To put this into historical perspective, here is a look at the long-term capital gains tax rate going back to 1913. A 39.6% LT capital gains tax rate would be near the record high.

 

 

US Economy

 

Homebase provides online timekeeping and human resource services to over 100,000 small businesses nationally. The company’s real-time data on how many businesses are open and how many hours employees are working is valuable insight into economic activity. The October report shows an important change.

Key Points:

  • Small business activity recovered strongly in May/June, but the next four months saw no additional improvement.
  • Some 20% of small businesses remain closed.
  • Compared to a midsummer baseline, the metrics began declining in the first week of October.
  • The new weakness coincides with cooler weather and a spike in COVID cases, particular in northern states.
  • The hard-hit beauty and personal care sector saw the greatest recovery last month.
  • Nationally, the food, drink and retail sectors have remained relatively flat since September, but Homebase sees impact in the Great Lakes and Plains states, where COVID cases have been rising.

Homebase data continues to show that government restrictions aren’t the only problem. Business activity is down regardless and seems likely to remain so as long as the virus impacts consumer behavior.

  • US factory activity quickened last month, with the ISM PMI report exceeding forecasts
  • The index of new orders hit a multi-year high.
  • Employment is back in growth mode.
  • Manufacturers see their customers’ inventories as being too low.
  • Growth in construction spending slowed. The recent weakness was driven by nonresidential construction.
  • Mortgage originations hit a multi-year high.
  • The housing boom has been powered by borrowers with credit scores of 750 and above.
  • Evictions could climb as some renters struggle to make payments.
  • Migration out of urban areas is on full display in this year’s rent changes.
  • School closures and childcare challenges have forced many women out of the labor force.
  • States with best economic performance:

 

 

  • Household income and savings rates are heading toward pre-pandemic levels.
  • A substantial percentage of US households are tapping their retirement savings this year.
  • Last month’s ADP private payrolls report was considerably weaker than expected.
  • The nation’s service sector growth is losing momentum.
  • Unit labor costs declined sharply last quarter.
  • Initial claims are holding above one million per week.
  • The percentage of Americans who lost pay in the past week has leveled off at 15-18%
  • Job hunting search activity declined sharply last month.

 

Jobs Data

 

  • October payrolls grew 638,000 and the two prior months were revised up slightly.
  • The “leisure/hospitality” category led the growth as restaurants and bars brought workers back.
  • The unemployment rate dropped to 6.9% while the broader “U-6” rate fell to 12.1%.
  • Trade/transport saw another significant gain.
  • All the jobs growth came from workers without college degrees. Jobs actually fell in those with a bachelor’s degree or more.
  • The number of long-term unemployed (jobless for 26+ weeks) increased by 1.2 million to 3.6 million.
  • Those working “part-time for economic reasons” who would prefer a full-time job also grew.

 

The Fed

 

Economists expect the fed funds rate to remain near zero for another three years.

The Fed left its policy unchanged for now, but the central bank continues to call for more fiscal stimulus. Each successive round of stimulus pulls forward future consumption, which leaves a void. That void then has to be filled with more stimulus, which leaves a larger void in the future.

Eventually, the void will become too large to fill.

The continuous bailouts continue to distort the market’s price signals, which makes the markets less efficient in allocating capital. Such has led to the rising number of “zombies” and monopolies, the widening of wealth inequality, and lower productivity and growth.

The deformation of capitalism will be an economic plague that continues to lead to further dysfunction alienating younger generations. Social unrest and revolt will be the eventual result.

The bailouts began back in 2008 when the Federal Reserve intervened with the insolvency of Bear Stearns. To date, the Federal Reserve, and the Government, have pumped more than $36 Trillion into the economy.  However, during the same period, the economy grew by only $2.92 Trillion.

Our growing intolerance for economic risk and loss is undermining the natural resilience of capitalism and now threatens its very survival. Just as poor forest management leads to more wildfires, not allowing ‘creative destruction’ to occur in the economy leads to a financial system that is more prone to crises.

The Fed’s foray into “policy flexibility” did extend the business cycle longer than normal. However, those extensions led to higher structural budget deficits. The byproduct was increased private and public debt, artificially low interest rates, negative real yields, and inflated financial asset valuations. Such led to decreased savings rather than productive investments. A growing body of research shows that constant government stimulus has been a major contributor to many of modern capitalism’s most glaring ills. Easy money fuels the rise of giant firms and, along with crisis bailouts, keeps alive heavily indebted “zombie” firms at the expense of startups, which typically drive innovation. All of this leads to low productivity—the prime contributor to the slowdown in economic growth and a shrinking of the pie for everyone.

If capitalism were allowed to function, the weak players would fail. Stronger market players would acquire failed company assets. Bond holders would receive some compensation for their debt holdings. Shareholders, the ones who accepted the most risk, would get wiped out.

Furthermore, assuming capitalism was allowed to function, investors would require appropriate compensation for the risk when loaning money to companies. Such would provide higher returns to credit-related investors rather than the current state of abnormally low yields for junk-rated debt.

Easy money has juiced up the value of stocks, bonds and other financial assets, which benefits mainly the rich, inflaming social resentment over growing inequalities in income and wealth. It should not be surprising that millennials and Gen Z are growing disillusioned with this distorted form of capitalism and say that they prefer socialism.

In America, if you make $30,000/year, you are in the lower-income levels of the economy and barely above poverty levels. However, compared to the rest of the world, you are in the top 1% of income earners. 

Capitalism creates opportunities. Socialism destroys it by removing the incentives to innovate and produce.

The current “negative correlation” (See chart below) is quite an anomaly given that corporate earnings are the result of economic activity.

 

 

However, that relationship broke due to the massive amount of Federal Reserve interventions in the financial markets. That distortion masks the economy’s underlying weakness and the “moral hazard” created by the Fed. The definition of moral hazard is a lack of incentive to guard against risk as investors believe the Fed is protecting them from the consequences of it.

The current “negative correlation” is quite an anomaly given that corporate earnings are the result of economic activity. However, that relationship broke due to the massive amount of Federal Reserve interventions in the financial markets. That distortion masks the economy’s underlying weakness and the “moral hazard” created by the Fed.

The current “negative correlation” is quite an anomaly given that corporate earnings are the result of economic activity. However, that relationship broke due to the massive amount of Federal Reserve interventions in the financial markets. That distortion masks the economy’s underlying weakness and the “moral hazard” created by the Fed.

The CBO’s budget projections are a harsh reminder of the consequences of debt and deficits.

“The longer policymakers wait to fix the debt, the harder and costlier it will get. Delaying action means the necessary changes will be spread among fewer people. Policymakers will have less ability to carefully target adjustments. And ultimately, it will be harder to phase in new policies or give families and businesses time to prepare and adjust for them.” –  CFRB

However, even the “weaning process” will be painful. Stock markets will decline, the economy will weaken, and bankruptcies will rise. But such are the choices policymakers will have to make.

The continuous bailouts continue to distort the market’s price signals, which makes the markets less efficient in allocating capital. Such has led to the rising number of “zombies” and monopolies, the widening of wealth inequality, and lower productivity and growth.

The deformation of capitalism will be an economic plague that continues to lead to further dysfunction alienating younger generations. Social unrest and revolt will be the eventual result.

We can make choices today, which will be unpopular. Individuals will have to endure the short-term “pain.” However, it will be well worth the more robust economy tomorrow.

Or, you can wait until our creditors make those choices for us all at once.

 

 

By the way, how would the US market have performed without the Fed’s QE?

 

 

Safe Withdrawal Rate

 

With the market valuation at historical highs and interest rates at historical lows, the typical withdrawal rates will have the average retiree run out of money early.

Not our clients.

Typical financial plans use the pie chart where the withdrawal strategies are flawed.  The 4% Rule assumes an average return from bonds that are 4X what current interest rates produce.  Monte Carlo equity models are flawed because there are no assumptions for losses, just steady “average equity” returns and no big drawdowns. When equity market valuations are this high, historically, the next ten-year returns are flat to negative. Plus, why use bond funds when yields are so low and interest rate risk is so high?

Planners use a total return model which starts in the 1920s and shows that over time markets will give you an 8 to 9% return. They simply (and lazily) plug in that 8–9% number for each and every future year, assuming that time will take away the effects of a bear market and recession. And that is probably true if you have 80 to 90 years. If, however, you are retiring when the markets are at a very high valuation, like now, your model will likely give you really bad advice.

Pension funds are going to get devastated in this decade. So are many retirees. And it all comes from bad models on top of more bad models. It’s a big problem.

Our clients use principal guaranteed investments averaging about 6% and equity models designed to make money in up or down markets, so our clients’ risk of flat to negative returns for the next ten years is very low.

 

Market Valuation

 

The overall U.S. stock market is super-expensive right now. According to the “Buffett indicator” – the ratio of the total market capitalization of all U.S. stocks to the country’s gross domestic product – it’s bumping against its most expensive valuation ever.

 

 

Market valuations will tell us little about bull and bear market turning points, but they tell us a great deal about coming 10-year returns.

Let’s start with Shiller PE – otherwise known as CAPE (Cyclically Adjusted Price-to-Earnings).

 

 

Margin Debt

 

Let’s take a quick look at Margin Debt. It too is at a record high. In this next chart, simply take a look at the amount of “margin debt” that is in the system today vs. the 2000 Tech Bubble peak.

 

 

Bob Farrell and David Rosenberg Market Predictions

 

Bob Farrell has been studying and writing about markets for over 60 years. He spent 45 of them with Merrill Lynch as Chief Market Analyst and Senior Investment Advisor. He authored the firm’s Market Analysis Comment, which was distributed to individual and institutional clients worldwide beginning in 1971. After retiring from Merrill in 2002, he formed Farrell Advisory Associates and continued to write for a limited group of institutional clients for another 15 years.

  • We are seeing some deterioration in the momentum of the market.
  • I know that there’s a lot of bullish trading going on, even if the market has a lot of people that are still cautious.
  • I would think there’s a lot of people that have investments that have big profits that are going to worry about what capital gains tax they’re going to play, or that state tax that 40% and don’t want to pay the 40% so there’s ways to get out of that by selling out or taking money out of your state and I think there’s enough uncertainties that we just should be pretty cautious going into the new year.
  • The market believes that we’re going to have a last-second fiscal stimulus, because we’ve always done that in the past. In the final hour, it’s not so clear that’s going to happen. I actually think that’s incredibly important and I’ll tell you why: When you do the math, you’ll see that, without the fiscal stimulus, there would NOT have been a 30% growth rebound in the third quarter for GDP.
  • Risk number one is the prospect of an economic relapse.
  • There has to be some sort of catalyst. We have to have a vaccine.
  • I think gold is on the first leg of a bull move. I think it is going higher and I think so because I believe the dollar is going to go lower.
  • But as far as gold is concerned, I am bullish.
  • There is a sovereign debt problem out there and I felt that for many years that sovereign debt is going to be one of the biggest problems we’re going to face, and we can’t pay it all off.
  • Economists can tell and Dave can tell you how we are going to deal with it, but it just seems to me from a commonsense view that either we inflate our way out of it, or you’re going to have to somehow forgive bad debts.
  • I’m looking for a change in leadership in the markets.
  • In the 1990s, we had almost 18% per year. Then we had almost zero return on stocks in the decade that ended in 2010. And now we’ve had another decade with about 15% returns, which was another alternation. And I think that in the decade of ’20s, you’re going to have a tough time getting higher than average returns. It is more likely that you are going to get lower than average returns.

 

China Debt

 

 

Velocity of Money

 

“Velocity of money” is the rate at which cash changes hands as it moves through business and consumer accounts. Higher velocity indicates more activity and, generally, a more dynamic economy. Lower velocity indicates the opposite. So, this USD velocity chart isn’t good news.

 

 

Velocity has been steadily falling for more than a decade but really plummeted this year. That small uptick at the end isn’t especially reassuring, either. This isn’t what we would see if a strong recovery were building.

 

Market Data

 

  • More of the S&P 500 firms now have negative equity.

 

 

  • Companies with exposure to China were rewarded this week.
  • The divided Congress news also boosted managed care stocks since no significant health legislation is expected at this point.

 

 

All content is the opinion of Brian J. Decker