Rate of Change

The 'cash on the sidelines' myth has more lives than a cat. No matter how often the logical fallacy underlying it is pointed out, Wall Street continues to propagate it. Nevertheless, money and credit are of course extremely important factors in the analysis of asset markets. The below provides what are hopefully a few useful pointers as to which data one should keep an eye on in this context.

There is no point in trying to avert or prevent bubbles caused by monetary pumping by regulatory means. If one avenue for bubble formation is cut off, the newly created money will simply flow into another area. In fact, new bubbles almost always become concentrated in new sectors. If there were a genuine desire to keep the formation of bubbles in check, adopting sound money would be a sine qua non precondition. However, no-one who has any say in today's system has a desire to adopt sound money and give up on the failed centrally planned monetary system in favor of a genuine free market system. Our guess is that the booms and busts the current system inevitably produces will simply continue to grow larger and larger until there comes a denouement that can no longer be 'fixed'.

The Fed tightens by a little (sorry, tapering - flow - is and always will be tightening): markets soar; Turkey tightens by a lot: markets soar. If only it was that easy everyone would tighten. Only it never is. Which is why as we just reported, the initial euphoria in Turkey is long gone and the Turkish Lira is basically at pre-announcement levels, only now the government has a furious, and loan-challenged population to deal with, not to mention an economy which has just ground to a halt. Anyway, good luck - other EMs already faded, including the ZAR which many are speculating could be the next Turkey, and certainly the USDJPY which sent futures soaring last night, only to fade all gains as well and bring equities down with it.

The President will do his best to put a positive spin on the current economic environment and the success of his policies to date when he gives his speech tonight.  However, how you define the current environment may have much to do with where you fall in current income distribution.  This was a point made by Mr. Boyer: "In 2012, the richest 10 percent of Americans earned their largest share of income since 1917, said Emmanuel Saez, an economist at the University of California at Berkeley. Meanwhile, Census Bureau statistics showed that real average income among the poorest 20 percent of families continued to fall each year from 2009 to 2011." As with all things - it is the lens from which you view the world that defines what you see.  In the end, it will be whether we choose to "see" the issues that currently weigh on economic prosperity and take action, or continue to look the other way.  History is replete with examples of the demise of empires that have done the latter.

As 11.3 million Americans spend more than half their income on rent, a record increase of 28% in four years, increasingly more are faced with the core "New normal recovery" choice: “We either eat, or we pay rent.”  Welcome to the Blackstone recovery...

Retail sales are not currently indicating that the consumer is about to "drop kick" a game winning field goal in the coming year.  While the consumer is definitely "not dead," as evidenced by increased leverage in the recent credit reports, they are also not currently in the position to substantially increase demand five years into an economic recovery. Our perception is that the "struggle through" economy is likely to remain in 2014 which will disappoint the economic bulls.

While some would argue (as they always do) that there are good reasons to be bullish going into 2014 (central bank liquidity provision being an obvious one); there are ample reasons to remain vigilant with respect to your investments. The stagnation of wage growth combined with higher costs leaves an already cash strapped consumer with few options.  It is likely that we will see a push by consumers to re-leverage their household balance sheet which will be hailed by the media as a return of consumer confidence.  However, one should not forget the last time a highly levered consumer ran into problems. Furthermore, there are three potential headwinds that are likely to weigh on the economy and the markets which are potentially being overlooked.

There has been much debate in Washington about how to get the economy growing again.  Unfortunately, fiscal policy has done little to address the core of economic growth, which is the consumer, or the productive investment required to generate real employment and wage growth. As Schumpeter observed, "there are no entrepreneurs without capital." Simply put, there are no companies, and no jobs, without investment first. For anyone irrespective of ideology to deny the latter brings new meaning to willful blindness. Until we focus on creating an environment that leads to greater investment opportunities by business owners we will likely see a further deterioration in personal consumption.  There is currently a fine line between expansion and contraction within the overall economy, and while hopes are that 2014 will be a "breakout" year for the economy, the current economic data trends suggest otherwise.

The latest "most important payrolls day of all time" day is finally upon us. Of course, this is a ridiculous statement: considering that the average December seasonal adjustment to the actual, unadjusted number is 824K jobs, it will once again be up to the BLS' Arima X 13 goal-seeking, seasonal adjusting software to determine whether the momentum ignition algos send stocks soaring or plunging, especially since the difference between up and down could be as small as 30K jobs. As Deutsche Bank explains: " today's number is probably one where anything above +200k (net of revisions) will lead to a further dip in risk as taper fears intensify and anything less than say +170k will probably see a decent relief rally after a tricky week for markets. Indeed yesterday saw the S&P500 (-0.43%) down for a fifth day - extending a sequence last seen in September." And then consider that nearly 30 times that difference comes from seasonal adjustments and it becomes clear why "farcial" is a far better definition of labor Friday.

Just as in the 1930s the Fed fueled deflation by not making credit available, today the opposite seems to be the case – low rates are fueling deflation and preventing markets from clearing.

Even we were shocked when we ran the numbers on this one...

There is currently a debate being waged on Wall Street.  On one side of the argument are individuals who believe that we have entered into the next "secular bull market"  and that the markets have only just begun what is an expected multi-year advance from current levels.  The other side of the argument reiterates that the current market advance is predicated on artificial stimulus and that the "secular bear market" remains intact, and the next major reversion is just a function of time. The series of charts below is designed to allow you to draw your own conclusions. While it is certainly easy to be swept up in the daily advances of the stock market casino, it is important to remember that eventually the "house always wins."  What has always separated successful professional gamblers from the weekend sucker is strictly the difference of knowing when to cash in your chips and step away from the table.

With the economy now more than 4 years into an expansion, which is long by historical standards, the question for you to answer by looking at the charts below is: "Are we closer to an economic recession or a continued expansion?" How you answer that question should have a significant impact on your investment outlook as financial markets tend to lose roughly 30% on average during recessionary periods. However, with margin debt at record levels, earnings deteriorating and junk bond yields near all-time lows, this is hardly a normal market environment within which we are currently invested. Therefore, we present a series of charts which view the overall economy from the same perspective utilizing an annualized rate of change. (Spoiler Alert: the economy is far to weak to stand on its own two feet.)

The last two weeks have seen US equity markets on a one-way path to the moon, breaking multi-year records in terms of rate of change and soaring to new all-time highs. However, away from the mainstream media's glare, another 'market' has been soaring - but this time it is not good news. Chinese overnight repo rates - the harbinger of ultimate liquidity crisis - have exploded from 6-month lows (at 2.5%) to 4-month highs (6.7% today). The PBOC even added liquidity for the first time in months yesterday (via Reverse Repo - at much higher than normal rates) but clearly, that was not enough and the banks are running scared once again that the re-ignition of the housing bubble in China will mean more than 'selective' liquidity restrictions.

Today there is a great sense of relief that has swept the nation as news flowed through the media that the government shutdown had come to an end.  After all, during the 16 days of the shutdown, there was great hardship inflicted on the average American as the stock market rose by 2.4%, government workers that were furloughed received a 2+ week paid vacation and interest rates fell from a peak of 2.65% on October 1st to 2.59% on October 17th.  Outside of the financial markets, which were never concerned of a "default," the reality is that the government shutdown did likely clip up to 0.5% off of 4th quarter's GDP.  While that clip to economic growth created by the government standoff is temporary - the ongoing persistant weakness of economic growth is another issue entirely.  This is the focus of this discussion. The most disturbing sentence uttered during the debt ceiling debate/government shut down, that should raise some concerns by both political parties, is: "We must increase our debt limit so that we can pay our bills."