The Five-Tool Bond Market

The Five-Tool Bond Market, Danielle DiMartino Booth, Money STrongWillie Mays, Duke Snider and Ken Griffey, Jr.

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.

UpEnding the Fed: The Administration Redemption

Danielle Dimartino Booth, Money Strong, The Administration Redemption“Remember Red, hope is a good thing, maybe the best of things, and no good thing ever dies.” 

Wiser words were never spoken on the big screen than those of The Shawshank Redemption’s main character Andy Dufrense. We are none of us beyond redemption, so we are taught by this banker from Maine, even when we are punished for crimes we did not commit. In briefly researching the movie, one comes to learn that it is based on Stephen King’s 1982 novella Rita Hayworth and Shawshank Redemption. No doubt, Hayworth’s role in the movie stands out in all our minds, which is saying something as the superstar was no longer with us.

Dig deeper and you learn that King’s longer than a short story, but shorter than a novel, was part of a series called, Different Seasons, subtitled Hope Springs Eternal. How reassuring if enigmatic. More perplexing still is this master of the horror genre’s inspiration — Leo Tolstoy’s God Sees the Truth, But Waits. It would seem that Carrie has met Anna Karenina.

Clearly, it’s easier to judge those who write books by their most famous covers. But why not set such preconceived notions aside. You too can bask in King’s gorgeous prose from Shawshank and even Tolstoy’s beautiful words of inspiration: “If you want to be happy, be.” And redemption: “Everyone thinks of changing the world, but no one thinks of changing himself.”

These words resonate so against the backdrop of a country that remains intent on fomenting division, on splitting itself at the seams, bent on self-destruction. Perhaps it will have to come down to one man and his ability to change himself, to draw in more than his avid followers but his doubters as well.

For yours truly, it has thus been curious, nay fascinating that on matters of the Federal Reserve one Donald J. Trump has been silent as a mouse whose paws cannot bang out 140-character rants. Perhaps, just maybe, he is busy doing late night reading on the foundations of this venerable institution. If that’s the case, maybe he came across this little gem that was passed along recently:

“In selecting the members of the Board, not more than one of whom shall be selected from any one Federal Reserve district, the President shall have due regard to a fair representation of the financial, agricultural, industrial, and commercial interests, and geographical divisions of the country.”

Maybe that’s why the media has begun to dispense with the labels “hawk” and “dove” and is beginning to replace the aviary with simple human beings who have been there and done that, who have been on the receiving end of Fed policy for their entire careers. Take this from Kate Davidson at the Wall Street Journal:

“After his campaign criticism of the central bank’s low-interest-rate policies, many observers speculated he would seek more “hawkish” candidates who would favor higher borrowing costs. But his choices may be driven less by these issues and more by their practical experience, judging from his early picks for other top economic policy posts in the administration—drawn from investment banking, private equity and business—and the pool of early contenders for the Fed jobs.” 

Meanwhile, the Financial Times’ Gavyn Davies had this to say:

“The last four Fed Chairs have all been clearly on the economist side of the line, and because they have all bought into the Fed’s economic orthodoxy, their actions have been considered somewhat predictable by the markets. A business person or banker might be less predictable, at least initially, and more prone to shake up the Fed’s orthodoxies, for good or ill.”

With deference to Mr. Davies, there can be no ‘for ill’ in shaking up the Fed’s orthodoxies, if you can call them that. Orthodoxy, from the Greek word orthodoxia, implies officials are cleaving to a correct creed. But what if policymaking has devolved from correct to simply accepted?

That would imply a good dose of heterodoxy, also Greek from heterodoxos, was in order, as in a departure from the official position. To be crystal clear, heterodoxy does not equate to heretical, from the Greek hairetikos, (pardon the digression but who gave the Greeks a monopoly on multisyllabic, cool words?). Even so, a bit of heresy would also do the Fed a world of wonders. The literal Greek translation means ‘able to choose.’

A recent study determined the study of economics in academia had itself become incestuous with a great preponderance of students being trained in the same school of thought. This determination was not only disturbing and dangerous, it demands politicians introduce a bit of heresy into our nation’s central bank.

Perhaps President Trump, his administration and all members of Congress should sit down for a tutorial on Heterodox Economics (nope, not making that one up), which refers to schools of economic thought which fall outside of mainstream — read Keynesian – economics, which is predictably referred to as orthodox economics. Maybe, just maybe, it’s high time a variety of schools are incorporated, as in the post-Keynesian, Georgist, social, behavioral and dare say, Austrian approaches.

That last one, the Von Mises-inspired Austrian school of economics is apparently public enemy number one. The FT’s Davies goes on to warn that some candidates up for those open and opening positions on the Fed’s Board of Governors are ‘Austrian’ economists, a school that has apparently influenced Vice President Pence. An “Austrian” candidate would certainly alarm the markets.”

Davies has apparently done his homework. Back in 2010, one Mike Pence was serving in Congress as a representative of Indiana. In response to the Fed’s insistence on launching a second round of asset purchases, which the markets adoringly embraced as QE2, he blasted back that, “Printing money is no substitute for pro-growth fiscal policy.”

Pence’s words certainly ring Austrian, as the school considers malinvestment to be a menace, as well any rational person would. Malinvestment (we can finally score one for the Latins!) is defined as a mistaken investment in wrong lines of production, which inevitably lead to wasted capital and economic losses, subsequently requiring the reallocation of resources to more productive uses.

And we wonder why we’ve had such a long run of jobless recoveries that happens to coincide with the post-Greenspan era. Why would the markets abhor an Austrian? Clearly, we would not have starved productivity by overbuilding residential real estate in the years prior to the crisis. Nor would companies have gorged on record share buybacks in the years that followed. Agreed, these phenomena juiced returns. But to what end aside from protecting the legacy of the mythological ‘wealth effect’?

As my dear friend Peter Boockvar wrote of the wealth effect in response to the Fed’s meeting minutes from its January meeting: “The concept, invented by Alan Greenspan, and carried on by Mr. Bernanke and Mrs. Yellen, is the unspoken third mandate of the Fed. Well Fed, you certainly got what you wanted in terms of a dramatic rise in asset prices over the past 8 years (just look at the value of equities relative to the underlying US economy) but a wealth effect did not happen if the pace of personal spending in this expansion is any indication. For many, it’s the wages they earn and the savings they keep that drive spending decisions, not the value of their stock portfolios.”

For taxpayers’ money, because they will pay in the end, it would seem we need Peter to fill one of those vacancies on the Fed’s Board. Just sayin’. Would the man who coined the term, ‘monetary constipation’ to describe the, “constant hemming and hawing over a rate hike…even in the face of a world that clearly changed on November 8th  and as we approach the 8th  year of this expansion.”

President Trump, can you hear Peter?? This is not the time to be obtuse. This is the time to bring back the good things in life, beginning with the best – hope. Dig as deep as you can and ask yourself some probing questions. Can you stand up to the orthodoxy that’s robbed the business cycle of its very cyclicality? Are you man enough to populate the Fed with leaders who are so strong there’s no need to audit the out-of-control institution? Pray God, does Mike Pence have your ear? You may be a debt kind of a guy, you’ve said so yourself. But you’re also beholden to no one and have a once-in-a-century opportunity to reshape the world’s most powerful central bank and in doing so safeguard the sanctity of the U.S. dollar.

As Andy Dufrense explained to us all, “I guess it comes down to a simple choice, really. Get busy living or get busy dying.” It’s time we got back to the business of living in this country, every single one of us. Who are we to question if it takes a heretic to get us back to where we need to be?

In Case You Missed It

In Case You Missed It, Danielle DiMartino Booth, Money Strong, Fed UpDear friends,

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.

All best,

Danielle

Click through:

Debt and Deficits Are About to Matter Again for Investors — Bloomberg  

The Federal Reserve Has Squandered an Opportunity – CNBC 

Live Reaction to Release of Fed Statement — CNBC 

Federal Reserve Policy: The Cash Menagerie

Danielle DiMartino Booth, Money Strong, Fed Up, Cash Menagerie, Newsletter“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.

Amazon.com | Barnes & Noble.com | Indie Bound.com   |   Books•A•Million

 

Blinding Flash of the Obvious

Dear President Trump,

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.

  1. 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.

 

  1. 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.

 

  1. As you’ve recognized yourself, the financial markets are wrapped in bubble. You name it, they’re overvalued, some more than others.

 

  1. 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.

Sincerely,

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.

Bloomberg: Heed the Fed’s Balance Sheet Banter

Heed the Fed's Balance Sheet Banter, DiMartino Booth, Money Strong, Fed Up

Dear friends,

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.

Heed the Fed′s Balance Sheet Banter

https://www.bloomberg.com/view/articles/2017-01-23/heed-the-fed-s-balance-sheet-banter

Best,

Danielle

 

Retailing in America: Bricks & Torture

Retailing in America: Brick & Torture, Danielle DiMartino Booth, Money Strong, Fed UpFor 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.

Amazon.com | Barnes & Noble.com | Indie Bound.com

With Great Pride, I Give You Fed Up

With Great Pride, I Give You Fed Up, Danielle DiMartino Booth, Money Strong

Dear Friends,

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,

 

Danielle

The Corporate Bond Market: Binge-Borrowing

The Corporate Bond Market: Binge-Borrowing, Danielle DiMartino Booth, Money Strong, Fed UP: An Insider's Take on the Why the Federal Reserve is Bad for America

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.

The Labor Market: The End of the Innocence?

One of the first of life’s lessons we all learned is that we need not rush life; it will do that for us and in the end against our will.

The inspiration for this wisdom could well have sprung from Ecclesiastes wherein we read these peaceful words: To every thing there is a season, and a time to every purpose under the heaven. Co-writers Don Henley and Bruce Hornsby embraced the spirit of this message as the 1980s were coming to a close. You must agree 1989’s The End of the Innocence, that haunting and mournful ballad, was just the coda needed to move on to the last decade of the last century.

“Let me take a long last look, before we say goodbye,” the song asks of the listener who can’t help themselves but to listen.

Many veteran investors, those who don’t need to be reminded about the Reagan era because they were there, may be feeling a bit more wistful as they peer over the horizon. They have lived through extraordinary economic times and maybe even recall the early 1970s, the last time initial jobless claims were at their current historically low levels. They know, in other words, this can’t go on forever, that we are nearing the end of our own innocence.

Federal Reserve Chair Janet Yellen has been adamant that economic cycles can’t die of old age. At the end of this month, we can proclaim to be living through the third longest expansion in postwar times. The parlor game occupying those on the Street these days entails devising scenarios that can push us into the second, or dare we dream, longest expansion of all.

The Wall Street Journal perfectly captures the infectious optimism, the yearning to keep that dream alive, by asking this in a headline: How Low Can the Unemployment Rate Go? Rather than keep you in suspense, the article’s answer is as follows:

“Assuming the economy adds around 200,000 jobs a month in 2017 and the labor-force participation rate stays relatively constant, the unemployment rate would fall to 3.9 percent by the end of the year, according to a model maintained by the Federal Reserve Bank of Atlanta.”

If we do get there, a big if, we are sure to be staring down the barrel of appreciably higher interest rates and a flat, if not by then, inverted yield curve. The only precedent is, you guessed it, that which occurred in 2000, when the unemployment rate hit 3.6 percent as the longest cycle of all time was finally flaming out. Economics 101 teaches one tenet above all – that the unemployment rate is the most lagging within the data universe.

A recent visit with Dr. Gates, that steel-eyed sleuth, corroborated this maxim. “The unemployment rate is the single, most visible economic indicator for households. It’s easy to understand, black and white. Up is bad, down is good,” Gates observed. “If we keep getting downside surprises, it will feed even more consumer optimism. That happens late in the cycle.”

What goes hand in hand with these late cycles guideposts? Since you asked, that optimism Gates cites tends to correlate with households overreaching their paychecks, which is exactly what we’re seeing.

When adjusted for inflation, credit card borrowing is up 4.5 percent over last year, a full two percentage points above wage income, which is up 2.5 percent over the same period. That’s a new high for the current cycle. At 2.9 percent, inflation-adjusted spending is also running ahead of wage income. These data are validated by separate data that shows state withholding tax collections are way off last year’s figures.

“Vulnerabilities in household demand don’t happen overnight; they take time to rise to the surface,” Gates cautioned. “Households aren’t overstretched yet, but they’re getting there. Just like corporations substitute debt for profits late in the cycle, households also are starting to do just as they ride the wave of Trump optimism. Eventually this will run its course.”

The bottom line is households are really happy about the Trump win and they’re showing it by spending beyond their means. If we haven’t yet seen the low in the unemployment rate – a big if – expect many among the reluctant to be emboldened to jump ship at the prospects of a higher paying gig.

Before rushing out to buy that new SUV, as we know countless millions of Americans have, it might be wise to make note of the recent run in the length of the average workweek. As The Liscio Report notes, at 34.3 hours, the workweek has drifted down from 34.4 hours the first half of 2016 and an average of 34.5 hours from 2014-2015. Their conclusion: “This suggests there’s not a lot of pent-up hiring demand.”

The marked slowdown in temporary hires in December would agree with their assessment as would the trend that’s emerged among retailers. Hiring announcements in the critical September to December period fell to the lowest level in seven years, coming in just a hair above 2009 levels when the economy was on its knees. The paltry 6,000 announced retail hires in December’s nonfarm payrolls report, a third of its long-term average, could be but a precursor to what’s to come in the wake of Macy’s and Sears store closure announcements.

The mirror image is transportation and warehousing, where 15,000 workers were added to payrolls last month, three times the norm. Call that the Amazon effect whose sales figures were in a word, ‘astonishing.’ Bezos & Co. dominated ecommerce holiday sales to such an extent that at nearly 40 percent, Amazon’s share of the pie was ten times that of the next closest e-tailer’s numbers.

The odds are it will come down to a race to the Hill to determine if it’s possible to breathe new life into the last gasp of the current cycle. Will the stronger dollar and tighter financial conditions overwhelm profit margins before tax reform legislation is passed and validates all of that cocky confidence? Good question. If Trump expends all of his political capital on repealing Obamacare and confirming his nominees, the economy could be in for a reality check.

And then there are the conspiracy theorists out there who have begun to spread rumors that Yellen could have a Trump card of her own up her sleeve. The market continues to tell itself we’ll be on the beach by the time the Fed first hikes rates come June. A surprise hike at the March meeting would thus send a loud and clear message that there is more 2017 tightening to come, more than any investor expects and spending bill could withstand if a yield curve inversion is in the making. But wait! Politically motivated maneuvers amount to less than ladylike behavior from the Fair Chair. Surely not!

Dr. Gates for his part expects 2017 to be the year of Red Swans. Come again? “Black Swans don’t happen first. Red Swans precede them,” he explained. “First comes the heat and then they burn out. What we’re left with is Black Swans.” Hey, don’t shoot the messenger on that one. He said it. Plus, the heat, fueled by more credit card spending, subprime car sales and higher wages for coveted skilled workers, feels good when the economy is threatened with catching a chill.

Look. No one wants to see the end of any prosperous era, even one that’s left so many behind. But die off every era eventually does, some quicker than others. To the bulls who refuse to acknowledge that even the best intentions cannot stave off inevitabilities, Henley invites you one and all to, “Offer up your best defense.” But we all know how the song ends right after that – “But this is the end. This is the end of the innocence.”