US stocks are at or near all time record highs across all major indices, with the markets bursting out after the election win of Donald Trump back in November 2016. Since then investor bullishness has also spiked to 10 year high levels. While this bullish euphoria is occurring something else is taking place far more important. The US economy has been trending down for some time now and the slowdown momentum is gathering pace as it moves closer to a recession possibly as soon as this year.

Market Euphoria Clouds Judgement

The markets have a history of becoming totally blind to whats actually occurring in the real economy, instead focusing on the direction of the market to give them an indication of whats taking place. In the chart below you can also see that the composite bullish index (red line) back in mid 2007 was very high around 130 just before the markets began their 50% decline.

Currently the market greed / fear index (see chart below) is close to at the maximum level of extreme greed side, while the actual economy is rapidly declining with a similar dynamic playing out presently with a potential twist to the market outcome.

How Can The Market Be At Record Highs While The Economy Is Heading Towards Recession?

In a nutshell the answer is Central Banks, if you take a look at the chart below you can see how the Central Banks have massively increased their balance sheet since 2008 / 2009. This has been achieved by printing money and buying up assets to provide additional liquidity into the system. This extra liquidity has flowed its way into stocks all over the world, regardless of which Central Bank has been been providing the additional liquidity.

Recently though most Central Banks have once again picked up the pace in growing their balance sheet . So even though the US has effectively kept their balance sheet flat to slightly down over the last 2 years, the other Central Banks have effectively been adding to the pool of global liquidity pushing up prices of stocks, real estate and other assets. Clearly this practice is totally artificial and is giving false bullish signals to investors as the markets are not functioning on their own.

The S&P 500 Index No Longer Tracks Earnings

Further evidence that the Central Banks actions are providing false signals to the markets is shown in the chart below. S&P 500 earnings per share (EPS) are totally out of sync with the rise of the market and now represent a large divergence in their trends.


Earnings are now slowly tracking higher after falling for several years, however this is more a case of financial engineering of companies artificially raising their EPS by buying back their stock usually with debt. Since 2012 corporate profits are down so even companies themselves are misleading investors to the true financial health of their investments.

How Lower Corporate Profits Tie In With The Economy - Jobs, Jobs, Jobs

Since 2016 global employment in S&P 500 companies has been slowing down (see chart below) and late 2016 turned negative as the slowdown accelerated with employment growth. The last time this occurred the US economy went into a recession shortly after.

If you look at US non-farm payrolls you will notice that its also trending down but a slower pace.

The interesting point about the non-farm payrolls data is that the data each month is provided based on the combination of a Government surveys (small sample) as well Government generated predictions of jobs, Ie Birth death model of estimated new businesses commenced to produce the monthly result. Several months later up to a 1 year later the actual data collected from companies are imputed and adjustments are made on prior months. Usually the number of jobs actually created is readjusted lower. So the true effect of a slowdown with companies in the S&P 500 will not show in the non-farm payroll data for several months.

Every Time The FED's Own Signal Falls Below Zero Y/Y A Recession Occurs

Scroll video to 12min 52sec.

This video indicates that an indicator that the FED actually monitors has fallen -0.3 in December and has fallen 5.8% y/y, which is the largest since 2010. Each of the last 8 occurrences of this indicator falling below zero y/y has resulted in a recession in the US.

Consumer Credit Grow Demand Drops 43% Month on Month

In December consumer credit grew by $14.2 billion  a 43% drop compared to November's $25.2 billion. Since consumer spending makes up over 70% of the GDP data and the savings rates is falling in the US, a large drop in the amount of new credit card debt also points to a slowdown in retail sales.

The credit data below is actual data collected from the banks rather than from surveys, so it shows a very accurate picture of demand for credit card debt. Given the big collapse in S&P500 employments levels the trend in credit demand will likely continue to move lower and lower the GDP result.

FED Senior Loan Officer Survey Demand Falls Over

The overall trend for credit demand going forward is not looking good with the latest results from the FED senior loan officer survey. Indications for demand for debt for Construction, credit cards and auto loans are all down at multi year lows.

This is important as credit demand overall has been tied to overall demand within the economy and especially with consumers. If the intentions from the survey follow through, the slowdown in the economy will begin to gather pace with the higher probability of the US starting a recession in 2017.

Auto sales have performed very strongly since hitting the lows in 2009, with demand for auto loans driving a large proportion of retail sales demand. Auto sales have recovered strongly also because interest rates for auto loans have fallen substantially over the last 7 years from the FED dropping interest rates and pushing down bond yields via QE purchases. This has allowed buying a new car more accessible for consumers and allowed consumers to own more expensive models that previously they have not been able to afford on higher interest rates.

Auto sales Decline Y/Y First Time Since 2009

The strong performance of auto sales bubble appears to be over as December and January figures have been very weak. Making things worse y/y auto sales have recorded its first decline since 2009 the same year the US experienced a recession.

The data below shows the big 4 car companies in terms of autos units sold all experienced declines in y/y figures. Since the FED senior officer survey results for demand for auto credit is also falling, US car sales declines will  most likely continue in 2017.

With Record Amounts Of Stimulus Why Is The US Economy Weak?

Each month the Government releases the wages growth figures and overall they are usually positive rising slowly over time. The data that the financial media show is the data in the chart below (red line) which is nominal growth in wages. Since 2000 nominal growth has risen 40.2%, however when you take into account inflation real wages have declined 1.1% over the same period.

When the Government calculates inflation, the data they release is usually under reporting the true state of inflation due to various statistical measures like hedonics applied to the data to bring the level of actual inflation down. Therefore the average workers real wages have probably fallen by more than 1.1% since 2000.

Since the average worker has to spend more of their wages to buy the same amount of goods and services, this impacts on their spending power and ability to borrow. Lower spending and borrowing capability translates to weaker GDP growth since consumer spending makes such a large proportion of the calculation.

Weaker Economy = Higher Bankruptcies

The 2009 US recession caused bankruptcies to rise for several years and after peaking in 2011 the overall trend in bankruptcies continued to decline for the next 5 years as the economy recovered from record stimulus implemented by the FED and the Federal Government.

The declining trend has shifted when bankruptcies began to surge in November 2015 and continued to move higher in 2016. This has resulted in bankruptcies recording their first y/y rise since 2010 after rising 26% from the prior year.

Given bankruptcies is a lagging indicator due to the time required to process and complete bankruptcies, the deterioration of the economy has been occurring for an extended period of time now. Since other economic data  is showing further weakness, bankruptcies will continue to rise further in 2017 and into 2018.

Stimulus High No Longer Effective

Despite continuous stimulus of some form or another from Central banks and the US Federal Government growing their debt levels at record pace, the 2016 GDP growth came in at only 1.6% matching the 2011 low read after hitting 2.6% growth in 2015.

Based on the actual data from the US Government, the economy is slowing and no longer receiving a boost from the various stimulus options in place currently to support the economy, consumers and businesses.

Whilst the economy was slowing in 2016 another setback for the economy occurred in November last year, when the US 10 year Government bond yields soared over 0.60% within short period after the US election results.

Given the majority of consumer and business debt products interest rates in the US are priced from the 10 year Government bond yield rate, consumers and businesses effectively experienced two 0.30 rate rises over a 2 month period in late 2016. To view the article written back in November outlining the impact of higher Government bond yields on the US economy click the link below:

Surging Bond Yields Signalling Pain Not Growth Ahead For US Economy

A Rising Stock Market During A Recession Is A Possibility

After viewing this article you might come to the conclusion that despite the stock market sitting at record highs in the US, stocks are set to fall if an imminent recession is arriving in 2017. Well not exactly, since we are not in normal times and the actions of Central banks and the US Government are unprecedented.

When you take into consideration several of the previous FED QE programs occurred after US stocks began to correct by around 10%. In addition the odd market behavior in stocks over the last 6 - 12 months where we have not experienced a fall of greater than 5%. Its a reasonable possibility that stocks may stay elevated or even rise higher even if the US has an official recession. If this occurs this will be another new record in US history.

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Disclaimer: This post was for educational purposes only, and all the information contained within this post is not to be considered as advice or a recommendation of any kind. If you require advice or assistance please seek a licensed professional who can provide these services.

The world has changed a great deal in the last 85 years in terms of how the markets and the economy functions as well as how we see them operating. Slowly over time we have added and implemented more and more policies, regulations, controls, mechanisms and various forms of stimulus in an attempt to smooth out business cycles booms and busts. Central Banks (CB's) and Governments have tried very hard to shorten the busts / recession cycle by lowering interest rates and extend the boom cycles in each and every business cycle over the last 85 years.

Now we fast forward to 2016 and the chief aim is to never experience a bust / recession / depression or deflation ever again. Central Banks (CB's) have taught us that they are all bad things and that we must avoid them at all costs.

These CB's have tried multiple policies and even some new experiments like negative interest rates in attempt to keep the global economy from experiencing a slow down or any amount of deflation. How bad is it really if the price of everyday items like food, rent and fuel becomes 1 or 2% cheaper each year. For the average income earner around the world their money will be allowed to go further if prices fall.

The more we have tried to control every aspect of the market, capitalism and the economy, the harder its becoming to not lose total control of these very things. However I believe we are already in the process of losing control of one of the most important things, the real economy. Presently all the Central Banks have done an excellent job at keeping the Financial assets Ie Stocks and Bonds markets up at or near record highs , while the actual economy has been unable to improve in real inflation adjusted terms over the last 10 years.

Real Assets At All Time Lows

If we take a look at the chart below, it illustrates perfectly the complete distortion of over 85+ years of controlling mechanisms, policies and Central Bank experiments have done to the relative value of real assets compared to financial assets.

This chart goes all the way back to 1925 and currently we are at an all time low, for real assets (Houses, commodities, fine art, jewellery etc) relative to financial assets of stocks and bonds. All the stimulus and attempts at controlling the markets and economy have only influenced the price of financial assets. Financial assets are more easily influenced and controlled through electronic exchanges, rather than real tangible assets which are much harder to manipulate on a global scale.

In the video below, Ray Dalio and company deliver a frank assessment on how we have reached the physically limits of the system. As we have artificially pushed markets and demand higher through debt accumulation, lowering interest rates to zero and by ballooning the derivatives market.

Increasing Volatility And Valuation Divergence

The chart below provides a good understanding on the ever increasing huge swings in volatility the financial markets have experienced. Central Banks began to introduce and try new stimulus and policy ideas in the early 2000's to reduce the busts / recessionary periods, causing large swings in the prices of the financial market as well as the valuations.

The most recent round of stimulus that began in 2009 with Zero Interest Rate Policy (ZIRP), followed by QE 1, 2, 3 and negative interest rates have stretched out the valuation of the S&P 500 relative to US productivity. Up to 1995 / 96 US productivity moved in sync with the S&P 500 stock market. This is clearly no longer the case as the chart indicates a strong divergence in valuation.

This week we received the latest monthly industrial production number in the US and showed that the year on year figure remains negative.

Since mid 2014 you will notice that industrial production data used to coincide with the value of the S&P 500 index very well. Now industrial production has been falling for 2 years and the stock market is near nominal all time record highs.

One of the policies that the Central Banks have utilized to try and control the economy, markets and financial assets values is to physically adjust interest rates up and down. Since the 1980's when Paul Volcker raised interest rate to around 18% to combat high inflation, we have been steadily lowering them all the way to zero.

Why Lower Interest Rates No Longer Work?

Presently the federal funds rate is at 0.25% as you can see from the chart, however lower interest rates are no longer having the desired effects to stimulate the real economy anymore. One of the reasons for this is the fact we have reached the limits of our debt bubble cycle. We can no longer leverage ourselves any higher despite having interest rates at close to zero .

Leveraging Corporate America

One of the many side effects of lowering the federal funds rate to close to zero, has been the leveraging of US companies to levels higher than the 2007 and 2008 peak before the GFC crisis. Debt to equity is approaching 60% for non-financial companies, as the incentive to load up on debt has never been so high. But is it really helping corporate America?

What Is The Debt Being Utilized For?

The accumulation of more debt relative to assets would be ideal in the short term if companies were utilizing the debt to fund new innovation, capital expenditure and additional capacity for future growth.

The reality is that a large majority of the debt accumulation has been utilized to fund buybacks of company stocks to artificially boost earnings per share (EPS) which in turn helps stock prices rise despite the company profit not actually growing from this strategy.

The chart below shows that share buybacks have more than doubled since 2012 to $161 Billion in the 1st quarter of 2016, as more companies engaged in artificial growth strategies rather than invest in their own business models.

IBM a large technology company that has been an consistent innovator issuing several thousand new patents each year. However even though IBM still continues to issue several thousand patents, the company has been steadily increasing its debt levels (See chart below) to allow it to participate in stock buybacks.

IBM Increasing Debt & No Growth

These higher debt levels has allowed IBM to engaged in stock buybacks with the additional funds at their disposal. Unfortunately for IBM the stock buybacks have not helped the actual company as  it has struggled to grow over the last few years.

The chart below is a perfect example how a large company has tried to control its EPS through artificial boosting its profits with stock purchases funded through debt. However the actual result is that IBM's revenue (which can't be artificially adjusted through stock buybacks) has been falling since 2012 as the company continues to struggle to grow its top line and bottom line numbers.

Netflix, which is relatively young technology company that provide online streaming of TV content, is a company that has been investing large amounts of money into the companyto deliver new and original TV content, as it differentiates itself and reduces its reliance on licensing content from other media companies.

On the 18th October Netflix announced its latest quarterly result, which was above estimates for EPS and subscriber growth. However the interesting thing that investors didn't seem care about is that Netflix free cash flow is going the wrong way and accelerating. It burned through $506 million in a single quarter and just over $1 billion over 3 quarters. (See chart below) The stock ended up jumping around 19% after reporting its results.

Because of the huge drain of cash despite reporting a profit, Netflix did mention it will be tapping the markets for an increase in debt soon. Because interest rates are so low the market does not care that Netflix is essentially, borrowing more money to make new TV shows to attract more members. The current business model is simply not sustainable, especially when the company spends $142 to add one new subscriber.

If Interest rates were set by the market and were not manipulated by Central Banks the actual interest rate would be significantly higher to encourage savers to part with the capital. In this scenario Netflix business model would not survive in its current form.

The last chart summaries very simply, how "we have lost control of the real economy by trying to control everything". Global GDP estimates continues to decline as global stocks continue to increase, as Central Bank balance sheets fund global stocks higher.

Lastly this MUST WATCH video Rick Santelli makes a simple request to Central Banks.

Sources:

Forbes.com
Fred.stlouisfed.org
Zerohedge.com
Wsj.com

The S&P 500 broke its 8 month uptrend yesterday, as US 10 year Government bond yields have continued to move higher, signalling potentially more pain ahead for the S&P 500 stock index.

For the calendar year the S&P 500 is still up after falling in January and February this year, as the S&P 500  has not looked back since touching the lows for the year around the 1820 level. However the index has closed below its long term uptrend where it's current resting on a support level. (See chart below)

Moving forward the key to the direction of the S&P 500 is whether the break in trend is confirmed and it closes on a daily chart within or below the rectangle box shown in the chart below.

Break In Trend - Head Fake

An important note to make is that earlier this year on June 27th the index broke its uptrend after the Brexit vote shocked the international markets. However it quickly rallied back within the uptrend as coordinated efforts by the Central Banks, to artificially lift the stock markets with more stimulus worked. This allowed the index to move significantly higher over the next few months. Therefore it can't be ruled out that the break in trend is only a head fake by the markets and the Central Banks once again panic and step in to save the markets.

If the break of the uptrend is confirmed and is able to close below 2128 level on a daily basis the next level of support is around 2035 / 45 level.

Catalyst For The Break In Trend

Since making the highs in August this year the S&P 500 has been going sideways to slightly sloping down. One of the main catalysts for this is the rise in US 10 year Government bond yields, which have been steadily rising since making lows in July this year. (See chart below)

The chart below of the US 10 year Government bond yields is of a weekly chart, which allows you to see a better indication of the bigger longer term trend that is taking place.

From the chart you will notice that the weekly downtrend broke in the first week of September, where I have circled the chart. After it closed above its downtrend it fell briefly to the 1.59% level, which is now its new support level. After resting on support it started climbing again in the first week of October.

The fact that weekly downtrend that has been in place since 2015 broke last month, indicates a big shift is taking place for the S&P 500 index as well as global stocks in general.

Why Higher Rates Are Not Good For Stocks?

Stocks traditionally move in opposite direction to bond rates / yields, as stock indexes are priced / valued according bond yields. If bond yields move higher stock dividend yields need to move higher as well, to compete with higher returns from bonds. To get higher dividend yields stocks need to either, generate higher dividends or the price of stocks falls or both.

The other reason higher bond yields are not good for stocks is that the higher the yields go the more expensive it is to take on debt for consumers and companies.

Higher debt payments for consumers reduces demand for products and services effecting companies revenues and profits, which ultimately ends with stocks falling.

Since corporations in the US have record debt levels to fund massive buybacks and dividend payments. Rates climbing and breaking its downtrend is also bad news for stocks.

To see a recent article where I discuss the shifts in bond yields and the negative impact on global stocks you can click Is the bull market in stocks ending?

Disclaimer: This post was for educational purposes only, and all the information contained within this post is not to be considered as advice or a recommendation of any kind. If you require advice or assistance please seek a licensed professional who can provide these services.

The 7 Year Experiment

Central Banks around the globe have experimented with a myriad of different policy tools over the last 7 years, with the explicit goal of reigniting global growth to prior 2007 levels. Central Banks figured if they could reverse falling asset prices and deflation, by creating inflation via Quantitative Easing (QE) they would be able to re inflate asset prices and kick start growth.

However since the global economy slowed down in 2007 and reversed course, crashing in 2008 and 2009, growth hasn't been quite the same. In fact the recovery from the 2008 recession has been the weakest in history.

By flooding the world with trillions of dollars in liquidity and creating money out of thin air, by printing digital money or QE and dispersing it through the banking system, the Central Banks have been able to create the illusion that the global economy is growing and things are back on track.

Yes the S&P 500 is just off all time record highs in price, and yes real estate prices around the globe have either recovered most, or all of the losses prior to the 2008 crash. Better still real estate markets in some  countries like in Canada and Australia have surpassed their previous highs . Wages have also been rising steadily for the last 5 years after falling from 2008 to 2011. Yet for the average person it doesn't feel like we are better off with higher levels of standard of living. More importantly we cant seem to pin point the exact reason why.

The Hidden Tax

The actual reason why the recovery from 2008 crisis has been so sluggish, with the weakest on record is because real household incomes adjusted for inflation have gone nowhere. In fact real household wages are down 1.1% in the last 16 years. This is evident even though nominal wages have actually grown by just over 40% since the year 2000. (See chart below Titled: Median Household Income in the 21st Century)

Inflation is sometimes referred to as a hidden tax, because you don't seem to notice it as much on a day to day, quarterly or annual basis. Yet inflation over a 5 or 10 year period or longer can be really easy to spot when you take a look and compares prices over longer periods for goods, services and assets like food, rent, education and real estate.

Since real wages adjusted for inflation has not increased in 16 years, yet the level of private debt has grown dramatically over the same period, the share of wealth by the bottom 90% of US households has actually been declining. (See chart Titled: Distribution of wealth in the US since 1917)

The reason for the decline is because the bottom 90% have used debt to fund increasing consumption on their home and living expenses, since their real wages have stagnated. In comparison the top 0.1% have steadily been increasing household wealth as they have been able to utilize debt and higher equity / capital levels to take further advantage of rising asset prices over time.

Lastly to further illustrate the real cost of inflation, and how it can be subtly hidden from most people. Take a look at the chart below of the S&P 500 which has been adjusted for inflation.

If you take a look at the current level on the right hand side of the chart you will notice its only just above the price level from the year 1999 / 2000 level.

The second interesting point is that the last bull market that occurred between 2001 - 2007 did not reach the prior 1999 - 2000 level when adjusted for inflation, even though the nominal price chart for the S&P 500 recovered to the same level as 1999 - 2000.

Some Things Cant Be Manufactured

So after experimenting with so many different policies and trillions of dollars in QE, Central Banks have achieved the outcome they have desperately tried to create, inflation and an artificial type of manufactured growth. Artificial because when you factor or adjust for inflation, you realize that there isn't a whole lot of real growth to be shared around.

Sources:
macrotrends.net
zerohedge.com

On Friday the US markets experienced a sharp sell off across all 3 major stock indices including the S&P 500 which fell 53.5 points or 2.45% on Friday amid fears that a rate rise was coming as soon September or December this year from the FED.

The weekly chart below shows the S&P 500 closed right around the the support level of 2125, which was the previous resistance levels that it closed above back in mid July.

On the weekly chart you can also see that even though the S&P 500 experienced a sharp fall for the week, the current uptrend  has not been broken. The trend has been in place since the start of the year when the market fell sharply in the first couple of weeks, touching a low of 1810 on 2 occasions before starting its uptrend. 

The next week is key for the S&P 500 for both its support levels and its uptrend. If there is a follow through with further selling over the next week, the next level of support is around the 2035 level shown below with the thick black horizontal line, some 90 points away from the closing price reached on Friday.

So what caused the severe sell off on Friday across nearly every market, including Commodities, Currencies, Bonds and Stocks?

Well it started on Thursday when the ECB at its meeting, failed to indicate that further QE would be provided when the current program ends next year. The selling then continued on Friday and accelerated, when FED official Rosengren indicated that an interest rate hike in September is possible.

The chart below which was created by Zerohedge shows perfectly just how addicted the markets are to QE and low rates. The dotted line in the chart shows when the comments were made, it clearly illustrates the markets were spooked by the possibility of an interest rate hike.

Taking a closer look of the S&P 500 chart over the last 7 months, I have circled Friday's sharp fall as well as the even sharper falls experienced after the Brexit vote back in June. I wanted to give you some context to the volatility experienced on Friday, which the markets have not experienced anything similar since the Brexit Yes vote in the UK.

Similar to the Brexit event where volume spiked in June, the volume on Friday was noticeably above the average daily volume which is also a bearish signal.

The last 2 months has seen the S&P 500 show low volatility with the market going sideways with limited price action. Now the S&P 500 has broken the narrow sideways channel on Friday, the next 2 weeks leading up to FED rate decision on the  22nd September, will most likely be more volatile than the previous last 2 months. 

Disclaimer: This post was for educational purposes only, and all the information contained within this post is not to be considered as advice or a recommendation of any kind. If you require advice or assistance please seek a licensed professional who can provide these services.