Category Archives: Economy

Demand Trends and Deflation Watch

Global Growth

According to the latest IMF Global Financial Stability Report, “Amid huge uncertainties, a disconnect between financial markets and the evolution of the real economy has emerged. High levels of debt may become unmanageable for some borrowers, and the losses resulting from insolvencies could test bank resilience in some countries.”

Euro Zone

Prices on goods and services in Germany in September have decreased by 0.2% year-on-year following zero inflation in August.

The Euro Zone has resorted to negative interest rates to spur growth. Keynesian economists believe such action results in a “liquidity trap“when businesses do not see demand and inflation expectations, they will not increase investment, resulting in fewer jobs and less consumption. Negative interest rates and deflation become mutually reinforcing, with both households and businesses hold cash, causing deflation and a liquidity shortage.

China

In September, China’s Producer Price Index or factory-gate prices fell 2.1% year-on-year while the Consumer Price Index rose 1.7% year-on-year, missing the forecast for a 1.8% growth following August’s 2.4% rise. 

US Jobs

If you look at the U-6 rate (“real unemployment rate”), as it accounts for those who are unemployed, underemployed, and discouraged workers, then the unemployment rate is 10.3% vs. the official (U-3) rate of 7.9%. However, according to ShadowStats the reality is if the unemployment rate included those out of work long-term who stopped looking (Pre-1994 methodology), the rate would be 26.9% which is comparable to the rates we saw during The Great Depression.

Most unemployment measures are declining while long-term unemployment is still rising. The number of long-term unemployed – people out of work for a period exceeding six months – has ballooned. According to the Bureau of Labor Statistics, around 2.4 million Americans were unemployed for 27 weeks or more in September, up 781,000 from the previous month. The last time we saw this kind of jump in long-term unemployment was during the Great Recession. As of August, the long-term unemployed made up 5.1% of the labor force. And if the long-term unemployment rate stays high, the general unemployment rate will stay high, too. If the previous recession is any indication, reducing long-term unemployment may take a long time. 

Small Businesses

According to a study by Brookings released last month, more than 420,000 small businesses have closed their doors permanently since the beginning of the pandemic. That represents a staggaring 7.1% of all small businesses. The report states that through August, more than 18% of all US. small businesses, and more than 27% in leisure and hospitality, had not reopened. Brookings estimates 4 million jobs in the small business sector have been lost and “that will only return with the creation of new businesses.”

Poverty and the Middle-Class

The poverty level for a household of five in the United States is now $30,680. To give you an idea of how close that is to the middle class, the Social Security office has calculated that 44.79% of American workers made less than $30,000 last year, 56.46% made less than $40,000, and 65.91% made less than $50,000. That means that close to half of US workers are close to or below the poverty line. 

US Inflation

September CPI rose 1.4% over the last 12 months. Core CPI was up 1.7%. The Underlying Inflation Gauge (UIG) “full data set” is estimated at 1.3%.

The standout inflation driver since the pandemic began has been used vehicles. Since February, used vehicle prices have gained 14%. In September alone, used vehicle prices spiked 7%. Even though preowned cars and trucks account for less than 3% of the total consumer price index, it “accounted for most of the monthly increase in the seasonally adjusted all items index,” according to the BLS. As the CPI chart shows, Core CPI excluding used vehicles and housing actually fell in September.

Many goods prices that had spiked earlier on have either stopped rising or have started falling. Appliance prices fell 2% in September, while housekeeping supplies prices fell 1%. 

Perhaps most notable is the reversal in meat prices which jumped more than 13% between February and June and are now less than 4% higher than February.

The bigger worry, however, is what’s happening with the prices of services. In education, for example, prices are either flat or in outright decline.

Overall, services prices excluding energy were flat in September, while the annual inflation rate has slowed markedly. 

According to Gary Shilling, “If you think serious inflation is coming, you don’t believe in the fundamental power of excess global supply to depress prices. With globalization, Western technology is combined with cheap Asian labor to produce a vast array of goods and, increasingly, services. But Asian consumers purchase only a fraction of what they produce. China’s consumer spending is just 39% of gross domestic product, compared with 68% in the U.S., resulting in a saving glut that is highly deflationary.”

Falling prices may seem good for consumers, but they won’t be appealing if they translate into lower revenues for businesses and lower incomes for workers and investors.

Global Deflation

It’s a club that more countries may soon be joining.

Major central banks around the globe might be engaged in a manic policy of monetary and public debt INflation, but DEflation is growing. This week, banks are reporting that corporate loan demand and personal credit card use are declining, and savings rates remain high. A declining social mood appears to be fueling private debt deflation. But it’s price deflation that is grabbing attention at the moment as more countries slide into declining consumer prices.

The chart below shows the list of countries around the world where consumer prices are declining on an annualized basis (price deflation). Germany, the Euro Area and Australia are three recent additions to the club. This list of 36 countries amounts to 19% of the 185 countries that tradingeconomics.com monitors. Almost one fifth of the planet is experiencing declining consumer prices.

If we add in the countries where the annualized consumer price inflation is below 2% (considered by major central banks to be sub-optimal), the list of countries grows by 60 to 94. We can therefore state that 51% of the planet is experiencing sub-optimal – to the banks – consumer price changes.

We can refine the analysis to take out smaller nations and economies. Looking at the world’s major economies as defined by the G20 plus Netherlands, Spain, Switzerland and Singapore, we find that 29% of countries are experiencing price deflation and 66% have consumer price inflation running below 2%.

Secular Outlook for Stocks

The historical average for P/E has been in the range of 15 to 16,, depending upon the period used for the long-term average. The high range for P/E, under low and stable inflation rate conditions, has been 20 to 25. The low range for P/E, under high inflation or material deflation conditions, has been 5 to 10.

Going forward, we should expect a new paradigm. Slower growth drives the ranges for P/E lower, which will affect future assessments of fair value. Keep in mind that, had real economic growth averaged 2% instead of 3.3% over the past century, the historical average for P/E would have been near 11—not 15 or 16.

In the future, the fair value for P/E when the inflation rate is low will be 13 to 15. With average inflation, expect P/E to be near 11. During periods of high inflation and significant deflation, expect the low range for P/E to be 5 to 8.

This is not an extreme outlook. It is simply the quantification of concepts that nearly all investors use daily. As is commonly recognized, high-tech high growth stocks have higher P/Es; lower-growth household product companies have lower P/Es.

Market Waves, Demand, and Disinflationary Trends

Stock Prices Wave – bearish

Stock Prices / Volume Waves – bearish

Stock Prices / Volatility Waves – bearish

Momentum Wave – neutral

Stock Prices Intermediate Price Trend – bearish

Economic Demand

Participation Rate

The labor force participation rate decreased to 61.4% in September 2020.

Claims

After falling steadily for months, first-time unemployment claims have been elevated since early August, hovering between 800,000 and 900,000 and leading economists to fear the jobs recovery has lost steam.

Slightly more than half the 22.1 million net jobs lost in early spring as states shut down nonessential businesses to curtail the outbreak. 

The good news is that millions of jobs that were lost in the spring were in fact temporary. The bad news is that we are not even close to a bottom in the rise in permanent job losses which is happening at a faster pace than the Great Recession.

Recovery – Permanent Jobs

Openings

Total nonfarm payroll employment rose by 661,000 in September, below its February level by 10.7 million, or 7.0 percent. Employment in leisure and hospitality increased by 318,000, accounting for almost half of the gain in total nonfarm employment in September.

In April there were 18 million more unemployed than job openings. Since then the gap has closed somewhat, there are 7.1 million more unemployed than available job openings. As a result, there were just over 2 unemployed workers for every job opening.

Middle Class Income Expectations

Middle- and lower-class people continue to experience job loss, food insecurity, unable to pay bills, and eviction or foreclosure. The Census Bureau’s latest Household Pulse Survey shows 59.2 million Americans expect someone in their household to have a loss in employment or take a pay cut ahead of the presidential elections.

AND the need for a second stimulus package is presently mixed with Senate majority leader McConnell saying that many Republican senators believe the economy has already seen enough stimulus. 

Demand

The reality is demand/GDP has been on a downtrend since before the Great Recession and we may very well had been headed for recession before the pandemic.

Deflation

Euro Zone

The eurozone’s pandemic-hit economy sank into its second consecutive month of deflation in September, intensifying pressure on the European Central Bank to consider injecting more monetary stimulus.

Headline consumer price inflation fell to a four-year low of minus 0.3 per cent in September, below the expectations of economists surveyed by Reuters and down from minus 0.2 per cent in August.

It is the first time the eurozone has had two consecutive months of deflation since 2016, despite the ECB subsequently launching successive bond-buying programs totaling trillions of euros and cutting interest rates deep into negative territory.

The ECB’s money pump (bottom graph) has run at breakneck speed as total assets at rose six-fold from 1999 and then spiking above €6 trillion this year. All the major central banks put up hundreds of billions of emergency funding from early February to mid-March, providing trillions in liquidity operations.

The ECB cut interest rates an unprecedented 39 times alongside other central banks. These collective actions, though, did not underpin stocks — which collapsed 40% over that time. The view that the ECB, the Bank of England, or even the Fed can bolster stocks by printing money runs contrary to all available evidence.

Japan

In August, the Consumer Price Index (CPI) inflation fell to 0.2%. CPI excluding food prices fell to -0.4% plus energy fell to 0.1%.

US

Now everything depends on US stimulus: The stock market, the wealth of the wealthiest, and consumer spending – thereby not only the entire US economy but also imports from other countries, and thereby the economies of China and the rest of the world.

______________________________-

Since 2008 money and credit growth have been slowing.

Recently, credit card balances and other revolving credit fell “unexpectedly” by $3 billion in August, to $950 billion, the lowest since July 2017, and a level first obtained in September 2007.

Credit card balances and other revolving credit fell a devastating 9.5% from a year ago.

Money velocity has dropped over 30% year over year through September 30th.

Conclusion

A 2nd stimulus will obviously prolong the temporary recovery. Temporary in the sense that the jobs that haven’t returned by now will not be coming back means that the more reasonable U-6 unemployment rate combined with low productivity will continue to dampen consumer demand and inflation, short, intermediate, and long-term. The only question remains when will deflation hit the US.

Secular Outlook

The charts above reflect deflationary headwinds and thus increased downward pressure lies ahead for prices.

Stocks should trend lower due to deflationary concerns, and below-average returns are ahead of us as the larger secular bear unfolds.

The current state of the global recovery

I have watched how the recovery narrative has been promoted in the financial media and among confident economists and analysts.

To help individuals thoroughly consider their direction, here are the counterarguments against the over-idealistic recovery-narrative.

US Non Farm Payrolls

The consumer is the most significant driver of the U.S. economy (70% of U.S. Gross domestic product), and the greatest supporter of that is jobs. Private job increases jumped throughout the spring and it has since recuperated slightly. Now it has really slowed.

Total nonfarm payroll employment rose by 1.4 million in August 2020, following larger increases in the prior 3 months. In August, nonfarm employment was below its February level by 11.5 million, or 7.6 percent.

AND while the pace of corporate liquidations has eased, corporate insolvencies saw their greatest ever increment in August. This makes any further imminent improvements in employment unlikely.

Hiring

What is amazing is that even as the number of employment opportunities flooded by more than 600K, there was a startlingly plunge in recruiting, and after the BLS announced of 7 million recruits in June, in July this number out of the blue plunged by a record 1.183 million to simply 5.787 million in July, the most reduced since April.

China Industrial Production

In the 2nd largest economy, industrial production unexpectedly fell in January and February, and we have not seen any bounce yet to pre-Corona levels. With the current growth of 4-5%, it will take until around Christmas to arrive at the level where it was before the pandemic (in December 2019).

Euro Zone Industrial Sentiment

The Euro Zone was in recession in Q4 2019 before the pandemic. There are likewise not many indications of a genuine recovery in the area, reflected, for instance, in fallen industrial sentiment, which has not recovered. This will have adverse consequences for the banking sector which is already weak. What’s even worse is deflation has hit Europe.

Deflation arrives in Europe

Stimulus So Far

The issue overlooked in the recovery-narrative is that whatever lackluster recovery there is has only been achieved by truly colossal levels of fiscal and monetary stimulus.

The balance sheet of the Federal Reserve has also exploded from little over $4 trillion to over $7 trillion in just a few months. 

Stimulus in China has also broken records.

By the end of July, aggregate financing reached an astonishing $3.3 trillion, easily topping the previous record of $2 trillion set in 2019.

The situation can only be characterized as a business cycle artificially extended through monetary stimulation leading to excessive financial speculation.

What happens when the stimulus evaporates?

IMF Summary

Yesterday, IMF Officials weighed in on the global recovery.

“This crisis, however, is far from over,” they said. “The recovery remains very fragile and uneven across regions and sectors. To ensure that the recovery continues, it is essential that support not be prematurely withdrawn.’

Some Good News

From the CDC, this graph illustrates that all pandemics have a limited lifespan.

Source: FRED, BLS

We now have much in common with this country

There is no proof the Fed’s new “policy” will keep inflation steady at 2%. Of all the different approaches tried in the last 4o years, none have worked to halt the overall downward inflation trend. The only thing the Fed can do is try to talk up and beat the drum that they “are doing everything possible” to increase inflation. It will not make any difference.

Inflation has been on a 40 yr downward trajectory without pause

In October 2010, the NYT article “Japan Goes From Dynamic to Disheartened” painted a picture of “Japanification” in “which was the nation has been trapped in low growth and a corrosive downward spiral of prices, known as deflation, in the process shriveling from an economic Godzilla to little more than an afterthought in the global economy.”

THE US IS NOW STRIKINGLY SIMILIAR to Japan in many important ways.

Population Growth: Japan vs US

Japan
US

GDP: Japan vs US

Japan
US

Debt: Japan vs US

US

Exports: Japan vs US

Japan
US

Industrial Production: Japan vs US

Japan
US

The lynchpin to Japan, and the U.S., remains socioeconomics, interest rates, and debt. As the maturing populace develops the “social government assistance net” will keep on extending. The “benefits issue” is just a hint of something larger. 

Starting in 1990, Japan has run a massive “monetary easing” approach and GDP is thriving less than what it was pre 1990.

Their “quantitative easing” program is three times larger than the US and it’s economy faltered even before the pandemic

Japan has been tormented by recessions, deflation, and low financing costs. Japan’s 10-year Treasury rate fell into a negative territory for the second time recently.

As inflation creeps toward deflation (again), their economy faltered and monetary easing failed

While money related easing can prop up asset prices such as stocks it has not been able to combat disinflation/deflation. It basically has failed to help it’s economy and keep inflation steady to promote economic growth and rising wages.

AND in the US, Money Velocity (M2V) which runs 16-18 months ahead of PCE, projects a significant decline in prices.

Japanification of the US could be on target.

Source: Dr. Robert J. Shiller (https://www.multpl.com/sitemap), FRED

Small businesses update

New data on small business from Opportunity Insights finds the number of small businesses open recently turned lower.

The slump coincides with an overall economic recovery that stalled in late June. Fiscal uncertainty remains about how and when the next round of checks will be dropped to the 30 million jobless and an overall economic recovery that is reversing, the weakest companies, many of which are small firms, are closing up shop once more.

Between July & Aug small businesses open: – 7% vs – 19%

The double dip was seen in every state …

The northeast suffered the worst

Since small firms are the backbone of the economy, with many now closing for a second time, this means there will be no bounce as the market has priced in.

Wall Street once again misread the shape of the recovery curve and investors bought it.