By Kevin Muir of “The Macro Tourist” fame; reposted here with permission
One of the greatest traders of all time, yet probably one of the least well known, once said, “win or lose, everybody gets what they want out of the market.” Easy for Ed Seykota to say as he sits on his deck overlooking Lake Tahoe sipping a nice California cab. Yet as I struggle to make sense of this great game we all love to play, I wonder if maybe Ed is correct. I know his comment might seem a little preachy, but the older I get, the more I realize that a trader’s biggest obstacles lie in the dark recesses of their thoughts, not in the day-to-day zigs and zags of the markets.
So I wonder. Not only do we all get what we want, but do we only see what we want to see?
The other day, one of the biggest bond bulls out there posted the following chart:
I was confused by Raoul’s comments because as I examined the chart of M2 Money Velocity versus US Labour Force Participation, it only made me more bearish on bonds. But to Raoul and all the other deflationists, this chart demonstrates the futility of battling the overpowering forces of demographic deflation.
Before we go any further, I am about to commit the cardinal sin of trading – mixing timeframes. Bonds are hugely oversold on shorter-term charts and everyone is leaning short. It wouldn’t take much of an economic pause to cause a massive short covering rally. Therefore I am by no means advocating leaning hard on bonds down here for a trade.
Yet as an investment, bonds are a terrible risk-reward. And ironically, Raoul’s chart provides the reason.
Let’s assume that monetary velocity is affected by labour participation. Not a hard leap to make. The more people that are working, the more likely they are to borrow and spend.
But what has happened to labour over the past couple of decades? With the fall of the Iron Curtain, combined with China’s WTO admission, and topped off with a demographic bulge of baby-boomers, the global economy has been subject to a massive labour supply glut. This has driven down the cost of labour as a percentage of GDP to multi-generational lows:
This relentless deflationary force has made monetary policy increasingly less effective. It’s obviously not this simple as the increasing debt load is also a large factor muting monetary stimulus. And there can be no denying that the neutering of discretionary governmental fiscal spending during the last economic downturn only worsened the situation.
Yet both factors are no longer headwinds. Trump’s deregulation push and pro-business policies have encouraged banks and other lenders to once again extend credit. And the tax cut bill is providing fiscal stimulus as opposed to tightening.
But most importantly, the labour supply glut is finally getting worked through. China is no longer the cheap cost provider competing in a race-to-the-bottom on wages. Globalization is now headed in reverse with tariffs and other trade impediments being applied.
So I ask – what are the chances that labour participation continues declining? Even if it just stabilizes, this might allow the velocity of money to stop its relentless plummet.
And if the money velocity stops declining, and god forbid, even increases, what will happen to the mountain of monetary stimulus that has been administered over the past decade?
I don’t know if I am just seeing what I want to, but when I look at Raoul’s chart of M2 velocity versus the Labour Participation Rate, all I can do is worry about what happens if velocity follows the participation rate higher. Instead of just assuming this trend will continue forever lower unabated, I am preparing for the day it bottoms and turns everything we know on its head.
Ed would probably tell me that all of this analysis is most likely moot. It’s way more productive to listen to what the market is saying,
“If you want to know everything about the market, go to the beach. Push and pull your hands with the waves. Some are bigger waves, some are smaller. But if you try to push the wave out when it’s coming in, it’ll never happen. The market is always right.”
I have been worried about the oversold nature of bonds, but maybe the market knows better. Maybe this is one of those bigger waves you shouldn’t push against.
This is an interesting point. I’ve often wondered why the velocity has been declining since the 2008 crash (although never technically referred to it as velocity). From my point of view, the question has always been, why are companies hoarding so much money. To what purpose and what end. Apple, for example, has the equivalent of a small county. Banks who received the benefits of QE have not lended at levels that the amount of cash might have implied? I believe some of it is simply economic engineering. Cash is king, as they say. I also think the Fed move with QE has put visors onto everyone in the market creating a “wait and see” attitude about how the economy may go after such an experiment. As long as money is being made the “new” way instead of the “old fashioned way,” velocity is will take its course.
More so, I think it is right to wonder what may happen should velocity shift course, but would not expect a shift until after a massive correction. This, I believe, is another symptom of the bull cycle. As long as we don’t see a correction, I expect velocity to continue down.
Is there a way to short velocity for a while? LOL
You won’t find a good explanation for the velocity decrease from the anti-Keynesians that are often featured here, such as Stockman and Muir. After nearly a decade of spectacular failure you would think that they might seek a new model or convert to the dark side.
OTOH, here is a fun nightmare scenario from the Fed on an improbable liquidity shock from excess reserves.
https://www.minneapolisfed.org/research/economic-policy-papers/should-we-worry-about-excess-reserves
OK Dude – Knowing that a lot of bankers are the ones who ate the crayons in school, and mange to upset the apple carts in their favor on a regular basis, that Fed postulation scares the shyte out of me.
I think another huge factor in the decline in Velocity is the widening wealth gap. The wealth class hordes as their ranks shrink and their net worth increases geometrically. The consumer class grows in number gets squeezed with escalating mandatory expenses (housing, healthcare, education) leaving less and less for discretionary spending. There is a reason the consumer staples segment is struggling right now: consumers have no more money to spend so increases in input costs cannot be passed along.
I am a firm believer in a meritocracy, but at some point we need to admit to ourselves that the game is rigged and this not good for the long term economic growth of the country (US). It will eventually lead to lower net worth for the wealth class as eventually Consumption will implode and recede markedly making all those greedy pricks poorer.
I think another huge factor in the decline in Velocity is the widening wealth gap. The wealth class hordes as their ranks shrink and their net worth increases geometrically. The consumer class grows in number gets squeezed with escalating mandatory expenses (housing, healthcare, education) leaving less and less for discretionary spending. There is a reason the consumer staples segment is struggling right now: consumers have no more money to spend so increases in input costs cannot be passed along.
I am a firm believer in a meritocracy, but at some point we need to admit to ourselves that the game is rigged and this not good for the long term economic growth of the country (US). It will eventually lead to lower net worth for the wealth class as eventually Consumption will implode and recede markedly making all those greedy pricks poorer.
PS- not sure why the previous posted as anon. can’t figure out how to delete that comment. Please delete it if anyone knows how