We are entering 2018 with the major central banks moving away from the emergency monetary measures of the last ten years in varying degrees if you include the Bank of Japan’s hints at a possible policy shift. The Fed is still the clear leader in the tightening process by both raising rates (as it did again yesterday) and slowly shrinking its balance sheet. China may even proceed at a more tempered pace. Strangely, equity markets are viewing these synchronized initiatives as a nonevent for now with all eyes on possible tax cuts.
We remain skeptical that the Frankensteinian global financial system can continue to handle reduced central banker coddling. About $15 trillion of securities has been accumulated on central bank balance sheets over the last ten years to keep the hopes and dreams of the Establishment alive by fostering one more grand debt binge to “cure” the last one. Brand us fools for thinking a low risk tolerance is in order as liquidity is drained from this highly experimental system in the face of record valuations with little fundamental support and overestimated bid-side liquidity.
We are in the midst of the greatest financial bubble of all time across numerous asset classes including stocks. There’s simply no other way to put it. We define a bubble in equities as a period when they become broadly disconnected from the underlying stream of cash flows that support their values to a degree that pushes earnings yields to levels that are not justified by the risks being borne. We are there. Real estate in numerous countries and other assets like European sovereign debt are also quite bubbly. We could go on.
Most central bankers are as overly confident as many investors that global growth can withstand less monetary accommodation. Both camps don’t realize how much they have China to thank for this year’s uptick in economic activity. With oil prices up this year, the renewed vigor in the energy sector is another big driver of growth, but those easy year-over-year comparisons for oil production have now passed. In the U.S., rebuilding after the hurricanes has also helped create a burst of spending that will begin to ebb soon.
Of course, the carnage in brick-and-mortar retail stands out as the year’s most obvious trouble spot in the real economy. The savings rate is hitting cycle lows as consumers stretch budgets and borrow like mad to keep pace, so it’s not just an online competition story accounting for the weakness at restaurants, malls, and shopping centers. Households are stretched because incomes are not growing for most wage earners. Automakers have kept incentives at high levels to keep production near current rates, but they can’t sustain output beyond replacement demand forever.
GDP has been coming in a bit stronger in recent quarters, but contrary to the common narrative, the pace of hiring has slowed again this year as it has in each of the last three. Average monthly job gains of 175K are down about 75K or 30% from the recent peak in 2014. Wage growth is also decelerating. How many market commentators would get those employment trends right if asked?
There is a movement afoot globally to lean more on fiscal stimulus as the central banks back away. The pols know that future elections depend upon them keeping the bubble afloat. The proposed tax cuts in the U.S. are largely a gift to K Street and corporations with much more limited benefits to most consumers. If you really want to immediately help those outside the top 10-20% of earners, cut the payroll tax for goodness sakes. That is avoided because it would open the Pandora’s box of the insolvent entitlement programs those taxes fund.
A near term “sugar high” from the passage of current proposals is certainly possible, but numerous industries, like housing, may be hurt by some of the provisions. The S&P 500 may get a 5-10% earnings boost based on reasonable estimates we have seen, but we don’t see that as a gamechanger.
The views expressed on this blog are the opinions of the authors. This information is not intended as investment advice or to recommend the purchase or sale of securities. More information on Strategic Balance, LLC may be obtained by contacting investor relations.