It’s a sign of how much trouble we’re in when a budget deficit of a half trillion dollars seems like fiscal restraint.
It is progress, given that annual budget deficits were running above $1 trillion a year throughout President Obama’s first term and have been as high as $1.4 trillion. And it could have been worse. Recall the effort made by President Obama to stop the automatic spending cuts that took place when sequestration was adopted.
But a half trillion dollars is still a mountain of money. It helps to give the number some context.
To reach a half trillion dollars, you would have to spend $8 per second beginning with the year 0 and continue spending through today. If you had a stack of $1 bills adding up to $500 billion and were able to put them one on top of another, the stack would be 34,000 miles high.
The Federal Reserve Board has now put a date on the quantitative easing apocalypse, letting us know that bond buying will end in October – unless the central bank changes its mind, of course.
The October ending is not unexpected. The Fed has been cutting back bond purchases by $10 billion a month since last year and it doesn’t take a math wizard to figure out that there will be nothing left to taper post-October.
Yet this news, reported in the just-released minutes to last month’s meeting of the Federal Open Market Committee, is being treated as a revelation. It was, for example, the lead story in The Wall Street Journal, which typically doesn’t lead with news that was discussed last year and made official at a meeting that took place a month ago.
The real news, though, is what wasn’t discussed – the end of near-zero interest rates. As a result, rather than pushing yields up and bond prices down, release of the meeting minutes had the opposite impact.
When the Bank for International Settlements (BIS) calls central bank market rigging “the fairy dust of illusory riches,” it’s time to pay attention.
The BIS is the central banks’ central bank. Its role is “to serve central banks in their pursuit of monetary and financial stability, to foster international cooperation in those areas and to act as a bank for central banks.”
To provide the statement with some context, and to alert you about what else you can expect from central banks moving forward, we provide a summary of other key points made in this year’s BIS annual report, which is appropriately titled, “In Search of a New Compass.”
First, there’s recognition that easy money policy has gone far enough. That’s self-evident, but of special interest when you consider the source. BIS notes that despite a pickup in economic growth, the world economy “has not shaken off its dependence on monetary stimulus. Monetary policy is still struggling to normalize after so many years of extraordinary accommodation.”
It’s all stress-free bliss these days … at least for anyone who’s not paying attention.
Has someone been putting anti-depressants in the water supply? That’s one way to explain Wednesday’s non-reaction to the report that the economy shrank by 2.9% in the first quarter – not the 1% drop previously reported.
It would also explain continued investor complacency reported last week, with the VIX (volatility index) approaching single digits. And it would explain the plunge in junk bond yields to 5.6%, which is a full 3.4% points lower than the decade-long average of 9%.
Yet investors showed that they still have a pulse, when they took the Dow down 100 points after James Bullard, president of the St. Louis Federal Reserve, announced that an interest rate hike may take place in the first quarter of 2015.
So consider this in context. In addition to the slumping economy, we have Russia’s continued takeover of Ukraine, which is now being overshadowed by the continued takeover of Iraq by Muslim terrorists known as ISIS and the possibility of U.S. military intervention. We have civil war continuing in Syria and continued nuclear development in Iran, in spite of the lifting of sanctions. We have U.S. veterans in need of medical treatment being ignored while the Veterans Administration fudges numbers. We have the missing e-mails of Lois Lerner and six other IRS employees who allegedly targeted conservative groups. We have continuing fallout in the healthcare industry from the pains of implementing Obamacare. We have a stock market so overblown that price-to-earnings ratios are at levels higher than they’ve been through 89% of the history of the S&P 500.
So what’s moving the market? A statement made by a Fed board member that repeats a statement he previously made.
The recovery that wasn’t a recovery may have come to an end, as the Bureau of Economic Analysis reported that gross domestic product dropped by 1% during the first quarter of 2014.
Even with the drop in GDP, lower housing sales and continued high unemployment, no one is saying the economic is in a recession. Perhaps when a recovery is as insignificant as the one we’ve experienced for nearly five years, the distinction between recession and recovery is insignificant.
The economy was in sad shape five years ago and it’s in sad shape today, in spite of record stimulus spending, bond buying, and warm and fuzzy messages from the President, Congress and the Fed.
But fear not. The bar is so low now, even a baby step over it will look like a high jump. At least that’s the opinion of PNC Chief Economist Stuart Hoffman who wrote, “I believe this real GDP decline, mostly due to the polar vortex, coiled the ‘economic spring’ even tighter for a sharp snap-back (boing!) this quarter, where I have an above-consensus forecast for a 4.0% annualized rise in real GDP.”
In other words, bad news for the first quarter is good news for the second quarter. Stop me if you’ve heard that story before.
The 2014 “Economic Report of the President” and many media reports indicate that the U.S. economy has finally recovered. But has it?
One measure of economic health is household income.
Historically, America has prospered, as each generation typically has earned more inflation-adjusted income than the generation that preceded it. The American Dream is not just to succeed yourself, but to provide your children with a better life.
A better life means more than money, of course, but money enables the next generation to do more, live more comfortably and worry less about making the mortgage payments. Materialistic though it may be, it’s part of the American Dream.
So it’s alarming to see the drop in income that has taken place since 2007, when the financial crisis began. Median household income has dropped from $56,000 to $51,017, which is a dip of nearly 10%.
We’ve had dips before, as the chart below shows, particularly during the “stagflation” years of the late ’70s and early ’80s. But this has been the most dramatic drop in income in recent history.
Household Income
When household income shrinks, some in the middle class risk sinking down to the lower class and those on the cusp of becoming middle class no longer are able to achieve that status. As the lower class grows, government expenditures grow, resulting in higher taxes and even further erosion of discretionary income for those in the middle class.
Few investors today would consider investing in long-term Treasury bonds.
The yield curve, which measures the spread between interest rates for short-term and long-term bonds, is not as flat as it has been in recent years, but that’s faint hope for investors.
A 10-year Treasury is still yielding less than 3% interest. If the Federal Reserve Board achieves its goal of pushing inflation up to 2%, the real interest on a 10-year bond purchased today will be under 1%, payable at maturity.
If the Fed overshoots its goal and inflation moves higher, which is highly likely, a 10-year bond would produce a negative yield. What’s the probability that inflation will remain lower that the current yield on a 10-year Treasury over that entire period?
The U.S. has not had a period when inflation remained below 3% for a 10-year period since the days of the Great Depression. During the period of recession then slow growth that we’ve experienced since the financial crisis began in 2008, inflation has remained low and the Fed’s focus has been on fighting deflation. But when the economy improves and normal growth returns, inflation is likely to move significantly higher, as higher inflation is a byproduct of a healthy economy.
“The markets are rigged. … These firms make their money by front-running trades. They’re using their speed advantage to buy shares first and then selling them back at a higher price. The result is higher prices for investors in those shares. That’s rigged.” Michael Lewis
Based on the Federal Reserve Board’s actions of the past five years, you may have thought that “market rigging” was a good thing. After all, a great deal of wealth has been created from the Fed’s bond buying – although, granted, almost all of it went to those who were already wealthy.
But suddenly, high-frequency trading is being charged with rigging the markets and it’s creating a bit of a furor. Apparently the Fed is responsible for good rigging and HFT is responsible for bad rigging. Consider this week’s HFT-related news:
Michael Lewis, author of Moneyball, was interviewed by “60 Minutes” in advance of publication of his book, Flash Boys, in which he makes the case that HFT rigs the markets against the small investor.
There was the heavy backlash from those who disagree with his conclusion … that is, the people who make money off of high-frequency trading. Supporters contend that HFT has created liquidity and reduced the cost of trading for small investors. In other words, the market is rigged against small investors, but it costs them less to make a trade. Yippee!!
Then there’s The Wall Street Journal’s announcement this week that HFT is being investigated by the FBI – not the Securities and Exchange Commission (although it is participating in the investigation), the FBI. You know, the guys who investigate bank robberies, money laundering, drug cartels and the Mafia. And now you can add high-frequency trading to that list. Apparently, insider trading was already taken. (more…)
While the week’s biggest news has taken place in Russia, Ukraine and China, it’s the news out of the Federal Reserve Board’s Federal Open Market Committee that’s most in need of translation.
The Fed regularly uses language that no one understands, because if America’s taxpayers really knew what’s been happening, they’d totally freak. Keep that in mind and proceed with caution as we attempt a translation of Fedspeak from new Chair Janet Yellen’s first press conference:
“ … the FOMC’s outlook for continued progress toward our goals of maximum employment and inflation returning to two percent remains broadly unchanged.”
The dots are moving and we’re not achieving the results we expected, but you won’t hear it from me.
“Unusually harsh weather in January and February has made assessing the underlying strength of the economy especially challenging.”
The economy still stinks, but we’re going to blame it on the weather.
The unemployment rate, at 6.7 percent, is three‐tenths lower than the data available at the time of the December meeting. Further, broader measures of unemployment such as the U6 measure, which includes marginally attached workers and those working part‐time, but preferring full‐time work, have fallen even more than the headline unemployment rate over this period. And labor force participation has ticked up.
You’ve probably heard that corporate America is swimming in cash. Something like $4 trillion worth of it. And once corporate America starts spending it, the economy will boom again, jobs will be created, GNP will soar and the stock market will boom ever higher.
Corporate cash is the good news. Corporate debt is the bad news.
While cash is at record levels, corporate debt now exceeds the level it was at in 2008 and 2009. In case your memory is really short, that’s when America was wondering whether its financial system would survive.
But temper your nostalgia for those bad old days. When we say “exceeds,” we mean that corporate debt is 35% higher than it was then.
Net debt – what you get when you subtract cash from total debt – has been climbing steadily for American companies since 1998, as the chart shows. It doesn’t mean corporate America is insolvent (not yet, anyway), but it does have nasty implications for future corporate growth, profitability, unemployment and income growth.
Given all of that cash on hand, some are making heady predictions about accelerating capital expenditures. Goldman Sachs’ David Kostin predicted that capex spending will grow 9% in 2014, compared with 2% growth in 2013.
He may be right, given the need to replace aging and outmoded equipment, but a prediction is only a prediction. And more capex spending will mean less cash for paying down corporate debt.
Brenda Wenning has 22 years of investment management and security analysis experience. Her company, Wenning Investments, applies the same principles discussed in this blog.
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