A tale of two Christmas’

The 2016 Christmas run up saw the shares of retailers ( tracked by XRT, first chart ) rise an anaemic 1%, while in 2017 the same stocks BOOMED, soaring some 5.17 during the last two weeks of December. Why?

Well, MasterCard reports record Christmas spending of some $800B this year. In fact, this was single largest Christmas season on record. So what’s going on?

Well clearly the American consumer is back, with consumer confidence soaring to a 17 year high. Feeling more comfortable about the economy, the best job prospects for a decade, wages rising for the fastest in a decade and amid the promise of falling bills for a majority of taxpayers, the American consumer drove spending this Christmas season to record levels. This is important as some 70% of US GDP is driven by consumption. Higher consumption means likely higher GDP. I spent yesterday reviewing economic forecasts from about a dozen Investment Banks and some optimists are suggesting 2018 could see at least one quarter of 5% GDP growth, annualised ( and clearly nominal ).

A rough approximation to 1Y forward GDP is the sum of CPI and the yield on the US 10Y; with CPI running at 2.2% and the 10Y yield about 2.45% we see this approximation suggests 1Y look ahead US GDP of about 4.6%. Things are heating up, but anyone reviewing forward looking metrics of inflation already knows this; inflation isn’t as benign as the ( heavily manipulated ) index would suggest

So where goeth US GDP? Well, with Consumer Debt Service still at a manageable 5.48% and wages increasing amid an environment where some 85% of Americans will see their tax bills falling, it seems there is plenty of upside. Another factor is Americans new enthusiasm for charging it. Looking at Debt Service as a percentage of Disposable Income, we see American’s credit cards have a ways to go before they max out ( chart below ).

I suspect we’ll see US GDP topping out at close to 5% before it falls back. Oh yeh !! This is the third consecutive quarter of 3% plus US GDP.

Net Neutrality — What does The Money know?

Lots of angst in The United States these days, as Net Neutrality comes up to a critical vote which may see Obama era regulations rescinded. Curiously, in The United States the competitive landscape for internet access is already relatively backwards, when compared to other Western Democracies.

Specifically, its not uncommon for cities, counties or even entire US states to have either a single provider, or a very small set of providers to choose from. For comparison I’ll point out our personal experience in The UK. At home we’ve got cable from Virgin and ADSL from Sky. Cable runs a stoking 70 Mpbs while the ADSL runs, by comparison, a pedestrian 3 Mpbs.

But we also have Mobile WiFi devices — MiFis — one on The UK’s 3G network ( via Three ) and the other on the much speedier 4G network ( via Vodafone ). Clearly if there are problems with one of the ISPs we can just hop to another. Also if someone in the house is doing something contentious with the bandwidth ( which is tough on a 70 Mpbs connection, but hey it happens ) we can just hop to another. Problems with landlines in our area? ADSL down, move to cable. Problems also with cable? We hop to wireless. You get the picture.

Speaking with folks in The US it seems very often they have a choice of one provider and one provider alone. And often that single provider supplies both wired and wireless access. So clearly very, very backward.

So clearly folks living in The United States — already second class ‘Netizens when viewed globally — have lots of lose with the Net Neutrality vote.

For insight into most matters I tend to look at The Money. The chart below shows the well known “FANG” stocks — Facebook, Apple, Netflix and Google ( now called ‘Alphabet’ ). Over the past five days, we see as a whole they’ve performed very, very badly, when compared to the benchmark S&P 500.

On the other hand, when we look at the big ISPs in The United States, we see over the past five days they have tended to outperform the benchmark S&P 500.

Is this a class case of sector rotation? Money leaving The FANGs — a sector that has performed very, very well to date — and moving to value stocks? Or is The Money telling us more?

What does The Money know?

Americans hitting peak debt?

Not a chance, there are always lenders looking for new & creative ways to offer Americans enough rope to hang themselves. For proof of this look no further than the growth of consumer credit in The United States, increasing at an annual growth rate of some 6.6%, MUCH faster than US GDP. So what’s the problem you ask?

Its simple: used properly debt is a tool to pull future earnings into the present, where funds can be used to improve current living standards e.g., buy a house, or improve one’s future prospects e.g., University tuition. Used improperly, debt is a yet another way to binge, to engage in what Americans do best — live for the moment.

Consider Credit Card debt held by Americans, which this month hit a post WWII high, according to The Federal Reserve and now exceeds $1T.

At current interest rates we see Americans paying approximately some $20B a month in interest alone, which, of course, enriches only banks and other lending institutions. And does little to nothing to improve American’s current or future standards of living. As I said, live for the moment.

Still, whats the problem you ask? Well, credit care delinquencies are starting to increase. The chart below shows the rate of change of delinquencies on credit cards on a rolling one year basis. The first quarter of 2017 showed an delinquency increase of well over 12%, a rate we haven’t seen since Q3 of 2007.

Looking at the last two US recessions, Credit Card delinquencies started to increase about six to nine months before a recession was formally announced.

Can it happen again? Of course. Especially considering The Federal Reserve is increasing interest rates.

That $20B a month of money just pissed away? It will only increase.

How do you pronounce Trump trade?

I’ve presented two charts below, first The US Dollar Index. I tend to watch this index as its a broad measure of The US Dollar’s exchange rate against a basket of six of America’s most important trading partners i.e., EUR, JPY, GBP, CAD, CHK & SEK. Its better to look at a broad measure than any specific currency pair, as the relationship between any two currencies might be distorted due to isolated, nation specific factors.

We can see the strong dollar euphoria actually began before election day. But we already know lots of Investment Banking chatter predicted an election win by then-Mr Trump. So not really a surprise, but what was a surprise was the sharp run app in USD, some 6.25% in roughly 46 days, or about 61% annualised. BLISTERING doesn’t begin to describe the speed of this ascent.

And then the fall. We see the USD declining at a relatively modest speed, roughly 9.1% from its December 20th peak to where its has currently settled out. What happened? Most curiously this is all taking place in an environment of divergent monetary policy, in other words, as interest rates rise in The US even as they remain constant among most of America’s trading partners, theory would predict we should see The USD rise. But a recurrent theme in many of my presentations on finance is the undeniable fact the markets very often does disagree with theory. RUTHLESSLY SO it would seem.

And the US Dollar has weakened, in fact it is now trading at levels we’ve last seen in 2015, or at a two year low. Some are suggesting the weak US Dollar is the big surprise of 2017.

So again, what happened? Lets talk about that later. Meanwhile, below I’ve presented three different stock market indexes, $SPX, aka “The S&P 500″, $INDU aka, “the venerable Dow Jones Industrial Average” and $COMP or “The NASDAQ”. Clearly all are booming and decidedly so!.

So what’s going on? Well a lot can be said for different markets, different market participants. And that’s true. The foreign exchange market tends to be dominated by professionals. And while professionals also dominate trading of the US stock markets, retail investors tend to buy and hold. And we’re still seeing lots of retail money flow into US stocks, much driven by 401K auto investment programmes, even as professionals withdraw from trading.

Net result: USD falling due to concerns about Mr Trump’s agenda. Stock markets soaring as retail money keeps flowing. Retail money is very, very bullish.

Meanwhile, speculation about an upcoming crash simply does not go away.

Poverty in The United States

The Administration recently suggested that ‘ “Anybody who says we are not absolutely better off today than we were just seven years ago, they’re not leveling with you, they’re not telling the truth.” ‘ — is this really the case?

I’ll be dissecting these (specious) claims over the next few posts, but lets start with a metric that everyone can understand — poverty. The chart below shows the so-called “Poverty Universe”; essentially the population of the United States, or all people who might be susceptible to falling into poverty (red one, right scale). The black line shows the percentage of the population of America’s population living below the poverty line.

In 2008 some 13.2% of Americans, or 39.1M lived in poverty. In 2014 (most recent year data is available) some 15.5% of Americans, or 48.1M lived in poverty. Clearly there has been an ENORMOUS increase in poverty. Is this “absolutely better off”?

To put this into context I’ve sourced some OECD data; the chart below shows America compared to forty other nations. I’ve highlighted the G7 (curiously, Japan is missing). America has more citizens living poverty than every other G7 nation. Only two countries — Israel and Mexico — have more citizens living in poverty than America.

So “absolutely better off”?

I don’t think so.

So who is lying then?

Last week Mr Obama went on what some might call a victory lap, crowing about his Administration’s economic accomplishments, all but calling those who criticise the current state of the American economy “liars”. Hmmm. Why not stop with the name calling, please?

Sure, GDP is positive, but eager to distribute the Happy News Mr Obama neglects to look at the bigger picture. The chart below shows two very, very different eras in American history. One characterised by relatively fast economic growth, and other by relatively slow. Annual percentage change in nominal GDP is presented in black (left axis), with America’s debt / GDP ratio presented in blue (right axis). As usual with FRED data, periods of economic recession are noted by vertical gray bars.

We can see that when American debt / GDP was below 50% economic growth surged, averaging some 7.9% pa (in nominal GDP) from the period 1967 to 1989. From that point on US debt / GDP breached above 50%, and GDP began to slow. From 1989 to 2015 US GDP averaged 4.9% pa, while the debt / GDP ratio surged to well over 100%, where it remains today.

And the period after the nation (allegedly) emerged from The Great Recession we see GDP running at roughly 3.5% pa. And, by the way, appears to be slowing even further, as US debt hits record levels of some $19T.

In fact this is the tenth straight year of sub par economic growth in The United States. Now the data tells a rather different picture, doesn’t it?

Mr Obama may wish to ignore the national debt, but its starting to attract bipartisan attention, with some even suggesting America is rather broke. So how did we come to this? Some blame a surge in social spending, while others suggest its all down to out of control military spending, but regardless, interest payments on the national debt may soon eclipse the military budget. Even the Congressional Budget Office is concerned about the mess Mr Obama’s profligacy has created.

So perhaps the problem will fix itself? Like a failed South American nation, some warn that America’s debt / GDP ratio may hit 150% by 2040. Just like Japan, it would seem. Another nation with anemic economic growth, disinflationary forces and debt to GDP well above 200%.

Are things really that rosy in The United States? Or are politicians doing what they usually do — deceive?

So The G20 Finance Ministers are having a meeting …

In Shanghai no less, epicenter of recent market volatility. Apparently on their agenda is a discussion that will allow these nations to agree a way forward to improve global growth. The IMF is urging bold action, while China suggests is has a few tricks up its sleeve in fact more than a few , while both The British and Germans both argue further currency devaluations or negative interest rates would be counterproductive.

Music to my ears, as long as they don’t repeat 2009 when the G20 Finance Ministers pledged “to do whatever is necessary to restore confidence, growth and jobs” (among other pledges) as IT DIDN’T WORK.

The chart below shows G7 growth from 1960 to the present. The vertical gray bars represent US recessions, and for each non recessionary period I’ve calculated the average across the term.

After the post World War 2 spurt of economic activity focused on rebuilding Europe, the overall trend for global growth is apparent — slowing. From the mid 1980s debt levels in The United States sharply soared. Concerning, because the relationship between excessive sovereign debt and slowing economic activity is well defined, as Rogoff & Reinhart have asserted many times, both in academic journals as well as mainstream media. This “growth at any cost” agenda led to what many are calling the worse economic recovery since the end of World War II.

So what can the G20 do to increase growth rates? Maybe nothing at all — some suggest the post World War II growth spurt was due to a confluence of factors such as technological innovation or mass migration of people that we may never see again.

Keeping in mind that from 1850 to 1913 the long run average global growth rate was roughly 2.1% its less likely we’re going to see sustainable growth rates above 2% ever again.

No New Deal for America

Lots of excitement in The United States about upcoming elections. Many of the most enthusiastic are backing what might be called “outsider candidates” — Trump on the (far) right and Sanders on the (far) left. As usual, from my perspective of an ex-patriate Investment Banker-cum-University Lecturer, I tend to see things differently from my stateside compatriots.

Specifically when it comes to Bernie Sanders. Don’t get me wrong — I do like much (most?) of what he says regarding social inequality in America. And the need to act. But its the proposed policy solutions that trouble me.

Mr Sanders proposes a Roosevelt-style New Deal, aiming to pump some $14.5T into the US economy by ”spending on infrastructure, youth employment, increasing Social Security benefits and expand family leave”. Some enthuse that not only would unemployment drop, poverty would drop and GDP would surge to 5% or more, albeit without providing details. Still others argue unemployment would drop below 4% while wages would grow by 2.5% .

All good stuff. But here is why it will never happen, and its pretty simple: the current occupant of The White House spent all the money. The chart below (source CBO, 2016) shows US debt / GDP from 1790 to 2000. You’ll see that when Roosevelt launched his New Deal The United States ran a debt / GDP ratio of roughly 48%. In other words, America had plenty of borrowing capacity.

The chart below shows US debt / GDP from 2000 to 2016. It is well above 100%. The “economic recovery” is fake — its been created by excessive borrowing. Its almost as through you or I max out the credit cards to artificially create an aura of prosperity. Its neither sustainable nor realistic to create prosperity by borrowing excessive sums of money.

In fact many argue as China is a net seller of US Treasuries as are many other nations America will soon have to pay it’s own way. In other words, America won’t be able to borrow from developing nations any longer, as they have their own problems to solve. America will not only have to live within its means, but pay back principal as US Treasuries mature.

Imagine that. America paying down its national debt?

That would truly be a New Deal.

The low inflation myth

The media is full of reports these days about low inflation or no inflation, in fact some refer to this period as another installment of the great moderation, or a protracted period of low inflation amid moderate, but positive economic growth.

Is this really true?

Let’s leave growth out of this for the moment; several times I’ve questioned the relationship between US economic growth and Quantitative Easing, and I’ll revisit the topic soon enough. So how about low inflation then? Is inflation really low?

Well, depends upon where you look. If one accepts The Consumer Prices Index (CPI), or a measure of inflation as defined by The U.S. Bureau of Labor Statistics, the answer is yes. How about we switch our focus away from CPI to other measures, my answer is a resounding NO. But I’ll let you make up your own mind by looking at some data.

There are three charts below, each showing CPI compared to another metric. Each chart originates at January 1st, 2005 and baselines the time series to this date at 100. The first chart shows CPI (red) against a metric known as The Personal Consumption Expenditure: Services (black) — how much we pay for a mixed basket of services. Over the horizon CPI ends up at 108.0, while The Personal Consumption Expenditure metric ends at 121.0 — in other words,

    CPI under measures the cost of purchasing services.

The second chart shows CPI (red) against a metric known as The Personal Consumption Expenditure: Services: Health Care (black) — how much we pay for a basket of Health Cares services. Not broad, but focused on Health Care only. Again, over the horizon CPI ends up at 108.0, while The Personal Consumption Expenditure metric ends at 121.6.

    CPI under measures the cost of purchasing health care.

The third and final chart again shows CPI (red) against a metric known as The Harmonised Index of Consumer Prices: Education (black) — this captures how much we may for higher education in The United States. While CPI ends at 108 as before, Education ends at 119.9.

    CPI under measures the cost of education.

So does CPI really measure the cost of living? Sure, if you don’t need health care or a higher education, or have to pay for people who might need these services. Otherwise no, CPI is deficient.

But there is more. Looking at the art markets we see records being broken at auction in many world cities even as the property market in many countries enters new bubble phases driven by negative interest rates.

Conclusion: there is plenty of inflation about. But CPI doesn’t measure it. CPI is deficient by design.

Central Banking Vodooo

Last month in a surprise move The Bank of Japan (BOJ) moved to negative interest rates, meaning deposits of regulatory capital for some banks will be charged. Theory says this will incentives financial institutions to lend, and by doing so stimulate the economy. Theory. However many are comparing BOJ’s move to a step through the looking glass. Or what I like to call Central Banking Vodoo.

A good question: why would consumers willingly take on debt in a deflationary environment?

Simple answer: they wouldn’t. Deflation magnifies debt, as repayments over time use units of currency (i.e., Yen, Dollar, Euro, etc) that can purchase more not less. That’s what deflation does — prices fall. You don’t borrow in a deflationary environment, you borrow in a inflationary environment, where the purchasing power of currency declines over time. Pretty simple economics, really.

And both consumers as well as businesses know this. IF borrowing does occur you can be sure funds won’t be used for frivolous spending, aka “stimulating” the economy via mindless consumption. I suspect those borrowing in such an environment will be using funds to invest in assets that generate significant cash flow. And probably not even assets found in Japan e.g., property in London or New York, to name but two possible destinations.

Regardless, and just to illustrate how disconnected theory and some economists are from reality, as recently as November 2014 many investment banks were targeting 130 Yen to the USD.

And by March, 2015 a survey of 27 economists suggested 140 Yen to the USD was achievable, applauding BOJ’s efforts to stimulate inflation and weaken the Yen.

Well, as the chart below shows, once again markets refused to cooperate with theory. As soon as BOJ announced it’s negative interest rate policy the Yen obligingly weakened. For one day. And then once again began to strengthen. At this rate the Yen certainly isn’t hitting 140 to the USD anytime soon.

Key takeaway: there is theory and there is markets. And they may disagree. The trend seems to be for strong Yen.

Possible contrary indicator: as I write this post Goldman Sachs apparently has abandoned their weak Yen call. Imagine that.