Global growth is at its weakest since 2009 according to the International Monetary Fund (IMF). Large cap U.S. indices have stagnated for 18 months. The underlying breadth of the markets still looks even weaker than those indices, with small cap stocks trading particularly softly. Economic data has been weak and earnings estimates have come down.
Many pundits act as if surely this is quite a bullish environment. It may well be bullish, but it sure looks exactly like what we witnessed at the 2000 and 2007 market tops, including the refusal by commentators and the media to give much credence to less than rosy forecasts. We keep our eyes squarely on the corporate bond market because it will decide the future direction of markets more broadly. It provided the firepower for speculation and is looking a little shakier than it did in recent years.
The deciders are basing all policies on stock market gyrations. Grammar school children exhibit higher level thinking than those in charge. The main indices move with the tweets and headlines, but most stocks lack a robust trend. The European Central Bank (ECB) at least admits it has returned to money printing. The Fed is hiding behind the sort of semantics that might make a politician blush.
The talking heads, as usual, point to high consumer confidence and low unemployment (boosted by an unmentioned low labor force participation rate) as proof positive that the bull market has legs. However, when both of those measures are near these historically strong levels, the cycle is usually close to a peak. Is this time different? Besides, employment is a lagging indicator and job growth has already slowed significantly. Increased borrowing has sustained consumer spending, but retail sales still fell 0.3% in September.
Recession fears are becoming more pronounced. Manufacturing surveys and flat yield curves with rallying bonds all point to a pronounced slowdown. To make matters worse, inventories have risen to problematic levels relative to sales at 1.4 times. Throw in another of our favorite real-time indicators, collapsing weekly rail volumes, and we can see why investors are starting to worry.
Housing prices are softening in once hot markets and private equity players are cutting valuations meaningfully. WeWork, which was poised to come public at a $50 billion market value, is now being restructured, likely wiping out much of that paper value practically overnight.
Most of our paltry 1-2% economic growth now comes from government spending. The Treasury is issuing huge amounts of debt to finance the splurge as the deficit approaches $1 trillion. It all has to go somewhere and it’s clogging the system. To help matters, the Fed has decided it will expand its balance sheet anew to provide liquidity to banks that should be able to fund themselves, but apparently can’t. As a result, the Fed has gotten back in the QE game, but it doesn’t want anyone to call it that. Too honest.
The Fed will be buying $60 billion of T-bills per month (apparently just for fun) without acknowledging that the short-term securities lending market would shut down if the Fed did not intervene in a meaningful way. Telling the banks to shrink their balance sheets and reduce risk is too logical. Warning Congress that government spending is out of hand would reveal the unpleasant reality that private sector GDP growth has stalled.
Trump appears to be caving to China on trade because he faces pressures from a weakening economy and impeachment threats. He knows stocks will crack without a “deal.” He might be starting to think that any deal will do. While China deserves reproach for its unethical business tactics, the tariffs are angering people in the U.S. who are footing the bill. Team Trump is getting nothing from the Chinese but vague promises to buy the food products they need anyway in return for U.S. silence on their shameful treatment of the protesters in Hong Kong.
It would be stupid for China to agree to anything meaningful at this point given the presidential election next year. All the grand talk of “Phase 1” success and other such nonsense simply means that little real progress has been made so far. China is simply running out the clock. If China agrees to nothing in coming months, it could sink Trump’s re-election chances and maybe face someone more amenable in the future.
Due to more than just trade tensions, those running businesses have gotten as gloomy as they did at past major cyclical turning points. We doubt they have been reading our letters, but they now see what we have discussed for quite a while: declining profit margins and a fading cycle. Corporate bond investors notice these red flags even if stock players often wait until they are more obvious.
Most of the Wall Street strategists and analysts were bullish at those prior instances of budding CEO gloom and shrinking margins, and made no mention that stocks typically give back large portions of the cycle’s gain as it completes. This time, their bets are squarely on the Fed. The 2000 stock mania was euphoria over the internet revolution. In 2007, it was the notion that housing prices could never go down. We were the “tin foil hat” guys then until our positioning proved timely. Those that were less than enthusiastic were considered foolish until that bubble burst.
We don’t use the term bubble lightly. We just don’t know how else one can describe environments like the current one where valuations are completely divorced from the underlying reality. Investors are willing to abandon past guideposts because with the central bankers having lost their collective mind, it’s tough to stay disciplined. We get that, but over time valuation prevails.
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.