It’s been a whirlwind week here in New York launching Fed Up — running from one TV spot to another, opinion pieces to reviews, responding to criticism by Fed officials (a good thing), radio and back. I can tell you that I’ve lost my voice a few times but not my bearings. The sun is shining brightly on Fed Up.
If anything, listening to Janet Yellen testify this week strengthened my resolve in doing everything I can to get Fed Up into the hands of those to whom the book is dedicated: Every hardworking American who wakes up in the morning asking themselves what went wrong.
Chair Yellen’s insistence that the economic recovery is sturdy only served to reinforce my thesis: Those leading the Federal Reserve simply don’t grasp the reality that so many participants in our economy perceive the recovery to be anything but sturdy, and it is sorely lacking in inclusiveness. Savers continue to be penalized, millions of millennials remain trapped in modern day debtor’s prisons, and the younger generations behind them are woefully oblivious to the virtues and rewards of saving today to ensure a better tomorrow.
It’s fair to say far too many central bankers still don’t get it, which is why I chose some of the wisest words ever written on the error of central bankers’ ways to open Fed Up: Never in the field of monetary policy was so much gained by so few at the expense of so many. Thank you for writing them, Michael Hartnett.
The good, no great, news is that President Trump has a tremendous opportunity to restore the integrity of the Federal Reserve. The end of the book, as so many of you have learned, provides him and those in Congress a road map on how to reform the institution. I know many of our leaders have the book in hand. Let’s hope they find some time over this long weekend to read it.
Linked below is a page to my website containing some, but not all, of the press that’s accompanied the book launch. I would add, ‘just in case you missed it’ to the end of that sentence. But even I haven’t been able to keep up.
One last word of thanks to all of you for feedback, admirable speed reading of the book and reviews posted to Amazon. Keep them coming!
Have a great weekend,
Click to Press Page: Get Fed Up
Fed Up: An Insider’s Take on Why the Federal Reserve is Bad for America.
“If it were possible to take interest rates into negative territory, I would be voting for that.”
— Janet Yellen, February 2010
As her fame has grown, Janet Yellen is recognized in restaurants and airports around the world. But her world has narrowed. Because the Fed chairman can so easily move markets with a few casual words, Yellen can’t get together regularly and shoot the breeze with businesspeople or analysts who follow the Fed for a living. She must rely on her instincts, her Keynesian training, and the MIT Mafia.
“You can’t think about what is happening in the economy constructively, from a policy standpoint, unless you have some theoretical paradigm in mind,” Yellen had told Lemann of the New Yorker in 2014.
One of Lemann’s final observations: “The Fed, not the Treasury or the White House or Congress, is now the primary economic policymaker in the United States, and therefore the world.”
But what if Yellen’s theoretical paradigm is dead wrong?
The woman who “did not see and did not appreciate what the risks were with securitization, the credit rating agencies, the shadow banking system, the SIVs . . . until it happened” has led us straight into an abyss.
It’s time to climb out. The Federal Reserve’s leadership must come to grips with its role in creating the extraordinary circumstances in which it now finds itself. It must embrace reforms to regain its credibility.
Even Fedwire finally admitted in August 2016 that the Federal Reserve had lost its mojo, with a story headlined “Years of Fed Missteps Fueled Disillusion with the Economy and Washington.” In an effort to explain rising extremism in American politics in a series called “The Great Unraveling,” Jon Hilsenrath described a Fed confronting “hardened public skepticism and growing self- doubt.”
Mistakes by the Fed included missing the housing bubble and financial crisis, being “blinded” to the slowdown in the growth of worker productivity, and failing to anticipate how inflation behaved in regard to the job market. The Fed’s economic projections of GDP and how fast the economy would grow were wrong time and again.
People are starting to wake up. A Gallup poll showed that Americans’ confidence that the Fed was doing a “good” or “excellent” job had fallen from 53 percent in September 2003 to 38 percent in November 2014. Another poll in April 2016 showed that only 38 percent of Americans had a great deal or fair amount of confidence in Yellen, while 35 percent had little or none — a huge shift from the early 2000s when 70 percent and higher expressed confidence (however misguided) in Greenspan.
In early 2016, Yellen told an audience in New York that it was too bad the government had leaned so heavily on the Fed while “tax and spending policies were stymied by disagreements between Congress and the White House.” Maybe if she hadn’t been throwing money at them, lawmakers might have gotten their house in order.
“The Federal Reserve is a giant weapon that has no ammunition left,” Fisher told CNBC on January 6, 2016.
The Fed must retool and rearm.
First things first. Congress should release the Fed from the bondage of its dual mandate.
A singular focus on maintaining price stability will place the duty of maximizing employment back into the hands of politicians, making them responsible for shaping fiscal policy that ensures American businesses enjoy a traditionally competitive landscape in which to build and grow business.
The added bonus: shedding the dual mandate will discourage future forays into unconventional monetary policy.
Next, the Fed needs to get out of the business of trying to compel people to spend by manipulating inflation expectations. Not only has it introduced a dangerous addiction to debt among all players in the economy, it has succeeded in virtually outlawing saving.
Most seniors pine for a return to the beginning of this century when they could get a five- year jumbo CD with a 5 percent APR, offset by inflation somewhere in the neighborhood of 2 percent. Traditionally, 2 to 3 percentage points above inflation is where that old relic, the fed funds rate, traded. The math worked.
Under ZIRP, only fools save for a rainy day. The floor on overnight rates must be permanently raised to at least 2 percent and Fed officials should pledge to never again breach that floor. Not only will it preserve the functionality of the banking system, it will remind people that saving is good, indeed a virtue. And that debt always has a price.
Limit the number of academic PhDs at the Fed, not just among the leadership but on the staffs of the Board and District Banks. Bring in more actual practitioners— businesspeople who have been on the receiving end of Fed policy, CEOs and CFOs, people who have been on the hot seat, who have witnessed the financialization of the country and believe that American companies should make things and provide services, not just move money around.
Governors should be given terms of five years, like District Bank presidents, with term limits to bring in new blood and fresh ideas.
Grant all the District Bank presidents, not just New York’s, a permanent vote on the FOMC. Why should Wall Street, not Main Street, dominate the Fed’s decision making?
While we’re at it, let’s redraw the Fed’s geographical map to better reflect America’s economic powerhouses.
California’s economy alone is the sixth biggest in the world. Add another Fed Bank to the Twelfth District to better represent how the Western states have flourished over the last hundred years.
Why does Missouri have two Fed banks? Minneapolis and Cleveland can be absorbed into the Chicago Fed. Do Richmond, Philadelphia, and Boston all need Fed District Banks? Consolidate in recognition of the fact that it isn’t 1913 anymore.
Slash the Fed’s bloated Research Department. It’s hard to argue that a thousand Fed economists are productive and providing value-added insight when their forecasting skills are no better than the flip of a coin and half of their studies cannot be replicated.
Send most of the PhD economists back to academia where they belong. Require the rest to focus on research that benefits the Fed, studying how its policies impact American taxpayers and citizens. (Did the Fed do any studies about how ZIRP and QE would impact banking and consumers before it imposed them? No.)
Now take all the money you’ve saved and aim it squarely at Wall Street investment banks intent on always staying one step ahead of the Fed’s regulatory reach. Hire brilliant people for the Fed’s Sup & Reg departments and pay them market rates. Rest assured this will be ground zero of the next crisis.
And mix it up. One of Rosenblum’s students applied for a job at the New York Fed. He came from a blue- collar background, spent seven years in the military, and earned his MBA from SMU on the GI Bill. Smart guy. But he couldn’t get to first base at the New York Fed. They hire people from Yale and Harvard and NYU—people just like themselves. Others need not apply.
Then the top Ivy Leaguers stay for two years and move on to bigger money at Citibank or Goldman Sachs. It’s a tribe that’s been bred over ninety years and slow to change.
But if the culture of extreme deference at the New York Fed (which also exists in District Banks to a lesser degree) is not quashed, regulatory capture will continue with disastrous results. The Fed must give bank examiners the resources they need to understand the ever-evolving financial innovations created by Wall Street and back them up when they challenge high- paid bankers who live to skirt the rules.
Regulators must focus on the big picture as well as nodes of risk. Interconnectedness took down the economy in 2008, not just the shenanigans of a few rogue banks.
Focus on systemic risk and regulation around the FOMC table. Create a post with equal power and authority to that of the chair to focus on supervision and regulation. Yellen talks about monetary policy ad nauseam, but when challenged by the press or Congress on regulatory policy she stumbles and mumbles and does her best doe-in- the- headlights impersonation. Markets need predictability and transparency when it comes to Fed policy, not guesswork, parsing of the chair’s words, and manipulation of FOMC minutes.
Finally, let nature take its course. Reengage creative destruction. Markets by their nature are supposed to be volatile. Zero interest rates prevent the natural failures of weak companies, weighing down the economy with overcapacity for generations.
Recessions might have been more frequent, the financial losses greater for some, but if the Fed had let the economy heal on its own, America would have been stronger in the end and the bedrock of our nation, capitalism, would not have been corrupted.
I could never have imagined how my near decade-long journey at the Federal Reserve would play out.
In the beginning, I had been a “risk radar” to benefit myself and those closest to me. I wanted to stay out of debt and make certain that my children had great educations and a foundation of financial savvy so that they could pursue their versions of the American dream.
But I realize now the stakes are much higher.
We’ve become a nation of haves and have-nots thanks to Fed policies that benefit the wealthiest investors, punish the savers and the retired, and put the nation’s balance sheet at risk.
As consumers on the receiving end of Fed policies, we must reform our education system so that the American dream can be accessible to everyone. We must campaign for Congress to stop hiding behind the Fed’s skirts.
And we must demand that the Fed stop offering excuse after excuse for its failures. Short- term interest rates must return to some semblance of normality and the Fed’s outrageously swollen balance sheet must shrink in size. And most of all, the Fed must never follow Europe by taking interest rates into negative territory.
No more excuses. The Fed’s mandate isn’t to have a perfect world. That only exists in fairy tales, dreams, and the Fed’s econometric models.
For those of you who subscribe to the Wall Street Journal, please link on to today’s story on the book: A teaser in the form of a quote from Richard Fisher who the Journal interviewed for the article. “The book’s greatest value is in describing ‘the hubris of Ph.D. economists who’ve never worked on the Street or in the City,’ as well as flagging ‘the protected culture’ of Fed officials in Washington. Many central bankers are, ‘not going to like the book.”
Not that Mr. Fisher asked for an answer. But to those who ‘don’t like it,’ I say, “So be it.” With that, please enjoy an excerpt from Fed Up, Chapter 11: Slapped in the Face by the Invisible Hand.
“You want to put out the fire first and then worry about the fire code.” — Ben Bernanke, December 1, 2008
Among the economists at the Dallas Fed, Bernanke’s optimism prevailed. The Bear Stearns rescue was the punctuation mark that ended the paragraph. Bernanke would trim the sails to right the foundering ship.
I disagreed. The demise of the Bear was a flashing red light that shouted “danger.” My colleagues rolled their eyes.
Rosenblum treated me with a new respect. The chain of events was playing out as I had predicted. He and I began collaborating on a paper on moral hazard. It would make Rosenblum no fans at the Board of Governors.
The bailout both relieved and alarmed the financial press.
The Economist wrote that the Fed was “taking the unprecedented (and, some say, disturbing) step of financing up to $30 billion of Bear’s weakest assets. This could cost the central bank several billion dollars if those assets fall in value.”
The fear of the unknown prompted the Fed, for the first time ever, to extend lending at its discount window to all bond dealers.
Under previous rules, only institutions offering depository insurance or under strict regulatory oversight were allowed to use the discount window, paying a penalty fee for the privilege. Now any distressed investment bank, broker, or commercial bank was allowed to come, hat in hand, to use the window.
The Economist expressed skepticism at this development, saying that fear persisted because the “new Fed window is untested and the very act of drawing on it could rattle markets.” No bank wanted to be perceived as the next sick buffalo.
Inside the Fed, the academics naïvely assumed that just because the window was opened it would be used. The people who had been in the market, such as Fisher and myself, knew the stigma associated with the discount window. Borrowers might as well invite speculators into the boardroom to short their stock.
Fisher told the FOMC that if the Fed could coax some “big boys” to access the discount window, “it could be a life-changing event in removing the stigma.”
To encourage lending, the Fed at its March 2008 FOMC meeting dropped interest rates again, to 2.25 percent. Fisher dissented, as he would again in April when the FOMC again lowered rates.
Fisher wanted to raise rates instead of lower them. This got under Bernanke’s skin. Bernanke “vented” in an e-mail to Kohn the day after the 10 to 1 vote with the subject line “WWGD?”: “I find myself conciliating holders of the unreasonable opinion that we should be tightening even as the economy and financial system are in a precarious position and inflation/commodity pressures appear to be easing.”
Like Rosenblum, Bernanke had internalized Greenspan’s approach to monetary policymaking. The Fed’s tradition of consensus was so powerful “in that context a ‘no’ vote represents a strong statement of disagreement,” Bernanke wrote in his memoir. “Too many dissents, I worried, could undermine our credibility.”
But tradition be damned, Fisher refused to be a yes man. He always feared the consequences of “pushing on a string”— a phrase with a venerable history at the Fed.
In 1935, Federal Reserve Chairman Marriner Eccles testified during hearings on the Banking Act that little could be done with monetary policy to stimulate growth.
“You mean you cannot push on a string?” Congressman Alan Goldsborough said.
“That is a very good way to put it, one cannot push on a string,” Eccles said. “We are in the depths of a depression and…beyond creating an easy money situation through reduction of discount rates…there is very little, if anything, that the [federal] reserve organization can do toward bringing about recovery.”
Fisher feared the same thing was happening. In the middle of what would become known as his year of dissent, he sat down for an interview with the Wall Street Journal.
“It’s really a question of, are we getting the bang for the buck?” Fisher asked. “And clearly we’re not. The system was sputtering and I began to feel that at 3.5%. After that, that’s when I dissented,” referring to his January 2008 dissent, when the FOMC lowered the fed funds rate to 3 percent.
The problem wasn’t interest rates. Banks didn’t begin making loans because they first had to shore up their capital bases to cover potential losses from their own toxic waste.
“The U.S. economy was suffering from a breakdown of the nervous system and they wanted to use conventional macroeconomic tools,” said Rosenblum years later. “None of these people had ever been through a financial crisis. Their response was the height of tunnel vision, shortsightedness and myopia.”
The Fed’s medicine was incapable of treating the disease in the system, but they insisted on using it. By doing so, they began to cripple the very banks they desperately needed to convalesce.
In an attempt to keep things flowing, the Fed expanded the type of assets it would accept as collateral from distressed banks, reduced penalty rates to virtually nothing, and speeded up auctions of quality bonds, so banks could put those on their balance sheets and off-load the junk onto the Fed. But there was still no stampede to the discount window.
Buyers of securities had disappeared; the great derivatives locomotive had slammed on the brakes, causing the train cars behind to slam into one another, derail, and slide off the mountain.
In mid-April 2008, the IMF warned that potential losses from the credit crunch foreshadowed by Bear’s fall could surpass $1 trillion. As if on cue, Swiss bank UBS reported an $11.5 billion loss and announced that it would cut 5,500 jobs by the middle of 2009.
The bond issuers were the next to get hit. On May 13, MBIA, the world’s largest bond insurer, reported $2.4 billion in losses due to write-downs of CDSs. By early June, Moody’s announced it would probably downgrade MBIA and the second- largest player, Ambac. S& P followed two days later with a similar announcement.
If only the monoline bond insurers had stuck to their original business of insuring municipal bonds. But the potential for fee generation by selling insurance for CDOs was too tempting.
One after another, financial institutions announced deep losses. The $5.4 billion loss announced by American International Group (AIG), a massive underwater depth charge waiting to explode, was lost in the parade.
The next systemic risk flare-up came from the West Coast. On July 11, 2008, IndyMac Federal Bank, a subprime lender based in Los Angeles and valued at $30 billion, was placed in receivership by the Office of Thrift Supervision (OTS).
Inexplicably, the OTS downgraded IndyMac without informing Yellen, whose bank had been in the process of offering IndyMac loans. What did the OTS know that Yellen didn’t?
That week, Congressman Barney Frank (D-Mass.) characterized as “solid” the future prospects of Fannie Mae and Freddie Mac, the two mammoth GSEs that guaranteed three out of every four mortgages in America. And made huge contributions to his political campaigns.
Frank had blocked all attempts by the Bush administration to rein in excesses at Fannie and Freddie. “The more people exaggerate a threat of safety and soundness [at Fannie and Freddie],” Frank said, “the more people conjure up the possibility of serious financial losses to the Treasury, which I do not see. I think we see entities that are fundamentally sound financially.”
But the GSEs were on a greasy slide to ruin. The companies had combined outstanding liabilities of $5.4 trillion. By early September, the Fed would be forced to take control of both Fannie and Freddie.
These past two weeks rank among some of the most tumultuous in U.S. postwar history, not just for investors, but every group imaginable save young children who’ve the freedom to not pay attention, much less care. ‘Uncertainty’ has taken on new meaning as the news cycle contracts to a nano-range in which sentiment can turn in the space of a 140-charcater transmittal of an unexpected message.
Into this breach stepped the Federal Reserve on Wednesday. Rather than capitalize on the uncertainty of the moment, policymakers retained their relatively cautious stance, wasting the chance to prepare markets for 2017 being the most aggressive year of tightening in over a decade. Recall that there are but four FOMC meetings followed by a press conference. If FedSpeak can’t jawbone a March rate hike back onto the table, policymakers will have precious little room for error to make good on their promised three rate increases for the remainder of the year.
Of course, ‘data dependent’ remains the mantra. Following Wednesday’s ADP report, and despite the data’s unreliable predictive power, confidence in today’s January labor report skyrocketed. This echoed household’s healthiest prospects for the job market since Reagan was in office. That makes it a good thing headline job growth did not disappoint. Private job creation exceeded estimates by a healthy margin, coming in at 237,000, 62,000 more than expected. Meanwhile the unemployment rate ticked up for the right reason, as more able-bodied workers rejoined the labor force.
The one black eye in the report was wage growth. At 2.5 percent in the 12 months through January, average hourly earnings ticked down from December’s 2.6-percent rate. That’s something of a surprise given the minimum wage rose in 19 states at the start of the year. Add to this what Peter Boockvar pointed out – that 305,000 jobs were lost by those in the 25-54-year cohort. Those ‘prime earning years’ have just not delivered for far too many in the current recovery. Strong wage gains remain the missing link, a subject I will write about in the coming week.
As for the trading week we’re about to log into the history books, it was a very busy one for yours truly in chilly New York. I’ve pasted links to what you might have missed below. As always, your feedback is most appreciated.
With that, wishing you the best for a relaxing weekend. To capture that peace, you might want to pretend we’re back in medieval times and not being endlessly pinged. In other words, unplug, lest you’re constantly jolted back to the new news cycle and our collective newfound restlessness.
“Yes, I have tricks in my pocket, I have things up my sleeve. But I am the opposite of a stage magician. He gives you the illusion that has the appearance of truth. I give you truth in the pleasant disguise of illusion.”
The next time you happen to find yourself at 111 West 44th Street in New York’s theater district, make it a point to gaze up at the haunting image of the illuminated sign for The Glass Menagerie, the play that launched the career of America’s greatest playwright. Maybe you too will recall the unsettling opening lines written in 1944 by Tennessee Williams, spoken by his protagonist, Tom Wingfield. Tom’s words promised to deliver the sort of truths few of us covet, though the play’s entertainment value has clearly withstood the test of time.
If you’re of the rip-the-Band-aid-off philosophy on facing life’s unpleasant realities, pivot on your heel and look across the street, to 110 West 44th Street. Your eyes will be immediately drawn to the less mesmerizing, but equally inescapable, signage gracing the edifice of that building, the U.S. debt clock, that live, unrelenting tally that is marching towards $20 trillion, be we all damned.
One must wonder if Broadway’s denizens see the theater in having these two facades stare one another down, as if taunting the other to wax more fatalistic.
This week, Federal Reserve policymakers will release a policy statement that paints an illusion of prosperity in cold monetarist verbiage that feigns the appearance of truth. The doves’ message will be uncharacteristically hawkish. They will flap their wings about accelerating underlying growth and inflation. They will allude to the time being upon us to normalize interest rates, to come in from a long, brutal winter of artifice.
The truth, you ask? Unconventional monetary policy in the form of zero interest rates and quantitative easing braced an economy that has been and remains fragile. And yet, as evidenced by the most recent bout of euphoria, animal spirits are out in full force.
There are other calendar years ending in the number ‘7’ associated with rampant speculation in asset markets and a strong Fed. Only one of the two proved to be a buying opportunity. The other stands as testament to one of the greatest monetary policy blunders in history.
As was the case in 1936, monetary policy had been manipulated to serve political needs. It’s noteworthy that the form assumed differed from that of recent years: it was huge gold inflows that were being monetized back then, but similarly, interest rates had been held closer to the zero lower bound for a protracted period.
In another parallel, measured goods inflation was conspicuous in its inability to achieve liftoff while that of asset prices was off the charts. (Has it really been 80 years of repeating the same mistake in gauging aggregate price behavior?) Then and now, investors exiled to a yield dessert justified their irrational approach to investing by rhetorically asking, “What’s the alternative?”
Commodities and stocks were the primary target of speculators in the recovery that took hold in 1933. Today, commercial real estate (CRE) and bonds have taken center stage while that of stocks is running a close third depending on your preferred valuation metric.
The latest Moody’s/RCA CPPI aggregate price index for CRE is remarkable. Prices through November, the latest on offer, are up nine percent over the past year. But they are perched 23 percent above their pre-crisis peak, which represents a vertigo-inducing 159 percent recovery of prices’ peak-to-trough losses. Morgan Stanley’s Richard Hill and Jerry Chen helpfully provide perspective on this figure: residential real estate, by comparison, has recovered a mere 80 percent of its losses. As for what’s driving the CRE train, office and industrial properties have taken the lead while, no shock here, retail property prices have begun to decline.
As was the case throughout the housing mania, loose underwriting standards can be credited with initially pushing prices upwards. Add to this lender behavior. Smaller banks, in particular, have aggressively reduced fees to garner market share, raising the ire of Fed regulators alarmed at the growing concentration of banks’ exposure to CRE loans. At last check, banks accounted for nearly half of CRE lending activity, up from 35 percent a few years ago. The good news, unless you’re a seller, is that lending standards have tightened for five consecutive quarters. In response, transaction volumes fell 21 percent in the final three months of last year. Hill and Chen observed that the sales slide, “was unusually high for a period that is typically very active.”
The prima facie evidence on extreme bond market valuation is equally compelling. Rather than delve into specifics on sovereign, corporate and emerging market bonds, we’ll let Deutsche Bank’s math speak for itself. It took a mere eight weeks through early January for the global bond market to rack up $3 trillion in losses. The swiftness of the move placed in stark perspective how hyper-sensitive bonds had become to interest rate moves. Investors should consider themselves warned.
As for stocks, the broadest valuation measure compares the market capitalization of all stocks to gross domestic product. Anything north of 100 percent denotes overvaluation making today’s reading of 127 percent disconcerting. That said, it has been higher – the ratio peaked at 154 percent in 1999 and was 130 percent in late 2015. It was, though, appreciably lower shortly before the stock market tanked. Just before the 2008 crisis, the ratio was at ‘only’ 108 percent. So make your own determination on this count. Does a relatively lower nosebleed valuation give you great comfort?
Looked at from a holistic perspective, the VIX, or so-called fear index, which reflects investors’ comfort level with stocks, flirted with single-digit territory last week. Though it did not break through 10 on the downside, which would have matched its 2007 low, the 10-handle is associated with plenty of daunting history.
“When the VIX is low and yields are falling, stocks do very well,” wrote Citigroup’s Brent Donnelly in a recent report. “When the VIX is low and yields are rising, stocks do poorly.”
That’s intuitive enough. Donnelly then goes on to compare the move in the benchmark 10-year Treasury to moves in stocks over the next 120 days. The sample set he used incorporates instances in which the VIX was less than 11 since 1990. A second step entailed comparing these occurrences to their corresponding three-month moves in the 10-year. Donnelly found that the largest three-month rise had been one standard deviation (you recall the term from Statistics 101, as in the distance from the center point on the bell curve). That is, until today.
“The craziest thing is this: Currently, the three-month rise in 10-year yields is more than 2.5 standard deviations. So based purely on this analysis, the 120-day outlook for U.S. equities is very poor.” The strength of the relationship between yields and future returns suggests stocks will fall by about seven percent over the next three months.
Like it or not, risky assets certainly appear to be sticking to the post-election, honeymoon-is-over script.
The burning question will quickly become one of, how will the Fed react? In its past life, stocks wouldn’t have to give back even 10 percent to trigger the next iteration of quantitative easing riding to the rescue. Listen to the doves’ tough talk today, though, and they sound as if they’re finally comfortable leaving risky assets to their own devices. Politics anyone?
The problem is that perhaps too much like the breakable menagerie of glass animals on display in Tennessee Williams’ play, borrowers of all stripes have amassed a veritable collection of debts throughout the market acts playing out since the Fed first lowered interest rates to the zero bound.
In an economy contingent upon conspicuous consumption, it won’t take much for the Fed to bring on a recession. The recent downtick in the personal saving rate is no cause for alarm on its own. Combine it with the steady increase in credit card spending – inflation-adjusted credit card spending has outpaced that of income growth for over a year now — and you quickly understand just how dependent continued gains in consumption are on interest rates not rising.
It’s been a mighty long time, eight years to be exact, since paper gains eviscerated the net worth of U.S. retirement savings in its various 401k, IRA and pension forms. Factor in the demographic backdrop, however, and know it won’t take long for investors to tune in to just how precious their non-yielding cash has become.
Perhaps the best news is that all heretical arguments in favor of the abolishment of cash necessarily go by the wayside during times of tightening financial conditions. After all, economic theory advocates the destruction of cash for the purpose of forcing hoarded money back into the economy. Even the illusionists at the Fed, hellbent as they are in their insistence that the economy is overheating, cannot square that circle.
Click on one of the links below to purchase Fed Up: An Insider’s Take on Why the Federal Reserve is Bad for America.
It’s conceivable you are not a regular reader of these newsletters. In deference to how busy you’ve been since last Friday, I’ll resist directing you to the full archive for the moment. Suffice it to say these missives usually begin with a catchy or sometimes kitschy cultural hook to draw readers in to such spicy subjects as bond market valuation, the prospects for monetary policymaking and one that’s near and dear for you — the state of the commercial real estate market.
But this week, in an open letter to you written in all humility, on behalf of myself and every patriotic American, I’d like to share with you the wisdom of one of our nation’s best and brightest military minds in the hopes you might adapt it to the economic issues you will be tackling during your time in office.
Lieutenant General John W. ‘Jack’ Woodmansee, Jr. served 33 years in the United States Army before retiring with the highest honors. Today, Lt. Gen. Woodmansee is the CEO of Tactical and Rescue Gear, Ltd., an 18-year old company that manufactures and sells goods to the Department of Defense, Department of Homeland Security and law enforcement markets. He’s a huge patriot if there ever was one and I’m sure you will agree we can all stand to benefit from his experience.
It is not uncommon to have mantras by which we live on our desks. When I was on Wall Street, I read and re-read mine every day, “Pigs get fat, Hogs get slaughtered.” That’s a good one, but perhaps better suited to your former day job. In your new role, which includes that of Commander in Chief of the Armed Forces, you would be better served to adopt the quotation Lt. Gen. Woodmansee uses as his guidepost to resolve “complex future requirements,” to borrow his words. (Get with me privately if you’d like to see Lt. Gen. Woodmansee’s Top Four Foreign Policy Priorities for National Security.) Without further ado, you may recognize these words as those of George Orwell:
“Sometimes the first duty of intelligent men is the restatement of the obvious.”
Let’s simplify that, military-style, in case you’re inclined to tweet this in the night. Call them Blinding Flashes of the Obvious that guide you — Bravo-Foxtrot-Oscar — to help sear the words into your memory bank. With that, what exactly are the obvious issues facing our economy? The Lt. Gen. narrowed his list to four, so I shall follow suit.
- The biggest challenge is what got you elected, that is the sense among millions of Americans that they’ve been on the outside looking in on the so-called economic recovery which technically started in 2009.
- Time is the second obvious element that is not on your side. Next Thursday marks the beginning of the third longest expansion in the post-World War II era. Recession will be a reality on your watch, and perhaps sooner than later.
- As you’ve recognized yourself, the financial markets are wrapped in bubble. You name it, they’re overvalued, some more than others.
- And finally, your central bank is, as my former boss Richard Fisher said, “a giant weapon that has no ammunition left.”
If only the solutions to what ails the economy were as glaringly obvious as what ails it. Patience and fortitude will see you through but you must prepare yourself for what’s to come. And though your initial actions do make it appear as if you believe economic prosperity can be signed into being with the whisk of an executive order, take it on faith that the country needs a lot longer than 100 days to get this economic party started.
That isn’t to say your energy industry actions aren’t to be lauded. Here’s for hoping exports are next. That natural foray accomplishes a national security aim as well. Foreign policy will be greatly strengthened if a certain egomaniac who lives east of Western Europe can no longer hold our allies hostage with the threat of their natural gas supplies being cut off in the depth of winter. Energy exporting and building those pipelines will also take us one step closer to energy independence, which is a foreign-policy and economic positive.
Then there’s the red tape that’s increasingly strangled our proud history of entrepreneurship. Please proceed to dump them at the nearest exit as you’ve promised to do. Let’s start-up and grow small businesses.
Afraid that sums up the low hanging economic fruit you can pick right away. Bringing bigly job growth back requires long term investment in educating our children in science, technology, engineering and math. Do you want to build the factories of tomorrow on American soil? Fine. Rip up the game plan and rebuild our education system, one community at a time.
If you won’t take my word for how critical this is, have a quick look at our literacy stats vis-à-vis other developed nations. As for the desire and wherewithal, Google that photo of single African-American mothers marching across the Brooklyn Bridge to retain charter school funding. Easier yet, pull up footage of this past Tuesday’s protest on the south steps of the Texas state capitol building – thousands of parents demanding tax dollars to help fund optionality in where they educate their kids. It IS broken and you’re not beholden to any special interests. Let’s fix education!
Fair warning: the recession inevitability thing won’t be easy on you. So why not bet on the come? Starting points do matter and, hate to break it to you Dorothy, but we are not back in Kansas circa 1980 anymore. Resisting radical central bank intervention will be a difficult test of your mettle. Helicopter money, negative interest rates, more bond purchases to grow the Fed’s balance sheet further, the abolition of cash. Just say no, which you can do via proxy, which we’ll get to shortly.
When it comes to recessions, we all know that discretionary spending is hit the hardest. That’s where those tax cuts and infrastructure spending you’ve committed to come in. They’re not perfect, but why not anticipate a crisis and simplify the tax code now – like tear it up and start from scratch? That’s called an uphill battle as your own party might not cotton to radical change. But you say you’re an artful master in the deal-making department. Go make one while the sun is still shining and what little time you have left remains on your side.
You’ll note that a purist’s approach to tax reform slaughters many sacred cows in the process. In the event this is intimidating, recall that thing about owing no one anything. Ask yourself a few questions. Will hedge funds, private equity firms and venture capitalists be destitute if you close the carried interest loophole? Do occupants of mansions really need the extra tax break afforded mortgage interest deductibility? And would it be better to bring a big chunk of those overseas profits back home? If you answered yes to that last question, ask around — there are ways to ensure those firms don’t simply plunk what’s repatriated back into share buybacks. We’ve seen how that stagnates economic growth, so why go there?
Tax reform will, by the way, go a long way toward dispensing with the searing criticism you face as you approach the desperate, and bonus, obvious, need to upgrade the country’s crumbling infrastructure. While you might like to have this be a purely privately funded scheme, it’s reasonable to assume that some public funding will come into play – think they call it ‘hybrid’ funding (call up your Australian counterpart for the specifics). The good news is that unlike tax cuts, which can be saved or diverted here or there, investment in bridges, tunnels, roads, schools, hospitals and the like is here to stay and keeps paying economic dividends in the form of the other business spending it induces around it. So, direct and indirect lasting economic benefits.
As for those bubblicious markets, they’re sure to be upset once they get the first whiff of that recession we just discussed. We can agree that letting the air out of the markets will be disruptive, and not in a good Uber way. There are no easy answers on this count. You might be faced with so few options that you’re forced to focus on the really heavy, preemptive, legislative lifting discussed above to mitigate the collateral damage. The best news that can be offered is that reasonably valued assets forge a natural pathway to future economic growth.
Finally, there’s the thorniest issue of all, the Fed. You may note the long road ahead is fraught with legislative barriers. To the extent financing is required, it’s always beneficial to contain borrowing costs. It would be nice to think you could rush into the Treasury market and issue a boatload of 50-year and 100-year bonds. But there are more than even odds that opportunity has been squandered by an epidemic of short-sightedness on the part of your predecessors. Let’s be magnanimous and say they didn’t appreciate the immense fiscal defenses that could have been built up against the backdrop of the lowest interest rates in 5,000 years. Deficit smoke-and-mirrors surely never came into play.
For the here and now, Fed officials seem intent on doubly tightening financial conditions by shrinking the $4.5 trillion balance sheet while raising interest rates. Knowing recessions are an inevitability should give you the resolve to offer the politically-driven doves-turned-hawks two words: “Try me.”
This done, back legislation to reduce the Fed’s mandate to minimize inflation. This will prevent future bouts of mission creep. Next, beef up bank supervision (note, never used word “regulation”) to stay one step ahead of nefariousness. And finally, fill those two open vacancies on the Board, and fast, with individuals who don’t think “no” is a four-letter word. Bring dissent back to the Fed by installing the best and brightest, who also happen to have uncompromising constitutions. Let the new kids on the block carry out your leadership of the Fed by proxy.
Tall orders, one and all? Without a doubt. But at least you’ve got hope, ebullience and inspiration on your side. Surveys of businesses and households suggest you’ve even got the fillip of an economic acceleration in the cards. So seize the moment and embrace the fact that you don’t require a lot of sleep to effectively lead. The hardest deals of your lifetime lie ahead. Don’t back down for all our sakes. And keep Orwell’s words in mind if wily politicians try to bog you down in the weeds. Bravo-Foxtrot-Oscar. An added bonus: it makes a great Tweet.
We the People
PS – for a more detailed road map to upending the Fed, Click “Fed Up” – happy to chat in person at your convenience.
How is it exactly that we’ve journeyed from Uber-Doveville to life on Tightening Row? My answer is, “You tell me.” In the space of one election, Fed officials have metamorphosed from crying for fiscal stimulus to opining that the economy doesn’t really need all that much help after all from fiscal authorities.
The outlook has, in fact, improved so much that the unheard of, the sacrosanct, is now reasonable. Yes, if you have to ask, I speak of the precious balance sheet that was protected as is it were the very Ark itself. It, too, now is fair game to shrink.
If it looks like double tightening and sounds like double tightening, well then, by golly that’s what it is. The economic recovery is now so durable it can not only handle rising interest rates but an absent Fed in the Treasury and mortgage-backed securities in which it’s been ever present since the zero bound was hit back in 2008.
Yes, it is time to pinch yourself or ask if politics is so blatant as to be conspicuous in its very presence. For an explanation of this cryptic concoction, please read an opinion piece published yesterday.
For those living under Chinese rule of law and inclined to matricide, patricide or simply high treason, their luck in sentencing matters took a decided turn for the better in 1905.
It was then that after 1,000 years as part of China’s penal code, Lingchi, or Death by 1,000 Cuts, was formally outlawed by the merciful order of Shen Jiaben. Consider this method of torture that eventually, emphasize that eventuality, leads to death, to be as far as opposite as can be from a mercifully speedy beheading by razor sharp sword. The good news, for history’s more squeamish voyeurs, is that we mere mortals can only endure so much pain and terror — the 1,000 cuts was probably an egregious exaggeration. Though accounts vary, in most cases, all that was required were a few well-placed, satisfyingly deep cuts and the condemned lost consciousness, missing the worst of their own cuttingly meted misfortunes.
As with many things throughout history, it would seem that necessity is indeed the mother of invention, even in matters of torture. In the case of Lingchi, we can thank dear old Confucius and some of his closely held ideals as they related to filial piety and the form of punishment deserved, if not fully observed. If you respect mom and dad, and your elders in general, you demand of yourself the highest standards. If however, you fail these most sacred of duties, you could not reasonably expect to arrive whole, as in intact, to your spiritual life, hence Lingchi.
As for being intact, after a messy holiday shopping season, some investors have begun to question how the physical retail body will survive Jeff Bezos’ answer to Death by 1,000 Cuts. The poster child for a slow death in retailing, Sears, kicked off 2017 with the announcement that it would close an additional 150 stores, bringing to 200 the total for the current fiscal year. That’s on top of the 78 shuttered last year and the more than 200 in 2015. By April of this year, the once-quintessential retailer will have fewer than 1,500 stores left standing, down from 2011, when it had more than 3,500.
Six years ago, it appeared that Sears might be the only icon to give new meaning to, “Anchors Away!” The reality today is that Sears has been joined by more than a handful of other names we once thought impermeable to the scourge of E-Commerce.
You would agree it’s been a rough go of it for bricks and mortar. Circuit City started things off a decade ago and was followed by Linens & Things, Blockbuster, Borders, and more recently, Radio Shack and Sports Authority. As is the case with the most recent fallen name, The Limited, many of these once-household names were invaded by private equity kingpins and saddled with untenable debt loads.
Outright bankruptcies, nonetheless, are not where the pain is most acute. That preserve is on reserve for a different kind of demise, an appreciably slower descent into irrelevance. At first, the disruptive power of E-Commerce appeared to apply only to things that could be read or viewed on a screen. More recently, though, any product that’s quantifiable at any level is fair game whether it be Jimmy Choo’s, a trip to Katmandu or Vintage Scooby Doo. Hence the frantic game of catch-up so many retailers are playing to raise their online visibility. The problem is catch-up can be costly. Just ask any retailer closing stores, one not-quite-lethal cut at a time, and they’ll set you straight.
On the other hand, as we well know, many nasty storms proffer a silver lining. Surely all of this capacity coming out of the standing retail universe invites opportunity in some form? Sorry to report this to all those investors looking to capitalize on bargain basement retailers, you can consider yourself warned. Not only is private equity sufficiently burned to steer clear of the sector, E-Commerce sales are not nearly as modest as what’s being reported. Wait a minute – “Modest??”
A brilliant, albeit perfectly private, analyst recently deconstructed the retail sales data, carving out auto, food and beverage and gasoline sales from the pool to arrive at what he calls Relevant Internetable Sales, or RIS. Of the roughly $1.2 trillion in annual retail sales, half can be classified as RIS, or the ‘fair game’ referenced above.
Don’t want to lose you here and shouldn’t even be running the risk as this is simple math. E-Commerce sales represent just north of eight percent of the total retail sales pie. Those are the figures you read about month in and month out. Narrow it down to the RIS half of the total retail sales pie, and lo and behold, E-Commerce’s market share rises to 15 percent of the halved pie.
In the event you think yours truly has fallen into an intellectual ditch, promise there IS a point forthcoming. If you examine the growth of RIS sales back to when the economy technically exited recession, in mid-2009, a distinct pattern emerges. The growth in E-Commerce Sales came out of the gate at a run rate of roughly a third of that of RIS sales. Flash forward to today and the growth rate of E-Commerce sales is half that of RIS sales and poised to soon overcome that of RIS’ sales growth. Looked at slightly differently, the growth rate of E-Commerce sales has risen to 15 percent year-over-year while that of RIS has meandered at a third of that rate.
The click, in other words, is in full cannibalization mode and intent on razing a mall near you in the near future.
It would be easy enough to trail off onto a tangent and begin debating how many warehouse jobs will be created even as traditional retail jobs disappear by the tens of thousands. Amazon, after all, just announced it would be creating 100,000 jobs in the next 18 months. (No, Virginia, a lifer retail sales associate cannot miraculously morph into a warehouse workhorse. But let’s not go there.)
Instead, let’s delve into the driving force behind E-Commerce eating into established emporiums’ empires. A gaggle of researchers from Harvard, Stanford and the University of California recently released the findings of a study that delved into the lifetime earnings capacity of different generations of Americans dating back to those born in 1940, one in the same with those who hit 30 in 1970. They then compared subsequent generations born 10 years hence – 1950, 1960, and 1970 – all the way through those born in 1980.
What, pray tell, did the fine professors find? In a nutshell, the impetus behind the exodus.
A neat 92 percent of those born in 1940 made more than their parents did, defining the American Dream, baseball and apple pie. Leap ahead to the baby class of 1980, though, and the legions of leap frogs dwindles to 50 percent. Do you recall that thing about necessity and motherhood and invention? What if, just say, Bezos was such a visionary he foresaw demographics and an atrophying economy necessitating the disruptive forces that manifested themselves in the form of E-Commerce and his brainchild Amazon?
OK – maybe that’s a stretch, even for me.
But Bezos, born in 1964, has been able to connect a dot or two since founding a company that back in the day committed the comparatively cordial sin of putting book stores out of business. That toll was tentative and tame compared to the devastating damage being exacted on countless contemporary chains today.
The fact is, pricing power is dead, having been tortured into extinction. Yes, yes….hallucinogenic harried housewives who’ve convinced themselves they’re busy could well give Alexa a run for their husbands’ money, barking out orders for everything from 52 Weeks of Flowers a Year to 50 Shades of Grey’s sequel’s sequel’s sequel (seriously?).
For the rest of us slaves to Amazon Prime, it could come down to affordability, or the lack thereof. Plan on the punditry assuring you in the months to come that the growth in credit card spending is as clear a vote of confidence in the country’s future as any out there. Consumers aren’t telling you they’re optimistic, they’re showing you, by golly!
While it’s true, that the plastic in peoples’ wallets has caught fire, the incendiary indulging has yet to catch up with still-inadequate income growth. The latest figures from November, lamentably reported with a lag, tell us that inflation-adjusted credit card spending is outpacing that of inflation-adjusted wage growth by 2.8 percentage points, the widest margin of the current expansion, and discernibly greater than October’s gap of 1.7 percentage points.
You tell me – are the rest of us confident or desperate to make ends meet?
Better yet, how much better or worse off will the collective ‘we’ be when tens of thousands of sales associates are shoved out of the workforce? These working folks are some of the last of the non-college-educated souls toiling away in our midst, grinding out honest livings. As things stand, the pay gap between degree holders and those who weren’t fortunate enough to study after high school is at its widest point on record. Wherever exactly do we go from here?
Few care to admit that most of the malls in America will disappear in the decade to come. For far too many, retail executives included, it’s a simple matter of not being capable of letting go of the past, which is understandable. Nevertheless, and as much as we’d like to believe differently, economic and demographic realities, and let’s face it, cultural shifts in shopping behavior, beg to differ. We do, though, have a choice: we can begrudgingly acquiesce into acceptance, by way of 1,000 blood-curdling cuts, or move on to what will be the next generation of retailing in America, as unrecognizable as she may be.
Click on one of the links below to purchase Fed Up: An Insider’s Take on Why the Federal Reserve is Bad for America.
Today I am proud to announce that the book I have spent the last two years working on – FED UP: An Insider’s Take on Why The Federal Reserve is Bad for America – will be available wherever books are sold on February 14th. Consider it a Valentine’s Day Forget Me Not to the country. FED UP is not only important to me, but it’s a critical read for every citizen of this country, especially now. As I stated in my Bloomberg piece last week, President Elect Trump has the opportunity to rebuild the Federal Reserve from the bottom up and reshape our economy in unfettered, uncompromised fashion.
In Fed Up, I pull back the curtain on the Fed and explain what really happened to the economy after that fateful December day in 2008, when interest rates were taken to the zero bound. I elaborate on how a cabal of unelected academics within the Federal Reserve made fatal policy decisions based not on the direct impact it would have on the average American household, but rather on their theoretical models that effectively muffled the voices of this country’s working men and women.
Please know that without the weekly Money Strong newsletter and your loyal support, there would be no book. Accept my humble gratitude for your undying encouragement with this gift of an early look at the book, before it hits the stands. For those of you who choose to order the book in advance, I’ll send you an early sneak peek. Please click HERE for more info.
I cannot tell you how excited I am to embark upon this journey with you and, as has always been the case, welcome your feedback.
All the best,
Celery and raspberry? Marathon miles of Sudoku and crossword puzzles? Extra reps at the gym? Binge away.
‘Tis the season after the season, that other most wonderful time of the year when it’s a challenge to get a machine at the gym and resolutions are resolute, at least until February or a more intriguing deal comes along. What better way to make amends for that huge holiday hangover that crescendos with so many a New Year’s Eve bash?
Some of us chose to ring in 2017 in a substantially more subdued manner that nevertheless entailed binging of a decidedly different derivation. Enter Netflix. Yours truly must confess that closet claustrophobia was the culprit in keeping this one indoors coveting the control, confining the choices to richly royal romps. It all started innocently enough, with a recommendation to catch The Crown, which has just won a Golden Globe. The devolution that followed began in Italy, with Medici, stopped over in France, with Versailles, and round tripped back to England, with the epic saga that kicked off the modern day, small screen genre, The Tudors. At some point hallucinations began to give the impression that all the series’ stars had British accents. Wait, they actually did.
Thankfully, at some point, bowl games snapped the spell and reality rudely reared its redemptive head before anyone’s else’s head rolled (those royals were a bloodthirsty lot!). Sleep and sanity followed.
Sadly, the same cannot be said of borrowers of almost every stripe these days. For those tapping the fixed income markets, the borrowing bingefest is conspicuous in its constancy. Not only did global bond issuance top $6.6 trillion last year, a fresh record, sales are off to a galloping start thus far in January.
In the lead are corporate bond sales, which accounted for $3.6 trillion of last year’s super sales. To not be outdone, investors ran a full out sprint in the new year’s first trading week, “shattering,” not breaking records, in the words of New Albion Partners’ Brian Reynolds. In the first three trading days of the year alone, investors bought $56 billion of new corporate bonds. Some context in the context of what’s been one record-breaking year after another in issuance:
“An average month in recent years would see investors buy about $130 billion of corporate bonds,” noted Reynolds. “Investors just bought more than 40 percent of that monthly average in just three trading days!”
For those of you who have ever had the pleasure of a good, long visit with Reynolds, he is anything but prone to using exclamation points. (!)
In any event, waves of heavy issuance often coincide with big deals carrying ‘concessions,’ or enticements in the form of higher yields than what the issuer’s existing bonds offer. Despite 2017’s already extraordinary deal flow, a good number of issues stood precedence on its head, coming out of the gate with negative concessions. “It’s as if corporate bond buyers are rabid, as if there are not enough corporate bonds to go around, even though there is a record amount of corporate bonds!” added Reynolds.
The kicker – there always is one when fever sets in – is that issuers are earmarking proceeds as generically as they can, for “general corporate purposes.” In other words, they can use the sales proceeds for whatever they desire, including share buybacks.
But wait! (Can exclamation points be contagious?) Haven’t we just learned that buybacks took a nosedive in the latest Standard & Poor’s data release? That quarter-over-quarter share repurchases had fallen by 12 percent and tanked by a stunning 25.5 percent over 2015’s third quarter? What superb sleuthing you’ve done, Watkins!
And right you are, except this one little thing. The pre-election world is so passé.
What are the odds share repurchases reaccelerate under the new administration? In one word ‘growing,’ fed by two springs. The first is mathematically driven. Calpers, the country’s largest pension, recently announced it would be “gradually” lowering its rate of return target to 7.0 percent from 7.5 percent. In the nothing-is-free department, estimates suggest taxpayers will have to cough up an additional $2 billion per year to make up for what the pension no longer anticipates in the form of pension returns.
(Suspend reality as the pension returned 0.61 percent in its most recent fiscal year ended June 30. We could ride off on a tangent but link to this if you’d like to hear more on pensions’ prospects http://dimartinobooth.com/will-public-pensions-trumps-biggest-challenge-2/)
The funny thing is California governor Jerry Brown just announced he anticipates the state will run a $1.6 billion deficit by next summer as the tax base continues to atrophy driven by – wait for it – rising taxes. And where are a lot of those tax dollars going? You guessed right again – backfilling that yawning pension gap. Will the exodus out of the Golden State continue, leaving only the uber-wealthy and economically immobile behind? You tell me.
Promise there’s a point here. Calpers will lead the way to other pensions also lowering their rate of return targets, which will in short order trigger more in the way of rising taxes and, it follows, more actual monies pensions allocate to fresh investments to thereby generate those fairy tale returns. To stay deeply deluded and convince oneself (still) high returns are achievable, the de rigueur investment is private equity credit funds in their many high voltage varieties. At Reynolds’ last count, pensions have voted a record dollar amount into credit every single month since the stock market panic of 2015.
And the momentum just keeps building. December 2015’s record pension credit fund inflows of $7.3 billion were blown to bits by this past December’s $10.6 billion – and that’s before any leverage is put to work. As we have hopefully learned, the credit machine feeds the buyback machine, and away we go. Tack on the prospects of a Republican Congress facilitating the repatriation of all that offshore cash and you’ve got the makings of a true buyback renaissance. Oh, and by the way, a seriously overvalued bond market.
Jesse Felder, president of Felder Investment Research, recently put pen to paper to quantify the value investors get today. What sets Felder apart from the crowd, in a good way, is that he factors in the backdrop of record bond issuance feeding what had, until very recently, been a record pace of share buybacks.
“When you look at corporate valuations more comprehensively, including both debt and equity, we have now matched that prior period,” Felder wrote in a recent report, referring back to peak dotcom bubble valuations. To arrive at this conclusion, he compares the value of nonfinancial corporate debt and equity relative to gross value added, an effective gauge of enterprise value-to-sales.
How does Felder calculate such a clever metric? With the help of some Federal Reserve data, no less, he incorporates the buyback bout to create a holistic valuation methodology to capture comprehensive corporate valuations. Because one frenzy, bond sales, has fed the other, the stock market’s historic run by way of share count reduction, it’s simply disingenuous to not marry the two. You can want to try, but it’s futile to examine bond or stock valuations in a vacuum.
“This has essentially been a massive debt for equity swap that serves to reduce the value of equity outstanding while greatly expanding the amount of debt outstanding,” added Felder. “Equity-only valuation measures fail to account for this phenomenon. This measure incorporates it.”
The point, though, is not that the current rally will necessarily buckle under the weight of bloated valuations. To the contrary, pensions’ sheer buying power, their trillions upon trillions of dollars of monies to be allocated, can indeed make it appear that we are now in 1999, or better yet, 1996. But don’t be fooled – you’re still paying a dear price to play with fire.
So stop yourself the next time you hear some talking head reassuring you that the price-to-earnings ratio on a trailing 12-month basis is dirt cheap. Fight the temptation to validate your sense of security by proclaiming, “Wow, that erudite expert has some set of lobes!” Don’t just move on to the next episode, hitting BUY on that equity ETF. Stop and ask yourself just how profoundly this deep thinker has probed into the true drivers of valuations in recent years. More to the point, ask yourself whether the source is clean or compromised.
If you need inspiration, look to some of the greatest lines ever penned in Politics and the English Language by George Orwell: “The great enemy of clear language is insincerity. When there is a gap between one’s real and one’s declared aims, one turns as it were instinctively to long words and exhausted idioms, like a cuttlefish spurting out ink.” And yes, Orwell was English. You can safely read his words aloud, with a British accent.