IN-DEPTH: TRANSCRIPTION - LONGWave – 04-13-22 - APRIL – A Stalling Wealth Effect
SLIDE DECK
TRANSCRIPTION
SLIDE 2
Thank you for joining me. I'm Gord Long.
A REMINDER BEFORE WE BEGIN: DO NO NOT TRADE FROM ANY OF THESE SLIDES - they are COMMENTARY for educational and discussions purposes ONLY.
Always consult a professional financial advisor before making any investment decisions.
COVER
Sentiment and Investor confidence are critical pillars of the financial markets. The wealth effect encapsulates both.
As markets rise, investors feel richer and better prepared and able to accept the risk inherent in financial markets. As such their confidence grows.
This well describes the Stock Market over the last decade as central banks injected huge amounts of liquidity into the financial system. Rising tides lift all boats.
However tides also go out.
This well appears to be what the near to intermediate term has in store for the markets!
AGENDA
If this occurs, then the powerful driver which the Wealth Effect has been is highly likely to reverse and become a major drag on the markets.
I therefore want to examine why this is likely to occur and what we need to pay close attention to in identifying if in fact this is occurring.
As such I would like to cover the Agenda items listed here.
SLIDE 5
Markets can seem, and in fact are, irrational at times. However, markets change their behavior and perspectives when the underpinnings change. The biggest such underpinning is the cyclical nature of the Business Cycle.
We have had one of the longest uninterrupted business cycles in history since the Financial Crisis of 2008. Yes it was rocky during the 2012 EU Banking Crisis and the 2020 Covid Shock but the current business cycle was artificially and continuously extended over the last decade by massive liquidity injections.
SLIDE 6
Throughout most of the decade this came in the form of various (and I remind you, never before used) Quantitative Easing (QE) expansions and in 2020 massive Covid-19 fiscal relief and Monetary Facilities initiatives.
These continuous liquidity injections extended the business cycle by bringing future demand forward through lower financing rates and readily available credit.
But what happens when we stop? For that matter even slow? Where is the ongoing demand going to come from?
To better grasp the answer we need understand the difference between Liquidity, Credit and Debt!
SLIDE 7
Being very simplistic, Liquidity enters the system through the Monetary Policies of the Federal Reserve and increasingly the Fiscal Deficit Policies of the government.
That liquidity is turned into Credit through the Banking System and increasingly the Shadow Banking System. The Bank System being Regulated and the Shadow Banking System less so.
Credit on the other hand is turned into Debt when it is actually used or in fact “Borrowed”. The Borrowers being Consumers, Corporations or even in some cases by governments who must borrow in other currencies through international banks.
The process is based on:
- Central Banks wanting to increase Liquidity into the system,
- Banks wanting and being able to lend,
- Borrowers wanting and being able to borrow
But what happens when:
- Central Banks want to stop increasing Liquidity or in fact actually start withdrawing Liquidity?
- Banks start restricting credit because of concerns with potential non-performing loans or simply a lack of new credit worthy lenders.. or…
- Borrowers stop borrowing because their debt levels are such that they have insufficient collateral to borrow further or are at their limit of carrying existing debt?
This is usually the situation when the Cyclical Business Cycle starts reverses.
SLIDE 8
Well it is a fact that the US Federal Reserve has not only stopped liquidity injections but is about to start withdrawing money from the system at a rate of $90B per month. The life blood of the huge market lift we have experienced over the last decade is about to reverse for the first time.
The Fed also plans to accelerate rate increases by 50 basis points at future FOMC meetings.
Because of the massive amount of liquidity injected primarily as a result of Covid-19 the Fed faces an Inflation problem not experienced since the 1970’s and appears to be even much more serious in comparison.
We currently have the classic situation of too much money chasing too few goods!
As a result, there is every likelihood that the black channel shown here is about to be tested on the bottom side – or worse -- over the next 18 months.
SLIDE 9
Unfortunately, it may be even worse! Because liquidity is one thing, but as we showed, credit is another!
SLIDE 10
The US household sector net worth has increased by $150 Trillion since 1952. $19 Trillion occurring last year alone!
Over the past three years wealth has increased by $46T or 44%.
Since its pre-crisis peak on 2007 it has increased by $80 Trillion or by 114%,
Clearly, liquidity increases have had the expected result of increasing paper wealth in America.
SLIDE 11
The recent acceleration begs the obvious question of whether this is sustainable?
SLIDE 12
At a 14.4% increase in 2021 this matched the highest increase in 70 years.
The average of 7.1% in that period of time was less than half of last years.
It is any wonder we now have Inflation and the Federal Reserve needs to do something?
SLIDE 13
The problem the banks and lenders of credit face however is that household net worth is now 825% of disposable personal income.
This is 23% above the Q4 2006 peak of 670 which led to the 2008 Financial Crisis and US Mortgage debacle.
SLIDE 14
Here is a clearer illustration of the problem.
My colleague Richard Duncan produces what he often refers to as his Credit Gauge.
Credit and Debt are the opposite sides of the same coin.
For lenders, credit doesn’t become debt until it is borrowed
Credit Growth historically must GROW at 2% or more on an Inflation Adjusted Annual basis. If it does not the US falls into a Recession.
Banks must increase their lending and borrowers must increase their debt by 2% annually.
With debt at 825% of disposable income how does this increase occur??
The answer is it doesn’t!
In fact it shrunk last year and is likely to only get worse!
Warren Buffet’s famous measure of when stocks are too high is a similar view where he compares market capitalization to GDP. The economy can only produce so much Market Capitalization as similarly credit can only be extended to a level that it can be counted on to be paid back.
We are presently walking head long into a recession with a tapped out consumer, corporate zombies and tightening financial lending standards.
SLIDE 15
Where can the required increased lending and borrowing come from?
SLIDE 16
The simple fact is that banks and lending institution are out of additional, new viable lenders. They have stuffed credit wherever they could for over a decade and now face potential loan losses, defaults, delinquencies and foreclosures if (and maybe we should just say) when the business cycle turns down!
Lending institutions would be expected to and are already reacting & planning accordingly.
SLIDE 17
The total debt of all sectors of the US economy combined totals approximately $88 Trillion.
SLIDE 18
Total debt to GDP now stands at 384%.
From 1980 to 2008 credit growth drove economic growth. After 2008, the Fed used QE to push up assets prices in order to create a Wealth Effect that would supplement Credit Growth and make the economy grow.
This was all part of Fed Chairman Ben Bernanke’s “Enrich-thy-Neighbor’ doctrine.
It worked. Unfortunately, but expectantly it has now come time to “pay the piper”!
SLIDE 19
We appear to be out of monetary and financial gimmicks and new sources of credit and debt creation. More liquidity is no longer the answer.
SLIDE 20
We can expect to see a rather significant reversal in the wealth effect unless the powers to be can pull yet another “rabbit out of the hat”?
SLIDE 21
With the Federal Reserve increasing rates and the 10year US Treasury note already exploding higher to 2.8% it is only a matter of time before something breaks somewhere.
Too many players are too far out in front of their skis and will get caught and can be expected to take others with them. This historically happens every time the Federal Reserve starts raising rates.
The contagion this time, because of the levels we have taken credit and debt to, has the potential to make such an event something which we have never seen before?
We have a whole newly minted ETF industry which has never been tested when holders start hitting their computer sell buttons all at the same time.
SLIDE 22
My concern additionally is that during slowing economic conditions we historically see Price-Earnings or PE ratios contract. This is particularly so when inflation becomes elevated.
SLIDE 23
We currently have PE ratios at historic levels with the market indexes dependent on 10 large players with astronomical PE ratios.
Scan the level of PE ratios shown here and appreciate that during a similar time in the 1970’s we saw PE ratios drop from 15 to 8 or approximately half. What is to say this doesn’t occur again or even take that PE ratios go back to those 1970’s highs?
SLIDE 24
Market Euphoria disappears in a heartbeat once it starts to change.
SLIDE 25
As big a concern as the coming US Recession may be, and the fact it could be a global recession, I am more concerned that it will usher in an era of Stagflation.
SLIDE 26
Stagflation may in fact soon be felt throughout the developed economies! There is little doubt a Recession is on the horizon but the question of an era of Stagflation is not to many – at least yet!
SLIDE 27
To me what is key is to understand that today a potential Stagflation problem is much bigger and much more intractable than most yet fully realize!
The way to visualize what is occurring is to think of Stagflation as a potential Black Hole. It is easy to unwittingly and unsuspectingly get into but extremely if not impossible to get out of once trapped in it.
The secret is to avoid it with sound economic policies before you reach the “Event Horizon”!
Many knowledge money managers perceive we are potentially entering such a situation.
SLIDE 28
The reaction by central bankers and those on control of Monetary Policy is to apply traditional Keynesian thinking to the problem. But in this case it doesn’t work!
What must be done to control Inflation crushes growth.
What must be done to foster growth inflames Inflation!
It is the proverbial “Catch 22”.
The solution therefore is you must identify it early and act aggressively.
SLIDE 29
The hidden problem is that the distortions, and reporting games we have been playing for a very long time, have let us get much to deep in the Black Hole than we understand because our measures have failed to alert us of the reality of the situation.
The political “Kick-the-Can-Down-the-Road” policy approaches have only fostered “tweaking” the warning measures to buy time and make it someone else’s problem!
SLIDE 30
Let me be specific.
Inflation through statistical distortions such as Hedonics, Substitution, Imputation and others which I have previously chronicled have distorted Inflation as measured by the CPI to such a degree that Inflation, Inflation Breakevens and Real Rates are ineffective measures.
SLIDE 31
I most recently laid out how the new world of Inflation Swaps has exploded in an attempt to protect the more sophisticated institutional investors from these mirrors and mirages.
SLIDE 32
Economic Growth is also seriously distorted by an obsolete formula that is based on sound money and adopted during the era of the gold standard and fails miserably to adequately describe real growth in an era of massive government debt, transfer payments and debt financed consumption now being nearly 70% of the economy. The creators of the simple formula never imagined an economy like the one we operate in today.
SLIDE 33
Our 2017 Thesis paper entitled “The Illusion of Growth” lays out the indisputable reality of the facts in its 111 pages of detailed analysis.
The central problem and difference with what occurred in the 1970’s is important to understand. We not only have an order of magnitude worse “black hole” problem but our tools are dull and our thinking seriously obsolete. Our politically polarized governance is also a big problem but which I will leave for another day!
SLIDE 34
The simple truth and reality is that the US is highly likely to be well below the event horizon!
SLIDE 35
I have unfortunately presented a pretty bad overall story here so far! I am sorry to be so negative but the facts are the facts.
I have learned over the years however is it is never as good as I hope nor as bad as I expect.
We tried to lay out the good news in my recent video entitled “The Dam Has Broken” with Charles Hugh Smith.
The bad news is fundamentally about imbalances that must be corrected before we can launch ourselves into a new era of prosperity. The good news is they will herald new and required changes for a more dynamic and productive future.
SLIDE 36
The changes can be expected to be centered on shifts in:
- Financial Rebalancing between productive countries and indebt, unproductive countries consuming more than they produce,
- Charles Theory on De-Growth
- Re-Shoring,
- De-Financialization
- De-Globalization
SLIDE 37
Yes there will be pain as we experience the items as shown here that are likely to occur.
SLIDE 38
However, there are going to be investment opportunities for those that are prepared to an extent we have never seen before.
This is what happens when change occurs!
SLIDE 39
You may have heard that the Chinese word for “crisis” can be represented as “Danger + Opportunity.” President John F Kennedy once inspired America with this quote:
“The Chinese use two brush strokes to write the word, 'crisis'. One brush stroke stands for danger; the other for opportunity.”
Grasp the Opportunity!
Sentiment and Investor confidence are critical pillars of the financial markets. The wealth effect encapsulates both.
As markets rise, investors feel richer and better prepared and able to accept the risk inherent in financial markets. As such their confidence grows.
This well describes the Stock Market over the last decade as central banks injected huge amounts of liquidity into the financial system. Rising tides lift all boats.
However tides also go out.
This well appears to be what the near to intermediate term has in store for the markets!
AGENDA
If this occurs, then the powerful driver which the Wealth Effect has been is highly likely to reverse and become a major drag on the markets.
I therefore want to examine why this is likely to occur and what we need to pay close attention to in identifying if in fact this is occurring.
As such I would like to cover the Agenda items listed here.
SLIDE 5
Markets can seem, and in fact are, irrational at times. However, markets change their behavior and perspectives when the underpinnings change. The biggest such underpinning is the cyclical nature of the Business Cycle.
We have had one of the longest uninterrupted business cycles in history since the Financial Crisis of 2008. Yes it was rocky during the 2012 EU Banking Crisis and the 2020 Covid Shock but the current business cycle was artificially and continuously extended over the last decade by massive liquidity injections.
SLIDE 6
Throughout most of the decade this came in the form of various (and I remind you, never before used) Quantitative Easing (QE) expansions and in 2020 massive Covid-19 fiscal relief and Monetary Facilities initiatives.
These continuous liquidity injections extended the business cycle by bringing future demand forward through lower financing rates and readily available credit.
But what happens when we stop? For that matter even slow? Where is the ongoing demand going to come from?
To better grasp the answer we need understand the difference between Liquidity, Credit and Debt!
SLIDE 7
Being very simplistic, Liquidity enters the system through the Monetary Policies of the Federal Reserve and increasingly the Fiscal Deficit Policies of the government.
That liquidity is turned into Credit through the Banking System and increasingly the Shadow Banking System. The Bank System being Regulated and the Shadow Banking System less so.
Credit on the other hand is turned into Debt when it is actually used or in fact “Borrowed”. The Borrowers being Consumers, Corporations or even in some cases by governments who must borrow in other currencies through international banks.
The process is based on:
- Central Banks wanting to increase Liquidity into the system,
- Banks wanting and being able to lend,
- Borrowers wanting and being able to borrow
But what happens when:
- Central Banks want to stop increasing Liquidity or in fact actually start withdrawing Liquidity?
- Banks start restricting credit because of concerns with potential non-performing loans or simply a lack of new credit worthy lenders.. or…
- Borrowers stop borrowing because their debt levels are such that they have insufficient collateral to borrow further or are at their limit of carrying existing debt?
This is usually the situation when the Cyclical Business Cycle starts reverses.
SLIDE 8
Well it is a fact that the US Federal Reserve has not only stopped liquidity injections but is about to start withdrawing money from the system at a rate of $90B per month. The life blood of the huge market lift we have experienced over the last decade is about to reverse for the first time.
The Fed also plans to accelerate rate increases by 50 basis points at future FOMC meetings.
Because of the massive amount of liquidity injected primarily as a result of Covid-19 the Fed faces an Inflation problem not experienced since the 1970’s and appears to be even much more serious in comparison.
We currently have the classic situation of too much money chasing too few goods!
As a result, there is every likelihood that the black channel shown here is about to be tested on the bottom side – or worse -- over the next 18 months.
SLIDE 9
Unfortunately, it may be even worse! Because liquidity is one thing, but as we showed, credit is another!
SLIDE 10
The US household sector net worth has increased by $150 Trillion since 1952. $19 Trillion occurring last year alone!
Over the past three years wealth has increased by $46T or 44%.
Since its pre-crisis peak on 2007 it has increased by $80 Trillion or by 114%,
Clearly, liquidity increases have had the expected result of increasing paper wealth in America.
SLIDE 11
The recent acceleration begs the obvious question of whether this is sustainable?
SLIDE 12
At a 14.4% increase in 2021 this matched the highest increase in 70 years.
The average of 7.1% in that period of time was less than half of last years.
It is any wonder we now have Inflation and the Federal Reserve needs to do something?
SLIDE 13
The problem the banks and lenders of credit face however is that household net worth is now 825% of disposable personal income.
This is 23% above the Q4 2006 peak of 670 which led to the 2008 Financial Crisis and US Mortgage debacle.
SLIDE 14
Here is a clearer illustration of the problem.
My colleague Richard Duncan produces what he often refers to as his Credit Gauge.
Credit and Debt are the opposite sides of the same coin.
For lenders, credit doesn’t become debt until it is borrowed
Credit Growth historically must GROW at 2% or more on an Inflation Adjusted Annual basis. If it does not the US falls into a Recession.
Banks must increase their lending and borrowers must increase their debt by 2% annually.
With debt at 825% of disposable income how does this increase occur??
The answer is it doesn’t!
In fact it shrunk last year and is likely to only get worse!
Warren Buffet’s famous measure of when stocks are too high is a similar view where he compares market capitalization to GDP. The economy can only produce so much Market Capitalization as similarly credit can only be extended to a level that it can be counted on to be paid back.
We are presently walking head long into a recession with a tapped out consumer, corporate zombies and tightening financial lending standards.
SLIDE 15
Where can the required increased lending and borrowing come from?
SLIDE 16
The simple fact is that banks and lending institution are out of additional, new viable lenders. They have stuffed credit wherever they could for over a decade and now face potential loan losses, defaults, delinquencies and foreclosures if (and maybe we should just say) when the business cycle turns down!
Lending institutions would be expected to and are already reacting & planning accordingly.
SLIDE 17
The total debt of all sectors of the US economy combined totals approximately $88 Trillion.
SLIDE 18
Total debt to GDP now stands at 384%.
From 1980 to 2008 credit growth drove economic growth. After 2008, the Fed used QE to push up assets prices in order to create a Wealth Effect that would supplement Credit Growth and make the economy grow.
This was all part of Fed Chairman Ben Bernanke’s “Enrich-thy-Neighbor’ doctrine.
It worked. Unfortunately, but expectantly it has now come time to “pay the piper”!
SLIDE 19
We appear to be out of monetary and financial gimmicks and new sources of credit and debt creation. More liquidity is no longer the answer.
SLIDE 20
We can expect to see a rather significant reversal in the wealth effect unless the powers to be can pull yet another “rabbit out of the hat”?
SLIDE 21
With the Federal Reserve increasing rates and the 10year US Treasury note already exploding higher to 2.8% it is only a matter of time before something breaks somewhere.
Too many players are too far out in front of their skis and will get caught and can be expected to take others with them. This historically happens every time the Federal Reserve starts raising rates.
The contagion this time, because of the levels we have taken credit and debt to, has the potential to make such an event something which we have never seen before?
We have a whole newly minted ETF industry which has never been tested when holders start hitting their computer sell buttons all at the same time.
SLIDE 22
My concern additionally is that during slowing economic conditions we historically see Price-Earnings or PE ratios contract. This is particularly so when inflation becomes elevated.
SLIDE 23
We currently have PE ratios at historic levels with the market indexes dependent on 10 large players with astronomical PE ratios.
Scan the level of PE ratios shown here and appreciate that during a similar time in the 1970’s we saw PE ratios drop from 15 to 8 or approximately half. What is to say this doesn’t occur again or even take that PE ratios go back to those 1970’s highs?
SLIDE 24
Market Euphoria disappears in a heartbeat once it starts to change.
SLIDE 25
As big a concern as the coming US Recession may be, and the fact it could be a global recession, I am more concerned that it will usher in an era of Stagflation.
SLIDE 26
Stagflation may in fact soon be felt throughout the developed economies! There is little doubt a Recession is on the horizon but the question of an era of Stagflation is not to many – at least yet!
SLIDE 27
To me what is key is to understand that today a potential Stagflation problem is much bigger and much more intractable than most yet fully realize!
The way to visualize what is occurring is to think of Stagflation as a potential Black Hole. It is easy to unwittingly and unsuspectingly get into but extremely if not impossible to get out of once trapped in it.
The secret is to avoid it with sound economic policies before you reach the “Event Horizon”!
Many knowledge money managers perceive we are potentially entering such a situation.
SLIDE 28
The reaction by central bankers and those on control of Monetary Policy is to apply traditional Keynesian thinking to the problem. But in this case it doesn’t work!
What must be done to control Inflation crushes growth.
What must be done to foster growth inflames Inflation!
It is the proverbial “Catch 22”.
The solution therefore is you must identify it early and act aggressively.
SLIDE 29
The hidden problem is that the distortions, and reporting games we have been playing for a very long time, have let us get much to deep in the Black Hole than we understand because our measures have failed to alert us of the reality of the situation.
The political “Kick-the-Can-Down-the-Road” policy approaches have only fostered “tweaking” the warning measures to buy time and make it someone else’s problem!
SLIDE 30
Let me be specific.
Inflation through statistical distortions such as Hedonics, Substitution, Imputation and others which I have previously chronicled have distorted Inflation as measured by the CPI to such a degree that Inflation, Inflation Breakevens and Real Rates are ineffective measures.
SLIDE 31
I most recently laid out how the new world of Inflation Swaps has exploded in an attempt to protect the more sophisticated institutional investors from these mirrors and mirages.
SLIDE 32
Economic Growth is also seriously distorted by an obsolete formula that is based on sound money and adopted during the era of the gold standard and fails miserably to adequately describe real growth in an era of massive government debt, transfer payments and debt financed consumption now being nearly 70% of the economy. The creators of the simple formula never imagined an economy like the one we operate in today.
SLIDE 33
Our 2017 Thesis paper entitled “The Illusion of Growth” lays out the indisputable reality of the facts in its 111 pages of detailed analysis.
The central problem and difference with what occurred in the 1970’s is important to understand. We not only have an order of magnitude worse “black hole” problem but our tools are dull and our thinking seriously obsolete. Our politically polarized governance is also a big problem but which I will leave for another day!
SLIDE 34
The simple truth and reality is that the US is highly likely to be well below the event horizon!
SLIDE 35
I have unfortunately presented a pretty bad overall story here so far! I am sorry to be so negative but the facts are the facts.
I have learned over the years however is it is never as good as I hope nor as bad as I expect.
We tried to lay out the good news in my recent video entitled “The Dam Has Broken” with Charles Hugh Smith.
The bad news is fundamentally about imbalances that must be corrected before we can launch ourselves into a new era of prosperity. The good news is they will herald new and required changes for a more dynamic and productive future.
SLIDE 36
The changes can be expected to be centered on shifts in:
- Financial Rebalancing between productive countries and indebt, unproductive countries consuming more than they produce,
- Charles Theory on De-Growth
- Re-Shoring,
- De-Financialization
- De-Globalization
SLIDE 37
Yes there will be pain as we experience the items as shown here that are likely to occur.
SLIDE 38
However, there are going to be investment opportunities for those that are prepared to an extent we have never seen before.
This is what happens when change occurs!
SLIDE 39
You may have heard that the Chinese word for “crisis” can be represented as “Danger + Opportunity.” President John F Kennedy once inspired America with this quote:
“The Chinese use two brush strokes to write the word, 'crisis'. One brush stroke stands for danger; the other for opportunity.”
Grasp the Opportunity!
SLIDE 40
As I always remind you in these videos, remember politicians and Central Banks will print the money to solve any and all problems, until such time as no one will take the money or it is of no value.
That day is still in the future so take advantage of the opportunities as they currently exist.
Investing is always easier when you know with relative certainty how the powers to be will react. Your chances of success go up dramatically.
The powers to be are now effectively trapped by policies of fiat currencies, unsound money, political polarization and global policy paralysis.
SLIDE 41
I would like take a moment as a reminder
DO NO NOT TRADE FROM ANY OF THESE SLIDES - they are for educational and discussions purposes ONLY.
As negative as these comments often are, there has seldom been a better time for investing. However, it requires careful analysis and not following what have traditionally been the true and tried approaches.
Do your reading and make sure you have a knowledgeable and well informed financial advisor.
So until we talk again, may 2022 turn out to be an outstanding investment year for you and your family.
Thank you for listening
