QE may have reached its limits, that is the stability it brought to the financial system may now have passed its inflexion point, overwhelmed by the relationship between portfolio focussed money and the supply of real returns: volatility may now dominate as asset prices become increasingly sensitive to real fundamentals. In other words the inherent leverage of QE risks negatively impacting asset prices, whereas before it provided support.
US Central Bank credit has increased 1.075trillion (End 2008 to 1 May 2013) and reserve balances with the Federal Reserve have increased 958bn over the same time frame – source data H8 and H4.1 reports of the Federal Reserve.
I keep reading blog posts and newspaper articles that state that, you know, debt in the post war years was higher than it is now and therefore high levels of government debt are not a problem.
We seem to be overly dependent on leverage and over optimistically dependent on asset class returns for future growth. Building up asset values while ignoring the dynamics of the universe is a risk to the universe itself.
We know the main PMI index weakened in April and the two most recent regional PMIs also disappointed (Phil Fed/NY Empire State) and March industrial/manufacturing output confirmed a weaker manufacturing picture. The most recent NFIB report, while showing improvement, was still decidedly gloomy.
Low interest rates and quantitative easing could deter new capital investment projects. QE is no doubt helping asset prices rise, but it is also forcing down the cost of capital at a time when the return on capital should, arguably, be higher, given the risks. Returns on the different components of the cost of capital equation should justify the risk, and cash and bonds are both important components.
One of my many issues with modern portfolio theory is that it assumes not only that markets clear but that supply and demand are also optimal.
In a low growth environment where asset prices are being pushed upwards through quantitative easing, modern portfolio theory tenets becoming increasingly irrelevant for efficient asset allocation in risk return space and a serious risk to effective withdrawal management. In such an environment we have to be very careful in our assessment of beta and the risks both allocating to and away from it present.
The number of variables by which any number of threads could snap is mind boggling!
Increasing unemployment, weakening retail sales, falling real incomes, falling investment, fiscal austerity, weak bank lending…..and of course the 15 month decline in the Composite Markit PMI…
US residential home ownership and vacancy rates based on Census Bureau data (hat tip Zero Hedge): home ownership rates keep falling from their 2005 peak, while rental costs have moved (up) in the opposite direction. House prices have risen in spite of falling home ownership, lending support to the theory that the recent boost in housing demand has probably been led by speculative activity. Rental vacancy rates are the lowest since at least 2002 and home owner vacancy rates are at their lowest Q1 levels since 2006. What I find most concerning is the apparent financial squeeze on US renters at a time of high unemployment and weak real per capita wage increases.
One of the things about short term data is that each individual component has its ups and downs. Not all expenditure is constant. Therefore, a dip in one component’s expenditure may have little impact on GDP in the next, as the dip is reversed. But cuts to Federal Government expenditure will, because this is not expenditure temporarily held back. This decline in expenditure will feed back into GDP’s other expenditure components in the coming quarters.
New capital goods orders fell in March, but the longer term trend is of more concern than the monthly decline.
There is also some concern over a) motor vehicles and parts orders, given that new orders look like they could be well above steady state fundamentals, and b) the rising inventory to sales ratio across the durable goods sector. Capital goods investment ex defense ex aircraft needs grow to drive recovery forward and we can see, not only that such orders have plateaued since the middle of 2011, but that new orders have shown no nominal growth since the late 1990s.
Debt accumulation needs to be related to prospective economic growth and where the NPV of future returns (growth) is less than the present value of the debt and equity, the difference will be adjusted for in GDP growth until the two are in parity.
I would have to say that overall debt must matter and that much recent press commentary has got its hands on the wrong stick. But how much debt matters depends on a number of dynamics.
According to the recent IMF Global Stability report Canada’s housing market is off the charts:
Paul Weller: “I stood as tall as a mountain; I never really thought about the drop; I trod over rocks to get there; Just so I could stand on top; Clumsy and blind I stumbled;…I didn’t stop to think about the consequences; As it came to pieces in my hands.”
The 2008 crisis told us that there was a mismatch between asset values and debt, asset values and future return, and debt and economic growth as well as some rather large structural economic imbalances.
We have tried to delay the eventuality implied by the difference in the hope that the “true” magical economic growth rate should return. Have we built up a bigger monster, and if so, how do we slay the beast?
In the soon to be released IMF World Economic Outlook, the IMF make the following claim:
Are we heading for a short sharp boom and a terrific final bust or a bust without a terrific boom, because there can be no middle ground? Or is Japan the Jack in the Box, a latent growth powerhouse ready to spring back from the dead?
Banks earn a spread on the money they lend versus the money they borrow. The historically low relative return for cash based investments has been based on bank regulation, risk management and government backed deposit based guarantees.
At the margin: weaker private consumption expenditure, weaker inventory adjustment, weaker government expenditure, weaker equipment and software expenditure but stronger non residential and residential structure investment. Better exports and weaker import figures helped nudge the small upward adjustment in GDP.
As the following chart shows (% change in employment since Jan 2007), no explanation is needed:
Many have noted the difference between the Current Population Survey (sampled data but wider spectrum) and the CES payroll data, but there is a two step pattern here.
The biggest benchmark adjustments were made to private sector service industries (excluding health and education), yet the January increase for private sector jobs came in at the lowest monthly increase since July.
Revisions to construction employment show substantial additional jobs having been created in the construction sector. The revisions go some way back with even the December 2011 data being raised upwards significantly (66,000 difference between Nov 2012 report and the Jan 2013 report). Most of the revision (based on November 2012 data) had been baked into the pie by May 2012 – revisions look to start in May 2011 data. That is until the Jan 2013 report showed a large revision of 44,000 in November.
Without looking at some perspective, short term data is close to meaningless in terms of its ability to provide a robust cyclical and historical comparative:
Obviously, mathematically, as one component becomes a bigger part of the pie, so must another become a smaller, but there are times when it is not just a question of relatives, but absolutes. It would appear, based on the limited data to hand, that exports tend, though not always, to go in the opposite direction to residential property investment.