Author: Scott Brown, CFA, Founding Partner
Quantitative Tightening (QT) by the Fed is impacting the economy and markets in a negative way. Economic growth is becoming more obviously sluggish as money growth slows. Even those soft data surveys like the PMI’s are returning to earth and becoming more in line with hard data and the flat yield curve. Growth outside the U.S. is also looking less robust.
Does anyone besides us think growth prospects can’t be too great when the yield curve is in danger of inverting with fed funds still below 2%? The QT narrative is being kept quiet as everyone focuses on everything else that can be spun as a positive or a risk to be overcome. The U.S. is still stuck near 2% GDP growth despite those tax cuts that mostly padded the pockets of corporations. Many taxpayers are perplexed by their lack of benefit given all the hype around this legislation.
Just as the Fed and Wall Street coaxed every last investor into an index fund or ETF by enabling banks to pay you 0% on your savings, they would rather you not notice that the monetary tide is now receding. There is a downside to 10 years of extremely reckless monetary policy. Problems were hidden, not fixed, and big new ones were created.
When the central bankers printed fiat currencies like lunatics, the pundits gleefully shouted it from rooftops and sang praises. We guess the policy reversal and its aftermath are not fit discussion for children that might be near the TV. “Excuse me folks, we are going to be talking about Quantitative Tightening in the next segment, so you might want to usher the kiddies to the playroom.”
Attempts are being made to blame Trump’s trade policy initiatives or past transgressions for any market tumult, but everything outside of monetary policy tightening is a sideshow. The Fed would like you to think otherwise.
We do applaud efforts to correct years of Chinese trade abuse, but the situation is more complicated than the administration conveys because there are benefits as well as costs to weigh in considering tariffs. We can’t expect to only improve employment and wages in the U.S. on the export side without also facing higher costs of goods imported from China.
Reasonable views are often openly derided late in bull markets. Mention that valuations are quite stretched and prepare to be chastised as if shouting obscenities in the front row of a church. Actual data be damned! Anyone less than fully invested is considered a fool, though cycles typically give back a major portion of the total gains. The last two sure did. Wall Street is mum on that and encourages us to forget the past. It has always been that way.
Never has the gap between perceptions and reality grown so wide. The Fed/government propaganda machine has combined with Wall Street’s usual sunny spin to distort reality to a degree that Ken Kesey might celebrate. They must work together to make us think the good old days will be resurrected any second now or folks with pitchforks might knock on their doors.
Having pushed growth expectations to cycle highs coming into this year in a bout of tax cut euphoria, investors backed themselves into a corner, much like the Fed. They share the same problem. It will require a giant about-face for the Fed to back away from tightening plans and admit growth is disappointing for the umpteenth time. Many investors who went all-in on a miraculous growth surge will have to reduce risk positions as reality intervenes.
Hurricane repair spending swayed a lot of investors into thinking an inflection point had finally been reached. At the same time, consumers decided to go deeper into hock late last year just to pay for food, housing, healthcare, and energy. Houses became ATM’s again in a refi wave. Credit card usage surged as the savings rate plunged. Those are not signs of strength. Lenders do appear to now realize this is a budding problem as credit does seem to be becoming a bit more restrictive.
We think many investors do not fully understand that with so much debt having been created in recent years, it will not take much of an increase in rates for distress and defaults to rise dramatically and for corporate earnings to come under pressure. Interest expense is going up dramatically for trillions of dollars of loans benched off of Libor.
Encouraging enormous leverage to continue to build in the financial system and calling that a recovery was never going to allow much room for policy normalization given how gargantuan the scheme has become. $15 trillion of QE globally over ten years was experimental and unprecedented. It encouraged enormous borrowing to the tune of $70 trillion or 45% growth since 2007. That debt must be serviced in future years. It is just future spending brought forward to maintain the status quo. To top it off, each new dollar of debt produces much less growth than it did in the past. That explains why GDP has been constrained though debt has skyrocketed.
The IMF and some on Wall Street have finally joined us and begun to sound the alarm about how unsustainable the situation has become. With this debt overhang, we think it’s likely that the financial system has been permanently impaired. Regardless, massive debts will remain an impediment to growth unless the bureaucrats allow assets to find their natural clearing levels by staying out of the way. That involves shared sacrifice as a society. The deciders will never let that happen without a fight, of course, but it is likely beyond their control.
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.