Over very long periods—decades or centuries—economic growth tracks closely with population growth. It can deviate for a while, but ultimately higher production requires more producers, and higher consumption requires more consumers. So this chart matters…

 

 

The line is the number of US births per US deaths. A reading over 1 means the population (ignoring immigration) is growing. That has always been the case, and particularly so in the postwar Baby Boom period. After a relatively stable period after 1970, it began dropping again in 2008 and plunged in 2020. But even a return to the pre-pandemic level (which is already beginning) would leave the prior downtrend intact. On the positive side, a similar chart would look even worse in many other developed countries. So the US has a population problem, but is relatively better than its peers. That may help sustain growth longer here.

 

Home Sales

 

The latest HUD data showed US single-family home sales dropped 6.6% in June, to a 676,000 seasonally adjusted annual rate. Of the homes that did sell, the median price rose 6.1% to $361,800. So it appears high prices may finally be deterring some buyers. This chart is a longer-term view of home sales. The current level is actually quite a bit lower than the 2005 peak. So with the Millennial generation forming families, maybe there’s still room for home sales to grow.

 

 

On the other hand, the recent decline in the 6-month moving average (blue line) is steeper than anything seen since the slide that began in 2005. Another few months like this will bring it back to the somewhat gentler pre-pandemic uptrend. So homebuyers— and sellers—may soon find this crazy, unusual period was just that: crazy and unusual.

 

The Fed

 

Historically, QE, the monetary policy designed to infuse more dollars into the economy’s circulation, has been considered only usable as a short-term fix because of the danger that could arise from falling dollar values leading to hyperinflation. Traditional economists would insist that when the Fed feeds the economy for too long, there are unavoidable consequences. Tapering, which gradually reduces the amount of money the Fed pumps into the economy, should theoretically incrementally lessen the economy’s reliance on that money and allow the Fed to remove itself as the economy’s crutch.

However, since 2015, the Fed has found various ways to infuse cash into the economy without lowering the value of the dollar. These new policy tools, such as the repurchase window, may have ushered in a new chapter in the future study of macroeconomic policy. However, it will be several years before economists and academics, in hindsight, will be willing to declare such tools effective or dangerous. However, investor behavior always involves not just current conditions but expectations of future economic performance and Fed policy. If the public gets word that the Fed is planning to engage in tapering, panic can still ensue because people worry that the lack of money will trigger market instability. This is particularly a problem the more dependent the market has become on continued Fed support.

Last week’s Fed statement was another non-story. They added a new line about continuing to “assess progress” which some interpret as a step toward tapering. If so, it was a baby step. They’re simply thinking about whether they should start discussing the possibility of making a plan to begin tightening when conditions are right.

This means the Jackson Hole speech in August will likely be a nonevent, and the earliest the Fed will even consider beginning to taper its massive quantitative easing is at the December meeting. Rate hikes are not even a discussion yet.

The FOMC wants to see “sufficient further progress” toward the central bank’s “broad labor market recovery” goals.

Nordea Markets expects the taper decision in September and the first QE reduction in December.

 

 

The market reaction was muted. The dollar weakened.

Fed funds futures continue to price in the first hike in early 2023.

Debt monetization is the last and only option left on the table at this point. Interest rates can’t go low enough to spur growth as they are near zero anyways nor can they rise high enough to rebalance the system without leading to debt default and depression. QE forever doesn’t work so what’s left?

Debt monetization and real money printing are the only options left and it’s only a matter of when.

So, transitory inflation, then disinflation followed by deflation and another recession. The economy is still very weak and long yields are signaling slowing growth already. The reflation trade will be brief and I do not believe we’re going to get anything close to an economic boom. The current expansion looks more like a dead cat bounce.

Politicians panic at that point and introduce yet more massive stimulus and with debt spiraling and deflation taking hold, debt monetization becomes the only option to create inflation.

And that’s when we get real, sustained inflation… probably starting sometime next year.

Powell’s term as Federal Reserve Board chair ends in February 2022. We don’t yet know if Biden will reappoint him. Ideally, this isn’t a partisan exercise. Powell is a Republican, originally named to the board by Obama (while Biden was VP), then elevated to chair by Trump. We shouldn’t assume Biden will replace him just for that reason, but he might have other reasons.

The Fed is incentivizing everyone to leverage up and everyone (especially corporations) is responding. The problem is some percentage of these borrowers are in good condition now, but won’t be when something goes wrong. Then what?

This yield curve is exactly what the Fed would want if its real goal were to subsidize federal deficits and give Treasury time to refinance existing debt at lower rates.

The Fed has accepted the third mandate of keeping stock and real estate prices moving ever upward.

The stimulus money is going to run out soon. Eviction notices will start coming out in August and September.

We realize this is a time when stock market “valuation” seems not to matter. But eventually it will matter once again, and numerous measures say prices are higher than fundamentally justified. Here’s one of them. The line in this chart is the S&P 500 forward price/sales ratio. It grew steadily from the 2008 low, briefly plunged early in the pandemic, and then began climbing at an even faster rate.

 

 

Before 2020, investors were willing to pay about $2.25 to get $1 in sales.  Now they are paying about $2.95, or about 31% more, for the same dollar in sales.  They are betting that future growth will close this gap.  History says their bet may not work out.

 

US Economy

 

  • New home sales missed expectations, dipping below 2019 levels in June.
  • Inventories, measured in months of supply, climbed.
  • Suburban homes experienced the fastest appreciation since the start of the pandemic.

 

 

  • Foreigners have been reducing purchases of US homes.
  • The nation’s apartment market has become extremely tight.
  • Credit card usage surged in the second quarter, but households are paying off their balances.
  • The Dallas Fed’s regional manufacturing index pulled back from the recent high.
  • Factories are somewhat less upbeat about the future.
  • CapEx expectations moderated.
  • Employees are working long hours.
  • Supplier bottlenecks appear to be easing.
  • High vaccination rates among US seniors:

 

 

  • Despite increasing COVID cases, the Conference Board’s consumer confidence index is holding near pre-pandemic levels (exceeding forecasts).
  • Durable goods orders were weaker than expected.
  • Nonetheless, the rebound in capital goods orders during this recovery has been remarkably strong.
  • The Richmond Fed’s manufacturing index surprised to the upside this month, although new orders growth moderated.
  • CapEx expectations remain robust.
  • Indicators of hiring and wage increases are soaring.
  • Supply bottlenecks continue to plague manufacturers in the region.
  • Prices pressures are hitting extreme levels.
  • At the national level, inventories-to-sales ratios are at record lows.

 

 

  • Bottlenecks at West Coast ports persist.
  • Once again, the Case-Shiller home price appreciation report surprised to the upside, +17% year over year.
  • The massive divergence between housing prices and wages is not sustainable. Home price appreciation should begin to moderate shortly.
  • Economists’ expectations for the Q2 GDP growth have been moderating in recent weeks.

 

 

  • Goldman expects strong growth for the rest of the year but sees a sharp pullback in the second half of next year.
  • While fiscal and monetary stimulus has been immense, the fiscal impulse will turn into a drag on growth next year, according to Deutsche Bank.

 

 

  • While economic growth remained robust in the second quarter, the GDP report surprised to the downside.
  • The GDP is now above pre-COVID levels but remains under the CBO’s 2020 projections.
  • Business investment was healthy but was dragged lower by weak spending on structures.
  • Inventories were once again a drag on growth.
  • The Citi Economic Surprise Index tumbled after the GDP miss. The hard-data component (2nd chart) has been particularly weak, pointing to a loss of economic momentum.

 

 

  • The velocity of money remains near all-time lows amid record levels of liquidity.

 

 

  • Initial jobless claims (excluding emergency programs) are now running at 2013 levels. We are ways away from full recovery, but the index is finally back within the 10-year range.
  • The distribution of Child Tax Credit funds boosted consumer spending (based on BofA’s card data).
  • However, the loss of emergency unemployment benefits has been a drag on spending.

 

 

GDP data on Thursday suggested the pace of growth may be slowing. The U.S. economy expanded at a 6.5% annualized rate in Q2, but that was discouraging given expectations for 8.4% growth.

Disappointing sales from Amazon, weak IPO debut from Robinhood, meme stocks drifting lower all put pressure on the markets last Friday.

The next big spectacle in Washington is the debt ceiling as that topic comes back into force last weekend following a two-year suspension. The deadline will curb the Treasury’s capacity to issue new debt unless lawmakers can reach an agreement, which seems far-fetched at the moment due to the Republican position. GOP leadership contends that Democrats are in a spending free for all and will only support raising the debt ceiling if they promise major spending reforms and cutbacks.

It’s already having some effects. Starting at noon today, the Treasury will use the first of its so-called “extraordinary measures,” which will suspend sales of securities that help states and municipalities invest bond proceeds. Others will take months to kick in, and starting in October or November, the Congressional Budget Office predicts the Treasury will run out of cash. While raising the debt ceiling has turned into a bitter partisan issue in recent years, both sides have always reached a late deal to avoid the country going into default.

Many expect a similar scenario this time around and the game of chicken could continue in the coming months. However, if Democrats can’t get support from ten Republican senators, they may be forced to increase the debt limit via an upcoming budget reconciliation bill (which only needs a simple majority). They could also advance a vote to raise the debt ceiling along straight party lines before the August recess or tie the debt ceiling to a must-pass funding bill at the end of September.

 

China

 

Sweeping crackdowns across China continued to send shockwaves across financial markets, with investors finding themselves in the firing line of some of the nation’s hottest sectors. Shares of Tencent (OTCPK:TCEHY) fell 10% on Monday after Beijing ordered the company to give up exclusive music licensing rights, food delivery companies such as Meituan (OTCPK:MPNGY) were also targeted, while education stocks like TAL Education (NYSE:TAL), New Oriental (NYSE:EDU) and Gaotu Techedu (NYSE:GOTU) slumped about 25% each amid a ban on for-profit tutoring. In fact, the Nasdaq Golden Dragon China Index – which tracks 98 of China’s largest firms listed in the U.S. – dropped 8.5% last Friday and another 7% on Monday, marking the biggest two-day selloff since ’08.

“Even when you think China risk is priced, it can get worse,” Goldman Sachs wrote in a research note. “The government could come down much harsher than expected penalties for Tencent, they could implement much stricter social insurance programs for delivery drivers/temp employees, they could crack down on other industries viewed as a threat to social cohesion (SFV? Livestreaming? Who knows.)”

While Beijing has tolerated conventional regulations on certain sectors in the past, the government now looks ready to kill whole companies or entire industries. One doesn’t have to look far to the recent pulling of Ant Group’s (NYSE:BABA) IPO or the DiDi Global (NYSE:DIDI) fiasco that shook the investing world earlier this month. China has pointed to financial risk, antitrust concerns and national security violations, but its acceptance of stockholder pain for long-term social control appears to have some market participants reassessing Xi Jinping’s Communist Party. Meanwhile, Beijing looked to contain some of the fallout later in the week by holding a call with global investment banks. The country said it would consider the impact on markets when it introduces new policies in the future, and will allow Chinese companies to go public in the U.S. as long as they meet listing requirements.

Investors aren’t the only ones reviewing their relationship with China. Another contentious meeting between Washington and Beijing proved unsuccessful on Monday, with Vice Foreign Minister Xie Feng saying the relationship was at a “dead end” and risks “serious consequences.” He even presented U.S. Deputy Secretary of State Wendy Sherman with two lists of “red lines” that were necessary to stabilize ties, including “U.S. wrongdoings that must stop” and “key individual cases that China has concerns with.”

Mark Grant has concluded US investors should avoid China, and explains why in this short note.

  • The Chinese government is reaching out to global investors in an attempt to sooth the water after recent disastrous interventions.
  • China has no rule of law, no due process, and Chinese companies don’t provide audited financial statements.
  • Beijing is rapidly issuing new regulations on “national security” grounds.
  • These actions are negating all the reasons that previously made China an attractive investment market.

The points Grant makes are partly why index providers classify China as an “emerging market.” Hopes that it will mature to Western standards now look delayed, at best. This will have consequences in many financial markets around the globe.

 

Market Data

 

  • The S&P 500 managed to close at yet another record high to end the week, but it’s been more than 90 days since the small-cap Russell 2000 has done so.
  • Shares in Hong Kong remain under pressure.

 

 

  • The large-cap valuation premium hasn’t been this high in two decades.

 

 

  • Small-cap ETF outflows are at an extreme.

 

 

  • Small caps continue to underperform
  • Here is the S&P 1500 Automobiles subindex.

 

 

  • Emerging market stocks have greatly underperformed those in the U.S. Through late July, this is the 4th-widest amount that emerging markets stocks have trailed domestic ones, and the precedents all led to even more underperformance.
  • The year-to-date performance gap between US and non-US stocks keeps widening.

 

 

  • GDP estimates

 

 

Inflation Data

 

The core PCE inflation jumped 6.1% in the second quarter, the biggest increase since the early 1980s.

Many of the sectors that saw significant price gains this year had spent a substantial amount of time in deflation over the past couple of decades.

 

 

High-frequency data continue to point to a jump in rent CPI in the coming months.

 

 

Thought of the Week

 

May the road rise to meet you,

May the wind always be at your back,

May the sun shine warmly upon your face,

May the rains fall softly upon your fields..

  • Irish Blessing

 

Pictures of the Week

 

 

 

 

All content is the opinion of Brian J. Decker