Enjoy the fantasy of a V while you can

It is too early to project what the new world will look like after this, but the world will change. The Black Death of 1347 – 1351 brought about huge changes, including contributing to the breakdown of the system of serfdom. The ability for individual labourers to demand a higher level of payment (money and food) for working on the lord’s, or the neighbouring lord’s fields, was opposed by the nobility and even resulted in the “Statute of Labourers” making it illegal to pay more than pre-plague wages / amounts. The Statute ultimately failed, but was implemented in places. The depopulation of manors and loss of serfs made the reality on the ground, so to speak, the driver for having to attract labour through increased wages.

So what types of changes might we see, and why?

In summary, expect cascading failures and pull-backs from existing economic activity to become self-perpetuating. Business failures will increase unemployment and reduce disposable income across the business services and service industries. Reduced incomes will impact retail while staff returning to the office will be entering a new world, with fewer people in the office at any time, and ‘home working’ becoming common. Manufacturing with recover, slowly, but during that recovery excess capacity will act as a drag on capital expenditure. Financial institutions, regardless of the level of government support and bailouts, will suffer a rising wave of commercial and individual defaults and bankruptcies. There will be failures of financial institutions, especially local banks and financial institutions are not considered of national or international systemic importance. The dream of recovered stock markets will die along with the destruction of Price/Earnings ratios and revenue projections. Social unrest and backlash against an uneven bailout will grow further, and will eclipse the “Occupy Wall Street” movement. The real danger is that the failure of “Occupy Wall Street” to result in any meaningful change will drive more hard-line social unrest.

So let us enjoy this time of quarantine and fear, when we are being told and still believe that everything will somehow return to the status-quo-ante. Let us enjoy this moment of the fantasy of the coming “V” shaped economic recovery, before we realise that a Nike Swoosh is probably the best we can hope. Yes, there will be a powerful rebound, but that will not be sustainable, and full recovery from the underlying recession or depression will take a considerable time.

Although this article focuses on the economics and potential economic impact of the crisis, there will be massive social and cultural impacts. I'm not addressing those here, though the impact will be more significant than we expect.

Employment

One of the first things that I hope we have all learned is that our society, no, our civilisation, is held together by people paid minimum wages. That profit is the primary motivator of companies, even in this time of crisis. As horrible as it may sound, to many companies, people are a fungible resource.

When economies do stagger back to life, businesses will discover that they are extremely tight for resources and cash, and that labour is plentiful. Are hiring companies going to pay a "living wage" if they can hire at slave wages and serfdom conditions? Profit is still the only meaningful motivation, and it will stay that way.

Yes, even in the middle of this crisis, profit comes first. There have been stories of private-equity backed Healthcare providers cutting the salaries, time off, and retirement benefits of staff, citing lost revenue. Let me just say, there is a special place in hell for people who make decisions like this. Maybe there will be regulatory intervention, and personally, I hope so, but I am not hopeful that the kleptocracy that runs corporations has a soul (certainly there are some, but I admit that I'm speaking in generalities here), or that it has any god before money.

Expect that as workers return, they will be returning to a working world in which their benefits have been cut and their pay is less, and they will be reminded that they should be thankful that they have a job. This is in no small part because a lesson from this crisis is that machines and automation do not need safe working distances, do not get sick, and do not suffer from rising health insurance costs, where employers cannot get out of paying health insurance.

The Statute of Labourers failed because the shortage of labour changed the economic equation. This time, if there is a Statute it will be for safe workplaces to protect production, not people. There will be no need for the Statute to constrain the cost of labour, because automation, reduced economic activity, and reduced demand will further undermine labour, with more labour than will be required.

There will still be very good employers, and there will be companies for whom their internal society is terribly important, and their people truly matter to the owners and managers. Yet most of these will be the privately held companies, and for the listed companies that rely on the highly skilled and knowledge workers.

Tourism

The first area of fundamental change will be tourism. Let’s look at one example; why will tourism and annual migrations from the UK to Spain be a casualty? First, we need to see why it grew and became the reality that it is. We need to follow the chain.

Higher incomes allowed people to travel to Spain every year. Cheap flights were possible because so many people could afford to travel, and the volume of flights and available seats that grew to meet that need drove down prices. The high level of available flights created the opportunity for the development of huge resorts, which once again become ‘cheap’ due to volume. Safe water and food removed concerns about health. Rising incomes in the UK led to more travel, which generated more airline seats, feeding more and larger resorts, building better destination infrastructure (including food and health), boosting local incomes, creating the economic capacity for outbound travel. And so a “virtuous” cycle continues.

Destroy any link in that chain, and that virtuous cycle collapses.

• Remove flights and seats, and the numbers of travellers plummet, resorts lose business and lay off workers, local incomes drop, impacting local infrastructure that services tourists.
• Remove perceptions that Spain is a ‘healthy’ destination, and the desire to travel falls, and with that fewer travellers, fewer flights, failing resorts, and carry on around the circle.
• Shut resorts (even for a short while) and local unemployment increases, reducing incomes, increasing pressures on infrastructure, and follow the circle. A high percentage of hotels are at risk of bankruptcy in tourist destination countries.
• Bankrupt hotels and resorts, and the property values of private residents will fall, making it difficult to sell those properties, creating a glut and resulting in property development projects failing and new projects being stopped. Properties go empty, jobs are lost, travel slows, and follow the circle.

How much will tourism change? I have no idea, but I do not expect tourism to ‘rebound’ any time soon. “Safe” destinations will be few, and capacity to carry tourists will be also limit any rebound. Even the perception of destination health will be impacted by reduced capacity due to loss of demand from reduced economic activity in the source countries. 2020 will be the “year without tourists”.

Greece, for example, is accepting already that there will be no meaningful tourist season this year. The economic damage will be significant, for a country that survives on tourism. There are large, high-end resorts on the island of Karpathos that are reliant almost entirely on tourism from Italy. That will not be happening this year. These high-end resorts will simply not open this year. But their debt will not disappear, nor will the need for basic maintenance, though that, of course, will be reduced by the reduced wear and tear from zero guests.

And yet tourism is only one sector.

Commercial property is another. There are two commercial property markets that will change. While we may not know exactly how “retail” or “business” will be impacted, we can guess. Each will be impacted differently, but for similar reasons.

Retail commercial property

In much of the developed world, in-store retail has been in decline with online retail taking a growing percentage of sales, though still small. In the UK, online grocery shopping has exploded, and may well become the norm. What will this mean? Supermarkets will shrink. Local grocery and ‘convenience’ store will remain, servicing smaller sales and local customers who do not move online. But I expect that in six months, possibly 50% of grocery sales will be online and delivery or collection.

Already a major supermarket chain in New Zealand has closed one of its large stores and converted it into a fulfilment centre for online orders. It is easier to fulfil from one location and provide central delivery management than to implement a store-picked and collect system in each store.

Grocery is only one area where this will become a new norm. Electronics, household, possibly even furniture will be bought online and delivered. Ikea, famous for their massive stores, may well find that much of their product moves online, and that foot traffic drops.

All is not lost. Expect shoe and clothing stores to, possibly, ‘survive’ because is it difficult to try on a pair of shoes, a shirt or jeans online. Browsing will also change, with some stores, clothing and other, already scheduling the booking time of patrons, or as in the case of Greece, limiting the number of shoppers to 1 shopper per “x” square metres or feet of retail space.

Commercial office property.

If we have learned one thing already, it is that we can work from home, and that people can be productive outside the office. Yes, some are not productive, but some were not productive in the office. “Video meetings of multiple people are not possible.” Well, actually, it has been possible for well over a decade, there just has not been "compelling reasons" to do so, when everyone was able and expected to come into the office, and business travel was inexpensive.

No more. There is now a compelling reason to not be in the office.

I’m guessing that once out the other side of this, total office floor space requirements will fall. While there will be a mandated increase in the floor space per person, the number of people in offices will drop dramatically.

For example, the number of people that actually need to be in the office has been falling for some time already. The General Medical Council in the UK has reduced floor space in London over the past years. Many jobs were moved to Manchester from London, and the London office was reduced to a single floor. Yet total employees in London began to rise again. As the numbers of people on the floor came close to reaching saturation, the order went out for all workers to work one day a week from home, and to hot-desk when in the office.

This worked, and it proved that people can work from home.

Many businesses are now discovering that all their staff can work from home. Internet speeds can be an issue, as can the availability of laptop computers for all staff. But computing capability and internet access in developed countries are ubiquitous, and companies are functioning.

Many businesses have discovered that they can work from home. Recently an Audit Committee met via video meeting from four locations, when historically all participants would have flown to the corporate headquarters. That was before the full work from the home requirement. Another meeting after complete lock-down brought together over a dozen company Directors for a working session, each via video from their home offices.

When this has passed and people are expected to return to the office, we probably will not have everyone in the office at any time. We may well divide our companies into Teams-A, B and C. Only one team would be in the office any given week. This would be to allow the socialisation aspects of work that are so important for company culture and giving people a sense of belonging, to allow training, and to provide the opportunity for face to face administrative activities (hiring, firings, reviews, etc). In such a scenario, even with each person requiring more space, the total floor space required by the company would drop by a third.

Reducing office space requirement by a third, even for a subset of companies, will depress significantly the total commercial office space required. It will also impact the supporting businesses that provide services, food and drink to workers, and the transport infrastructure required at peak times to move people to and from workplaces.

The fall in office space demand has started, and it will “fall off a cliff” through 2020 as companies change how they work, and of course, as existing companies go out of business in the recession/depression that is upon us, thus “freeing up” even more commercial office space.

The difference is that recovery will be slowed by the fundamental change in the way people work and in the way companies bring their people together for work.

Service industry

Considering the drop that we can expect in commercial office demand, the ripples from this will be catastrophic, or not, depending on your perspective. Possibly the only industry that will grow will be the professional cleaning services, who may find that the amount and detail of cleaning that will be required will shoot up and remain up, once businesses are able to reoccupy offices. The need to deep clean offices will remain, and pre-Covid cleaning was not enough.

But the CBD (Central Business District) coffee and sandwich shops, dry cleaners, document destruction services (printing could drop by 50% or more) and almost any business that supports offices will be returning to an environment in which much of client base has disappeared.

Public transport utilisation will drop. There will be fewer commuters, and there will be fewer miles driven (though people will use cars over public transport if at all possible). All services that rely on commuters and traffic will find their volumes have reduced and will take longer to recover than hoped. Public transport will continue to be the primary form of commuting in urban areas, but quite probably the ridership levels will decrease. Certainly, there will be a demand for higher levels of cleaning to continue.

Yet the rot will go far beyond services, and into production and manufacturing.

Manufacturing

Consider the Automobile industry. Shocked by supply chain shortages first originating from the shutdown of factories in China, automobile plants in Korea shut, and in the US factories have been shuttering temporarily. The collapse in the automobile industry was beginning before Covid, as a combination of market saturation and excessive debt was already manifest in reduced sales around the world. Covid has crushed not only demand but supply as well.

And with the economic depression that is coming, demand will remain low.

Demand will remain low across a range of products and services. Where there is demand today, that demand will be lower in the coming year or two, pushing small and medium manufacturing companies to the wall. For example, steel fabrication companies could be in trouble, if commercial and multi-residency property construction declines or fails.

Again, failures or contractions in one area of the economy will ripple through to other segments. Reduced personal and corporate incomes will reduce capital spending on higher value or cost items. This will result in lower production and lower incomes for manufacturing, resulting in failing companies and fewer workers, and so the cycle will continue.

As the companies fail or are so constrained in income and payment delays to survive, loans delinquencies will increase. And not just corporate loans.

Financial Services

This section might sound like "unfinished business" from the 2008 crisis, and the reason is that there indeed remains "unfinished business".

A new age of deleveraging is upon us. And unlike the 2008 crisis, this will not be short term. Of course, immediate deleveraging is not going to happen. The first thing that will happen will be massive stimulus to attempt to soften the blow and hopefully keep businesses open, or at least enable them to reopen after the lock-downs are lifted and people can circulate freely once again. But heaven help us after the end of the sugar rush – a rush as monsterous in size as it is becoming.

The age of massive consumer debt will come to a shuddering end. Without assets, there will be no credit, and leveraged assets are the first thing that is going to disappear. Leveraged assets include credit card debt and capacity, mortgage capacity, and the ability to borrow against the equity in high-value property or other assets. Consumer credit will increase in cost at the same time that consumer credit (credit cards, revolving loans, auto loans and student debt) will go into arrears, and default rates will climb. There simply will not be enough stimulus available to keep those loans from going bad.

It won’t happen overnight, but it will happen within months, not years.

Mortgages, rental and utility payments will not be forgiven, even if there is a moratorium on evictions of foreclosures. All that will happen is that the pain will be pushed out by a period of months, because rental property owners, individuals and small or large businesses are themselves leveraged, with their own mortgages or other loan facilities payments due.

Take away the incomes from a population that already lives pay-cheque to pay-cheque and stimulus will not keep them in their homes (rented or mortgaged) and will not pay utility bills. What will give first?

Moving now to corporate debt. Bond purchases by national governments can only carry on for so long. Eventually, the only bonds left to buy (or issue) will be junk, and governments will know that they are purchasing assets in the form of bonds that will default, because the underlying businesses will not be able to survive. We will see bonds being issues to pay operating costs and not for capital investment or other productivity creating an investment.

And be clear, with or without bans on share buybacks, clever CFOs around the world will be finding ways to shuffle bailout monies to the shareholders. These CFOs know full well that the defaults will rest only on the companies, employees and counterparties and ultimately of the government agencies that have purchased their debt. Yes, the shareholders will “lose everything”. But that “everything” lost will be lost after every last penny that could have been sent their way has been. Managerial bonuses will be paid, but not as bonuses. Advances on projected income; personal loan forgiveness, contractual obligations to forward pay multi-year benefits, and stuffed personal pension funds will ensure management gets the pie.

Yet all that will come at a cost to the financial sector as loans default, collateral is rendered valueless, and bonds default. Non-Performing Loans are going to grow at a scary rate in the coming year, and eventually, we should expect the creation of one or more national “bad banks” to hold the non-performing debt, while more money is pumped into zombie corporations that are “systemically important”. Of course, the money will not be pumped into the original failed companies, but into the companies that will be required, via central bank mandated shotgun weddings, to purchase the assets of the failed companies, including their outstanding debt.

Ultimately that newly created debt will need to be paid, and there are two options only; greater productivity that grows at a pace faster than the debt, or through inflation. And inflation will need to be at a pace, ultimately, that is faster than the growth of the debt.

So who has confidence that their government will be able to manage that and not turn all our countries into later day Zimbabwes?

Will the US become the new Greece?

----------------

This continues my series of closer looks at the seven areas I think can bring the 103 (now 105?) month economic expansion in the US to an end. The previous articles are here (overview), here (interest rates), and here (Inflation).
----------------

When considering "Budget Deficits" we are naturally looking at Government deficits, and not the overall global debt load, a load that in and of itself should scare almost anyone. In addition, government deficits are not a US-only problem, at least not US government debt alone. Governments around the world have spent the past decade amassing an ever growing pile of national debt. This has been an easy way to stimulate economies, placate masses, and generally take advantage of the ability to make new, cheap money, or to access pools of "cheap" money.

What happens when the markets' perception turns, and easy government money is viewed as a liability that will push down economic growth? The answer is Greece, where crushing debt, and without its own flexible, sovereign currency, coupled with no external forgiveness resulted in the destruction of the economy, in a self-reinforcing cycle of negative government policies and economic collapse.

How long can budget deficits continue to grow before the markets decide that US sovereign debt is no longer "risk free", or that there are other options for making a return greater (and at equal or lower risk) than government debt? When will there be a tipping point of belief that deficits and national debt payments actually do matter, with the expectation of a drag on economic growth by allocation of national budgets to interest payments, greater probability of a recession, ultimately resulting is loss of market confidence (and reduced resilience should a recession occur)?

Couple the growth of visible budget deficits with the fiscal gap of promised future expenditure, and the outlook is even worse (though perhaps a subject for a future article).

There is a fine balance between Sovereign debt as a safe-haven, and the returns on sovereign debt being strong enough to shift money from other markets - especially if such strength is due to an increase return (the occasional spikes in Spanish and other European debt as a good example), and therefore the future drain on government coffers to pay the interest. Once those interest payments are perceived as being high enough to impact the economic viability of the rest of the economy, we could see a general loss of faith and an associated flight to any "safe" none-market assets.

It is fairly easy to see the reason for concern. Currently 6% of the Federal budget is required to make payments on the interest on the national debt. This is interest only, at an average rate of 2.32% for January 2018, which on a national (Federal) debt of $21 Trillion. This should represent an annualised total debt servings cost of $481 Billion, with no associated reductions in the outstanding debt. In fact, US Federal debt will continue to grow, and with that growth, an even growing servicing cost.

Currently the Fed 10-Year treasury rate is hovering around 2.8%. This is a .5% increase over the past six months effectively matching the increase in the Fed discount rate.

So what happens if the Fed does deliver 3 rate hikes in 2018 (2 more)? If they increase at the .25% rate, we should see a Fed rate in the 2.75% range from the current 2.25% rate.

All things being equal, we should then see the actual rate of interest paid by the US Government rise by .75% to around 3.1%. This excludes any sovereign debt risk premium should China and Japan stop purchasing US sovereign debt, or if there is another downgrade of US debt.

So if we then look at the total that would be payable on the $20.7 Trillion debt, (but for simplicity staying at the current level even though this debt will rise to closer to 21.5 Trillion by the end of the year). The increase to 3.1% across the $20.7 Trillion debt would result in an annualised cost of $642 Billion, an increase of almost $160 Billion.

Markets will look at that increase, and see a combination of increased government spending to fund that debt, and a compounding level of debt expenditure. If the current debt load on the US budget is at 6%, every increase squeezes the amount of government spending available for non-debt servicing expenditure.

This at a time when economists are predicting that the US will begin running almost perpetual $1 trillion deficits. The interest component of the Federal budget is going to rise quickly. The tipping point will come not when the debt can no longer be serviced, as that realistically is too far in the future to be meaningful in terms of market reactions (years, not months). But it will be the tipping point of lost confidence that such deficits can deliver economic growth. And that point is either very soon, or may already have passed.

In their 2009 book “This Time Is Different” Reinhart and Rogoff state that national debt above 90% of GDP results in falling GDP growth. This number certainly caught the headlines, and for a while was presented as a Great Truth. Of course, there were then numbers of papers downplaying that Truth, and highlighting potential errors in their calculations.

Yet their premise stood up to critics, in as much as the 90% threshold does seem to signal a future decline in GDP growth due to debt servicing headwinds at the national level.

The United States is now well past that level, with the current (Federal) debt load of $21 trillion, and State and Local debt loads adding another $3 trillion, for a combined government debt load of $24 trillion. This against a GDP of approximately $19.5 trillion, the US is already running at well over 105% at the Federal debt level, with an additional 15% debt at the State and Local level.

This entire discussion ignores, though it should not, the fiscal gap, and therefore excludes the future bow wave of additional, already promised expenditure. It was this bow wave of pensions expenditure and social support expenditure that ensured Greece would only dig deeper into debt, regardless of bail-outs. 

Both the US and the UK face such a systemic problem - over promise of future expenditure that is not already considered in existing budget and deficit projections. In addition, these future promised expenditures are not limited to the Federal government budgets, and we already are seeing pressure on state and local level pension and entitlement programs.

At some stage there will be a loss of confidence that the combined debt load is manageable, and that the predicted negative impact on growth either has begun or will be felt in the near term.

When that happens, the “US will be the new Greece”. That will not be a pretty picture.

Will Interest Rates kill the recovery?

In my "103 Months" post last week, I specifically mention seven areas that could bring about the end of the Bear market, and result in the end of this business cycle. First on the list was Interest Rates. I also specifically stated that none of the seven areas could take sole credit for a fall in the markets (and flow on negativity and economic contraction), and that each may be impacted by others, and impact others. Which will come first, an Interest Rate hike generated collapse in house sales, or a collapse in house sales spreading uncertainty resulting in an interest rate spike?

Markets exist to facilitate the effective application of capital. As such, capital will flow to the markets in which capital can be expected to deliver the greatest return to the owners of the capital. Capital will flow to assets with the greatest probability or generating the highest risk-weighted return. And while markets do not get this right all the time, generally markets sense where returns will be achieved, high or low, and move capital to those asset classes. The result has been capital allocation distortions. (It was interesting to write that first sentence, then to google the exact words - first place returned was the SEC) 

The mythical Rational Market Hypothesis tells us that open access to information ensures that capital will flow efficiently. This or course does not and cannot happen, as there is not free and open access to all information relevant to investment decision making. Different players have and always will have access to market moving information that is not available to all investors. In addition, a range of human and even algorithmic factors will ensure a different weighting of information by different market participants, ensuring a less than efficient market.

What does this have to do with interest rates?

Each time the Fed or the BoE talks rate hikes, the markets pause (for milliseconds sometimes) and asks if the higher rate will have a negative impact of economic activity, and thus on market value, or if Treasury Bills will deliver a higher capital growth, and therefore, is it time to leave one market and enter another (leave stocks, enter treasuries or other bonds). Business and investors have become so numbed to ZIRP (Zero Interest Rate Policy) that they have come to see any hikes as potential speed bumps on the economic highway.

Continued ZIRP has resulted in behavioural distortions, with a new set of assumptions, including current market reactions reinforcing self-delusional assumptions of market rationality. In the middle 2000s we were convinced that we had become expert at managing risk, now we believe in the power of monetary policy to ensure ever-expanding market value. This cannot end well.

In the UK, the change in the "Ogden rate" (the discount rate applied to large insurance claims, predicated on the assumption that large claims will be invested in the most conservative manner) in early 2017 provides a wonderful example of a political decision designed to reinforce the "end of boom and bust" narrative. A change in a long term discount rate from 2.5% to -.75% both boosted insurance pay-outs and imposed massive loses on the insurance industry (The rate is now under review). The political nature of the decision was in effect a reiteration of the UK government’s assumption or expectation that interest rates would remain in the ZIRP range for the foreseeable future.

ZIRP ensured a limiting of the range of options for capital, be effectively removing treasuries, US, British Gilts, Japanese, from the portfolios of available return generating assets.

The end of ZIRP has seen a steady increase in the retail cost of money. At some stage, that increase will be perceived as reaching a point at which users of credit will begin to make decisions to not invest, or not spend. Owners of capital will begin to ask if the markets will therefore continue to increase at a rate significantly higher than "safe haven" investments.

So what is that interest rate number that will move the markets?

Only this past week the Chairman of the Federal Reserve presented to Congress for the first time, with his upbeat assessment of the US economy having quite a strange impact. The Wall Street Journal reported: "On Tuesday, Mr. Powell made his first Capitol Hill appearance since taking over as Fed chief this month, where he underscored the improvement in economic prospects, which many investors took as a suggestion that the central bank will lift borrowing costs four times this year. “It now looks more likely that the Fed is going to tighten more quickly,” said Peter Elston, chief investment officer at Seneca Investment Managers."

The markets seem to be at a point where positive economic news itself causes concerns about interest rates, upsetting the fragile balance between shares as the probably area of best return on capital, and fear that shares will fall resulting in negative returns.

That fragility could tip either way, although the messaging would suggest a greater probability of a negative shock. Bad economic news (such as the reported fall in new housing starts) could hint at a slower pace of rate hikes while at the same time undermining confidence. Alternatively, stronger economic news could cement more rate hikes sooner, again undermining confidence in the markets as the source of future capital appreciation.

Further, that fragility is all about perceptions and perceptions of perceptions. Will rates increase? If rates increase, will shares fall? If shares fall, will that force rates higher, or will a continued fall in shares erase gains. Should gains be "locked in" by selling now and putting the capital into "safe" options, and ride out a fall in share values, while earning more interest on the bonds / treasuries?

The Fed rate after all flows through into mortgage rates, auto loan rates, student loans, and credit card interest rates. All of these have a direct impact on individuals' economic behaviours and choices.

So if we game this situation, it looks something like:

1. Fed increases interest rates, reaching an eye-watering 2.5% by mid-2018.
2. Following a Fed rate rise event, markets expect reduction in mortgage lending, increase in credit card interest, reduction in auto loans.
3. Market data is released showing a drop in new mortgage applications.
4. Home builder and real estate stocks hit.
5. REITs drop on expectation that housing prices will stabilize or fall.
6. Contagion across industries creates further falls in equities.
7. Holders of capital determine that treasuries will provide a "no loss of capital" position and that shares have created a "capital at risk" situation.

As the "rational" market distributes and creates information with an inequitable and non-transparent distribution, individual market participants reach widely different conclusions, ultimately coalescing into a consensus that the stock markets are no longer the best place to hold or invest capital for a time long enough for stable bottom to be found.

In this way Interest Rates may provide one of the catalysts for a substantial and sustained drop in market values. This is only one of the seven situations that I discussed last week. Next week we'll look at another of the seven.

What remains clear is that in a world with so many potential contributors or drivers of a change from Bull to Bear, there is no single non-interconnected economic or political situation that will be "the cause" of the coming end of this expansion. The big question will be which, through the lens of history, will carry the "blame".

103 Months of recovery, what could end it

After years of single-direction trajectory for the markets, the recent correction has jolted people from their complacency. Well, many people. The subsequent rallies are proof to one set that pressure has been taken out of the markets, and the upward track can restart. To others, the expression "dead cat bounce" continues to be the phrase of the week.

Being very clear, I do not know if the top has been reached, or is there more headroom in this market. I have no idea. None. Also being clear, while the discussion focuses on the US markets, there is nothing in here that either does not have or is not impacted by events and economic situations in other countries.

If the markets continue their advances, how far can they go, and for how long? Is theUS in the "demographic sweet spot" that I wrote about in August 2017? I asked if the fall in the US labour market participation rate had been strong enough to create sufficient pools of surplus labour to allow for multi-year growth as that surplus labour drip-feeds into the workforce. If it is, then there may actually be a few more years of growth in the economy and the markets. If not, then the third longest recovery in US history may come to a sudden end.

So what happens when this recovery comes to an end, and the US enters recession? At 103 months as of writing, this recover is the third longest since the end of theGreat Depression, and only 4 months short of being the second longest. The fourth longest was only 92 months, and the fifth a mere 73. This recovery is almost a year longer than its number four, and two and a half years longer than the fifth. Interestingly the longest lead up to the “dot-com” bubble and subsequent crash. Does this recovery have another 17 months, another year and a half, of additional steam, to tie the longest recovery? And if so, will we see continued growth in bubbles that we saw leading up to 2000? Or, do we have enough bubbles already?

Again, I cannot answer that because I simply do not know. The recent market "correction" was a wake-up call, and a reminder that it is not all "sunshine and lollipops". There are systemic pressures building up, and one day, the markets will switch from Bull to Bear. What might make that happen?

There are a number of potential catalysts that could provide the tipping point, and with that a sustained downward trajectory for the markets. The following list is not complete by any means, but gives an idea of the range of potential situations that could, once the fall is well underway, be pointed to as the catalyst.

Most important, there is not one situation that will cause the coming crash, and all are interlinked and interdependent. Each can, and probably will, impact and potentially exacerbate another or multiple others. If housing starts collapse, so will house prices, and with that the “wealth effect” tripping over into consumer credit (although in this example, consumer credit may stabilise instead of continuing to grow) and potentially rising default rates.

I will delve deeper into each one of these in coming posts, but for now, the following outline of each should serve to set the scene, so to speak.

Interest Rates: Off the back of rate hikes by the Fed, the Feb rate could reach as high as 3.25% or even 3.5% by late 2018. This will flow into the 10-year Treasury, already hovering around 2.9% up from a low of 2.06% only six months ago. Should the rate continue to rise, the flow-on effects will be felt throughout the debt-driven economy. At some stage, the forward potential negative impact on consumer credit creation and utilization capability will strike, and with that a sudden loss of confidence.

Inflation shock: Years of QE, QEII, Twist, Abbenomics, and ECB purchases has flooded the system with new money. Where has it gone, what why hasn't inflation appeared as so frequently predicted? Countering the assumption that the new money should be driving inflation, there is an argument that surplus labour is keeping wage inflation in check, and with the, general economy-wide inflation. If they are not making more money, then the average worker cannot drive up prices. What happens when a really bad inflation number prints - in the US, UK or Germany for example?

Budget deficits: But what is the single event that is used by media pundits to 20/20 explain what happened. Could it be a Congressional Budget Office projection stating that servicing of the national debt will exceed 8% of the 2019 federal budget (from a current 6% of the federal budget)? Or could it be a projection for $1 trillion budget deficits for the next four years? After all, no one believes the projected temporary increase in spending followed by a drop to a balanced budget level.

External Shock: Or maybe the markets will react to an external event or geopolitical risk event, such as a US strike against the nuclear capabilities or Iran or North Korea. The intervention in northern Syria by Istanbul has already resulting in a sharp drop in the Turkish stock markets. Such a shock could undermine confidence in international trade or fuel expectations of increased in input costs and commodity costs. The markets have been remarkably resilient to geopolitical risk over the past year, so any shock will probably need to be a big one. Ultimately, the list of potential geopolitical shocks is as long as you wish to spend reading or writing.

We should not forget that there are a number of major economies each under their own strains, with many of those strains being similar to those witnessed in the US economy. The UK has suffered a 5.7% drop in year on year private auto sales, with predictions for a further drop in car sales in 2018. And before saying "but they are a small country" remember that they represent 65 million people, and that this slowdown will impact German auto makers as well, providing some stress, albeit minor, to the German economy. 

Housing market: Bad news in the housing market could tip the scales, and send the marketing into a self-reinforcing negative spiral. This potential shock is tied closely to underlying interest rates, inflation, and the Wealth Effect based on an ever-raising stock market. A multi month sustained drop in housing starts, completed sales, or house prices could shock the markets, and become the 20/20 hindsight event that causes a crash.

Automotive Loans default rates: Current default rates are increasing, and the total outstanding loan period is also at a record high. In 2016 the average outstanding car load was 5.5 years. It is possible to get an auto loan at 72 or even 84 months duration. In addition, over 30% of used car trade-ins areunder water. Combine the two, and the consumer is likely to become trapped in the vehicle they are in, and with that trap will come a reduction in car sales, and an expectation of future poor performance by the automotive section, a sector that accounts for X% of the US economy.

Credit Card default rates: The American binge on consumer credit continues, and in fact never really stopped. Net savings rates are at historic lows of around 2% (average across the entire economy) while credit card debt continues to rise. This is unsustainable. The only questions are, what is sustainable and when will the bubble pop, and will we recognise that it has popped. A failure in confidence that consumers will be able to afford the current credit load will not come as a slow dawning, but will come as a sudden shock, and that shock could rock the markets.

Productivity: Linked so closely with that credit crisis is the concept that worker productivity will continue to improve. Yet for the past few quarters that has not been the case, or has been true at a much reduced level. A failure to continue to increase productivity will directly impact worker wages, company profitability and therefore achievement of earnings expectations. Again, a sudden realisation of future down-trend impact on company values may arrive as a shock, and may be the catalyst for a market collapse.

Environmental event: To this point I’ve focused purely on potential economic events or situations, and have avoided environmental events. These could range from the hurricane that breaks the insurance industry, storms in Europe that result in a short term economic downturn, or a major earthquake on the West Coast of the US. I’m ruling out volcanos and meteors, as the probability is simple too low. I’m not ruling out Climate Change related events or situations, major droughts, or resource depletion such as a collapse of the water table in the San Joaquin valley of California.

Maybe the "dead cat bounce" is just a slightly longer bounce, and the fall is already coming.

Whatever the trigger, when the fall in the markets come, it will be steep and quick, followed by months if not quarters of a cyclical bear market. And while I am writing based on the US economy and markets, the same issues highlighted above are true for so many economies, and any individual large economy could provide the trigger for a global rout.

Insanity, in 19 bullets

The United States of Amerika has become one of the most insane countries in the world.

I've written a series of posts on what could end the current record-breaking "recovery". What is missing from all of those posts is a list of the individual items of insanity that collectively represent a very Dark Swan in the form of the collapse of Amerika as a nation. I have started to use Amerika because the America that I knew, and the Constitution I swore to protect (from enemies foreign and domestic) no longer seems to be meaningful. I consider this my form of protest, something still theoretically protected by the First Amendment to the Constitution.

This list of insanity bullet points does not include anything that the man-child, probable Russian puppet (or at least patsy), and also possibly early stage dementia suffering porn-star paying adulterous "fucking moron" (me quoting others, not stating this as a fact) is doing to distract from the internal problems, and in fact internal problems that he is encouraging. This also excludes the quislings in Congress who would rather destroy the country than admit what their leader, with their support, is doing. 

Some examples, in no particular order:

1. The police can pull you over and take you assets on the grounds that the policeman thinks, maybe, you might use those assets to commit a crime. It is then up to you to engage a lawyer to fight in court to have your assets returned to you. In 2014 police departments across the US seized more in value from citizens that the total value of assets stolen in burglaries. Asset seizures now account for reasonable parts of police budgets. So, the police are encouraged to steal from the people.

2. In a number of states, there are "open carry" laws that mean a person can walk down the street, or into a shop, openly carrying an assault rifle. Therefore, in such a state, you have no idea if the person with the gun is a nut, a terrorist, or just has a very small penis.

3. Meanwhile the organization (NRA) that rents congressmen to ensure no laws are passed that will reduce the ability of their members to sell guns, also refuses to allow people to carry guns at their national convention. I wonder why? In addition, we recently learn that the NRA will happily take money from anyone, including non-Amerikans. That the NRA is basically an anti-Amerikan entity happy to overthrow the Constitution (while pretending to protect it) can be seen in the appointment of their new president, a man who when in the Military, overrode instead of protecting the Constitution, as he swore to do (protect it, not override it).

4. Almost anyone can buy an assault rifle and/or handgun, but buying a pressure cookers makes you a potential terrorist. Cooking for yourself instead of eating out has become the sign of a sick mind that must be watched, and of course a potential terrorist.

5. The Fed cannot raise interest rates to any meaningful level, because to do so will increase US government debt payments to a level that will bankrupt the government (and the country). So more stimulus will be added, with the objective of pumping the money supply enough to ensure that interest rates remains low. There is plenty of evidence that this is destroying the savings and retirements of a generation.

6. The "Wealth Effect" requires that the Fed be more interested in propping up asset prices in the short term, with little or no regard for the negative impacts when stimulus is no longer effective (which might be now). The "Wealth Effect" is based on the idea that if stocks/equities and other assets (like houses) go up in value, people will think they are rich and there will be greater spending and therefore greater economic activity.

7. Borrowing is future spending brought forward. Eventually that future will be "now". The Fed and government are stealing the future's spending, beggaring us, our children, and quite possibly their children. But as long a "now" doesn't happen until the next person is in office, all will be good.

8. After promised to reduce the deficit, the Republican Party and Trump have actually, even though they control both houses of Congress and the White House, actually raised the deficit and predictions are now for multi-year $1,000,000,000,000 deficits through the 2020s. Does the expression "unsustainable" mean anything to anyone?

9. Companies are considered "people" and therefore political contributions or advertisement are considered "free speech" and are protected by the constitution - effectively protecting the right of corporations to use money to drown out the voice of the people.

10. Fewer jobs are created each month than the number of people entering the workforce, yet unemployment continues to decrease. After all, if you are not receiving an unemployment benefit or are not "actively looking for work" then you are not counted as unemployed. Of course, unemployment benefits only last so long.

11. The jobs that are being created are mostly in the service sector and are low wage jobs. Couple that with importing educated labor to displace US educated workers through the H1B1 program, and corporations, with the help of the government, are able to push down wages for what should be the remaining higher-wage jobs. A great race to the bottom.

12. The labor participation rate is as low as it was in the late 1970s, but unemployment is at 4.0%. Either large numbers of couples are able to live on a single income (which we know is not true), or something else is happening.

13. The national debt is now greater than 100% of GDP and rising, with no end in sight. Unfortunately the Fed and congress seem to be taking a lesson from Japan - that a country really can go on buying debt from itself to fund itself forever (really?). All this when economists are telling us that a Debt to GDP ratio of greater than 90% will demonstrably reduce GDP growth. That >100% debt to GDP is for Federal debt only, and does not include state or territory (such as Puerto Rico) debt, or local (such as Chicago) debt.

14. The two political parties' candidates are a Sheep in Wolf's Clothing vs a Wolf in Sheep's Clothing. Both are equally scary, for different reasons. Neither will save the country, let alone actually make changes that will reduce the coming pain of default and economic depression. Both are crooks, but of different kinds and times. They fight to retain their seats in Congress and do not care about the country or the future.

15. Home ownership rates are at their lowest in decades. The dream of home ownership, through government programs encouraging unsafe lending, quite possibly contributed to the GFC (Global Financial Crisis) and the Great Recession. The increased ownership has unwound, yet the dream remains.

16. The country is probably as polarized as it has ever been. Republicans from Democrats, Black and Whites and Hispanics from each other, Muslims from everyone else. All this in a context of a social media world designed to reinforce existing positions and prejudices. The "Melting Pot" has become the boiling pot.

17. In the last financial crisis, the US Government bailed out the major banks, with a very large chunk of the bailout money then being paid out in bonuses to employees of the Too Big to Fail (TBTF) banks.

18. TSA and the abrogation of the Constitution through the Patriot Act (and extensions) while providing "security theatre" only, serves as a proving ground for how to complete the subjugation of the population - the "Sheeple". I've been known to mutter "Baa baa" when standing in the TSA lines.

19. Meanwhile, the exercise of protest by kneeling for the flag is presented as some form of treason and disrespect, when the protesters themselves have very clearly and carefully explained exactly what they are protesting.

Sadly, all "sides" are so polarized that there will be no movement toward common solutions. One side will make a proposal, the other will reject it out of hand. And round and round it will go. And when it does fall apart, there will be enough blame to go around to ensure that the country continues to be polarized, avoiding anyone being held to account.

"This cannot end well" is so right, and when it ends, it will be in the breakup of the United States of Amerika. A civil war is coming, and if not that, then the imposition of the ultimate police state. 

First of course there will be the Second Great Depression, and that cannot be far way. People who actually understand the economics are already predicting a recession in the second half of 2019 ("if there are no Black Swans before then"). 

Yet Black Swans are all around, mostly in the unsettling of international markets by the current traitor in the White House, who hops from one artificial international crisis to another, all with the goal of distracting us from his crimes. "Fake News" will be the cry, from him and his toadies.

If there is any good news, it is that the Praetorian Guard can only be bought for so long, and any Galba, Ortho, or Vitellius (I admit, I always forget the third in that list) will have a short shelf-life. That includes the current Galba, who with his sons Uday and Qusay (as some are calling them) will be discarded when the time comes. Yet we need to remember that the very process that Galba came to power because the prior Emperor was mad and the system had collapsed.

Galba's end wasn't pretty, and my own guess is the best this Galba can hope for is a pillow over his head, and not to be publically murdered in the Forum by his Praetorian Guard.