- People suffering from sudden, unexpected hardship are likely to adopt views they previously thought unthinkable. The past idea, then-unthinkable, that the US would have to monetize its debt and eventually see a worldwide debt jubilee is now a possibility. In the past, I never would have believed that $3T would be spent on fiscal stimulus in just 60 days. I doubt Jerome Powell would have ever said having the Fed buy junk bonds was feasible or advisable, or that unemployment would hit 20% with U6 likely over 25%. These are Depression-era numbers. We have never seen a sudden spike like this.
- Reversion to the mean occurs because people persuasive enough to make something grow don’t have the kind of personalities that allow them to stop before pushing too far. Look at our politicians, lawmakers and current government officials.
- Unsustainable things can last longer than you anticipate. For instance, I’ve been saying for years that our massive government debt is unsustainable. Ditto for gargantuan private debt. Yet both are here, and in fact growing considerably as this crisis pushes politicians to spend and also pushes the Fed to buy. For that matter, who thought the Fed could sustain near-zero interest rates for over a decade, and now possibly another decade to go? I keep highlighting the woefully underfunded public employee pensions. Many state and local government plans, weighed down with ridiculously generous benefits for a few high-level bureaucrats while most public servants get crumbs, are doomed by any rational calculation. They were already hurting before this crisis and now will be worse. We may finally be reaching a point where they either have to mutualize the debt or split up into multiple currency zones. Not this year or next, but it is coming.
- Progress happens too slowly for people to notice; setbacks happen too fast for people to ignore.
- Wounds heal, scars last.
Inflation/Deflation
Prices have gone down recently for:
- College Tuition
- Car Insurance
- Automobiles
- Used cars
- Gasoline
- Hotels
- Airfares
- Car rentals
- Apparel
- Rent
- Home prices
- Interest rates
Prices have risen recently for:
- Hospital Services
- Meat
- Stock markets
Why Low Interest Rates May Be Here To Stay
The chart below is a history of long-term interest rates going back to 1857. The dashed black line is the median interest rate during the entire period. I have compared interest rates to the 5-year nominal GDP growth rate over the same period.
Interest rates are a function of healthy, organic, economic growth that leads to rising demand for capital over time. There have been two previous periods in history, which have been supportive of rising interest rates.
The first was during the turn of the previous century as the country became more accessible via railroads and automobiles. Manufacturing increased as World War I began, and America began shifting from an agricultural to an industrial one.
The second period followed World War II as America became the “last man standing.” After the war, France, England, Russia, Germany, Poland, Japan, and others were left devastated. It was here that America found its strongest run of economic growth in its history as the “boys of war” returned home to start rebuilding.
But that was just the start of it.
In the late ’50s, America embarked upon its greatest quest in human history as humankind took its first steps into space. The space race, which lasted nearly two decades, led to leaps in innovation and technology that paved the wave for the future of America.
These advances, combined with the industrial and manufacturing backdrop, fostered high levels of economic growth, increased savings rates, and capital investment, which provided support for higher interest rates.
Currently, the U.S. is no longer the manufacturing powerhouse it once was, and globalization has sent jobs to the cheapest sources of labor. Technological advances continue to reduce the need for human labor, which suppresses wages as productivity increases.
In the current economic environment, the need for capital remains low, outside of what is needed to absorb incremental demand. The impact on the economy from record levels of unemployment will have a wide range of impacts, which will forestall an economic recovery.
The profound suppression of wage growth from job losses will greatly reduce the demand for credit. Consumers’ focus will turn from a “want” to finance autos, durable goods, and houses, to the “need” to survive.
Currently, there are few economic tailwinds prevalent that could sustain a move higher in interest rates. The reason is simple. Higher interest rates reduce the flow of capital within the economy.
This is the worst thing that could happen:
1) The Federal Reserve has been buying bonds for the last decade and has now moved into permanent “QE.” The recovery in economic growth remains dependent on massive levels of domestic and global interventions. Sharply rising rates will immediately curtail that growth as rising borrowing costs slows consumption.
2) The Fed currently runs the world’s largest hedge fund with over $6 Trillion in assets. Long Term Capital Mgmt., which managed only $100 billion, nearly crashed the economy when rising rates caused it to collapse. The Fed is 60x that size.
3) Rising rates will immediately kill the housing market. People buy payments, not houses, and rising rates mean higher payments.
4) An increase in rates means higher borrowing costs that lead to lower profit margins for corporations. This will negatively impact the stock market as capital investment, buybacks, and debt issuance for M&A declines.
5) One of the main arguments of stock bulls over the last 10 years has been that stocks are cheap based on low-interest rates. When rates increase, the market quickly becomes overvalued.
6) The massive derivatives market will trigger another credit crisis as rate-spread derivatives go bust.
7) As rates increase, so do the variable rate interest payments on credit cards.
8) Rising defaults on debt service will negatively impact banks, which are still not adequately capitalized and burdened by large levels of bad debts.
9) Commodities, which are sensitive to the global economy’s direction and strength, will plunge in price as the current recession extends.
10) The deficit/GDP ratio, which is already surging, will escalate as borrowing costs rise sharply. The many forecasts for lower future deficits will crumble as new estimates propel higher.
I could go on, but you get the idea.
Like Japan, the U.S. is caught in an ongoing ‘liquidity trap’ where maintaining ultra-low interest rates is the key to sustaining an economic pulse. As we are witnessing in the U.S., the unintended consequence of such actions is the battle with deflationary pressures. The lower interest rates go – the less return the economy can generate. An ultra-low interest rate environment, contrary to mainstream thought, has negative impacts on productive investments, and risk begins to outweigh the potential return.
Economy
Economists continue to downgrade their GDP growth forecasts. The latest consensus estimate suggests that during this quarter, the US economy will shrink by nearly a third.
About 50% of Americans have withdrawn money from their retirement accounts or plan to do so. The second chart shows the reasons for withdrawals, and the third one provides the breakdown by usage and generation.
Good news! Supply chain relocations from China to the US! As the U.S. tries to wrestle global supply chains back from China, Taiwan Semiconductor, a major supplier to Apple and Qualcomm has confirmed plans to build a $12B chip factory in Arizona. The plant, which would create over 1,600 jobs, will produce the most sophisticated 5-nanometer chips that can be used in high-end defense and communications devices. The Trump administration is also in talks with Intel about new foundries. While the company has major manufacturing operations in the U.S., it supplies only its own chips rather than making them for outside customers.
“These stupid supply chains that are all over the world… and one little piece of the world goes bad, and the whole thing is messed up,” President Trump told Fox Business Network’s Maria Bartiromo. “We shouldn’t have supply chains. We should have them all in the United States,” he added, citing effects of the coronavirus pandemic. “My goal is to produce everything America needs for ourselves and then export to the world.”
The White House is also preparing an executive order which will require certain essential drugs be made in the U.S., sources told CNBC’s Kayla Tausche, adding that an announcement could come as soon as today. The order would direct HHS to study the supply chain, analyze weaknesses and report back to the Trump administration in 90 days. About 72% of pharma ingredient manufacturers supplying the U.S. are located overseas, including 13% in China, according to an October congressional testimony by Janet Woodcock, director of the FDA’s Center for Drug Evaluation and Research.
The prospects of negative interest rates in the United States is growing, with some futures contracts already pricing in the possibility. While it is sometimes framed as a sign that economic growth has collapsed and markets are heading to oblivion, the experience in other countries showed drops in their currencies when rates first turned negative which is positive for Gold and Silver.
Stock rallies in recent weeks ignore reality and don’t recognize that the United States is likely entering a depression, facing double-digit unemployment for at least three years, secular changes in consumer spending and saving, and deflation followed by stagflation. It’s pure fantasy to think that normalized earnings are not going to be seriously dented by the likely permanent loss of some 10 million workers in the future from what the baseline was prior to the crisis, which means lost labor income of roughly $1 trillion. Since it is an economy where 70% of GDP is derived from consumer spending, I just have a really tough time wrapping my head around the concept that the long-term trend line for corporate profits is miraculously going to be left unscathed. The adjusted normalized P/E multiple currently sits at 20, residing in the top 10% evaluation extremes of all time.
The U.S. Chamber of Commerce said that 25% of small businesses have already shut down and 40% have enough working capital on hand to last another two weeks, and that’s it. The AARP reports that 53% of American households have no emergency savings. So even as the stock market is telling you that it is all figured out, I can assure you, what we face at this very moment is a highly uncertain economic future, and unfortunately, most of the longer-term risks are to the downside, not the upside. At a minimum, we will endure a prolonged period of weak economic growth, widespread excess capacity, deflationary pressure and a wave of bankruptcies.
The Fed
We have some updates on the Fed’s crisis-related liquidity and credit initiatives. Look at this list and ask yourself why these needed to be bailed out?
- Program summary:
Total balance sheet (approaching $7 trillion) and weekly changes:
Company Debt
Here’s a sector ranking of issuer leverage (debt/EBITDA) above 4x and 6x (from Fitch Ratings).
Market Data
- The top 5 stocks in the S&P 500 are driving this rally. This handful of companies has accounted for nearly 25% of the S&P’s total point gain since the March 23 low, among the highest percentages of any rally since 1990. Rallies that are driven by so few stocks have had a much harder time adding to gains.
- The S&P 500 has been stuck under its widely-watched 200-day average for months now. After another attempt to climb back above it earlier this week, sellers stepped in again. Big rejections from below the 200-day average have seen stocks struggle in the past.
- Here is the number of companies discussing the suspension of buybacks and/or dividends (by sector).
All Content is the Opinion of Brian J. Decker
