Saturday, June 25, 2016

Central Bankers on the run—sent by aaajoker

Stockman: "At Last The Tyranny Of The Global Financial Elite Has Been Slammed"

Tyler Durden's picture

by Tyler Durden

Jun 25, 2016 5:10 PM

Submitted by David Stockman of ContraCorner

Bravo Brexit!

At long last the tyranny of the global financial elite has been slammed good and hard. You can count on them to attempt another central bank based shock and awe campaign to halt and reverse the current sell-off, but it won’t be credible, sustainable or maybe even possible.

The central bankers and their compatriots at the EU, IMF, White House/Treasury, OECD, G-7 and the rest of the Bubble Finance apparatus have well and truly over-played their hand. They have created a tissue of financial lies; an affront to the very laws of markets, sound money and capitalist prosperity.

After all, what predicate of sober economics could possibly justify $10 trillion of sovereign debt trading at negative yields?

Or a stock market trading at 24X reported earnings in the face of a faltering global economy and a tepid domestic US business cycle expansion which at 84 months is already long in the tooth and showing signs of recession everywhere?

And that’s to say nothing of the endless ranks of insanely over-valued “story” stocks like Valeant was and the megalomaniacal visions of Elon Musk still are.

So there will be payback, clawback and traumatic deflation of the bubbles. Plenty of it, as far as the eye can see.

On the immediate matter of Brexit, the British people have rejected the arrogant rule of the EU superstate and the tyranny of its unelected courts, commissions and bureaucratic overlords.

As Donald Trump was quick to point out, they have taken back their country. He urges that Americans do the same, and he might just persuade them.

But whether Trumpism captures the White House or not, it is virtually certain that Brexit is a contagious political disease. In response to today’s history-shaking event, determined campaigns for Frexit, Spexit, NExit, Grexit, Italxit, Hungexit and more centrifugal political emissions will next follow.

Smaller government—–at least in geography—–is being given another chance. And that’s a very good thing because more localized democracy everywhere and always is inimical to the rule of centralized financial elites.

The combustible material for more referendums and defections from the EU is certainly available in surging populist parties of both the left and the right throughout the continent. In fact, the next hammer blow to the Brussels/German dictatorship will surely happen in Spain’s general election do-over on Sunday (the December elections resulted in paralysis and no government).

When the polls close, the repudiation of the corrupt, hypocritical lapdog government of Prime Minister Rajoy will surely be complete. And properly so; he was just another statist in conservative garb who reformed nothing, left the Spanish economy buried in debt and gave false witness to the notion that the Brussels bureaucrats are the saviors of Europe.

So the common people of Europe may be doubly blessed this week with the exit of both David Cameron and Mariano Rajoy. Good riddance to both.

Spain's Mariano Rajoy and Britain's David Cameron in September 2015

At the same time, the anti-Brussels parties of both the left (Podemos) and the right (Ciudadanos) are certain to make further gains. But even then, Spanish politics will remain splintered and paralyzed. There will emerge no government strong enough or willing enough to execute Brussels’s inevitable dictates in the event that drastically over-valued Spanish bond market goes into a tailspin and requires another EU intervention.

And that’s the next leg of the Brexit storm. To wit, sovereign bond prices throughout Europe have been lifted artificially skyward by the financial snake-charmers of Brussels and the ECB. The massive rally in Spain’s 10-year bond after Draghi’s “whatever it takes” ukase was not due to Spain becoming more credit worthy or the fact that its unemployment rate has dropped from 26% to a mere 20%.

The whole plunge of yields from 7% to a low of 1% about a year ago was due to a front-runners’ stampede. That is, the fast money crowd was buying on repo what the ECB promised to take off their hands at ever higher prices in due course. They were shooting the proverbial ducks in a barrel.

But as global “risk-off” gathers worldwide momentum, look-out below. There will be no incremental bid from Frankfurt for a flood of carry trade unwinds. That’s because the ECB will soon be embroiled in an existential crisis as the centrifugal forces unleashed by Brexit tear apart the fragile consensus on which Draghi’s lunatic monetary experiments depended.

In particular, the populist political insurgencies throughout Europe are as much anti-German as they are anti-immigrant. It is only a matter of time before German acquiesce in the ECB’s massive bond buying campaign—–which essentially bails out the rest of Europe—–will be abruptly ended by an internal revolt against Merkelite accommodation.

Spain Government Bond 10Y

Moreover, Spain is by no means unique. Italy’s Five-Star movement, which just came from winning 9 out of 10 mayoral contests including Rome, will surely now be energized mightily. Its Northern League ally has already called for a referendum on exiting the euro.

Needless to say, Italy’s fiscal circumstance is far more dire than even Spain’s. The likelihood that its 10-year bonds are money good at last week’s 135 basis points of yield are between slim and none. Either the threat of an exit or a 5-Star/populist coalition government would send the front-runners who scarfed up Italy’s bonds running for the hills.

Since Italy owes upward of $2 trillion on it government accounts alone, its bond market is an explosion waiting to happen. And that means its bedraggled banks are, too.

That’s because one feature of the Draghi Ponzi was that national banks in the peripheral nations started buying up their own country’s rapidly appreciating sovereign debt  hand-over-fist. Italy’s banks own upwards of $400 billion of Italian government debt.

That’s the one and same Italian government that cannot possibly cope with its existing 135% debt to GDP ratio. And that’s also before the populists take power and are forced to bailout the country’s already insolvent banking system. The latter will suffer from a shock of capital and depositor flight after the current government falls(soon), and Prime Minister Renzi joins Cameron and Rajoy at some establishment rehab center for the deposed.

Italy Government Bond 10Y

During the last financial crisis our elite rulers cried financial “contagion”. That scary story generated panic among the politicians and acquiescence in their crooked regime of massive bailouts and relentless money pumping.

The effect of was to bailout the gamblers from the Greenspan/Bernanke housing and credit bubble, and then to shower unspeakable windfalls on the 1% as the central banks reflated an even more monumental bubble during the regime of QE, ZIRP and NIRP.

But now the world’s financial rulers are going to be on the receiving end of an even more virulent and far-reaching political contagion. That is, a tidal wave of voter demands to emulate the British people and take back their countries and their governments from the financial elites and politicians like Cameron who are their bagmen.

This time populist and insurgent politicians are not going to roll-over for the rule of unelected central bankers and the international financial apparatchiks of the IMF and related institutions.

In that context, it can be confidently said that the Eurozone and ECB are finished. That’s because the monstrously inflated euro-bond market that Draghi created will implode if the front-running speculators lose confidence in the scheme.

At length, it will become evident that Draghi’s “whatever it takes” gambit was the single most foolish act in the history of central banking. It assumed that the rule of the financial elite was limitless and endless.

Brexit proves that both assumptions are wrong. Now every nook and cranny of the world’s bloated and radically mispriced financial casinos will face the same shock to confidence.

Central bankers everywhere will be on the run. Just in the nick of time.

Has THE Crash begun?

Black Friday: Shocking Brexit Vote Result Causes The 9th Largest Stock Market Crash In U.S. History

By Michael Snyder, on June 24th, 2016

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Brexit Vote - Public DomainHas the next Lehman Brothers moment arrived?  Late Thursday night we learned that the British people had voted to leave the European Union, and this could be the “trigger event” that unleashes great financial panic all over the planet.  Of course stocks have already been crashing all over the globe over the past year, but up until now we had not seen the kind of stark fear that the crash of 2008 created following the collapse of Lehman Brothers.  The British people are certainly to be congratulated for choosing to leave the tyrannical EU, and if I could have voted I would have voted to “leave” as well.  But just as I warned 10 days ago, choosing to leave will “throw the entire continent into a state of economic and financial chaos”.  And “Black Friday” was just the beginning – the pain from this event is going to continue to be felt for months to come.

The shocking outcome of the Brexit vote caught financial markets completely off guard, and the carnage that we witnessed on Friday was absolutely staggering…

-The Dow Jones Industrial Average plunged 610 points, and this represented the 9th largest one day stock market crash in the history of the Dow.

-The Nasdaq was hit even harder than the Dow.  It declined 4.12 percent which was the biggest one day decline since 2011.

-Overall, Black Friday erased approximately 800 billion dollars of stock market wealth in the United States.

-Thursday was the worst day ever for the British pound, and investors were stunned to see it collapse to a 31 year low.

-Friday was the worst day ever for European banking stocks.

-Friday was the worst day for Italian stocks since 1997.

-Friday was the worst day for Spanish stocks since 1987.

-Japan experienced tremendous chaos as well.  The Nikkei fell an astounding 1286 points, and this was the biggest drop that we have seen in more than 16 years.

-Banking stocks all over the planet got absolutely pummeled on Black Friday.  The following comes from USA Today

Stocks of some British-based banks suffered double-digit losses in heavy U.S. trading. Barclays (BCS) shares plunged 20.48% to close at $8.89. HSBC (HSBC) shares closed down 9.04% at $30.68. And shares of Royal Bank of Scotland (RBS) plummeted 27.5% to a $5.43 close.

Top U.S. banks also suffered from the Brexit fallout, although not as badly as their British counterparts.

Shares of JPMorgan Chase (JPM) closed down 6.95% at $59.60. Bank of America (BAC) shares fell 7.41% to a $13 close. Citigroup (C) shares dropped 9.36% to close at $40.30. And Wells Fargo (WFC) closed 4.59% lower at $45.71.

-Friday was the best day for gold since the collapse of Lehman Brothers.

-George Soros made a killing on Black Friday because he had already positioned his company to greatly benefit from the Brexit vote ahead of time.

But please don’t think that “Black Friday” was just a one day thing.  As I warned before, the Brexit vote “could be the trigger that changes everything“.  And if you don’t believe me on this, perhaps you will listen to former Federal Reserve Chairman Alan Greenspan.  This is what he told CNBC on Friday…

This is the worst period, I recall since I’ve been in public service,” Greenspan said on “Squawk on the Street.”

“There’s nothing like it, including the crisis — remember October 19th, 1987, when the Dow went down by a record amount 23 percent? That I thought was the bottom of all potential problems. This has a corrosive effect that will not go away.”

I completely agree with Greenspan on this point.  This “corrosive effect” on global markets is not going to go away any time soon.  Sure there will be days when the markets are green just like there were after the collapse of Lehman Brothers, but overall the trend will be down.

Now that the United Kingdom has decided to leave the EU, financial markets have been gripped by fear and uncertainty, and there is a great deal of concern that this Brexit “could harm the economies of everyone involved”

Important British trading partners — including India and China — indicated they were worried that an exit would create regulatory and political volatility that could harm the economies of everyone involved.

The U.K.’s Treasury itself reported that its analysis showed the nation “would be permanently poorer” if it left the EU and adopted any of a number of likely alternatives. “Productivity and GDP per person would be lower in all these alternative scenarios, as the costs would substantially outweigh any potential benefit of leaving the EU,” a summary of the report said.

This threat even extends to the United States.  CNN just published an article that lists four ways the U.S. could be significantly affected by all of this…

1. Fears that the EU may be falling apart
2. Volatile markets slow down the engine of U.S. growth
3. Brexit triggers a strong dollar, which hurts U.S. trade
4. Brexit forces the Fed to rewrite its rate hike playbook

Fortunately we are now heading into the weekend, and that might have a calming effect on the markets.

Or it might just cause financial tension to build up to an extremely high level which will subsequently be released on Monday morning.

We shall see.

RCB’s Charlie McElligott is warning that Black Friday was just the beginning and that “today is the appetizer for Monday”.

And UBS derivatives strategist Rebecca Cheong says that we could see more than a hundred billion dollars of selling over the next two to three trading days

Strategies designed to mitigate risk will actually add to downward pressure in the S&P 500 over the next week as computerized selling ramps up to keep pace with falling prices. It reminds Cheong of the rapid stock selling that roiled markets in August, when the S&P 500 fell 11 percent to a 10-month low while facing similar behavior from algorithmic traders.

“The bigger the down move today, the more they have to sell, which would basically create a vicious cycle,” Cheong, head of Americas equity derivatives strategy at UBS, said in a phone interview. “We’ll see front-loaded selling in the range of $100 billion to $150 billion over the next two to three days. It could be very similar to August in terms of model-based selling.”

Personally, I am hoping for calm when the markets open on Monday.  But without a doubt, something has now shifted as a result of this Brexit vote, and things have suddenly become a whole lot more serious.

So what do you believe we will see happen next week?

Please feel free to tell us what you think by posting a comment below…

*About the author: Michael Snyder is the founder and publisher of The Economic Collapse Blog. Michael’s controversial new book about Bible prophecy entitled “The Rapture Verdict” is available in paperback and for the Kindle on*

Gold Fever’s highest temperature

The Latest Commitment Of Traders Report Shows Something We Have Never Seen Before

Jun.25.16 | About: SPDR Gold (GLD)

Hebba Investments

Hebba Investments


The latest COT report shows a net speculative long position of close to 257,000 contracts, the highest we have ever seen.

Additionally, total speculative longs are at 279,000 long contracts outstanding which is also the highest ever seen.

This report closed on Tuesday, so it does not include any of Friday's tremendous price action in gold and so we expect current positions to be even more bullish.

All of this is worrisome from a contrarian point of view, and we think investors need to stay disciplined here as there are few longs left to buy.

In the latest Commitment of Traders report (COT), we saw another week where, surprisingly enough, speculative longs continued to build on record-breaking position levels. This build in speculative long positions was despite the fact that the COT report closes on Tuesday and thus didn't include any of Friday's massive post-Brexit jump in the gold price - which means whatever positions we see this week that we should expect a more extreme position next week with gold $50 higher.

We will get a little more into some of these details but before that let us give investors a quick overview into the COT report for those who are not familiar with it.

About the COT Report

The COT report is issued by the CFTC every Friday to provide market participants a breakdown of each Tuesday's open interest for markets in which 20 or more traders hold positions equal to or above the reporting levels established by the CFTC. In plain English, this is a report that shows what positions major traders are taking in a number of financial and commodity markets.

Though there is never one report or tool that can give you certainty about where prices are headed in the future, the COT report does allow the small investors a way to see what larger traders are doing and to possibly position their positions accordingly. For example, if there is a large managed money short interest in gold, that is often an indicator that a rally may be coming because the market is overly pessimistic and saturated with shorts - so you may want to take a long position.

Friday, June 24, 2016

Truck Tonnage Down

The Amount Of Stuff Being Bought, Sold And Shipped Around The U.S. Hits The Lowest Level In 6 Years

By Michael Snyder, on June 23rd, 2016

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Trucks - Public DomainWhen less stuff is being bought, sold and shipped around the country with each passing month, how in the world can the U.S. economy be in “good shape”?  Unlike official government statistics which are often based largely on projections, assumptions and numbers seemingly made up out of thin air, the Cass Freight index is based on real transactions conducted by real shipping companies.  And what the Cass Freight Index is telling us about the state of the U.S. economy in 2016 lines up perfectly with all of the other statistics that are clearly indicating that we have now shifted into recession mode.

If you are not familiar with the Cass Freight Index, here is a definition of the index from the official Cass website

Since 1995, the Cass Freight Index™ has been a trusted measure of North American freight volumes and expenditures. Our monthly Cass Freight Index Report provides valuable insight into freight trends as they relate to other economic and supply chain indicators and the overall economy.

Data within the Index includes all domestic freight modes and is derived from $25 billion in freight transactions processed by Cass annually on behalf of its client base of hundreds of large shippers. These companies represent a broad sampling of industries including consumer packaged goods, food, automotive, chemical, OEM, retail and heavy equipment. Annual freight volume per organization ranges from $1 million to over $1 billion. The diversity of shippers and aggregate volume provide a statistically valid representation of North American shipping activity.

When they say “all domestic freight modes”, that includes air, rail, truck, etc.  As you are about to see, the total amount of stuff that is being bought, sold and shipped around the country by all these various methods has now been declining for 15 months in a row.

If it was just one or two months you could say that it was just an anomaly, but how in the world can anyone explain away 15 consecutive months?

Not only that, but the brand new number that just came out for May 2016 is the lowest number that we have seen for the month of May in 6 years.

Of course the number for April was the lowest number that we have seen for that month in 6 years too, and the number for March was also the lowest number that we have seen for that month in 6 years.

Are you starting to get the picture?

Below is some analysis of these numbers and a chart from Wolf Richter

The Index is not seasonally or otherwise adjusted, so it shows strong seasonal patterns. In the chart below, the red line with black markers is for 2016. The colorful spaghetti above that line represents the years 2011 through 2015. The only month this year that was not the worst month since 2010 was February; only February 2011 was worse. That’s how bad it has gotten in the Freight sector:

Cass Freight Index - Wolfstreet

“Truck tonnage continues to slide for both linehaul and spot markets,” according to the report. And railroads are also singing the blues.

To me, these numbers are absolutely staggering.  How anyone can look at them and then attempt to claim that the U.S. economy is heading for good times is a mystery to me.

And this is especially true considering all of the other news that is pouring in.  Just today, we learned that new home sales have fallen by the most in 8 months.  If you are trying to sell your home, hopefully you will get that done very quickly, because this latest property bubble is starting to burst in a major way.

Of course there are many, many more numbers that tell us that a new U.S. economic crisis has already begun and has been going on for quite a while.  If you doubt this at all, please carefully read my previous article entitled “15 Facts About The Imploding U.S. Economy That The Mainstream Media Doesn’t Want You To See“.

Today, I also came across a stunning IMF report that was just released that criticized the U.S. for our shrinking middle class and our rising levels of poverty…

A rising share of the U.S. labor force is shifting into retirement, basic infrastructure is crumbling, productivity gains are scanty, and labor markets and businesses appear less adept at reallocating human and physical capital. These growing headwinds are overlaid by pernicious secular trends in income: labor’s share of income is around 5 percent lower today than it was 15 years ago, the middle class has shrunk to its smallest size in the last 30 years, the income and wealth distribution are increasingly polarized, and poverty has risen.

If you follow my work on a regular basis, you already know that everything that the IMF said in that paragraph is true.

A little bit later in the report, the IMF shared some absolutely startling facts about the growth of poverty in this country…

There is an urgent need to tackle poverty. In the latest data, 1 in 7 Americans is living in poverty, including 1 in 5 children and 1 in 3 female-headed households. Around 40 percent of those in poverty are working.

This distressing growth in our poverty numbers has taken place during Barack Obama’s so-called “economic recovery”.

So how bad are things ultimately going to get for America’s poor now that a new economic crisis has begun?

Before I wrap up this article, I have to mention the early returns from the Brexit vote.  All day on Thursday, global news sources were reporting that the latest polls had “Remain” comfortably in the lead, and global financial markets soared on that news.

But now that the actual votes are being reported, it looks like it is going to be much, much closer than anticipated.  In fact, as I write this article “Leave” is ahead by a 54.16 percent to 45.84 percent margin.  Only a relatively small fraction of the votes have been counted so far, but global financial markets are already being spooked by these results.

If “Leave” does actually win, that is going to have enormous implications for the markets and for the future of Europe.  So let’s keep a close eye on what is happening.  If “Leave” does prove to be victorious, that will be one of the biggest things to hit Europe in decades, and I am sure that I will be posting an article about it tomorrow.

We live at a time when global events are beginning to accelerate, and there is much uncertainty in the air.  If you do not have a solid foundation on which to stand, the events of the coming months will likely shake you greatly.  I encourage everyone to start focusing on the things that really matter, because a lot of the other things that we obsess over will soon become quite insignificant.

Risk Off

Beyond Brexit: Why The U.S. Economic Data Is So Bearish As Well

Jun. 24, 2016 3:52 AM ET




The markets went risk on again based on hopes for "Remain" in the UK referendum.

Yet that was entirely wrong based on the evolving, real time data.

Despite the sell-off on the Brexit vote, US stock markets remain grossly overpriced based on the latest fundamentals and multi-year trends.

To support the above view, several recent economic reports from Thursday are analyzed and put in perspective.

Also discussed are long-term patterns that also suggest risk off as a macro theme until a new direction of the economy has clearly been set.


This is looking more and more like 2000 and to a lesser extent 2007 all the time. Namely, a late cycle stock market (NYSEARCA:SPY) that refuses to quit, but with an economy that refuses to cooperate.

Even with the SPY at $201.10 (futures trading) as I write this slightly after midnight EDT, there is massive downside risk based on fundamentals. So even though Brexit is roiling markets, the topics discussed herein ultimately mean more to US markets for US and other investors. So I'm going to submit this without referring much to Brexit until the summary. Again, I'm writing this as a US citizen and resident who made the decision some time ago that the US markets and economy were the most attractive (or least unattractive) globally and thus mostly ignored international investing on that basis.

As soon as interest rates backed up substantially this week, I found bonds attractive; in this article, I reveal and discuss a much longer perspective on this topic.

From a modern historical standpoint, the facts of the stock versus bonds "battle" has been gotten completely wrong by the media. These facts also orient me toward the under-rated asset, bonds. To wit: we are now in the 51st year since stocks and bonds have, more or less, yielded the same total returns. Yet if you read the WSJ, Barron's, or of course have the financial news networks or news shows on the TV, it's "all stocks all the time."

Obviously stocks are more profitable business lines for the financial industry than bonds.

So I've been oriented more toward bonds than equities the last few years because half a century of history, greater predictability and less hype work for me.

However, just a week ago, T-bond yields had crashed so low, and the stock market had sold off a bit simultaneously, that I wrote a macro article that basically said, a pox on both your houses; I'll favor cash. Which I did, with a fair amount of my trading portfolio; meaning, I took profits on some Treasuries in our IRAs.

This was done when the RSI (relative strength index) on the daily charts dropped to as low as 25 (oversold), with the yields on the 10-year down to 1.51% on Thursday morning. Thursday, a mere week later, they were up to 1.74%. In a world where cash yields are close to zero in the US and lower than that in Canada and the UK, and zero or so in the eurozone or Japan, this is how I think of that yield change: it's an increase of 23/151 or 15%.

Just think of the panic that goes on in the financial media when the dividend yield on the SPY increases by 15% in a week. They call it, or act as if it is, a crash. That they do so shows how "crash" has been defined down, but so it goes. Yet the same thing goes on with bond yields and it's not even reported on.

At the same time, the SPY has increased over 2% since then, which means its dividend yield has decreased by over 2%. In other words, almost overnight, the murder of one British MP has catalyzed close to a 20% relative gain of stock yields versus bond yields.

This is a big move on a percentage basis, yet in the next sections, I'll present the data that argues that this is just technical action, and that the past week's fundamentals are not bullish for stocks. Rather, this looks similar to the last two pre-election periods where a 2-term President was leaving office and lengthy booms were faltering.

I'll begin with the most reliable high-frequency data that few appear to pay attention to.

Gallup's daily spending plunges

The Gallup polling organization has been running the same real-time poll that's a good proxy for discretionary consumer spending for some years now. In real time, I have found it very useful. In 2013, this proxy showed that the surge in the SPY was for real, as the 2009-12 tremendous slump in spending ramped up toward (but not to) the prior baseline.

Since then, spending has been a complete dud, and the latest spending data during and subsequent to the Father's Day weekend appears to have broken the modest upward momentum of recent weeks.

Gallup reports 3-day and 14-day average spending. The spending as of Thursday, June 23, covers June 20-22 as I understand it, which is Monday-Wednesday. This cratered to $72 as of Thursday's data, which is lower than any 3-day data I can see for June in 2013, 2014 or 2015. The more reliable 14-day data plunged from a respectable or even good $100 range earlier in the month back to $86. This is similar to or notably lower than 14-day average spending in 2013, 2014 or 2015.

Thus the never-revised data that Gallup directly obtains, without modeling or adjustment of the data, with a modest error range, suggests that after even 1% inflation in consumer goods the past 3 years, per capita discretionary consumer spending in real terms has been flat or down this entire period.

Worse, the 3- and 14-day data from June 28, 2008 were $96 and $94. That was no aberration. The 3- and 14-day data from June 20, 2008 were $83 and $93. That in turn appeared aberrationally low at the time, at least the 3-day data did.

For example, as of May 11, 2008, the 3- and 14-day spending numbers were $102 and $110. That $110 has not been reached at any time this "recovery" even though the Fed has "printed" about $3.5 T dollars via QE, taking the money supply up an unbelievable 4X in several years instead of a typical 7% per year (which is still high).

As everyone knows, the peak of economic activity was in November-December 2007, so May and June 2008 represented about a half-year into the Great Recession.

So this spending number is pathetic, 8 full years on and unimaginable Fed "money printing."

But the spending story is actually worse than that.

The GSEs were taken into conservatorship as September began. That was in the setting of a worsening but not widely recognized recession. Shortly after that, the Lehman disaster hit. The day after the announcement that Lehman had failed with no bailout, the SPY soared (Brexit/Bremain traders, take note). Then the crisis was upon us. Numerous large, super-regional banks began being absorbed by TBTF banks, as the very term 'TBTF' began to come into use. Gasoline prices plunged, which should have allowed lower spending as people merely maintained their standard of living.

Yet despite this spreading disaster, 14-day consumer spending as measured by Gallup was higher than now on the following days in 2008:

  • Sept. 30 - $93
  • Oct. 29 - $90
  • Nov. 12 - $88

So, within measurement error, mid-late October and early November spending (remember, these average the prior 14 days beginning the day before the date of the actual report) was the same as or higher than it was the past 14 days.

That's really pretty disgraceful for a "recovery."

Yet the story gets even worse when noting that these are the dollar spending numbers provided at the time. They are not adjusted for inflation.

So, if one averages the $88 and $90 from autumn 2008 to get $89, it's reasonable to add about $13 to that for cumulative consumer inflation to get to $102. Compare that to the current $86 and perhaps a moderately higher number for all of May-June (the number averaged $93 in May).

Basically there has been no recovery from near the depths of the Great Recession. That's as in none.

Yet QE has forced so much money into chasing risk assets that the President can do what President Bush did before him (before the meltdown) and President Clinton before him: point to the record stock market as a sign of a strong economy.

Consumer spending is up mostly because of mandated healthcare inflation, food inflation (especially shrinkflation), and rental inflation; plus population growth.

Nothing like this has ever happened in this country outside of the Great Depression. Maybe it will change, but the latest Father's Day and post-Father's Day data are consistent with the well-established stagnation.

And this, in turn, is much more consistent with current 10-year T-bond rates than with a P/E on the SPY of 24.4X and a Shller P/E of 26.3.

I go through this because all other data are corroborative. Just from Thursday we got two new data points that are similar. Here they are.

Markit also says that consumer spending is disappointing

On Thursday, Markit reported the "flash" US manufacturing PMI. This is "softer" data than is ideal. While the headline number was up marginally from May at 51.4, the details were worse than that. First, the actual manufacturing output number was below zero (the public report does not quantify it). Second, here is the commentary from Markit's economist:

The flash PMI for June brought welcome news of improved performance of manufacturing, but the sector still looks to have acted as a drag on the economy in the second quarter, leaving the economy reliant on the service sector and consumers in particular to drive growth.

"Any improvement could be largely traced to better export sales, in turn linked to the weakening of the dollar compared to earlier in the year. Domestic demand was again worryingly weak, especially from business customers, meaning overall growth of order books remains subdued.

That's pretty bad. Markit finds that manufacturing was recessionary in Q2 and the B-to-B business demand, which of course includes the (larger) service sector, is poor. Overall, once again we have begun to see specific and direct comparisons with the Great Recession. The economist, Dr. Williamson, concludes by saying:

"Despite the improvement in the current month, the three months to June has seen the worst quarter for manufacturing in terms of both production and employment growth since 2009.

Yikes - yet another reference to 2009; these have been popping up this year in US economic data for the first time since the Great Recession. But it's not surprising when looking at the consumer spending data.

In addition, Markit found intensifying cost pressures and price increases thereby imposed. This is occurring while business is sluggish: therefore, stagflation with a Fed that is looking to fight said inflation. This is alsoconsistent the 2007 situation. The US certainly would have been in recession before December had it not been for booming exports related to the weak dollar and seemingly impregnable BRIC economies.

Yet another implication of this boost to manufacturing from the declining dollar and the repeated failure of the Fed to raise interest rates even once this year is that the USD was not truly strong this past year or two. It was just that as in 1998, the rest of the world was weaker.

Remember the timing in that bubble. In 1998, oil prices crashed. Even though that was unequivocally good for the US, which had a small E&P sector then, the US economy weakened. The Fed saw the US and global weakness, cut rates ("printed money") thrice in H2, then the bubble reinflated and worsened. But, importantly, corporate profits did not rise much, ultimately peaking for the cycle in late 1997. As has been the case with secondary indices here, the Value Line Index was hit hard in 1998, did not come close to joining the SPY or NASDAQ in setting new highs in 1999, and collapsed again in 2000 as those indices roared to fresh new highs.

Here we are, two years and then some since the peak in the oil market. And of course, the US this time round had a much more substantial hydrocarbon sector of the economy. So is Y2K, 2 years on from the oil collapse of 1998, analogous to 2016, 2 years on from the peak of the oil market?

Thus I think there are worrisome signs in the details of the evolving, real-time economic data as revealed both by Markit and Gallup - two non-governmental sources of data that do not retroactively revise previous data (and for obscure reasons).

Then there's the Chicago Fed's CFNAI:

The National Activity Index confirms no significant recovery this "cycle" at all

Here's a chart from ZH showing the monthly results from the CFNAI going back to 2009:

This is a chart showing expansion or contraction based on a broad array of economic data points that sum to the CFNAI. Red, down monthly bars far outweigh the green, positive bars.

The only periods of reasonably sustained "green-ness" were during QE 1 and then QE 3. That's it - artificial money-printing steroids or amphetamines if you like. Before moving on to the latest data, it's important to look at this, because it's consistent with the evolving negative revisions to growth that the government's statisticians have been making this year and before this year (with more downward revisions apparently coming to GDP).

This horrible performance fits exactly with the trends shown on the Gallup consumer spending site (full graph not shown; please review at that link at your leisure).

So basically the economy has never recovered according to this as well as with Gallup. All that occurred in H2 2009 and the next year or so was inventory restocking, eventually including labor. This was really proven by the fact that all the mainstream economists really and truly expected 2010 to have a "recovery summer." They really believed it, and they were proven those 6 years ago to have no clue - and they still have no clue. That's why the emergency "QE 1.5" the Fed felt forced to do in August 2010 - the reinvestment of maturing bonds - is still in effect.

Before going to Thursday's report on May, some additional perspective arising from all the above data.

The bond market has gotten it gradually right all along. The Fed was unable to move because it was not really suppressing interest rates to near zero. It was the real economy that was pushing rates to the floor. If one was observant, that became crystal clear - proven - during Operation Twist in 2012.

That's because what was going on then was that the Fed was selling short-term securities and buying long-term bonds. There was no QE for that period other than the ongoing QE 1.5, which has become a permanent fixture keeping asset prices elevated but proportionately so.

If the Fed was massively selling short bonds, as it was doing, that should have pushed short rates up off the bottom. But it did not. Rates remained pinned near zero on the short end as long rates were forced downward by the combination of the weak economy and Fed buying. The 10- and 30-year bond interest rates are today about where they were then (partly artificially), but the upsloping yield curve in 2012 foreshadowed noticeably higher rates. So the bond market got it wrong even with those record low 10- and 30-year T-bond rates in 2012. Based on recent trading levels, they should have been even lower then.

Now, in addition to the above conclusion, and in addition to the weak Gallup and Markit data about the domestic economy, we almost have one of two recession signals from the CFNAI.

First, the introductory statement from the Chicago Fed in its report:

Led by declines in production-related indicators, the Chicago Fed National Activity Index (CFNAI) fell to -0.51 in May from +0.05 in April. All four broad categories of indicators that make up the index decreased from April, and all four categories made negative contributions to the index in May.

That's pretty darn bad. All four sectors were in contraction. Yikes (again)! The report continues with some details, which are not too pretty:

The index's three-month moving average, CFNAI-MA3, decreased to -0.36 in May from -0.25 in April. May's CFNAI-MA3 suggests that growth in national economic activity was somewhat below its historical trend. The economic growth reflected in this level of the CFNAI-MA3 suggests subdued inflationary pressure from economic activity over the coming year.

The CFNAI Diffusion Index, which is also a three-month moving average, moved down to -0.30 in May from -0.23 in April. Twenty-eight of the 85 individual indicators made positive contributions to the CFNAI in May, while 57 made negative contributions. Twenty-eight indicators improved from April to May, while 56 indicators deteriorated and one was unchanged. Of the indicators that improved, 12 made negative contributions.

The report then goes on to provide two recession indicators, one of which has almost been triggered. That's the 3-month diffusion index, which at -0.30 is "oh so" close to the recession signal number of -0.35 (and might be revised to that for all we know next month).

The other recession signal, the CFNAI-MA3, which is at -0.35, requires -0.70 to be triggered, so that's safe for now.

But this is a very bad sign. The CFNAI has basically been negative since December 2007 except for some periods of massive quantitative easing.

I think this is a challenge to the bulls.

One additional bit of breaking data from Thursday, then a wrap-up.

Other flash PMIs are poor as well

It's not just the US. The world is in a funk, and that's the way it is. Markit had some other flash reports Thursday. The one from the world's 3rd largest economy was especially dismal:

Nikkei Flash Japan Manufacturing PMI

Manufacturing conditions worsen for the fourth consecutive month

Flash headline PMI signals marked decline in operating conditions.

Also, the chronically depressed EU economy had its flash report:

Markit Flash Eurozone PMI®

Eurozone growth slips to weakest in nearly one-and-a-half years.

This is not horrible, but these are month-to-month comparisons by purchasing managers. So if conditions have been poor most of the time, a marginal upturn is not too encouraging.

However, at least the eurozone was positive. This actually becomes worrisome for the US, because Markit had this to say in its Japan commentary:

"Latest survey data pointed to a further deterioration in manufacturing conditions in Japan. Both production and new orders declined at marked rates, led by a sharp drop in international demand.

If the eurozone was doing OK, what parts of the world could a "sharp drop" in demand come from? Only two: the US and China. And of course a decent part of China's import demand is for assembly and subsequent finished goods export to the US and EU (and back to Japan, etc.).

So no matter how the British referendum comes out, I do not think it is all that material for a US-based investor who's investing mostly in the US markets and who has a longer-term perspective. These stories go on and on and on. How they affect asset prices is unpredictable and changeable, and thus I think it's easier for now to focus on more settled themes. Again, this is written as a US investor, not an EU resident, a Brit, etc.

Basically, I think that the US economy does not support a P/E, averaging the TTM EPS of the SPY and the Shiller P/E at a level above 25X.

Now I want to sum up and put matters in both a personal and other perspective.

The bigger picture

In my second month as a blogger, on January 6, 2009, (before there even was a Zero Hedge to set a new standard of bearishness), I wrote that the US was going Japanese, though in its own way as the global superpower with an inherently stronger economy. By saying this, I meant that as an investor, I was going to take the economic "under" and also that a structural downtrend in interest rates was likely in gear. That was why I titled that particular blog post:Land of the Setting Sun. These were the points I made as to why the bulls on the economy who thought the Great Recession were wrong in thinking the economy would snap back strongly:

The days of living off the sweeping victory in WW II have ended or are ending. The same is largely true with the Cold War victory; that party ended September 11, 2001. As with Japan, giant deficits are bipartisan policy. Massive wealth transfers to the undeserving corporate losers are also bipartisan and Fed policy. This is the zombification of America just as much as Japan did with its big banks in the 1990s. It is worse here and now for at least two reasons. One reason is that at least Japan could point to its culture and find a reason to support the zombie companies. Our zeitgeist was supposed to be 'agin that. The second reason is that we lectured Japan contemporaneously not to create zombies, and we were probably correct: but how hard it is for the doctor to diagnose and treat himself!

I think these comments hold up pretty well. I went on to say in the blog post:

Americans are looking at disordered finances, economic stagnation, and political discord rising from the above. The people are dispirited and see the rot in the body politic. The October bank bailout, supported with excessive force by no good reason and/or changing rationales by the Establishment, was a defining moment. Massive wealth transfers have gone and continue to go to the worst-run giant companies in America. All this in a world of domestic peace, good harvests, abundant raw materials, a hard-working labor force, a general culture of honesty and fair dealing among the people at large (excepting the higher levels of government and many businesses), and unchallenged world dominance. This shouldbe among the best of times.

The above, and the concluding punch line still look good more than 7 years on:

We deserve better than it looks like we are going to get.

And so it has been following the "oh so" Japanese move in 2008 to bail out the banks and reward the bankers, and fundamentally fix nothing.

If anyone wants to take the "over" and be bullish on economic growth in the US right now by going long the SPY, great, go for it. I'll root for you - but stay - for now - with the non-cyclical healthcare sector for the most part in my (underweighted) equity exposure.

Since we are always in new times, and the past shows us different patterns as we move forward into the future, it's most important to always be humble not only about the future but about the present and even the past. So my "take" is caution and taking some prudent gambles, which as I mentioned at the top, was much more quickly than I anticipated a week ago, to resume some extra betting on the long bonds I sold. Markets move quickly, and so did I.

A word on Brexit and the markets

Re the referendum, I wrote an InstaBlog Wednesday titled:

If The Queen Favors Brexit, Has She Been Sniffing The Winds? Investment Implications

My main point there was that since the bookies had "Remain" at 3:1 odds, I'd take the "under" and remain cautious. I thought it was more like the toss-up that it is as of about 10 PM as I prepare to finalize and submit this for publication. A second point was that even if the vote was for "Leave", there was a good chance that leaving would not actually occur. So, as an American, I was just going to trade normally until there were actual results - which at 12:18 AM EDT there appear to be.

At this time, the yields on Treasuries have collapsed to 1.50% and 2.37% on the 10- and 30-year bonds. The British pound is down to $1.35, down almost 9%. WTI and Brent crude oil are each down 5%. And the SPY is down a symmetric 4.44%.

My reaction is that in view of the deteriorating US economic fundamentals, this rapid turnaround in the bonds is not something I'm going to take trading profits on. My sense is that my longstanding 1% target for the 10-year is in play. Certainly, the breakdown in yields a couple of weeks ago did put new lows for at least the 10-year and perhaps the 30-year in play.

As far as US stocks go, once again it goes back to not seeing clearly how Brexit will affect them beyond short-term roiling. So I'm going to stick to fundamentals and continue to look at cyclicals with disfavor based on all the above fundamentals.

I also plan to look very carefully at purchasing a British pound ETF and/or a domestically-oriented British stock fund. This may be a classic over-reaction.

Concluding thoughts - staying data-dependent

In my view, it's extremely important - nay, crucial - to look past the drama of an important event such as the vote for Brexit and remain au courant with the real facts on the ground. What pattern have they created? Has the pattern changed?

I think not. Whether the US is in or soon heading into a recession is not the key point. That key point is whether the massive historical overvaluation of equities will continue. Based on all the facts I have discussed above, and the pattern into which they fit going back to the onset of the Great Recession; and the lead-in to the 2000-2 stop-start bear market(s), my game plan is to continue to underweight US stocks and handle the bond market fluctuations as best as I can. Mostly that's with buy-and-hold muni bonds and a core of Treasuries; then with trading around liquid Treasuries and ETFs (NYSEARCA:TLT).

The vote for Brexit, which I congratulate the country for simply holding, changes relative valuations but not, from a US perspective, the fundamentals of the US company and valuations of the markets. I continue to see the fundamentals of the US economy as meriting, under traditional valuations, a P/E of no more than 10X TTM GAAP EPS, and that's without a recession.

Thanks for reading on this fraught day. Best of luck to all.

Disclosure: I am/we are long TLT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Additional disclosure: Not investment advice. I am not an investment adviser.

Thursday, June 23, 2016

IMF downgrades US economy

Global Geopolitics

All Politics is now Global


IMF downgrades outlook for US economy

Posted by aurelius77 on June 23, 2016

The International Monetary Fund is downgrading its forecast for the U.S. economy this year and says America should raise the minimum wage to help the poor and offer paid maternity leave to encourage more women to work.

In its annual checkup of the U.S. economy, the IMF predicts 2.2 percent growth this year, down from 2.4 per cent in 2015, and lower than the 2.4 per cent growth it forecast in April for this year.

Full article: IMF downgrades outlook for US economy (CNBC)

You live in interesting times: Chinese curse

Overvalued Stocks, Six Sigma Black Swans, And The Most Important Chart In The World

Jun. 23, 2016 4:39 AM ET

The Heisenberg

The Heisenberg

TheoDark Report


Things that statistically speaking should never happen are happening all the time.

The fractious political landscape greatly increases the risk of tail events occurring at a time when equity valuations are stretched.

But at the end of the day, it all comes down to China.

I think the scariest thing about the UK referendum, the refugee crisis in Europe, the growing influence of political parties that were previously relegated to the fringes, and the upcoming US presidential election, is that markets really don't need all these extra tail risks right now.

Sure, you always prefer a situation with less event risk than more, but the problem is that for a variety of reasons, tail events are happening more and more often already. That is, we're all just kind of holding our breath each and every day as it stands. We don't need endogenous political shocks exacerbating an already precarious situation.

Let me show you what I mean. Have a look at the following chart from Citi's Matt King:

(Charts: Citi)

In the simplest possible terms: things that aren't supposed to happen ever are happening all the time.

Whether it's the abandonment of the franc peg, the great bund VaR shock of 2015, or the Treasury flash crash, the existing market structure is creaky and ill-prepared to handle the dislocations created by the potent combination of parasitic HFTs and central banks. Here, for instance, is a rather terrifying chart from Nanex which depicts the more than 220 ETFs that fell more than 10% on the morning of August 24:

(Chart: Nanex)

And here's a revealing look at what happened to liquidity during the Treasury flash crash:

(Charts: Citi, Nanex)

The point: there's already a heightened risk of absurdly anomalous moves even in what are supposed to be the deepest and most liquid markets on the planet. We don't need politicians enhancing the risk of tail events.

But alas, we are living in some of the most fractious political times in recent memory, and that means coping with potentially destabilizing geopolitical outcomes.

Here's the problem: if you're going to have to deal with this type of uncertainty, you don't want to go into it long an asset class that's overextended. Especially when that asset class benefited from a perpetual central bank put for years and then, when that dissipated, corporations stepped in to fill the void with the buyback bid.

I talked about this on Wednesday from the perspective of the US economy. That is, I looked at the underlying economic data and asked whether it supported elevated multiples for US equities (NYSEARCA:SPY). The answer, I concluded, was no.

Let's take a closer look at valuations, because trust me, Brexit isn't the last or even the most dangerous geopolitical landmine buried out there, and you don't want to be long a fully valued asset class that's lost its artificial support network when some manner of black swan lands.

So first, here's another look at multiples via Credit Suisse:

(Chart: Credit Suisse)

As you can see, fully valued. And here's a particularly disturbing graphic which suggests that the smoke and mirrors factor is sitting near an all-time high:

(Chart: Credit Suisse)

Here's how CS puts it:

Operating earnings reported by US corporates, which exclude "unusual" items as defined by the corporates themselves, are unusually high relative to reported earnings as defined by US GAAP. This indicates to us that some corporates may be trying to artificially improve their earnings by classifying reoccurring costs as "unusual."

Meanwhile, the buyback effect is drying up and will likely continue to do so as the cost of capital rises...

...while debt-to-EBITDA is at its highest levels since the crisis (even ex-energy):

(Chart: Credit Suisse)

So yeah, things are looking a bit stretched as the risks pile up. The key thing to remember though, is that barring some kind of absolute catastrophe in Syria that plunges NATO into a direct military confrontation with Russia and Iran, the biggest risk out there isn't the UK or the US election. It's China and the yuan (NYSEARCA:CYB). Here's SocGen's Albert Edwards:

But there is an argument that global investors have overly focused on Brexit at the expense of other more important macro events. We believe China's ongoing stealth devaluation of the renminbi is far more important for the global economy.

Meanwhile, our attention has been diverted. China has embarked on a stealth devaluation of the renminbi. Its new trade-weighted currency basket has fallen 10% since just before its initial August 2015 devaluation (white line in chart below) and it has continued to decline since January even as the Rmb/dollar has stabilised. The Wall Street Journal has reported that this is a deliberate shift in policy. China is now exporting its deflation, and my goodness it has a lot of deflation to export.

On that note, I'll leave you with a chart which shows the spread between the onshore and offshore RMB plotted against the S&P.

It should speak for itself (hint: the dashed line is parity, the wider the spread, the more likely it is that capital is flowing out of China, and when that happens, risk sells off).

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.

Yellen will mess things up for women’s advancement

The Fed’s Third Mandate And The Destruction Of Honest Finance

by David Stockman • June 23, 2016

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California Rep. Edward Royce had the temerity yesterday to ask Yellen whether the Fed was propping up stock prices. Imagine that!

In fact, he hit the nail on the head when he characterized the Fed’s unrelenting intrusion in financial markets and constant dithering on rate normalization as a “third pillar”, and one found nowhere in its statutory authorities:

ROYCE: I’m worried that the Federal Reserve has created a third pillar of monetary policy, that of a stable and rising stock market. And I say that because then-Chairman Bernanke, when he appeared here, stated repeatedly that, “the goal of QE was to increase asset prices like the stock market to create a wealth effect.” That seems as though that was goal. It would stand to reason then that in deciding to raise rates and reduce the Fed’s QE balance sheet standing at a still record $4.5 trillion, one would have to be prepared to accept the opposite result, a declining stock market and a slight deflation of the asset bubble that QE created. Yet, every time in the past three years when there has been a hint of raising rates and the stock market has declined accordingly, the Fed has cited stock market volatility as one of the reasons to stay the course and hold rates at zero. So indeed, the Fed has backed away so many times from rate normalization that – and I think this is a conceptual problem here that the market now expects stock market volatility to diminish the odds of a rate increase. So Madame Chair,is having a stable and rising stock market a third pillar or the Federal Reserve’s monetary policy if I go back to what I originally heard Ben Bernanke articulate?

Yellen’s reply is a risible insult to the intelligence of anyone who can fog a mirror. The sum and substance of what the Fed does these days is wealth effects pumping via the Greenspan/Bernanke/Yellen Put, but that did not stop our duplicitous school marm from denying the obvious:

YELLEN: It is not a third pillar of monetary policy. We do not target the level of stock prices. That is not an appropriate thing for us to do.

There you have the essence of the extreme danger embedded in today’s incendiary casinos. Yellen has no trouble denying the patently obvious because she does not credit what is in plain sight. If the chart below is a “coincidence”,  then its truly time to don our tinfoil hats.


In fact, to the denizens of the Eccles Building reality is what the Fed’s woebegone Keynesian model tells them it should be. At the moment it is apparently saying that the bathtub of full-employment GDP is filling nicely. Or as Yellen put it in her dupe-athon on Capitol Hill this week,

‘The U.S. economy is doing well. My expectation is that the U.S. economy will continue to grow.’

Accordingly, they do not have a clue why the stock market, which they purportedly do not target, has been grinding exactly sideways for 600 days since the end of QE3 in late 2014. Nor do they recognize that its periodic lunges southward have been reversed only by another punt on interest rate normalization.

Apparently, that’s because it is not in the “model”. Indeed, what is actually in the model is statistical noise emitting from a 50-year old time warp of a closed economy that hardly existed then, and not at all now.

So the Fed’s cowardly “choke” in March was actually worthy of the disdainful epithet that Donald Trump hurtled at Senator Rubio and then some.

How could the US economy be “doing well”? Yellen blathered that phrase less than 90 days after having determined just the opposite.

Namely, that by historic standards and all prior economic learning what was an ultra-emergency economic bailout rate at 38 basis points needed to be prolonged into what is now month 90 on the zero bound.

The truth is, the Fed is stranded there, and it will continue to dither and split hairs until the on-coming recession is undeniable, and the third great bubble of this century comes crashing down in a monumental spasm of panic in the casino.

This is the inevitable outcome because the Fed’s actual “wealth effects” policy is essentially a monetary time bomb. Its fatal flaw is the presumption that by falsifying and inflating financial asset prices in order to induce households and businesses to spend and invest, respectively, that the real main street economy will eventually grow into these blatant over-valuations.

Call it the Fed’s version of the Laffer Curve: Inflate financial asset prices to a fare-thee-well, and profits will grow their way back to sensible and sustainable capitalization rates.

To the contrary, the ridiculous mispricing of the stock market this late in the business cycle—–where the S&P 500 closed today at 24.2X reported LTM earnings—-is proof that the wealth effects doctrine is completely bogus. As Congressman Royce rightly observes above, “it would stand to reason” that the Fed should have expected that an eventual normalization of rates would result in a “declining stock market”.

But you only need to peruse what the Fed’s big thinkers have said about macro-economic stimulus via the wealth effects doctrine and its obvious that the Rep. Royce’s logically obvious proposition was never contemplated.

Instead, as described by Bernanke himself in the passage below, wealth effects is just another variation of mechanical Keynesian pump-priming. Rising financial asset wealth would induce households to spend, which would cause higher utilization of slack labor and business capacity. That, in turn, would generate more income and profits and then more spending and investing still, world without end.

At some point a long the way, presumably, rising business profits from this virtuous Keynesian chain would permit companies to earn their way back into their Fed inflated stock prices.  As Bernanke said after launching QE1,

This approach eased financial conditions in the past and, so far, looks to be effective again. Stock prices rose and long-term interest rates fell when investors began to anticipate the most recent action. Easier financial conditions will promote economic growth. For example, lower mortgage rates will make housing more affordable and allow more homeowners to refinance. Lower corporate bond rates will encourage investment. And higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending.”

When you think about it, the above passage is downright goofy unless you do really believe in “trickle down” growth of wages, profits and GDP.

Then again, what if Leroy don’t want the ball?

That is, if the US economy is at Peak Debt and its economic borders are wide open, what happens when a stock market winner allocates part of his gain to consumption spending (PCE), such as on a new Porsche SUV, and part to fixed asset (FA) investment, such as on some rental housing properties?

Obviously, the added PCE dead ends; it does not mobilize domestic output, wages and then more spending and the Keynesian virtuous circle. Instead, it adds to the trade deficit (negative GDP) and to Germany’s current account and national income.

As for the FA investment in a rental property, all things being equal it will bid up the price of the existing rental stock. By contrast, new construction is caused by rising apartment occupancy rates, which is mainly a function of main street wage and salary gains, not wealth effects.

In essence, therefore, the wealth effects gain in this example would simply represent a transfer of inflated asset values from the stock market to the rental property market if the original stock appreciation were realized. And if it was simply used as collateral for borrowing from Goldman’s private wealth department, it would amount to a leveraged speculation and further inflation of aggregate asset values.

Beyond that, grant Bernanke and his wealth effects comrades their due, and assume that lower mortgage rates do cause incremental demand for residential housing units and that some are actually built. But if mortgage debt is priced off the 10-year treasury note, do they really expect that rates will stay at today’s 170 basis points until the end of time?

If rates ever normalize, and eventually they must or the monetary system will blow-up, then the same rate suppression that Bernanke says  “will lower mortgage rates (and) will make housing more affordable and allow more homeowners to refinance” will cause the opposite effect down the road.

Or even before that, it will contribute to a speculative housing bubble and an eventual crash when the dumb money hits the last offer.

(to be continued)

Monday, June 20, 2016

Most extreme overvaluation in market history


Jun. 20, 2016 8:15 AM ET

John Hussman

John Hussman

Imagine the collapse of an extended speculative tech bubble, resulting in a broad economic recession. Imagine if the Federal Reserve had persistently slashed short-term interest rates during the downturn, to no avail, leaving rates at just 1% by the time the S&P 500 had lost half of its value and the Nasdaq 100 collapsed by 83%. Imagine that the Fed kept rates suppressed, in the initially well-meaning hope of encouraging lending, growth and employment. Imagine that the depressed level of interest rates made investors feel starved for yield, and drove them to look for safe alternatives to Treasury bills.

Imagine that investors found the higher yields they sought in mortgage securities, which had historically always been safe, and that Fed policy inadvertently created voracious demand for more of that debt. Imagine Wall Street had weak enough requirements on capital and underwriting standards that financial institutions had an incentive to create more “product” by lending to borrowers with lower and lower creditworthiness. Imagine that by the magic of “financial engineering” and lax oversight of credit ratings, Wall Street could pass these mortgages off to investors either directly by bundling, slicing and dicing them into mortgage-backed securities or by piggy-backing on the good faith and credit of the government by transferring them to Fannie Mae (OTCQB:FNMA) and Freddie Mac (OTCQB:FMCC) in return for funds obtained from investors in these “agency” securities.

Imagine that this Fed-induced yield-seeking speculation changed the dynamics of the housing market, and produced a bubble in home prices, coupled with overbuilding and malinvestment. Imagine that the Federal Reserve, focused exclusively on exploiting the very weak links between monetary policy and its “mandates” of employment and price stability, ignored the phrase “long-run” in those mandates, and wholly disregarded the speculative effects of its actions, which any thoughtful central banker should have viewed as a significant risk to the long-run economic health of the nation. Imagine that the then-head of the San Francisco Federal Reserve, Janet Yellen, answered questions about 1) whether speculative risks existed, 2) whether the Fed had any role in addressing them, and 3) whether there was any doubt that the Fed could halt a resulting economic downturn if it occurred, responding with a dismissive “No, No, and No.”

Imagine that this second speculative bubble collapsed anyway, producing the worst economic downturn since the Great Depression, and that persistent easing by the Fed failed to stop any of it, just as it failed to do so during the preceding collapse. Imagine that the Fed violated the existing provisions of section 13.3 of the Federal Reserve Act (later rewritten by Congress to spell it out like a children’s book) and created off-balance sheet shell companies called “Maiden Lane” to take bad assets off of the ledgers of certain financial institutions, in order to protect the bondholders of those companies and facilitate their acquisition by purchasers. Imagine that the crisis continued, and that what actually ended the crisis was a change in FASB accounting rules in the second week of March 2009, which relieved the need for financial institutions to mark their distressed assets to market value, and instead allowed them “significant judgment” in valuing those assets, instantly removing the specter of widespread financial insolvencies with the stroke of a pen. Imagine that legislation following the crisis was heavy on paper regulation, signed assurances, and living-wills, but was light on capital requirements, and contained provisions that essentially tied the hands of the FDIC and instead gave veto power to the Treasury and the best friend of the banking system, the Federal Reserve Board itself, in deciding whether a “too-big-to-fail” bank would actually go into receivership (where bondholders often lose money, but depositors are protected) if it was to become insolvent.

Imagine that in response to the collapse of a yield-seeking mortgage bubble, a resulting global financial crisis, and a 55% collapse in the S&P 500, the Federal Reserve insisted on pursuing more of what created the bubble in the first place; refusing to admit the weak cause-and-effect relationship between monetary easing and the real economy, pushing interest rates to zero, and expanding the monetary base to the point where $4 trillion of zero-interest hot potatoes constantly had to be held by someone in the financial markets. Imagine that despite pursuing this experimentation for years, the response of the real economy was no different than could have been predicted using prior values of non-monetary variables alone. Imagine that the main effect of this unprecedented intervention was to drive the most reliable measures of stock market valuation (those best correlated across history with actual subsequent 10-12 year market returns) well beyond double their historical norms, and that it prompted massive issuance of low-grade, “covenant lite” debt, in much the same way yield-seeking speculation encouraged the issuance of low-grade mortgage debt in the preceding bubble.

Imagine that the Fed not only refused to take serious account of the distorting impact of yield-seeking speculation on the financial markets, but actually welcomed it, citing it as an example of the “effectiveness” of quantitative easing, in the appallingly misguided belief that “wealth” is inherent in the price you pay for a security, rather than in the long-term stream of cash flows that the security will deliver over time. Imagine that investors adopted the same overconfidence in a Fed “put option” that they held before the 2000-2002 and 2007-2009 market collapses. Imagine the Fed failed to take any steps at all to reduce the size of its balance sheet at historically low interest rates, and painted itself into a corner because despite the weak relationship between short-term interest rates and the real economy, any normalization of policy threatened to burst a bubble that was already at a precipice.

Imagine that as a result of a massive combined deficit in the government and household sectors after the housing collapse, corporate profit margins temporarily soared to the highest level in history (an implication of the saving-investment identity under assumptions that typically hold in U.S. data). Imagine that because of this temporary elevation of profit margins, many of the borrowers that issued debt most heavily during this yield-seeking bubble were companies with elevated short-term profitability, but more fragile prospects over the full economic cycle. Imagine that energy and mining companies were among these, but were only the tip of the iceberg, exposed sooner than the rest because of early weakness in commodity prices.

Imagine if central banks took the position that when the relationship between their policy instruments and the real economy proves to be weak, the only option is to push those instruments beyond even the most extremist, historically unprecedented, and wholly experimental limits. Imagine that after years of persistent yield-seeking speculation, valuations were driven so high that the prospective 12-year return on a conventional 60% stocks, 30% bonds, 10% Treasury bills investment portfolio was compressed to just 1.6%. Imagine that corporate, state, and municipal pension funds were still assuming a 7% annual return on their investments, and that as a result of this mismatch, pension funds were becoming both massively underfunded, and vulnerable to severe capital losses over the completion of the market cycle.

Imagine that despite the delusion that low interest rates made stocks “cheap relative to bonds,” years of speculation had already created a situation where stocks were actually likely to underperform even the depressed yield on 10-year Treasury securities in the decade ahead, making the majority of corporate stock repurchases (which are typically financed by debt issuance), negative contributors to shareholder value. Imagine that the latest stick-save by central banks, in response to initial weakness following the 2015 peak of the bubble in global equity markets, had brought the median price/revenue ratio of the S&P 500 to the highest level in history, far exceeding even the 2000 peak (which was more focused on large-capitalization stocks, particularly in technology).

Imagine that all of this could be demonstrated with a century of reliable evidence, but that hardly anyone, particularly in the investment profession, gave it any more attention than the empty lip-service they offered during the tech and housing bubbles. Imagine that central bankers were focused instead on toy models that had weak theoretical and empirical foundations, inadequate transmission mechanisms, and an inability to explain more than a tiny fraction of economic variation over-and-above what could be explained in the absence of their deranged monetary activism. Imagine that they ignored real data in preference for the comfort and bizarre allegiance to a “Phillips Curve” that does not exist (Phillips’ work actually demonstrated a relationship between unemployment and wage inflation - and real wage inflation at that, given that he studied a century of British data when the U.K. was under the gold standard).

Imagine that a divided Congress, incapable of agreeing on fiscal policies to encourage productive investment in the public and private sectors, instead allowed a handful of unelected bankers and college professors to become the untethered de-facto overlords of the financial markets, repeatedly promoting destructive speculative bubbles. Imagine that nobody cared to recognize the role of financial speculation and malinvestment as the primary source of repeated economic dislocations and crises, because they were, nearly to a person, too lazy, uninformed, or dogmatic to actually get their hands dirty by questioning their assumptions or carefully examining the historical data.

Imagine that years of speculative recklessness had driven the S&P 500 to the second most extreme level of equity market overvaluation in postwar U.S. history (the third highest if one includes the 1929 peak), and to the single most extreme point of overvaluation for the median stock. Imagine that market internals and momentum had already deteriorated, and that the market had traced out an extended top-formation, as it had in late-2000 and again in late-2007.

Now imagine what might happen next.

A side-note. Though I was one of the few market participants who correctly anticipated the tech and housing collapses (also adopting a constructive or aggressive investment outlook following every bear market decline in three decades as a professional investor, and navigating complete market cycles admirably over that span), I regularly acknowledge that my 2009 insistence on stress-testing our discipline against Depression-era data, coupled with a Fed policy focused on intentionally encouraging financial speculation, inadvertently created an Achilles Heel for us in the advancing portion of this market cycle. We addressed those challenges in mid-2014. See the “Box” in The Next Big Short for the complete narrative. This episode of central bank recklessness will likely end in tears, and while I can certainly be blamed for the challenges that followed my 2009 stress-testing decision, it strikes me as ill-advised to dismiss a century of reliable objective evidence on the basis of subjective challenges that were highly unique to elements of our own discipline (specifically, the impact of QE on the outcomes of “overvalued, overbought, overbullish” syndromes, in the absence of weakness in market internals).

A few charts

Some of the following charts have appeared in prior market commentaries, but are presented again below to provide a graphic overview of the current situation. The first presents the ratio of nonfinancial market capitalization to national nonfinancial corporate gross value-added. One can think of this essentially as an economy wide price/revenue ratio for equities, including estimated revenues from foreign operations. I introduced this measure in May 2015, largely as an alternative to the next most reliable measure, which is market capitalization/nominal GDP. The objection to using GDP is that it includes non-corporate income, and as a “domestic” measure, it also includes the output of foreign companies operating in the U.S. while excluding the foreign income of U.S. companies operating abroad. As a practical matter, using national corporate gross value-added (including estimated foreign revenues) instead of gross domestic product has only moderate effect on implied market valuations, for empirical reasons I detailed in The New Era is an Old Story.

That said, MarketCap/GVA, shown below, has a stronger correlation across history with actual subsequent S&P 500 total returns than any of a score of alternative measures we’ve examined, including the Fed Model, price/earnings, price/forward operating earnings, the Shiller CAPE, Siegel’s NIPA CAPE, Tobin’s Q, price/dividend, and numerous other metrics.

The following chart presents the same data, but on an inverted log scale (left), along with the actual S&P 500 nominal average annual total returns over the following 12-year period. A 12-year horizon is used here because that is the point where the autocorrelation profile (the correlation of current valuations with later valuations) falls to zero, and is therefore the horizon over which valuations most reliably mean-revert. The correlation between this valuation measure and actual subsequent 12-year S&P 500 total returns is approximately 93%.

The next chart shows the data in a somewhat unusual way. The horizontal axis of the chart below shows the ratio of market capitalization to corporate gross value added, but is scaled to the current level of the S&P 500 (as of May 2016). As a result, the chart shows the levels of the S&P 500 Index that would currently be associated with various expected 12-year expected returns. For example, we currently estimate that a decline to the 1480 level on the S&P 500 would be required in order to restore expected 12-year nominal total returns to a level of 6% annually. Notably, not a single market cycle across history has completed without prospective 10-12 year returns reverting to the 8-10% range. This includes cycles prior to 1960 when interest rates regularly visited levels similar to the present.

The following chart expands the perspective to include returns from fixed income securities, and shows just how far yield-seeking speculation has gone in the financial markets. At present, investors can expect a conventional portfolio mix of 60% S&P 500, 30% Treasury bonds, and 10% Treasury bills to return only about 1.6% annually over the coming 12-year period. This situation is likely to provoke a broadening pension crisis in the years ahead, due to the combination of underfunding and capital losses over the completion of the market cycle.

Notice that the recent speculative episode has been accompanied by massive issuance of new corporate debt. While this increase in corporate indebtedness appears more acceptable relative to corporate earnings, profit margins have been dramatically elevated in recent years as a result of large deficits in the household and government sectors (in equilibrium, the deficits of one sector emerge as the surplus of another). This imbalance has begun to narrow considerably in recent quarters, which we observe as a contraction in corporate earnings. Relative to gross value added, the most historically reliable “sufficient statistic” for the future stream of corporate cash flows, current debt levels are disturbingly elevated. This is an example of a speculative outcome that appears manageable and benign in the short-run but is likely to have brutal longer-term consequences in the form of corporate defaults, even in the absence of a significant increase in Treasury yields.

The following chart presents the ratio of market capitalization to nominal GDP, which provides a longer-term perspective due both to a longer data set, and to a more reliable ability to impute pre-war data points using highly correlated proxies. The chart below shows this valuation measure since 1926, on an inverted log scale (left), compared with actual subsequent 12-year stock market returns.

Finally, the chart below shows the median price/revenue ratio of S&P 500 component stocks, which recently pushed to the highest level in history, exceeding both the 2000 and 2007 market peaks. In recent quarters, the broad market has deteriorated, even in the most reasonably valued decile of stocks, but the most richly valued decile has held up for a last hurrah, as it did near the peaks of previous bubbles. This dispersion has created a headwind for hedged-equity strategies in U.S. stocks, particularly value-conscious strategies, but investors should understand that beneath the surface of this short-term outcome is singularly the most extreme point of overvaluation for the broad equity market in history.

The foregoing comments represent the general investment analysis and economic views of the Advisor, and are provided solely for the purpose of information, instruction and discourse. Please see periodic remarks on the Fund Notes and Commentary page for discussion relating specifically to the Hussman Funds and the investment positions of the Funds.