Edge and Odds

The enemy of knowledge is not ignorance, it’s the illusion of knowledge (Stephen Hawking)

It ain’t what you don’t know that gets you into trouble. It’s what you know for sure that just ain’t so (Mark Twain)

Edge and Odds

Invest with smart knowledge and objective odds

THE DAILY EDGE: 29 APRIL 2019

Pointing up You might have missed Saturday’s post: IN GODS WE TRUST
Economy Regains Momentum After Shaky Start to Year The U.S. economy started 2019 with a pop, growing at a 3.2% clip despite headwinds such as weaker domestic demand. The GDP data suggested the expansion has more room to run.

Gross domestic product—the value of all goods and services produced in the U.S., adjusted for inflation and seasonality—rose at a 3.2% annual rate from January through March,  the strongest rate of first-quarter growth in four years, the Commerce Department reported Friday.

Rising exports, falling imports and higher inventory investment drove much of the growth, helping to offset weaker gains in consumer spending and business investment. (…)

After stripping out the volatile categories of trade, inventories and government spending, sales to private domestic buyers rose at an annual rate of 1.3%—half the rate of the prior quarter and a far slower pace than the overall GDP growth number. The housing sector was a drag on growth for the fifth-straight quarter.

Consumer spending, which makes up two-thirds of economic activity, rose at a mere 1.2% rate in the first quarter, down from a stronger 2.5% in the fourth quarter of 2018. (…)

The Commerce Department estimated the government shutdown shaved 0.3 percentage point from growth in the first quarter.  (…)

The Fed’s preferred inflation measure, the price index for personal-consumption expenditures, increased at a 0.6% seasonally adjusted annual rate in the first quarter, down from 1.5% in the final quarter of 2018 and below the Fed’s 2% target. Core prices—which exclude volatile food and energy costs—rose at a 1.3% rate. (…)

David Rosenberg agreed with President Trump’s assessment of the 3.2% GDP growth figure, “an incredible number”.

(…) So let’s stick to what can actually be observed and measured as opposed to “airy fair” estimates. You simply add up consumer spending, nonresidential construction, business capital spending, and housing – the key guts of the domestic private sector economy – and it slowed to a 0.9% annual rate, from 2.3% in Q4, 3.0% in Q3 and 4.0% in Q2 of 2018 as the tax stimulus kicked into high gear. At no time in the early-2016 “soft patch” were the domestic guts of GDP this weak. You have to go back to the third quarter of 2012 to see something this soft (…).

I’ll take more lipstick off. Add up all the areas of GDP that are actually sensitive to the economic cycle: consumer durable goods and cyclically-sensitive services and nondurables (transportation, recreation, restaurants, accommodation, clothing), business spending on plants and equipment and housing – collectively they contracted at a 2.1% annual rate. You read that correctly. The recession in underlying cyclical spending has already begun. (…)

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The BEA publishes a series that I had been telling everyone all week to pay attention to – real final sales to domestic producers. Another way to look under the hood. This key metric was cut in half in Q1 to a 1.3% annualized rate (…). And why this is important is because it will be the real headline GDP growth rate that will soon be converging on this subpar trend, not the other way around. (…)

Hmmm…not obvious to me:

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The YoY trends:image

Same thing happened in Q1’18:

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The WSJ editorial has valid points:

(…) Yet the government shutdown took some 0.3% off growth and that won’t be repeated in the second quarter. Auto sales took 0.49% off GDP in the quarter, but sales rebounded in March heading into the second quarter. Overall consumer spending contributed a relatively small 0.82% to GDP, perhaps due to the fall in consumer confidence after the stock market swoon in the last months of 2018. With job growth strong and wages rising, consumers should contribute more to the expansion the rest of this year.

Private business investment kicked in a relatively measly 0.27% in the quarter, which is disappointing. But (…) private capital investment has driven the rebound in growth since 2017. Business investment fell through the floor in the last half of 2015 and 2016, offset in part by a robust housing market. But that has reversed since Donald Trump took office, with business investment taking the lead as housing slowed and moved into negative territory in late 2018 and the first quarter of 2019.

What changed? Well, the economic policy mix. The Trump Administration lifted the threat of new regulation and harassment of business in 2017, which liberated long-stifled animal spirits. Then came the Trump tax reform with its sharp reduction in business tax rates and immediate 100% expensing of new investment. This was targeted precisely to stimulate the weak capital investment that had stymied growth in the Obama years.

This has also kept the U.S. expansion going even as growth in the rest of the world has slowed markedly. U.S. growth over the last four quarters year over year is now above 3%. Politicians in Germany or France would be elated, and maybe faint dead over, if they could keep growth above 3% for 12 months. (…)

U.S. Auto Sales Seen Cooling in April as Prices, Rates Rise

Cox Automotive and the team of J.D. Power and LMC Automotive on Friday both said they expect U.S. auto sales of about 1.37 million units in April. That represents a rise of 1% on a reported basis, but a decline of 3.5% when adjusted for an extra selling day this year.

Both surveys showed an expected seasonally adjusted annual sales rate in April of 16.9 million units, down from 17.5 million in March and 17.2 million in April 2018, according to figures from Cox.

Retail sales, which exclude fleet sales, are expected to post an even weaker showing in April. J.D. Power and LMC said they expect retail sales of 1.04 million units, down 5.3% on a selling-day adjusted basis and marking the 10th straight month of year-over-year retail sales declines. (…)

INFLATION…DEFLATION

April 20, the WSJ:

(…) But if it turns out that core inflation, which excludes volatile food and energy categories, falls and stays near 1.5% for several months, “I would be extremely nervous about that, and I would definitely be thinking about taking out insurance in that regard” by cutting rates, he said.

Dallas Fed President Robert Kaplan didn’t endorse such a move outright but said Thursday that inflation running persistently around 1.5% or lower is “something I’m going to certainly take into account” when setting rates.

Clearly communicating the rationale for an interest-rate cut would be especially important to avoid signaling alarm about the broader economic outlook, which could chill spending and investment. “We would need to be very careful,” said Mr. Evans.

Fed Vice Chairman Richard Clarida, speaking earlier this month on CNBC, appeared to be lowering the bar for such a move. He volunteered that a recession wasn’t the only situation in which the Fed had cut rates in the past, pointing to instances in the 1990s in which the central bank “took out some insurance cuts.” (…)

Mr. Evans must be quite nervous after the Q1 GDP report which showed core PCE inflation at +1.26% annualized in Q1 and +1.52% on average for the last 3 quarters. If Rosenberg’s thesis has any weight at the FOMC, an insurance cut is imminent.

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Trump’s New Nafta Faces Mounting Trouble in House President Trump’s push to revamp North America’s trade rules is hitting a roadblock in Washington as Democrats and labor groups demand changes, dimming its chances of passage before next year’s election.

By Chuck Grassley (R- Iowa)

(…) As chairman of the Finance Committee, I’m leading the Senate effort. I’ve been involved in the passage of every U.S. free-trade agreement, and it’s never easy. Reorganizing a massive economic relationship affects many constituencies, and that’s inevitably complicated.

I’ve met with congressional colleagues, as well as U.S., Canadian and Mexican trade officials, to discuss how our nations will secure legislative approval of USMCA. A significant roadblock is the administration’s tariffs on steel and aluminum and retaliatory Canadian and Mexican tariffs on U.S. products. These levies are a tax on Americans, and they jeopardize USMCA’s prospects of passage in the Mexican Congress, Canadian Parliament and U.S. Congress. Canadian and Mexican trade officials may be more delicate in their language, but they’re diplomats. I’m not. If these tariffs aren’t lifted, USMCA is dead. There is no appetite in Congress to debate USMCA with these tariffs in place. (…)

Earlier this year U.S. Trade Representative Robert Lighthizer told the House Ways and Means Committee that failing to pass USMCA this year would damage the credibility of America’s global trade agenda, particularly the efforts to secure a deal with China. He’s right.

The administration can take the lead by promptly lifting tariffs on steel and aluminum from Canada and Mexico and working with allies to address the true source of overcapacity: China. This essential step is fully within the administration’s control and would immediately clear a significant hurdle to passage. Meanwhile, Speaker Nancy Pelosi and congressional Democrats should recognize this historic win for the country and engage in good faith to pass USMCA this year.

USMCA is good for the environment, for workers, for jobs and for nearly every sector of America’s economy. I hope Washington rises to the occasion.

EARNINGS WATCH

From Refinitiv/IBES:

Through Apr. 26, 229 companies in the S&P 500 Index have reported earnings for Q1 2019. Of these companies, 77.3% reported earnings above analyst expectations and 17.0% reported earnings below analyst expectations. In a typical quarter (since 1994), 65% of companies beat estimates and 21% miss estimates. Over the past four quarters, 76% of companies beat the estimates and 17% missed estimates.

In aggregate, companies are reporting earnings that are 6.1% above estimates [actual growth +3.8%], which compares to a long-term (since 1994) average surprise factor of 3.2% and the average surprise factor over the prior four quarters of 5.4%. The E

The estimated earnings growth rate for the S&P 500 for 19Q1 is -0.3%. If the energy sector is excluded, the growth rate improves to 1.2%. Five of the 11 sectors in the index expect to see an improvement in earnings relative to 18Q1.

Of these 229 companies, 56.1% reported revenues above analyst expectations and 43.9% reported revenues below analyst expectations. In a typical quarter (since 2002), 60% of companies beat estimates and 40% miss estimates. Over the past four quarters, 67% of companies beat the estimates and 33% missed estimates.

In aggregate, companies are reporting revenues that are 0.2% below estimates, which compares to a long-term (since 2002) average surprise factor of 1.5% and the average surprise factor over the prior four quarters of 1.1%.

The estimated revenue growth rate for the S&P 500 for 19Q1 is 5.0%. If the energy sector is excluded, the growth rate improves to 5.5%.

Trailing EPS are now $162.72, up from $161.93 for all of 2018.

Revisions have turned positive last week…

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…but have yet to translate into better official estimates for the rest of the year: the estimated earnings growth rate for the S&P 500 for 19Q2 is 1.9% (+2.8% on April 1). If the energy sector is excluded, the growth rate improves to 2.0%. Q3: +2.1% vs +2.7% and Q4 +8.6% vs +8.9%. Full year 2019: +3.0% vs +3.3% on April 1.

  • Despite the earnings beats (above), companies have turned much more cautious on growth. (The Daily Shot)

Source: BofA Merrill Lynch Global Research

The Rule of 20 P/E is 20.03 @ 2934 on the S&P 500 Index. Since the December low (2343), the Index is up 25.2% as the Rule of 20 P/E rose 19% from 16.83 while trailing EPS rose 1.4% and inflation receded from 2.3% to 2.0%.

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Reasonably good earnings coupled with downward inflation trends should keep the Rule of 20 Fair Value (currently 2929, yellow line) in a positive trend in coming months. Generally, the Rule of 20 P/E traverses the “20” Fair P/E when the Fair Value is rising. We don’t know the future but it seems fair to think that most of the recent market angsts have faded: the recession risk, a hawkish Fed, declining earnings, inflation. Remaining, in no particular order: China, trade wars, Italy, Brexit, oil, deflation, debt.

TECHNICALS WATCH

Lowry’s Research sees little evidence to support contentions of a significant market top as “the forces of Supply and Demand continue to support a healthy bull market headed for further new highs in the months ahead.”

I should warn, however, that Lowry’s Selling Pressure and Buying Power indices were on a converging trend last week for the first time since mid-September. To be monitored.

For now, most technical indicators are green, except investor sentiment measures, most of which being high (contrarian negative).

From Barron’s:

(…) Only 49% of the 148 professional money managers responding to Barron’s spring 2019 Big Money poll call themselves bullish about the prospects for stocks over the next 12 months, down from 56% in our fall 2018 survey. The percentage of bulls hasn’t dipped below 50% since the fall 2016 survey.

At the same time, the bears’ ranks have grown to 16% from just 9% last fall, while the neutral camp has held steady at 35%. And almost 70% of Big Money managers consider stocks fairly valued today—the highest percentage in nearly half a decade. (…)

What were they thinking in January 2018 when the actual P/E was 21.2 and the Rule of 20 P/E was 23.5?

IN GODS WE TRUST (follow up)

I posted this last Saturday morning but I read Steve Blumenthal’s On My Radar today. Good supplement:

(…) Today, we’ll look at what I believe are two of the most important indicators you can follow to help you manage the risk and potentially profit from the defaults that will present in the next recession. Timing, of course, is critical and I’m trusting that what I’ve followed for nearly 27 years can help you and me identify the turning point. To which, I believe the HY price trend holds the key. (…)

The leveraged loan market is generally where companies whose credit is so weak they can’t access the high-yield bond market to obtain financing. Read that last line again. This is the sub-prime of the corporate bond market. The popularity of leveraged loan funds and ETFs was enabled by zero interest rate policy. Seeking to improve returns on their savings, investors moved their money into riskier asset classes. That liquidity, like sub-prime in the mid-2000’s, gives borrowers to hold the upper hand. The problem is one of size, scale and poor quality. Let’s take a closer look. (…)

Moody’s evaluates and rates covenant protection on a scale of 1 to 5 with 5 being the least protection for lenders and 1 being the best. [It is now above 4.2]. (…) Next is a look showing the percentage of covenant-light loans in the index grew from 31% in June 2012 to 79% in September 2018. It hit 87% in January. (…)

When you consider the $1.22 trillion in leveraged loans, the $1.21 trillion in high yield junk bonds and the $2.56 trillion in BBB-rated corporate bonds, the $2.55 trillion in High Grade/Quality bonds is “dwarfed” by the $5 trillion in high risk debt.

Moody’s estimated the post-default trading prices for senior unsecured bonds was 53.9% in 2017, up sharply from 31.5% in 2016. The high yield bond market declined 45% in the last crisis. Given the low covenant quality today, I estimate the next recession will see that $5 trillion in debt off 60% from its highs. The sub-prime problem turned out to be an approximately $3 trillion global blow-up that is now defined as the “Great Recession.” I believe the next recession and default wave that concludes by recession-end will match or exceed the sub-prime problem when you factor in the derivatives that are tied to the corporate credit markets. (…)

The HY market is a good lead indicator for the equity market and both are good lead indicators for the economy. The fireworks will occur in the next recession. Thus, I believe the HY market holds the key. Keep it on your radar. (…)

My Saturday post explains the corporate debt box the Fed has put itself in with its lower for longer experiment. FOMC voters can shy away from tightening but the bond market will eventually do the job for them. Not happening just yet:

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IN GODS WE TRUST

From “too big to fail” to “ too leveraged to tighten”

Landing in Lima, at sea level, our spirits are high. Tomorrow morning, we fly to Cusco, the Inca capital, 13,000 feet above, on our way to Machu Picchu where we would sight perhaps the most magnificent scenery we ever saw. Arriving at Machu Picchu via the Inca Trail, the first view of the citadel is from the Sun Gate, 1000 feet up. The scene is truly magnificent. From this perch, an uninformed eye would think the 500-year old citadel intact and vibrant. Perspective can be tricky.

Throughout our journey in beautiful Peru, most of it seeming almost halfway to the space  station, the perspective was always grandiose.

Image result for images machu picchu

Uber officers must also feel pretty high up there, declaring in the IPO prospectus that Uber’s Total Addressable Market (TAM) amounts to $12.3 trillion, equivalent to 14.5% of world GDP per Grant’s calculations. Left to itself, Uber could end up cashing $1 out of every $7 spent worldwide. Ambition on wheels.

Investors in technology stocks are ambitious people with high spirits. Never mind mundane details having to do with profitability and return on capital, they revere concepts such as TAMs and Lifelong Subscriber Value, focused as they are on the larger perspective offered by instantaneous global reach.

Much like the Incas who worshiped just about anything impacting their lives, tech investors see any company addressing people’s “needs” as godsends worthy of blind veneration.

Take the week after April Fools day. Jumia Technologies (JMIA), the expected Amazon of Africa, PagerDuty (PD), the latest arrival in the SaaS (software as a service) space and Tufin Software (TUFN) together raised $522 million on a $3.8 billion initial market cap, quickly revalued to around $6B as investors’ appetite far exceeded the 13% of equity offered. The old trick of starving the supply to create oversubscribed conditions…

If you care, these 3 companies had aggregate revenues of $310 million and operating losses totalling around $225 million in 2018.

The same week also saw one SPAC IPO, B. Riley Principal Merger (BRPM.U), raise $125 million. Don’t know what a SPAC is? There were 46 of them in 2018 that raised $10.7 billion from investors blindly volunteering money to a few people who will, it is hoped, be able to find an attractive company to acquire at good enough terms to justify the promoters eventually pocketing 20% of the pot.

As of 4/25/19, the Renaissance IPO Index, a market cap weighted basket of newly public companies, was up 33.4% year-to-date, double the S&P 500 gain.

Today’s investing crowd is truly faithful. Only solid faith can support a $90 billion valuation for a company having lost $12.1 billion in the last 5 years alone and whose business model is essentially based on a phone app and predatory pricing. Any comparison with Amazon is blind heresy.

While investors trip over themselves to buy IPOs of money losing companies with but vague prospects to ever become cash-flow positive, they digress infinitely about whether or not they should care if S&P 500 companies’ earnings decline 2% or 3% in the first quarter.

The Incas were focused on risk management, living where long rainy seasons succeed long dry seasons, surrounded by volcanoes and amid an earthquake prone geography. They proved very smart devising numerous ways and means to survive and prosper. And just in case, their numerous gods presumably had their backs.

But they had no gods prepared to help them face a danger in the form of Spaniards seeking to impose their own god while grabbing gold and various other natural resources in the process. Or was it the other way around?

Current day investors may also think that their central banker gods have their back but who knows what would happen if Spaniards, or Italians, or Brits or even Chinese for that matter decide to play hard ball.

The Oval Office may be near sea level but this President is way up in the clouds, oblivious to what is happening down below. Investors also seem to have high spirits in spite of admittedly poor data overall. In truth, nobody seems to care about the devil in the details.

For the Incas, the devil arrived by boat in 1532. The Inca Empire then covered a large portion of western South America including all or parts of today’s Colombia, Ecuador, Peru, Bolivia, Chile and Argentina. At its peak, the Inca population was estimated at between 6 and 14 million people.

They were nonetheless easily defeated by Francisco Pizarro’s army of 168 men, one cannon and 27 horses. Empires can be toppled by unsuspected forces, however unassuming they may appear. Pizzaro was both smart and lucky, using a divided population, smart communications, technology and trickery to surprise the Incas.

Pizarro was keenly attracted by the Incas’ gold and silver which, for them, had no monetary value but which they revered as the sweat of the sun (gold) and the tears of the moon (silver). Pizarro was perhaps the first corporate raider in history.

Incredible as it was, Pizarro’s victory caused Peru to become a radically different country. In just a few decades, most Peruvians became catholic, spoke Spanish and adopted the Spanish culture. Talk about an unbelievably improbable consequential event.

Donald Trump’s election may also prove to be fairly consequential.

Investors currently fear no devils. Jerome Powell quickly hid his horns at the end of December 2018 after financial markets sided with Trump on monetary policy. Two months later, Powell told Congress that he believes high corporate indebtedness could make any U.S. downturn worse.

Coincidentally, Dallas Fed president Robert Kaplan released an essay on March 5 (Corporate Debt as a Potential Amplifier in a Slowdown) with this conclusion:

I am also sensitive to these corporate debt developments in light of the historically high level of U.S. government debt and the forward estimates for the path of government debt to GDP. An elevated level of corporate debt, along with the high level of U.S. government debt, is likely to mean that the U.S. economy is much more interest rate sensitive than it has been historically.

To be clear, Kaplan told Reuters

It’s something that I’m aware of, which sort of reinforces for me why I feel we should be taking no action for some period of time (…) yet another reason why I think we are wise — inflation is not running away from us — I think we are wise to take a very patient approach.

From “too big to fail” to “ too leveraged to tighten”.

The Fed is wisely using a wide perspective to protect the U.S. empire. In effect, the government’s current and prospective debt combined with the huge corporate indebtedness are now variables significantly influencing monetary policy.

Add the President’s trade wars, Pelosi’s $1-2 trillion new infrastructure spending proposal and democrats’ Modern Monetary Theory printing machine idea and you have a Fed boxed in risk management mode praying that inflation remains low enough so that it can “wisely be patient” and allow the economy to grow enough to offset politicians’ and corporate officers’ fiscally irresponsible behavior.

But the Fed ain’t so wise. On the burning issue of excessive indebtedness, it actually is the chief arsonist with its “lower for longer” interest rate management experiment. Bernanke/Yellen’s message was a clear ticket for leverage. This Fed goes even further with it’s newly admitted “too leveraged to tighten” stance and its growing tolerance for rising wages and inflation.

Powell at his December 2018 presser post FOMC:

I do expect, and I think many forecasters expect, that wage increases will continue, and that would be a welcome development. Wage increases do not need to be inflationary. There’s plenty of evidence of situations, for example, in the very tight labor market of the late 1990s [when] (…) we had wage increases above productivity plus inflation. We didn’t have high inflation. So, it would be welcome. We hear a great deal of anecdotal information about labor shortages, along with other, you know, bottlenecks and things. So I would expect that wages will keep moving up, and it doesn’t necessarily mean inflation. We don’t think of it that way.

Investors, perched ever closer to heaven, trust that the new gods, Trump and Powell, will blend perfectly: one stimulating forever, the other providing the necessary low cost financing. Doesn’t that sound like MMT already?

However, investors’ focus on the gods of economic and monetary perfection prevents them from seeing the details in the devils.

When one drills down into this leveraged economy the narrower perspective becomes even more worrisome. As Grant’s reveals, only 15% of the $1.1 trillion leveraged loan market resides in public companies’ balance sheets. The other 85% is hidden within private companies’ liabilities. Iceberg, here we come!

In the last 5 years, the SEC-filers (public companies) have improved their debt/ebitda and interest coverage ratios while private borrowers, giddily showered with greedy cash, have shown a meaningful deterioration in both ratios to the point where the sum of all leveraged loan borrowers now shows debt vulnerability well in excess of the 2007 levels.

As a result, private companies, invisible to the investing public, are seriously sensitive to any rise in interest rates and/or any meaningful slowdown in the economy. Too leveraged to tighten. This, following a full year of tax reform benefits.

Private indebted companies and their private equity sponsors got the message last year that lower for longer may not be forever. The Fed’s sudden pivot opened a window which the Lyft and Uber of this world understood needed to be used hastily. Perhaps WeWork and others will also notice that investors are currently little bothered buying companies with losses larger than their revenues. One really needs to have long term vision to invest in such companies, vision only possible from way up there, where the gods hide the details behind their back.

The Investment Grade bond market also has a peculiar reality when one can focus on the details. This apparent safe harbor is now actually 50% populated by triple-B bonds, from 32% ten years ago. To this $2.5 trillion near-junk basket, we must add another $400 billion in BBB reverse‑Yankee bonds (U.S. companies issuing in euros) residing in the Euro IG basket. Ultra low interest rates prevent 55% of these bonds from being considered junk and sent to the High Yield junkyard based on leverage alone as per Morgan Stanley’s analysis.

History shows that 7-15% of BBB bonds get downgraded to junk in a recession. But today, never mind the recession risk, pre-emptive tightening can in itself cause significant downgrades and create a tsunami in the HY bucket which is only 40% of the size of the BBB market.

Given the large number of such companies on the IG-HY fence, even pre-emptive moves by the Fed can actually trigger the recession they want to prevent.

The ‘BBB’ mega borrowers are double that of the next-largest rating concentration – the ‘BB’ category – and a significant chunk of the investment-grade portfolio that together accounts for 59 percent of total ratings. (Fitch)

Zooming even closer, we see not only mega borrowers but also smaller companies having jumped on the lower for longer bandwagon.

According to Sun Trust, about 60% of small cap debt is junk-rated versus less than 10% for the S&P 500; 40% of small cap debt is floating. Moreover, 36% of the Russell 2000 did not produce earnings over the past 12 months, a record in non-recessionary years, 10 years into the economic cycle.

Interest coverage of the median Russell 2000 company is below 3.0, a level only seen during recessions. With 40% of the small caps’ debt floating, a 100bps increase in short-term rates would reduce their interest coverage by nearly 10%, potentially triggering defaults, restructuring, cost cutting (layoffs) and a tightening of lending standards.

Too leveraged to tighten.

It is now obvious that our central bank gods had but a wide, grandiose perspective on the USA land when they doubled short term interest rates during 2018. Investors went along, supported by the big corporate tax cut, until they started to see the 2019 details shaping up in early October.

Lower for longer has radically changed the complexion of America’s corporate world, so much that conventional pre-emptive policies could actually prove totally counterproductive. The Fed seems to have realized this new reality and swiftly pivoted early this year to the relief of equity markets.

But the Fed finds itself in a very uncomfortable box it has unknowingly designed. Its QE experiment now calls for experimenting how to exit a maze puzzle box having a thick but nonetheless very fragile and sensitive bottom.

Powell and company must be praying the inflation gods to stay put long enough to allow corporate deleveraging to happen. But President Trump has his sight on November 2020 now and any sign of slowing growth will trigger a stimulus attempt to keep corporate confidence high. Perversely, such confidence coupled with a quiet Fed are no incentives to deleverage.

The hope must be that receptive equity markets will allow for a quick rebalancing of debt/equity ratios, before inflation shows its ugly goddess head.

Too leveraged to tighten is also prevalent in Canada where it is the consumer that is too indebted for the BOC to become hawkish. And in Europe where the economy is still too weak for the ECB to let loose. And in Japan where the BOJ keeps begging the inflation gods to splurge on sushis. And in China where deleveraging is a goal only after the economy has clearly stabilized, courtesy of the USA, Europe and Japan if it ever happens. The true meaning of a sharing economy.

Concurrently, much of the world electorate seems to be shifting to the left as income inequality and populism grow in tandem and increasingly dominate political platforms.

In brief, the world seems totally synchronized with expansionary economic and monetary policies across the firmament. The only brake pressure comes from President Trump’s trade feuds, about to calm down, it is hoped by many. But given the damage to world growth, would a resumption in global trade flows spark faster growth… and higher inflation, tilting central bankers’ models towards their hawkish levers?

The timing could be perfect for the GOP and the elections of 2020. But the Fed and most other central banks might think it a little premature. Raising interest rates could well hit the corporate sector hard enough to hurt the economy and create chaos in both fixed income and equity markets.

Not raising rates would likely boost growth when additional labor resources are very limited. Since the 1950s, trends in inflation and labor costs have been pretty well synchronized and only recessions have succeeded in breaking the nasty upward trends.

Perhaps it would be wise for investors, not only to manage their current risk profile down, but maybe also to start thinking about the sweat of the sun and the tears of the moon. The Inca gold Pizarro and others were reportedly never able to take home has yet to be found.

As Paul Krugman once quipped, “Whom the Gods would destroy, they first put on the cover of Business Week.”

                                         Aug. 13, 1979                                          April 17, 2019                                     

     

Mark Twain said, “the reports of my death are greatly exaggerated”. Inflation is not dead, and it’s a killer. Watch for its resurrection.