Economy

Where Will the Next Crisis Begin?

By David Stockman  |  November 7, 2019

I don’t mind being the skeptic in situations like these. Nor does Michael Coolbaugh, whose contribution this week is a particularly trenchant look at a “market” making all-time highs…

Of course, we’ve made The Stockman Letter more flexible so we can take advantage of the upside inherent in the Federal Reserve’s self-ascribed “easy money forever” mission.

But we won’t ignore what’s happening in the real world.

To wit, we often talk about the fact that this recovery from the Global Financial Crisis/Great Recession has been historically weak.

Lately, we’ve also been discussing the fact that this recovery, as weak as it’s been, is now the longest uninterrupted period of growth in U.S. history. It’s now 126 months old.

So, something to bear in mind right now is that, at the end of business cycles, initial prints of the macro data tend to materially overstate activity rates. That’s because initial reporting is based heavily on extrapolation models biased in favor of the recent trend.

And that’s especially true of the Bureau of Labor Statistics’ monthly headline jobs number. It includes a huge plug factor for business “births” and “deaths.” Yet, when the cycle turns, down, net business formation is the first activity rate to falter.

This factor only shows up months, even years, later when BLS jobs numbers are revised based on actual business filings that most definitely do not include tax payments for phantom employees.

During the last down cycle, this bias resulted in an initial overstatement of the jobs print by about 560,000 per month during the first (and worst) six months after the Lehman Brothers meltdown in September 2008.

Well, folks, get ready. Because it’s about to happen all over again…

The U.S. Census Bureau publishes a series on business startups based on applications for taxpayer identification numbers with the Internal Revenue Service. Between the third quarter of 2010 and the third quarter of 2018, the quarterly application figure increased by nearly 40%.

During the last year, that figure has plateaued. And, during the third quarter of 2019, the application rate rolled over. In the subcategory for applications that includes business expected to hire new employees, the rate fell by 2.1% compared to the quarter ending in September 2018.

It’s also more than evident that business capex is rolling over too. I don’t put much stock in tax cuts paid for by borrowing rather than spending cuts or more benign revenue sources. But it’s undeniable that in the very short run they do pull forward investment spending that would otherwise have occurred later in time.

That clearly happened with the Christmas 2017 business tax cuts. They ran at a $200 billion annual rate during 2018 and caused real capex to surge at an 8% annualized rate.

That pull-forward was not long lasting. During the most recent quarter, in fact, real business capex declined at a 1% annual rate.

None of these are signs of MAGA.

Indeed, it’s more reminder that the rot down below the Donald inherited from his predecessors is still there… and it’s getting worse.

Here’s Michael with a great start on a roadmap to clarity…

How to Ask the Right Questions

By Michael Coolbaugh

Bernard Baruch said, “Something that everyone knows isn’t worth anything.”

I absolutely love this quote. A lot of smart people invoke it. And they always assume you know what they’re talking about. This dynamic itself reveals what Baruch was getting at.

Here’s the thing: When we talk “markets” out in the world, people often assume we mean the Dow Jones Industrial Average, the S&P 500 Index, and/or the Nasdaq Composite.

And why wouldn’t that be so? After all, those are just about the only data nightly news programs report to fill their “business” segments. And, of course, stories about “euphoria” or “panic” will lead the broadcasts when they happen, as big gains and big losses for those indexes make for great graphics.

We’re amenable to those kinds of “heuristics,” or shortcuts – and then they’re seared into our brains.

But, sometimes, we have to cut through all of that training. Because there’s a potential risk lurking that dwarfs the 2008 Global Financial Crisis or the 2000 Dot-Com Bubble. And it has absolutely nothing to do with the stock market…

Before the GFC, it was considered fact that, in order to secure your financial future, you needed to buy a house. Not only would buying a house give you equity. As the story was told, home prices would also always go up over time.

Part of this “belief” was a matter of demographics – anyone born after 1940 had only witnessed rising home prices over long periods of time.

But the other part of this was the blind acceptance of conventional wisdom despite the lack of true empirical evidence.

So, what is it today that everyone knows to be “fact” but that, in reality, poses grave potential risk to your wealth? Well…

The Bedrock of Every Portfolio…

I earned my first real experience in the world of finance during my undergraduate years, interning at several wealth management firms during academic breaks.

Regardless of title, from intern to middle manager to CEO, there was one rule of thumb; I’m sure many of you have heard it: “The percentage of your investments allocated to fixed income should match your age.”

Seems pretty simple and rooted in logic…

It provides a steady stream of income and – here’s the kicker – it diversifies your portfolio.

When Stock Prices Fall, Bond Prices Rise…

We’re then shown some form of this chart, which demonstrates how a mixture of stocks and bonds will not only improve returns but greatly reduce your risk as well…

These types of charts, prepared by purported experts, do well to establish conventional wisdom.

At the same time, as was the case with home prices, demographics also support this belief.

Anyone – individual or professional – who’s been investing since the early 1980s has only witnessed falling interest rates and rising bond prices over long periods of time. (Interest rates and bond prices move inversely to each other).

All sounds great, right?

But what happens when something we accept as “fact” turns out to be slightly less than true?

What happens if an analysis similar to one performed on home prices dating back to the late 1800s demonstrates that stocks and bonds are not always inversely correlated?

In fact, analysis from Artemis Capital Management demonstrates that stocks and bonds have been “highly correlated” more often than they’ve been “anti-correlated.” And that undermines the premise upon which every single financial plan and institutional portfolio is built.

It means that vast sums of capital around the world are predicated on safe bonds protecting a portfolio of risky stocks.

Masters of the Universe

You see, it’s a well-known fact that interest rates are low. It’s equally known that central banks around the world are dedicated to keeping them there for a very long time. The argument is low interest rates make equities more attractive.

As we can see below, the difference between the S&P 500 dividend yield and the yield on the 10-year U.S. Treasury note is near extreme levels that have preceded strong moves higher for equities.

And the same can be said for Europe as well…

What If?

But what if we’re looking at all of this the wrong way?

What if these modern-day “Masters of the Universe” can’t maintain control?

What if something that’s guaranteed to always go up over time no longer follows these imaginary laws?

What if a shock originates, not from risky stocks, but from safe bonds?

Maybe – just maybe – we might want to consider that interest rates below the rate of inflation aren’t worth the risk…

The Informed Skeptic Starts Here…

This is the most politicized market in history. And the Tweeter-in-Chief is still in charge. So, the situation is changing almost by the minute.

It’s “Impeachment!” in Imperial Washington and all over the Mainstream Media. It’s “Easy Money!” on Wall Street and across Bubblevision.

And it seems as if the whole world has, indeed, gone mad.

Amid this chaos, prices will continue to rise and fall, trends will continue to develop and dissipate.

Well, The Stockman Letter is made for times like these. And we’ve updated our design to help us better navigate to not only the safest harbors but also the most promising opportunities.

The stakes are as high as they can be heading into 2020. Markets appear to be straining, catching up to an economy that’s been weak and getting weaker for years.

The Donald is tied up in the day-to-day movements of the major stock indexes like no president before him. The increasingly desperate incumbent will do anything he must to hold the White House.

It’s a major tipping point. And there’s no telling what the Donald’s great disruptions could do to your wealth.

You’ve got to be nimble to win in this market…

If You Need Your Money in the Next 5 Years…

America is at a crossroads. The middle class is disappearing… government spending is out of control… and the implosion of Bubble Finance will cause the greatest market crash in history. So, if… Read More
David Stockman

David Stockman is the ultimate Washington insider turned iconoclast. He began his career in Washington as a young man and quickly rose through the ranks of the Republican Party to become the Director of the Office of Management and Budget under President Ronald Reagan. After leaving the White House, Stockman had a 20-year career on Wall Street.MORE FROM AUTHOR