16/5/19: Gundlach on the U.S. Economy and Debt Super-cycle

U.S. growth over the past five years is based “exclusively” on government, corporate and household debt, according to Jeffrey Gundlach, chief executive of DoubleLine Capital, as reported by Reuters (link below). This is hardly surprising. In my forthcoming article for Manning Financial (in print since last week), I am covering the shaky statistical nature of the U.S. GDP growth figures, and the readers of this blog would know my view on the role of leverage (debt) in the real economy as a drug of choice for boosting superficial medium term growth prospects in the U.S., Europe and elsewhere around the world. What is interesting in Gundlach's musings is that we now see mainstream WallStreet admitting the same.

Per Gundlach, the U.S. economy would have contracted in nominal GDP terms (excluding inflation effects) three out five last years if the United States had not added trillions in new government debt. Just government debt alone. “One thing everybody seems to miss when they look at these GDP numbers ... they seem to not understand that the growth in the GDP it looks pretty good on the screen is really based exclusively on debt - government debt, also corporate debt and even now some growth in mortgage debt.”

And if private sector debt did not expand, U.S. "GDP would have been very negative.” Per Reuters report, nominal GDP rose by 4.3%, but total public debt rose by 4.7% over the past five years, Gundlach noted. "Against this debt backdrop and financial markets “addicted to Federal Reserve stimulus,” these are “very, very dangerous times” for the next U.S. recession, Gundlach ...said."

Per CMBC report on the same speech, Gundlach said that “Any thoughtful person would be concerned... It’s sounding like a pretty bad cocktail of economic risk, and risk to the long end of the bond market.”

As reported by Reuters: https://www.reuters.com/article/us-funds-doubleline-gundlach/u-s-growth-would-have-contracted-without-trillions-in-government-consumer-debt-gundlach-idUSKCN1SK2KW and by CNBC https://www.cnbc.com/2019/05/14/doublelines-gundlach-warns-of-recession-cocktail-of-economic-risk.html

As the charts below show, Gundlach is correct: we are in a continued leverage risk super-cycle. While nominal debt to nominal GDP ratio remains below pre-GFC peak, nominal levels of debt are worrying and debt dynamics are showing sharpest or second sharpest speed of leveraging during the current recovery phase. Worse, since the start of the 1990s, all three non-financial debt sources, households, corporates and the Government, are drawing increasing leverage. 

14/5/19: Agent Trumpovich Fails to Deliver... Again...

In the months following China's retaliatory introduction of tariffs on U.S. soybean exports, both traditional and social media were abuzz with the screeching sound of 'analysts' claiming that Trump Administration trade war with China is a boon to Vladimir Putin's Russian economy.

Behold this from the

• Venerable CFR (albeit intellectually vulnerable): https://www.cfr.org/blog/trumps-trade-war-china-makes-russia-great-again and 
• WSJ: https://www.wsj.com/articles/russia-exploits-u-s-china-trade-tensions-to-sell-more-soybeans-11550745001 and 
• Bloomberg: https://www.bloomberg.com/news/articles/2018-05-17/china-buys-record-amount-of-russian-soy-as-it-shuns-u-s-growers and more Bloomberg https://www.bloomberg.com/news/articles/2018-11-07/china-turns-to-russia-in-search-to-replace-u-s-soybeans and 
• And a good collection of sources across the media here: https://www.dailykos.com/stories/2019/1/7/1824363/-Is-Russia-profiting-from-Trump-tariffs-on-China and
• The Hill: https://thehill.com/blogs/blog-briefing-room/388178-china-buys-record-amount-of-russian-soybeans-amid-halt-on-us-imports and
• A more somber and sober analysis from Carnegie Moscow Center: https://carnegie.ru/commentary/77443 and so on

 Alas, given that Russia supplies less than 1% of Chinese imports of soybeans, it might take a major Congressional investigation and a few PoliSci 'Russia experts' to get serious imaginary beef on the Trump Administration's alleged Russia-benefiting policies. Here is the data from ... well... Bloomberg, via Global macro Monitor (https://global-macro-monitor.com/2019/05/14/who-pays-the-tariffs/) showing that Russia is hardly a major winner from Trump's Trade Wars when it comes to soybeans:

Let's put the thin blue line of 'Russia winning, thanks to Trump' through some analysis:

1. There is no dramatic massive rise in Russian exports of soybeans to China in 2018, and some dip in 2019.
2. 2018 increase - moderate - came in after 2017 moderate decrease.
3. Russian exports of soybeans to China have been rising-falling-rising very gently since 2013.

Friendly Canada quietly dramatically increased its sales of soybeans to China in the wake of the Trade War, although its exports were rising since 2015. Argentina also acted as a substitute supplier to China during the Trade War period so far, but that increase came on foot of massive collapse in exports to China since the start of this decade. In fact, while the U.S. share of Chinese imports of soybeans fell 30 percentage points, Brazil's share rose 35 percentage points. Trump's Administration-triggered Trade War with China has helped Brazil first, followed by Canada and Argentina. Russia hardly featured in this dastardly plot to serve Vladimir Putin's interests by Agent Trumpovsky.

Sorry, my dear friends in American mass media. You've faked another factoid.

14/5/19: TrueEconomics makes Top 100 Blogs by the Intelligent Economist

Delighted to see TrueEconomics making it (for the fourth year running) into https://www.intelligenteconomist.com/economics-blogs/ Intelligent Economist's Top 100 Economics Blogs of 2019.

14/5/19: Monetary Policy at the edge of QE

My new column for the Cayman Financial Review on the current twists in global Monetary Policies is now available on line: https://www.caymanfinancialreview.com/2019/05/07/monetary-policy-at-the-edge-of-qe/.

14/5/19: Trump's Trade Wars and Global Growth Slowdown Put Pressure on Corporate Earnings

The combined impacts of rising dollar strength, reduced growth momentum in the global economy and President Trump's trade wars are driving down earnings growth across S&P500 companies with double-digit drop in earnings of companies with more global (>50% of sales outside the U.S.) as opposed to domestic (<50 exposures.="" of="" p="" sales="" the="" u.s.="" within="">
Per Factset data, released May 13, "The blended (combines actual results for companies that have reported and estimated results for companies yet to report) earnings decline for the S&P 500 for Q1 2019 is -0.5%. For companies that generate more than 50% of sales inside the U.S., the blended earnings growth rate is 6.2%. For companies that generate less than 50% of sales inside the U.S., the blended earnings decline is -12.8%."

5/5/19: House Prices and Household Incomes

A recent note from Brookings on the nature of the ongoing housing crisis in America has opened up with a bombastic statement:

"Over the past five years, median housing prices have risen faster than median incomes (Figure 1). While that’s generally good news for homeowners, it puts additional pressure on renters. Because renters generally earn lower incomes than homeowners, rising housing costs have regressive wealth implications." 

(Source: https://www.brookings.edu/blog/up-front/2019/05/02/your-city-has-a-housing-crisis-the-answer-is-more-less-building-money-regulation/)

It sounds plausible. And it sounds easy enough to understand for politicos of all hues to take up the claim and run with it. There is is even a handy chart to illustrate the argument:

Except the claim is not exactly consistent with the evidence presented in that chart.

For starters, Case-Shiller Index covers 20 largest metropolitan areas of the U.S., which is a sizeable chunk of population, but by far not the entire country. And rents, as the Brookings article correctly says, are rising across whole states (the article, for example referencing California, which is way larger than the largest urban areas of the state alone). Second point, the article is completely incorrectly uses nominal house prices inflation against real (inflation-adjusted) income growth figures. If the converse of the article claim held, and real incomes exceeded housing price inflation, it would mean rising purchasing power for American households shopping for houses. However, that is not what the housing markets are historically, longer-term about. They are more about hedging inflation. The third, and more important point is that the article refers to the last 5 years. Why? No reason provided. But even a glimpse at the chart supplied in Brookings paper is enough to say that the same problem persisted prior to the Great Recession, was reversed in the Great Recession, and then returned post-Great Recession.

What's really happening here?

Ok, let's take four time series:

• House prices 1: Median Sales Price of Houses Sold for the United States, Dollars, Annual, Not Seasonally Adjusted;
• House prices 2: S&P/Case-Shiller 20-City Composite Home Price Index, Index Jan 2000=100, Annual, Seasonally Adjusted (same as in Brookings article);
• Income 1: Real Median Household Income in the United States, 2017 CPI-U-RS Adjusted Dollars, Annual, Not Seasonally Adjusted (same as in Brookings article); and 
• Income 2: Nominal Median Household Income in the United States, Current Dollars, Annual, Not Seasonally Adjusted

Observe that we have data only through 2017 for the last two measures due to data reporting lags.

Now, compute annual rates of growth in all four and plot them:

Blue line is the reference point here. Notice that the grey line (real household income growth) is really underperforming house price growth over virtually all periods, except for one: the Great Recession. Yellow line, however, is less so. Nominal incomes have more benign relationship to nominal prices than real incomes do to nominal house prices. Why would that be surprising at all? I am not sure. It did surprise folks at the Brookings, though.

Let's compute some average rates of growth for all four series and calculate the difference between:

1. Real Median Household Income growth rate and the growth rate in the Median Sales Price of Houses, percentage points; and
2. Nominal Median Household Income growth rate and the growth rate in the Median Sales Price of Houses, percentage points.

Instead of using an arbitrary 5 years horizon, consider instead the business cycle and longer term averages. Here they are:

Historical averages are, respectively, -3.71 percent and -1.31 percent. Across the last Quantitative Easing cycle, -2.94 percent and -1.60%, ex-QE cycle, -4.05% and -1.19%. 

So what does the above tell us? Things are not as dramatic, using nationwide house prices, than the Brookings claim makes it sound, and, more importantly, there is no evidence of a significant departure in the current QE cycle from the past experiences. When it comes to property prices, hoses inflation seems to be much less divorced from real and nominal income growth rates in the last four years (the recovery period post-Great Recession) than in the periods prior to the GFC.

3/5/19: The Rich Get Richer when Central Banks Print Money

The Netherlands Central Bank has just published a fascinating new paper, titled "Monetary policy and the top one percent: Evidence from a century of modern economic history". Authored by Mehdi El Herradi and Aurélien Leroy, (Working Paper No. 632, De Nederlandsche Bank NV: https://www.dnb.nl/en/binaries/Working%20paper%20No.%20632_tcm47-383633.pdf), the paper "examines the distributional implications of monetary policy from a long-run perspective with data spanning a century of modern economic history in 12 advanced economies between 1920 and 2015, ...estimating the dynamic responses of the top 1% income share to a monetary policy shock." The authors "exploit the implications of the macroeconomic policy trilemma to identify exogenous variations in monetary conditions." Note: the macroeconomic policy trilemma "states that a country cannot simultaneously achieve free capital mobility, a fixed exchange rate and independent monetary policy".

Per authors, "The central idea that guided this paper’s argument is that the existing literature considers the distributional effects of monetary policy using data on inequality over a short period of time. However, inequalities tend to vary more in the medium-to-long run. We address this shortcoming by studying how changes in monetary policy stance over a century impacted the income distribution while controlling for the determinants of inequality."

They find that "loose monetary conditions strongly increase the top one percent’s income and vice versa. In fact, following an expansionary monetary policy shock, the share of national income held by the richest 1 percent increases by approximately 1 to 6 percentage points, according to estimates from the Panel VAR and Local Projections (LP). This effect is statistically significant in the medium run and economically considerable. We also demonstrate that the increase in top 1 percent’s share is arguably the result of higher asset prices. The baseline results hold under a battery of robustness checks, which (i) consider an alternative inequality measure, (ii) exclude the U.S. economy from the sample, (iii) specifically focus on the post-WWII period, (iv) remove control variables and (v) test different lag numbers. Furthermore, the regime-switching version of our model indicates that our conclusions are robust, regardless of the state of the economy."

In other words, accommodative monetary policies accommodate primarily those with significant starting wealth, and they do so via asset price inflation. Behold the summary of the last 10 years.

3/5/19: Global and BRIC Manufacturing PMIs signal ongoing growth declines

The latest data, released this week by Markit under their PMI headings, shows that manufacturing sector global slowdown has entered into its 6th consecutive quarter in the first month of 2Q 2019. In line with this momentum, BRIC economies overall, with exception (for now) of Russia and China have also posted slower growth in April compared to 1Q 2019 average:

Russia posted slightly more upbeat growth in April at 51.8 compared to 1Q 2019 average growth of 51.3. China has barely bounced back into growth in April 2019 compared to 1Q 2019 reading of 49.7. Brazil slowdown was marked, with PMI for Manufacturing down from 53.0 in 1Q 2019 to 51.5 in April, while India suffered an even more significant fall-off in activity, with Manufacturing PMI falling from 1Q 2019 average of 53.6 to April reading of 51.8.

Global Manufacturing sector PMI averaged 50.7 in 1Q 2019, and in April it fell to 50.3, statistically implying zero growth in the sector. One has to go back to 3Q 2013 to see a reading at or below April 2019 levels. 

30/4/19: Journal of Financial Transformation paper on cryptocurrencies pricing

Our paper with O’Loughlin, Daniel and Chlebowski, Bartosz, titled "Behavioral Basis of Cryptocurrencies Markets: Examining Effects of Public Sentiment, Fear and Uncertainty on Price Formation" is out in the new edition of the Journal of Financial Transformation Volume 49, April 2019. Available at SSRN: https://ssrn.com/abstract=3328205 or https://www.capco.com/Capco-Institute/Journal-49-Alternative-Capital-Markets.

23/4/19: Income per Capita and Middle Class

New research reported by the Deutsche Bank Research shows that, on average, there is a positive (albeit non-linear) relationship between the per capita income and the share of middle class in total population:

Source: https://pbs.twimg.com/media/D42GiWNXkAMpID2.png:large

There is an exception, however, although DB's data does not test formally for it being an outlier, and that exception is the U.S. Note, ignore daft comparative reported in chart, referencing 'levels' in the U.S. compared to Russia, Turkey and China: all three countries are much closer to the regression line than the U.S., which makes them 'normal', once the levels of income per capita are controlled for. In other words, it is the distance to the regression line that matters.

Another interesting aspect of the chart is the cluster of countries that appear to be statistically indistinguishable from Russia, aka Latvia, Estonia and Lithuania. All three are commonly presented as more viable success stories for economic development, contrasting, in popular media coverage, the 'underperforming' Russia. And yet, only Latvia (completely counter-intuitively to its relative standing to Estonia and Lithuania in popular perceptions) appears to be somewhat (weakly) better off than Russia in income per capita terms. None of the Baltic states compare favourably to Russia in size of the middle class (Latvia - statistically indifferent, Lithuania and Estonia - somewhat less favourably than Russia).

23/4/19: Property, Property and More Property: U.S. Household Wealth Bubble

According to the St. Luis Fed, U.S. household wealth has reached a historical high of 535% of the U.S. GDP (see: https://www.zerohedge.com/news/2019-04-16/where-inflation-hiding-asset-prices).

There is a problem, however, with the above data: it reflects some dodgy ways of counting 'household wealth'. For two primary reasons: firstly, it ignores concentration risk arising from wealth inequality, and secondly, it ignores concentration risk arising from households' exposure to property markets. A good measure of liquidity risk controlled allocation of wealth is ownership of liquid equities (note: equities, of course, and are subject to Fed-funded bubble dynamics). The chart below - via https://www.topdowncharts.com/single-post/2019/04/22/Weekly-SP-500-ChartStorm---21-April-2019 shows a pretty dire state of equity markets (the source of returns on asset demand side being swamped over the last decade by shares buybacks and M&As), but it also shows that households did not benefit materially from the equities bubble.

In other words, controlling for liquidity risk, the Fed's meme of historically high household wealth is seriously challenged. And controlling for wealth inequality (distributional features of wealth), it is probably dubious overall.

So here's the chart showing just how absurdly property-dependent (households' home equity valuations in red line, index starting at 100 at the end of the Global Financial Crisis) the Fed 'wealth' figures (blue line, same starting index) are:

In fact, dynamically, rates of growth in household home equity have been far in excess of the rates of growth in other assets since 2012.  In that, the dynamics of the current 'sound economy' are identical (and actually more dramatic) to the 2000-2006 bubble: property, property and more property.

22/4/19: At the end of QE line... there is nothing but QE left...

Monetary policy 'normalization' is over, folks. The idea that the Central Banks can end - cautiously or not - the spread of negative or ultra-low (near-zero) interest rates is about as balmy as the idea that the said negative or near-zero rates do anything materially distinct from simply inflating the assets bubbles.

Behold the numbers: the stock of negative yielding Government bonds traded in the markets is now in excess of USD10 trillion, once again, for the first time since September 2017

Over the last three months, the number of European economies with negative Government yields out to 2 years maturity has ranged between 15 and 16:

More than 20 percent of total outstanding Sovereign debt traded on the global Government bond markets is now yielding less than zero.

I have covered the signals that are being sent to us by the bond markets in my most recent column at the Cayman Financial Review (https://www.caymanfinancialreview.com/2019/02/04/leveraging-up-the-global-economy/).