The DOW and Pandemic disconnect

The DOW Industrial Average stock index reached 30,000 yesterday, a new record high. Trump claims credit, of course. 

The markets are a good forward-looking indicator of the economy (or they were) and as such, any immediate movement is a reflection of near to mid-range expectations, and trends provide a forward-looking expectation of medium to longer-term economic performance. A rising market used to indicate an expectation of a generally growing economy.

And yet we know that the US economy is in deep trouble. Pandemic trouble coupled with long-term small to medium-sized business trouble. The promised V-shaped recovery is petering out and will return to a more 'normal' recovery. Wall Street and Main Street have rarely been so out of sync.

So why the jump to record-level valuations?

Of course, the stimulus that has been and continues to be pumped into the markets to avoid a crash decoupled Wall Street from Main Street some time ago. So the significant jumps over the past two weeks can and should be seen as market (and therefore the investing class) expectations that there will be greater certainty under a Biden administration, and therefore medium to longer-term plans can be made, and investment programmes confirmed.

It begs the question of why, with the need for ongoing stimulus and 8%-10% federal budget deficits, the markets think the future is so bright. 

The answer is that the US economy has passed the point of being able to fix its systemic debt problem, and any attempt to do so will simply destroy the markets, killing large and medium-sized companies (the small companies are barely holding on already) and that will wipe out any hope of an employment recovery, plunging the US into a multi-year depression. Therefore with an adult in the White House, and an economic team that is willing to tell him hard truths, the markets are betting that the stimulus will keep on rolling.

It begs the question of where the markets would be today without the constant meddling-by-tweet and bogus trade wars of the past four years? 

Still the pandemic continues to build. 

There can be no doubt, and history will declare (and so will any who are looking at this even now and into the coming year) that Trump’s personal response and the craven enablers in the Republican party, and directly contributed to a disaster in the US. 

Meanwhile, US Covid-19 deaths are at a seven-day moving average of 1640 deaths, a number that was last seen on May 12th (as a seven-day moving average). The first time that the rate was that high was as the pandemic was building force (as it is again) on April 7th. There were 34 days between the first time the average was above 1650 and the first time is dropped below 1650. 

If those numbers provided a pattern and an expectation for now, then we will not see the numbers reach this level again for another month. Certainly the numbers could already have peaked, but that is not what the seven-day moving average is telling up. With up/high days and lower/dropping days, the seven-day moving average continues to climb.

The same is happening with new cases. The seven-day average is still rising, at 176,000, even though there are occasional ‘down’ days, usually at the weekends. The three-day average is on another downward wave, but the latest number are not encouraging. Hospitals are becoming overloaded again, and National Guard troops are being called in to deal with the numbers of corpses in Texas.

 

Across the country, the cases are still growing and growing fast. And we are being warned that the coming winter will make matters even worse, with people being cramped inside, and when they go to places where others are or have been, the need to retain the heat will necessitate recycled warm air, increasing the risk of contagion. So for the US, there is little hope that the next weeks will see any actual peak in cases, and certainly little hope that there will be any sustained drop in the number of new cases. Unless, of course, Trump is able to continue to reduce the total number of tests being performed, and thus artificially holding down the number of cases.

Yes, still there is no meaningful response from the Republicans.

All they can do is look on now, still afraid of Trump and his ability, they believe, to destroy their political futures, by calling them out as disloyal. Even now. 

So Amerika has to wait, and hope that Biden and his team will be ready on day-one to implement effective measures. Certainly, the roll-out of vaccines will already be underway before Christmas, but the general population will not be seeing vaccinations until mid to late-January. First will be the front-line workers in healthcare, and then their families, and then the elderly, and then those at most risk. Only after those have been vaccinated will the general population be able to be vaccinated. That will probably not happen until February or later, depending on how fast the Biden team can push, or how much of their programme can start before he is sworn in. (By stealth of course, because Trump will “burn it down” if he sees any tangible support for Biden that is actually is able to interrupt).

Here in Greece things seem to be moving in the other direction, though it will take another week before we can have any confidence. 

The bad news is that the seven-day moving average number of deaths continues to rise, and is over 80. There was a high last week of over 100 deaths in a day. The hospitals are overwhelmed, and in Thessaloniki and the north, 99% of ICU beds are occupied. The military is building a field hospital on the grounds of the Military Hospital here in Thessaloniki, providing an additional 50 (ICU?) beds at least.

Two private clinics have been requisitioned, adding 200 beds to the total available in the public system in Thessaloniki. Hopefully, these will be enough, but I very much doubt it with the steep rise in cases through November. 

Thessaloniki is the epicentre, with over 600 new cases yesterday, reaching more than 14,500 cases in Thessaloniki in total, in November only.

Characteristic of the rapid growth of the virus is the fact that in October - the month in which the spread of the coronavirus had already begun - Thessaloniki had recorded 4,027 cases while in September it had only… 422 cases, a number that is now exceeded daily by the city. In less than two months, Thessaloniki jumped from 422 cases to 14,517, proving the aggression of the new virus. It is noted that in total, since the beginning of the pandemic at the end of February in Thessaloniki, 20,334 cases have been recorded.

https://www.typosthes.gr/ygeia-epistimi/covid-19/234679_koronoios-paramenei-ypo-piesi-me-607-nea-kroysmata-i-thessaloniki

Across Greece, the numbers of new cases are coming down, which if a good thing to see. However, this may be illusory for the same reason as the US, we are entering ‘real’ winter. The article also said that the optimum temperature for the virus is 8 – 10 degrees Celsius (of 48 – 50 Fahrenheit). 

If there is good news it is that the seven-day moving average of new cases is heading downward. Not much yet, but definitely, a peak, if only a week old. We will need much more time to see that it is a real peak and fall, which will be problematic with the winter conditions. But the lockdown here is in its third week, and that is about the time it takes for the asymptomatic contagious cases to spread as far as they can, then begin to die off. After all, if the virus cannot reach someone, then it cannot infect them.

So while cases continue to rise rapidly, the speed of rise has slowed down a little. But the numbers are still increasing, and that continues to drive the need for more beds.

The latest news this morning is that we will be in lockdown at least until December 6th, which is another two weeks. I would not be upset if it were another week after that, to really limit the potential spread. 

The spread cannot be halted by the lockdown; we still need to buy food and go and feed the stray cats. And we are not alone. The entire city must have some limited interactions, even if more limited than ours. And our interactions are limited. We do not move more than about 100 meters from the building, and even then we enter any building with caution, checking that there are not many people inside and that there is plenty of ventilation via open window and doors. The pet-shop is a good example. The front door is open all the time, and upstairs there is a pet grooming station with its window open. Hopefully, this is providing enough airflow to reduce the risk of spread. 

And masks are obligatory, and for the most part, are now being worn property. For the most part. There are still too many people who think that they cannot speak through a mask, so pull the mask down to talk, and then usually to talk too loudly.

But lockdowns work, and this one is already reaping some rewards in peaking infections. I hope. 

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.