New Mission, New Website coming soon! Learn more now.

Equities logo
Search
Close this search box.

Can Printing Money Trump a Depression?

Mark my words: We are headed for very big trouble ahead, and all because the Fed thinks it can print its way out of any crisis.

Image source: Pension Pulse

Fred Imbert of CNBC reports stocks extend losses ahead of Trump China news conference:

The S&P 500 rose slightly on Friday, erasing losses earlier in the session, as traders breathed a sigh of relief after President Donald Trump signaled no changes to the trade deal with China despite rising tensions.

The U.S. equity benchmark finished the session up 0.4%, or 14.58 points, at 3,044.31. The Dow Jones Industrial Average fell 17.53 points, or less than 0.1%, to 25,383.11 as American Express and JPMorgan weighed. The 30-stock index ended the day well off the lows as it was down as much as 368 points at one point. The Nasdaq Composite jumped 1.2%, or 120.88 points, to 9,489.87 as chip stocks rallied.

The S&P 500 and the Dow gained 3% on the week, bringing their advance in May to 4.5% and 4.2%, respectively. The tech-heavy Nasdaq rose 1.7% this week, pushing its rally this month to 6.7%.

During a much-awaited news conference, Trump said he would take action to eliminate special treatment towards Hong Kong. However, he did not indicate the U.S. would pull out of the phase one trade agreement reached with China earlier this year, easing trader concerns for the time being.

“Basically the items he could have talked about he chose not to talk about, but it’s not an end point,” said Julian Emanuel, chief equity and derivatives strategist at BTIG. “It’s a continuation on the way to more tensions.”

The iShares PHLX Semiconductor ETF (SOXX) jumped to its session high following the news conference, ending the day 2.5% higher. Marvell Technologies and Nvidia were among the biggest gainers in the ETF, rising 8.8% and 4,6%, respectively.

The news conference comes after China approved a national security bill for Hong Kong that experts warn could endanger the city’s “one country, two systems” principle. That principle allows for additional freedoms that mainland China residents don’t have.

Tensions between China and the U.S. have risen lately as Trump criticizes the Chinese government’s response to the coronavirus outbreak. U.S. lawmakers have also been critical of China increasing its stronghold over Hong Kong.

White House economic advisor Larry Kudlow said Friday that people in Hong Kong are “furious,” adding: “the U.S. government is … I’ll use the word furious at what China has done in recent days, weeks and months. They have not behaved well and they have lost the trust, I think, of the whole Western world.”

JPMorgan strategist Marko Kolanovic, who called the comeback for the market in March, said Thursday evening he was turning more cautious because of a possible economic clash with China.

“A complete breakdown of supply chains and international trade, primarily between the two largest economies (US and China), would justify equities trading drastically lower,” Kolanovic wrote.

Paul Christopher, head of global market strategy at Wells Fargo, said he expects more rhetoric from the U.S. regarding Hong Kong and China, noting: “It could end up being a headwind once the market finishes pricing in all of this hopium.”

Still, the market has had a massive run on optimism about economic reopening, with the S&P 500 bouncing about 38% off its March low. The benchmark is about 10% below its record high set in February.

“The market has discounted the coronavirus very quickly and has correctly predicted the apex of the virus,” said Mike Katz, partner at Seven Points Capital. “Having said all that, prices are up there. The S&P 500 trading above 3,000 is pricing in a full recovery.”

“If there is a second wave of the virus that ends up being more detrimental than people think, then I would think the S&P 500 is not valued correctly,” said Katz.

Don’t you love these guys that make outlandish claims like: “The market has discounted the coronavirus very quickly and has correctly predicted the apex of the virus.”

What a bunch of rubbish! The market took the $3 trillion Uncle Fed digitally printed out of thin air and the wolves of Wall Street speculated on stocks and other risk assets.

Of course, nobody wants to say this, that in effect the Fed has once again bailed out Wall Street and orchestrated another liquidity bubble which will exacerbate income inequality to levels we haven’t seen since the 1920s.

Michael Pento, President and Founder of Pento Portfolio Strategies, is right: Money printing is the new mother’s milk of stocks, as he wrote at Kitco:

My friend Larry Kudlow always says that Profits are the mother’s milk of stocks. That used to be true when we had a real economy. But sadly, that is no longer factual because we now have a global equity market that is totally controlled by central banks. To prove this point, let’s look at the last few years of earnings. During the year 2018, the EPS growth for the S&P 500 was 20%; yet the S&P 500 Index was down 7% over that same time-frame.

Conversely, during 2019, the S&P 500 EPS growth was a dismal 1%; yet the Index surged by nearly 30%. What could possibly account for such a huge divergence between EPS growth and market performance? We need only to view Fed actions for the simple answer: it was the degree to which our central bank was willing to falsify asset prices.

During 2018, the Fed raised the overnight bank lending rate 4x and by a total of 100bps, and at the same time, it increased the amount of its Quantitative Tightening Program from $10 billion per month to $60 billion per month. In sharp contrast, Mr. Powell indicated one month before 2019 began that the Fed would stop raising interest rates; and by early ’19 he indicated that the pace of balance sheet runoff was flexible and its termination was in sight. The Fed then announced in July of ’19 that it would cease the selling of its assets come August. Most importantly, by the end of the summer, the Fed did a complete 180-degree pivot–it was once gain cutting interest rates and re-engaged with Quantitative Easing. The Fed ended up cutting interest rates by 75bps during 2019.

Hence, 2018 was a terrible year for equities despite surging EPS growth. However, 2019 turned out great for stock investors despite having virtually zero earnings expansion.

Turning to 2020, the S&P 500 EPS growth rate is projected by FactSet to decline a whopping 15.8% during Q2, and GDP is tracking to shrink by around 25-30% at a seasonally adjusted annualized rate. Adding to the misery, the unemployment rate is projected to reach a depressionary 17%. Nevertheless, the S&P 500 is down a very ordinary and pedestrian 10% YTD. How did the Fed pull off this magic trick yet again? Take a look at what its balance sheet has done so far this year.

Mr. Powell has committed to buying everything at this point except stocks. This includes junk bonds, issuing primary loans to businesses, and purchasing corporate bond ETFs. It has so far printed nearly $2.5 trillion in less than two months just to boost equities back to the thermosphere.

Because of these actions, the stock market is far more expensive today than it was prior to the start of the Wuhan virus crisis. This is because the ratio of total market cap to GDP has increased. Simply stated, the numerator is down just slightly while the denominator has crashed. Equity market capitalization is reported to be 138% of GDP as of this writing. This is down from the record high of 150% reached at the start of this year. Nevertheless, the current ratio is still extremely high, historically speaking. However, that figure is based on antiquated GDP data. As the new data is reported for Q2, expect the ratio to soar.

There are now over 30 million newly unemployed Americans who have lost their jobs in the past six weeks. We have now completely wiped out the 22.7 million new jobs created since the Great Recession ended in June 2009 plus another near 8 million. The damage to US balance sheets is immense, and that debt is accretive to the $71 trillion already oppressing growth. Tremendous psychological injuries have occurred to consumers and corporations, as they are forced to take on new debt due to a dearth of liquidity. For example, listed US companies took on an additional over $300 billion in new debt since March alone. At that pace of corporate debt accumulation—which was already at an all-time high both nominally and in terms of GDP pre-virus–will surge by nearly 25% in just one single year. But what else would you expect when the Fed is promoting more borrowing by providing a huge fat bid for businesses to sell all the debt they need…and more.

The stock market has already priced in a “V” shaped recovery in the economy, but the rebound will most likely be of the insipid variety. The question is will stocks care even if economic growth doesn’t rebound? It is my view that the economy and EPS will certainly not return to pre-Wuhan virus levels for a very long time.

Therefore, the answer to how stocks react to a sluggish economy even after the lockdowns are lifted can be found within the confines of D.C. Will the continued panoply of negative earnings news and economic data cause the Federal government to announce even more fiscal stimulus programs to bail out states and municipalities? And, will the Fed continue to monetize all that debt? I believe the answer to those questions is a resounding yes, but only after we see another crash in asset prices that results from a negative reaction to a failed reopening of the global economy. This is the salient risk during the mid-May through July time-frame. A failed opening can be defined as one in which consumers don’t return to normal activities because of balance sheet, unemployment, and wealth effect issues. And, the virus makes a comeback in the context where there is no effective treatment or vaccine yet available.

One sentence from the Fed’s meeting of April 29, which produced an unusually-horrific statement even for the FOMC, “The Committee expects to maintain this target range (of zero percent interest rates) until it is confident that the economy has weathered recent events and is on track to achieve its maximum employment and price stability goals.”. In other words, the Fed will be offering free money until the 30 million displaced workers find a job, and inflation runs well above its 2% target on its core PCE favorite metric, which removes all prices that go up—interpretation; expect ZIRP for another decade.

We continue to hold 20% gold-related investments, 15% invested in defense, healthcare, and clean energy, and 10% TIPS. Passive Index investing has become a sure way to lower your standard of living, and therefore, we will continue to actively trade the portfolio with a continued vigilance on the cyclical dynamics of growth/recession & inflation/deflation. Is your wealth manager monitoring these changes? Or are they just telling you to hang on to their brand of an index fund that is blindly and passively heading towards the slaughterhouse yet again?

That comment was written two weeks ago. In his more recent comment, Pento is adamant that money printing can’t Trump a depression:

The Atlanta Fed’s GDP Now Estimate for Q2 Economic growth is minus 41.9%.

Thirty-nine million people filed Initial Jobless Claims in the past nine weeks. Continuing Jobless Claims (including Pandemic Unemployment Assistance) surged to over 31 million individuals.

US home construction fell by 30.2% in April.

The fiscal deficit in April (which is always a surplus month) was minus $738 billion!

Yes, unfortunately, we are in a depression. But that fact is not at all reflected in stocks.

The total market capitalization of equities is now back to 140% of GDP. That level is at the ceiling of the ratio’s history, and it is purely due to unprecedented central bank actions. However, even that eye-popping level is understating things by a great deal because the ratio is calculated using a denominator based on previously reported GDP data, which has since crashed. But it is critical to note that money printing has its limitations even when governments are buying stocks.

Look at a chart comparing the S&P 500 vs. Japanese stocks (EWJ) and China’s shares (CNYA).

As you can see, the S&P 500 is up 34% in the past 5 years, even though the Fed hasn’t yet resorted to buying stocks. For now, it has instead bought everything else, including junk bonds. In contrast, the PBOC and BOJ have purchased everything, including stocks. In the case of Japan, its central bank has been buying equities since 2013, and the Communist/Dictatorship that controls China has commanded the PBOC to support the market since at least 2015. And yet, China’s shares are up a paltry 13%, while Japanese stocks have actually made zero progress throughout the past five years. Meanwhile, both of those country’s indexes are still 50% off of their all-time highs.

The truth is that central bank equity purchases do not at all guarantee there will be a roaring bull market, but they can support stocks even when an economy has become zombified.

Indeed, Mr. Powell is breaking records in his attempt to reflate the market. The balance sheet of the Federal Reserve, which is a proxy for the amount of debt monetization undertaken by the central bank, has skyrocketed by $3.2 trillion (from September 2019 through today) –that is a grand total of only eight months. This compares to a $3.7 trillion increase in Fed money printing from the start of the great recession (in December 2007), through 2018–which is a total of over ten years.

Nevertheless, the bluffing game is over for central banks, as they can no longer pretend there is a pathway to normalcy. Perhaps this is what the gold market has been sniffing out over the past 20 years. The precious metal has soared by over 500% since 2000, while the S&P 500 has merely doubled in the past two decades. The fact that gold has trounced the S&P proves that the faith in fiat currencies is collapsing, and the Wuhan virus has expedited this process.

The current illusion of stock market prosperity has three predicates. The first is that there will be a robust reopening of the economy as the virus dissipates in the context of imminent therapies and vaccines. The second is that inflation is far off in the future, which will enable the Fed to control the level of long-term interest rates much more easily. And, the third is that central banks will have no interest in letting up on the monetary throttle for a very long time. The second and third conditions are indeed far off in the future. However, whether or not we have a successful reopening of the economy depends entirely on the progression of the virus; and that verdict will be known in the very near future.

This begs the question: even though the predicted economic depression has arrived, where do markets go from here? We should all understand that in the longer term, a viable economy cannot be engendered through the process of diluting the purchasing power of a currency and falsifying asset prices. But what will happen to stocks while we wait for stagflation to run intractable? To help answer that question, we must monitor the number of new Wuhan virus infections and deaths.

The hope is for a viable treatment and/or a vaccine by the fall. On the subject of vaccines, it should be noted that Moderna Pharmaceutical made positive comments about finding an effective and safe vaccine on May 18, which sent the Dow up 900 points. However, it is very disturbing that Moderna only partially released results of an interim Phase 1 trial without any specific data on neutralizing antibody counts; and then conveniently announced a $1.34 billion stock offering the following day. If the company’s confidence in the vaccine was robust, then why not wait a few more weeks until the Phase 1 trial data could be fully released, with peer-reviewed status, and then make the secondary offering at a much higher price?

It also should be noted that the Wuhan virus is a coronavirus. The common cold is also a type of coronavirus, and so is SARS and MERS. These differ from the influenza virus, and there has never been a vaccine approved for any coronavirus…ever. In addition, vaccines normally take years to develop in order to ensure both their safety and efficacy. Nevertheless, President Trump wants one ready to disseminate in just a few months’ timeframe. The President’s “operation warp speed” is seeking 100 million vaccine doses by November. But a vaccine not only must not harm people, it also cannot give them a false sense of protection. Despite all this, Moderna has amazingly created its mRNA-1273 vaccine within just two months from the first breakout of this novel virus.

In any event, the economy is now in the reopening phase, and it is imperative to analyze the capacity levels within the leisure and hospitality sector to determine how consumers are responding to being let out of lockdown. For example, airlines breakeven at 75% capacity but are currently flying at just around 28%, with bookings plunging by 95%. According to the WSJ, after the 9/11 terrorist attacks, it took three years before airline capacity recovered; eight years before the average fare got back to what it was in 2000, and it was six years before airlines turned profitable once again. Looking at hotels, occupancy on the island of Oahu, for example, during the week ending April 6 was down 90%. Turning to the foodservice industry, regulators are requiring restaurants to open at between 25%-50% capacity; but they need around an 80% capacity level to breakeven.

Analyzing the rate of change with this data will be critical to determine how to correctly allocate the portfolio according to the appropriate economic cycle. Our IDEC Model currently has the portfolio positioned in 25% stocks, 15% gold, and 10% TIPs. Our 50% cash hoard is being used to generate income right now until we can determine the quality of the reopening. Much more will be known during June, and I will analyze how the 20 components of the IDEC Model react to it and then take the appropriate action.

Pento is a smart strategist, I don’t agree with him on gold or stagflation as I’m in the debt deflation camp but he raises a lot of excellent points and he’s not the only one raising cash:

Of course Icahn got grilled on his long Hertz position so he’s hungry to make up those losses:

Still, all eyes remain on the Fed as its balance sheet topped $7 trillion this week, as reported by Marketwatch:

The Federal Reserve’s balance sheet rose marginally to $7.1 trillion as of Wednesday, up from $7.04 trillion last week. A large chunk of that growth came from a $33 billion increase in the central bank’s emergency lending programs aimed at buying corporate bonds. But that increase in the lending facilities reflects the Treasury Department’s equity contributions. Taking that into account, the facilities only saw a $1.2 billion increase in buying of corporate debt exchange-traded funds.

Note, however, the rate-of-change is slowing as the increase in debt is exploding, something which doesn’t augur well for risk assets going forward:

So what will the Fed do? David Mericle, an economist at Goldman Sachs, outlined what he thinks is coming, as reported by Marketwatch:

First he expects the Fed to establish a more consistent quantitative easing program, as the current purchases are done on an ad hoc basis. Mericle says the Fed will settle on a pace of roughly $80 billion to $120 billion in U.S. Treasury securities a month, and $25 billion to $35 billion of mortgage-backed securities.

He also expects a change to its forward guidance. Drawing on comments from Governor Lael Brainard, he says the Fed could say it won’t increase interest rates until the economy reaches full employment and 2% inflation. “Waiting to make sure that inflation reaches 2% before raising interest rates would seem roughly consistent with what Fed officials appear to mean by average inflation targeting — aiming for a range of 2-2.5% inflation during the expansion phase of the cycle, while stopping short of a full make-up strategy,” he says.

After the Fed clarifies its forward guidance, it could move forward with yield curve control, Mericle says, and it would move to cap interest rates, of shorter maturities, out to a horizon somewhat short of the date when the Fed forecasts its liftoff criteria will be met.

Federal Reserve Chair Jerome Powell on Friday said forward guidance and QE are no longer non-standard tools, and said the central bank would comfortable using them.

The market isn’t expecting a hike anytime soon, with Eurodollar contracts not pointing to a possibility until 2023.

The yield on every Treasury security with a maturity of 10 years or shorter is below 1%, with the 30-year yielding 1.44%.

Stocks have benefited from the Fed’s actions, with the S&P 500 up 35% from the March lows.

No doubt about it, stocks have rebounded in a huge way since March lows when Bill Ackman came on CNBC to scare the hell out of retail investors as he and his hedge fund buddies loaded up on stocks and other risk assets, and the Fed scared the hell out of bears, inflicting them with monetary coronavirus:

And it’s tech companies like semis (SMH) but also the most speculative biotech stocks (XBI) which have seen the biggest gains from March lows:

Bullish! Buy the breakout in tech, biotech, semis, banks, industrials and other cyclicals — WHATEVER — just buy, buy, buy and never fight the Fed.

The problem with that logic is the Fed has increased its balance sheet by over $3 trillion and it has received help from its Swiss surrogate which is buying tech shares and it has only managed a bounce of 38% from the March lows?

Meanwhile, over in the real economy, corporate profits are sinking and Americans are saving like crazy, scared to death about what lies ahead:

Have no fear, the Fed will save the day, BlackRock, Fidelity and Vanguard will save the day, elite hedge funds will save day, just buy stocks, stocks for the long run, they can only go up, up and up!

I’m being cynical but the only thing the Fed is doing is making a bunch of obscenely rich people a lot richer and I can’t wait to see the real depression when Bezos, Gates, Zuckerberg, Dalio, Simons, Cohen, Griffin, Fink, Musk and a lot of other Forbes billionaires see their net wealth sliced in half or more.

That won’t happen today as stocks etched out another gain with Nasdaq leading the way but mark my words, we are headed for very big trouble ahead and all because the Fed thinks it can print its way out of any crisis.

It can’t and when when the real depression hits elites, that’s when all hell will break loose.

But for now, enjoy the liquidity party and Trump show, it’s all very entertaining and helps distract the masses from what really ails America.

Lastly, since it is Friday, this made me chuckle:

Below, SBTV speaks with Michael Pento, Founder of Pento Portfolio Strategies, about the worsening state of the global economy. With 30 million people made jobless within weeks, Pento has no doubt that the economic depression is here and it will impact everyone, including pensions.

Second, Credit Suisse’s Jonathan Golub thinks the rally can’t go on much longer. With CNBC’s Melissa Lee and the Fast Money traders, Tim Seymour, Guy Adami, Dan Nathan and Pete Najarian.

Third, Vanguard is one of the largest active fund companies in the world with $5.7 trillion in assets under management. Greg Davis, chief investment officer at Vanguard, joins “Squawk Box” to discuss investing amid the coronavirus-driven uncertainty.

Fourth, Grant’s Interest Rate Observer Founder and Editor James Grant and CNBC’s Rick Santelli discuss the consequences of unprecedented policy.

Fifth, Moody’s Analytics Chief Economist Mark Zandi says investors are too optimistic about a quick economic rebound from the coronavirus pandemic. He explains what policymakers should do to boost the recovery and discusses longer-term changes in the economy.&

Sixth, Federal Reserve Chairman Jerome Powell discusses the rollout of the central bank’s “Main Street” medium-sized business aid program, saying “we expect to start making loans in a few days.” He speaks at a virtual discussion at a Griswold Center for Economic Policy Studies Princeton Reunion Talk event.

Seventh, James Pethokoukis, American Enterprise Institute economic policy analyst, and Ron Insana, Schroders North America senior advisor, join ‘Power Lunch’ to discuss the state of the markets as they wait for President Trump’s press conference on US-China relations.

Lastly, President Donald Trump holds a news conference from the Rose Garden at the White House discussing US-China relations. Listen to the rhetoric, it’s not good.








Leo Kolivakis is a Canadian-based senior analyst specializing in pension funds and investments across public/private markets.

_____

Equities Contributor: Leo Kolivakis

Source: Equities News