There’s Only One Buyer -The Fed

Sooner or later (my bet is sooner) investors and speculators will realize that the Fed is currently the only major buyer for US stocks and bonds - at least indirectly, if not directly since the US central bank is prohibited from buying shares (other central banks aren’t, e.g. the Swiss National Bank has a portfolio valued at over $95 billion in stocks).

What do I mean by indirectly? Simple: the Fed has flooded the system with $3 trillion, ballooning its balance sheet from $4.2 to $7.2 trillion in mere weeks.  By comparison, it took 20 years for the Fed’s assets to rise from $1 trillion to $4 trillion (Chart 1). To be clear, that’s  fresh dollars circulating in the system.

Chart 1

(Note: There is a parallel observation to be made on Chart 1;  after dealing with the Credit Crisis in 2008-10 by doubling assets to $2 trillion, the Fed kept printing money and reached to $4.5 trillion.  It’s no wonder stock prices, bonds, real estate, etc. kept rising and rising.)

So, asset prices are being boosted by the Fed’s printing presses for a long time now.  The latest injection is, therefore, not unusual - it’s just spectacularly enormous.and furiously fast.  I think, dear reader, you understand why I say that the Fed is, essentially, the only buyer.

What would happen if the printing presses stopped, or if they started running in reverse? How long would it take for trigger-happy speculators to realize there’s no one else left to buy their overbloated portfolios?  To quote one of my (very) old posts, how long before people realize they own trading sardines rather than eating sardines? (RIP Sandra K. 😢).

It’s very early days to conclude that the Fed is reversing course, but the last few weeks have seen its balance sheet shrink, if only modestly (Chart 2).

More to follow as data become available on this, the Moral Hazard to end all moral hazards..

Chart 2

Smart Money Moves - Warren Buffett

Berkshire Energy announced a $9.7 billion deal to acquire the natural gas pipeline and storage facility business of Dominion.  It is being interpreted  as a vote of confidence for the economy by Warren Buffett.  Nothing could be further from the truth.

First of all, the deal involves $4 billion in cash and the assumption of $5.7 billion in debt.  That’s a tiny investment for Berkshire Hathaway which had accumulated $137 billion in cash at the end of 1Q20 (the deal “consumes” just 2.9% of the cash hoard).

Secondly, the gas pipeline business is a highly regulated utility that produces stable annual returns, a very good alternative to, say, government bonds.

So, if anything, this is a vote of NON confidence by Mr. Buffett.  It’s not as if he’s buying anything related to a V recovery, consumer spending, etc. represented by the “bargains” in the travel and leisure or retail sectors.

The sage is being as conservative as possible.

Employment Data - Not All Job Gains Are Created Equal

According to the Bureau of Labor Statistics (BLS) the US added a total of 7.5 million jobs in May and June, after suffering a massive wave of 32 million layoffs in March and April due to COVID (Chart 1).  Mr. Trump gave himself laurels and markets (the only thing that apparently matters in this Brave New World)  cheered loudly.

Chart 1

But let’s look beyond the headline numbers.

In March and April 2020 the economy lost 32 million jobs;  8.5 million of them where in the Leisure and Hospitality sector, accounting for 27% of all job losses.  This same sector added back 3.5 million jobs in May - June (Charts 2 and 3) accounting for an oversize 47% of all jobs gained.

=> Keep this in mind: Leisure and Hospitality was 27% of all jobs lost, but 47% of all jobs gained back.

Chart 2

Chart 3

Why is this important? Because those are part-time, very low paying jobs: On average, such employees work only 25.5 hours per week and make $17/hr. (Table 1).   In fact, Leisure and Hospitality employees work the fewest hours and get paid the least wages of ALL employees. By comparison, the national averages for all private employees are 34.4 hours/week and $28/hr.

Table 1

Let’s do a bit of math: in March - April the private sector lost 32 million jobs worth:

 23.5 million jobs x 9 weeks x 34.4 hrs x $28 = $204 billion in non L&H jobs
Plus
8.5 million jobs x 9 weeks x 25.5 hrs x $17 = $33 billion in L&H jobs
for a total of $237 billion.

In May-June the economy gained 7.5 million jobs worth:

4.0 million jobs x 9 weeks x 34.4 hrs x $28 = $35 billion in non L&H jobs
Plus
3.5 million jobs x 9 weeks x 25.5 hrs x $17 = $14 billion in L&H jobs
for a total of $49 billion.

That’s a very long way from repairing the damage done to the real economy, no matter what Mr. Trump or stock indexes say.

(Looking at it another way, each job lost was worth $7.400, but each job gained only $6.500 - the economy is adding back mostly low value-added, low-paying jobs.)

Consumer Spending Will Make Or Break The Economy

Personal consumption makes up the vast majority of GDP in the United States, currently around 68-69% (see Chart 1).

Chart 1

So, what people choose to do with their disposable income (i.e. after taxes and deductions) is crucial for the economy: they can spend it, or save it.  This behavioral pattern, called Marginal Propensity to Spend, can be easily deduced by the difference between Disposable Income and Personal Consumption Expenditure, in dollar terms (see Chart 2).

Chart 2

Right before the COVID crisis Americans as a whole spent on average almost 90% of their disposable income (caveat: lower income families routinely spend 100% or more of their income, i.e. they go into debt, while richer ones save and invest more).  The gap between disposable income and consumer spending was running around $2 trillion per year, or just about 10% of GDP, and jumped to almost $7 trillion, a historically unprecedented 35% of GDP (all the figures are annualized) as the Trump administration sent everyone those $1.200 checks which people on lockdown had nowhere to spend (again, not the poorer folks).

The gap has now narrowed to a still enormous approx.  $5 trillion since there are no more handout checks and the US is slowly emerging from the lockdown with consumption boosted by pent up demand.

In my opinion, this is the single most important indicator of the economy’s current condition.  I will be watching closely, but I think that the Marginal Propensity to Spend will remain muted for quite some time and cause the economy to drag, instead of bounce.

Proximity Blindness

Seven States that are currently experiencing the sharpest rises in new daily COVID cases account for  35.5% of total US GDP:  CA, TX, FL, GA, AZ, LA and SC. Of those, just the first three produce a massive 28.5%.

By comparison,  three of the states which have managed to successfully deal with COVID (so far) are NY, NJ,  CT and produce a combined total of just 13% of GDP.

Yet, that’s where the vast majority of investment bankers, traders, hedge fund managers and  speculators live and work.  IMHO, they cannot but fall prey to a very human proximity blindness, particularly after suffering greatly from the virus.

May partly explain the phenomenal rebound rally.

Reading The Tea Leaves

Charting is an arcane art form 👽 at best and total mumbo  jumbo 👹 at worst.  Yet, it has its uses.  With no further ado, a long term chart of S&P 500 with some annotations.  I won’t add any comment, if you are a practitioner of the “dark arts” you will understand 😆

Something Is Gonna Give

One picture only: NASDAQ and daily new COVID cases in the US are both making new highs.

Something is seriously out of whack here...

The Five R’s - Deflation Warning

If nothing else, the coronavirus crisis has accelerated my conviction that our Permagrowth (tm) model is busted.  What’s Permagrowth?  Ever increasing consumer spending in the West on goods made cheaply in the East, all made possible by ever increasing debt. Some call it Globalization, but all it took was one microscopic virus to effectively kill it in a matter of days around the globe.

What is the cure currently used to revive it? More debt, of course, in the form of government bonds purchased (or financed) by central banks, almost exclusively.  The situation is so dire that the most extreme measures are being used.  For example, the ECB pays banks 0.5% to go out and buy government bonds that yield anywhere from 0% to 1.50%.  Yes, that’s right, the ECB lends at negative interest rates, confounding anyone who espouses “neither a lender nor a borrower be.”  In one transaction alone, the ECB is effectively both lender and borrower!! Double the sin, double the fun!!

Now, follow the trade: a bank can go to the ECB, borrow 10 billion euro and receive 50 million annually. It then turns around and buys 10 billion worth of, say, Greek government bonds and receives another 150 million, for a total of 200 million per year.  This is literally free money, produced entirely out of thin air.  No savings needed, no assets, no reserves.. nothing!

Obviously (to me alone??) this is a complete perversion of a proper financial system and a VERY loud alarm bell.  Wake up, folks:  “ Whatever it takes” are NOT soothing words, it’s a cry of desperation.

Anyway, back to the demise of Permagrowth.  I believe we are now seeing its last hurrah, soon to be replaced with something else.  What will that be?  Hopefully, the Five R’s practiced by 8 billion consumers in the following order:

1. Reject - don’t buy the new “phone” (shoe, watch, app, trinket)
2. Reduce - one “phone” is enough
3. Repair - fix the “phone” when it’s damaged, instead of replacing it
4. Reuse - give the old “phone” to your daughter
5. Recycle - finally, recycle it

The Five R Economy

The US, EU, China and Japan have a combined GDP of $60 trillion, a whopping 75% of global GDP even though they account for only 30% of global population.  Consumption makes up almost 70% of GDP in the US, 60% in the EU and Japan -  and (just) 43% in China, which exports lots of what the other three consume, taking their IOUs as payment.

Now, when and if Permagrowth is replaced by the 5R’s the effects will be enormous - assuming, of course, that the change will be accomplished peacefully (not a foregone conclusion).  For one, deflation will be prevalent, resulting in sharply lower equity and corporate debt valuations.  Energy sources will not need to be as “dense” as today (oil, natural gas, coal) and could more easily shift to renewables.  The US dollar - petroleum relationship will come apart, leaving the dollar to fend for itself and the US government to seek a much more rational fiscal and monetary policy.

And that’s just for starters... it could get really nasty OR really spectacular out there.  Hopefully, we will all realize our full potential as human beings and choose the latter.

Elections

The Economist has come up with a US Presidential election prediction model which is updated daily. Right now it gives Mr. Biden an 87% chance of winning the electoral college votes.

In my opinion, this projection is completely ignored by the stock market which is focusing (hoping) on a rapid exit from COVID lockdowns, a possible vaccine, etc.  However, I believe that the fiscal policy of the next President is more important than anything else.

According to the Congressional Budget Office the budget deficit will reach $4 trillion this year, some 20% of GDP, or even higher if a second round of  business closures is necessary later on.  Combined with record low corporate tax rates, there is every reason to expect that a Democratic President will seek to repair finances by raising taxes on businesses, particularly those that benefited greatly during the COVID pandemic.

As things stand right now, the risk-reward balance for stocks, particularly the FANG++ types, is heavily skewed towards risk, IMHO. 

Jobless Claims

Initial and continued claims for unemployment benefits is, by far, the best concurrent indicator for the economy’s health.  Both are extremely high and seem to have stabilized at around 10 times higher than their previous levels (see charts below).

Initial Claims For Unemployment Benefits

Continued Claims For Unemployment Benefits

What does this mean?  That even after opening up after the lockdowns, businesses are still laying off a huge number of people and most of them are very weary of rehiring.  In other words, the economy is most certainly NOT currently in a V-shaped recovery.  For comparison, the highest level previously reached for continued claims was 6.8 million during the 2008-09 Debt Crisis, when the most that real GDP dropped was around 3.5%. If claims remain elevated, by this measure alone we’re looking for at least a 10% contraction going forward during 2020/21.

Now, the stock market has already bounced back in V fashion, apparently discounting a faster than ever economic rebound.  Or... is something else happening?  I will use just a single chart to illustrate: Shopify has zoomed almost 300% in just a few days during the pandemic.

Shopify Inc.

The company is currently capitalized at $101 billion, i.e. around 60x REVENUE.  Forget P/E, there are no Es, the company is losing money.

So, what gives?? My thesis is that a few million millennials got a few thousand dollars into their hands and decided to punt with it. What companies do they know and use, which “new ideas” and “new paradigms” do they think they understand better than everyone else, Warren Buffett included?  Why, everything Internet, of course... and wouldn’t you know it, similar chart patterns and nosebleed ratios can be seen across the entire “tech” sector, from Facebook and Amazon all the way to Spotify and Google.  Throw in a religious belief in the Fed as Saviour Of All and you get an enormous bubble..

But, what the millennials clearly do not understand is that the “real” economy is about earned income  (wages) and spending, and more specifically, disposable discretionary income - the part that remains after paying taxes and necessities such as mortgage/rent, food, transport, health, etc.  This is where the economy makes it or falls flat on its face - on the margin, not on the whole.

It does not take a genius to figure out that with a huge number of unemployed, earned income and the propensity to spend on non-essentials is sharply curtailed.  And, yes, it WILL affect the earnings of every company out there, Internet or not.

One more point, learned from decades of experience: in stocks, most money is lost by those who buy on the rebound and not on the initial sharp leg down.  That’s when the sharps unload by the bucket..