My Comments: This one is for those of you who are nerds and interested in economics and finance. If not, then hopefully you’ll check in tomorrow. But…
Have you been puzzled? I have, but apparently Darwin is alive and well. Only this time it has nothing to do with bugs in the Amazon jungle but the world economy. As for iPads, that’s another puzzle.
Those of us who profess to know something about investing money, along with economics and finance, have long been wondering if there is anything different about the markets this time around. This overview is long, but helpful.
Debt can be seen as a percentage of the US economy. It hit its peak at the end of WWII, and then trended down. In the early 80’s, under Reagan and Bush, it started upward again. It’s clearly not a function of a sluggish economy or imminent doom.
Yes, it needs to be controlled. But it has settled somewhat as the economy has grown over the past few years. The problem is that few of us are enjoying this growth, and that’s a concern.
Nov. 18, 2014 / an anonymous author at Mercenary Trader
• Wages may be the key to everything. The Fed has kept rates near zero to bring a return of positive inflation and positive wage growth to the US economy.
• But rising wages imply a normalization of interest rates. That, in turn, means the forced unwinding of all the gross excesses built up over the years.
• Those differentials then make the dollar yet stronger, with brutal impact on multinational outlooks. Small caps, meanwhile, still enjoy historically rich valuations and will be hit with wage pressure too.
Many sacred cows have been slaughtered these past few years. Beliefs held as obvious, incontrovertible even, were crushed to dust.
Take, for example, the notion that the United States was due to implode under the weight of accumulated debts. In a recent issue of the Strategic Intelligence Report, we completely dismantled this false notion, which fails to consider the asset side of the US balance sheet.
(For a very quick eye-opener, consider this piece from the Institute for Energy Research, “Federal Assets Above and Below Ground.” It is hard for Uncle Sam to be broke when his asset-based net worth, let alone his annual cash flows via the power to tax, runs to the hundreds of trillions.)
To be clear, we are no fans of prolonged market meddling from central banks. Such is not “money printing” – that phrase is so grossly misused it should be banished – but has significant negative impacts as explored here.
With that said, there is a powerful takeaway from the recent stretch of years. Markets – both financial markets and economic systems on the whole – do not care about the poor. And by that we mean they really, really don’t care.
The functional attitude is “Let them eat cake,” as Marie Antoinette supposedly said. Except in the real world it is “Let them eat iPads” – and there are no subsequent uprisings or beheadings.
In other words: It is wholly possible for a free market economic system to survive, and even thrive, as those on the lower rungs of the economic totem pole see their personal prospects threatened, flattened, or even flat-out crushed. Nobody cares about the poor, not really. Not on Wall Street and not in Washington. The Federal Reserve indeed wants to help the middle class, but they can only do so by helping the rich first (and then hoping for the best).
The iPad and iPhone are instructive examples of this – and as of this writing we are still long Apple (NASDAQ:AAPL). These devices add significant value and productive GDP to the economy, but only via those who can shell out serious bucks for an expensive piece of technology. This is all well and good in practical terms. Those who spend help the system to mend. Those with empty pockets on the bottom rungs (and increasingly the struggling middle rungs) can be safely ignored.
This is not a moral observation. It is simply an observed aspect of harsh reality. In fact the lack of morality in respect to capitalist systems is often an essential point. When we recently argued for the robust nature of US recovery, one of the objections received was that “50 million Americans are on food stamps.” The number may actually be higher than that. But does it matter from a pure functioning-of-the-system perspective? Perhaps not at all.
Consider the feudal system that dominated the Middle Ages. A system of “Lords, Knights and Serfs” dominated for centuries. Why could it not dominate again? Many years ago, we pointed out a growing phenomenon of “Digital Feudalism.” In 21st century Digital Feudalism, the “Lords” are holders and wielders of capital. The “Knights” are white collar knowledge workers (who in turn have a shot at becoming Lords themselves). And the “Serfs” are everyone else.
If you understand that markets do not care about the poor – and that free market economic systems can function well while ruthlessly suppressing the bottom half, or even the bottom two thirds, of the economic stratum – then you are closer to understanding why activity of the past few years has generated an overall picture of economic success for the United States (if not for other countries).
The Federal Reserve set out to save Blue-Chip Banks (NYSEARCA:KBE) first and foremost, which exist at the center of the system, by quarantining toxic assets (taking them onto its own balance sheet). The Fed then sought to create a “wealth effect” – as openly admitted by Bernanke and Yellen – via ZIRP (zero interest rate monetary policy) and the blatant encouragement of asset appreciation and financial engineering.
This was maddening from a moral perspective, leading to phrases like “socialism for the rich.” The non-rich, meanwhile, who did not participate in paper asset appreciation – for lack of anything but spare change in their retirement accounts – saw the return on their interest-bearing savings accounts asymptote above zero, even as wages stagnated and labor hours were cut.
The hard, brutal, Darwinian fact here – as based on empirical evidence – is that saving an economy by stimulating the assets and prospects of the wealthiest asset holders, which includes top-end corporations, is a strategy that to a real degree actually works. Consider the spending patterns of the top 30% of the US class pyramid, for example, as contrasted against the bottom 70%. Wal-Mart (NYSE:WMT) and payday loans aside, who do you think keeps the retail sector humming? The top 30% do.
Active market participants, who wish to actually make a profit from investing and trading, do not have the luxury of coloring their decisions with emotional sentiments. It may be unpalatable, sickening even, to consider the possibility that the free market system on the whole is geared toward elevating the haves rather than the have-nots, often at direct expense of the have-nots.
But if such is true, well, then what’s true is true. Darwinism in nature, at its most stark and brutal, also is a morally unpalatable phenomenon. That has no bearing on the reality of things.
What, you may ask, does this have to do with markets and trading? Well, it may turn out that wage suppression is the key – the hidden solution piece – to fully unlocking the market puzzle.
Via the lead article in this week’s links, Gavyn Davies of the FT makes a fascinating observation, by way of a paper from Morgan Stanley. The basic line of reasoning runs like this:
• Real wage growth has grossly lagged productivity growth.
• Wage growth has been suppressed via globalization, technology, and other means.
• Suppressed wage growth leads to outsized corporate profits.
• But also to sluggish economies via lack of spending from workers.
• And thus to perpetually low interest rates in a deflation-prone, low-inflation world.
• With perpetually low rates fueling the financial engineering cycle.
• Plus perpetually higher profits and expanded multiples on those profits.
That is a brilliantly elegant argument chain, is it not?
The working masses can’t keep their wages up. As a result, corporations have fatter profits. As a further result we get sluggish, molasses-like recoveries… which cause central banks to keep interest rates low… which in turn feeds the financial engineering cycle as wealthy companies borrow cheaply and spend the money on share-pumping schemes (which yield-chasing investors, spurred by near-zero rates, happily snap up).
And then, because these companies are primarily spending on buybacks and dividend payouts, future productive economic growth is stymied (which suppresses the long-run jobs outlook). The upper echelons win again through greater leverage applied to paper assets, showing up as higher multiples here and now. The economic masses are once again left out in the cold – no accumulated paper assets to speak of, no fair rate of return on their interest-bearing savings account (on what little they have saved), and no wage growth in their pockets.
Long-term globalization trends only cement this phenomenon further. When jobs can be outsourced or automated, the deflationary impact on wages is multiplied. Corporations win because they mainly cater to the top thirty percent (bottom seventy percent more or less who cares)… and suppressed wages keep profit margins high as productivity increases… and low interest rates in perpetuity via lack of inflationary pressures seal the self-reinforcing deal.
America is indeed rich. The richest country in the history of the world in fact. It just so happens the distribution of those assets is incredibly Darwinian. And yet there are no clear arguments as to why this state of affairs has to change (except one as we shall soon touch on).
Are the American masses – the lower seventy percent – going to rise up and facilitate economic revolution because of wage stagnation? No, that is wishful thinking in the extreme. As someone tweeted regarding the 2014 mid-term elections: “That wasn’t an election, it was a Game of Thrones finale” – a pun on the sea of Republican red that washed over the United States. The dominating corporate welfare state is under no threat from the serfs.
Digital Feudalism is a binary prospect. For the top thirty percent, the future is wonderful and bright. It is an amazing time to be alive. For the bottom seventy percent, however, one is reminded of the bleakest line from Orwell’s 1984: “If you want a picture of the future, imagine a boot stamping on a human face – forever.”
Except the story is not that cut and dry – because it is not clear that wage suppression lasts forever.
There is, in fact, evidence that wage pressures in the United States could be returning… and are now in the process of returning. Supply and demand pressures may be finally shifting the picture. And that would change everything.
Wage growth has been flat-to-sideways these past few years. It is one of the reasons the US recovery has felt utterly disappointing to the masses (even as paper assets soared). It is also one of the reasons inflation pressures have been all but non-existent. You need wage pressures to really get an inflation cycle going. (In the high inflation environment of the 1970s, unions had massive negotiating power and regular wage-boosts were built into employment contracts.)
Here is where the argument gets quite bearish for elevated paper assets, and thus for all equities (including US equities)…
The entire market is now leveraged to outlier levels of corporate profits. This corporate profits to GDP chart tells the story. And as Bajinath Ramraika and Prashant Trivedi point out, there is ample evidence that elevated corporate profit margins are simply not sustainable. Closing tax loopholes will have a notable impact. Rising debt service costs will have yet further impact.
And the return of wage growth pressures is what makes it all happen.
Wages may be the key to everything, or so we argue here. The Federal Reserve has to keep rates at near-zero levels to try and bring a return of positive inflation and positive wage growth to the US economy. To the degree that the Federal Reserve succeeds in getting wages to rise, they have managed success in their mandate.
But rising wages, if we see them, further implies a normalization of interest rates. And that, in turn, means the forced unwinding of all the gross excesses built up over the years, by way of market distortion and multiple expansion in a near-zero interest rate world, where a combination of financial engineering and profit-boosting wage suppression took equity valuations far above non-manipulated sustainable levels.