The US economy lies somewhere between boom and bust as shown by the following graphical representation of real GDP growth. Nevertheless, there are aspects of US economic growth that have boom type characteristics/risks; these are found primarily in the significant increases in auto focussed consumer credit and automotive production/capacity
Short term data has varied wildly of late; such can often obscure the underlying trend: what if we adjust for inventories and changes in consumer credit? Well we see less noise for one, but we also see a slower underlying growth profile – yes, credit creation is part and parcel of growing expenditure but I still feel we are in a high debt/deleveraging and weak income growth dynamic that needs to be especially sensitive to growth in credit/debt.
I just wanted to extend the line of thought I was developing in my previous blog post: that is of the synchronisation of weak growth/capex and the increasing amount of corporate capital being allocated to share buybacks.
To a certain extent they all have one common thread, and that is a depreciation of corporate assets both current human and capital, and, with respect to the future, lower future rates of productivity growth that reduced human/capex investment imply. I also thought it worthwhile noting the decline in shareholder capital on the balance sheet of corporations like IBM and the increase in liabilities. Companies are becoming more highly leveraged at a time when economic growth and its important driver, income growth, is on a distinctly weakening trend.
So when the cycle turns, what should we expect to see happen first? An uptick in wages followed by capex and new issuance, or would buybacks slack off first, followed then by wage growth and finally capital expenditure. Or should we first look earlier in the chain to the composition of employment?
If we are in a strong stagnation dynamic I would expect that the economy would move through several iterations before a new wage growth cycle gains its own momentum. And there are many stagnation dynamics overlaying the economic structure….
More and more people are talking about declining real and nominal wage growth and more and more people are asking when is wage growth going to pick up.
It is a very good point. But I think we need to look at the dynamics of wage growth from another perspective. This perspective is that of human capital investment: wages are an investment in human capital and you pay more when you want to invest/upgrade/increase productivity etc. If you expect to grow and you expect to depend on investment in human capital to grow, you will invest more, and one indicator of this investment is wages.
Now, we know that capital investment as a % of GDP has been declining for some time and we also know that corporations have been buying back shares and borrowing money to do so. But these three (wages, capex, buybacks) all look to me to be pretty synchronised.
It looks pretty much as if corporations are adjusting to lower long term economic growth either as a consequence of lower wage growth, less investment or some other natural dynamic —productivity/TFP or demographic dynamic. Of those who discuss the issue of secular stagnation many point to the 1980s as the starting point and the trends noted above would fit into this timeframe….
US retail sales if we move outside the month to month volatility and look at smoothed data (which focuses on capacity as opposed to volatility) and adjust for inflation and population growth is looking weak:
If we just look at nominal and monthly data it looks as if retail sales are recovering strongly as of the June data:
Scratching my head? How far does this asset thing need to be pushed before mission accomplished?
The blue line shows household and NPO asset per capita relative to annual growth in income per capita (over rolling 10 year periods). The red line shows the annualised increase in disposable personal income per capita over 10 year rolling periods.
Now clearly assets are growing relative to income at a time when income growth is declining. QE is filling the income growth gap.
I was thinking along similar lines..but if debt amplifies interest rate increases, what on earth is a neutral IR policy?
Why is raising interest rates currently a greater risk than usual? Not just highly priced asset markets but significant levels of debt and an increasing amount of new debt issuance in lower credit quality assets. In proportion to GDP growth, debt and asset levels are at historically high levels. A given amount of economic return is spread much more thinly over a much wider range and supply of assets and hence the impact of interest rate increases are much more highly leveraged. Understandably we needed to support asset prices during the abyss that opened up late 2008 to early 2009, but I am much less sanguine about monetary support 2011 onwards.
“Bursting implies force>than constraint, collapse implies constraint>than its force”
In a recent blog post I discussed the large build up of money supply in the US (this is pretty much replicated across the globe) and the fact that money supply in excess of nominal GDP growth is likely asset focussed. My point in this tweet was that a bubble either bursts, or deflates, or collapses under its own weight.
I am just parsing through a simple model of QE attempting to bring together the disparate strands and thoughts…
One point that is worth pointing out is the extremely large increases in money holdings in the US economy, especially over the last 12 years with regard to their differential with nominal GDP growth. I dealt in detail with the physics of changes in money supply and its distribution between expenditure and asset portfolios in a document I wrote in 2008.
A must read for anyone concerned with systemic risk issues to factors impacting asset class return and anyone interested in a comprehensive primer on the operation of today’s money markets. As the following two quotes surmise, the shadow banking sector has developed to the extent it has by virtue of certain structural economic imbalances and financial system checks and balances are not set up to manage the risks of this new plumbing.
one way to interpret shadow banking is as the financial economy reflection of real economy imbalances caused by excess global savings, slowing potential growth, and the rising share of corporate profits relative to wages in national income.
From a policy perspective, the fundamental problem at hand is a financial ecosystem that has outgrown the safety net that was put around it many years ago. Today we have a different class of savers (cash PMs versus retail depositors), a different class of borrowers (risk PMs to enhance investment returns via financial leverage versus ultimate borrowers to enhance their ability to spend via loans) and a different class of intermediaries (dealers who do securities financing versus banks that finance the economy directly via loans) to whom discount window access and deposit insurance do not apply.
The document also discussed the need to have better measures of “money supply” than the narrow money measures of insured deposits.
I for one am concerned over the large shadow banking cash pools and the financing mechanisms of today’s repo markets. At the top of my mind is a large question mark over the interplay between QE and today’s money/collateral/derivatives markets and the impact monetary tightening will have on the shadow banking system.
If you look at debt service ratios from 2008 to date you would be led to believe that consumer indebtedness has improved markedly. In fact you would believe that conditions are the best they have been since at least the early 1980s. But if you broaden your perspective you find that conditions today have not strayed too much from those conditions which have been in place for much of the last 14 years.
Some charts on US employment data drawn from the BLS CES and CPS surveys.
Yes employment is back to where it started the recession, but adjusted for civilian population growth not even close, and part time and self employed data points are still hanging in the reverb. Participation rates are also still way below pre recession peaks and there is a question mark over multiple job holders, which have risen significantly of late and may have contributed to some of the more impressive recent job gains.
Floating rate income funds are not automatic high yielding replacements for a portfolio’s low yielding core bond or cash holding and have a myriad of risks that may impact a portfolio’s ability to meet an investor’s income and or capital needs over the duration of their lifetimes, especially during risk events.
Yet, these investments are apparently “sold” with next to no disclosure over the risks, or the complete nature, of the investments and no apparent guidance over allocation and risk management imperatives. Too much emphasis is placed on a couple of simple and easy reasons for buying them – yield and reduced interest rate risk.
Floating-rate bonds differ from traditional bonds in several respects that we discuss next—notably, interest rate terms, capital-structure seniority, and borrower credit quality—with each contributing to the asset class’s unique risk–return profile – From Vanguard’s A primer on floating-rate bond funds.
There has been a lot of comment recently about Floating Rate Income funds. More recently we have Tom Bradley’ Fixed Income’s New Reality (Live) discussion over the credit and liquidity risks of Floating Rate investments as well as their role in the portfolio. There has of course been a lot of press about these vehicles, and most of this coverage with few exceptions barely scratches below the surface of the issue.
For the moment I am going to introduce excerpts from a Vanguard report (A primer on floating-rate bond funds) into these investment vehicles and in further posts discuss some of my concerns over the way they are likely being sold in the market place:
The report stated that the funding status of state and local pension funds was at some 72% of liabilities and would likely rise further assuming a return to historical returns. The report did look at current funding liabilities under a range of equity return scenarios none of which were as low as many pundits (Hussman, GMO and myself) would model. The lowest return figure of 4% (all assets combined) would yield a liability with a net present value of $3.8trn or circa 22% of current GDP or 32% of personal consumption expenditure ….this translates into my vague assumption that if future GDP rates are based on current consumption, then future return assumptions would need to incorporate pension fund liability shortfalls.
Profits as a % of National Income remain elevated:
Many other commentators have likewise commented on high profit levels in expressing concerns over price earnings ratios. Importantly the cross reference of personal disposable income growth is also useful in the economic context:
When have we ever had a bull market with such weak income growth…? At least not since the 1960s..
I was thinking of submitting a few arguments to round 3 of the point of sale framework, but flogging a dead horse gets kind of tiresome after a while and also raises questions over one’s own intelligence.
Needless to say I have not been surprised by many of the industry or “industry funded” comments. I would like nevertheless to draw attention to some points made in the Fasken Martineau submission.
I have been doing some research into aging populations, dementia and the care sector over the last 4 to 6 weeks, so I have not been commenting on a lot of economic and market issues. Needless to say the financial services industry appears in no way prepared to deal with the human issues associated with increasing rates of dementia and service structures in general remain mired in denial.
Economic concerns remain of course the same: weak growth dynamics in the US, world trade growth, China debt and slowing growth dynamics, European structural weakness and the depth of the decline post crisis, significant consumer and sovereign debt, demographics, income and wealth inequality, high market valuations and little margin for leeway in the event of a market or economic shock (interest rates and QE maxed out in most instances).
Growth risks going forward suggest a negatively skewed distribution of potential GDP growth outcomes and return distributions suggest significant risk of negative returns over fairly long time horizons. I share many of the same concerns as John Hussman, but my economic growth assumptions for risk management would be below his, indicating a potentially much worse risk outcome for global equity market returns.
It is a moot question whether the investment industry has appropriately modelled risks to return and hence income and capital withdrawal profiles on most portfolios. Leverage is also of concern, especially in markets with poor regulatory investor protection mandates (note Canada) and I suggest that the time to have reformed the financial industry from transaction to best interests has likely passed for those who have not yet passed through this loop (again Canada).
One of the reasons I feel that has driven markets forward has been due to increasing income inequality and historically high levels of profits that have pushed marginal allocation of income and profits towards investment assets. This is a dynamic that will break at some point, either threw an economic/market shock or through its own impact on growth in economic demand.