It had been 210 days since the S&P 500 had made a new record high, but, on Friday, August 24th, after several days of struggle, the market finally broke to a new high (2874.69). The struggle actually began the prior Tuesday (August 21st). During that trading day, the S&P 500 actually pierced the old record high intra-day (during the trading session). But Wall Street has its own set of quirky rules. One odd such rule says that the record books can only count the closing price. So, Tuesday didn’t count. But Friday did, and now that the January 26th record high close has been taken out, the market has moved higher. The real question is, “what is driving it up?”
The business media treats Wall Street themes as if they were God’s honest truth. Most of the time, they aren’t. For example, the Wall Street cheerleaders continue to insist that this has been the longest bull market in history; and that the record stock market is due to a strong and accelerating economy.
In my long career as an economist, this is the first time I have heard that the definition of a “bull market” is a period of time when there hasn’t been a 20% correction. What if the market stayed flat for 10 years without a 20% correction, but without a meaningful rise? Would that be a “bull market?”
Based on this “new” definition, one that clearly has been made to fit the Wall Street narrative, Wednesday, August 22nd, marked the “longest” bull market run in history. In this “bull market,” the closest we came to a 20% correction was in 2011. On 4/29/11, the S&P 500 closed at 1363.61. In the market correction that followed, the lowest market close was on 10/3/11, 157 days later, when it closed at 1099.23, for a drawdown of 19.4%. Clearly, whoever propagated the 20% correction rule went back to this 2011 period and picked a number just greater than the correction. 20%, a nice round number, just happened to be convenient. Since 19.4% is less than 20%, by this new definition, the “bull market” was still intact. But wait! A closer examination of the data reveals that the intraday high on 5/2/11 was 1370.58, and the intraday low on 10/4/11 was 1074.77. The actual peak to trough drawdown was 21.6%. Still a “bull market?” Of course it is; intraday numbers don’t count!
Silly stuff, right? Clearly manipulated to fit the intended narrative. So, what else should you question? How about Wall Street’s insistence that markets are up because the economy is strong. To quote a famous line with a slight twist: “It’s not the economy (stupid)!”
The U.S. and World Economies are Decelerating
In past blogs, I have discussed the deceleration in the U.S. and world economies. Here are more data:
• Both the Philly Fed and Kansas City Fed manufacturing indexes missed expectations to the low side, indicating decelerating manufacturing growth;
• The University of Michigan consumer sentiment survey showed consumer buying intentions at four year lows for durable goods, at five year lows for autos, and at 10 year lows for homes;
• The leading indicator indexes, while still showing growth, confirm growth deceleration;
• Real wages for the working class (i.e., wages after accounting for inflation) are actually down fractionally on a year over year basis (-0.2%);
• Inflation is popping, especially in the transportation industry (trucking and airlines). This has a large impact on final prices and will keep the pressure on the Fed to continue on its current tightening path and likely inverting the yield curve;
• Besides rate tightening, the Fed has embarked upon QT (Quantitative Tightening), the opposite of QE (Quantitative Easing). This means they are reducing their gargantuan holdings of government securities which reduces the growth in the monetary aggregates (see below). Eventually, a slow or negative growth in the money supply leads to softer (or negative) economic growth. In any case, this is clearly deceleration;
• Housing, itself, appears to be in the dumpster. Not only are consumer future buying intentions flagging, but the actual here and now numbers show poorly. New single family home sales for July were down to a nine month low and were significantly below consensus expectations. In addition, for the fourth month in a row, July’s existing home sales declined (to the lowest level since February ’16). Over this four month span, existing home sales are down at a 19% annualized rate, and that number was buoyed by spec buying. Without those spec purchases, the July number plunged 17% from June (month over month), leading some economists to speculate about an oncoming housing recession;
• The world’s economy, too, is anything but accelerating. China’s economic growth has stagnated, and now we have come to recognize significant issues in the emerging markets (EM) which Wall Street is ignoring, but which aren’t going away:
o Turkey’s currency has plunged more than 40% this year making it nearly impossible for its corporate debtors, much of whose debt is denominated in dollars, to be able to raise their local prices high enough to meet their dollar denominated obligations;
o Turkey is only the latest EM issue. Wall Street has ignored the plummeting Argentine currency, the downdrafts in the South African rand, the Indonesian rupiah, and even India’s rupee, not to mention the travesty going on in Venezuela’s currency and economy;
o And while Greece officially comes off of its European Central Bank (ECB) lifeline, the price it paid is an economy 25% smaller with 20%+ unemployment. The next European political crisis is likely to be Italy (budget) and/or the U.K. (no Brexit trade agreement with the EU), neither of which would be conducive to economic growth!
If Not the Economy, What?
Well then, if it isn’t the economy underpinning market prices, what is? Simple answer: money printing and liquidity. Milton Friedman’s thesis about money creation: When money is printed faster than the economy grows (assuming money’s velocity is constant), somewhere, prices rise. Even ex-Fed chief Bernanke has admitted that his QE programs were meant to influence the prices of equities and real estate.
In the U.S., over the four weeks ended August 8th, the money supply (M1) has actually contracted at a 6.4% annual rate. The other monetary aggregate measures are softer too. If the U.S. were an insulated economy, the market wouldn’t be displaying its current behavior. But money printing continues in much of the rest of the world (Europe, Japan, and now China). With higher interest rates than in many developed markets abroad (Europe, Japan, the U.K.), and a stock market with a great narrative, foreign money continues to find a home in U.S. market assets. No wonder the dollar continues to strengthen!
According to Wall Street economist David Rosenberg, both world liquidity and a reduction in U.S. supply have been buoying U.S. markets. On the demand side, the world’s sovereign wealth funds and even major central banks are not price sensitive, have very long-term time horizons and have made equity investments acceptable for their balance sheets:
• The Bank of Japan holds $250 billion of equity ETFs; this is new in the post-recession period;
• The Swiss National Bank has $180 billion of equities on its balance sheet, half of which are U.S. equities;
• The world’s sovereign wealth funds now have $7.4 trillion, up from $3.4 trillion pre-recession;
• Norway’s sovereign wealth fund has $860 billion in assets of which 60% are currently in equities with the expectation that this will soon rise to 70%.
On the supply side:
• Buy-back are on track for $1 trillion in the U.S in 2018, and $250 billion in the rest of the world, thus reducing available supply;
• In addition, equity issuance has been minimal since the cost of debt (although now rising) is much lower than the required return on equity.
Conclusions
Don’t believe the Wall Street narrative that stock prices are rising because of a strong and accelerating U.S. economy. They are rising because the post-recession monetary policies of the world’s major central banks have kept the money spigots on. The U.S. economy is actually decelerating; and if the U.S. economy were insulated from the rest of the world, the stock market would likely be behaving quite differently.
What could turn U.S equity markets? Any of the following, none of which are easily predictable as to timing:
• Debt defaults or other chaos in emerging markets;
• Political issues out of Italy and the U.K. or political issues at home (e.g., impeachment);
• The recognition that the U.S. economy is decelerating (likely with the initial Q3 GDP report in late October);
• A Fed induced recession over the next 18 months (yield curve inversion);
• Policy tightening in the world’s other major central banks (being broadly discussed).
Robert Barone, Ph.D.
Robert Barone, Ph.D. is a Georgetown educated economist. He is a financial advisor at Fieldstone Financial. www.FieldstoneFinancial.com .
He is nationally known for his writings and Robert’s storied career includes his having served as a Professor of Finance, a community bank CEO and a Director and Chairman of the Federal Home Loan Bank of San Francisco. Robert is currently a Director of CSAA Insurance Company (a AAA company) where he chairs the Finance and Investment Committee. Robert leads the investment governance program at Fieldstone Financial, is the head of Fieldstone Research www.FieldstoneResearch.com, and is co-portfolio manager of the Fieldstone Financial Unconstrained Medium-Term Fixed Income ETF (FFIU).
Statistics and other information have been compiled from various sources. The facts and information are believed to be accurate and credible, but there is no guarantee as to the complete accuracy of this information