Deflationary Boom 2.0 - Commodity Index Crashes To 13 Year Lows

Tyler Durden's picture

The Bloomberg Commodity Index tumbled once again today, hitting its lowest level since 2002. Stocks did not. We have seen this kind of 'deflationary' boom before... and it did not end well...

 

Who needs raw materials when you have eyeballs.

As BofAML somewhat mockingly reflected...

It's a deflationary boom: Nasdaq hits all-time high today; CRB breaking down to 2002 lows;

 

Wall St narrative flips from crash to boom/bubble as rally leadership = tech, biotech, banks, i.e. a heavy dose of deflationary "growth" stocks with a dash of domestic cyclical "value".

As Cornerstone Macro detailed in November 2014, the concept of a deflationary boom is a controversial one in economics. Truth be told it will not work in every economy. Indeed, a pre-requisite for this to unfold is an economy driven by consumers. In that sense, it does not get more consumer-centric than the US. The second, and necessary, condition calls for a major decline in commodity prices ideally compounded by a strong currency to provide the fuel for growth. In essence, a decline in commodity and import prices creates disposable income the same way the Fed Funds rate cuts used to a decade ago.

Positioning for a deflationary boom is a binary event. After all, “deflationary” implies that stocks levered to lower inflation will have a powerful tailwind, these are what we like to call early cyclicals such as consumer, transports and other similar segments. Meanwhile, the “boom” part of the story implies that segments levered to growth, US growth in this case, also find a tailwinds.

 

This should help the beleaguered financials to a better year in 2015 and also provides support for sectors like technology and some of the industrials. As we see it, “deflation” is going to become the operative word on the street... that and PE expansion since they typically go hand in hand.

As always, we shall see.

*  *  *

Two words - Priced In?

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wendigo's picture
wendigo (not verified) Jul 20, 2015 12:33 PM

I thought during a deflationary episode, if it were bad enough, they would print money like mad to compensate and unwittingly trigger hyperinflation? 

 

OT: today I will be debt free for the first time in my adult life. No mortgage, no credit card, no car payment, no nothing. Been looking forward to this day for a long time. 

Philo Beddoe's picture

Congrats! I am just going to assume that you are not married. 

froze25's picture

The words, "It was on sale" are ringing in my ears.  Congrats on being debt free buddy.  

tarsubil's picture

Just think. We are very near the place where it will be the best in a long time. This is nearly the best that it will get. Fucking great news.

EBT excepted's picture

jus' needs to loin some tricks bruthah...like dis' one...sold mah ol' ladys' car and put d'poceeds down on d'hout paymunt...aftah mah hout paymunt gone, EBT go a long ways peepses...

i_call_you_my_base's picture

You know what happens to animals that stray from the herd, right? /s

RobD's picture

Welcome to the party! Been dept free for a month now after selling our home. Married with two kids by the way, so it may not last long lol.

Groundhog Day's picture

wendigo,

congrats, i hard task for the many, though it is lonely on this side of the aisle, especially when the debtors seem to be living the dream for the past 2 decades and savers seem to be the idiots (for now)

venturen's picture

debt free....You should load up on as much debt as you can in a holding company....that you let fail with next years mega crash. Which would you rather be for the last 5 years...completely in the market loaded to the margin limit....or paying off debt! Debt is the Gold!

Scooby Doo's picture

Congratulations!!  I hope to be there at the end of this year.  That darn mortgage is the last to go.  If only I could print money.....

uhb's picture

congrats + thumbs up ! You're probly' not married?! ;)

r3ct1f13r's picture

Congratz.
About 2 months ahead of you. Still kinda hasn't set in lol.

de3de8's picture

Question is who wins?

Sir SpeaksALot's picture

people engaged with stocks.

JustObserving's picture

Those charts again?  Really, do charts matter in a manipulated market?

If you do not know that markets are rigged from top to bottom, you may want to buy the Brooklyn Bridge from me for the rock bottom price of $99.  And I will throw in the George Washington Bridge for only $49.  

Bear's picture

What kind of ROI can I expect from the bridges, especially with all the 'infrastructure' talk? Will I be responsible for retrofitting the bridges or will .gov create a thousand minimum wage jobs to shore them up. The prices seem right ... but maybe not the timing!

Omega_Man's picture

the FED is retarded

nope-1004's picture

You just offended all retards.

 

Omega_Man's picture

Sorry Retards, you are smarter than FED

Omega_Man's picture

it's a BS theory cause it only applies to US, other currencies are tanking, therefore things are not cheap, even in Canada

ArkansasAngie's picture

But their exports are.

Too bad for American manufacturering.  You're thrown under the global bus ... again.

Spungo's picture

The really neat thing is how so many graphs show the economy should have hit the wall in 1998, but the stock market kept going up for another 2 years. Then it kinds crashed and NASDAQ lost something like 70% of its value.

Winston Churchill's picture

In which case time is up right about now.

besnook's picture

the s and p reflects inflation in the .1% bracket, nothing more. the collapsing commodity prices exposes the myth of trickle down(supply side) economics. money bypassing the consumer is not invested in value added endeavors. it is invested in passive income producing endeavors, the proceeds of which are also invested in the same passive investments which leads to a rise in equity(and bond) prices without the theorized commensurate increase in real economic activity. indeed, the opposite happens. real economic activity is stifled as a result of the negligible difference between the return on investment low risk passive investment and higher risk active investment.

CClarity's picture

CNBC hasn't reported CRB for months now.  Used to run it just like all the other stuff - VIX, oil, Euro, interest rates, etc.  But poof gone.  Once again proving they don't care a whit to "inform" viewers about markets.  Shills!

 

Omega_Man's picture

Gold is still over $1500 in CDN, other currencies etc... All this is the US manipuliating things for their own benefit. Buy all the assets for a song... ban yankees

QQQBall's picture

Congrats on being debt free. Hard to get good cash flow from investments. The thing is, you will start looking at assets on an all cash basis and wondering if it is worth the life energy you traded to buy it. One key is living well below you means - next time look at buying a small plex propety and renting the other units out. You will get good leverage, depreciatoin and repair write-offs and live cheaper or "rent free" vs owning a traditional SFR.

BeaverCream's picture

Being a landlord is like the worst business on the planet unless you can afford to hire someone to manage your properties.  Don't do it.

polo007's picture

According to Macquarie Research:
 
http://personal.crocodoc.com/EmsBFiu
 
China’s policy response
 
How different is it to G4 economies?
 
The battery of policy initiatives that were unveiled by China’s regulatory Authorities in an attempt to reduce the massive rise in equity market volatilities has inevitably raised a question: how different are the tools used by China?
 
Whether Japan (post ’90’s), Eurozone/UK and the US (post ’08) or China today, the key challenge facing policy makers is that given the underlying leverage (in most cases it exceeds 3:1 – public/private debt to GDP), there is simply no room for excessive volatility in any of the key asset classes. High leverage, declining velocity of money and interconnected capital markets is the perfect recipe for a “butterfly effect” (in chaos theory, butterfly effect is the condition in which a small change in one state causes large differences somewhere else), with volatility in one asset class potentially causing major dislocation in other asset classes.
 
Given our view that most economies can no longer deleverage, the key policy objective is the need to ensure (a) limited volatility in the key asset classes; (b) at least some assets need to appreciate (otherwise there would be no room for further leveraging); and (c) avoidance of sustained contraction of nominal GDP.
In order to facilitate this objective, policy makers need to ensure ample and constantly growing liquidity to negate declining velocity of money. The volatility in China’s equities undermines this policy “bargain” and requires a policy response.
 
Whilst China’s responses thus far were more direct (rather than working indirectly through incentives), the basic policy tools were not significantly different. As PBoC and CSRC learn and refine their policies, it is likely that over time they would come to resemble more closely what was used previously in Japan, US, UK or Eurozone. Most of China’s recent policies have already been utilized in other jurisdictions: (1) temporary bans on short selling (US, UK, Euro); (2) easing collateral requirements (US, Euro, UK, Japan); (3) opening CBs wholesale and discount windows (US, Euro, UK, JP); (4) direct funding and recapitalization of systemic institutions (US, Euro, UK, JP); (5) direct CB lending to private non-financial enterprises (US, UK, JP); (6) QE-equity (Japan); (7) easing stock buy-back rules (US); (8) pressing national pension/investment funds to buy equities (Japan). There are a number of other tools China has yet to utilize, such as (1) QE-sovereign bonds; (2) QE-mortgage securities; (3) rapid rate cuts; (4) significant easing of mark-to-market accounting (US). One China policy outcome that is different (and arguably most destructive) is stock suspensions.
 
Whilst one could argue that the impact of asset price collapse in Japan in the ’90’s or GFC were worse than anything experienced thus far in China, China’s leverage is higher (or equal to) levels prevailing in previous episodes, the global outlook is uncertain and deflation is stronger. Hence the need to respond is equally urgent and basic tools have thus far been broadly similar to what other regulators used when confronted with rapid decompression of asset prices. However, key to the success of an aggressive policy is the ability of regulators to convince the private sector that measures are temporary and aimed solely at rectifying disequilibrium.

Whilst we do not believe that normal business or capital cycles could be restored or that CBs/regulators would ever be able to withdraw, this is not a consensus view of the West where there is a strong expectation of normalization. On the other hand inability or lack of desire to create and/or restore normality appears to be investors’ consensus view of China. Structural reform is the key to breaking this negative perception. We maintain that China has no alternative but to accelerate reforms, otherwise rising debt, overcapacity and strong deflationary pressures would become overwhelming, with dire consequences for China’s and the global economy.
 
……………………..
 
Whilst one can debate specifics, the key from our perspective is that no country or region in the world (or at least not the major ones, such as the US, UK, Eurozone, China, Japan, Korea) is any longer able to deleverage.

 
Unlike previous episodes in 1950s-80s, the global leveraging process that commenced in the late 1980s (in the case of Japan in the early 1980s), has now raised global leverage levels to 3x GDP (there is now in excess of US$220 trillion of debt instruments outstanding and indeed the number could be even higher on a gross basis). The leverage in developed countries exceeds 4x GDP (with Japan being the highest at over 5x) whilst EM’s are rapidly closing at 2x (and China is ~3x GDP). In order to place this in perspective, global leverage levels in the early to mid-1990s were not much more than 1.5x GDP (i.e. leverage more than doubled over the last two decades).
 
As leverage increased, eventually, the velocity of money dropped and indeed the higher the leverage, the lower the velocity of money tends to become (for example velocity of money in Japan is currently only 0.5-0.6x whilst in the US it is just under 1.5x, though still down from the high in 2000 of 2.2x). The excessive debt in turn generates growing overcapacity (in both merchandise and service market economies, such as too many steel and cement plants, too many hedge fund managers or bartenders, etc) as future consumption was being aggressively brought forward.
 
As discussed in the past we believe that secular stagnation that currently impacts global and regional economies is caused by a unique conjunction of three powerful forces (overleveraging and overcapacity; accelerating impact of the Third Industrial Revolution; and demographic shifts) (refer to What caught my eye? v.36 - Secular stagnation & four horsemen, 6 Feb 2015).
 
Also as we have highlighted in the past (here and here), we see only four long-term outcomes:
 
1. Allow business cycle to go through and thus eliminate excess capacity (highly deflationary and anyone who has undertaken excessive borrowing would suffer);
 
2. Exceptionally aggressive monetary response (far more than what we have seen up until now), potentially leading to hyperinflation to wipe out debt. Whilst this is a very sharp and fast recalibration, it would significantly impact older people and anyone who saved and relies on fixed income;
 
3. Co-ordinated debt write downs (between sovereigns and sovereigns and private sector), accompanied by re-building of monetary system. Whilst this remains our preferred outcome, it is usually easier to do after the war rather than before the war and has significant implications for banking, investment and insurance sectors; and
 
4. Gradual elimination of capital markets, with the Governments and regulators deciding where capital should flow and at what prices. This is pretty much what China has been doing for the last decade and what increasingly other economies are leaning towards (such as nationalization of mortgage finance, student loans, infrastructure loans, SME lending, etc as well as extensive use of macro prudential controls). The reason we tend to call this a “Cuba” option is that it would ultimately lead to misallocation of resources and a collapse in ROIC and ROE (as China is discovering and Cuba discovered long time ago).
 
We have difficulty seeing any other permanent, long-term solutions.
 
However, given that neither the populace nor politicians are prepared to embark on any of the above solutions (for obvious reasons), the default condition is a gradual elimination of capital markets and creation of conducive environments for continuing leveraging.
 
Volatility, however, is the key enemy of continuing leveraging beyond certain level of pre-existing debt.
 
Given declining velocity of money and interconnected capital markets, the key danger is that a flare up in volatility in one market or asset class could easily turn up in another (and sometimes completely unrelated) asset class, with potentially devastating economic consequences, magnified by high imbedded leverage.
Hence, whilst the Fed does not target specific levels of SPX or high yield pricing, it clearly does target volatility. The same largely applies to all other CBs and regulators.

ghostzapper's picture

If you went long crude at $60ish when the geniuses told you it "was cheap" and "bottomoed out" well at least you'll enjoy gas prices when it heads to $30ish.  

Yen Cross's picture

  This article is retarded. Large portions of corporate earnings are derived from overseas sales. A stronger currency is deflationary for those profits assuming they're repatriated. If they aren't it's still deflationary, because they aren't being utilized.

  The U.S. consumer is levered to the hilt. This ponzi has just about run it's course.

Government needs you to pay taxes's picture

When will the masses lose faith in .gov?  I guess only when the bread and circuses run low. . .

dot_bust's picture

What's central banks' answer to the equation of how to hold back hyperinflation for as long as possible? The suppression of commodity prices.

It's clear that fiat currencies around the world are in trouble because many countries are overburdened with unpayable debt.

The TBTF banks are using all manner of naked shorting and derivatives to prevent commodities from being properly priced. But, eventually, the pressure will build and price discovery will take effect no matter what the banksters want.

Fahque Imuhnutjahb's picture

"Truth be told it will not work in every economy. Indeed, a per-requisite for this to unfold is an economy driven by consumers. In that sense, it does not get more consumer-centric than the US. "

This boom is predicated on the middle class having more disposable income.  Who says the corporations will pass on the lion share of these deflationary savings?; look how Starbucks passed on the savings of lower

coffee prices. Also, what is saved in commodity price drops may very well be eaten by increases in: insurance, health care & pharma., tuition costs, municipal/state/federal fees & taxes, utilities, etc.  So I'm not ready

to start cutting cartwheels just yet.  Far as I can tell the frog is still in the pot and the temp. is headed up.

RaceToTheBottom's picture

These Bots have a mind of their own.  They need to get those Bots aligned!!!

HardlyZero's picture

Commodities, metals....and IBM taking DOW down (wow).

All down or going down.

Australia economy will impact first and hardest.

Lets keep and eye out for other impacts of real deflation. 

That first chart shows it's .com history repeating.

https://www.youtube.com/watch?v=yzLT6_TQmq8

Magooo's picture

I thought that when oil prices crashed that shoudl stimulate growth - restart the engine?

Especially when there are trillions of dollars of stimulus surging through the economy.

 

But nope --- growth is headed the wrong way.

 

Royally, totally, absolutely ---- FUCKED