How do you take your plaque?
C’mon, we all have our victual vices that risk turning the gourmet in us gourmand. Those naughty nibbles that do so tempt us. Is it a bacon, cheese, well…anything? Maybe a slice of pie – pizza or otherwise? Or do you take yours scattered, smothered and covered? As in how you order your late-night hashbrowns at Waffle House – scattered on the grill, smothered with onions and covered with melted cheese. That last order is sure to do the trick if clogging your arteries is your aim. Too exhausted to trek inside? Hit the drive through. It’s the American way.
Enter Morgan Spurlock. In 2003, he had grown so alarmed with the ease with which we can go from medium to jumbo (in girth) he conducted a filmed experiment. For 30 days, Spurlock consumed his three squares at McDonald’s, a neat average of 5,000 calories a day, twice what’s recommended for a man to maintain his body weight. Fourteen months later, Spurlock managed to shed the 24 pounds he’d packed on.
Released in 2004, Super Size Me garnered the nomination for Best Documentary Feature.
And since then? A freshly released paper finds that more than 30 percent of Americans were obese in 2015 compared with 19 percent in 1997. Of those who were overweight or obese, about 49 percent said they were trying to lose weight, compared to 55 percent in 1994.
One must ask, where’s that “Can Do!” spirit? Why acquiesce given the known benefits of restraint? Perhaps we’d be just as well off asking that same question of the world’s central bankers who seem to have also thrown in the towel on discipline, opting to Super Size their collective balance sheet, the known hazards be damned.
At the opposite end of the over-indulge-me spectrum sits one Harvey Rosenblum, a central banker and my former mentor who sought to push his own discipline to the limits throughout his 40 years on the inside, to take a stand against the vast majority of his peers. Consider the paper, co-authored with yours truly, released in October 2008 — Fed Intervention: Managing Moral Hazard in Financial Crises.
In the event your memory banks have been fully withdrawn to a zero balance, October 2008 is the month that followed the magnificent dual implosions of Lehman Brothers and AIG.
To speak of insurers and quote from our paper: “Moral hazard, a term first used by the insurance industry, captures the unfortunate paradox of efforts to mitigate the adverse consequences of risk: They may encourage the very behaviors they’re intended to prevent. For example, individuals insured against automobile theft may be less vigilant about locking their cars because losses due to carelessness are partly borne by the insurance company.”
As it pertains to central banking, we had this to say: “Lessening the consequences of risky financial behavior encourages greater carelessness about risk down the road as investors come to count on benign intervention. By intervening in a financial crisis, the Fed doesn’t allow markets to play their natural role of judge, jury and executioner. This raises the specter of setting a dangerous precedent that could prompt private-sector entities to take additional risk, assuming the Fed will cushion the impact of reckless decision-making.”
What a redeeming difference eight years can make?
If you’ve read Fed Up, you’ll recognize these words, which open Chapter One: “Never in the field of monetary policy was so much gained by so few at the expense of so many.” Every chapter of the book begins with a quote, most of them ill-fated words straight out the mouths of Greenspan, Bernanke and Yellen, chief architects of the sad paradox that’s benefitted “so few.” Those prescient words were written in November 2015 by Bank of America ML’s Chief Investment Strategist Michael Hartnett, before Brexit was on the tips of any of our tongues, before the anger of the “many” erupted at voting booths.
Chapter One goes on to recount the Federal Reserve’s December 2008 decision to lower interest rates to zero. According to the Bernanke Doctrine, the Fed’s purchasing securities, quantitative easing (QE) could not commence until interest rates had hit their lower bound. To suggest the chairman’s blueprint was arbitrary requires a vivid imagination. Few appreciate the Doctrine was conceived in August 2007 in Jackson Hole, in the tight company of his chief architects. But one can breathe a sigh of relief his models did not necessitate negative interest rates.
We know it’s been over two years since the Federal Reserve stopped growing its balance sheet to its current $4.5 trillion size. And yet, investors are anything but alarmed, comforted in their knowledge that Liberty Street stretches round the globe. There are plenty of corners on which moral hazard dealers can ply their wares, luring animal spirits out of their lairs. QE is global, it’s fungible and it feels so good.
As Hartnett reminds us in his latest dispatch, global QE is, “the only flow that matters.” Add up the furious flowage and you arrive at a cool $1 trillion central banks have bought thus far this year (note: it’s April). That works out to a $3.6-trillion annualized rate, the most in the decade that encompasses the years that made the financial crisis “Great.”
“The ongoing Liquidity Supernova is the best explanation why global stocks and bonds are both annualizing double-digit gains year-to-date despite Trump, Le Pen, China, macro…”
As so many sailors fated to crash onto the rocky shores of Sirenuse, investors have complied with central bankers’ biddings. And why shouldn’t they?
As Bernanke himself wrote in defense of QE in a 2010 op-ed, “Higher stock prices will boost consumer wealth and help increase confidence, which can also spur spending. Increased spending will lead to higher incomes and profits that, in a virtuous circle, will support further economic expansion.”
What a relief! This won’t end as tragically as the Greeks would deem fit. It’s the wealth effect, a different myth altogether, protected by virtue herself.
Investors are excelling at obedience in such rude form they’ve plowed fresh monies into emerging market debt funds for 12 weeks running. As for stocks, forget the fact that it’s a handful (actually two hands) of stocks that are responsible for half the S&P 500’s gains. Passive is hot, red hot. According to those at Bernstein toiling away at tallying, within nine months more than half of managed US equities will be managed passively.
As if to celebrate this milestone, Hartnett reports that an ETF ETF has completed its launch sequence. What better way to mark a decade that’s seen $2.9 trillion flow into passive funds and $1.3 trillion redeemed from active managers? In the event you too need a definition, an ETF ETF is comprised of stocks of the companies that have driven the growth of the Exchange Traded Funds industry. But of course.
In the event you’re unnerved by the abundance of blind abandon in our midst, it helps to recall the beauty of moral hazard. Central bankers know what they’re doing in encouraging moral hazard and they’ve got your back. If they can’t prevent, they can at least mitigate the future economic damage they’re manufacturing.
As Bernanke said in a 2010 interview, “if the stock market continues higher it will do more to stimulate the economy than any other measure.” If that was true then, isn’t it even truer today? More has to be more. Why diet when it’s so much more satisfying to indulge to our heart (attack’s) abandon?
No sequel. No Part II. No Redux. 1981’s smash hit Arthur is a classic example of what happens when well is not left alone. There was never going to be a way to replicate the hilarity born of sublime scripting and delivery to say nothing of the perfectly unconventional combination of casting and direction. Upon reflection, the only question is what sort of prig it takes to award the movie anything but five full stars – Amazon has it as 4.5 stars. (We’ll leave that one for another day, but you know who you are and you clearly need to get out more.)
Who, after all, could fault Dudley Moore’s best moments portraying Arthur Bach, cinema’s most darling drunk? A smattering of the film’s snippets:
When Susan, his fiancé by way of an arranged-marriage, suggested that, “A real woman could stop you from drinking,” Arthur rebutted that, “It’d have to be a real BIG woman.”
Or his description of his day job: “I race cars, play tennis and fondle women. BUT! I have weekends off and I am my own boss.”
Then, of course, there’s the farcical exchange between Arthur and his proper aunt and uncle when he’s caught out with a spandex-clad prostitute. Endeavoring to render his “date” passable, he claims she’s a princess from a speck of a country: “It’s terribly small, a tiny little country. Rhode Island could beat the crap out of it in a war. THAT’s how small it is.”
One beat later when it (re)dawns on him that his arm candy is actually said prostitute? Well, that’s the best of the best: “You’re a hooker? Jesus, I forgot! I just thought I was doing GREAT with you!”
In 1981, the audience was naturally attracted to Moore’s spoiled, over-the-top coddled character and to the sheer novelty of just imagining being him — breakfasted-in-bed, butlered, chauffeured and indulged in every conceivable way. A good many of those caught between the moon and New York City these days might not see the movie as so much comedy, but rather a droll performance, or better yet, dare one venture, autobiographical.
Welcome to the sequel to America’s Gilded Age. Fair warning, like Arthur 2: On the Rocks, it’s gauche, tacky and vulgar all at once. And for far too many angry Americans, this follow-on to one of history’s most raucous chapters is as unwelcome as was that of Arthur’s sequel to the original movie’s purist fans.
The dirty little secret the ostensibly wealthy consider to be indelicate cocktail conversation is that this second era of insulting inequality is rather old news. Inequality has been on the rise since 1987 when Alan Greenspan took the helm of the Federal Reserve. It was then the Maestro began his crusade to indemnify investors’ portfolios against any nasty side effects risk-taking might invite.
By 2012, the top one percent of U.S. earners were commanding 19.3 percent of household income, burying once and for all the prior record set in 1927. In other words, it’s been five years, people! At this point, the subject is borderline blasé. Can we move on to another subject already?
Plus, the runaway stock market has managed to benefit the ‘rest’ of Americans – OK, the top 20 percent — who owned 92 percent of the stock market in 2013.
One thing is for certain, that other eighty percent of Americans who controlled that other eight percent of stocks notwithstanding, the trickle-down effect to the top quintile is undeniably conspicuous in its overabundance.
A recent foray to the local posh mall (where else to see Boss Baby?) was all the show-and-tell required to illustrate the point. So lengthy was the valet line, one wondered if the intended task of shopping would ever be properly addressed. Forget the Ferraris. This is the mall folks, land of the SUV, as in the Bentayga, Bentley’s answer to every delusional soccer mom’s dreams. It is what it is if only the best will do. Besides, it’ll only set the hubby back a cool quarter of a million.
If only that had been what was ‘remarkable.’ No, that preserve was reserved for the three – count ‘em – three Rolls Royces queued up to be whisked away, for a smart tip, to be sure.
Pardon the urge to submerge your pleasurable 12-cylinder fantasy. But do you see anything wrong with this picture? Two questions (should) come to mind: Can this many people afford to be driving these beyond-luxurious vehicles? Much more critically, are their means so meaningful they’re licensed to brazenly brandish their wealth? Or is a fair bit of financial feigning at work to paint the impressive impression?
At the risk of being daft, it pays much more in mental dividends to ignore so much of the hyperbolic, hysterical ‘news’ spewed about by the shock-and-awe contingency whose sole aim is to scare the tar out of us. Pardon the interruption, but the stock market does not crash at appointed dates and times.
And yet, the devilish details demand our attention. It’s easy enough to dismiss the blaring headlines about subprime car loans blowing up. They don’t amount to a hill of beans in the aggregate compared to their mortgage predecessor, so move on. But what of the news that prime losses on securitized car loans had risen while recoveries had fallen in February, a month when seasonals tend to flatter the data? That one garnered an eyebrow raise.
And then there’s that pesky data on bankruptcy filings. In all, some 81,590 commercial and consumer bankruptcies were filed in March compared to 78,372 in the same month last year. The American Bankruptcy Institute’s Executive Director Samuel Gerdano sounded the following note of caution, “Distress in the retail sector is pushing up the total number of business filings, and we’re also seeing an uptick in consumer filings from previous months.” OK, so there’s that.
Oh, yeah. What about the recent front-page Wall Street Journal article on record levels of margin debt? Did those figures give you a little itch that was hard to reach? Did it bother you more that analysts chided your “naivete,” insisting this was no cause for alarm? That always ends well. To wit, we have this gem to file away, as we would any other embarrassing and awkward teenage photos saved for future parental blackmail:
“This isn’t a signal to me that markets are reaching an exuberant level like they did in the 1920s or 1990s, when speculation was rampant,” said Jeff Mortimer, director of investment strategy at BNY Mellon Wealth Management. “What our clients are doing is borrowing against their portfolios because interest rates are so low. They’re not leveraging up because they see the market exploding to the upside; they’re using leverage because they can pay it off at any time.”
Is that so? Aspirational investors are borrowing against their brokerage accounts at an unprecedented pace because they’re savvy, not because they feel there’s easy money to be made in a stock market that knows no upper bound. And they’re just sitting on some other pile of cash that can be used to square these same margin accounts…just in case? How exactly, then, have they also managed to tack on that multi-million-dollar mortgage and tuck into that car lease payment that exceeds most Americans’ monthly rent?
Could it be that the top 20 percent is living larger than ever, aspiring to flaunt and taunt as any one-percenter would? How else does one square the desire to lease a Rolls Royce in the first place, mind you, for $1,795 a month? While the ability to finance a Rolls explains the 42-percent spike in the brand’s sales since the election, it also induces an impulse to go shower off that one data point.
Do these aspirationals begin to appreciate the condemnation their affectations attract?
A recent conversation with an executive and long-time friend at a multi-generational luxury goods purveyor was more telling than any data set. His observation was that we have full-circled back to 2006. Many of his clients are new faces to him. They are leveraged to the hilt, living in more home than they can carry, driving more car than their incomes begin to justify and whipping out their credit cards with utter abandon to finance the purchase of his sparkly trinkets. They’re behaving as if they’ve time traveled into the future and know their margin account will cover what they’ll never be able to in cold, hard cash.
He too had seen so many Rolls Royces of late that he’d caught himself trying to make sure he wasn’t seeing the same one rounding the block. He confirmed that was not the case and relayed the same wonderment I’d felt at the mall. In what was almost an afterthought, my friend added that he could never bring himself to drive a Rolls Royce, even if he could afford one (he can).
But that’s the point. He was raised better than that and retains a healthy appreciation for how harshly history has treated pretentious pretenders.
“Let’s put it this way,” Arthur Bach explained of his immense and real (fictionally-depicted) wealth, “I wish I had a dime for every dime I have.” These cinematographic carefree one-liners were a delight to the ear in 1981 and remain so to this day for those of us with good memories and a solid sense of self. But the truth is, far too many in our midst mime a real-life version of Arthur in such cavalier fashion as to invite the fates to exact their unique form of revenge. Do you think they’re conscious they’ve been warned?
While it’s true the next downturn will ravage those on Main Street, that sad reality will always represent the wicked way of the world. Trickle-down economics is a fantasy at best during good times; it’s a real bitch when the economy turns south. The real question is will those who aspire today join the ranks of those they’ve disparaged, even pitied, tomorrow? In the end, will they too be forced to ask their brothers and sisters if they can spare a dime?
Quizzically-inclined quantum physicists quench their intellectuality by quoting philosophers first, then their fellow scientists.
It is in fact questionable whether quantum physics would have come into being if not for George Berkeley’s 1710, “A Treatise Concerning the Principles of Human Knowledge.” Berkeley’s most famous saying is, ‘esse est percipi,’ or, ‘to be is to be perceived.’ He elaborated using the following examples:
“The objects of sense exist only when they are perceived: the trees therefore are in the garden, or the chairs in the parlour, no longer than while there is some body by to perceive them.” So matters of matter exist only in our mind. It is critical to note that Berkeley never posed a question but rather he made a statement of the world view through his metaphysical personal prism.
It was not until the June 1883 publication of the magazine The Chautauquan that the question was put as such: “If a tree were to fall on an island where there were no human beings would there be any sound?” Rather than pause to ponder, the answer followed that, “No. Sound is the sensation excited in the ear when the air or other medium is set in motion.”
A vexatious debate has ensued ever since, one that eventually stumped the great Albert Einstein who finally declared “God does not play dice.” In recognizing this, Einstein also resolved himself to the quantum physics conclusion, that there is no way to precisely predict where individual electrons can be found – unless, that is, you’re Divine.
Odds are high that the establishment, which looks to ride away with upcoming European elections, is emboldened by quantum physics. The entrenched parties appear set to retain their power holds, in some cases by the thinnest of margins. What is it the French say about la plus ca change? Is it truly the case that the more things change the more they stay the same?
Is this state of stasis sustainable, you might be asking? Clearly the cushy assumption is that the voices of those whose votes will not result in change will be as good as uncast, unheard and unremarkable.
Except…and this is a big ‘except’ – time is on the side of the castigated and for one simple reason – they are young. Consider Great Britain’s majority decision to leave the European Union (EU). An un-astonishing 59 percent of pensioners voted to leave the EU while only 19 percent of those between the ages of 18 and 24 supported Brexit. The aged see the EU as a cash drain at just the wrong time, and for good reason while the young view those 28 member states as the land(s) of opportunities.
With the caveat that polling has been revealed to be anything but reliable, young voters in France see things a might bit differently. Nearly half of surveyed French youth say they will vote for far-right candidate Marie Le Pen. At the opposite end of the spectrum, the dark horse far-left candidate, Jean-Luc Melechon, has enjoyed a late-stage surge in the polls by vowing to increase wages and shorten workweeks. Both insurgent camps view the lead contender, former banker Emmanuel Macron as the epitome of elitism, their ‘Hillary.’
Polls show the initial round of voting, which takes place on April 23rd, will make Macron sweat, but that he will survive to stand as the strongest contender in the second round. The status quo thus prevails, which for many represents continued economic stagnation and evasion of fiscal reforms.
Now factor in the rising recognition of the fallibility and limitations of central bankers. Mario Draghi, encouraged shall we say by the Germans, looks set to begin tapping the brakes on Europe’s answer to quantitative easing. Let’s be clear. Draghi has made it plain that he won’t go down without a fight. Nonetheless, it appears monetary policy will slowly become less accommodating, dragging on growth in the peripheral countries.
And then there is the matter of the refugee crisis, the cost of which few in the United States fully appreciate. Faced with impossible living conditions and no access to work in Jordan, Turkey and Lebanon, hundreds of thousands have opted to risk the journey to Europe. In 2015, 1.3 million asylum seekers landed in Europe, half of whom traced their origins to Syria, Afghanistan and Iraq. That number plunged in 2016 to 364,000 owing mainly to a deal between the EU and Turkey which blocks the flow of migrants to Europe.
The cost, not surprisingly, is enormous. Europeans spend at least $30,000 for every refugee who lands on her shores. By some estimates, the cost would have been one-tenth that, as in $3,000 per refugee, had the journey to Europe NOT been made in the first place.
Of course, aid money helps cover the cost of the crisis. Some $15.4 billion, about 10 percent of global aid monies raised in 2016, was directed to hosting and processing migrants in developed countries last year. While charity lessens the burden, it can’t staunch anger at headline-grabbing statistics claiming that Chancellor Angela Merkel’s ‘failed migrant policy’ will cost German and EU taxpayers $46 billion in the two years ending 2017.
Fear thee not, the consensus is that September’s elections in Germany will come and go with little to no fanfare; pro-Europe candidates enjoy wide leads in the polls. Many macroeconomists expect the year to end with the strongest ties in generations between Germany and the rest of the eurozone, led by France. Bullish analysts expect the euro to shake its jitters and end the year above €1.10.
The biggest obstacle to a happy ending, for the time being at least, comes down to Italy. General elections must take place by May 2018 but an early vote remains a possibility if the current prime minister of the eurozone’s third-largest economy does not survive the year. Investors, for their part, yawn at the mention of Italy. As the Wall Street Journal pointed out in a recent story, numbness tends to set in after 44 governments have come and gone in the space of 50 years.
The most recent survey revealed a record one-in-three Italians would vote the Five-Star Movement into power if elections took place today. The rebellious, populist party has tapped the anxieties of Italians whose per capita economic output has suffered the most since the euro was formed in 1999. Even the Greeks can claim to have suffered less.
Is an Italian uprising in the cards? The bond market certainly doesn’t buy into the potential for major disruption, grazie Signore Draghi.
At some point demographics will start to matter. The situation in France is no doubt grave, with youth unemployment at nearly 24 percent. But that pales in comparison to Italy where 39 percent of its young workers don’t have jobs to go to, day in and day out. Older voters determined to keep the establishment intact will begin to die off. In their wake will be a growing majority of voters who are increasingly disenfranchised, disaffected and despondent.
If there’s one lesson Europeans can glean from their allies across the Atlantic, it’s that bullets can be dodged, but not indefinitely. As we are learning the hard way, necessary reforms are challenging to enact. Avoidance, though, will only succeed in feeding anger and despair. The longer the voices of the desperate go unheard, as just so many silently falling trees in the forest, the more piercing their cries will be in the end.
Had it not been for the genius of Thomas Crapper, champion inventor of the water-waste-preventing cistern syphon, Victorians would have been left to make their trek to that malodorous darker place otherwise known as the Out House, or perhaps the crockery pot stashed under the bed for a while longer.
Born in 1836, Crapper was apprenticed to a master plumber at the tender (today) age of 14 and had hung his shingle in Chelsea by his mid-twenties. Such was Crapper’s renown and stellar reputation, that even the Royals themselves were early adopters. The Prince of Wales, later King Edward VII, is the first known to grace the invention with his regal rear. Windsor Castle, Buckingham Palace and Westminster Abbey would be appointed in short order ensuring safe and sanitarily stately relief as the royal “We” traveled from castle to castle.
Of course, it took rude Americans to nick his last name, giving future generations of boisterous boys endless joy at having a humorous potty word to reference the potty. Crapper took great pride in publicly peddling his patented products. Legend has it prim British ladies would faint upon happening upon his Marlborough Road shop, such was the shock at the sight of this and that model of the technological wonder behind huge pane glass windows.
By our very nature, we are nothing if not imperfect, Crapper included. One of his innovative inventions fell flat, or better put, jumped too high. It would seem his spring-loaded loo seat, which leapt upwards as derrieres ascended, automating flushing in the process, was too ill-conceived and thus ill-fated, to be purveyed after all.
No one likes a rude slap on the bottom, bond market investors especially. Perhaps that’s why there’s such irritability among traders who prefer clarity above all, even as bond yields flash danger ahead. Just a guess here but all that angst could reflect concerns about a different sort of plumber, of the central banker ilk.
It’s no secret the plumbers at the Federal Reserve are feverishly at work devising a way to unwind their $4.5 trillion war chest of a balance sheet. Officials claim their carefully devised maneuvers will nary elicit an inkling of a disturbance in the markets they’ve coddled all these years with billions of dollars of purchases, month-in, month-out. But one must wonder, at the timing, at the ostensive optics, if nothing else.
Fed Chair Janet Yellen insists that economic recoveries do not die of old age. But why chance it? Unless, that is, the motivations of shrinkage are less than magnanimous and dare one say, immoral.
Consider the Fed’s Commander in Chief herself. Back in December 2011, then Vice Chair Yellen pushed back against the majority of those on the Federal Open Market Committee (FOMC). The time was ripe for more cowbell. She argued that “a compelling case for further policy accommodation” could be made despite visible green shoots in the labor market and business spending. The consummate dove, she added that while they were at it, why not commit to the Fed sitting on its hands until late 2014 from what was then mid-2013?
Why yes, since you raise the subject, a presidential election was indeed a matter of months away.
Take a step back further in time if you will, to August 2011. Though it is maintained that the subject of politics at FOMC meetings is unseemly, as religion is to cocktail parties, the upcoming election was too front and center to ignore given the subject of debate among committee members.
At the time, the markets were interpreting the Fed’s pledge to keep interest rates tethered to the zero bound for “an extended period” as several meetings. For markets, that period of time was sufficiently brief to begin to price in an impending tightening cycle, an abhorrent assumption to the dovish coalition who had several years, not meetings, in mind.
How best to broadcast the Fed was anything but a commitment-phobe? That’s easy. Do what the Fed did throughout its foray into unconventional policymaking and guarantee results the best way econometricians can, with a numeric commitment, in this case through “mid-2013.”
God love St. Louis Fed President James Bullard for piping up with this following gem: “It will look very political to delay any rate hikes until after the election. I think that will also damage our credibility. I also doubt that we can credibly promise what this committee may or may not do two years from now.”
Score two for St. Louis! Political tinder and who the heck knows where economy will be in two years!
Dallas Fed President Richard Fisher (full disclosure – the man I once simply referred to as ‘boss’) concurred: “The ‘2013’ just looks too politically convenient, and I don’t want to fall back into people being suspicious about the way we conduct our business.”
According to the transcripts, former Fed Governor Daniel Tarullo offered a helping hand with the suggestion that perhaps Fisher would be happier with committing all the way out to 2014. Lovely. And this coming from an individual who sported his Obama bumper sticker for years driving in and out of the parking garage.
For the record, then Chairman Ben Bernanke sided with the doves, defending the move to make binding for a set period the promise to keep rates on the floor. In the end, Bernanke withstood three dissenting votes though not without a fight.
Perhaps what’s most noteworthy is that no fewer than 20 pages of transcripts are devoted to Bernanke’s best efforts to quash the dissents. That’s a problem in and of itself. Healthy dissent should make for a healthy institution. Plus, common sense tells you markets never give back what you give. The time committed was downright irresponsible and all but set the stage for future market temper and taper tantrums.
You may note that the dissenting voices of reason never prevailed, hence the aforementioned $4.5 trillion balance sheet. That’s what makes the doves’ dogged determination to tighten on two fronts so damning. It’s clear that politics got us into this monetary quagmire and that politics will also land us in recession.
To be fair, recessions are inevitabilities down here on Planet Earth where business cycles are permitted to be cyclical. Just the same, for a group of folks who’ve done backbends for years endeavoring to prolong the recovery at all costs, it’s plain odd that they’re even flirting with shrinking the very balance sheet that secures their power base as Type A monetary control freaks.
The good news, for those fearing having to enter monetary rehab, is that it’s going to take a mighty long time to shrink the balance sheet. The fine folks over at Goldman Sachs figure that getting from Point A ($4.5 trillion) to Point B ($2 trillion based on balance sheet contracting just over a tenth the size of the country’s GDP) will take at least five years.
(An aside for you insomniacs out there: Have a look back at Mind the Cap, penned back on December 16, 2015, released hours before the Fed hiked rates for the first time in order to raise the cap on the Reverse Repo Facility (RRP) to $2 trillion. (Mind The Cap via DiMartinobooth.com) Come what may, you can consider Goldman’s estimate of the terminal value of a $2 trillion balance sheet and the size of the RRP to be anything but coincidental.)
In any event, things change. As per Goldman, by 2022, “…changes in Fed leadership, regulation, Treasury issuance policy, or macroeconomic conditions could alter both the near-term path and the intended terminal size of the balance sheet.” Indeed.
It is entertaining to watch market pundits shift in their skivvies trying to assure the masses that a shrinking balance sheet will be welcomed by risky assets. It was downright comical to read that the Fed’s strategically allowing only long-dated Treasuries to expire and not be replaced would prevent the yield curve from inverting, thus staving off recession.
Pardon the interruption, but domestic non-financial sector debt stood at about 140 percent of GDP in 1980. Today, it’s crested 250 percent of GDP and keeps rising. Interest rate sensitivity, especially in commercial real estate, household finance and junk bonds is particularly acute. Oh, and by the way, monetary policy is a global phenomenon. At last check, the European periphery and emerging market corporate bond market were not in the best position to weather a rising rate environment.
The best performance, though, was delivered by Chair Janet Yellen herself. In the spirit of giving credit its due, Business Insider’s Pedro da Costa highlighted this delightful nugget from testimony Yellen presented to Congress in February: “Waiting too long to remove accommodation would be unwise, potentially requiring the FOMC to eventually raise rates rapidly, which could risk disrupting the financial markets and pushing the economy into recession.”
Isn’t the rapidly flattening yield curve communicating that ‘removing accommodation’ today is one and the same with ‘pushing the economy into recession’? In Da Costa’s words, this preemptive philosophy is “dubious” and akin to, “a modern-day finance version of bleeding the patient to cure it.” Hope you’ll agree that leeching has no more place in modern medicine than outhouses do in our backyards.
Even as the Fed battles its own public relations nightmare, it would seem policymakers intend to follow through on their threat to tighten on two fronts, though not concurrently. Will President Trump pass the test and stand firm on reinstating leaders at the Fed who will transform it into a less compromised, more apolitical institution? Or will Trump fold, opting to keep the doves in command?
It’s just a hunch, but a less-threatened Fed could just as easily be expected to back down on shrinking the balance sheet. Given where the economy looks headed, newly empowered doves might even be inclined to grow the balance sheet anew. Stranger things or political posturing? You tell me and while you’re at it, ever noticed the word, ‘die’ is embedded in the word, ‘diet’? Let’s just say bulking up is easier done than slimming down.
Toro, toro? Hankering for Hamachi?
Have an urge for uni? In Midtown? Well then, head west, to 8th Avenue to be precise. And keep walking, west that is. But go easy on the sake if you’ve got a sushi crawl in mind. No fewer than six fine purveyors of some of the best raw fish on the isle of Manhattan await you. Clearly the law of game theory applies to more than just clusters of gas stations.
Not sure you’d agree, but game theory made the study of economics engaging. The brain teaser’s roots date back to the 1920s with the work of John von Neumann. His work culminated in a book he co-wrote with Oskar Morgenstern which delves into the oxymoronic theory in its most straightforward form – a ‘zero-sum’ game wherein the interests of two players are strictly opposed.
But it was John Nash who elevated the theory to fame. The eminent Nash Equilibrium added practicality to the theory and opened the door to nuance. The ‘players’ were numerous and shared both common interests and rivalries. Hence six sushi spots in one square block and a handful more a few steps in either direction.
But what happens when game theory hits reverse gear? Is such a thing possible? The answer may be coming soon to a mall near you, maybe even one with its theatre and Sears still standing. Huh?
Developed in 1973, Valley View Mall rose to be a retail darling on the 1980s Dallas shopping scene. Even its name worked well with an iconic mall-era film (Why Valley Girl, of course! (Retailing in America: Valley Girl (Interrupted) Foley’s, Macy’s Bloomingdale’s anyone? All of these icons anchored Valley View at one point or another.
But that was then, in a pre-Amazon world, when people clearly got out more and discretionary spending was more discrete. In December 2016, the mall literally began to be bulldozed, albeit with two tenants still operating amidst the dust storm – Sears and AMC Theatres. On March 21st, the world learned that it could soon be just the theater left standing.
Though the Valley View Sears will still be open today from 11 am to 8 pm, odds are the retailer will not be with us in a year’s time. On March 21st, Sears Holding Corporation submitted a filing with its regulators that it has “substantial doubt” it can continue as a “going concern.”
Don’t recall companies being charged with making their own death throes’ announcements from your Accounting coursework? You are correct. Meet the new and improved U.S. accounting rules that have just come into effect for public companies reporting annual periods that ended after December 15, 2016, Sears included. The change shifted the onus to disclose from a given company’s auditors to its management.
It was telling that the Sears news fell on the very same day discount retailer Payless announced it could soon file for bankruptcy protection. That same day, the less ubiquitous Bebe female fashion chain said it too was ‘exploring strategic options,’ typically code for that same ill-fated Chapter in the court system.
Did Sears strategically time its disclosure? Not in the least according to the retailer’s CFO Jason Hollar. The day after the disastrous disclosure, he blogged out that the ‘going concern’ reference simply complied with regulators’ requirements that investors be apprised of any risks looming over the horizon. Hollar went so far as to say that Sears is a, “viable business that can meet its financial and other obligations for the foreseeable future.” Don’t shoot the messenger, but selling Craftsman, the last valuable jewel in the once encrusted crown, certainly doesn’t suggest that much of a ‘future.”
Unless, that is, the reassurances come down to CEO Edward Lampert trying his level best to play game theory in reverse. That would entail capitalizing on the dying chain’s real estate holdings before the rest of the players on life support clue in to just how dire the situation will soon be across the full commercial real estate spectrum. Lampert does, after all, run a hedge fund that happens to be the retailer’s second-largest shareholder. You would agree, the best managers excel at games.
One does have to marvel at the degree of denial among retailers when websites such as deadmalls.com actively track shuttering structures.
At the opposite end of the denial spectrum sits Boston Fed President Eric Rosengren, who is and has been publicly worried about an entirely different sort of challenge facing the real estate market.
It’s no secret that apartment prices are soaring. Over the past year, prices have risen 11 percent, leading the broad market. While that increase may seem benign in and of itself, consider how the sector has fared over the course of the recovery: prices have recouped an eye-watering 240 percent of their peak-to-trough losses. In sharp contrast, retail has performed the worst; it’s only recovered 96 percent of its losses.
Rosengren is rightly worried that the “sharp” increase in apartment prices could catalyze financial instability. He went on to say that, “Because real estate holdings are widespread, and the monetary and macro-prudential tools for handling valuation concerns are somewhat limited, I believe we must acknowledge that the commercial real estate sector has the potential to amplify whatever problems may emerge when we at some point face an economic downturn.”
If you would indulge a translation: The bubble in commercial real estate (CRE) could trigger systemic risk, which of course, no central bank can contain.
The ‘macro-prudential’ tools to which Rosengren refers include rules and caps on banks’ exposure to CRE. Odds are, however, that the horse has already fled the barn. Over the past five years, CRE lending has been running at roughly double economic growth, a dangerous dynamic. The result: banks’ exposure to CRE has reached record levels. Last year alone, bank holdings of CRE and multifamily mortgages rose nine and 12 percent, respectively.
More worrisome yet is that the most concentrated cohort – those with more than 300 percent of their risk-based capital at risk – is banks with less than $50 billion in assets; most have assets south of $10 billion. How exactly will small banks confront a systemic risk conflagration? That pesky potential presumably is what’s robbing Rosengren of sleep at night. He might just remember that small German lenders called Landesbanks were where subprime bombs detonated unexpectedly way back when.
Beginning to connect the dots? All of this lending has led to massive amounts of building. After troughing at an annualized rate of 82,000 units in late 2009, multifamily starts hit a 387,000-annualized rate last year – a neat 372 percent rebound. Permits data suggest 2017 will push an equal number of units onto the market while 2018 looks to be about three percent below these lofty decade-high levels. There are similar supply stories in the hotel sector, which has led to the beginning of the end for lodging. Indeed, prices across the full CRE market have begun to fall for the first time since 2009.
Take all of these moving pieces into account and ask yourself, is it any wonder retailers are rushing the exits, all but falling over one another to accelerate announcements of thousands of store closures? As ugly as the situation is today, if widespread panic promises to present itself, prospects for retailers will get that much nastier. Demolition specialists will soon forget what it was to have down time and headlines screaming about malls sold for $1 will lose their novelty.
Is Sears’ Lampert craftily capitalizing on a trend he saw coming first, giving new meaning to ‘first mover advantage’? Is retail on the receiving end of reverse game theory? John Nash would be so proud.
To say that we live in a brave new world, at least as it pertains to the media, is an understatement. Forget TV and radio as the sole conduits. Since Fed Up’s release five weeks ago, which spans approximately a dog year, I’ve done countless podcasts, Skype radio and video interviews, and Sirius radio stations. I’ve been on channels I’ve never heard of with such deep followings I clearly need to get out more.
Don’t get me wrong, there’s been plenty of traditional live TV and radio interviews. We can just no longer say that’s the norm.
I’ve also written. A lot. And that’s in addition to my weekly, which still stimulates my mind as no other intellectual outlet can.
Manners dictate that I not bombard your inbox every time I opine, in the written word or otherwise. But given the never-ending wrangling to which we are now subjected when our TVs are unmuted, I thought I would share two opinion pieces and one podcast released this week that remind us it is essential to look forward. We can only hope a spirit of compromise prevails giving our leadership in D.C. license to propel the country and economy into forward motion. The Bloomberg piece shot to the top of the most read list so clearly hit nerves. Let’s get going America! (In my humble opinion).
You will see the links to all three below my signature line. Have a great weekend.
Pension Crisis Too Big for Markets to Ignore — Bloomberg
Nine Years Later…All Fed Up — The Bell by Adam Johnson and Tom Essaye Podcast
Few words are slipperier than ‘ethos’ to grasp.
Even the best translation of the word – essence – is hard to get your arms around. Perhaps that is why so many of us were blissfully unaware until recently that the very essence of the American Dream was slipping through our fingers. Though the phrase, which captures the very, yes essence, of the American thirst for adventure, dates back to the hopes and spirit that emboldened prospectors to ‘Go West,’ those who first engaged in California Dreaming, it was James Truslow Adams’ popularization of the term that cemented the ideal into our collective psyche.
“But there has been also the American Dream, that dream of a land in which life should be richer and fuller for every man, with opportunity for each according to his ability or achievement. It is a difficult dream for the European upper classes to interpret adequately, and too many of us ourselves have grown weary and mistrustful of it. It is not a dream of motor cars and high wages merely, but a dream of social order and in which each man and each woman shall be able to attain to the fullest stature of which they are innately capable, and be recognized by others for what they are, regardless of the fortuitous circumstances of birth or position.”
It is sweeter still, in the annals of our proud U.S. history that these words were written in 1931, during the thick of the most ravaging economic devastation this country has ever known. And still hope defeated despair, reigning supreme, inviting the lowliest of street urchins to achieve greatness in this country of endless possibilities. Were that only still the case today.
The housing crisis has long stopped commanding headlines. According to ATTOM Data Solutions, the new parent company of RealtyTrac, default notices, scheduled auctions and bank repossessions slid to 933,045 last year, the lowest tally since the 717,522 reported in 2006. Is the final chapter written? Not if you live in judicial foreclosure states such as New York, New Jersey and Florida where ‘legacy’ foreclosures take years to clear. At the end of last year, 55 percent of mortgages in active foreclosure were originated between 2004 and 2008. Factor in what’s still in the pipeline and one in ten circa 2006 homeowners will have lost their homes before it is all said and done.
That helps explain one part of the chart below which was generously shared with me by one Dr. Gates. Longtime readers of these missives will recognize the nom de plume of my inside-industry economic sleuth. His first take on this sad visual, was that, “The heart of the American Dream has stopped beating.” Did that stop your heart as it did my own?
As you can see, after a steady 40-year build, owner-occupied housing has stagnated and sits at the lowest level since 2004. This has sent the homeownership rate crashing to 63.4 percent, the lowest since 1967. It would be nice to think that things were looking up for would-be homeowners. But it’s difficult to be overly optimistic when the local newspaper reports that house flipping in the Dallas-Ft. Worth area rose 21 percent in 2016, seven times the national rate.
In all, 193,000 properties nationwide were flipped for a quick inside-12-months profit last year, a 3.1 increase to a nine-year high. Moreover, the median age of a flipped home rose to a two-decade high of 37 years, about double the median age of homes flipped before the crisis hit. That translated into a median gross profit of $69,624 on a median selling price of $189,900 in 2016, a neat 49.2 percent margin, the highest on record. Awesome!
That is, unless we’re still talking about the American Dream. But then maybe homeownership isn’t all it’s cracked up to be.
At least you can still hang a shingle in this country. Right?
You may note that the decline in self-employed is appreciably more dramatic than the fade among the ranks of owner-occupied homes.
You see, it took more than even the cruelest recession to wipe out two decades of ingenuity, to decimate a trend, to shift a culture. Think of the financial crisis as merely the initial catalyst, the first nail in the coffin.
Then came access to capital, which was dealt a once in a century body blow. Seemingly overnight, credit cards and home equity lines of credit disappeared as a source of operating income. Arguably these two growth governors spread the lack of wealth evenly across the country. But it was the heartland that suffered the most as the number of community banks in the six years ending 2013 sank by 14 percent. Federal Reserve data found that this shrinkage resulted in a 40 percent decline in the number of people with access to community banks. (No, Dr. Bernanke, zero interest rates do not benefit the little guy. They just make it cheaper to borrow for those who have never and never will lose their entree to the credit markets.)
Note that neither ‘Dodd’ nor ‘Frank’ were mentioned in that last paragraph. The awful Act did indeed further impinge access to credit, but let’s say that falls under a different heading, the most insidious of the plagues unleashed on small businesses.
To that end, it’s the last nail in the coffin, the one that’s left behind the most difficult stain to eradicate, as we are beginning to find out the hard way as the GOP tears itself asunder on the public stage. Of course, we speak of the imposition of a regulatory burden that knows no precedent. It’s all but inconceivable to fathom an additional $100 billion in annual regulatory costs but that’s the reality, the legacy of the last administration.
More than anything else, even the Federal Reserve’s assigning of the have’s and have not’s among us, this suffocation of the ability to succeed that raised the hackles of middle-income Americans, bitter that they’ve lost the right to what once was every American’s birthright. The hope is that the nascent rebound off 2014 lows in self-employment continues as red tape is rightly slashed back to where it belongs, that is countries where capitalism doesn’t exist, that the 40-year low in new business formation is squarely in the rearview mirror. The prayer is that recession is not around the corner, an unwelcome development that would undo what little progress has been made.
“My hope is for our current President to turn this tide. Lord knows the last President didn’t do anything to get us back on track, and neither did the Fed,” Dr. Gates observed. “At least we still have baseball, hot dogs and apple pie.”
It goes without saying, ‘tis the season for all three of those National Treasures. Thank you, Dr. Gates.
As for yours truly…shall we dispense with the niceties for just a moment? Like it or not, part of what’s happened in housing is a natural Darwinian outgrowth of the ridiculous zero interest rate policy that’s set profit-seeking scavengers on one another. What we’re witnessing is a mere reflection of a world in which rational investments have been whittled down to nothing.
Still, might we at least raise an eyebrow to the schadenfreude that’s infected the housing market? Should we truly take pride in crowding out those who would rather own than rent a home in the name of hard-to-come-by profits in a low rate world? And what good have we done, allowing our feckless politicians to snuff out a proud history of entrepreneurship that put our country on the map? Will the one percent be capable of lifting all boats, or even care to do so, in order to reestablish our national pride?
It was later in life that James Truslow Adams placed a punctuation mark on his written legacy with the following:
“The American dream, that has lured tens of millions of all nations to our shores in the past century has not been a dream of merely material plenty, though that has doubtlessly counted heavily. It has been much more than that. It has been a dream of being able to grow to fullest development as man and woman, unhampered by the barriers which had slowly been erected in the older civilizations, unrepressed by social orders which had developed for the benefit of classes rather than for the simple human being of any and every class.”
No more elegant words were ever written to ensure our ethos would never be endangered. And yet it is at risk of extinction today. It is high time we stand up for what is rightly ours and take back the American Dream for one and for all.
Of all virtues to which we must ultimately aspire, forgiveness demands the most of our souls. In our naivety, we may fancy ourselves man or woman enough to absolve those who have wronged us. But far too often, we find our pool of grace has run dry. So deeply burdened are we by our emotions that grace to us is lost. How many of us have the strength of resolve to let bygones be gone for good? Those of the cloth recognize the damage self-inflicted scars sear into our souls as they seek to guide us through life’s most difficult journeys. They pray for our deliverance from a painful inner turmoil and with it the peace only forgiveness can convey.
None who have ever heard Don Henley’s The Heart of the Matter could be blamed for thinking divine inspiration itself came down from the heavens to spawn those longing lyrics. But it isn’t just the words that scorch their way into your memory, it’s Henley’s tone, the raw pain that pierces every time you’re caught off guard by the mournful ballad released in 1989. Henley sings of our feeble struggle as no other, grasping for our collective release in humility. “The more I know, the less I understand. All the things I thought I’d figured out, I have to learn again.” In the end, Henley hands down the cruelest of convictions: If you truly want to vanquish your demons, you must find the strength within to forgive.
Astute policymakers might be saying a few prayers of their own on fixed income investors’ behalves. The explosion in corporate bond issuance since credit markets unfroze in the aftermath of the financial crisis is nothing short of epic. Some issuers have been emboldened by the cheap cost of credit associated with their sturdy credit ratings. Those with less than stellar credit have been prodded by equally emboldened investors gasping for yield as they would an oasis in a desert. Forgiveness, it would seem, will be required of bond holders, possibly sooner than most of us imagine.
For whatever reason, we remain in a world acutely focused on credit ratings. It’s as if the mortgage market never ballooned to massive proportions and imploded under its own weight. In eerie echoes of the subprime mania, investors indulge on the comfort food of pristine credit ratings despite what’s staring them in the face – a credit market that’s become so obese as to threaten its own cardiac moment. It may take you by surprise, but the U.S. corporate bond market has more than doubled in the space of eight years. Consider that at year end 2008, high yield and investment grade bonds plus leveraged loans equaled $3.5 trillion. Today we’re staring down the barrel of an $8.1 trillion market.
The age-old question is, and remains: Does size matter?
Ask yourself, did size matter as it pertained to the mortgage market way back in 2006, when it peaked in size at $13 trillion? (That was rhetorical in the event you weren’t on Planet Earth at the advent of all modern times’ meltdowns.) Still, it’s the why behind the growth of any given market that matters most. In the case of both markets, the credit rating agencies have helped investors sleep at night, a fact that might now keep you up at night.
First, a disclaimer. Of course, speculative grade debt is riskier than its investment grade brethren. The vast majority of investors in the go-go junk market know this and are hopefully buckled up as such, especially if a true rate-hiking cycle is about to test their mettle – more on this later.
Still, it’s the blind abandon with which issuance has risen among investment grade (IG) issuers that should, but has yet to, give supposedly conservative investors pause. Consider that in 2011, a (then) record $741 billion was sold into the IG market. As an endless encore, in every single year that followed, issuance has shattered the prior 12-month record. Last year alone witnessed $1.28 trillion in issuance. As for all the rate hike anxiety permeating the airwaves, 2017 also appears to be in it to win it — $254 billion was sold in the first two months of the year, $20 billion more than the same period in 2016. Investors might soon have to call upon Archimedes’ concept of exponentiation to sufficiently capture how very large the numbers have become.
You might wonder how the health of the corporate bond market is faring as it bulks up. As Bloomberg reported last week, you’d have to time travel back to 2002 to get back to the last time IG issuers were carrying more debt vis-à-vis their profits. The sticking point is leverage ratios tend to peak as an economy is just emerging from recession, as companies’ revenue streams hit their nadir.
Today, though, as we’ve been told in tsk-tsk fashion, the economy is at the precipice of an accelerating trend. That’s a good thing as companies have sold a heck of a lot more debt than their profit growth justifies, leaving their rainy-day cash to cover their massive, mounting obligations at the lowest levels since 2009.
The good news is that on the surface, the chances of a hiccup appear to have diminished. According to credit rating agency Standard & Poor’s (S&P), 2016 ended on a relatively better low note: Some 68 global IG issuers were at risk of being downgraded speculative grade, five fewer than the last time the data were compiled at the end of the third quarter.
S&P refers to these envelope-pushing issuers as ‘potential fallen angels,’ with ratings at the cusp of crossing over into junk-land. Though you might be thinking one notch on a ratings scale is just that – one measly notch – crossing that line in the sand makes a huge difference for borrowing costs. The yield ‘spread’ above Treasuries paid by junk issuers is typically about double that of what IG issuers pay.
The not so good news is that the universe of potential fallen angels remains at historically high levels. The latest read of 68 potential fallen angels is identical to what it was last summer and appreciably higher than as recently as 2015’s first quarter when 42 issuers were at risk of downgrade to spec grade. Moreover, the divide that began to open between potential rising stars – those with the potential to be upgraded into the IG sphere – and potential fallen angels remains at the current cycle’s wides.
Perhaps most worrisome is the sector at the greatest risk of downgrades — that is, financials. Years ago, a high yield strategist remarked that declining commodities prices would take their toll in two waves – first, the actual commodities producers, and second, the financials who banked them as the initial commodities cycle became super-sized in magnitude. Bank balance sheets are highly susceptible to a nasty contagion effect.
And yet, here we sit watching those oil prices Janet Yellen lectured us would be at ‘transitory’ lows (several years ago) decline anew. God help us if crude’s latest swoon presages a broader downturn. Precisely because leverage is rising among IG borrowers, economic growth literally has to hang in there. If growth even slows, or worse, contracts, all this ballyhooed record issuance among IG issuers will devolve into unprecedented levels of potential-to-actual fallen angels. It will be as if the heavens have opened up as their wings burn and they tumble back to earth.
Of course, downgrades don’t necessarily denote defaults. The Start of the Matter may nevertheless require forgiveness in some form as refinancing needs are also now at record levels and must be met. If the Federal Reserve does not intervene, markets are likely to revert back to pure price discovery mechanisms; they will be brutally agnostic to the rate environment to say nothing of the economic backdrop.
Investors have begun to smell a rat. IG exchange-traded funds (ETFs) have slid more in price compared to their high yield ETF peers since the surprise U.S. election that set rates rising. But unlike junk’s magnificent rebound since then, IG has yet to stage a return rebound.
It all comes down to refinancing risk. According to S&P’s competition down the block, Moody’s, the refinancing needs of both IG and spec grade issuers will hit record levels over the next five years.
Spec grade issuers’ five-years-out refinancing needs have officially crossed the trillion-dollar threshold. Some $1.06 trillion will come due between now and 2021, up from $947 billion in last year’s refinancing risk study and double what they were ten years ago. In the event you’re concerned spec risk has been overly downplayed in this missive, rest assured, the same dynamics that propel record fallen angel levels will be the mother of all default-rate cycle accelerants. File that one away in the ‘actual forgiveness’ to come file.
As for the IG space, $944 billion comes due in the five years through 2021. But here’s the kicker – the need to roll over debt is going to come on much more quickly for IG. Maturities are roughly evenly distributed over the next five years as opposed to the needs in spec grade, whose rollover risk gains speed and crescendos in 2021 with a record $402 billion in refinancing coming due.
Is that why junk is trading more richly than IG? The yield at which spec trades vs. its Treasury equivalent has only been wider 13 percent of the time over the past 17 years (2007 should provide you comfort because…?). IG on the other hand has traded this ‘tightly’ in only 25 percent of the times records have been kept.
Would the start of the matter – the prospects for debt forgiveness and debilitating defaults – be threatening so were it not for central bankers’ meddling ways in markets designed to determine their own damn prices? The ashes will indeed scatter. They will let us know.
Of course, comic legend Jackie Gleason was no schlep in the world of thespians. Odds were high he would deliver a handsome return on stuntman cum director Hal Needham’s investment. And while it’s no secret there would have been no directorial debut for Needham had his close friend Burt Reynolds not agreed to be in the film, it was Gleason’s improvisation that made the Smokey and the Bandit the stuff of legends.
Though Gleason’s character’s name screams ‘surreal,’ the stranger than fiction fact is that Reynolds’ father was the real life Chief of Police in Jupiter, Florida who just so happened to know a Florida patrolman by the name of Buford T. Justice. The treasure trove of quotes from the film’s tenacious Texas Sherriff Buford T. Justice, who so tirelessly pursues the Bandit in heedless abandon over state lines, elicited nothing short of laugh-out-loud elation from anyone and everyone who has ever feasted on the 1977 runaway hit (it was the year’s second-highest grossing film after Star Wars).
Gleason’s most famous ad-lib moment occurs at a roadside choke-n-puke where Justice unwittingly strikes up a conversation with the same Bandit he’s chasing. “Let me have a diablo sandwich, a Dr. Pepper, and make it quick. I’m in a goddamn hurry,” Justice barks at a waitress after which point he explains to an innocent-faced Reynolds that he’s in such a hurry because he’s chasing a ‘maniac.’ As for yours truly’s favorite, there’s simply nothing funnier than Justice’s rant to his witless son: “There’s no way, no way, that you came from my loins. Soon as I get home, first thing I’m gonna do is punch yo mamma in da mouth.”
As much as Justice wants to score one for the good guys — “What we have here is a complete lack of respect for the law” — in the end, the ‘bad guy’ eludes capture. By the time the credits roll, the audience has no choice but to feel a little sorry for Justice and his habit of acting, and speaking, before he thinks, which inevitably leads to his downfall.
Far from 1977, a new sheriff is in town, and a certain White House occupant is in equally hot pursuit of, not a Bandit, but a strong job market to indelibly leave his mark on history. For the moment, it looks like he’s going to get exactly what he’s asking for using brutish Buford T. Justice-style tweets. At least that’s the causality guaranteed to be drawn.
Something is for certain. The job market is not behaving as one would expect in an economic recovery that’s nearing its eight-year anniversary. And it’s not just one aberrant indicator we’re talking about here.
Forget that we’ve just enjoyed one of the mildest winters on record. The 106,000 goods-producing jobs created in February is officially one for ADP’s record books in data that stretches back to 2002. In all, companies added 298,000, the most in nearly three years. This report alone will quickly silence all the whining we’ve heard of late about soft data being stronger than hard data.
As ‘soft’ as the survey data may be, one indicator within the most recent ISM report is plenty hard. Care of one of the buyside’s best and brightest, whose name has to remain outside the public purview, ISM customers’ inventories at a 10-month low necessitate a period of catch-up on companies’ parts.
A quick primer: The ISM report is a composite index of five diffusion indexes – employment, production, inventories, new orders and supplier deliveries – gathered from surveying over 300 manufacturing firms. A reading of greater than 50 signals those at the forefront of a company’s supply chain anticipate accelerating economic activity; a sub-50 reading signals the opposite. A reading of 65 or higher on the most forward-looking ISM new orders index pushes manufacturing into technical ‘bubble’ territory. As for 70, if it’s reached, look out below as the economy will have officially overheated. The most recent two episodes of 70 being hit occurred before most of us can remember, in 1973 and 1983. The pullback in activity that followed was, shall we say, swift and not so neat.
The current 65-reading on the ISM new orders sub-index, coupled with depleted stockpiles, indicate economic activity could well boil over. Companies will try to get ahead of tight supplies by paying up; delivery times should rise alongside this impulsiveness. Surprise, surprise — the sell side will feed the frenzy, which will push purchasing managers to go one step further and pile on supplies in anticipation of future demand.
Inventory builds, you will recall from Econ 101, are GDP-friendly. So set aside the Atlanta Fed’s Debbie Downer first-quarter GDP forecast of a paltry 1.3 percent. The second quarter looks set to stage a raging comeback. And it looks to be widespread. Of the 18 industries surveyed by the ISM last month, 17 reported improving conditions, up from just 12 in January.
But here’s the catch (does there always have to be one?). This from the ISM: “Comments from the panel largely indicate strong sales and demand, and reflect a positive view of business conditions (but) with a watchful eye on commodities and the potential for inflation.”
In other words, firms are a wee bit concerned a margin squeeze is on the horizon. If that’s the case and the job market is gaining momentum, they should add tightening financial conditions to their worry list.
Pop back into that econ class for a moment. The unemployment rate is the most lagging of all indicators. That means Fed officials should be hard-wired to underreact to job market data. What’s more likely is that they will be compelled to play a bit of catch-up of their own, chasing the curve they’re woefully behind with all their might.
Look no further than the follow through in the bond market from the blowout ADP report. At 1.36 percent, the two-year Treasury note yield is near an eight-year high, which has grabbed investors’ attention by the short hairs. Meanwhile, back over at the Bloomberg Terminal, the following headline just crossed: “Jobs Data May Fuel Bets on Four Rate Hikes in 2017.” Three hikes are darn near baked into the cake, as in a one-handle on the fed funds rate by September. Imagine that.
Like it or not, the Fed’s chase is likely to end just as badly as Buford T. Justice’s did.
Crash landings tend to follow the unemployment rate when it overshoots to the downside, which is exactly what households suggest is in the offing. The last time this many folks were predicting the unemployment rate would be lower 12 months hence was the early 1980s. What followed? Not just overheating, but a 10 percent correction in the S&P 500 over those same next 12 months.
What if, just maybe, just sayin….these extreme readings indicate that firms are sticking like glue to their employees out of a sense of panic that they’re irreplaceable in a world bereft of sufficient skill setters? What if the true, underlying job market is not gaining strength.
That would certainly seem to be the case in the message delivered via gauntlet in the Conference Board’s latest online help wanted postings. Before the howls of, “One month never makes for a trend!” begins, bear in mind that new job postings peaked in November 2015 while those of re-postings (new net of old) peaked a month later.
Up until this latest data set from February, the decline in demand for new employees had been steady but orderly. All that changed last month with the record 364,000 decline in new help wanted ads. The only month that was anywhere near as ugly was January 2009 in the thick of the last recession. Not only that, all 50 states saw declines as did all 52 metro areas tracked.
The one-month move was so striking the Conference Board released the following note with its report: “Recently, the HWOL (Help Wanted Online) Data Series has experienced a declining trend in the number of online job ads that may not reflect broader trends in the U.S. labor market. Based on changes in how job postings appear online, The Conference Board is reviewing its HWOL methodology to ensure accuracy and alignment with market trends.”
You gotta give the number crunchers credit where it’s due – at least they admit to their potential fallibility. That’s more than can be said of the arbiters of the inflation data favored by Fed officials.
We will soon enough know if all this inventory building meets a happy ending. If today’s reported demand is still red hot come Labor Day, well then, the labor market’s current signals could bode well for one Donald J. Trump’s first year in office.
If that’s not the case, if this is a massive head fake, well then manufacturers could be warily eyeing bloated stockpiles come August, stockpiles built on hope. Those keeping the nation’s factories up and humming might even be disenchanted enough to strike out against Trump’s attempts to jawbone the U.S. manufacturing sector back to its halcyon days. The exchange that follows could echo the following from Smokey and the Bandit, one that took place between a peeved fellow sheriff and Sheriff Justice, who had crossed uninvited into the other’s jurisdiction:
U.S. Manufacturers: The fact that you are President is not germane to the situation.
DJT (in a tweet): The goddamn Germans got nothin’ to do with it!
Oh, and please pardon the slight artistic license taken with the cast of characters. Think you get the message about what can be lost in translation loud and clear.
It’s no secret that these bigger than life baseball players are all Hall of Fame legends. But what about Mike Trout of the Los Angeles Angels? Or the Pittsburg Pirates’ Andrew McCutchen or Carlos Gomez of the Texas Rangers? What do all six of these greats have in common?
If you guessed that none of them were pitchers, you would definitely be on to something. If you’ve really been doing your homework in the preseason, you would patiently explain that all six were “complete ballplayers,” with above-average capabilities in hitting, hitting for power, fielding, throwing and running. If you wanted to show off, you could elaborate that each has at least three qualified recorded data points in one season in each of the five areas rendering them “five-tool players.” These are the well-rounded players of field scouts’ dreams.
The idea of this quintessential, albeit exceedingly rare player, harkens to another picture of perfection – the bond market. After peaking above 15 percent in 1981, the yield on the benchmark 10-year U.S. Treasury fell in July of last year to a record low of 1.36 percent. That there is what we call the rally of a lifetime. A major contributor to the mountains of wealth that bonds have generated include the venerable inflation-fighting of one Paul Volcker. The three subsequent boom and bust cycles, largely engineered by Volcker’s successors at the Federal Reserve, each made their own contribution and brought greater and greater degrees of intervention to bear on the market and helped push yields lower and lower. In bondland, that translates to prices soaring higher and higher.
Over the years, the castigators were cast aside time and again. As for the few with steel constitutions, who quickly drew parallels between Japan’s intrusions and those of the Federal Reserve, let’s just say they can retire and rest in peace. They bought 30-year Treasury Strips and buried them, giving new meaning to the beauty of buy and hold. To keep the analogy alive, let’s say that at that juncture, the bond market was a four-tool player.
But then suddenly, last summer, something gave way.
Since July, the conventional wisdom has held that bond yields have finally troughed, bringing a denouement to the 35-year bull run. Of course, those comprising the consensus collided in arriving at their conclusions.
Market technicians, aka the chart-meisters, provide the simplest explanation. In 2016, the 10-year yield sunk below 2015’s low of 1.64 percent and rose above its high of 2.50 percent. Technicians refer to such boomerang behavior in short spaces of time as “outside events” that mark the beginning of the end of a cycle.
The reflationists point to the pronounced uptick in the industrial metals complex as proof positive that inflation has seen its lows of the cycle. Everything from nickel to rebar to copper and back validated the notion that pipeline and margin pressures were building, especially if you had building a pipeline in mind.
And then we have the bullish economist cabal who insist that gross domestic product is set to accelerate into some sublimely sustainable hyper-drive mode. The increase off the lows in interest rates purely reflects the markets being forward-looking mechanisms and sniffing out the bevy of incendiary economic accelerants. In the event you’ve just emerged from a medically induced coma, we’re talking about small business formation, tax cuts galore and repairing every crumbling bridge and filling every pothole from Bangor to Baja. Oh, and by the way, delivered care of our cuddly Congress, in full, tomorrow.
Lastly, there’s the camp with which yours truly would most likely be associated: The Skeptics. As the ridiculous veered into the surreal last year, as nearly a quarter of a trillion in global debt yielded from somewhere south of one percent into deeply negative territory, some of us skeptics began to ask the ye-of-great-faith-in-omnipotent-central-bankers if they grasped the implications of policymakers’ intrusions. Did they really believe Mario Draghi could vacuum up a corporate bond market lock, stock and barrel, and his counterpart Hiroki Kuroda an entire stock market and live to tell? Or was exhaustion overcoming exertion?
At the end of the trading day, all four camps’ arguments are moot. At least, that’s the message the 10-year Treasury is communicating in no uncertain terms. If there is one thing the 10-year can be called upon to deliver, it’s consistency, as in behaving in the same way over time so as to be fair and accurate in anticipating the future. Lest you etymologists, pundits and, dare say, traders in our midst be tripped up, try not to confuse consistency with what you believe to be predictability, as in behaving in an expected manner.
You can carry this much, though not all the way to the bank — the bond market should have corrected long ago if history was any judge. Inflation, heck hyperinflation, should have ignited and burned our currency to the ground by now. But that hasn’t happened, has it? Unlike so many of you who do indeed deliver on the expectations front (yawn), the bond market has consistently surprised those with cocky certitude calling for sea changes.
You’re forgiven if it’s been difficult to incorporate a once-in-a-century outlier factor into your decision-making framework. The entrant of over a billion workers into the global workforce, coupled with the building out of the equivalent of the United States in its glorious industrial age, introduced a deflationary impetus that simply doesn’t exist in any economics textbook in print today. The weighty subsequent suppressant on yields, combined with the artificiality of central banks butting their way into bond pricing, held rates lower than logic or any econometric models dictated, confounding the esteemed doctorate community.
As for the here and now, worry thee not about the chartists, the inflation worrywarts, the optimists and even the skeptics. The decline in the 10-year yield tells you everything you need to know, and probably more than you’d like to acknowledge.
The simple fact is, the current economic recovery has peaked and rolled over. It’s one thing if some subprime auto lender you’ve never heard of is whining about regulators clamping down on premature repossessions. It’s quite another when the data tell you that car inventories are up nearly 10 percent over last year, GM is choking on incentives of its hottest selling pickups and State Farm has just swallowed $7 billion in auto loan underwriting losses (gulp!). Last check these were not hot-money, private-equity-backed fly-by-nighters.
In the event you require yet more proof that the bond scare was just that – scary — Behold! The yield curve flattens! After hitting a wide of 136 hundredths-of-a-percentage-point (basis point) in mid-December – which just so coincided with global bond losses hitting a cool $3 trillion — the difference between the 2-year and 10-year Treasury has narrowed to 112 basis points. Finance 101 tells us that the slimmer the divide between short and long rates, the closer we are to crossing into the netherworld, otherwise known as recession.
This precarious position posits a pondering pause: Exactly where does the Fed fit into the equation? By the looks of things, the post-election Fed has morphed into its answer to Dirty Harry. Odds of a March rate increase have catapulted to 70 percent in the space of three trading days, a tidy trek for academics more apt to move at the pace of molasses in January. And yet, their tough talk is borderline brash.
Take this from New York Fed President William Dudley three whole days before the onset of the blackout period ahead of next week’s Federal Open Market Committee Meeting begins: “I just think it makes the risks to the outlook a little bit tilted to the upside at this point.” When further queried whether the next rate hike should come, ‘sooner rather than later,’ Dudley replied. “I think that’s fair.”
As benign as his comments may read, make no mistake, they’re fighting words for a Fed that’s given new meaning to skittish for the better part of three decades. It’s as if Fed officials were contenders within reach of that five-tool status save one that last qualifier – hitting for power with a home run distance of 425 feet or more. Recall that Dudley is Vice Chairman of the Federal Open Market Committee. In other words, his conceding to a ‘go’ in March cleared the ball way over the fences.
Rather than delve into any (deeply political so as to throw economy into recession) motivations, let’s look beyond the next recession, inadvertently induced by an overly aggressive Fed, to the next question: How do policymakers wage that next battle?
Since you ask, this is where baseball reenters the equation, in its positively perfect form, in all its five-tool glory. Fighting the next recession is theoretically where the academics shine brightest and hit their collective pleasure threshold. This is where the bond yields steal home. There’s one word for it. Wait for it… “MONETIZATION.” The debt doth disappeareth.
It wasn’t until a recent and very heated public debate, at which a friendly colleague attempted to put your fearless writer in her place (a mistake), that the height of the stakes became apparent. For starters, we both agreed that the overabundance of debt, not just in the United States, but globally, was problematic. Fair enough. The solution to such an intractable problem was thus by its very definition, tricky bordering on tempestuous.
The good news, he insisted, was that in the end, boys would be boys and men would be men. The overly indebted developed-world economies would march off into the great blue yonder and not return until a gentlemen’s agreement has been secured. Pray tell, what form would that take?
In short, not in the neatest of forms. A blanket propaganda campaign would have to be launched educating the clueless public about the virtues of negative interest rates and a cashless society. Upon that sturdy foundation, we could then construct a full-blown monetization of the bloated debt we carry today, one in the same with what we’re told is technically irrelevant because models dictate it can be wished away.
Lest you be led astray, there’s no cathartic Kumbaya that conveniently follows before the credits roll. Milton Friedman was, and remains to this day, spot on in his observation that there is no such thing as a free lunch. My undaunted debater conceded that there would be losers, mainly emerging nations shouldered with boatloads of dollar-denominated debt and developed nations that were naïve enough to not be burdened with excessive debts. But so be it.
In global credit markets that exceed $200 trillion in outstanding securities, dominated by dollar-denominated debt, I deign to accede that the losers have much to lose indeed. Whether they will take their lumps lying down like lambs, however, remains a much wider, open and heated debate than that which played out on a stage in Austin, Texas. My greatest fear is that the war we will eventually face is of the all-too-real variety, precipitated by the greatest income divide since the years that preceded the Great Depression and the Second World War.
Rather than focus on such dire potential outcomes, take comfort in the adage that history doesn’t precisely repeat itself, but rather merely rhymes. Between now and Sunday, April 2nd, baseball’s opening day, relish in the welcome distraction to come. Count your blessings as we count down to the day we hear, “Play Ball!” and spectate with hope for the next five-tool player to make us once again believe.