By now most market participants have been able to see through the smoke and mirrors of Friday’s ‘explosive’ wage growth data (driven by a drop in hours worked and declined on a weekly basis) but the narrative remains one of soaring wage growth and inflation anxiety on mainstream media today.
Perhaps that is why Goldman Sachs penned a rather fascinating report over the weekend that played down wage growth stories dramatically and – most surprisingly – pointed the squid-finger at the ever-increasing concentration of American business as the reason why… in other words, enabling oligopolistic (or monopolistic) economies across various sectors has crushed the American Dream for many – and will continue.
Goldman’s Jan Hatzius notes that the wage data released last week provided positive early indicators of a potential reacceleration of wages, which disappointed in 2017, but a strong of recent data misses in the various wage series – including the Atlanta Fed wage tracker and median weekly wages series from the household survey – have pushed down our broader wage growth tracker to just 2.1% as of Q4, as shown below.
More broadly, the moderate pace of wage growth over the last couple of years has fallen short of the expectations of many observers.
While the labor share – the part of national income paid to workers—has recently continued its decades-long decline, US corporate profit margins have risen further to historic highs, especially for the most profitable firms. Over the last two decades, most industries have also become more concentrated with a few large firms earning a larger share of revenue, potentially shifting the bargaining power from consumers and workers to firms and employers.
As the chart above shows, average wage growth has fallen from 3.5% in 1985-2007 to 2.1% in 2008-2017. While much of the weakness in wage growth over the last decade relative to pre-crisis norms can be attributed to cyclical labor market slack and soft price inflation, longer-run declines in trend productivity growth and in the trend labor share are currently still weighing on wage growth.
Exhibit 2 shows that the part of nonfarm business income paid to workers has fallen by 6 percentage points (pp) since 1999 to just 56%, while corporate profit margins have continued to rise.
Goldman suggests that rising concentration of employment could shift the balance of bargaining power from workers to employers. Wage-setting power allows employers to lower wages below workers’ marginal revenue product without losing too many employees. While a handful of superstar employers with better technologies could choose to hire more workers and pay higher wages than less productive firms, the limited availability of attractive alternative employers may prevent workers from earning their full marginal revenue product.
Exhibit 4 shows that the share of total industry sales attributed to the largest 50 firms has increased in 10 of the 13 two-digit industries covered by the Economic Census.
About 75% of the NAICS three-digit industries have experienced an increase in concentration levels over the last two decades. We have documented in previous research the relationship between concentration and profit margins, as illustrated in the right panel of Exhibit 4.
And as Goldman concludes,
Combining the average decline in the number of establishments in 2001-2016 and our coefficient estimates, we estimate that the rise in labor market concentration accounts for a 1% hit to the level of wages since 2001, or a 0.05-0.1pp drag to annual wage growth. A crude sum of our product and labor market concentration estimates suggests a combined drag from the rise in concentration to annual trend wage growth of around 0.25pp.
Which roughly translated means America’s increasingly monopolistic corporatocracy has weighed heavily on Average Joe’s wages…
And Goldman is not entirely optimistic this improves anytime soon…While the cyclical outlook for wage growth looks increasingly favorable given the ongoing fall in labor market slack, a continued decline in the trend labor share would hold down trend wage growth…we remain cyclically optimistic about wage growth and continue to expect a renewed acceleration as the labor market tightens further. Over a longer horizon, our analysis shows that the potential of continued rise in concentration implies some downside risk to our 3-3.25% trend wage growth estimate.
Only one thing matters in bubble markets: sentiment
Yesterday saw Jerome Powell sworn into office as the new Chairman of the Federal Reserve, replacing Janet Yellen. Looking at the sea of red across Monday’s financial markets, Mr. Powell is very likely *not* having the sort of first day on the job he was hoping for…
Also having a rough start to the week is anyone with a long stock position or a cryptocurrency portfolio.
The Dow Jones closed down over 1,200 points today, building off of Friday’s plunge of 666 points. The relentless ascension of stock prices has suddenly jolted into reverse, delivering the biggest 2-day drop stocks have seen in years.
But that’s nothing compared to the bloodletting we’re seeing in the cryptocurrency space. The price of Bitcoin just broke below $7,000 moments ago, now nearly two-thirds lower from its $19,500 high reached in mid-December. Other coins, like Ripple, are seeing losses of closer to 80% over the same time period. That’s a tremendous amount of carnage in such a short window of time.
And while stocks and cryptos are very different asset classes, the underlying force driving their price corrections is the same — a change in sentiment.
Both markets had entered bubble territory (stocks much longer ago than the cryptos), and once they did, their continued price action became dependent on sentiment much more so than any underlying fundaments.
The Anatomy Of A Price Bubble
History is quite clear on how bubble markets behave.
On the way up, a virtuous cycle is created where quick, outsized gains become the rationale that attracts more capital into the market, driving prices up further and even faster. A mania ensues where everyone who missed out on the earlier gains jumps in to buy regardless of the price, desperate not to be left behind (this is called fear of missing out, or “FOMO”).
This mania produces a last, magnificent spike in price — called a “blow-off” top — which is then immediately followed by an equally sharp reversal. The reversal occurs because there are simply no remaining new desperate investors left to sell to. The marginal buyer has suddenly switched from the “greater fool” to the increasingly cautious investor.
Those sitting on early gains and looking to cash out near the top start selling. They don’t mind dropping the price a bit to get out. So the price continues downwards, spooking more and more folks to start selling what they have. Suddenly, the virtuous cycle that drove prices to their zenith has now metastasized into a vicious cycle of selling, driving prices lower and lower as panicking investors give up on their dreams of easy riches and increasingly scramble to limit their mounting losses.
In the end, the market price retraces nearly all of the gains made, leaving a small cadre of now-rich early investors who managed to get out near the top, and a large despondent pool of ‘everyone else’.
We’ve seen this same compressed bell-curve shape in every major asset bubble in financial history:
And we’re seeing it play out in real-time now in both stocks and cryptos.
The Bursting Crypto Bubble
It’s amazing how fast asset price bubbles can pop.
Just a month ago, the Internet was replete with articles proclaiming the new age of cryptocurrencies. Every day, fresh stories were circulated of individuals and companies making overnight fortunes on their crypto bets, shaking their heads at all the rubes who simply “didn’t get” why It’s different this time.
Here at PeakProsperity.com the demand for educational content on cryptocurrencies from our audience rose to a loud crescendo.
We did our best to provide answers as factually as we could through articles and webinars, though we tried very hard not to be seen as encouraging folks to pile in wantonly. A big reason for this is we’re more experienced than most in identifying what asset bubbles look like.
To us, the run-up in the cryptocurrencies seen over 2017 had all the classic hallmarks of an asset price bubble — irrespective of the blockchain’s potential to unlock tremendous long-term economic value. Prices had simply risen way too far way too fast. Which is why we issued a cautionary warning in early December that concluded:
So, if you’ve been feeling like the loser who missed the Bitcoin party bus, you’ve likely done yourself a favor by not buying in over the past few weeks. It is highly, highly likely for the reasons mentioned above that a painful downwards price correction is imminent. One that will end in tears for all the recent FOMO-driven panic buyers.
And now that time has shown this warning to have been prescient in both its accuracy and timeliness, we can clearly see that Bitcoin is following the classic price trajectory of the asset price bubble curve. The chart below compares Bitcoin’s current price to that of several of history’s most notorious bubbles:
This chart (which is from Feb 2, so it doesn’t capture Bitcoin’s further decline below $7k) shows that Bitcoin is now about 2/3 of its way through the bubble life-cycle, and about half-way through its fall from its apex.
Projecting from the paths of previous bubbles, we shouldn’t be surprised if Bitcoin’s price ends up somewhere in the vicinity of $2,500-$3,000 by the time the dust settles.
Did The Stock Market Bubble Just “Pop”?
Despite the extreme drop in the stock market over the past two days, any sort of material bubble retracement has yet to begin — which should give you an appreciation of how overstretched its current valuation is.
Look at this chart of the S&P 500 index. Today’s height dwarfs those of the previous two bubbles the index has experienced this century.
The period from 2017 on sure looks like the acceleration seen during a blow-off top. If indeed so, does the 6% drop we’ve just seen over the past two trading days signify the turning point has now arrived?
Crazily, the carnage we’ve seen in the stock market over the past two days is just barely visible in this chart. If indeed the top is in and we begin retracing the classic bubble curve, the absolute value of the losses that will ensue will be gargantuan.
If the S&P only retraces down to the HIGHS of its previous two bubbles (around 1,500), it would need to fall over 43% from where it just closed today. And history suggests a full retracement would put the index closer to 750-1,000 — at least two-thirds lower than its current valuation.
How Spooked Is The Herd?
As a reminder, bubbles are psychological phenomena. They are created when perception clouds judgment to the point where it concludes “Fundamentals don’t matter”.
And they don’t. At least, not while the mania phase is playing out.
But once the last manic buyer (the “greatest” fool) has joined the party, there’s no one left to dupe. And as the meteoric price increase stops and then reverses, the herd becomes increasingly skittish until a full-blown stampede occurs.
We’ve been watching that stampede happen in the crypto space over the past 4 weeks. We may have just seen it start in the stock markets.
How much farther may prices fall from here? And how quickly?
History gives us a good guide for estimating, as we’ve done above. But the actual trajectory will be determined by how spooked the herd is.
For a market that has known no fear for nearly eight years now, a little panic can quickly escalate to an out-of-control selling frenzy.
Want proof? We saw it late today in the complete collapse in XIV, the inverse-VIX (i.e. short volatility) ETN that has been one of Wall Street’s most crowded trades of late. It lost over 90% of its value at the market close:
The repercussions of this are going to send seismic shockwaves through the markets as a tsunami of margin calls erupts. A cascading wave of sell-orders that pushes the market further into the red at an accelerating pace from here is a real possibility that can not be dismissed at this point.
Those concerned about what may happen next should read our premium report Is This It? issued over the past weekend.
In it, we examine the congregating perfect storm of crash triggers — rising interest rates, a fast-weakening dollar, a sudden return of volatility to the markets after a decade of absence, rising oil prices — and calculate whether the S&P’s sudden 6% rout is the start of a 2008-style market melt-down (or worse).
Make no mistake: these are sick, distorted, deformed and liquidity-addicted bubble markets. They’ve gotten entirely too dependent on continued largess from the central banks.
That is now ending.
After so many years of such extreme market manipulation finally gives way, the coming losses will be staggeringly enormous.
The chief concern of any prudent investor right now should be: How do I avoid being collateral damage in the coming reckoning?
Now that inverse VIX ETFs have effectively blown up, suffering “termination events” like XIV earlier today, one of the forming bullish market narratives is that there will be no incremental “squeezed” buying of VIX from this key vol-selling group. Of course, there is a perfectly obvious flipside to that which few have pointed out, namely that holders of the inverse ETPs lost $3.4bn as the products went bankrupt, which removes a steady source of volatility supply over the last year.
But a bigger question is whether the vol selling is indeed over, and according to a just released analysts from Bank of America the answer is a resounding no. In a note from BofA’s Benjamin Bowler, the derivatives expert writes that the ETP driven vol explosion which we described in painful detail previously, is just the beginning.
Here’s why.
While BofA’s model implements position changes in response to a given day’s moves on the close the same day, in reality, both risk parity and CTA strategies operate over varying horizons. In any case, the bank’s derivatives team expects actual rules-based risk parity and CTA strategies to implement significant allocation changes within a few days.
So, with BofA assuming $200bn in rules-based risk parity strategies and $250bn in model-driven CTAs, then its models estimate $140bn of global equity unwinds as a result of Friday’s moves and another $60bn as a result of Monday’s moves.
There are two ways to read that number: over the same two days global equity index futures volumes across the largest markets was approximately $1.6 trillion. So if BofA were to assume the entirety of equity unwinds were completed, then it would equate to approximately 12% of the volume over the last two days.
However, it is certain that the move is nowhere near done and BofA expects that if risk parity and CTAs are still unwinding equities in the coming days, then it will be against a continued rise in volumes due to higher volatility.
As a reminder, earlier in the day we presented calculations from Morgan Stanley‘s quant team, according to whom annuity funds will now need to sell between $30 and $35 bn of equities on Tuesday, and a similar amount Wednesday while Risk Parity could provide an additional $10 to $20bn in equity and bond supply this week.
Further, regarding risk parity BofA’s models estimate that funds are on average around 1.3x leveraged with an about 30% allocation to equities. Assuming about $200bn in unlevered AUM, that gives nearly $75bn remaining exposure to equities. Since risk parity typically does not go short, remaining equity selling pressure – once the current $200BN is offloaded – should be less than what some estimate, the question however is how easily digested that initial sale will be.
There is some good news: According to BofA’s models, CTA equity long positions are in the process of unwinding or are completely sold, with only $75BN left in global equitie4s.
While CTAs have the potential to continue selling via turning short, we believe the risk to that is low as CTAs often use moving average crosses to determine long and short positions. While specific parametrizations can vary tremendously across CTAs, in our opinion an important combination worth monitoring is both the 1M vs. 3M and 1M vs. 10M moving average crosses. Given the strong rally in equities over the last year and longer, the 1M moving average still remains well above the 10M and we do not believe shorts build up until we see that set cross.
However, speaking of CTAs, there is another potential major risk factor: a sudden spike lower in Treasury yields. Recall our article from January 24 “Momentum Traders Wreak Havoc For 2Y Treasurys, Could Unleash Sharp Bond Liquidation” in which we explained that some of the biggest marginal buyers, and sellers, of 2Y notes are CTAs.
Well, according to BofA’s latest analysis, the rally yesterday in bond futures “is causing our model CTA portfolio to cover its short US bond futures position in order to limit losses. Given the recent significant trend lower in bond prices prior to Monday’s reversal, our model’s short position was quite high. Should actual CTAs also start unwinding their short US bond futures positions, then we may see a squeeze in the coming days.“
Which brings us to BofA’s final observation: according to the quant strategists, if today’s dip is bought and we reach a local high, “CTAs could accumulate equity longs.”
Given that moving averages still point to positive trending equities, we believe CTAs could actually reinitiate longs should we see a snap back in the next one to two weeks. This incremental buying pressure could help propel any reversal in the markets and is worth monitoring.
In other words, if only central banks provide just enough support to stocks today, we may all simply forget that on “Black Monday 2017” we saw the biggest volatility freakout in history and the algos will be back to buying the dip, as they always have been, in no time as nobody learns any lessons once again.
It seems like just yesterday the overly confident bulls were openly taunting any market participant that dared counsel about the increasing risks in the equity market.
“You don’t get it. Trump’s tax policies have ushered in a new era of corporate profitability. Why fight the rise? Nothing can stop this freight train.”
Yadayadayada. It’s always the same. Markets make opinions, not the other way round.
All of sudden, in less than a week, the S&P 500 has given up 200 points.
But what happened? Why the change of heart?
Well, as much as I would like to point to a specific economic release, or some other geopolitical development, the truth of the matter is that there really was no catalyst. Equities were simply up on a stick, with everyone chasing the ever-rising market. It was made worse by the new era of electronic trading that favours VWAP or TWAP type orders that spread the buying out over the course of the day resulting in a relentless drip higher. This had the effect of tricking market participants into believing that volatility had permanently disappeared. And in today’s low alpha world, too many investors leaned on the short equity volatility trade to pick up yield.
Last night, short equity vol sellers got a lesson in getting squeezed. And as much as everyone wants to enter into these complicated discussions about kurtosis or the volatility of volatility, I am going to spell it out in much simpler terms. The short vol sellers were out over their skis, and the market always punishes the weak hands.
In the space of 20 minutes, VIX futures spiked to a level that was higher than 80% from the previous close, triggering the dreaded liquidation clause in the short XIV ETN. And sure enough, it appears the manager chose to exercise that right, with the market assuming the ETN will be wound down.
Whereas a week ago no one could imagine the equity rally ever stalling, this morning the financial world is filled with all sorts of doomsday contagion scenarios about the short volatility collapse.
And could that happen? For sure. If there is one thing that we should have learned from the recent past is that anything can happen.
Yet here is an alternative thought for you to ponder. What if this was simply a case of weak hands getting shaken out? Market history is replete with examples of short squeezes that were nothing more than the stronger capitalized players taking out the under capitalized ones.
It’s almost like that the stop loss for the short-volatility ETNs was a target for market participants to shoot for.
But the real question is whether the move from the weak hands to strong ones has already happened. Will VIX short sellers look back at last night’s spike and kick themselves for getting stopped out? Everyone on the financial TV is soooo convinced that the vol trade is about to spiral upwards out of control. A good trader learns to never say never, but I am not as sure that last night’s squeeze won’t prove to be the top in VIX for this move.
After a burst of record high job openings which started in June of last year and declined in the fall, today’s December JOLTS report – the favorite labor market indicator of now former Fed chair Yellen – showed another modest drop in job openings across most categories as the year wound down, with the total number declining from an upward revised 5.978MM to 5.8113MM, below the 5.950MM consensus estimate, the lowest print since May.
After the recent breakout, which started with the near record 414K monthly spike in job openings in June after years of being rangebound between 5.5 and 6 million, the latest job opening prints suggests that increasingly more vacant jobs are getting filled, although it is unclear if that is due to higher wages or looser employer standards. In any case, the fact that job openings is dropping is likely another modest negative for future wage growth.
The number of job openings was little changed for total private and for government. Job openings increased in information (+33,000) and federal government (+13,000), however job openings decreased in a number of industries with the largest decreases occurring in professional and business services (-119,000), retail trade (-85,000), and construction (-52,000). The number of job openings was little changed in all four regions. Now if only employers could find potential employees that can pass their drug tests…
It wasn’t just job openings that declined: total hires declined as well, although more modestly, dropping from a near record 5.493 million in November to 5.488 million in December. This is roughly the same as the May print of 5.472 million.
The other closely watched category, the level of quits – which indicates workers’ confidence they can leverage their existing skills and find a better paying job – reversed last month’s decrease, and in December increased modestly from 3.161MM to 3.259MM, suggesting workers were feeling more confident about demand for their job skills than the previous month. The number of quits was little changed at 3.3 million in December. The quits rate was 2.2 percent. The number of quits was little changed for total private and for government. Quits decreased in federal government (-4,000). The number of quits increased in the Midwest region.
And with a total 5.2 million separations (a 3.6% rate), this means that there were 1.6 million layoffs and discharges in December, virtually unchanged from November.The number of layoffs and discharges was little changed for total private and for government. Layoffs and discharges increased in state and local government education (+15,000). The number of layoffs and discharges was little changed in all four regions.
Putting all the data in context:
Job openings have increased since a low in July 2009. They returned to the prerecession level in March 2014 and surpassed the prerecession peak in August 2014. There were 5.8 million open jobs on the last business day of December 2017.
Hires have increased since a low in June 2009 and have surpassed prerecession levels. In December 2017, there were 5.5 million hires.
Quits have increased since a low in September 2009 and have surpassed prerecession levels. In December 2017, there were 3.3 million quits.
For most of JOLTS history, the number of hires (measured throughout the month) has exceeded the number of job openings (measured only on the last business day of the month). Since January 2015, however, this relationship has reversed with job openings outnumbering hires in most months.
At the end of the most recent recession in June 2009, there were 1.2 million more hires throughout the month than there were job openings on the last business day of the month. In December 2017, there were 323,000 fewer hires than job openings.
Finally, and perhaps most notably, the Beveridge Curve (job openings rate vs unemployment rate), appears to be gradually normalizing after a nearly decade-long “drift” from its conventional pattern. From the start of the most recent recession in December 2007 through the end of 2009, the series trended lower and further to the right as the job openings rate declined and the unemployment rate rose. In December 2017, the unemployment rate was 4.1% and the job openings rate was 3.8%.
Ignoring or downplaying these fundamental forces has greatly increased the fragility of the status quo.
The term dead cat bounce is market lingo for a “recovery” after markets decline due to fundamental reversals. Markets tend to bounce back after sharp declines as participants (human and digital) who have been trained to “buy the dips” once again buy the decline, and the financial media rushes to reassure everyone that nothing has actually changed, everything is still peachy-keen wonderfulness.
I submit that the past 9 years of market “recovery” is nothing but an oversized dead cat bounce that is finally ending. Here is a chart that depicts the final blow-off top phase of the over-extended dead cat bounce:
Why are the past 9 years nothing but an extended dead cat bounce? Nothing that’s fundamentally broken has been fixed, and none of the dynamics that are undermining the status quo have been addressed.
The past 9 years have been one long dead cat bounce of extend and pretend, i.e. do more of what’s failed because to even admit the status quo is being undermined by fundamental forces would panic those gorging at the trough of the status quo’s lopsided rewards.
This 9-year dead cat bounce was pure speculation driven by cheap central bank credit and liquidity. Demographics, environmental degradation, the decline of middle class security, the erosion of paid work, the bankruptcy of public and private pension plans, the global debt bubble, soaring wealth and income inequality, the corruption of democracy into a pay-to-play bidding war, the destruction of price discovery via market manipulation by those who have turned markets into signaling devices that all is well, the laughable distortion of statistics to mask the real world decline in our purchasing power (inflation is near-zero–really really really), the perverse incentives to leverage up bets in financial instruments that have no connection to the real-world economy–none of these have been addressed in the market melt-up.
Rather, ignoring or downplaying these fundamental forces has greatly increased the fragility of the status quo. Gordon T. Long and I discuss these fundamental forces in our latest half-hour video program, 2018 Themes (29:46 min):
In a widely anticipated hearing, the chairmen of the SEC and CFTC, the two federal regulators tasked with overseeing cryptocurrencies, will appear before the Senate Banking Committee today to discuss their regulatory approach to a market that’s rife with fraud and abuse.
In their prepared remarks, the two men appeared to focus on regulating ICOs – which they appear to see as a legitimate form of capital raising – and derivatives like the bitcoin futures launched late last year by the CME and CBOE.
Watch the hearing live below:
Below are the prepared remarks from CFTC Chairman Christopher Giancarlo
Cryptocurrencies rallied into the hearing, paring yesterday’s losses. Unfortunately, crypto stocks like Eastman Kodak and Advanced Micro Devices remained lower even as the broader market rebounded.
Yesterday, in a moment of humiliation for the entire alternative asset management industry, the websites of the largest US roboadvisors were down, blocking traders from accessing their trading accounts during the worst market rout in history.
Well, just hours later, the humiliation has spread to the pinnacle of the traditional asset management industry, because as of this moment the website of Fidelity has just gone offline, supposedly as a result of record traffic as investors scramble to find out just how big is the damage to their accounts from yesterday’s historic selloff.
