By David Stockman as originally published on Contra Corner and reprinted here with permission
Dow 25,000. What could possibly go wrong?
After all, just because there is a meltdown happening in the Oval Office why should that be a bother in the casino? The lemmings and robo-machines are obviously paying no attention whatsoever to a crisis of governance coming to the boil, and, instead, are buying stocks hand-over-fist because prices are melting-up—100 Dow points a day, rain or shine.
Then again, we know of no melt-up that had legs of more than a few months after the point that irrational exuberance went full retard, as is happening at this very moment.
So consider the carnage that is surely lurking just around the corner by reference to the last days of the dotcom mania. Back then, the NASDAQ 100 soared by 50% between December 14, 1999 and its peak at 4,704 on March 27, 2000.
Alas, during the next 14 trading days the revilers gave it all back. And that lightening fast 33% drop was just a warm-up for the sickening spiral that ensued thereafter. Wave after wave of capitulation and panicked selling ground the index lower relentlessly—until it reached a bottom at 810 in early October 2002.
The peak-to-trough loss weighed in at 83%! And the climb out of that speculators’ dungeon took more than 14 years: The 4704 high shown below was not crossed again until September 2016.
We recall the above chart not for the horror of it, but owing to the relative beneficence of the macro circumstances from which it arose. That is, at least back then the casino punters could legitimately believe they had a strong economy at their backs and that macroeconomic frailties were not likely to punk the party anytime soon.
For instance, both of our favorite bread-and-butter macros—real final sales and industrial production—had posted exceptional runs since the prior peak in August 1990. Real final sales were up by 40% or 3.4% per annum. And industrial production had soared by 50% or 4.1% per annum.
And not only that. Just in case the then longest business cycle expansion in US history faltered or got tired, the Washington fireman were fully loaded with “stimulus” ammo. The federal funds rate was at 6.5% and therefore had a long way to drop—as Greenspan subsequently proved when he cut the rate for 30 straight months to just 1.0%
Likewise, the Federal budget was actually in surplus (in part owing to massive capital gains tax collections from the dotcom bubble) and the public debt stood at just 55% of GDP, which was actually down considerably from the 65%ratio reached during the mid-1990s.
So the US economy was booming and the Washington fireman had plenty of fiscal and monetary stimulus reserves at their disposal. To be sure, there is never any reason to believe that “this time is different”, but at least back then complacency had some plausible excuse.
The fact that after 110 months of unprecedented monetary and fiscal stimulus we have had the weakest recovery in history does not suggest that the expansion still has a long life ahead, as apparently the party animals on Wall Street now presume. It’s actually a warning indicator of serious macroeconomic fragilities (see below). There is something fundamentally wrong with the US economy—a structural risk that could send the economy tumbling into the ditch at any time.
Nor does the current 2-3 quarter run of stronger economic performance indicate some kind of “escape velocity” has miraculously been attained. These short-term undulations—or mini-cycles within the cycle—have been happening for the past nine years and represent mainly the flow-though effect in the US economy of China’s giant but unsustainable credit impulses and the related global commodity and trade oscillations.
The more relevant point is that as of the latest reading, US industrial production has “expanded” at a 0.0% annual rate since the last business cycle peak 10 years ago; and rather than growing by 3.4% per year as per the tailwinds at the time of the dotcom crash, real final sales have risen at only 1.3% per year.
Stated differently, the US economy has been laboring to expand for a self-evident reason that has entirely escaped the attention of the Wall Street day traders. Namely, that the US economy is being smothered under $67 trillion of public and private debt, which now amounts to 345% of the current $19.5 trillion level of nominal GDP.
By contrast, back on the eve of the dotcom meltdown, total public and private debt was just $27 trillion, where it sat atop nominal GDP of $10 trillion and represented a 270% of GDP debt burden. So in dollar terms, it has taken $40 trillion of debt gains since the turn of the century to lift annual GDP by only $9.5 trillion.
Needless to say, an economy that is borrowing $4.30 for each dollar of income gain is neither stable nor sustainable. And most certainly does not warrant nosebleed PE multiples at a time when the business expansion at 102 months is already just shy of the 1990s record (118 months).
And we mean nosebleed when it comes to valuation metrics. The S&P 500 multiple is now hanging from a sky-hook at 25.3X LTM earnings; and the Russell 2000 is simply out of this world: It now stands at 132X trailing profits of the 2000 mid- and small-cap domestic companies that comprise the index.
What happens during the blow-off stage of financial bubbles, of course, is that the recency bias—which is already bad enough owing to the Fed’s financial repression and price-keeping policies—gets foreshortened to just months and weeks, and thereby looses all sense of relative context and underlying trends.
For example, this week’s report on nonresidential construction spending for November 2017 posted at a $719.2 billion annualized rate, and was head-lined in the financial press as a swell 0.6% gain from October.
Then again, the trend since June 2015 has been nearly flat as a board after you iron out the monthly fluctuations. More importantly, way back in July 2008, nonresidential construction spending posted at $719.5 billion—–meaning that we have not yet recaptured the last peak in nominal dollars!
Adjusted for inflation, construction spending on the US economy’s basic production infrastructure is still 18% below its pre-crisis level. The picture below is hardly one of an economy bursting out of the starting blocks.
The next picture starkly reinforces the story. The share of every age group being forced to “double-up” in households has been soaring during the course of the current so-called recovery because the overall growth has been punk, and the gain in jobs has been overwhelmingly on the low end of the scale.
The median individual income of an employed adult in a doubled-up household is just $30,000 compared to the $45,000 earned by their non-doubled-up counterpart. That is, adults living with roommates or family members earn 67 cents for every dollar made by adults who live on their own (or with a partner).
Needless to say, this suggests that in many places, employed people who currently live in doubled-up households would not be able to afford rent if they lived by themselves—nor even a car if it was not being financed by sub-prime lenders who are actually in the repo and used car churning business.
So what we actually have is something close to 2000 or 2008 redux. The 25%-40% run-up in the various stock indices since November 2016 has spread the mania to corporate America’s stock-option obsessed C-suites. Accordingly, they have once again loaded up on excessive inventories of labor and production goods and materials.
In the very near term, these inventory building actions tend to inflate the high-frequency indicators including the BLS “jobs” number and especially the quarterly GDP figures. But what happens to labor and inventory when the stock market bubble breaks is plain as day: Violent liquidations which swiftly bring the “R” word back into the narrative.
That is, the incoming data turns recessionary seemingly from out of the blue.
Yet this time there are no Washington fireman standing at the ready. Fiscal policy was long ago out of running room with the public debt at 106% of GDP rather than 55%. Even if you believe that the Obama-style $800 billion spend-a-thon made a difference to the recovery, which it didn’t, a Keynesian-style burst of “borrow and spend” is absolutely not going to happen this time around.
But the real skunk in the woodpile is a Fed that is entirely out of dry powder and is now undertaking a desperate attempt to re-load by pivoting to QT and rising money market rates.
And that’s the biggest difference of all compared to April 2000. At that point, Greenspan had 550 basis points of rate reduction on his game board, and the US economy was lugging just $27 trillion of debt, which would then benefit from dramatically falling carry-costs.
Not now. The chart below is fixing to slam the $67 trillion debt-berg that now sits atop the US economy with rising rates—a deleterious force that will only be exacerbated by what we believe will be trillion dollar deficits as far as the eye can see.
And that get’s us to the Donald’s meltdown. His apparently hand-crafted statement on the Bannon apostasy is more unhinged than anything we have heard from a President in the last 50 years.Steve Bannon has nothing to do with me or my Presidency. When he was fired, he not only lost his job, he lost his mind. Steve was a staffer who worked for me after I had already won the nomination by defeating seventeen candidates, often described as the most talented field ever assembled in the Republican party.Now that he is on his own, Steve is learning that winning isn’t as easy as I make it look.In fact, what is actually looking far too easy is the Donald’s ability to hang-on to the keys to the Oval Office.That’s because we are just days away from a massive fracturing of the GOP on Capitol Hill over $200 billion of add-ons in the pending two-year budget deal; and even more tens of billions for the pending ObamaCare bailout—along with the $100 billion unfunded tab for disaster aid and the existential battle over Dreamers vs. funding for the Wall.
And that is to say nothing about the fact that the debt ceiling is frozen again (as of December 8) and the Treasury is fast running out of cash. This means a serious shutdown is just around the corner, and that the Freedom Caucus dreamers in the House are going to awaken from their tax-cutting slumber to the prospect of a $1.2 trillion deficit in the year just ahead.
As a pretty nasty movie of a few years ago summarized it: There Will Be Blood!
So we are quite confident that as political carnage in the Imperial City erupts like never before, the Donald will tweet himself into terminal fit of rage.
In this context, Heisenberg’s recent observations about the unhinged action in the financial markets are well worth quoting at length. That is to say, when the now intensifying meltdown in the Imperial City collides with the melt-up in the canyons of Wall Street it will be April 2000 all over again—–and a lot more:
More generally, I’m not sure it occurs to a lot of investors just how anomalous 2017 really was. Two-way markets are no longer a thing. There is no price discovery. There is just the indiscriminate funneling of money into a market that, thanks to the wave dynamic, has become a self-fulfilling prophecy……So you know, “time stamp it.” Because sometime in the maybe-not-so-distant future, we’re all going to have a good hearty laugh at all of this.
On Tuesday, for instance, Forbes ran a story detailing how, thanks to 2017’s 32,000% gain in a digital token called Ripple, Cofounder and former CEO Chris Larsen is now the 15th richest American. On paper, he’s worth more than Ray Dalio and Carl Icahn. Let that sink in. A digital token which, at least according to some critics, is literally worthless, rose 32,000% in 2017 very nearly catapulting the above-mentioned Larsen ahead of Steve fucking Ballmer on the Forbes 400 list……
But again, that was nothing compared to what was coming. Within four months of that article running in the Times, Bitcoin had exploded by 500%. The ensuing digital gold rush transformed iced tea bottlers into tech enterprises, made crypto companies out of bra manufacturers and in one particularly hilarious case, prompted the maker of a bedwetting inhibitor called the “UrinStopper Patch” to get out of the piss prevention business in favor of Blockchain……
The result: the Seth Golden story appeared entirely sane by comparison. His short vol. strategy (assuming you can approximate it with XIV), was up around 200% in 2017. If you plot that against the Bitcoin rally, against some of the more egregious examples of short-term gains generated by companies that abruptly added “blockchain” to their name, or especially against Ripple, Seth’s gains look like an EKG flat line.