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Uncomfortably Revisiting Yellen's Bubble Doctrine
Submitted by Jeffrey Snider via Alhambra Investment Partners,
There is growing turmoil in buybacks that threatens the very fabric of the stock bubble. That was always the primary transmission of the foundation of its current manifestation, corporate debt, into asset prices; especially the huge run following QE3 and QE4. As represented by the S&P 500 Buyback Index, this liquidity propensity has found a durable reverse. After peaking all the way back in late February, the index is now more than 12% below that level after sustaining the August 24 liquidation.
The fact that this reversal is seven months in the making more than suggests a potential major shift. As the NYSE Composite, stocks were not long for continued momentum against the “dollar.” Buybacks seemed to have weathered the first piece of the first “dollar” wave, but as junk debt there was always conjoined a limit.
Some say expectations around the Federal Reserve have a lot to do with the buyback decline. Even though the central bank elected to keep its benchmark rate near zero Thursday, fears of higher rates are causing companies to rethink their capital return program, posits Boris Schlossberg of BK Asset Management.
“Even though rates have not gone up, we clearly are in a tightening position in terms of monetary policy, and I think they’re looking ahead and saying, ‘Do I really want to finance this thing with no-longer-cheap money that we used to have a couple months ago?'” Schlossberg said Tuesday in a ” Trading Nation ” segment.
I have little doubt that the causation effect claimed above is slightly misplaced, as “monetary tightening” isn’t the Fed so much as the eurodollar standard; that is just one mainstream method of trying to reconcile what is now seen with the financial plumbing remained misunderstood and largely hidden. As with the junk bond bubble, there is undoubtedly a correlation between re-assessing stock repurchases and the bald reductions of issuance in corporate credit. That hasn’t changed throughout this year, instead having gained further in this second “dollar” wave. Yet again, we see the “dollar” intrude in unwelcome fashion (to the bubbles).
The problem once momentum fades is that investor attention turns toward valuations that were repeatedly ignored before. As long as everything is moving upward and any fundamental downside is completely contained (in perception) as “transitory” then valuations are easily set aside as one form of rationalization. The effect of reversing momentum is for a more honest measurement; particularly by force of change in economic sentiment which is almost always concurrent.
To that end, valuations remain as they have been for the past several years. Stock prices are out of alignment with any historical trend (except the one weakly conjured by Bernanke to attempt self-justification, which instead actually furthered the score against him). Worse, some forms of valuation are subject the same kind of statistical subjectivity that has plagued main accounts like GDP and the Establishment Survey (trend-cycle).
In the Tobin’s Q measure of valuation for the stock bubble, the basis (denominator) is Nonfinancial Corporate Net Worth. Revisions in this segment of the Financial Accounts of the United States (formerly Flow of Funds) have followed the pattern of revisions in GDP; upward until the last benchmark which reduced 2012 and 2013 figures while preserving the levels for 2014 and 2015. That had the effect, on GDP, of reducing growth rates in the first period while thus increasing them in the second. Corporate net worth is somewhat derived from that economic view, and its revised results are somewhat reflective of that.
The numerator for Tobin’s Q is corporate equities (the classification now changed with this Q2 update from equity liabilities to market value of corporate equities) which somehow are continually revised downward. The net result is a vision of Tobin’s Q that is less outlier (but still historically high).
Even with these revisions and the decline in valuation intensity, the current calculated Tobin’s Q for Q2 2015 remains at the 90th percentile. The level for my modified Q ratio (which subtracts the market value of real estate from net worth, so as to not “justify” one bubble with another) remains above the 92nd percentile.
Robert Shiller’s CAPE’s current reading, also down from 2014, of 24.3 is also just about the 90th percentile but in a data series that goes back almost a century and a half. And if we exclude the obvious bubble period after 1995, 24.3 would have been in the 99th percentile for the period 1871-1995 (which shows you just how much the past two decades have skewed and screwed valuations).
That truly becomes a serious consideration where the eurodollar, the mother and proginator of all these bubbles, is no longer the assumed basis. In other words, if “investors” have been expecting “dollar” liquidity and eurodollar financial resources as a root for maintaining valuations and that turns out as a false assumption (like 2008) what becomes the true underlying value for stocks? Certainly not something close to the 90th percentile.
* * *
Without direct momentum, valuation and fundamentals begin to govern which is why, I believe, QE3 pushed the market as much as it did; it promised to provide both with a direct attachment to the corporate bubble to project that perfection. The lack of momentum in 2015 is the stock “market” waking up to the falsification of those assumptions as QE aided the debt-based flow but little else (and that spans the globe). Again, extreme valuations are trouble at any time, even when they are “justified” by economic expectations. That is the Yellen Doctrine whereby a bubble isn’t a problem when it leads to or even just leads recovery and booming growth.
That theory is, of course, as absurd as it sounds. The problem right now is that even if you buy into it, as so many did literally as well as rationalizing, the booming growth is still, at some point, necessary. That may be why the FOMC is so insistent upon “strong” no matter how much that is demonstrably assaulted. We are clearly at that point where it does not want to remain; if the growth doesn’t show up soon, then by this very count stocks are in a bubble and worse, already on the downslope. It is the raw force of the “dollar” in all forms, to rebuke Yellen by compelling sanity of asset bubbles, stripped of further financial inequality, making investors come to terms with reality rather than continued fantasy.
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Did she or did she not just have a stroke, live?
Sorry, wrong thread... oh well.
That was a stroke. Yellen will be out as chairman.
Petreus is next, I guess.
We need a Patriot willing to expand Mena for President Clinton.
Growth does not show up soon? I think it's too late to still wait for it.
According to Itau BBA:
http://is.gd/XzTkOs
The Big Fear
Thus, Fed announcement day arrived with most equity markets up 5%-10% off the late August lows, commodity prices higher and rates priced for Fed action. The main concern coming into the Fed meeting was not that the Fed would hike; it seemed quite clear that it would not go against virtually the entire global economic policymaking community and raise rates. No, the concern was that the Fed would stand pat and stocks, rather than rally, would sell off.
Lo and behold, that is exactly what happened, and that is why we need to be very, very concerned about how things move from here. It remains unclear whether the equity market reaction to the Fed decision was (hopefully) just a classic case of buy the rumor (no hike) and sell the news, or something much worse, namely that investors might be starting to price in policymakers? loss of control – The Big Fear.
The Big Fear of policymakers losing control has been lurking underneath the global equity market for years, underpinned as markets have been by central bank support. Think of it this way: there are two global growth drivers: China and the US. Recently, the competence of the policymaking community in both countries has been called into question, suggesting a possible loss of faith in policymakers, which if true is very worrisome, thus the Big Fear concept.
Why is the Big Fear so worrisome? It’s simple. If investors lose faith in policymakers and decide that cash or bonds are a better place for their money, then stocks are likely to sell off much further. How much further? One never knows, but maybe asking a few questions might help. First, at what level does the S&P need to be for the Fed to engage in QE 4? Second, what S&P level will be considered cheap (keep in mind 2016 E estimates need to come in sharply)? I don’t know the answer to either question, but it seems reasonable to expect that the S&P would need to go much lower than the 1870 level it bottomed at in late August or the 1830 level of a year ago.
The economic implications of such a sell-off would likely be a US and global recession. Such an environment could create a negative feedback loop between financial markets and the real economy, which policymakers would find very difficult to break.
It seems clear that the Fed will not raise rates this year, neither next month when they meet again nor in December, which is the last meeting of the year. Will they raise rates in 2016? From this armchair, the odds are against it, as the forces of recession gather while the forces of reflation stagnate. On this front, one has to question the Fed’s 2016 inflation forecast of 1.6%, up from 0.4% this year. The Fed’s crystal ball has been mighty cloudy for years, but this forecast takes the cake.
A look at the global economy helps explain why. Four factors stick out: excess debt, an absence of inflation, insufficient demand and excess supply of raw materials and manufactured goods. None of this is new – what is new is how the various hopes and remedies have fallen short while the problems deepen. The toxic combo of excess debt and disinflation is one powerful reason why the Fed did not move, and excess supply in commodities and manufactured items (look at the PPIs around the world) is another. The global economy needs demand-creation or production shut-ins, and to date both have been lacking.
There are small signs that the commodity complex is starting to finally adjust, with closures, dividend cuts and stock issuance in the mining sector and talks about talks in the world oil market. However, the manufacturing segment of the world economy is quite far behind the commodity segment, suggesting that China’s need to shift excess production will ensure manufactured-goods disinflation for the foreseeable future.
One can wish for inflation and for the Fed to be able to hike, but one also needs to be focused on the realities of the current global economy. Where is the demand going to come from? Who is going to shut in production? Let?s look at the three main economic regions: Asia, Europe and the Americas. Asia is likely to be a source of manufactured-goods disinflation as it seeks to rebalance itself to a China that is a competitor first, a customer second. Japan?s recovery is sputtering; it will continue QE while a fiscal stimulus package seems quite likely in the months ahead. Europe remains quite weak, and with the refugee issue now occupying policymakers, ECB-led QE seems the only game in town.
The Americas is a concern. South America is in a deep funk, whether it is Mexico?s subpar growth rate, Brazil?s political and economic travails, Andean copper dependency or the impact of weak oil on countries such as Colombia or Venezuela. All this is pretty well known.
The US is most worrisome because of its combination of still-high equity prices and a very bare policy toolbox to confront any economic weakness. How bare? Well, monetary policy is on hold, and the bar to QE4 is likely a much lower S&P. What about US fiscal policy, one might ask? Great question. Here is the only thing one needs to know about the US presidential election process: it takes fiscal policy flexibility away and locks it in the freezer until late 2017, two whole years from now. In other words, at a time when the US economic expansion is close to seven years old, with the Fed on hold, incomes flat, debt levels high, a strong dollar and absolutely no inflation, fiscal policy is locked away for the next two years at least!
By the way, the UK confronts similar issues and could possibly be a canary in the coalmine for US monetary policy – QE for the people on BOTH sides of the Atlantic perhaps? The UK?s negative rate discussion is likely to move across the pond over the next quarter or so. One other way of thinking about it is this: which comes first, the end of ECB QE or QE4 in America? I would go with the latter.
How does one vanquish the Big Fear? With aggressive policy action on the demand-and-supply side. What is the likelihood of that? Exactly. Seen in this light, it makes perfect sense for investors to worry that policymakers no longer have their back, and thus they take some money off the table. One analogy is that the US economy is like a ship that has engine trouble, is drifting towards the rocks and is left to hope that the wind shifts and takes it away from the reef…. not exactly a bull-market, high-valuation tableau. Hope is not a strategy.
Just the thought of telling one more lie, cough, cough das Yellen.
as a doctor who has seen his share of stroke patients, Wait What concludes Janet Yellen live streamed the moment she had a stroke. ah, the interwebz, never a dull moment.
The consumer is broke! End of story. Give them the money to spend will inflate assets just as when they gave it to the banks and wall street!
A 30-50% correction is do! And when it does be prepared!
The only debt you should have is your mortgage!