Tag: news

Excerpted from John Hussman’s Market Comment,

Key points

1) The May jobs “shocker” was largely a reflection of CARES coverage of corporate payrolls.

2) The gap between Wall Street and Main Street appears similar to the “incubation phase” of other major downturns.

3) Federal support remains essential, but is best targeted toward preserving the “circular flow” of the economy by supporting the basic incomes of families and incentives for productive investment, limited to those actually experiencing economic damage.

4) After years of overborrowing to finance stock repurchases (partly to offset dilution from stock-based compensation), many corporations were overleveraged coming into this crisis. Bankruptcies are likely to increase, but the government can support packaged restructurings and bank purchase-and-assumption transactions without bailing out private investors, who agree to accept these risks in a free-enterprise system.

5) Fed “leverage” of CARES funds to purchase uncollateralized corporate bonds violates FRA 13(3), CARES 4003(c)(3)(B), and potentially Article 1 Section 8 of the U.S. Constitution.

6) Projects that are enabled only by zero interest rates are most likely projects that are speculative and unproductive.

7) Improved market internals currently encourage an agnostic near-term outlook (though not a bullish one) despite several features that suggest the improvement is fragile.

8) Valuations are again near historic extremes.

9) Continued dispersion within the U.S. equity market suggests particular risk for richly valued large-cap stocks.

Incubation phase

On Friday June 5, the Bureau of Labor Statistics reported that U.S. nonfarm payrolls jumped by 2.5 million in May, following a (downwardly revised) loss of 19.7 million jobs in April, sending Wall Street on a full-tilt, dubstep remix of “Happy days are here again.” It was a fitting choice, given that the song was written in 1929. Of course, the Great Depression also began with a spectacular financial rebound that bore no relationship to the underlying deterioration on Main Street.

Severe economic recessions often feature what might be called an “incubation phase,” where an exuberant rebound from initial stock market losses becomes detached from the quiet underlying deterioration of economic fundamentals and corporate balance sheets. From the post-crash low of November 13, 1929, the Dow Jones Industrial Average enjoyed a 48% rebound, peaking on April 17, 1930, followed by an 86% collapse by July 8, 1932 (an overall loss of 89% from the September 3, 1929 bull market peak).

To understand the apparent jobs report “shocker,” a bit of arithmetic may be useful. As part of the $3 trillion CARES economic bailout package, the “Paycheck Protection Program” (PPP) provides $349 billion to small businesses, which can cover payroll costs for up to 24 weeks, and is payable regardless of whether employees are actually working or not – so long as they are kept on the payroll. Now, median personal income in for U.S. workers is about $34,000 a year, and 24 weeks amounts to $15,700. So $349 billion of PPP funds essentially covers the paychecks – temporarily – of over 22 million U.S. workers.

In the Household Survey, which is used to calculate the unemployment rate, the Labor Department admitted that survey takers mistakenly counted 4.9 million furloughed workers as employed, but did not correct the data, ostensibly “to avoid the appearance of political manipulation.” Accordingly, the reported unemployment rate was 13.3% for the month of May. The corrected data would show a 16.1% unemployment rate.

Even that figure does not reflect the 4.7 million workers who have abruptly dropped out of the civilian labor force since March, and are not included because they are not presently looking for work. To gauge this impact, note that the ratio of May civilian employment (corrected for miscounts) to the March civilian labor force is 0.812. So even if every single worker currently counted as “employed” would still retain that status without PPP or other CARES funds covering their paycheck, a plausible estimate of the U.S. unemployment rate would still be about 18.8%.

A New York Times analysis noted that if one includes marginally attached U-6 workers, those working part-time but looking full-time work, and those reporting they want a job but are not currently looking, the unemployment rate would be 27.0% here. However, that figure can’t be directly compared with the headline number, which never includes these categories.

Still, Wall Street was shocked and exuberant that reported employment bounced back by 2.5 million, evidently not giving a moment’s thought of what has financed this rebound, nor the fact that this support is impermanent. What we are observing is not “recovery,” it’s the impact of a government program that is paying the salaries of employees that are kept on payroll, whether they are actually working or not.

One thing that Wall Street does have going for it, however, is that to the extent that companies are still generating revenues, and are paying workers with PPP funds from the government, some portion of the $349 billion in PPP funds actually represents a pure subsidy to profit. That’s because forgiveness of these loans is not conditional on whether companies have actually suffered economic damage.

While the PPP program is targeted toward small businesses, some portion of the $500 billion slush fund provided to the U.S. Treasury for states, municipalities, and businesses is also likely to feed into profit subsidies – though not enough to offset overall weakness in U.S. corporate earnings.

Many civic-minded members of Congress were distressed at how insistent some legislators were to avoid oversight that could prevent the misuse of public funds. For a discussion of how future policies can better ensure that economic support goes to families and businesses that have been negatively affected, rather than subsidizing corporate profits, extraordinary compensation, and private investment losses, see the economic policy section of last month’s market comment.

Severe economic recessions often feature what might be called an “incubation phase,” where an exuberant rebound from initial stock market losses becomes detached from the quiet underlying deterioration of economic fundamentals and corporate balance sheets.

Part of the current enthusiasm of investors seems to be the idea that the stock market typically reaches its low before the economy does (though this was certainly not true of the 2001 recession). On the idea that the second quarter of 2020 will be the low point for the economy, there is a superficial sensibility in “looking over the valley.” The problem is that post-recession bull markets typically begin at valuations about 40% of those we observe at present.

Investors make the same mistake when they observe that the stock market essentially went nowhere between 1918 and 1920 despite the Spanish Flu pandemic, and then launched into a bull market that extended for nearly a decade. What this argument fails to observe is that market valuations between 1918 and 1920 stood at less than a quarter of current levels, representing the most steeply undervalued period in U.S. history. So yes, if the U.S. stock market loses three-quarters of its value from current levels, I expect that stocks would become fairly resilient in response to additional negative developments, and would likely enjoy an extended bull market from those levels.

Gradually, then suddenly

It’s sometimes said that “risk happens fast.” Yet underlying financial damage often has a long and quiet incubation phase, which is why Hemingway, in The Sun Also Rises, described bankruptcy as occurring “gradually and then suddenly.”

The current “incubation phase” is reminiscent of 2008. Early that year, AIG admitted that it could not “reliably quantify” its losses. In March, Bear Stearns failed. The Associated Press published an article discussing the unprecedented interventions by the Federal Reserve, including Bernanke’s creation of “Maiden Lane” shell companies to absorb bad mortgage-backed debt (which at least represented collateralized debt, unlike the uncollateralized corporate debt the Fed is illegally purchasing today). The article quoted Richard Fuld, the CEO of Lehman Brothers, who argued that this intervention, “from my perspective, takes the liquidity issue for the entire industry off the table.” Clearly, it did not remove the solvency issue.

After the failure of Bear Stearns, after strains in the subprime loan market were fully recognized, and after the Federal Reserve and the U.S. Treasury had already launched unprecedented interventions, the S&P 500 advanced in May 2008 to a level that was within 9% of its October 2007 peak, on the notion that all of the bad news had been “discounted.” The S&P 500 then lost 53% of its value.

The market reaction to the unemployment numbers today is our Bear Stearns ‘systemic risk is off the table’ moment.
– Ben Hunt, Epsilon Theory, June 5, 2020

The same sort of slow incubation characterized the financial markets in May 2001. An economic recession had already started two months earlier, and the S&P 500 had been in a bear market for over a year. But as the S&P 500 rebounded within 14% of the March 2000 bubble peak, the Wall Street Journal observed “Though economists are expecting this year to be the economy’s worst since 1991, only a tiny percentage think the economy is in a recession.” The S&P 500 would lose an additional 40% of its value by October 2002, and the technology-heavy Nasdaq 100 would lose an additional 60% of its value, bringing its overall bear market loss to 83%.

It’s sometimes said that ‘risk happens fast.’ Yet underlying financial damage often has a long and quiet incubation phase, which is why Hemingway described bankruptcy as occurring ‘gradually and then suddenly.’

In the face of a breathtaking disconnect between Main Street and Wall Street, largely based on overconfidence in free money, my sense is that there remains a crisis ahead that will emerge “gradually and then suddenly.” It is important to allow for that possibility, but nothing in our investment discipline relies on that outcome. It is enough to simply align our investment stance with prevailing, observable conditions – primarily valuations and market internals – and to shift our outlook as the evidence shifts.

…

Those of you who know me well know that I’ve had three mentors in my life; two of them, Jimmy Carter and my teacher Thich Nhat Hanh, who I’ve been blessed to call my friends; and Dr. King, who our nation rightly celebrates this week (and who, to close the circle, long ago nominated Thich Nhat Hanh for the Nobel Peace Prize). Among the many things they’ve all taught, and stood for, is that the person we might call our adversary is another human being, suffering in a way that we may not understand – perhaps from hatred, ignorance, fear, or perceptions of injustice – and that the only path to reconciliation is to encourage each to understand and address the suffering of the other. It’s always possible to do that in a way that is consistent with our own security.

My sense is that the peace of our world, and the civility of our nation, is at risk because people don’t really trust that idea. They’ve come to believe that an adversary is someone to be insulted, and attacked, and ultimately destroyed. That’s the behavior that they see modeled for them; encouraged to ignore our interconnectedness – that all of us are empty of a separate self, and full of causes and conditions that are common to our humanity. We become a stronger nation and a better world when each of us feels heard – and I don’t mean just when “we” feel heard and respected, but also when whomever we call “they” also feel heard and respected.

It’s often imagined that peace is the result of sufficiently crushing one’s opponent; of inflicting so much injury and suffering that they surrender. There’s little doubt that conflicts can be ended in this way, but only at terrific cost, and with deep scars that feed later hatreds and conflicts. Others somehow come to imagine that waging peace requires one to lay down defenseless. It’s just not so. Peace doesn’t mean that one doesn’t defend oneself, or refrain from criticism. Peace doesn’t demand the absence of strength. It asks each side to see and understand the suffering of the other, whether that suffering is rooted in reality or misperception. It asks us to refrain from needlessly provoking the adversary, or to insult them in order to boost our pride. It asks us to look to address their suffering in ways that are consistent with our own security. If peace demands anything from us, it is to refrain from being infected by hatred. Dr. King recognized that:

“Darkness cannot drive out darkness; only light can do that. Hate cannot drive out hate; only love can do that. I have decided to stick with love. Hate is too great a burden to bear.”

…read more here.

An alarming number of Americans are having trouble making rent payments amid a period of high unemployment and an unfolding depression across the U.S. At least 17% didn’t pay their latest monthly rent and an even larger number of folks are worried about missing upcoming rent payments as the squeeze on households is getting worse, reported Bloomberg, citing the U.S. Census Bureau’s Household Pulse survey.

Census Bureau’s Household Pulse survey showed in the last five weeks through June 2, 31% of households said they had “little or no confidence” about paying rent next month. 

The survey showed 11% of households with a mortgage skipped servicing payments last month, and 16% said they wouldn’t be able to make payments in the future.

The consumer is in rough shape, despite President Trump touting of a V-shaped recovery and how the stock market is at record highs — households, mainly ones of the bottom 90% — are getting absolutely crushed in this downturn. This sets the stage for a consumer that died with a bang: because in a time of virtually no visibility on job prospects, economic recovery, and how the pandemic is resolved, consumer behavior suggests winter is here. 

“Households who suffered a loss of income due to Covid-19 may be reducing their spending on non-housing goods/services in order to make their rent or mortgage payment,” said Shawn Bucholtz, an economist with the U.S. Department of Housing and Urban Development.

Federal Reserve Chair Jerome Powell said Wednesday that he has told lenders to offer distressed consumers forbearances on their debt payments.

“There’s been a tremendous amount of forbearance on the part of the banks,” Powell said during a press conference. “But those are not decisions that we hold any legal authority to make, and by the way, we have encouraged those decisions.”

So how long until people can afford to pay rent and mortgages again? Or better yet, how long until people can start spending? The answer is that nobody knows, but one thing is certain: there can be no V-shaped recovery this year.  

Our advice to Americans: the economic storm is not over. 

Back in March, when the Fed unleashed Unlimited QE with the added kicker of buying corporate bonds as central banks around the globe activated the monetary firehose of helicopter money, Albert Edwards finally admitted that the deflationary “Ice Age”, a term he coined back in the 1990s, was coming to an end. Three months later, the SocGen analyst is now convinced: “We are transitioning from The Ice Age to The Great Melt” he writes, as “massive monetary stimulus is  combining with frenzied fiscal pump-priming in an attempt to paper over the current slump.”

Looking back to the start of his working career in financial markets in 1982, Edwards writes that inflation and bond yields in developed economies have enjoyed a one-way disinflationary slide, although as he notes “It has not been all plain sailing” and points out that his “Ice Age thesis explained how a tipping point would be reached where western financial markets would mirror what we saw in Japan during the 1990s and beyond.”

Said tipping point would arrive as “a gravitational pull towards outright deflation (exacerbated by policy mistakes) would cause a re-rating of stability in absolute and relative terms compared to cyclicality.” To be sure, the last few years of the Ice Age served not only bond investors but also equity investors well, “as bond proxies within the equity market have massively re-rated relative to cyclicals.”

However, all that is coming to an end as Edwards now believes that the world is finally in the transition phase as The Ice Age begins to thaw. The reason: “this economic bust is so serious and so deflationary that policymakers felt they had no choice but to cross the policy Rubicon.” Looking ahead to what he called the “The Great Melt”, Edwards posits – correctly – that there will never be any serious attempt to reverse policy stimulus. “Indeed we will see more and more stimulus until the deflationary ice melts.”

But there is one final, interim step before The Great Melt gains proper real economy and inflationary traction: According to the SocGen analyst “first we need to fully embrace The Great Melt-Down – the final stage of the Ice Age.” And although even Edwards has thrown in the deflationary towel and is now a believer that inflation will be properly re-ignited in the next economic cycle, “the markets remain focused on what lies ahead and not on the deflationary crevasse that has just opened up beneath them.”

Case in point, yesterday’s May US CPI data saw an unprecedented three consecutive mom declines in core CPI, Edwards notes, adding that “previously even a single sighting of a 0.1% mom decline in core CPI was as rare as hen’s teeth. Before this year there were only three mom declines since inflation peaked in 1982! US core CPI has now slumped into deflation and the markets will find this a most difficult crevasse to bridge.”

Referring to the chart below, Edwards writes that in May, US core CPI (ie ex food and energy) continued its unprecedented slide with the yoy inflation rate slowing to 1.2%, half the rate seen as recently as February. But excluding imputed Owner Equivalent Rent (OER is not included in the eurozone measure)  this comparable measure is rising only 0.4% yoy and falling sharply on a 6m basis.

Indicatively, if one uses the Eurozone’s definition of core CPI for the US, one would get the following dramatic slide into outright deflation (of course, try explaining that to all those millions of people who can’t afford rent at any cost).

Indeed, it appears that sticky rent prices via OER inflation (which tends to mirror actual rent inflation) have held up core CPI. The rapidity of the slump in the core inflation ex OER is shocking and we have discussed the likely temporary nature of high OER/rent inflation on core CPI previously. 

Yet despite the quasi-deflationary data reported by the CPI, inflation expectations remain anchored, and in fact the Fed’s latest survey of consumer expectations showed that people believe inflation is set to rise (see below).

As Edwards notes, “it is curious that investors have not absorbed the current deflationary reality”, suggesting that the next leg of US “Japanification” may be a shift in long-term price outlooks (unless of course most Americans remain focused on the abovementioned rents and food prices which remain rather sticky).

In any case, the slump in inflation feeds into the core of Edwards’ Ice Age thesis and concerns equities too. Indeed, nominal GDP growth is set to slow further (blue line in chart below) dragging down analyst forecasts of long-term eps growth, which are already weighed down by the ongoing profits collapse, and forcing the Fed’s hand further.

Finally, and most ominously, the slump in core CPI is bringing the Japanification of US nominal growth to an economy already saddled with record debt, which in turn will lead to a reset in price levels as investors realize companies are unable to “grow” into their record high valuations.

For those wondering what this means for stocks, Edwards saves the best for last: “As this will trigger a further decline in L/T eps, nose-bleed expensive PEG ratios will likely be fatally undermined. Before markets can properly embrace The Great Melt, they first need to comprehend the new normal: deflation has arrived.”

Producer Prices rebounded MoM in May with headline Final Demand PPI rising 0.4% (against +0.1% exp) but it left PPI YoY still down 0.8%…

Source: Bloomberg

Some serious dispersion in the various sector’s price swings…

This rebound was driven by a record surge in food prices…

Source: Bloomberg

Two-thirds of the May increase in the index for final demand goods is attributable to a 40.4-percent jump in meat prices.

Source: Bloomberg

The indexes for gasoline, processed young chickens, light motor trucks, liquefied petroleum gas, and carbon steel scrap also moved higher.

Source: Bloomberg

Conversely, prices for chicken eggs fell 41.2 percent. The indexes for diesel fuel and for plastic resins and materials also decreased.

What will Jay Powell do now that average joe’s cost of living is soaring?

Despite last week’s hope-restoring nonfarm payrolls “recovery”, in the last week 1.542 million more Americans filed for unemployment benefits for the first time (slightly better than the 1.55mm expected).

Source: Bloomberg

That brings the twelve-week total to 44.21 million, dramatically more than at any period in American history. However, as the chart above shows, the second derivative has turned the corner (even though the 1.54 million rise this last week is still higher than any other week in history outside of the pandemic)

Continuing Claims did drop very modestly but hardly a signal that “re-opening” is occurring! And definitely not agreeing with payrolls data…

Source: Bloomberg

The claims by state, show an outlier improvement in Florida, where nearly there was a decline of 100K claims, with Texas and Georgia also on the mend, while California, Massachusetts and New York saw the biggest increases in the past week.

And as we noted previously, what is most disturbing is that in the last twelve weeks, twice as many Americans have filed for unemployment than jobs gained during the last decade since the end of the Great Recession… (22.13 million gained in a decade, 44.21 million lost in 12 weeks)

Worse still, the final numbers will likely be worsened due to the bailout itself: as a reminder, the Coronavirus Aid, Relief, and Economic Security (CARES) Act, passed on March 27, could contribute to new records being reached in coming weeks as it increases eligibility for jobless claims to self-employed and gig workers, extends the maximum number of weeks that one can receive benefits, and provides an additional $600 per week until July 31.

A recent WSJ article noted that this has created incentives for some businesses to temporarily furlough their employees, knowing that they will be covered financially as the economy is shutdown. Meanwhile, those making below $50k will generally be made whole and possibly be better off on unemployment benefits.

Additionally, families receiving food stamps can typically get a maximum benefit of $768, but through the increase in emergency benefits, the average five-person household can get an additional $240 monthly for buying food.

But, hey, there’s good news… stocks are near record highs and Treasury Secretary Steven Mnuchin said he anticipates most of the economy will restart by the end of August.

The big question is – what happens when the $600 CARES Act bonuses stop flowing?

Finally, it is notable, we have lost 392 jobs for every confirmed US death from COVID-19 (112,914).

Was it worth it?