The Dow Jones is coming under pressure at a time when market pundits are being told to expect a market recovery. What’s new? There have been numerous opportunities for equity markets to go into a tailspin, but on each occasion asset prices (equities, property and bonds) have tended to rise. The elusive recovery to date could be attributed to:
- The strong equity markets
- The housing market recovery
- Low unemployment
- Low interest rates
The problem is apparent in the following chart. The market has had a huge ‘unprecedented’ rally in terms of its longevity. Even if you were positive about the outlook, you might question the sustainability of this rally, given the expectation of rising rates. Looking at the following chart it seems reasonable to expect a ‘good retracement’ to at least the 14,000pts level. The reason why we might not expect more than that is simply that, there is every reason to expect a recovery in the real economy because:
- Interest rates remain very low – so there is scope for the market to accept some increase in rates
- Higher rates would actually encourage more spending because the incentive to pay off one’s liabilities will be lower. The problem is that the Fed would not raise rates if there was any prospect of sinking equity & property markets.
- There are no signs of inflation
Source: Google Finance
- The ‘dead-cat’ bounce in China’s equity markets, suggests a lack of confidence there
- Ominous signs of political instability in the USA, with elections looming in 2016
- The prospects of a currency war, that can only undermine confidence in political leaders. This is the surest sign of no demand.
Housing market recovery
Judging by the following chart of new housing starts in the US, you could be forgiven for thinking the strong growth in construction is a ‘good sign’. The reality is however is that:
- Current levels of housing construction only offset the ‘pent-up demand’ for new housing that arose after the global financial crisis.
- There is no ‘fundamentals’ which would support the persistence of this trend, as I will show next.
Looking at this chart and the absence of fundamentals to support it, it is easy to conclude that the USA is about to enter another recession, and that housing starts are destined to dip down soon. Might the Fed arrest this prospect with another QE program. The problem is the lack of jobs to justify it. You can put credit into the banking sector, but in the absence of ‘real spending’, it will just end up in already over-priced asset markets. If the Fed resorts to QE, it would probably also raise rates, and prompt more liquidity to enter the derivatives market ‘short’. That would not help confidence in the real economy.
Low unemployment myth
The myth is being perpetuated that the unemployment rate is low, and that it has fallen over the last 7 years since the global financial crisis. In fact, we have simply seen a lot of Americans, as in other countries, live off their equity, and simply stop looking for work. I’m way ahead of these people because I left the workforce 15 years ago to simply live off investments. I was motivated by the decline in Western values; but others were mostly motivated by the decline in opportunities, i.e. retrenchments. The problem of course is that we have four types of people in the market place:
- Families spending like there is no tomorrow because they have kids and little savings
- Subsistence lifestylers living frugally – mostly these are skilled people leaving themselves flexible
- Subsistence welfare recipients – mostly these are ‘estranged’ unskilled people, or skilled people in vocations that society does not value. Sometimes they are just people who don’t readily integrate into society, i.e. libertarians, white supremacists, atheists, disabled or convicted felons for drug use.
- Skilled people who have seen a rapid rise in incomes – Even these people are not spending because they are rapidly paying off their homes
You can see from this ‘anecdotal survey’ of Americans that the only people spending are working families; whilst everyone else in ‘economizing’, whether because they are struggling, cautious or opportunistically paying down debt on their significant liabilities. This explains why spending is subdued, and why it will not increase until:
- There is a recovery in the ‘real economy to justify a rise in interest rates by over 100bp beyond Sept-2015
- Quantitative easing in order to stimulate the US market
I am actually expecting the Fed to pursue both of these courses of action. So-called reference to a ‘liquidity crunch’ is nonsense. The reality is that there is a ‘wage gap’ between Western society and Emerging Markets. This will take time to resolve, however Western governments have done the exact opposite of what they need to have done in order to solve the problem. Far from increasing productivity, they have reduced it. Far from reducing waste; they have taken it to new levels with more intrusive ‘distortionary’ laws. This is why I support Donald Trump. He’s not a political hack, he talks about reducing waste, and unlike Rand Paul, he resonates like a conservative, so he is plausibly electable.
It is therefore important to appreciate that ‘low unemployment’ is a ‘dirty white lie’ that is in fact a long term decline in the US workforce participation. You could argue that too many people have simply left the workforce, or 2-income families have become one, or full-time workers have become part-time, that more children are staying at home until their 50s, or more people are packing into ever-smaller apartments. Of course there are more Americans on welfare programs. But the greater reality is that they are simply living minimalist lives. This is actually one of the reasons why governments have shifted to taxing consumption, as well as expanding their powers to intrude into foreign bank accounts, as more people ‘live abroad’.
Why would this rate be falling if unemployment is falling. People have simply stopped looking for work. Not everyone of course. It is also fair to say that a lot of people are ‘under-employed’.
Excess business inventories
There are however also other ‘demand indicators’ that are used to justify the premise that the US economy is recovering, such as new vehicle sales, which are at “record levels”. There is other evidence however to suggest that not all is well in the US economy, namely:
- US inventory levels – see the ominous signs of recession below
- Vehicles in the US are a ‘necessity’ unlike Japan. The issue is not ‘car ownership’ but car cost. Moreover the credit terms for new cars have never been easier, and anyway delaying the purchase has a reason to jump into the market….they have been saving for 7 years.
- Judging by the statistics belong, vehicle sales are at ‘break-neck’ rates, so I’d expect a fall in coming months.
In conclusion, there are strong reasons to be cautious about the outlook for the next few years. There are also compelling reasons to appreciate that the current crop of conservative and democratic politicians have no intent to reform goverrnment. Only politicians like Rand Paul and Donald Trump are likely to make those tough decisions to cut costs, that will restore the US economy to health. Note the following:
- Stock and bond prices – the tendency for stock indices to fall every 7 years (2001, 2008 and now 2015??)
- Excess inventory levels – a precursor to recession
- Prospect of a modest interest rate increase – not so significant as only 25bp probable
- Election concerns diminishing confidence in the next year