut-down” just prior to the mid-term elections. So, rather than doing what is fiscally responsible for the long-term solvency and financial health of the country, not to mention the generations to come, they decided it was far more important to get re-elected into office.

As I noted last week:

“For almost a decade, Congress has failed to pass, and operate, underneath a budget. Of course, without any repercussions from voters in demanding that Congress ‘does their job,’ the path to fiscal insolvency continues to grow.

The Committee For A Responsible Federal Budget made the following statement:

“We’re pleased policymakers have likely avoided a shutdown and actually appropriated most of this year’s discretionary budget on time. But let’s not forget that Congress did so without a budget and had to grease the wheels with $153 billion to pass these bills. That isn’t function; it’s a fiscal free-for-all.”

Of course, with trillion-dollar deficits just around the corner, the negative impact from unbridled spending and debt increases will begin to reverse the positive effects from deregulation and tax reform.”

…click on the above link to read the rest of the article…

Bubbles and Zombies

Bubbles and Zombies

They say nobody rings a bell at the top of the market. But whether this is the top or not, two prominent market observers and historians, Robert Shiller and Edward Chancellor, are expressing concern.

First, Shiller warns readers not to take big increases in earnings too seriously because earnings are volatile.

Everyone knows that stock prices have risen dramatically since 2009. A $100 investment in the S&P 500 in 2009 has grown to nearly $400 at the end of August 2018. But Shiller reminds us that earnings have grown dramatically too. In fact, “real quarterly S&P 500 reported earnings per share rose 3.8-fold over essentially the same period, from the first quarter of 2009 to the second quarter of 2018,” according to Shiller. Prices, in fact grew a bit more slowly than earnings since the end of the crisis.

So should we think stocks are reasonably priced since earnings have grown at the same pace as prices? Not so fast, Shiller says. Earnings, the difference between two other data sets — revenues and expenses, are volatile, and cyclical. Rapid rises in earning are often followed by a return to long term trends or subpar levels. Such episodes have occurred more than a dozen times in U.S. stock market history.

Earnings can grow dramatically from things like “panicky demand” for U.S. goods from Europeans at the beginning of World War I. This led to political calls for “wealth conscription” or a heavy taxation on war-related profits. At that time stock prices didn’t follow profit advances as investors seemed to realize those gains would be short-lived.

In the “Roaring ‘20s,” however, emergence from a “war to end all wars” and a spirit of freedom and individual fulfillment spurred stock prices by Shiller’s lights. And this, of course, led to a crash at the end of the decade.

…click on the above link to read the rest of the article…

What Turkey Can Teach Us About Gold

What Turkey Can Teach Us About Gold

If you were contemplating an investment at the beginning of 2014, which of the two assets graphed below would you prefer to own?

Data Courtesy: Bloomberg

In the traditional and logical way of thinking about investing, the asset that appreciates more is usually the preferred choice.

However, the chart above depicts the same asset expressed in two different currencies. The orange line is gold priced in U.S. dollars and the teal line is gold priced in Turkish lira. The y-axis is the price of gold divided by 100.

Had you owned gold priced in U.S. dollar terms, your investment return since 2014 has been relatively flat.  Conversely, had you bought gold using Turkish Lira in 2014, your investment has risen from 2,805 to 7,226 or 2.58x. The gain occurred as the value of the Turkish lira deteriorated from 2.33 to 6.04 relative to the U.S. dollar.

Although the optics suggest that the value of gold in Turkish Lira has risen sharply, the value of the Turkish Lira relative to the U.S. dollar has fallen by an equal amount. A position in gold acquired using lira yielded no more than an investment in gold using U.S. dollars.

Data Courtesy: Bloomberg

This real-world example is elusive but important. It helps quantify the effects of the recent economic chaos in Turkey. Turkey’s economic future remains uncertain, but the reality is that their currency has devalued as a result of large fiscal deficits and heavy borrowing used to make up the revenue shortfall. Inflation is not the cause of the problem; it is a symptom. The cause is the dramatic increase in the supply of lira designed to solve the poor fiscal condition.

…click on the above link to read the rest of the article…

The Weaponization of the Dollar

The Weaponization of the Dollar

The Uncivil Civil War discussed the sanguine approach many investors take towards equity risk despite clear signs of domestic political turbulence. The article put the upcoming elections and the growing political divisions amongst the populace into context with market risks.

While we read plenty of politically related articles and many more investment related articles, we have found precious few that bridge the gap and gauge the effect politics has on markets. The intersection of markets and politics is important and should be followed closely, especially with a mid-term election months away. As so eloquently described by the late Charles Krauthammer, “You can have the most advanced and efflorescent cultures. Get your politics wrong, however, and everything stands to be swept away. This is not ancient history. This is Germany 1933.

In this article, we readdress politics and markets from an international perspective. In particular, we focus on suspicions we have regarding Donald Trump’s negotiation tactics and goals for the U.S. relationship with Turkey.

Emerging Markets and the Dollar

China, Turkey, and Iran are all classified as emerging markets. While the classification is broad and includes a diverse group of countries, these countries have many things in common. One is that their currencies, for the most part, are not liquid or highly valued. Thus, they heavily rely on the world’s reserve currency, the U.S. dollar, to conduct international trade.

As an example, when Pakistan buys oil from Qatar, they transact in U.S. dollars, not rupees or riyals. To facilitate trade efficiently, these countries must hold excess dollars in reserve. In almost all cases, emerging market nations rely on U.S. dollar-denominated debt for their transactional needs.

…click on the above link to read the rest of the article…

Boiling A Turkey

Boiling A Turkey

There is an age old fable describing a frog being slowly boiled alive. The premise is that if a frog is put suddenly into boiling water, it will try and save itself. However, if the frog is put in tepid water which is then brought to a boil slowly, it will not perceive the danger and will be cooked to death. The metaphor is often ascribed to the inability, or unwillingness, of people to react to or be aware of threats which arise gradually rather than suddenly.

This metaphor was brought to mind as I was writing last weekend’s newsletter discussing the issue of Turkey and the potential threat posed to the global economy. Specifically, I was intrigued by the following points from Daniel Lacalle:

“The collapse of Turkey was an accident waiting to happen and is fully self-inflicted.”

It is yet another evidence of the train wreck that monetarists cause in economies. Those that say that ‘a country with monetary sovereignty can issue all the currency it wants without risk of default’ are wrong yet again. Like in Argentina, Brazil, Iran, Venezuela, monetary sovereignty means nothing without strong fundamentals to back the currency.

Turkey took all the actions that MMT lovers applaud. The Erdogan government seized control of the central bank, and decided to print and keep extremely low rates to ‘boost the economy’ without any measure or control.

Turkey’s Money Supply tripled in seven years, and rates were brought down massively to 4,5%.

However, the lira depreciation was something that was not just accepted by the government but encouraged.  Handouts in fresh-printed liras were given to pensioners in order to increase votes for the current government, subsidies in rapidly devaluing lira soared by more than 20% (agriculture, fuel, tourism industry) as the government tried to compensate the loss of tourism revenues due to security concerns with subsidies and grants.

…click on the above link to read the rest of the article…

Kass: Tops Are Processes & We May Be In That Process

Kass: Tops Are Processes & We May Be In That Process

The Yield Curve Will Likely Invert by November, 2018

  • Economic growth is less synchronized than the consensus believes
  • On a trending and rate of change basis the economic data is slowing down
  • The Fed’s continued pivot to tighter money will likely lead to curve inversion – which will likely stoke fears of recession

“China, Europe and the Emerging Market Economic Data All Signal Slowdown: It’s in the early innings of such a slowdown based on any realtime analysis of the economic data. The rate of change slowdown (on a trending basis) is as clear as day. A rising US Dollar and weakening emerging market economic growth sows the seeds of a possible US dollar funding crisis.” – Kass Diary, Investors are Not Being Compensated For Risk

At economic peaks everything on the surface looks Rosy (except to some observors like myself and Rosie (David Rosenberg)!) – until it doesn’t.

Towards that end, here is what I wrote yesterday about US and overseas economic growth in my two part opener:

“Global Growth Is Less Synchronized as the trajectory of worldwide growth is becoming more ambiguous. I have featured the erosion in soft and hard high frequency data in the US, Europe, China and elsewhere extensively in my Diary – so I wont clutter this missive with too many charts. But needless to say (and seen by these charts and here), with economic surprises moderating from a year ago and in the case of Europe falling to two year lows – we are likely at ‘Peak Global Growth’ now. (The data is even worse in South Korea, Taiwan, Indonesia and Thailand).

…click on the above link to read the rest of the article…

Quick Take: The Risk Of Algos

Quick Take: The Risk Of Algos 

Mike ‘Wags’ Wagner: ‘You studied the Flash Crash of 2010 and you know that Quant is another word for wild f***ing guess with math.’

Taylor Mason: ‘Quant is another word for systemized ordered thinking represented in an algorithmic approach to trading.’

Mike ‘Wags’ Wagner: ‘Just remember Billy Beane never won a World Series .’ – Billions, A Generation Too Late

My friend Doug Kass made a great point on Wednesday this week:

“General trading activity is now dominated by passive strategies (ETFs) and quant strategies and products (risk parity, volatility trending, etc.).

Active managers (especially of a hedge fund kind) are going the way of dodo birds – they are an endangered species. Failing hedge funds like Bill Ackman’s Pershing Square is becoming more the rule than the exception – and in a lower return market backdrop (accompanied by lower interest rates), the trend from active to passive managers will likely continue and may even accelerate this year.”

He’s right, and there is a huge risk to individual investors embedded in that statement. As JPMorgan noted previously:

Quantitative investing based on computer formulas and trading by machines directly are leaving the traditional stock picker in the dust and now dominating the equity markets.

While fundamental narratives explaining the price action abound, the majority of equity investors today don’t buy or sell stocks based on stock specific fundamentals. Fundamental discretionary traders’ account for only about 10 percent of trading volume in stocks. Passive and quantitative investing accounts for about 60 percent, more than double the share a decade ago.

As long as the algorithms are all trading in a positive direction, there is little to worry about. But the risk happens when something breaks. With derivatives, quantitative fund flows, central bank policy and political developments all contributing to low market volatility, the reversal of any of those dynamics will be problematic.

…click on the above link to read the rest of the article…

The Next Crisis Will Be The Last

The Next Crisis Will Be The Last

It is an interesting thing.

Throughout the last four decades there is a direct link between the actions of the Federal Reserve and the eventual economic and market outcomes due to changes in monetary policy. In every case, that outcome has been negative.

The general consensus continues to be the markets have entered into a “permanently high plateau,” or an era in which asset price corrections have been effectively eliminated through fiscal and monetary policy. The lack of understanding of economic and market cycles was on full display Monday as Peter Navarro told investors to just “buy the dip.”

“I’m thinking the smart money is certainly going to buy on the dips here because the economy is as strong as an ox.”

I urge you not to fall prey to the “This Time Is Different” thought process.

Despite the consensus belief that global growth is gathering steam, there is mounting evidence of financial strain rising throughout the financial ecosystem, which as I addressed previously, is a direct result of the Fed’s monetary policy actions. Economic growth remains weak, wages are not growing, and job growth remains below the rate of working age population growth.

While the talking points of the economy being as “strong as an ox” is certainly “media friendly,” The yield curve, as shown below, is telling a different story. While the spread between 2-year and 10-year Treasury rates has not fallen into negative territory as of yet, they are certainly headed in that direction.

This is an important distinction. The mistake that most analysts make in an attempt to support a current view is to look at a specific data point. However, when analyzing data, it is not necessarily the current data point that is important, but the trend of the data that tells the story.

…click on the above link to read the rest of the article…

The Mind Blowing Concept of “Risk-Free’ier”

The Mind Blowing Concept of “Risk-Free’ier”

  • The Earth is flat
  • Cigarettes are healthy
  • Leeches are the cure for everything
  • The universe revolves around the Earth
  • California is an island
  • Red wine is healthy, unhealthy, healthy…

Facts are essential as they offer humans a sense of stability in a chaotic world. For instance, we find comfort in the “fact” that the life-sustaining sun will continue to shine for billions of years. If there were serious doubts about this fact, our lives would be very different today.

In this article, we debunk a “fact” that serves as the foundation for the pricing of all financial assets. It was not that long ago that people who thought the earth round were labeled delirious madmen. Today, questioning the “risk-free” status of U.S. Treasury securities (UST), as we do, will lead many financial professionals to decry our prudence as foolish irrationality. That said, we would rather assess the situation objectively than get caught “swimming naked when the tide goes out”.

Mesofacts

In a must-read article entitled, My Leitner-esque Moment, Kevin Muir of The Macro Tourist blog broaches the topic of sovereign debt risk and, in what must be a moment of temporary insanity, questions the so-called “risk-free” status of UST.

Sovereign debt risk exists and said bonds default from time to time. Despite history and facts, associating the word “risk” with UST is for some reason blasphemous amongst financial professionals. The yields of UST are treated by all investors, even those nay-sayers like Muir and ourselves, to be the risk-free rate. This argument does not refer to the risk of changing yields but more importantly to that of credit risk.

All financial and investment models and theories assume that UST have no credit risk which, by definition, implies zero chance of default. What in this world has no risk? If you can name something, congratulations, we cannot.

For background, consider that sovereign debt defaults have been commonplace among big and small countries. The graph below shows the frequency by country since 1800.

Graph Courtesy Carmen Reinhart and Kenneth Rogoff

…click on the above link to read the rest of the article…

Uneven Economy & The Hidden Depression

Uneven Economy & The Hidden Depression

Are we in a depression? The question seems absurd. There has been GDP growth since 2009 and some mild inflation to go with it. In fact, this is the second longest economic expansion on record. As Robert Shiller said over the weekend (though in the context of warning against complacency), “[i]f the economy manages to expand for 16 more months, the United States will have set a record.” Unemployment is the lowest in history, nothing like the 17% we had by a U.S. Bureau of Labor Statistics estimate a decade after the stock market crash in 1929 and the average of 18% in the 1930s. House prices have come screaming back across the nation. The stock market has increased by more than 15% annually beginning in 2009. And even middle-class wages have shown signs of picking up lately.

Depression-Era Demographics In Some Exurbs

And yet, even overlooking the opioid epidemic and the 42 million Americans on food stamps (happily down from nearly 48 million in 2013), there are disturbing signs around the country that all is not well. For example, a recent article in the New York Times by Robert Gebeloff focusing on Hunterdon County in New Jersey shows that many suburban and exurban Northeast and Midwest counties have stopped booming. More people are dying than being born or moving in through immigration or migration. Hunterdon County, 60 miles from New York City, is the sixth richest county nationally with a median household income is over $100,000. But young people are having fewer children, and the recession-stalled migration patterns are only resuming in certain parts of the country. According to Geberloff, “Some of the once-fastest-growing counties in the United States are growing no more, and nationwide, the birthrate has dropped to levels not seen since the Great Depression.” Since a recent peak in 2007, lifetime births per woman in the U.S. is down 16%.

…click on the above link to read the rest of the article…

“GDP Growth Driving Rates Higher!” – Is That True?

“GDP Growth Driving Rates Higher!” – Is That True?

“Peter Cook is the author of the‘Is That True?’ series of articles, which help explain the many statements and theories circulating in the mainstream financial media often presented as “truths.” The motives and psychology of market participants, which drives the difference between truth and partial-truth, are explored.”

Summing up the current conventional wisdom:

  1. Global GDP growth has bottomed and is accelerating systematically higher,
  2. Which will cause the inflation rate to accelerate higher.
  3. Bond markets hate higher inflation, so interest rates have bottomed and will move even higher.
  4. The stock market, dependent on low rates for high valuations, will fall if rates move higher,
  5. Which is why the stock market peaked on January 26, 2018, and then declined dramatically,
  6. Ushering in an era of systematically higher volatility

In this article, we will investigate the data behind the first three assertions related to GDP growth, inflation, and the bond market and offer explanations that differ from the conventional wisdom. Next Friday, we will continue this theme with a discussion of the following three assertions.

  1. Global GDP Growth Is Accelerating

Unless GDP can be exported from another planet to Earth, the main drivers of global GDP growth are in four large economic zones.  Here are the past 30 years of GDP growth in the U.S……

The past ten years in China……

The past 20 years in Europe…..

and Japan.

In summary, each of the main economic zones are growing at lower rates than they did 10-20 years ago.  While they are each trending slightly higher after bouncing off recent troughs in early 2016, all are well within a range established since the Global Financial Crisis (GFC).

…click on the above link to read the rest of the article…

Peak Hubris

Peak Hubris

In the past month, two well-known and highly respected money managers have made confident assertions about the markets. Their comments would lead one to believe that the future path of the market in the coming months is known. Sadly, many investors put blind faith in the words of high-profile, accomplished professionals and do little homework of their own. While we certainly respect the background, knowledge, and success of these and many other professionals, we take exception with their latest bit of advice.

Before the election In November 2016, were there investment professionals that claimed a Donald Trump victory would drive equity prices significantly higher? Although we are certain there were a (very) few, they certainly were not publicly discussing it, and the broad consensus was overwhelmingly negative.  In March of 2009, which professional investors were pounding the table claiming that the next decade would produce some of the greatest market returns in history? Again, while some may have thought valuations were fair at the time, few if any were raging bulls.

The two instances are not unique. More often than not, investor expectations fail to accurately anticipate the future reality. This is not solely about amateur individual investors, as it equally applies to the best and brightest. Despite the urge to heed the sage advice of the “pros”, we must always remain objective, especially when everyone seems so certain about what will happen next.

The Known Future

The current message from Wall Street analysts, media gurus and most investors is that stock prices will undoubtedly go up for the foreseeable future.  Unbridled optimism about corporate earnings offer one point of fundamental justification for such views, but in large part these forecasts are predominantly based on the simple extrapolation of prior price trends.

…click on the above link to read the rest of the article…

Technically Speaking: This Is Nuts

Technically Speaking: This Is Nuts

Since the election, markets have accelerated the pace of the advance as shown in the chart below.

The advance has had two main story lines to support the bullish narrative.

  • It’s an earnings recovery story, and;
  • It’s all about tax cuts.

There is much to debate about the earnings recovery story but as I showed previously, and to steal a line from my friend Doug Kass, this “new meme increasingly resembles ‘Group Stink.’” To wit:

“Despite many who are suggesting this has been a ‘rational rise’ due to strong earnings growth, that is simply not the case as shown below. (I only use ‘reported earnings’ which includes all the ‘bad stuff.’ Any analysis using “operating earnings” is misleading.)”

“Since 2014, the stock market has risen (capital appreciation only) by 35% while reported earnings growth has risen by a whopping 2%. A 2% growth in earnings over the last 3-years hardly justifies a 33% premium over earnings. 

Of course, even reported earnings is somewhat misleading due to the heavy use of share repurchases to artificially inflate reported earnings on a per share basis. However, corporate profits after tax give us a better idea of what profits actually were since that is the amount left over after those taxes were paid.”

“Again we see the same picture of a 32% premium over a 3% cumulative growth in corporate profits after tax. There is little justification to be found to support the idea that earnings growth is the main driver behind asset prices currently.

We can also use the data above to construct a valuation measure of price divided by corporate profits after tax. As with all valuation measures we have discussed as of late, and forward return expectations from such levels, the P/CPATAX ratio just hit the second highest level in history.”

…click on the above link to read the rest of the article…

Olduvai IV: Courage
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Olduvai II: Exodus
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