Productivity | Strategy | Profitability
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Productivity | Strategy | Profitability
They are adding 15% of GDP per year to the whole insolvent dung heap. This record amount of debt will soon be held in the context of rapidly rising inflation due to the Fed’s monetisation of direct government payments to the private sector.
President Obama took a full eight years to add $9 trillion to the outstanding debt load. The MAGA President accomplished this baleful deed in only four. Now, Joe Biden indicates he wants to “go big” with spending over the next four years. It took over two hundred years’ worth of US history to accumulate $1 trillion in National debt. We did 4x that amount in the past 12 months alone, with the promise of trillions more in debt already on the way.
The Fed is enabling the Federal Government’s proliferate spending with low rates. The problem here, is that each Fed-induced boom/bust cycle has served to addict the economy and market to lower and lower interest rates. The historical average Fed Funds Rate (FFR) has been about 5.5%. However, it only took a 5.25% FFR in June of 2006 to collapse the real estate market and the entire global economy. The FFR was still 25 bps below average, but that was too high to sustain the housing bubble and its related debt. Likewise, in December 2018, the FFR was inched back to just 2.5%. Nevertheless, that lower rate was enough to crash the REPO and stock market–pushing the Fed once again into retreat on its rate hiking cycle. This was true, even though that rate was far less than half its average.
The simple truth was, asset-price valuations had soared to a level that only made sense in an environment of ultra-low interest rates. It’s the same for debt, which had climbed to a level that was untenable without near-zero servicing costs.
INTEREST RATES CAN NEVER BE RAISED
The fact is, Mr. Powell and his cohort of counterfeiters will never be able to normalise interest rates—not even remotely close. Forget about raising rates; they most likely will not even be able to exit QE this time around without cratering the markets. The next time the Fed reduces its bond purchase program, the market reaction should be more like a nervous breakdown, rather than just a tantrum.
First let’s review a bit of the historical histrionics surrounding the initial Taper Tantrum. Back in September 2012, the Fed’s Quantitative Easing program was running at the level of $85 billion per month. The asset purchase program consisted of both Mortgage-Backed Securities and Treasuries. Then, in December 2012, Fed Chair Ben Bernanke expanded his massive QE 3 scheme by making its duration unlimited. But by May 2013, the time had finally arrived to start discussing the tapering of its asset purchases. And in December of that year, Tapering officially began; with QE ending by October 2014. Of course, the Fed would be back in the QE game six years later. But at the time, the overwhelming consensus thinking was that the 100-year economic storm had passed and we would never witness such extraordinary actions by our central bank ever again.
While the S&P 500 did drop by 5% in just a few weeks after Bernanke first discussed reducing asset purchases, the carnage was much worse in the sovereign debt market. In May 2013, after just a mere suggestion of an imminent reduction in bond purchases, panic spread throughout global bond markets. The 10-year U.S. Treasury took it especially hard, sending bond prices plunging. The Benchmark yield gained 140 basis points between May and early September 2013. According to PIMCO, the yield on the 10-year Note was 1.94% on May 13th, the day before Bernanke’s testimony. But less than four months later, that yield surged to 3.34%.
As bad as that Tantrum was, there are three reasons why the next Taper Tantrum should make the previous markets’ hissy fit look like a state of tranquility.
MARKET BUBBLES AND EXCESSIVE DEBT
The first difference is that the Fed is now buying $120 billion worth of assets each month instead of the $85 billion during QE 3. It was buying MBS and Treasuries during the run-up to the last Taper Tantrum. But now, the Fed is not only buying those same types of assets, it has thrown in (for the first-time ever) new types of debt including municipal and corporate bonds—even junk-rated debt—with its current QE 4 program. This humongous market distortion has forced bond yields much lower than they were seven years ago. Back in the Taper Tantrum days, the thought that there could ever be negative yielding sovereign debt was absurd.
The second reason why the next tantrum will be worse than before is that equities are in a much bigger bubble today. The price to sales ratio of the S&P 500 back in March of 2000 (the previous peak of stock market valuation) was 2.1; and this metric was just 1.3 prior to the Taper Tantrum. Today, it is at an all-time record high ratio of 2.7. The other most important and revealing valuation metric is the total market cap to GDP ratio. The total market cap of the Wilshire 5000 to GDP was 1.4 at the March 2000 peak. This ratio was just about 1.0 in the Taper Tantrum days. However, it is now over 1.85. Therefore, the stock market is not only at a much higher valuation than at any other time in history, it is immensely greater than its 2013 levels. How bad could it get? For those investors who bought the NASDAQ at its peak; the ensuing plunge was over 80% and you would have to wait 15 years to break even in nominal terms. When adjusting for inflation the waiting time was even longer.
Both the Dot.com crash and Taper Tantrum were the result of the Fed taking away the punch bowl. Jerome Powell tacitly admitted during his December press conference that the continuation of near-zero borrowing costs, is the only thing keeping the stock market bubble from bursting. Hence, it is imperative to avoid making the mistake of buying and holding stocks at these levels once the Fed starts draining its liquidity.
HIGH INFLATION & INTEREST RATE RISES
Finally, there is now a record amount of total debt that is clinging precariously to the Fed’s artificially-induced low yields. The more debt there is outstanding in relation to the underlying economy, the more unstable the economy becomes–and the more damaging its eventual reconciliation will be. The National debt to GDP ratio now stands at 128%. It was “just” 100% in 2013 and a mere 57% in March of 2000. Most importantly, the ratio of Total Non-financial Business Debt to GDP, is both daunting and ludicrous. Back in the lofty days of the Internet Bubble, this ratio reached 67%. But it declined to 42% during the days leading up to the Taper Tantrum. Today, Total Non-financial Business Debt has soared to become a full 82% of the overall economy (sources: Z.1, World Bank). There is now a record amount of high-yield corporate debt outstanding and that yield is the lowest in history. And remember, the Fed wasn’t buying junk bonds back in 2013.
The common catalyst for previous bubble explosions, has been a central bank that has removed its massive and indiscriminate bid for the bonds it buys. For it is exactly that process which indirectly inflates those asset bubbles to begin with. It is a rapidly rising rate of inflation, as measured by the Core PCE Price Index, which will prompt the Fed into reversing its easy monetary policy stance.
To sum up: we will have higher taxes, much higher interest rates and rapidly rising inflation. All this will occur at the same time the market will be worrying about front-running the Fed’s exit from record manipulation of bond and stock prices.
Powell may be rendered powerless to stop the market from plunging precipitously. It may only be in the wake of the carnage of a deflationary depression that Powell’s move to buy stocks has any real benefit. Only then will his printing press become effective. Alas, that will be way too late for those who suffered going over the cliff and the multiple years you have to wait to make up the loss. PPS is ready to protect our gains and profit from the coming gargantuan reconciliation of asset prices. In contrast, the deep state of Wall Street will buy and hold your retirement account into the abyss. EG