Participation in the labor force has dropped to levels not seen since 1973 and is a crucial measure to watch. Since the “Financial Crisis,” the participation in the “Labor Force” never significantly rose despite “record low unemployment rates.”  This is because the labor force was shrinking sharply over the last decade as more and more participants were “no longer counted.”

 

 

Those “Not In Labor Force” are individuals that are considered out of the labor force and no longer seeking employment. Do you believe that nearly 50% of the working-age population are no longer looking for work?

 

 

Tax Planning Before Year End

 

Any low-cost basis stock or real estate?  If so, you have 6 weeks for Long Term Capital Gains tax at 15% before it goes up next year.  Check with your tax advisor, you may benefit by selling low cost basis stock or real estate, pay the capital gains at 15% and establish a higher basis.

Roth Conversion this year before year end 2020.  Make sure to stay on track for using this year to convert another chunk of your IRA to Roth.  Make sure we do not raise your tax bracket by doing so.

The SECURE Act eliminated the stretch IRA. The estate tax exemption and lifetime gift exclusion could be substantially reduced next year, and the step-up basis may be eliminated, which could hit heirs with substantial capital gains taxes. Annual gifting and split gifting could be more important than ever. To help maximize inheritance and minimize potential estate tax concerns, review gifting strategies and beneficiary designations. High-net-worth clients may want to consider leveraging the lifetime gift exemption to reduce their taxable estate. If both parents and grandparents are wealthy, consider transfers to grandchildren in anticipation of changes to the generation-skipping tax.

 

US Economy

 

  • Companies are preparing to cut jobs and automate if Biden gets $15 minimum wage hike
  • US factory output rose last month, in line with expectations.
  • Manufacturing capacity utilization continues to improve.
  • Here is the total industrial production performance vs. the 2008 recession.
  • October retail sales were softer than expected amid signs of consumer activity losing momentum.
  • Gains in online sales activity have been impressive.
  • Retail sales face significant headwinds going forward, such as increased concerns about the pandemic, COVID-related hospitalizations and mobility.
  • Homebuilder optimism hit another record as demand soars
  • Import prices rose again, boosted by a weaker US dollar.
  • Many households are concerned about not being able to pay the next month’s rent.
  • Consumer confidence shows further signs of strain.
  • Lockdowns are picking up again.
  • Airfare prices are gradually recovering.
  • The Philly Fed’s manufacturing report showed continued strength in the region’s factory activity this month.
  • New orders remain robust and there is a substantial backlog of work.
  • Hiring is back at 2019 highs.
  • More manufacturers have been raising prices.
  • Facing the pandemic headwinds, manufacturers were less upbeat about the future.
  • The Kansas City Fed’s manufacturing report was also relatively strong.
  • However, hiring has slowed.
  • US sales of previously owned homes hit a multi-year high for this time of the year – up 24% vs. 2019
  • Based on container shipments at US ports, imports are far outpacing exports.
  • Domestic shipping volumes are now up year-over-year.
  • US trucking fleets have shrunk this year.
  • Rising demand for freight transport and tight capacity sent truckload rates sharply higher.
  • The labor market recovery is stalling.
  • Initial unemployment claims rose last week as the pandemic takes its toll.
  • Long-term unemployment has been climbing.
  • As regular state unemployment benefits run out, emergency programs kick in.
  • But these emergency programs are about to end. Will Congress act?
  • This chart shows the unemployment rate in the lowest- vs. highest-earning industries.
  • The Fed’s balance sheet hit another record high this week.

 

 

  • The economy has been dependent on federal aid this year.
  • Mortgage rates hit another record low.
  • Homebuilder optimism points to further gains in residential construction.
  • The inventory of homes for sale, measured in months of supply, is the lowest on record.
  • Black Friday and Cyber Monday online spending is expected to hit a record as shoppers shun brick & mortar stores.
  • This year’s spike in the nation’s money supply has been unprecedented.

 

Stock Market

 

There is a strong historical correlation between the market and the economy. Markets are currently near all-time highs. Today, there is a disconnect:

 

 

The break in the historical correlation has nothing to do with a change to market fundamentals. Instead, it is the Federal Reserve’s massive monetary interventions.

 

 

The distortion of market pricing from the economy is quite astronomical. Without QE the Nasdaq 100 should be closer to 5,000 than 11,000, while the S&P 500 should be closer to 1,800 rather than 3,300.

 

 

The distortion of the financial markets by the Federal Reserve has created an illusion that the economy is doing exceedingly well when in reality it isn’t.

The correlation is more evident when looking at the market versus the ratio of corporate profits to GDP. With a 90% correlation, investors should not dismiss these deviations.

 

 

There is additional confirmation with an 84% correlation between the S&P 500 and corporate profits growth.

 

 

 

When it comes to the state of the market, corporate profits are the best indicator of economic strength. The detachment of the stock market from underlying profitability guarantees poor future outcomes for investors. But, as has always been the case, the markets can certainly seem to remain irrational longer than logic would predict.

 

Ten-year forward average returns fall nearly monotonically as starting Shiller P/E’s increase. Also, as starting Shiller P/E’s go up, worst cases get worse and best cases get weaker.

If today’s Shiller P/E is 22.2, and your long-term plan calls for a 10% nominal (or with today’s inflation about 7-8% real) return on the stock market, you are basically rooting for the absolute best case in history to play out again and rooting for something drastically above the average case from these valuations.”

We can prove that by looking at forward 10-year total returns versus various levels of PE ratios historically.

 

 

In a market where momentum is driving participants due to the “Fear Of Missing Out (FOMO),” fundamentals are displaced by emotional biases. Such is the nature of market cycles and one of the primary ingredients necessary to create the proper environment for an eventual reversion.

Stocks are far from cheap. Based on Buffett’s preferred valuation model and historical data, as depicted in the scatter graph below, return expectations for the next ten years are as likely to be negative as they were for the ten years following the late ’90s.

 

 

While investors insist the markets are currently not in a bubble, it would be wise to remember investors believed the same in 1999 and 2007.

 

 

The Great Reset (excerpts from John Mauldin)

 

The Great Reset is simply a term for climactic events that resolve our global debt overload while at the same time dealing with slow economic growth, high unemployment, and social unrest. It could happen many different ways, some better than others. But I firmly believe we will see some kind of resolution. The present course is unsustainable.

Anxiety about the world’s social and economic prospects is only intensifying. There is good reason to worry: a sharp economic downturn has already begun.

To achieve a better outcome, the world must act jointly and swiftly to revamp all aspects of our societies and economies, from education to social contracts and working conditions. Every country, from the United States to China, must participate, and every industry, from oil and gas to tech, must be transformed. In short, we need a “Great Reset” of capitalism.

The current morass of crony capitalism and lobbying for special government favors is abhorrent. But “revamp all aspects of our societies and economies” sounds ominous. Especially coming from the people already nominally running the global economy.

When you start talking about resetting the educational and social contracts and working conditions, you are talking a radical social agenda. I believe we are going to have to have considerable change in the social structure of this country. That is what the current partisan politics is telling us. Too many people on both sides feel the current “social contract,” whatever you might think it is, is not working for them. Income and wealth inequality are very real. I am not convinced a Davos Switzerland World Economic Forum (WEF) -style “Great Reset” is the answer. They are proposing programs to alleviate frustration—expensive, society-altering programs. But they would still let the game at the top continue where the wealth gap remains and is preserved.

But it gets worse.

Quantitative historical analysis reveals that complex human societies are affected by recurrent—and predictable—waves of political instability.

In the United States, we have stagnating or declining real wages, a growing gap between rich and poor, overproduction of young graduates with advanced degrees, and exploding public debt. These seemingly disparate social indicators are actually related to each other dynamically. They all experienced turning points during the 1970s. Historically, such developments have served as leading indicators of looming political instability.

Very long ‘secular cycles’ interact with shorter-term processes. In the United States, 50-year instability spikes occurred around 1870, 1920, and 1970, so another could be due around 2020. We are also entering a dip in the so-called Kondratiev wave, which traces 40-60-year economic growth cycles.

This could mean that future recessions will be severe.

In addition, the next decade will see a rapid growth in the number of people in their twenties, like the youth bulge that accompanied the turbulence of the 1960s and 1970s. All these cycles look set to peak in the years around 2020.

The hard times we’ve long anticipated are here. We are now at what Turchin calls the final stage, when elites try to pacify the masses with bread and circuses. Doing so racks up the debt and suppresses economic growth. Debt is accumulating faster than I expected, so The Great Reset may happen sooner than I expected.

What happens when we come to the place where we have to deal with all that debt?

The current crisis should be used to rethink in order to build a more stable economic system, one in which fiscal policy plays a greater role and that relies more on productive investment.

We’re on a slope where monetary policy has become increasingly ineffective in promoting real economic growth. Every crisis was met with monetary easing that caused debt and other imbalances to accumulate over time, and that caused the next crisis to be bigger than the previous one. The next crisis then needed more punch from central banks. But since interest rates were never raised as much in upturns as they were lowered in downturns, the capacity to deliver that punch was decreasing.

True, the Fed had no choice but to step in to prevent a financial meltdown. But this meltdown only happened because of the monetary policy followed over previous years.

My point is: Central banks create the instabilities, then they have to save the system during the crisis, and by that they create even more instabilities. They keep shooting themselves in the foot.

William Dudley and other central bankers are beginning to admit that they have come to the end of their effective ability to manage their respective economies. Governments have to step in with fiscal policy that is actually targeted and productive.

Then Bill Dudley lists four ways that we can deal with the debt, not all of them palatable:

One: Households, corporations and governments try to save more to repay their debt. But we know that this gets you into the Keynesian Paradox of Thrift, where the economy collapses. So this way leads to disaster.

Two: You can try to grow your way out of a debt overhang, through stronger real economic growth. But we know that a debt overhang impedes real economic growth. Of course, we should try to increase potential growth through structural reforms, but this is unlikely to be the silver bullet that saves us.

This leaves the two remaining ways: Higher nominal growth—i.e., higher inflation—or try to get rid of the bad debt by restructuring and writing it off.

When later asked about write-offs he said this:

That’s the one I would strongly advise. Approach the problem, try to identify the bad debts, and restructure them in as orderly a fashion that you can. But we know how extremely difficult it is to get creditors and debtors together to sort this out cooperatively. Our current procedures are completely inadequate.

How long can this go on? Longer than you might think. Japan is a country with a 700% total debt-to-GDP ratio, two decades of zero interest rates, and a central bank balance sheet that is 130% of GDP. Nice to see how all the credit creation has managed to spur on a reflationary backdrop. Shades of what’s to come in the US. Japan is facing: a deflationary economic cycle with no growth. All while new technology (especially biotechnology) makes our lives better. It will be a strange new world that will have no resemblance to the last decade’s “normal.”

 

Zombie Companies

 

The definition of a zombie company is a company whose earnings cannot cover their debt payments from internally generated cash flows.  About 300 companies that received as much as $500 million in pandemic-related government loans have now filed for bankruptcy. Not to mention that we have a market where nearly 15% of the companies make absolutely no money.

As I said, a very speculative market. We also see Bloomberg analysis showing that, of the 3,000 largest publicly traded companies, “zombies,” are now a 20% share of the market —and they have been able to add, with the help of the Fed, nearly $1 trillion of debt since the pandemic started eleven months ago. Almost 200 companies have joined the “zombie” ranks…from 335 at the end of 2019 to 527 currently!

That is more than double the $500 billion of debt these spurious and dubious entities had on their books at the height of the Great Financial Crisis twelve years ago. The outstanding debt for these de facto insolvent companies being allowed to hang on via Federal government/central bank assistance is now $1.36 trillion (“zombie debt” before the pandemic stood at $378 billion).

 

 

Vaccines Illustrated

 

Initial data shows positive results for two different coronavirus vaccine candidates. Both use “messenger RNA” to produce viral proteins that spur the body’s immune response. The economy hinges on how well these (and other) vaccines work so investors should get familiar with them. This handy Bloomberg graphic helps.

 

 

 

 

All content is the opinion of Brian J. Decker