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The baton is still being passed to the real economy and fiscal policies and away from monetary efforts. The Fed decided to raise the federal funds rate yesterday even as growth has remained quasi-recessionary. The flat treasury yield curve does not seem to be buying into the growth dreams of stock investors, so it looks like future tightening may be more problematic than many seem to think.
The subprime-fueled auto boom looks to be on its last legs as loan defaults rise and used car prices fall. A glut of cars will be coming off lease in coming quarters. Auto sales had been a key positive for growth. Yesterday’s (12/14/16) retail sales and industrial production reports confirmed that the strong growth story is simply more wishful thinking.
As we said last month, the new administration may be just the excuse the Fed needed to lean toward tighter policy. We think the FOMC might secretly buy into the Trump hype as well, if only because it dutifully follows the accepted market views. The tighter Fed and the resulting stronger dollar are forcing the hand of other central banks that face intensifying currency pressures that can cause import prices to rise beyond what local consumers might accept. They cannot remain as accommodative as they otherwise might and that is a growth drag. The balance is tenuous.
Last week, the ECB moved to diminish its QE program in terms of monthly purchase amounts, but will continue for a bit longer than originally planned. Even the BOJ is somewhat less heavy-handed for now on the monetary front, though it has become more opaque in its operations. This transition period will be a tricky maneuver fraught with risk because markets grew entirely dependent on ever increasing monetary interventions for seven years.
In the U.S., all hopes and dreams are now seemingly predicated on the success of new fiscal policies and deregulation out of D.C., but we re-emphasize that economies still face late-cycle headwinds and secular trends that will likely overwhelm or significantly dampen any short-term boosts that new initiatives may bring. Most importantly, the current fancy of waxing poetic about the Reagan years may be fun and all, but Trump will be coming into office with stocks at extremely expensive valuations. From an investor’s standpoint, that is all that matters and a key difference between now and the early 1980’s.
Those who seem determined to spend hard-earned money on stocks based on a Trump miracle of some kind might want to keep in mind that given the current equity pricing environment, that trade is more than just quite crowded, it’s gone viral. The “greater fool theory” nature of current trading is running into the fact that in terms of percentiles of valuations over the years, at current levels it has been just about impossible to find a marginal buyer historically. We don’t like that math.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.
While the new administration may provide welcome relief from the current central bank-dominated regime, the new guy on the block might face some harrowing times given the fact that the already shaky foundation of the current system was beginning to crumble under its own poor design before he came to office. We sense that the Fed and the other central bankers might have just found their scapegoat for their own monetary policy failures.
It looks like maybe some voters had been reading our monthly letters regarding how the underlying economy was not working for a lot of people. If the employment situation was really as robust as was popularly proclaimed, Trump would not have won. Pundits are busily acting as if they have all the answers about what the future holds and what you ought to do to make a ton of money today. It happens every election cycle. Of course, these are the same commentators who did not recognize the discontent below the surface of the manipulated markets or who do not do valuation work. We mostly have initial thoughts and questions, not answers at this point. From our perspective, the investment math has not changed much at all.
The elections have changed the landscape a bit and a lot of ad hoc and unsubstantiated game plans are being bandied about in response. Many investors were obviously quite surprised by the result. Some of the price movements in markets are pretty amazing as emotions took over and levered players and short traders were forced to close out losing positions. The sheer size and speed of some of the swings suggest these moves will likely be faded. History shows that similar stock price spikes have not proven sustainable when valuations were rich at the outset.
At the same time, it seems that a lot of the current activity is just a rapid acceleration of what was going on already and much like late last year as the Fed was preparing to tighten policy for the first time of the cycle. If it moves in December as expected, it will once again be doing so with an economy struggling along, so that alone presents risks.
It is very amusing to hear the same guys who said a Trump win was the worst thing imaginable now declare that “happy days are here again.” We are still working through our thinking and much is up in the air given the high number of unknowns regarding the new administration’s priorities. Plus, Congress will obviously weigh in. We are quite confident that the new guys do not recognize that the exact prescriptions that may have worked at one time may not be the best cure now because the current disease is so different.
We do get the sense that attempts will be made to transition from a world dependent on central bank activities and financial markets to one that is driven by the underlying real economy. We would welcome that. The problem is that asset prices in stocks and real estate are of the bubble variety and no sustainable growth program can work until the system is cleansed of these massive distortions. That will be painful and lead to a lot of finger-pointing and name-calling that the Fed took upon itself to avoid.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.
We remain baffled by many participants generally sanguine view of economic growth. We think investors are allowing some of the employment-related data to lead them astray. For instance, numerous economists look at the jobless claims data, which is at historically low levels, without realizing that there has been a gigantic drop in the number of workers who are even eligible to file unemployment claims in recent years. So it’s no wonder the weekly data is near 40-year lows.
Another common mistake is assuming that the new jobs of today are of the same quality as jobs that were lost in the recession. They are not. They pay less and are more likely to be part-time. Besides, all of those new waiter and bartender gigs that have been reported the last few years may be coming to a screeching halt as it looks like the restaurant industry has entered a very rough stretch that even the media cannot ignore now.
A lot of guesswork goes into monthly employment reports. Another cause of confusion is that employment models contain assumptions that new businesses are being formed at historical rates. They are not. That leads to bad inputs about new job creation from small businesses and puts a big upward bias on payroll growth. All of these issues and more help explain why worker productivity data is at such low levels and why growth and wages are so badly lagging the expectations of the central bankers.
One of numerous major issues may be the catalyst for increased risk aversion. The big picture problem is that the world has entirely too much debt. The substitution of debt growth for the terrible growth of real incomes being perpetrated by the deciders has rapidly run into a brick wall. We refer you to past letters in which we discuss more specific problems including European bank capital shortfalls, rising credit defaults in China, or Japanese policy failures to name a few. Any or all may lead to a crisis of confidence.
History suggests that waiting for such a crisis to appear is a poor substitute for an investment approach based on valuations. The first serious worries about the U.S. housing market surfaced in 2006-07 with many proclaiming that the issue was fully discounted when it obviously had not been based on the 2008-09 market catastrophe. We wish we had a nickel from everyone who told us “housing prices never go down,” “subprime was just a small part of the mortgage market,” or the “Fed has your back” in an effort to justify paying the sky high valuations of the last cycle. Believe it or not, the median valuation was lower then. Our only point is that the common wisdom or ubiquitous adages are not insurance against owning completely overvalued securities.
The PhD’s have gone too far with no clear benefits for the masses and they are losing political support as a result. They seem desperate and in extreme denial about policy failures. We also see more strategists at the major brokerage houses warning about the high valuations of equities. That seems a bit strange, but so does watching bottom-up equity analysts casually put “buy” ratings on cyclical stocks at 17-20 times peak earnings even when company managements sound downbeat.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.
Investors are ditching active managers and hedge funds in droves opting for index-oriented passive strategies. Those flows seem to be largely offsetting one another. The only net buyers of stocks are companies themselves who are diligently trying to maintain the EPS growth façade as revenues flat line or worse. Even those corporate buybacks are slowing in recent months as credit protection measures reach concerning levels.
Markets once again find themselves going through one of those inane Fed tightening fire drills that have become so familiar in recent years. Of course, 1% down days for the indices used to be standard operating procedure, but now strangely qualify as a cause for alarm by the talking heads. Even as growth expectations are being dialed down once again, Fed rhetoric about the wonders of the economy has put markets on edge a bit. You didn’t expect the FOMC to sound concerned right before we head to the polls did you? Never mind that Ford is cutting auto production as auto sales slow or that rail traffic is down 7% year-to-date.
Stocks have been a tad softer, the dollar is rallying, and bonds are falling on the thought that in December the Fed will finally nudge rates higher again. However, a stronger greenback brings the pain of the dollar shortage to the surface once again in Europe and Asia. Simply put, the Fed has so little room to maneuver as central banker to world. It has boxed itself in. Way too many non-U.S. entities borrowed dollars by the ton during our crazy QE days and paying the money back is proving to be much more expensive for them than they had expected. The danger of tightening with growth so slow and European banks melting down is obvious. This year started on a volatile note precisely because of the same sort of dollar scarcity panic after the Fed tightened in late 2015.
We do marvel at the chorus of ridiculous calls for more fiscal stimulus when our government’s debt has doubled to about $20 trillion in roughly ten years. Of course, deficit spending has already picked up in intensity in recent months heading into the November election. Add to that fiscal irresponsibility the recent central bank babbling about “running the economy hotter” to overcome longer term structural issues. It seems to be the laughable latest foray into central planner propaganda. This is part of their mind-bending explanations on why policy might need to remain accommodative. We do wonder what would happen if they tried to run things “cooler.” After all, we have now seen GDP growth estimates in the U.S. for the current quarter fall from over 3% to something below 2%.
GDP for this year is looking painfully close to only1.5% in spite of triple seasonably adjusting data and throwing intangibles into the calculation in recent years. We guess by some sort of magic the Fed can somehow manage to tighten in December and “run the economy hotter” at the same time. It is an incoherent concept. But I guess that is what we pay them for! It seems that the Fed is not really “running” anything other than a “spin machine” as it tries to coax the yield curve steeper like its counterparts at the ECB and the BOJ have been doing. They are all trying to help the banks facing major net interest margin pain.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.
We subscribe to the “they are damned if they do and damned if they don’t” view of monetary policy. If the central planners do more meddling, the negative unintended consequences like continued snail-paced growth and social unrest will be the dominant factors. If they do less, the errors of their ways will become obvious more quickly. Nonetheless, when the Fed floats the idea of changing laws to allow it to openly buy equities in the “next” downturn like it suggested might be necessary in recent weeks, you know there’s a big problem. Markets are close to figuring that out.
The policy maker’s last “brilliant” scheme of negative rates is crushing bank earnings in Europe and Japan. Current QE strategies are crowding out traditional investors like insurance companies whose business models were based on a free market for bonds. Most of the deciders’ remaining choices like widespread and unmasked use of outright equity purchases by the central banks would be a more blatant crossing of the socialist Rubicon, but directionally and philosophically that is where they have been taking us anyway. On that front, Japan does not seem to be getting much bang for the equity QE buck, or should we say yen.
We really do wonder. Will the traditional socialist P-E multiple discounts apply like they used to when investors valued some non-U.S. markets in days gone by or will we all just pretend capitalism has not been completely strangled to death if our Fed began to openly buy stocks? Who will vote the proxies at the Fed? Regardless, if the monetary despots become less involved, volatility will erupt sooner rather than later because the markets depend on their horrible drugs of easy money and soothing chatter. However, capitalism with all of its many strengths and a few weaknesses would come to the fore if the manipulation ceased. That would be good. In the end, volatility will be going higher anyway as the effects of continued quasi-recessionary growth lead to diminished corporate cash flows.
The powers that be are pedaling furiously on an economic bike that is virtually stationary. We think it is important to remember just how much fiat money is being conjured just to keep the current increasingly distrusted order in place. Stocks have been stuck in the same range for about two years despite the ECB, the BOJ and other central banks now pumping nearly $200 billion per month into the global system.
China has done its part for the establishment cause by reversing course on promised lending reforms when things started to hit the fan in February. It has grown broader measures of credit at an astounding 20% annual rate in recent months according to estimates. That throws any pretense of caution out the window. New loans have re-inflated the real estate markets to bubblier levels, but “official” GDP growth has slowed to an historically low 6.7% rate. The reality is that true growth is well below that number as just about everyone knows.
Trading volumes remain lackluster with the computers still calling the shots. A magical bid shows up at regular times throughout the day as if some invisible hand wants to keep the hopes and dreams of the elite alive. Volatility sellers are still “picking up dimes in front of freight trains” at key technical points on the charts as well, driving stocks higher when needed. Pension plans have turned to this endeavor to replace incomes lost to Fed repression. That can’t end well. What we find bizarre is how relatively quiet the IPO market has been given that stocks are so close to record highs. We suspect it speaks volumes about the lack of a real bid in the markets.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.
The Fed has remained inactive versus its QE-crazed counterparts around the globe. Nonetheless, it is still facing a groundswell of anger at its poor stewardship. That tempted it to tighten policy this week to try to quell the rebellion. It once again teased markets for weeks about the prospect. In the end, it joined the BOJ and did nothing yesterday, making it hard for anyone to listen to a word they say. Policy normalization is a fantasy.
If the Fed had raised rates for only the second time of this cycle, it would have done so at a really low growth point for both the U.S. and global economies. After all, year-over-year real GDP growth is at only 1.2% here. That is a level often seen near recessions and points out how full of “hot air” many of the growth bulls have become. We could bore you with a very long list of retailers and restaurants that reported earnings over the last couple of months whose managements have no idea how pundits can continue to beat “the strong consumer leading the economy” drum. That idea is simply hogwash.
Some policy makers are now openly frustrated that they have spent trillions of dollars on QE programs and pushed rates to zero or below without getting any sustained positive response from the real economy. Currencies are not even cheapening as they hoped and that was supposed to be the easy part. Their textbooks were wrong. Meanwhile, all that remains in their monetary arsenal are more negative rates, “helicopter money,” or broader use of outright equity purchases.
If the bureaucrats do back away from asset purchase programs, market volatility will erupt, but it would at least be a move back towards a more normally functioning system, which is desperately needed. Amazingly, talk of banning cash is now being casually floated by the PhD’s as a way for governments to keep control of matters in case negative rates drive depositors to pull money from banks. In response, sales of safes to hoard cash at home are rising and precious metals have had a nice run this year as well.
None of the remaining policy options is desirable. Any further bureaucratic meddling might just push the populace into a full-blown insurrection, while also making it blatantly clear that the system remains in crisis mode. The central bankers are walking a tightrope with alligators below and very unhappy people with pitchforks at both ends. Have no mercy on them! They created this inane framework by constantly employing untested theories while pretending they saved the system from an even worse outcome with no real proof to back that up. What’s more, they have now blown their third bubble in twenty years using the same tired tricks to constantly placate the markets.
We will spare you excerpts from some well-known investors who have recently joined the growing chorus of those wishing that the bureaucrats would simply get out of the way. Many also highlight the unsustainable nature of current markets under the current central banker regime. We will only say that some of the commentary out there makes us look downright reserved in our criticism of current policies.
We admit feeling uncomfortable being almost part of the consensus crowd after years of holding a minority view. However, when we look at recently high equity sentiment and exposures we conclude that many participants must be talking bearishly, but acting bullishly. When we saw a headline proclaiming that “stocks are the new bonds,” we felt a lot better about our positioning. Such open espousing of the idea that the 1-2% dividend yields of equities tells one anything about likely future total returns is simply music to the ears of the bearishly inclined. It sounds pretty bold and cannot be substantiated with any math.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.
Equities are absurdly overvalued as are large segments of the global bond markets. Because we take our job of finding compelling investments very seriously and use historical valuation metrics as the primary driver of our overall risk position, we have been more than willing to materially hedge our exposures for quite some time. However, when we also consider the foolhardy “musical chair” dynamics driving markets, we are even gladder to swim close to shore because current monetary policy is not a stimulant, but an economic depressant.
When we look back one day on this sad period of U.S. history with the worst growth since around 1949, it will be obvious that this nation never should have let a bunch of academics at our central bank with no real world experience take control of things for seven years. We will call it the “PhD Bubble” because we were led around by econ professors and their pet theories. As we have been saying for far too long, it is silly. The deciders built a system that reduces market volatility. It helps them sleep at night but cripples capitalism.
Importantly, the tide is clearly turning some more against the monetary policy belief system that holds markets aloft. The Washington Post recently contained a piece titled “The Old Fed is Dead” and a long-time Fed groupie at the Wall Street Journal penned “The Great Unraveling: Years of Fed Missteps Fueled Disillusion with the Economy and Washington.” We think the titles speak for themselves. Even the cheerleaders on TV often mock a Fed that talks about tightening policy, but never does.
The view that bureaucrats leading the Fed, the ECB, and the BOJ can save the world has come under intense scrutiny in political circles. The rise of populist, anti-establishment politicians across the globe is largely a direct result of monetary madness. The average person suffers from the slow growth while the deciders take solace in the illusions they have crafted. In addition, more of the central planners themselves are conveying doubts as their confusion about what to try next builds. The BOJ floated a bunch of grand ideas for weeks before its announcement yesterday, but its desperation has become apparent. In the end, it merely tweaked current policies.
Obviously the central banks have been allowed to assume entirely too big a role in the world economy, driving most asset prices to very overvalued levels, but likely hurting economic growth in the process. The damage to savers from rate manipulation is monetary malpractice that thwarts consumer spending. Home prices are once again absurdly priced in many locales globally, making them quite unaffordable. How does that help the homebuilding industry in the long run? Banks and insurance companies are having more difficulties making money because of flat bond curves and negative rates. What does that do for lending? We could go on, but our point is simply that policies are having pronounced real world impacts that are being discounted and ignored by those in charge.
Most stocks and bonds are priced to produce very low returns with lots of risk and that does not bode well for future growth. Paying twice the price for half the growth or less is making equity investors a grumpy bunch and rightfully so. Market participants are beginning to realize that not only have extreme monetary policies done very little to help the real economy, but also that there is very little else that the deciders can do anyway. We are only surprised by the fact this took so long to become obvious.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.
We sense profound frustration among investors and the electorate and it seems to be building. We also wonder what else the central planners can do and what would happen to markets if their meddling was curtailed because the realization that they are doing more harm than good became impossible to ignore. Recent comments out of the Fed seem to suggest growing doubts within it about the effectiveness of its monetary policy regime of the last five years. Meanwhile, the ECB and BOJ are overwhelming markets and crowding out traditional participants in their gigantic QE activities with no real improvement in their respective economic fortunes.
This landscape makes us more patient when others appear to be less so. We do know we cannot fathom blindly paying the current high valuation multiples in any environment, let alone one in which EPS growth is so challenged. We have been discussing for some time now how the typical equity is trading about twice its normal valuation. One can look at a number of different metrics and indices, but the conclusion is often the same.
A rational investor should look at the graph below of small cap stocks over the years and conclude that one does not need to be in any hurry to broadly buy them. Relative to twenty years of data they are enormously expensive when comparing Enterprise Value (Debt + Equity Market Capitalization) to EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization). If you went back further in the data, the conclusion would be the same.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relation.
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Has the greater fool gone viral?
The baton is still being passed to the real economy and fiscal policies and away from monetary efforts. The Fed decided to raise the federal funds rate yesterday even as growth has remained quasi-recessionary. The flat treasury yield curve does not seem to be buying into the growth dreams of stock investors, so it looks like future tightening may be more problematic than many seem to think.
The subprime-fueled auto boom looks to be on its last legs as loan defaults rise and used car prices fall. A glut of cars will be coming off lease in coming quarters. Auto sales had been a key positive for growth. Yesterday’s (12/14/16) retail sales and industrial production reports confirmed that the strong growth story is simply more wishful thinking.
As we said last month, the new administration may be just the excuse the Fed needed to lean toward tighter policy. We think the FOMC might secretly buy into the Trump hype as well, if only because it dutifully follows the accepted market views. The tighter Fed and the resulting stronger dollar are forcing the hand of other central banks that face intensifying currency pressures that can cause import prices to rise beyond what local consumers might accept. They cannot remain as accommodative as they otherwise might and that is a growth drag. The balance is tenuous.
Last week, the ECB moved to diminish its QE program in terms of monthly purchase amounts, but will continue for a bit longer than originally planned. Even the BOJ is somewhat less heavy-handed for now on the monetary front, though it has become more opaque in its operations. This transition period will be a tricky maneuver fraught with risk because markets grew entirely dependent on ever increasing monetary interventions for seven years.
In the U.S., all hopes and dreams are now seemingly predicated on the success of new fiscal policies and deregulation out of D.C., but we re-emphasize that economies still face late-cycle headwinds and secular trends that will likely overwhelm or significantly dampen any short-term boosts that new initiatives may bring. Most importantly, the current fancy of waxing poetic about the Reagan years may be fun and all, but Trump will be coming into office with stocks at extremely expensive valuations. From an investor’s standpoint, that is all that matters and a key difference between now and the early 1980’s.
Those who seem determined to spend hard-earned money on stocks based on a Trump miracle of some kind might want to keep in mind that given the current equity pricing environment, that trade is more than just quite crowded, it’s gone viral. The “greater fool theory” nature of current trading is running into the fact that in terms of percentiles of valuations over the years, at current levels it has been just about impossible to find a marginal buyer historically. We don’t like that math.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.
Careful, Donald…It’s a Trap
While the new administration may provide welcome relief from the current central bank-dominated regime, the new guy on the block might face some harrowing times given the fact that the already shaky foundation of the current system was beginning to crumble under its own poor design before he came to office. We sense that the Fed and the other central bankers might have just found their scapegoat for their own monetary policy failures.
It looks like maybe some voters had been reading our monthly letters regarding how the underlying economy was not working for a lot of people. If the employment situation was really as robust as was popularly proclaimed, Trump would not have won. Pundits are busily acting as if they have all the answers about what the future holds and what you ought to do to make a ton of money today. It happens every election cycle. Of course, these are the same commentators who did not recognize the discontent below the surface of the manipulated markets or who do not do valuation work. We mostly have initial thoughts and questions, not answers at this point. From our perspective, the investment math has not changed much at all.
The elections have changed the landscape a bit and a lot of ad hoc and unsubstantiated game plans are being bandied about in response. Many investors were obviously quite surprised by the result. Some of the price movements in markets are pretty amazing as emotions took over and levered players and short traders were forced to close out losing positions. The sheer size and speed of some of the swings suggest these moves will likely be faded. History shows that similar stock price spikes have not proven sustainable when valuations were rich at the outset.
At the same time, it seems that a lot of the current activity is just a rapid acceleration of what was going on already and much like late last year as the Fed was preparing to tighten policy for the first time of the cycle. If it moves in December as expected, it will once again be doing so with an economy struggling along, so that alone presents risks.
It is very amusing to hear the same guys who said a Trump win was the worst thing imaginable now declare that “happy days are here again.” We are still working through our thinking and much is up in the air given the high number of unknowns regarding the new administration’s priorities. Plus, Congress will obviously weigh in. We are quite confident that the new guys do not recognize that the exact prescriptions that may have worked at one time may not be the best cure now because the current disease is so different.
We do get the sense that attempts will be made to transition from a world dependent on central bank activities and financial markets to one that is driven by the underlying real economy. We would welcome that. The problem is that asset prices in stocks and real estate are of the bubble variety and no sustainable growth program can work until the system is cleansed of these massive distortions. That will be painful and lead to a lot of finger-pointing and name-calling that the Fed took upon itself to avoid.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.
The World Has Entirely Too Much Debt
We remain baffled by many participants generally sanguine view of economic growth. We think investors are allowing some of the employment-related data to lead them astray. For instance, numerous economists look at the jobless claims data, which is at historically low levels, without realizing that there has been a gigantic drop in the number of workers who are even eligible to file unemployment claims in recent years. So it’s no wonder the weekly data is near 40-year lows.
Another common mistake is assuming that the new jobs of today are of the same quality as jobs that were lost in the recession. They are not. They pay less and are more likely to be part-time. Besides, all of those new waiter and bartender gigs that have been reported the last few years may be coming to a screeching halt as it looks like the restaurant industry has entered a very rough stretch that even the media cannot ignore now.
A lot of guesswork goes into monthly employment reports. Another cause of confusion is that employment models contain assumptions that new businesses are being formed at historical rates. They are not. That leads to bad inputs about new job creation from small businesses and puts a big upward bias on payroll growth. All of these issues and more help explain why worker productivity data is at such low levels and why growth and wages are so badly lagging the expectations of the central bankers.
One of numerous major issues may be the catalyst for increased risk aversion. The big picture problem is that the world has entirely too much debt. The substitution of debt growth for the terrible growth of real incomes being perpetrated by the deciders has rapidly run into a brick wall. We refer you to past letters in which we discuss more specific problems including European bank capital shortfalls, rising credit defaults in China, or Japanese policy failures to name a few. Any or all may lead to a crisis of confidence.
History suggests that waiting for such a crisis to appear is a poor substitute for an investment approach based on valuations. The first serious worries about the U.S. housing market surfaced in 2006-07 with many proclaiming that the issue was fully discounted when it obviously had not been based on the 2008-09 market catastrophe. We wish we had a nickel from everyone who told us “housing prices never go down,” “subprime was just a small part of the mortgage market,” or the “Fed has your back” in an effort to justify paying the sky high valuations of the last cycle. Believe it or not, the median valuation was lower then. Our only point is that the common wisdom or ubiquitous adages are not insurance against owning completely overvalued securities.
The PhD’s have gone too far with no clear benefits for the masses and they are losing political support as a result. They seem desperate and in extreme denial about policy failures. We also see more strategists at the major brokerage houses warning about the high valuations of equities. That seems a bit strange, but so does watching bottom-up equity analysts casually put “buy” ratings on cyclical stocks at 17-20 times peak earnings even when company managements sound downbeat.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.
The Fed is Running a Spin Machine
Investors are ditching active managers and hedge funds in droves opting for index-oriented passive strategies. Those flows seem to be largely offsetting one another. The only net buyers of stocks are companies themselves who are diligently trying to maintain the EPS growth façade as revenues flat line or worse. Even those corporate buybacks are slowing in recent months as credit protection measures reach concerning levels.
Markets once again find themselves going through one of those inane Fed tightening fire drills that have become so familiar in recent years. Of course, 1% down days for the indices used to be standard operating procedure, but now strangely qualify as a cause for alarm by the talking heads. Even as growth expectations are being dialed down once again, Fed rhetoric about the wonders of the economy has put markets on edge a bit. You didn’t expect the FOMC to sound concerned right before we head to the polls did you? Never mind that Ford is cutting auto production as auto sales slow or that rail traffic is down 7% year-to-date.
Stocks have been a tad softer, the dollar is rallying, and bonds are falling on the thought that in December the Fed will finally nudge rates higher again. However, a stronger greenback brings the pain of the dollar shortage to the surface once again in Europe and Asia. Simply put, the Fed has so little room to maneuver as central banker to world. It has boxed itself in. Way too many non-U.S. entities borrowed dollars by the ton during our crazy QE days and paying the money back is proving to be much more expensive for them than they had expected. The danger of tightening with growth so slow and European banks melting down is obvious. This year started on a volatile note precisely because of the same sort of dollar scarcity panic after the Fed tightened in late 2015.
We do marvel at the chorus of ridiculous calls for more fiscal stimulus when our government’s debt has doubled to about $20 trillion in roughly ten years. Of course, deficit spending has already picked up in intensity in recent months heading into the November election. Add to that fiscal irresponsibility the recent central bank babbling about “running the economy hotter” to overcome longer term structural issues. It seems to be the laughable latest foray into central planner propaganda. This is part of their mind-bending explanations on why policy might need to remain accommodative. We do wonder what would happen if they tried to run things “cooler.” After all, we have now seen GDP growth estimates in the U.S. for the current quarter fall from over 3% to something below 2%.
GDP for this year is looking painfully close to only1.5% in spite of triple seasonably adjusting data and throwing intangibles into the calculation in recent years. We guess by some sort of magic the Fed can somehow manage to tighten in December and “run the economy hotter” at the same time. It is an incoherent concept. But I guess that is what we pay them for! It seems that the Fed is not really “running” anything other than a “spin machine” as it tries to coax the yield curve steeper like its counterparts at the ECB and the BOJ have been doing. They are all trying to help the banks facing major net interest margin pain.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.
Who will vote the proxies at the Fed?
We subscribe to the “they are damned if they do and damned if they don’t” view of monetary policy. If the central planners do more meddling, the negative unintended consequences like continued snail-paced growth and social unrest will be the dominant factors. If they do less, the errors of their ways will become obvious more quickly. Nonetheless, when the Fed floats the idea of changing laws to allow it to openly buy equities in the “next” downturn like it suggested might be necessary in recent weeks, you know there’s a big problem. Markets are close to figuring that out.
The policy maker’s last “brilliant” scheme of negative rates is crushing bank earnings in Europe and Japan. Current QE strategies are crowding out traditional investors like insurance companies whose business models were based on a free market for bonds. Most of the deciders’ remaining choices like widespread and unmasked use of outright equity purchases by the central banks would be a more blatant crossing of the socialist Rubicon, but directionally and philosophically that is where they have been taking us anyway. On that front, Japan does not seem to be getting much bang for the equity QE buck, or should we say yen.
We really do wonder. Will the traditional socialist P-E multiple discounts apply like they used to when investors valued some non-U.S. markets in days gone by or will we all just pretend capitalism has not been completely strangled to death if our Fed began to openly buy stocks? Who will vote the proxies at the Fed? Regardless, if the monetary despots become less involved, volatility will erupt sooner rather than later because the markets depend on their horrible drugs of easy money and soothing chatter. However, capitalism with all of its many strengths and a few weaknesses would come to the fore if the manipulation ceased. That would be good. In the end, volatility will be going higher anyway as the effects of continued quasi-recessionary growth lead to diminished corporate cash flows.
The powers that be are pedaling furiously on an economic bike that is virtually stationary. We think it is important to remember just how much fiat money is being conjured just to keep the current increasingly distrusted order in place. Stocks have been stuck in the same range for about two years despite the ECB, the BOJ and other central banks now pumping nearly $200 billion per month into the global system.
China has done its part for the establishment cause by reversing course on promised lending reforms when things started to hit the fan in February. It has grown broader measures of credit at an astounding 20% annual rate in recent months according to estimates. That throws any pretense of caution out the window. New loans have re-inflated the real estate markets to bubblier levels, but “official” GDP growth has slowed to an historically low 6.7% rate. The reality is that true growth is well below that number as just about everyone knows.
Trading volumes remain lackluster with the computers still calling the shots. A magical bid shows up at regular times throughout the day as if some invisible hand wants to keep the hopes and dreams of the elite alive. Volatility sellers are still “picking up dimes in front of freight trains” at key technical points on the charts as well, driving stocks higher when needed. Pension plans have turned to this endeavor to replace incomes lost to Fed repression. That can’t end well. What we find bizarre is how relatively quiet the IPO market has been given that stocks are so close to record highs. We suspect it speaks volumes about the lack of a real bid in the markets.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.
Fed Policy Normalization is a Fantasy
The Fed has remained inactive versus its QE-crazed counterparts around the globe. Nonetheless, it is still facing a groundswell of anger at its poor stewardship. That tempted it to tighten policy this week to try to quell the rebellion. It once again teased markets for weeks about the prospect. In the end, it joined the BOJ and did nothing yesterday, making it hard for anyone to listen to a word they say. Policy normalization is a fantasy.
If the Fed had raised rates for only the second time of this cycle, it would have done so at a really low growth point for both the U.S. and global economies. After all, year-over-year real GDP growth is at only 1.2% here. That is a level often seen near recessions and points out how full of “hot air” many of the growth bulls have become. We could bore you with a very long list of retailers and restaurants that reported earnings over the last couple of months whose managements have no idea how pundits can continue to beat “the strong consumer leading the economy” drum. That idea is simply hogwash.
Some policy makers are now openly frustrated that they have spent trillions of dollars on QE programs and pushed rates to zero or below without getting any sustained positive response from the real economy. Currencies are not even cheapening as they hoped and that was supposed to be the easy part. Their textbooks were wrong. Meanwhile, all that remains in their monetary arsenal are more negative rates, “helicopter money,” or broader use of outright equity purchases.
If the bureaucrats do back away from asset purchase programs, market volatility will erupt, but it would at least be a move back towards a more normally functioning system, which is desperately needed. Amazingly, talk of banning cash is now being casually floated by the PhD’s as a way for governments to keep control of matters in case negative rates drive depositors to pull money from banks. In response, sales of safes to hoard cash at home are rising and precious metals have had a nice run this year as well.
None of the remaining policy options is desirable. Any further bureaucratic meddling might just push the populace into a full-blown insurrection, while also making it blatantly clear that the system remains in crisis mode. The central bankers are walking a tightrope with alligators below and very unhappy people with pitchforks at both ends. Have no mercy on them! They created this inane framework by constantly employing untested theories while pretending they saved the system from an even worse outcome with no real proof to back that up. What’s more, they have now blown their third bubble in twenty years using the same tired tricks to constantly placate the markets.
We will spare you excerpts from some well-known investors who have recently joined the growing chorus of those wishing that the bureaucrats would simply get out of the way. Many also highlight the unsustainable nature of current markets under the current central banker regime. We will only say that some of the commentary out there makes us look downright reserved in our criticism of current policies.
We admit feeling uncomfortable being almost part of the consensus crowd after years of holding a minority view. However, when we look at recently high equity sentiment and exposures we conclude that many participants must be talking bearishly, but acting bullishly. When we saw a headline proclaiming that “stocks are the new bonds,” we felt a lot better about our positioning. Such open espousing of the idea that the 1-2% dividend yields of equities tells one anything about likely future total returns is simply music to the ears of the bearishly inclined. It sounds pretty bold and cannot be substantiated with any math.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.
The PhD Bubble
Equities are absurdly overvalued as are large segments of the global bond markets. Because we take our job of finding compelling investments very seriously and use historical valuation metrics as the primary driver of our overall risk position, we have been more than willing to materially hedge our exposures for quite some time. However, when we also consider the foolhardy “musical chair” dynamics driving markets, we are even gladder to swim close to shore because current monetary policy is not a stimulant, but an economic depressant.
When we look back one day on this sad period of U.S. history with the worst growth since around 1949, it will be obvious that this nation never should have let a bunch of academics at our central bank with no real world experience take control of things for seven years. We will call it the “PhD Bubble” because we were led around by econ professors and their pet theories. As we have been saying for far too long, it is silly. The deciders built a system that reduces market volatility. It helps them sleep at night but cripples capitalism.
Importantly, the tide is clearly turning some more against the monetary policy belief system that holds markets aloft. The Washington Post recently contained a piece titled “The Old Fed is Dead” and a long-time Fed groupie at the Wall Street Journal penned “The Great Unraveling: Years of Fed Missteps Fueled Disillusion with the Economy and Washington.” We think the titles speak for themselves. Even the cheerleaders on TV often mock a Fed that talks about tightening policy, but never does.
The view that bureaucrats leading the Fed, the ECB, and the BOJ can save the world has come under intense scrutiny in political circles. The rise of populist, anti-establishment politicians across the globe is largely a direct result of monetary madness. The average person suffers from the slow growth while the deciders take solace in the illusions they have crafted. In addition, more of the central planners themselves are conveying doubts as their confusion about what to try next builds. The BOJ floated a bunch of grand ideas for weeks before its announcement yesterday, but its desperation has become apparent. In the end, it merely tweaked current policies.
Obviously the central banks have been allowed to assume entirely too big a role in the world economy, driving most asset prices to very overvalued levels, but likely hurting economic growth in the process. The damage to savers from rate manipulation is monetary malpractice that thwarts consumer spending. Home prices are once again absurdly priced in many locales globally, making them quite unaffordable. How does that help the homebuilding industry in the long run? Banks and insurance companies are having more difficulties making money because of flat bond curves and negative rates. What does that do for lending? We could go on, but our point is simply that policies are having pronounced real world impacts that are being discounted and ignored by those in charge.
Most stocks and bonds are priced to produce very low returns with lots of risk and that does not bode well for future growth. Paying twice the price for half the growth or less is making equity investors a grumpy bunch and rightfully so. Market participants are beginning to realize that not only have extreme monetary policies done very little to help the real economy, but also that there is very little else that the deciders can do anyway. We are only surprised by the fact this took so long to become obvious.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.
Frustration is Spreading
We sense profound frustration among investors and the electorate and it seems to be building. We also wonder what else the central planners can do and what would happen to markets if their meddling was curtailed because the realization that they are doing more harm than good became impossible to ignore. Recent comments out of the Fed seem to suggest growing doubts within it about the effectiveness of its monetary policy regime of the last five years. Meanwhile, the ECB and BOJ are overwhelming markets and crowding out traditional participants in their gigantic QE activities with no real improvement in their respective economic fortunes.
This landscape makes us more patient when others appear to be less so. We do know we cannot fathom blindly paying the current high valuation multiples in any environment, let alone one in which EPS growth is so challenged. We have been discussing for some time now how the typical equity is trading about twice its normal valuation. One can look at a number of different metrics and indices, but the conclusion is often the same.
A rational investor should look at the graph below of small cap stocks over the years and conclude that one does not need to be in any hurry to broadly buy them. Relative to twenty years of data they are enormously expensive when comparing Enterprise Value (Debt + Equity Market Capitalization) to EBITDA (Earnings before Interest, Taxes, Depreciation and Amortization). If you went back further in the data, the conclusion would be the same.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relation.