Thursday, October 21, 2021

Our Dystopian Gilded Age

For a while now I have been thinking that we are living in a 21st Century dystopian version of the Gilded Age. Why dystopian? Because we get the Robber Barons, but not the rapid rise in workers' wages and higher living standards of the late 19th Century. Instead, we see the annihilation of America's once thriving middle class and its transformation into a Working Poor class. 

The dystopia is even more obvious during the pandemic, which has upended American society  to a degree only now becoming more noticeable. For example, people are quitting their jobs in record numbers and job openings are the highest ever.

 Sum Of Job Openings And Quits Hits An All Time Record

Doing a little more work with the data, I look at (Openings + Quits) as a percentage of the civilian labor force and compare them to the unemployment rate - see chart below

Job Openings + Quits As Percentage Of Labor Force (blue line) And Unemployment Rate (red)

 It is immediately apparent that openings and quits are much higher today than at other times when unemployment was similar as now - twice as high, in fact. It seems like the working class is revolting. Why?

Several academic researchers are rapidly amassing hard evidence that workers are no longer satisfied with the quality of their lives, no longer willing to work  for low pay and no flexibility, no or very few essential benefits like healthcare and vacation, no job satisfaction, no time off to create a family... in sum, to live and work in America as opposed to, say, Sweden or even Canada.  They are quitting and not going back to work quickly, not willing to accept just any job.

This "wooly" type of economic data, much closer to psychology than econometrics, is routinely ignored, and even thought of as nonsense, by Wall Street, central bankers and even politicians. Yet, it shouldn't. After all, the 2017 Nobel Prize in Economics went to Richard Thaler for his work on Behavioral Economics.. His seminal  Misbehaving: The Making of Behavioral Economics is a must read for all who still operate under the delusion that our species is homo economicus.

In his book Thaler recounts a research presentation he made to professors in the psychology department of the University of Chicago. They were all dumbfounded that their colleagues in the economics department completely ignored the very basics of human behavior when developing their economic models. The two departments never consulted each other. Amazing, isn’t it? 

Back to our version of the Gilded Age.

Our Robber Barons are getting more hubristic with each passing day, exhibiting behavior not seen since "Diamond" Jim Brady, Jay Gould, JP Morgan and the Vanderbilts.  Conspicuous consumption, space yacht competition, direct political influence, stunning disregard for the "common man", direct and indirect manipulation of markets (trading chat rooms, cryptos, meme stocks).

I am convinced that the current labor situation indicates a very deep level of popular dissatisfaction manifesting itself as a sort of workers' "flipping the finger" to the establishment. 

The original Gilded Age ended abruptly with the market Panic of 1899 and the election of reformist Teddy Roosevelt as President. Ours…?

Wednesday, October 20, 2021

Update: The US Economy Is Stalling Fast

The US economy is even closer to stagflation today.  

Following this week's weak numbers for Industrial Production and Housing Starts, the latest GDPNow update for 3Q2021 real GDP is at a mere 0.5% (annualized). The Atlanta Fed projection was at 6% as recently as August 27. 

Meanwhile, the mean Blue Chip consensus estimate stands (sleepwalking?) at 3.7%, with a range of 2.10% to 5.25%.

We know that inflation is very high with September CPI at 5.4%, so unless the Atlanta Fed estimate is grossly wrong, stagflation is no longer a possibility but a reality.

Bond Buyer's Arithmetic

 Very short post today. 

Should you buy bonds right now?

Inflation is at 5.4% and 3 year Treasury notes yield 0.723%.  

Let's accept the Fed's 400 PhDs prophecy (see previous post) which predicts that inflation will dip back to 2% in 2022 and out. Further, let's assume that inflation has already peaked and that for the rest of this year (3 months left) it will average 4% annualized.

So, during the next 3 years your money will lose purchasing power as follows:

Rest of 2021: 1%

2022: 2%

2023: 2% 

9 months 2024: 1.5%

Total for 3 years: 6.5% (ignoring compounding)  

If you buy the 3 year Treasury note right now you will make 3x0.723% = 2.17% in interest.

Thus you make      2.17% - 6.50% = -4.33% a negative real return 

Should you buy the 3 year Treasury note, even if you believe the Fed's 400 inflation projections? 

  1. Yes, but only if you believe there is an imminent economic collapse which will result in massive deflation. 
  2. No, you're not a fool to give money away.

In case #2, what interest do you want to receive TODAY as a minimum per year just to break even? Easy arithmetic: 6.5%/3 = a little over 2.1% 

Looking at the chart of the 3 year Treasury yield...


The corollary is that the Fed's constant manipulation of the bond market through QE has created a Catch-22 situation, where we either go into a deep deflationary recession or allow interest rates to rise very significantly above current levels, also likely creating a recession through a bubble collapse.

Welcome to Modern Economics. 

PS... remember the "soft landing" meme back in 2006? I'm willing to bet that's exactly what the Fed and Treasury are hoping for today as well.  How did that work out in the past, eh?


Tuesday, October 19, 2021

The Fed Goes Delphic

Forecasting is ancient business. The Greeks, for example, had several oracles who provided godly prophecies in exchange for cash and gifts. Business was particularly brisk in Delphi, where Pythia sat on her tripod in a fume-induced trance to produce the ancient world’s most famous and prestigious omens. A whole rich town developed around her, complete with huge temples to Apollo, a big theater, a stadium and, yes, banks (they were called thesaurus - Treasuries).

The Thesaurus (Treasury) Of Athens In Delphi

Like all prophecies, hers involved both art and science. A team of experts (Apollo’s priests) carefully weighed who asked what before “interpreting” Pythia’s conveniently incomprehensible mutterings for the paying customer. The priests were sophisticated professionals, very up to date on global political, military and financial affairs, since clients came from all over the known world. Meaning, the resulting "prophecy" had everything to do with who and when asked for it.

A Delphic prophecy was highly sought after because it provided a kind of official public endorsement: for example, a king was not likely to go to war without first consulting Pythia. It then became a matter of cash-lubricated geopolitical negotiation to obtain the most propitious omen.

Did oracles make mistakes? Never! If the priests found themselves in a bind between conflicting interests, they would use the famously contorted ancient Greek grammar and syntax to compose completely ambiguous omens.  Or, if they did actually make a (rare) mistake in their original assessment, they would resort to Apollo: the customer must have somehow offended the god after the omen was tendered, so the prophecy became null and void.

Enough with ancient history..

Today I got my regular morning e-mailed update from Bloomberg.  On top was an article proclaiming that "the Fed's army of more than 400  PhD economists has a message on inflation for policy makers and the American public: Chill out."  They expect inflation to fall back under 2% in 2022 and claim that their track record is better than Wall Street's or other private forecasters. 

I don't know if they are right longer term, but a year ago the same Fed staff PhDs were anticipating a rise in inflation from 1.3%, but nowhere near today's 5.4% (their consensus was around 1.7%). Therefore, the relevant question to ask of the 400 priests... errr, economists... is this: why was your prediction so very wrong?

This is my opinion on the matter: 

Forecasting is 99% looking at the past and casting it forward, expecting it to repeat. This usually works pretty well, particularly if you possess the mountains of raw data and computing power of the Fed (those 400 PhDs...).   We call the process Econometric, the ancient Greeks called it Delphic. 

But if the econometric formula itself is only validated for a certain limited time period in the past,  when the economy did not exhibit big fundamental shifts, the data will go in and produce erroneous, or possibly disastrous, results (omens).  We have already lived through exactly such an event with the collapse of the Great Credit Bubble in 2008.  

In that case, all the mortgage securitizarion, tranching  and credit derivatives were based on a formula that was validated only back 30-40 years, when mortgage defaults never exceeded 3-4% at most. It presumed this would also hold in the future, with disastrous results. Had the financial engineers gone back and included default data from the 1930's this would have never happened.

Today's forecasters may be making the same mistake by failing to take into account how interconnected today's global economy truly is. By not tweaking their formulas to calculate the effects of just-in-time commerce on consumer prices or, perhaps even more importantly, the Fed's own unprecedented cash deluge, which may result in asymmetric, even exponential inflationary effects.

Or, it may just be that the priests do not want to upset the paying customer who insists on 2% or less..


Monday, October 18, 2021

Flipping Bonds… Or Burgers?

The following is an excerpt nefariously purloined from the daily digital diary of Bubba Bondaddy, a bond trader at one of  Wall Street’s major bond dealers.

Tuesday Oct. 12, 2021

Woke up early and anxious.  A new 3 year Treasury note is being auctioned today, and I really, really don't want to buy any. To be honest, I don't even wanna bid!

Inflation is picking up and the Fed is gonna have to start tapering its  QE and raising interest rates soon. Yeah, Powell keeps saying inflation is transitory but, man, it sure feels mighty sticky lately.

I mean, jeez, natural gas prices in Europe are zooming, coal in China is zooming... who woulda thought that I would give a fig about coal in China, huh? It's a brave new world out there, fershure. And at home, I drive by all those fast food joints begging for people to flip burgers at $15/hr…it ain’t natural, man.

Anyway, I am obliged to bid because I work at Smith Harris Smythe & Co. who is a primary dealer. When you gotta bid, you gotta bid....

...... Well, I did bid and got a bunch of the 3 year paper at 0.635%. Boy, was I surprised  because the 3 year traded at 0.560% yesterday, so I bid low on purpose (NB meaning at a higher yield)  - and I still got filled 7.5 basis points higher! Damn, they must have scraped the bottom of the barrel to get this baby sold. Oh well, it's only a 3 year, how bad can it get? 

Seriously, though, I don't feel good about holding all this paper on my book.

Wednesday Oct. 13, 2021

Dammit, wouldn't you know it? Inflation numbers came in today, worse than expected. Headline CPI at 5.4% year over year - last month it was at 5.3%. The coneheads in analysis were calling for 5.3% again - but you know how they play the game... They call for a "safe" number expecting  the actual will come in better and thus "beat" the expectation to produce a rally.  Well, duh, it came in worse! 

So now what? The 3 year immediately jumped to 0.684% following the bad inflation numbers, meaning I get hit with a mark to market loss of  14 ticks on the price (NB from 100.00 to 99.86) -  in just one effing day!!

If there is one thing I hate most of all is to buy into an auction on Tuesday and start losing money on Wednesday!! In just 24 hours I'm losing in mark to market what I will earn in interest in almost three months! 

Monday, Oct. 18, 2021

I’m getting killed this morning. The 3 year is at 0.760%, almost 13 basis points higher. I’m losing  40 ticks in price on my  mark to market - in less than a week. On a friggin’ 3 year!!

Three Year Treasury Note Yield

The way this is going my bonus is gonna be toast this year and I might as well start flipping burgers… aaaarghhhh.


Sunday, October 17, 2021

Wages And Inflation

Real, inflation adjusted wages in the US have been stagnant for decades, particularly for men. (The spike up during COVID is explained by the mass layoffs of  workers in the low-pay service industries like hotels, restaurants, etc. which brought up the average of those employed.) Even so, median wages are at the same level as 1979!

Is this about to change significantly? Perhaps yes. 

Job openings (ie demand for labor) are at historic highs, while the number of people quitting their jobs (a measure of shrinking labor supply) is also at an all time high.

Data From Latest JOLTS Release Point To Significantly Higher Wages Soon 

As with anything else, higher demand plus lower supply equals higher prices, in this case higher wages. But wages, unlike commodity prices, are “sticky” on the upside - you can’t have people working side by side doing the same job but getting paid different wages. That’s why we say that inflation gets “baked in” when it passes through to labor costs.

What is going on in China is another reason to expect, indirectly, higher US labor costs. Cheap imports were driven mainly by extremely low Chinese wages (“one bowl of rice”). That’s clearly over now:  Xi Jingping’s brand new “Common Prosperity” policy means living standards must rise for the working class, paid for by higher wages.  No longer will US employers be able to “import” China’s cheap labor, providing American workers with greater wage bargaining power.

Bottom line: inflation is not going away soon.

Saturday, October 16, 2021

Stagflation Arrives To America

 The following chart shows the GDPNow estimate for 3Q2021 real GDP (annualized) now at 1.3% vs CPI inflation at 5.4% for September. I remind readers that GDPNow is an algorithmic estimate for the most current, upcoming GDP number. It is produced by the Atlanta Fed without using any economists’ “guesstimates” or, even worse, biases - political or otherwise.

GDPNow Growth Estimate Way Below Inflation

Assuming the GDPNow estimate proves accurate (a pretty good assumption given its excellent track record), the chart shows that stagflation has arrived to the US - and in spades.

Next stop in the stagflation process? Rising labor costs, now growing at the fastest rate in 20 years - see below, another helpful interactive data service from the Atlanta Fed.   And once inflation passes into wages it gets pretty much “baked in”. 

It looks increasingly certain that inflation is not transitory and that stagflation is upon us, despite Mr. Powell’s dictums.The question now is, how long will will the unwelcome guest stay? 

IMHO, for as long as Fed and Treasury keep stocking the buffet with QE and zero interest rates, stagflation will be with us for the duration. 

Friday, October 15, 2021

October Surprise?

The Atlanta Fed has a mathematical model to estimate GDP on a running basis. It’s called GDPNow, and this is how it is described:

GDPNow is a nowcasting model for gross domestic product (GDP) growth that synthesizes the bridge equation approach relating GDP subcomponents to monthly source data with factor model and Bayesian vector autoregression approaches.

Good luck with that explanation if you do not have a degree in statistics. But you don’t need one if all you care about is its forecasting accuracy.

The current GDPNow forecast for 3Q2021 real GDP growth is just 1.3% annualized, way below the 6.5% expected by “blue chip” economists - see chart below.  This high number is what Wall Street is betting on as well, given the heroic equity P/Es. It is interesting to observe that GDPNow was also projecting a little over 6% growth as recently as late August, and then declined sharply within weeks.

This is the detailed evolution of the GDPNow estimate:

So, just how accurate is the forecast? Excluding the COVID quarters which witnessed huge statistical volatility, the GDPNow model is very accurate, particularly nearer the release of the official GDP numbers - see chart.

The Bureau of Economic Analysis will release its estimate for 3Q21 GDP on Oct. 28, just 13 days from today. Given the GDPNow track record above, it is highly unlikely that it will err by more than 0.5%-1% in either direction, thus producing an October surprise.

Wednesday, October 13, 2021

Individual Folly

 Global equity markets… well, basically it all boils down to the US stock market.. have exploded upwards during the pandemic as the Treasury and Fed unleashed a torrent of fresh cash (ie debt), upwards of $5 trillion in less than 2 years. 

Where did the money go? Stocks, real estate, cryptos and loony-price NFTs.

Who did the buying? Individuals, many of them young first timers who “know better” and scorn all professionals.

Here are two eye-popping charts from the Financial Times.

First observation: all this money came in during the first half of 2021. Since then, equity markets made new highs, but then reversed and are now back neat the levels reached at the end of the first half.

What does this mean, in my opinion? There is likely a “rotation” going on, typical of all late stage bull markets: stocks are being increasingly sold by “smart” money holders and being bought by retail investors/speculators.

Second observation: on the S&P chart above, what does the price pattern look like to you? All comments encouraged. 

Third observation: the majority of investing in stocks these days has almost nothing to do with individual stock picking;  instead, it is almost entirely ruled by passive indexing.  Apart from meme stocks (which aren't many, anyway), retail investors buy broad index funds and then "forget" everything else. It's like using a "smart" weapon in FAF mode: fire and forget, trust the electronics to find the target.

I'm not sure how successful this strategy will be during a prolonged bear market or, even worse, if it could precipitate or accelerate a crash.  If an investor ONLY looks at a single number all the time (eg S&P 500) to the exclusion of EVERYTHING else like earnings, dividends, corporate news, valuation metrics, balance sheet data... wouldn't that make him/her more likely to jump when the trend changes instead of being patient? And what would happen when/if everyone wants to jump at the same time?

Tuesday, October 12, 2021

How Much Is Left In The Till?

"Countries don't go bankrupt" was an infamous riposte by Citibank Chairman Walter Wriston (1967-1984).  He was proven disastrously wrong, particularly in Latin America.

 Aaaah... bankrupcy... how does it happen? Well, for countries it's the same as for businesses, a matter of how many australs, pesos or dollars you have in the till against your current bills. Solvency vs. Insolvency. 

Business analysts routinely calculate the Acid Ratio: Current assets (mostly cash and equivalents) divided by current liabilities. Anything less than 1.0 and you are close to being toast. How's the US doing? In a word, terrible. 

Last month the debt limit was reached and no more borrowing was possible. The country was speeding headlong towards insolvency, until Republicans relented and offered a very limited short term "solution" to fund the government only until early December. Think dam, Dutch boy and finger.

The US has been running budget deficits for decades, constantly raising its debt load and requiring one debt limit extension after another. In the past, such political decisions were pretty routine affairs, even if they involved grandstanding in Congress.  No more - the deficit has exploded to third world levels at the exact same time when political rivalry is at its most intense.  The budget chasm is as big as the chasm between Republicans and Democrats - see chart below.

Federal Current Expenses (red line) And Current Revenues (blue line)

Deficits for FY2020 and FY2021 reached $3.13 trillion and $3.67 trillion. These are truly staggering figures, translating to 15% and 16% of GDP respectively.  (For reference, Greece reached similar percentages in 2010 and was forced into bankruptcy.) 

Fiscal 2022 is expected to be better with a deficit of "just" $1.84 trillion, around 7-8% of GDP. That's assuming, of course, that Congress will agree to raise the debt limit before December.

So, how solvent is the US, what is its Acid Ratio? First, a chart of the the Treasury's balance at its "checking" account at the Fed.  The account zoomed to $1.8 trillion as the Treasury borrowed record amounts during the pandemic, and then dropped just as fast as the money was disbursed far and wide. As of last Wednesday it stood at $96 billion.

 US Treasury General Account At The Fed And Days Of Deficit Cover

It may seem like a lot of money, but the government currently runs a monthly deficit of $171 billion (as of August), so $96 billion covers (covered..) only 16 days of operations. That's mighty tight, by any measure - a 30 day acid ratio of just 0.56x.  Compare this with 135 days just prior to the pandemic (4.5x) and 207 days at the top (6.9x).

Are we toast yet?

Congress just passed the stopgap bill which will provide the Treasury with increased borrowing authority (and thus extra cash through T-Bill sales) until early December. It should bring the acid ratio back up to around 2-2.5x as of this week - but then what? Since this is a very limited borrowing authority, the cash will immediately start to drain again without replenishment. Unless the debt limit is raised significantly by December, the US will once again skirt with insolvency. 

How in God's good name did the US reach this point? 

Is this the way a global Empire should be run, and is it therefore really entitled to a AAA/AA+ rating? Unless the government/Congress gets its act together fast by raising revenue and cutting expenses it will soon lose the faith of markets. Global investors will spurn Treasurys and then... bye bye Empire. The till is empty - the United States cannot keep acting as if massive deficits are an entitlement. American exceptionalism can only go so far.

It is time for America to bite the bullet and make hard decisions.


PS  In yet another sign that the political chasm is immense, Republican Texas Governor Greg Abbott yesterday issued an executive order banning all COVID vaccine mandates. This means that companies such as American Airlines, Facebook, Google, etc cannot require proof of vaccination for their workers in Texas and cannot fire them if they do not comply. 

 If America's political leaders cannot agree on something as scientifically straightforward as vaccination, using it instead for political gamesmanship by risking the very lives of their citizens, what is likely to happen with the debt ceiling in two months?