By David Stockman as originally published on Contra Corner and reprinted here with permission
That was quick. The trade war scare was over by noon yesterday, and by the market close they were singing “Gary Cohn, we hardly knew ya”.
Folks, what more evidence do you need that the financial markets are completely uncoupled from reality and that these feeble bounces between the 50-day and 20-day chart points are essentially the rigor mortis of a dead bull?
At the moment, the 50-day stands at 2740 on the S&P 500 and is functioning as “resistance” according to the chart mavens, while the 20-day at 2700 is purportedly acting as “support”.
So there’s that, but also this: At the exact mid-point of 2720, the broad market is currently trading at25.6X reported earnings for 2017. That’s the nosebleed section of history no matter how you slice it—-and most especially in the context of an earnings growth trend that is shackled to the flat line, and which has no prospect of breaking away before the next recession, either.
With virtually every company having reported, it turns out that GAAP earnings for 2017 came in at $109.46 per share on the S&P 500. Then again, 40 months earlier in September 2014 reported LTM earnings were $105.96 per share. That tabulates to a 1.0% per year gain during what will surely prove to have been the sweet spot (month #63 to month #102) of the current long-in-the-tooth business expansion.
Yet to hear the talking heads tell it on bubblevision, robust earnings growth is purportedly breaking out all over—-as if this gray-haired cycle is getting a stiff shot of financial Viagra.
But we’d say there no evidence yet—nor is any likely to be forthcoming. Yes, Q4 2017 earnings of $26.54 per share were up 10% from the $24.16 per share posted for the S&P 500 during Q4 2016.
But here’s what the man from Bloomberg didn’t tell you:To wit, S&P 500 earnings were actually $26.48 per share way back in Q4 2013.
That’s right. The has been just six cents per share of earnings gain during the last four years!
Needless to say, we think there is a considerable difference between round tripping as opposed to growing.
What happened during the interim, of course, was just the pig-passing-through-the-python owing to the China-driven global credit, production and earnings mini-cycle. Apparently, however, Wall Street views zero growth over 4 years as either ancient history or a mere factoid. In either case, the dip-buying robo-machines and punters are ignoring it—like most else—at their own peril.
Likewise, LTM earnings for 2017 of $109 per share compare $85 per share way back at the prior cycle peak in mid-2007. So earnings have grown at only 2.5% per annum for the entire decade; and even much of that was due to share count shrinkage owing to massive buybacks.
At the same time, future earnings growth due to the tax cut is vastly exaggerated because it ignores the upcoming bond market “yield shock”. We are referring, of course, to the unprecedented $1.8 trillionfiscal/monetary collision in the government bond pits that will incept six months from now during FY 2019.
Thanks to the $300 billion first year cost (with added interest) of the front-loaded GOP/Trump tax cut and $200 billion of spending add-ons for defense, domestic and disasters, the US Treasury will be issuing $1.2 trillion of new debt at the same time the Fed is dumping $600 billion of existing securities.
And we think those staggering numbers are about as certain as the rising sun. It is far too late both legislatively and technically to slow the surging river of red ink unleashed by the Trumpite/GOP during three months of fiscal infamy in December through February.
Similarly, the Keynesian Fed heads in the Eccles Building are so obstinately mistaken about the strength of the US economy that they have put their balance sheet shrinkage/QT program on what is essentially an automatic pilot basis.
To be sure, the market will clear—but at a much higher yield than 2.90% on the ten-year UST. That’s especially the case because the ECB is getting out of the QE/bond buying business in December per today’s announcement; and there is also every sign that the newly coronated Emperor Xi and his minions have the same thing in mind as they now deal with the morning after effects of the monumental credit party they staged in the run-up to October’s 19th Party Congress.
Accordingly, the US benchmark yield could easily rise to 3.75% during the year ahead, and most probably a lot beyond the 4.00% level–once the hedge fund front-runners make their own pivot and get the hang of selling what the Fed is now selling.
But even at 3.75% on the benchmark UST, after-tax interest expense for the S&P 500 companies as a group will rise from $16 per share (2016 actual) to $36 per share. That prospective $20 rise is surely the current unseen skunk in the Wall Street woodpile: It would wipe-out virtually the entire one-time gain from the new 21% corporate tax rate.
Still, we are not alone in espying the headwinds now gathering. No less than the co-president and head of JPMorgan’s giant investment bank, Daniel Pinto, recently reminded in a manner that left little to the imagination that business cycles do, in fact, come to an end:
There is never just one trigger, it’s a combination of factors and it depends on valuation at the time. The market probably has some way to go probably for the next year or two, but the correction could be 20% to 40%. And for us, we just try to be prepared because during those times, the clients really need you.”
Indeed, you could call this the Chuck Prince aphorism for the present cycle. That is, the apparent mandate is to keep on dancing right until the end, but in a year or two its bloodbath time all over again.
That begs the question, of course, of why bother with 5% more of upside (to say 3,000 on the SPX) when it’s 20% to 40% in the southerly direction thereafter.
Indeed, we expect that the Donald will be frantically searching for the passcode to the Plunge Protection Team’s trading desk any day now. That’s because the “trade war” has by no means been ended by his loophole riddled announcement today from the White House. Instead, the trade war is just getting started and from here it is going to lurch and thrash for months to come, leaving Washington in a state of even great dysfunction than already exists.
In fact, the last thing any President should get tangled up with is the rabid protectionists of the US steel industry, and their capacity to incite a chain reaction of demand and counter-demands from domestic lobbies in Washington and trading partners all around the globe.
As we described to Wolf Blitzer on CNN today, the steel industry is the greatest protectionist crybaby in the whole beltway Lobby Farm. It gang tackles every new President who comes to town with its risible tales of woe, and this time it has found the greatest sucker yet.
That is, the Orange Combover is utterly clueless about the intricacies of world trade and is enthralled with a primitive 17th century mercantilist trade model that has no capacity whatsoever to help make the American economy become great again.
Worse still, he fancies himself going full retard on the “art of the deal”. That was exemplified by today’s highly qualified interim exemption for Canada and Mexico—so that they will presumably buckle under during the NAFTA negotiations on pain of being whacked by a revocation of the steel tariff waiver; and hints that other nation’s which play ball–Australia, for instance—-could be let off the hook, as well.
Here’s the thing. No one has explained to the Donald that the global steel supplies are highly fungible and that if he lets Canada and Mexico off the hook, which account for 10 million tons of our 36 million tons of imports, these fortunate friends and neighbors will sharply increase their exports to the US at a 25% higher price, while backing out their current exports to the rest of the lower-priced world market.
That prospect, in turn, will lead to a tangled negotiation over “rules of origin” to insure, for example, that zinc-coated steel from Canada actually originated in a hot roll made in Canada, that came from a steel furnace slab made in Canada, that originated in an electric arc furnace or blast furnace that was also located in Canada.
And that’s not the half of it. Steel exporting countries, such as Brazil with 4.7 million tons or Japan with 2 million tons will be looking for ways to slightly fabricate their steel so that it skirts around the 25% tariff on steel products, as defined.
Moreover, at the drastically lower price than such value-added “fabrications” will carry in the US domestic market, downstream manufacturers and users will have every reason to seek out such foreign fabrications.
In short, the Donald just stuck a wobbly stick in a very big and nasty hornets’ nest. And your editor does speak with some authority on the matter.
We negotiated the first comprehensive steel quota deal back in 1983 as an effort to keep the hard core protectionists, which had infiltrated the Commerce Department in the Reagan Administration, at bay.
It was some kind of nightmare. The steel lobby’s promise at the time that a one-time five-year quota at 18.5% of the market—except for a laundry list of loopholes—would bring it back to the pink of health is one of the more egregious falsehoods ever peddled by the jackals of K-street.
But this time will be far, far worse because back then China was just emerging from the industrial disaster of the Great Helmsman’s disastrous Great Leap Forward. China didn’t even get a quota in the 1983 deal.
By contrast, last year China produced 800 million tons of steel, which is more than the next 40 worldwide suppliers combined; and even then this tsunami of steel came from a partially idled industry that actually has 1.2 billion tons of capacity.
Stated differently, the world is downing in China’s excess steel capacity.But since it has now diverted most of the exports it was preciously dumping on the US market to other customers, the Donald’s tariff won’t amount to even a pinprick.
To wit, in 2017 China was only the #12 steel importer at 800,000 tons into the 107 million ton US end market. Its shipments compared to 36 million tons of total steel imports. Accordingly, we’d be surprised if the Donald’s tariff would add even $100 million to the landed cost of China’s current exports to the US.
That’s right. the Donald is hitting the steel users of the US with a notional $7.5 billion tariff cost in order to smack the real target—-the Red Ponzi—with what amounts to a 1.4% of the total upcharge.
And that’s before the Chinese start shipping their 400 million tons of excess steel capacity to the US in the form of full fabricated cars— at about 3,000 pounds of steel each.
But here’s the madness of the whole deal. As we have explained in the last few days, the US has a giant trade problem measured by last year’s $810 billion trade deficit, and the 43 years of continuous trade deficits which came before it that now cumulate to $19 trillion in present day dollars.
Yet steel is just a tiny sliver of what is a giant macro problem. Last year, the US imported 36 milliontons and exported 10 million tons. Accordingly, the trade deficit in steel was just $20 billion or2.5% of the total US trade deficit.
Moreover, the world is so awash in excess steel owing to the investment madness of the Red Ponzi that there will never be a shortage as far as the eye can see. Cheap world price steel, in fact, is the greatest imaginable bargain for downstream domestic manufacturers, miners, energy producers, utilities, government infrastructure projects, construction sites and much more.
That the Donald managed to fire his protectionist musket randomly and bring down what amounts to an economic dodo bird—against the advice of nearly everyone except the steel lobbies, his octogenarian crony capitalist Secretary of Commerce, and the certifiable lunatic who advises him on Trade, Mr. Navarro—-is not merely reflective of another day of chaos at the White House.
To the contrary, it well and truly reminds that the Donald is indeed the Great Disrupter.
So if nothing else, it should be obvious after today that no amount of whistling is going to make this particular graveyard one bit less scary.