The least the bull market cheerleaders and talking heads could do is mount a plausible excuse.
The popular half-assed trope in the news these days is the brutally cold weather, as if it has any bearing on economic reality.
I guess if you only have a couple hours to get your talking points in line with your agenda, partial positive correlation is an easy way.
People hate going out in the cold, so certainly they didn’t go out to secure necessities like food, shelter, transportation, clothes, and jobs. One doesn’t lead to the other — they simply have coexisted over the last several months.
Dig just a couple lines into the tepid to downright miserable economic reports being issued and it is obvious that isn’t the case.
As Peter Schiff pointed out in a March 7th post for Euro Pacific Capital, Inc., there is a whole lot going on that undermines these paltry attempts.
Here is a short list of troubling news of economic malaise being ascribed to the whims of nature that Mr. Schiff points out:
- Lackluster retail sales — Online sales were similarly weak, which doesn’t add up if consumers were sitting around at home all day.
- Weak auto sales — Luxury brands surged to record levels, as if the rich brave the cold more than the poor.
- The job report — Weather was to blame for terrible reports over the last two months, but the weather was in full force when the February numbers came in at 175,000, a celebrated figure that is about half of what is needed.
GDP, productivity, factory orders, weak housing sales, and mortgage activity were all dismissed as flukes.
Mr. Schiff nailed it right on the head when he stated, “In truth, economic activity persists in good weather and bad. Winter is largely predictable. It comes around once a year, basically on schedule. Consumers are used to the patterns and know how to deal with them. But don’t tell this to today’s economists.”
So who is to blame if it isn’t Mother Nature?
The Failing Model
I really wanted to highlight Mr. Schiff’s article today because he eloquently sums up the problem in two lines: “Our current policies help the wealthy at the expense of everybody else. Unfortunately, I don’t think the economy will improve as long as the QE keeps us locked into a failing model.”
Talk about hitting the nail on the head. Fed officials didn’t understand the market and economy enough to form a cohesive reaction to crisis seven years ago (throwing money at it doesn’t count in my book).
They still don’t today. Yet they’re settling for a failing model because it provides the illusion of stability in it’s early stages.
Unemployment is a prime example. In spite of a mandate to bolster employment, a vast majority of job gains since the recession are in part-time, low-paying jobs.
Even Janet Yellen had to acknowledge this shortcoming in official figures. While unemployment has dropped, the labor participation rate is abysmal, and the Fed has ignored it to date.
A de facto double-dip recession is highly likely because, at the current rate of job creation, it’ll be well over a decade before employment figures and labor participation will catch up to pre-recession levels.
Unfortunately, instead of the concern about employment translating to concern over the failing model, the only proposed solution is to extend QE measures. After all, the best thing to do when things are going wrong is to double down, right?
Another perfect example is distortion in the market. For that, we turn to some tried and true methods of looking at the market.
Q and CAPE
In bizarre, distorted, and manipulated markets, classic indicators just get weird. There may be hints of truth, or indications of sentiment, but most cannot be trusted to reflect reality.
Ultimately, we’re all better off ditching the short-term metrics in favor of broader measures. Let’s take a look at Tobin’s q and CAPE today, as tried-and-true as economic metrics come.
Short explanations are in order. Tobin’s q is a ratio between the market value and replacement cost of a company (almost literally the cost to make a duplicate of the company). Add q ratios for a bunch of companies up and you get a ratio for the whole market.
CAPE is the cyclically-adjusted price to earnings ratio, also called the Shiller PE. It measures the price of a company’s stock relative to average earnings over the past 10 years, adjusted for inflation.
Here is a chart from the Andrew Smithers of Smithers & Co.:
While these measures purposely cannot give much info in the short-term, they show that U.S. equities are dangerously overvalued at around 70% above fair value.
Mr. Smithers went on to state in a Financial Times article that this distortion in the market appears to be — in his opinion — tied to strong buying of shares by companies and the impact of quantitative easing.
Looking at more of his data, it is my opinion that both of these driving factors are attributable to the failing model being used in our economy that Mr. Schiff noted. Here is why…
Corporate Buyers and Bonuses
While q and CAPE are showing that the market is severely overvalued right now, that can easily change. All it would take is a trend toward meaningful growth.
Spend some cash on capital growth and the replacement cost goes up, thus driving the q ratio down. Spend some cash to support long-term earnings growth (capital investment again) and even 10-year P/E ratios trend downward.
If only that was happening today.
Management of U.S. corporations are tasked with increasing earnings per share for shareholders. They’re rewarded with insanely lucrative bonuses if they do.
In a healthy economy, there are disincentives to discourage boosting earnings per share without meaningful growth through capital investment. Out-sized EPS growth burns out and strips corporations of the ability to create meaningful growth later.
Our failing model does the exact opposite.
With easy money pouring into corporate coffers through virtually free loans trickling down from the Fed and through financial institutions, it is far easier to tie up future cash flow for large buyback programs today.
2013 was second only to 2007 for the total value of share buybacks. $500 billion, equivalent to about half of the money the Fed used to juice the economy, was used this way.
Corporations capitalized on the low interest rates by issuing $18.2 trillion of bonds worldwide since 2008. Currently outstanding corporate debt has risen over 50% to $9.6 trillion over the same period.
Let’s look at how that affected capital investment in another chart from Mr. Smithers:
Behold the fallout from the easy money flowing through the Fed’s failing model.
Even more disturbing is how households, including mutual funds, have an almost perfect inverse reaction to non-financial corporate buying.
It isn’t the weather that has gutted employment figures, GDP, retail sales, and auto sales, amongst many other economic indicators.
It is the failing model that only supports the wealthy elite at the cost of everything else.
Well, everything except corporate executive bonuses and record-setting luxury car sales.
P.S. You can check out Peter Schiff’s article here, Andrew Smither’s articles here, and Smithers & Co. here.
