Chop, Chop, Choppin' In Harm's Way
By David Stockman. Posted On Wednesday, October 19th, 2016
The stock market has been chopping sideways for the last 100 days, but it's not evidence of a pause that refreshes. What is actually happening is that the smart money is getting out of dodge---even as the clueless day traders and headline-stalking algos keep the bubble inflated on purely speculative fumes.
The fact is, the stock market is priced far more irrationally at the moment than at either the dotcom bubble peak or the October 2007 pre-crisis high. Reported earnings for the September LTM are now estimated at $90.59 per share, meaning that the S&P 500 was valued at 23.6X at Tuesday's close.
But here's the thing. Reported LTM earnings way back in September 2014 came in at $106 per share at a time when the S&P 500 was at 1950. Thus, earnings are down by nearly 15%, while the S&P 500 index has gained 10%.
Needless to say, that's multiple expansion with a vengeance----since back at the September 2014 peak the PE multiples stood at just 18.4X. As a matter of reality, the latter wasn't all that plausible, either. But more than 5 points of multiple expansion in today's tenuous global economic and financial environment is just plain nuts.
The robo-machines and gamblers left in the casino, therefore, are truly chopping away in harm's way. The only possible outcome is to be carried down in a crash far more severe and violent than the previous two meltdowns since the turn of the century.
Yet they dither on the edge of the gathering storm owing to a wholly misplaced confidence in the Fed and other central banks. In fact, our monetary politburo is utterly clueless about the rampant speculation it has encouraged throughout the warp and woof of the entire financial system.
So when the black swan arrives once again, the Fed will be caught even more flat-footed than in September 2008, and with virtually no dry powder to smoother the blaze as Bernanke did last time around.
That our monetary central planners are leading the casino into catastrophe was made evident again earlier this week in the blather delivered by vice-chairman Stanley Fischer to the New York Economic Club:
And the third concern is that low interest rates may also threaten financial stability as some investors reach for yield and compressed net interest margins make it harder for some financial institutions to build up capital buffers. I should say that while this is a reason for concern and bears continual monitoring, the evidence so far does not suggest a heightened threat of financial instability in the post-financial-crisis United States stemming from ultralow interest rates.Exactly what planet does this man live on? The entire financial system has been falsified by the massive and continuous intrusion of the central banks. These artificially inflated bond and stock prices have, in turn, triggered a manic process of collateralization in which inflated financial assets are hocked to obtain more financing, which then begets even higher bids from the proceeds and then even more rounds of rinse and repeat.
In short, the end product of massive interest rate repression by central bankers is always and everywhere the same. That is, an explosion of debt fueled speculation, destruction of market stabilizing forces like short-sellers and expensive hedging insurance and one-way markets that inflate to lunatic heights before they inexorably rollover, crash and burn.
Indeed, the silver lining in the coming traumatic implosion of the global financial bubble is that the academic snobs like Fischer will be unmasked as the Keynesian knuckleheads that they actually are.
Last time our monetary central bankers escaped blame because they fooled the world into believing that they had saved the system from Great Depression 2.0 by doubling down on what had already been reckless monetary expansion. But this time they won't be able to generate a phony financial asset reflation to cover their tracks after the coming crash.
Instead, like Stanley Fischer at the New York Economics Club, they will be all over the record insisting that the financial system was fixed and there was nary a bubble or instability risk in sight.
Actually, you don't have to get many paragraphs into the text of Fischer recent speech to realize that he really is an academic knucklehead. Thus, the whole speech, which is a pretentious rumination about the cause of very low interest rates, begins with this assertion:
To explain why interest rates are low, we look for factors that are boosting saving, depressing investment, or both.He then goes on to finger low productivity, aging demographics, weak investment and slowing foreign economic growth. But that's not just specious nonsense-----it self-evidently ignores the monetary elephant crowding the entire room.
To wit, the Big Fat Bid of the central banks is what has caused interest rates to be so low for so long. As we showed in the Chart of the Day recently, the balance sheet of the top 10 central banks has soared fr0m $6 trillion in 2006 to more than $21 trillion at present. Compared to just $2 trillion less than two decades ago, the combined footings of the world's central banks have experienced an incredible 11X expansion.
Apparently, no one has explained to the good professor that despite their best efforts, central bankers have not yet abolished the law of supply and demand. It is they, and they alone, who have crushed the yields on sovereign debt by buying it and its near substitutes hand-over fist; and not with savings from current production, but with printing press credits conjured from thin air.
This rampant sequestering of sovereign debt and its official cousins in the vaults of central banks to the tune of more than $20 trillion, in turn, has caused sheer desperation among the bond and investment fund managers of the world, thereby driving prices on even risky sub-investment grade securities skywards and taking their yields to rock bottom levels.
As merely one example of the financial instability caused by the systemic price falsification, consider the $300 billion plus of junk bonds issued by companies in the shale patch. Upwards of $100 billion of actual and mark-to-market loses have already been incurred by holders of those high yield bonds; and the big losses from another leg down in the global oil price which will be triggered by the next recession have not even happened yet.
So there are financial bubbles in plain sight everywhere. The busted shale bonds, the lunatic valuations of momentum stocks like the FANGs (Facebook, Amazon, Netflix and Google), white hot commercial real estate markets in Silicon Valley and New York, rampant frauds like Tesla and Valeant and vastly excessive PEs in the broader stock markets are just a few examples.
Yet ignoring all of these consequences of central bank interest rate repression, professor Fischer instructed his audience to dust off their economics 101 textbooks and look elsewhere for the cause of ultralow interest rates.
For those of you lucky enough to remember the economics you learned many years ago, we are looking at a point that is on the IS curve--the investment-equals-saving curve. And because we are considering the long-run equilibrium interest rate, we are looking at the interest rate that equilibrates investment and saving when the economy is at full employment...As I said, the man is an outright knucklehead, yet he is supposedly the intellectual leader not only of the Fed, but Keynesian central bankers on a worldwide basis. After all, he even supervised Ben Bernanke's PhD dissertation at MIT during the 1970s.
In any event, are we to actually believe that the $21 trillion of fiat credit that has now been manufactured by the world's central banks does not impact the price of debt and therefore the vaunted IS curve?
Yep. According to professor Fischer the cause of low interest rates is not monetary falsification----which, by the way, is exactly what they say they are doing to stimulate more borrowing and spending---but too much savings and too little opportunity for profitable investment.
That's complete rubbish, of course, oozing out of an intellectual time warp. Before the era of massive central bank bond purchases there surely was an interest rate on the I/S curve that reflected the balance between true savings out of current income and demand for debt and other investment funding. But that world is long gone owing to the full throttle monetary central planning that Fischer himself is engaged in.
But never mind. Fischer claimed that the real culprit behind low interest rates is the sharp deceleration of productivity growth from more than 2% annually prior to the turn of the century to just o.5% in the last five years. That has resulted in lower trend economic growth owing to the obvious fact that by definition real output growth comes from more labor hours and/or higher productivity.
By Fischer's lights, however, this non-explanatory truism has far more ominous implications. To wit, it means that the invisible, arbitrary and made-up economic realm called "potential GDP" has experienced a sharp slowdown from a purported historical norm of about 3.0% to exactly 1.75% annually.
In turn, this unmeasurable and unproveable slowdown in the theoretical full employment economy, according to the Fed's FRB/US model, as cited by Fischer:
".....would trim 120 basis points from the longer-run equilibrium federal funds rate".Say what?
Well, reduced "potential GDP" growth is supposed to adversely affect the balance between savings and weakened investment demand, thereby lowering the equilibrium interest rate. But here's another idea. Lower income growth means lower aggregate savings at any given savings rate. So there would be no impact at all from lower economic growth on the market clearing interest rate unless the savings rate changes.
But on that very point is where Fischer really veers off into economic crazy town. A reduced rate of theoretical GDP growth purportedly causes consumers to "save" too much:
Lower productivity growth also reduces the future income prospects of households, lowering their consumption spending today and boosting their demand for savings. Thus, slower productivity growth implies both lower investment and higher savings, both of which tend to push down interest rates.That's right! More than half of US households have saved less than $1,000 and most of them are so busy keeping up with the Kardashians that they don't even think about saving for the long haul. Yet the vice-suzerain of out monetary system claims they are actually discounting their income streams into the distant future, and upping their lifetime savings rates accordingly!
Anyone who stays in the casino based on confidence in the likes of Stanley Fischer deserves to have their head handed to them on a platter.
Besides that, Fischer's ruminations about people upping their savings rate is not remotely true empirically. Interest rates have been pushed steadily lower for decades by the Fed and other central banks, but the household savings rate in the US has steadily fallen, not risen as Fischer claims.
Indeed, Japan is the test bed for Fischer's theorizing about high savings causing low interest rates. The BOJ has had the money market rate on the zero bound for the entirety of this century so far, and is on the verge of pushing all of Japan monumental government debt into subzero land. Yet Japan's once vaunted household savings rate has now disappeared entirely.
Indeed, even a knucklehead could see that a surplus of savings is not why the Japanese economy is stumbling toward national bankruptcy on the zero bound.
But that's not the extent of the rubbish emanating from the Eccles Building. The monetary central planners domiciled there are so ensnared in group think that they actually claim to scientifically ascertain the otherwise invisible "natural rate of interest" which is compatible with full employment in the current macroeconomic setting.
And since that benchmark is asserted to be exceedingly low owing to the type of spurious reasoning contained in Fischer's speech, they conclude they have no choice except to keep interest rates pinned close to the zero bound.
For example, Fischer claims that the aging of the labor force alone causes the real rate of interest to be 75 basis points lower than in the 1980s.
Really? The massive retirement wave of baby boomers is liquidating its savings and will be doing so at an accelerating rate as the retirement wave crests a decade from now. All other things being equal, therefore, US demographic trends would tend to raise interest rates in an honest financial market. That is, one cleared by the law of supply and demand rather than the whim of Stanley Fischer and his coterie of monetary central planners.
And the nonsense just kept coming in Fischer's speech. He claimed, for example, that another 60 basis points may be attributable to under-investment.
Here's an alternative idea. During the last 10 years US businesses have borrowed like there is no tomorrow, but they channeled the overwhelming share of proceeds into financial engineering, not productive investment. In fact, more than $10 trillion was spent on stock buybacks, M&A deals and leveraged buyouts and recaps during that period.
Needless to say, this massive channeling of capital into the casino would not have happened on the free market. It is the direct result of the Bubble Finance policies of the nation's central bank.
At the same time, the resulting drastic inflation of financial asset values was not harmless, and not just because it showered stupendous amounts of unearned riches on speculators and the elites who own most of the financial assets.
Bubble Finance also turned the C-suites of corporate American into stock trading rooms and financial engineering parlors. In pursuits of unspeakably large stock option gains, like the $100 million plus recently pocketed by John Stumpf, the balance sheets of companies have been strip-mined and investments in long-range growth and competitive enhancement have been starved.
The numbers speak the truth. After inflation and current consumption of fixed assets (i.e. depreciation and amortization), the rate of real net investment in productive business assets is today 22% lower than it was in the year 2000.
There is no mystery, therefore, as to why productivity has vanished. Stanley Fischer and his posse of money printers have been the culprits all along.
Indeed, the above chart puts you in mind of the young boy who killed both of his parents and then threw himself upon the mercy of the court on the grounds that he was an orphan!
At the end of the day, the financial markets have morphed into dangerous, unstable casinos owing to the kind of Keynesian central banking now practiced by Fischer and the Fed. Among the many resulting ills is the fact that the link between financial asset prices and the real main street economy has been totally severed.
This weeks "incoming" data provided yet another piece of evidence. Industrial production posted lower on a Y/Y basis for the 13th straight quarter, and now stands 2.3% below its November 2014 peak.
More importantly, it is also below the pre-crisis peak and at a level first crossed nearly 10 years ago.
That's right. The S&P 500 is up by 55% from early 2007, yet US industrial production----which represents nearly two-thirds of GDP----is stuck on the flat-line, even as the US economy slides toward the next recession.
As we said, the corporals' guard of day traders and robo-machines left in the casino are indeed chop, chop, choppin' in harm's way. But their troubles will soon be over.