A Number of US Monetary Signals Are Flashing Red… Does it Matter?

By Gordon Johnson of Vertical Group

Is the US Economy as Strong as Equity Markets Suggest?

US equity markets have been on fire & some economic indicators point to more optimism yet ahead (i.e., PMI readings, durable goods orders, nominal wholesales, factory orders, & retail sales all suggest strong growth [Ex. 1-5]).

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However, these are largely coincident or lagging indicators, as well as surveys influenced by mkt sentiment.  Meanwhile, when analyzing forward-looking monetary indicators, we note:

(1) US public debt rose to 105% of GDP (vs. just 31% of GDP when Reagan cut taxes), vs. 62% in 3Q07, & with fewer tax receipts + higher spending likely in the coming yrs. some pundits est. this ratio rising to ~125% by ’30,

Exhibit 6: US Public Debt to GDP

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(2) as a result of (1), the relationship between GDP & debt has recently ventured into neg. territory (the correl. since 4Q09 is -68.2%, vs. +5.6% 3Q74-4Q08 & +38.2% 4Q66-2Q74)

Y/Y Growth in U.S. Real GDP versus Growth in Public Debt

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(3) the reality that sharply rising debt levels, historically, lead to an asymmetric effect from incremental monetary policy (i.e., a lot of loosening is needed to spur even a muted impact on growth, whereas the slightest monetary tightening can disproportionately depress activity), which...

(4) implies tax cuts or infrastructure spending – likely to be financed with debt – would ultimately be a drag on growth – 2009’s $1 trillion dollar US debt- funded stimulus was supposed to boost inflation/growth, but instead led to lackluster GDP & a lower inflation rate.

(5) a recently dramatic flattening in the yield curve, which will likely erode banks’ profitability (banks make money by borrowing short & lending long)

Slope of Key Maturities on US Treasury Yield Curve

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(6) C&I loans, a leading indicator of growth, are growing near the slowest rate since the financial crisis – YTD (thru 12/20), net new C&I loans were down 82% y/y

Net New US Bank Commercial & Industrial Loans & Leases YTD, SA

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(7) M2 growth has decelerated to just below 4.5% over the past 12 months, vs. +7% in 2016  – & the velocity of money at 1.43% this year is the lowest since 1949 (a decline in velocity > M2 = lower real GDP).

Y/Y Growth in U.S. M2 Money Supply

 

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U.S. Velocity of M2 Currency

 

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We, thus, question: Is the US economy as strong as the equity markets & financial headlines suggest, or are investors willfully ignoring leading monetary indicators?