By Christiaan van Huyssteen (@cvh23)
Some interesting (scary?) charts that has appeared in Zerohedge over the past 2 or so weeks:
(All the charts are from Zerohedge, who in turn got it from other places. Click on the heading to view the source. My comments follow at the end.)
One indicator we do like to keep an eye on is the ADX, or Average Directional Index. It is essentially an indicator of the strength (or lack of strength) of the prevailing trend over a specified period, regardless of the trend’s direction. A high number indicates a strongly trending market and a low number reflects a lack of trend. The traditional default look-back period is 14 days so we tend to stick with that. Interestingly,recent readings of the 14-day ADX applied to the S&P 500 have been among the lowest of the last 65 years, indicating an extremely “trendless” market.
On several days over the past 2 weeks, the ADX reached a reading of 9. Since 1950, there have been just 42 total days – or ¼ of 1% – that saw the ADX that low. Expanding the net to readings of 10 or lower yields 145 days, still less than 0.9% of all days since 1950.
Chinese stocks are the most expensive relative to bonds in almost six years.For the first time since June 2009, Bloomberg notes, the earnings yield on the Shanghai Composite Index has dropped below the yield on top-rated corporate debt… and just like in now, stocks rallied 100% in the preceding year beforeplunging over 20% in the next month, and further still in the ensuing months.Already we are seeing Chinese stocks faltering – with a disappointying post-rate-cut move – which leads on analysts to note, “the market will enter a correction phase, and it will be very volatile,” and comments by officials have raised concerns that PBOC will “quickly erode its credibility.”
The evidence continues to mount…
“Most since Lehman” has become the new meme for macro-economic data in the US as day after day brings another lacklustre superlative to be dismissed with some excuse by the cognoscenti of sell-side economists…
Of course, that is aside from anything related to aggregate jobs that is spewed by the government’s official ministries of truth… (do not look at this chart)
So here are seven charts that scream “recession” is here…
Retail Sales are weak – extremely weak. Retail Sales have not dropped this much YoY outside of a recession…
And if Retail Sales are weak, then Wholesalers are seeing sales plunge at a pace not seen outside of recession…
Which means Factory Orders are collapsing at a pace only seen in recession…
And Durable Goods New Orders are negative YoY once again – strongly indicative of a recessionary environment…
Which is not going to improve anytime soon since inventories have not been this high relative to sales outside of a recession.
And just in case you figured that if domestic prosperity won’t goose the economy, Chinese and Japanese stimulus means the rest of the world will save us… nope!! Export growth is now negative… as seen in the last 2 recessions.
And deflationary pressures (Import Prices ex-fuel) are washing upon America’s shores at a pace not seen outside of a recession…
But apart from that, given that US equities are at record highs, everything must be great in the US economy…
“Like any trend in an unhinged market, it’s next to impossible to predict when the confidence will peak. Based on previous peaks, it could (should) be any time,” warns Jason Goepfert, president of Sundial Capital Research.
Are stocks disconnected from reality? Probably, according to Tobin’s Q, a rather elegant way to assess equity valuations developed by the late Nobel Prize-winning Yale economist James Tobin. Put simply, Tobin’s Q compares the total value of stock prices with the value of underlying assets such as plants, inventory, and equipment (i.e. replacement costs). Add up the value of the equity, then buy all the assets, and see if you have some cash left over. If you do, stocks were overvalued….According to Tobin’s Q, equities in the U.S. are valued about 10 percent above the cost of replacing their underlying assets — higher than any time other than the Internet bubble and the 1929 peak.
[Tobin’s Q = MarketCap/Assets as opposed to the more commonly quoted price to book – which is MarketCap/Equity]
As we’ve documented exhaustively — in fact, one might argue that it’s been the single most important narrative we’ve pushed this year — companies are taking advantage of record low borrowing costs and voracious demand for corporate bonds by issuing record amounts of debt. The problem: the proceeds aren’t going towards capex (i.e. future growth and productivity) but rather towards buybackswhich not only inflate EPS but also management’s equity-linked compensation.
This means that while stocks climb ever higher thanks to a perpetual bid from price insensitive corporate management teams and investors (and central banks) frontrunning the buybacks (repurchase authorizations hit a record in April, so it’s not difficult to see what’s coming), productive assets deteriorate, jeopardizing top line growth and, in turn, the ability to service debt costs down the road. Here are a few graphics that tell the story
One may argue that “capex is higher than ever”, but that is slightly misleading because while it may be at its highest level on record in absolute terms, a look at the following pretty clearly indicates that buybacks have the momentum…
As I asked in previously ‘is this time different?’ It rarely is. But the question is what will happen when the next crash takes place, when the US is officially declared to be in recession? What will happen to interest rates? They can’t go any lower surely? Will the market force them higher? Will countries default on their debt? Will deficit spending still be a realistic when borrowing costs go up? Will the tax payers be willing to fund another bailout, should a major bank need it? Will QE4 start again, and if it does will there be any confidence left in a central bank (the Fed) with $4t of printed money on its balance sheet? Will currency wars turn into real wars as global trade collapses? Will the IMF (the only global financial institution with a remotely unsoiled balance sheet) come in to bail out countries and major companies with freshly printed SDRs?
From Legendary Austrian Economist Ludwig von Mises’s essay on the theory of the trade cycle written in 1936:
It is a well-known phenomenon, indeed, that in a period of depressions a very low rate of interest—considered from the arithmetical point of view—does not succeed in stimulating economic activity. The cash reserves of individuals and of banks grow, liquid funds accumulate, yet the depression continues. In the present  crisis, the accumulation of these “inactive” gold reserves has for a particular reason, taken on inordinate proportions. As is natural, capitalists wish to avoid the risk of losses from the devaluations contemplated by various governments. Given that the considerable monetary risks which the possession of bonds or of other interest-bearing securities entail are not compensated by a corresponding increase of the rate of interest, capitalists prefer to hold their funds in a form that permits them, in such a case, to protect their money from the losses inherent in an eventual devaluation by a rapid conversion to a currency not immediately menaced by the prospect of devaluation. This is the very simple reason why capitalists today are reluctant to tie themselves, through permanent investments, to a particular currency. This is why they allow their bank accounts to grow even though they return only very little interest, and hoard gold, which not only pays no interest, but also involves storage expenses. Another factor which is helping to prolong the present period of depression is the rigidity of wages.
Wages increase in periods of expansion. In periods of contraction they ought to fall, not only in money terms, but in real terms as well. By successfully preventing the lowering of wages during a period of depression, the policy of the trade unions makes unemployment a massive and persistent phenomenon. Moreover, this policy postpones the recovery indefinitely. A normal situation cannot return until prices and wages adapt themselves to the quantity of money in circulation.
Public opinion is perfectly right to see the end of the boom and the crisis as a consequence of the policy of the banks. The banks could undoubtedly have delayed the unfavorable developments for some further time. They could have continued their policy of credit expansion for a while. But—as we have already seen—they could not have persisted in it indefinitely without risking the complete collapse of the monetary system. The boom brought about by the banks’ policy of extending credit must necessarily end sooner or later. Unless they are willing to let their policy completely destroy the monetary and credit system, the banks themselves must cut it short before the catastrophe occurs. The longer the period of credit expansion and the longer the banks delay in changing their policy, the worse will be the consequences of the malinvestments and of the inordinate speculation characterizing the boom; and as a result the longer will be the period of depression and the more uncertain the date of recovery and return to normal economic activity. It has often been suggested to “stimulate” economic activity and to “prime the pump” by recourse to a new extension of credit which would allow the depression to be ended and bring about a recovery or at least a return to normal conditions; the advocates of this method forget, however, that even though it might overcome the difficulties of the moment, it will certainly produce a worse situation in a not too distant future.
Finally, it will be necessary to understand that the attempts to artificially lower the rate of interest which arises on the market, through an expansion of credit, can only produce temporary results, and that the initial recovery will be followed by a deeper decline which will manifest itself as a complete stagnation of commercial and industrial activity. The economy will not be able to develop harmoniously and smoothly unless all artificial measures that interfere with the level of prices, wages, and interest rates, as determined by the free play of economic forces, are renounced once and for all. It is not the task of the banks to remedy the consequences of the scarcity of capital or the effects of wrong economic policy by extension of credit. It is certainly unfortunate that the return to a normal economic situation today is delayed by the pernicious policy of shackling commerce, by armaments and by the only too justified fear of war, not to mention the rigidity of wages. But it is not by banking measures and credit expansion that this situation will be corrected.
This may have been written 80 years ago, but things don’t change. If there is one thing investors and savers and business people hate, it is uncertainty. This time may not be different after all. If there is one thing history and economics tell us, it is that in the long run, you can’t suppress or escape the laws of supply and demand – ie, the market and its cycles. Things will return to normal. Economic intervention by governments and central banks only make things worse.
The key thing to watch out for will be interest rates. If they start rising, the party is over for speculators who gamble with free money, banks with trillions of $s of interest rate linked off balance sheet derivatives and governments who can borrow cheap to spend on things like welfare or the military.
The Fed doesn’t want to raise rates until they see growth, but at the same time there won’t be any growth until they do raise rates. The Chinese central bank for instance has cut interest rates twice already this year alone, and have recently started forcing banks to finance insolvent provincial infrastructure projects. There is speculation about the Fed raising rates in 2015. The only reason the Fed might want to raise them is in order to be able to lower them again when the next crisis hits. For the fed to make a call and say they will raise rates within a specific timeframe is a very risky move, because if there were to be a recession or a significant economic event of some kind, the Fed may have to lower rates into negative nominal territory (the natural rate can never be negative – as it would destroy savings and capital investment). This would send a signal out to markets that the Fed contradicted itself, and may be seriously wide off the mark with regards to their analysis of the state of the economy – some confidence in the effectiveness of Fed policy will be lost. As capital markets expert Jim Rickards says, adjusting interest rates to create the desired inflation/deflation is not as simple as adjusting a thermostat, rather it is like playing around with a nuclear reactor, where the pure complexity of the global economic system can runaway in a state of inflation or deflation.
It seems, to me at least, unlikely that the Fed will be able to raise rates at any time in this calendar year. If they do end up raising rates, it will be by a ceremonial maximum of 0,5%, and odds are it won’t stay there for too long, with the world economy on a knife edge, they won’t hesitate to cut them again.
There will be a correction or reset of some sort, in fact we need to flush the system. It just needs to take place orderly and without too much drama. The longer the central banks and governments paper over the cracks, the higher the cliff will be from which we fall.
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