Marc Chandler, Managing Partner at Bannockburn Global ForEx joins me for a comprehensive recap of economic from the US and around the world and how it all impacts the markets. We have seen a shift to a more risk on attitude but the safe assets are not getting hit as hard as one would think. All this data needs to be looked at in a big picture sense to help investors navigate these choppy markets.
Chris joins me for an in depth discussion on the Fed statement and press conference. The Fed delivered a rate cut but it is being considered a hawkish rate cut as they will be on hold until next year. We also look at the ADP jobs number and GDP data point from this morning.
“Is Slow Still the New Normal for GDP Growth?”
The Federal Reserve Bank of San Francisco raises the question… and proceeds to answer it:
Estimates suggest the new normal pace for U.S. GDP growth remains between 1.5% and 1.75%, noticeably slower than the typical pace since World War II…
A larger challenge is productivity. Achieving GDP growth consistently above 1.75% will require much faster productivity growth than the United States has typically experienced since the 1970s.
Productivity — as we have argued prior — is the spring of enduring prosperity.
Productivity growth transformed these United States from a bucktoothed backwater into a global behemoth… a modern Colossus bestride the world.
Productivity growth averaged 4–6% for the 30 years post-WWII. But after 1980?
Average productivity has languished between 0–2%.
Meantime, labor productivity averaged 3.2% annual growth from World War II to the end of the 20th century.
But since 2011… a mere 0.7%.
What might account for America’s declining productivity growth?
We have previously implicated Richard Nixon and his 1971 murdering of the gold standard.
The gold standard, though a sad caricature in its dying days, nonetheless enforced an honesty.
A wastrel nation that consumed more than it produced would eventually run through its gold stocks.
The fiat dollar, the unbacked dollar, lifted the penalty.
A liberated Federal Reserve finally broke loose from its golden shackles… spread its nets… and ensnared the nation in debt.
Michael Lebowitz of Real Investment Advice:
The stagnation of productivity growth started in the early 1970s. To be precise it was the result, in part, of the removal of the gold standard and the resulting freedom the Fed was granted to foster more debt… Over the last 30 years the economy has relied more upon debt growth and less on productivity to generate economic activity.
“Unfortunately, productivity requires work, time and sacrifice,” he adds.
But the emerging American economy left behind the grimy toil of the factory floor and the workbench…. and headed for Wall Street.
It went chasing after the fast buck — the easy buck.
The financialization of the American economy was underway.
Ten percent of GDP in 1970, the finance industry grew to 20% of GDP by 2010… like weeds in an abandoned factory.
And like spreading weeds, finance choked the path of labor…
The bottom 90% of American earners advanced steadily from the early 1940s through the early 1970s.
But they’ve been sliding back ever since — or held even at best.
In contrast we find the top 1% of earners…
From 1920 to the early 1970s they lost ground to the bottom 90%.
But beginning around 1980 they went leaping ahead… and began showing society their dust:
But perhaps we can declare the race a wash.
Labor’s loss is simply capital’s gain. And the economy as a whole comes out even. Perhaps the transaction even benefits it.
But has it? Has the United States economy benefited from financialization?
The facts may run precisely the other way…
Economists Gerald Epstein and Juan Antonio Montecino slaved over the numbers.
Since 1990, they conclude…
The financial sector has drained as much as $22 trillion from the United States economy:
What has this flawed financial system cost the U.S. economy?… We estimate these costs by analyzing three components: (1) rents, or excess profits; (2) misallocation costs, or the price of diverting resources away from nonfinancial activities and (3) crisis costs, meaning the cost of the 2008 financial crisis. Adding these together, we estimate that the financial system will impose an excess cost of as much as $22.7 trillion between 1990 and 2023, making finance in its current form a net drag on the American economy.
Meantime, we sag and groan under majestic mountains of debt.
A financialized economy demands perpetually increasing credit — debt, that is — to keep the show going.
Servicing that debt absorbs increasing amounts of society’s income. That in turn leaves less to save… and to invest in productive assets.
It is a dreadful cycle.
Eventually it leaves the cupboards bare… and the future empty.
Average real annual economic growth since 2009 runs to 2.23%.
Compare the past decade’s 2.23% with the larger 3.22% trend since 1980.
One percentage point may seem a trifle. And one year to the next it is.
But Jim Rickards calculates the United States would be $4 trillion richer — had the 3.22% trend held this decade.
Run it 30, 50, 60 years… Jim concludes the nation would be twice as rich over a lifetime.
Here is Lebowitz with the sting in the tail:
“Given the finite ability to service debt outstanding… future economic growth, if we are to have it, will need to be based largely on gains in productivity.”
But from where?
Below, George Gilder shows you how real money could “work miracles of growth.” Read on.
Managing editor, The Daily Reckoning
The first-quarter GDP number was released this morning. And at 3.2%, it came in far above estimates. Consensus was about 2.3%. It was also the highest Q1 GDP print since 2015.
But there’s probably less here than meets the eye.
About half the GDP gain came from a surge in inventories and a sharp reduction in the trade deficit, neither of which is sustainable. They are likely one-time boosts.
The economy has been growing since June 2009, making this the second-longest economic expansion on record. However, it has also been the weakest economic expansion on record. That has not changed under President Trump.
Even during Obama’s weak expansion we saw strong quarters including the first quarter of 2015, which was 3.2%, and the second quarter of 2015, which was almost 3%. The problem is that these strong quarters soon faded; growth in the fourth quarter of 2015 was only 0.5%, almost recession level.
Under Trump, second-quarter 2018 growth was a very impressive 4.2% annualized. Third-quarter 2018 growth was 3.4%. Trump’s tax cuts seemed to be producing exactly the kind of 3–4% sustained trend growth Trump had promised.
But then the economy put on the brakes and growth slowed to only 2.2% in the fourth quarter. It looked like the 2018 “Trump bump” in growth was over and growth was returning to the 2.2% trend that had prevailed during the Obama administration.
And despite the first quarter’s 3.2% outlier, I expect lower GDP in the quarters ahead, returning to the same punk levels we’ve seen for nine years.
For the year, economists believe GDP will expand 2.4%, down from last year’s 2.9% gain, as the boost from the 2017 tax cuts and increased government spending over the past two years start to fade.
What about the possibility of recession?
Most investors are familiar with the conventional definition of an economic recession. It’s defined as two consecutive quarters of declining GDP combined with rising unemployment and a few other technical factors.
But investors may not be as familiar with two other aspects of recession timing. The first is the exact body that makes the determination, and the second has to do with the timing of that body’s announcements.
The group that “officially” decides when the U.S. economy is in a recession is called the National Bureau of Economic Research (NBER) based in Cambridge, Massachusetts, although there’s nothing official about what they do.
NBER is a private nonprofit think tank that receives substantial input from scholars at Harvard and MIT, but it is not a government agency. Their decisions on the start and finish of recessions are not technically “official,” but they are widely accepted by Washington, the Fed and Wall Street.
Less well known is the fact that recessions are not called by NBER until well after they have begun. In this respect, NBER looks backward at the data rather than forward like a forecasting firm.
On occasion, the NBER might not identify the start date of a recession until nine months or a year after the recession began. By that method, the U.S. could be in a recession next month and we would not know about it until a year from now when the data were all in.
The Fed may be on pause, but previous Fed action has been catching up with the economy. Monetary policy operates with a lag of six–18 months, so the slowing of the economy we saw in the fourth quarter of 2018 was the result of Fed tightening in late 2017 and early 2018.
Don’t be surprised if we wake up a year from now only to find the NBER says the recession began in April or May of 2019.
The Fed move to a rate pause in January 2019 and the end of QT in September 2019 will not be felt in the real economy until late 2019 and early 2020.
The timing has serious implications for next November’s presidential election. If the economy improves ahead of the election, Trump has an excellent chance. If it falls into recession, the Democratic candidate will probably win, whoever it is.
In that case, get ready for class warfare, much higher taxes and even more government spending than today.
for The Daily Reckoning
This week, the global elite descended private jets to their version of winter ski-camp – the lifestyles of the rich and powerful version. The World Economic Forum’s (WEF) five-day annual networking extravaganza kicked off in the upscale ski resort town of Davos, Switzerland.
Every year, the powers-that-be join the WEF, select a theme, uniting some 3000 participants ranging from public office holders to private company executives to the few organizations that truly do help fix the world that they mess up. This year’s theme is “Globalization 4.0”, or the digital revolution. The idea being, the potential tech take-over of jobs, and what wealthier countries are doing to lesser developed ones in the process.
While the topic might be focused on the future, the present is just as troubling, if not more so, than the future. Such is the disconnect between real people and corporations. That’s what the estimated 600,000 Swiss Franc membership to be a part of the WEF constellation gets you as a CEO at the Davos table.
Government leaders like German Chancellor Angela Merkel, Brazil’s president, Jair Bolsonaro and Chinese Vice President, Wang Qishan are in attendance this week. Business leaders like Microsoft co-founder Bill Gates and JPMorgan Chase CEO, Jamie Dimon will also take part in the festivities.
Yet, even though the various leaders will likely promote their achievements, what’s lurking behind the pristine snowcapped Alps, is a dark foreboding of a less secure world. Nearly every major forecast from around the world is projecting an economic slowdown. As one Bloomberg article reports, “companies are the most bearish since 2016 as economic data falls short of expectations and political risks mount amid an international trade war, U.S. government shutdown and Brexit.”
The list of non-attendees includes U.S. President Donald Trump, UK Prime Minister Theresa May and French President, Emmanuel Macron. They are too busy dealing with complex political problems in their own government institutions and domestic home fronts to make the trek.
Below is a breakdown of the three flashpoints that the Davos crowd should be watching in 2019:
Economic Growth Will Slow
Signs of slowing global economic growth are increasing. We’re seeing that in both smaller emerging market countries and larger, more complex ones. Weaker-than-anticipated data from the U.S., China, Japan and Europe are stoking worries about the worldwide outlook for 2019.
Many mainstream outlets are beginning to understand the turmoil ahead. Goldman Sachs, my old firm, is predicting an economic slowdown in the U.S. And the International Monetary Fund (IMF) has revised downward its 2019 U.S. growth prediction to 2.5% from 2.7% from 2018. It believes that the U.S. will be negatively impacted by the economic slowdowns of American trade partners and that the 2020 slowdown could be even “sharper” as a result.
The IMF also points to pressure from ongoing trade tensions between the U.S. and China and growing dysfunction between the U.S. and other major trading partners, such as Europe.
Because the world’s economies have become increasingly interdependent, problems in one economy can have widespread consequences. We learned this once before: the collapse of U.S.-based investment bank, Lehman Brothers, triggered a greater international banking crisis in 2008. That sort of connectivity has only grown. The reality is that we may now face even greater threats than forecast so far, which could lead to another financial or credit crisis.
It is likely that China could be ground zero for a global economic slowdown. Recent data out of China indicates that much global GDP and trade activity that should normally be in the first quarter (Q1) of 2019 was pulled forward into Q4 2018 to “beat” the tariff increase.
It’s likely that the same phenomenon could happen in the U.S. If this trend does snowball, you should expect to see rapidly deteriorating economic numbers arriving in the months ahead.
Debt Burdens Will Worsen
No matter how you slice it, public, corporate and individual debt levels around the world are at historical extremes. Household debt figures from the New York Federal Reserve noted that U.S. household debt (which includes mortgage debt, auto debt and credit card debt) was hovering at around $13.5 trillion. That debt has risen for 17 straight quarters.
What is different this time is that current levels are higher than just before the 2008 financial crisis hit.
In addition, global debt reached $247 trillion in the first quarter of 2018. By mid-year, the global debt-to-GDP ratio had exceeded 318%. That means every dollar of growth cost more than three dollars of debt to produce.
After a decade of low interest rates, courtesy of the Fed and other central banks, the total value of non-financial global debt, both public and private, rose by 60% to hit a record high of $182 trillion.
In addition, the quality of that debt has continued to deteriorate. That sets the scene for a riskier environment. Over on Wall Street they are already disguising debt by stuffing smaller riskier, or “leveraged” loans into more complex securities. It’s the same disastrous formula that was applied in the 2008 subprime crisis.
Now, landmark institutions like Moody’s Investors Service and S&P Global are finally sounding the alarm on these leveraged loans and the Collateralized Loan Obligations (CLOs) that Wall Street is creating from them.
CLO issuance in the U.S. has risen by more than 60% since 2016. Unfortunately, it should come as no surprise that Wall Street is now proposing even looser standards on these risky securities. The idea is that the biggest banks on Wall Street can actively repackage risky leveraged loans into dodgy securities while the music is still playing.
If rates do rise, or economic growth deteriorates, so will these loans and the CLOs that contain them, potentially causing a new credit crisis this year. If the music stops, (or investors no longer want to buy the CLOs that Wall Street is selling) look out below.
Corporate Earnings Will Be Lower
With earnings season now underway, we can expect a lot of gaming of results in contrast to earlier reports and projections. What I learned from my time on Wall Street is that this is a standard dance that happens between financial analysts and corporations.
What you should know is that companies will always want to maximize share prices. There are several ways to do that. One way is for companies to buy their own shares, which we saw happen in record numbers recently. This process was aided by the savings from the Trump corporate tax cuts, as well as the artificial stimulus that was provided by the Fed through its easy money strategy.
Another way is to reduce earnings expectations, or fake out the markets. That way, even if earnings do fall, they look better than forecast, which gives shares a pop in response. However, that pop can be followed by a fall because of the lower earnings.
The third way is to simply do well as a business. In a slowing economic environment, however, that becomes harder to do. Plus, it’s even more difficult in today’s environment of geopolitical uncertainty, as a multitude of key elections take place around the world in the coming months.
These three concerns were central in conversation in Davos. Expect global markets to be alert to the comments coming from the Swiss mountain town. Severe dips and further volatility could be ahead if any gloomy rhetoric streams from the Davos gathering.
How Will the Fed React?
Ready to help, is the answer. This month, yet another top Federal Reserve official noted that economic growth could be slowing down. That would mean the Fed should, as Powell indicated, switch from its prior fixed plan of “gradually” raising interest rates to a more “ad-hoc approach.”
Indeed, Federal Reserve Bank of New York President John Williams, used Chairman Powell’s new buzz phrase, “data dependence,” to indicate that the Fed would be watching the economy more. While he didn’t say it explicitly, it has become largely clear that the markets are determining Fed policy.
Based on my own analysis, along with high-level meetings in DC, I see growing reasons to believe the Fed will back off its hawkish policy stance. As we continue to sound the alarm, there are now a myriad of reasons including trade wars, slowing global economic conditions and market volatility.
Traders are now assigning only a 15% chance of another rate hike by June. Just three months ago, those odds were 45%.
Watch for even more market volatility with upward movements coming from increasingly dovish statements released by the Fed and other central banks. Expect added downward outcomes from state of the global economy along with geo-political pressures.