David STOCKMAN
We have been here before—-in the blow-off stage of a stock market mania that is being driven by nothing more than momentum. Speculators and robo-machines alike are buying the market solely because it is going up (almost) every day.
Their excuse is FOMO. But their downfall will be utter failure to have noticed headwinds gathering everywhere—but most especially in the Imperial City.
The fact is, the current Continuing Resolution (CR) impasse underscores that Washington has been reduced to a state of operational dysfunction, policy fracture and partisan paralysis like never before. The pols can only keep the lights on 4 weeks at a time—or maybe even less as tonight's shutdown showdown will determine.
To be sure, the talking heads of bubblevision bravely insist that this latest shutdown threat doesn't matter because when push-comes-to-shove these CR and debt ceiling impasses always get resolved, enabling the market to live for another day. No sweat!
Au contraire. Each time the fiscal can is kicked down the road by one of these pathetically short CRs, it is actually a measure of defeat because under today's macroeconomic and financial circumstances, time is the absolute enemy as the pressure in the cooker inexorably builds to the explosion point.
Everything is out of sync and behind the curve—on the monetary, fiscal and macroeconomic fronts.
The Fed has dithered for 100 months in failing to normalize interest rates and reduce its hideously bloated balance sheet. Belatedly, however, the knee-jerk Keynesians who inhabit the Eccles Building have become positively desperate about re-loading their "dry powder" to combat the next recession.
So they have put shrinkage of their massive portfolio of govevernment and GSE debt on automatic pilot. This means that for the first time in history the Fed will be dumping bonds on the market at a $600 billion annual rate come October.
And there is every reason to believe that the ECB's bond buying days will hit the zero marker in October, as well, and that compares to a $90 billion purchase rate only a few quarters ago. Indeed, under its upcoming German leadership takeover, it is likely that the ECB will actually pivot in 2019 and embark on a bond dumping campaign, too.
So what has been a concerted central bank bond-buying campaign at the $1.5-$2.0 trillion level per year is heading for the flat-line. And eventually the entire $22 trillion convoy of central banks will pivot toward QT (shrinkage) when the madman Kuroda of the BOJ is finally nudged off the stage next spring when his term ends.
To be sure, the impending era of relentlessly rising bond yields is not especially indicative of an outbreak of monetary policy enlightenment among the world's central bankers. Rather the lead dogs are the Fed and the PBOC and each has their own Keynesian-statist reasons for pivoting to QT.
In the case of the Red Ponzi, it's the palpable fear of Beijing that its $40 trillion house of debt cards will come tumbling down unless it sharply curtails the explosive growth of credit—especially in the shadow banking system and real estate sectors. But the point is, with the Fed and PBOC pulling in the reins, the balance of the world's central banks will have no choice but to follow their lead or experience devastating foreign exchange market dislocations.
It is only the suspension of disbelief on Wall Street—-owing to several decades of central bank coddling—-that fails to recognize the QT danger. Yet the three main central banks are sitting on elephantine balance sheets that account for 23%, 50% and 95% of GDP in the US, Eurozone and Japan, respectively.
These levels are so far off the charts of historical practice that they fairly shout out: The global bond market is a fake!
It's actually the artificial product of trillions of phony central bank "demand" for debt securities that is now coming to an end, meaning that the $100 trillion global fixed income securities market is about to clear based on real money savings, not central bank fiat.
This will soon become known as the Great Bond Market Reset, and that development will knock the stuffings out equity and risk asset markets, where aberrationally low yields and cap rates are still priced-in.
In this regard, a key milestone was punctured this morning when the 10-year treasury yield hit 2.64%or exactly double the 1.32% bottom record in July 2016— after a 35 year downhill march from the15.8% yield your editor once experienced up close and personal.
Needless to say, neither Washington nor Wall Street are prepared for the Great Bond Market Rest, and an era of relentlessly rising yields. In this context, in fact, the complacent theory of the talking heads is especially egregious.
Not too worry, they aver, the Fed's withdrawal of "extraordinary monetary stimulus" is being well telegraphed and implemented slowly.
Right. Somehow the implication is that if you know a freight train is barreling toward you, it's safe to remain sitting on the tracks.
And that gets us to the current shutdown crisis. The can will be kicked in due course, of course, whether it's before midnight Friday or late Sunday evening in order to assure an orderly opening to the markets in Asia.
But the reason this is very bad news is exemplified by the manner in which the House GOP leadership passed the 4-week extension with relative ease last night by a 230-197 margin. In a word, Speaker Ryan and his henchman bought off the leaders (Mark Meadows and Jim Jordan) of the Freedom Caucus with promises to, well, spend a lot more money as soon as possible!
That's right. The only remnant of political support for fiscal rectitude will get a vote within ten days on raising the defense appropriations for FY 2018 (the current year) by $80 billion, and also a standalone vote on an anti-immigration package to include the Donald's $30 billion Mexican Wall boondoggle.
Up until around 6 p.m. Thursday the House also did not have the votes needed to pass the CR, but reluctant Republicans got on board after House GOP leaders negotiated a deal with Freedom Caucus leaders Mark Meadows and Jim Jordan for upcoming votes on defense spending and immigration. President Donald Trump was also involved in the dealmaking, Meadows said.
What this means, of course, is there is no stopping what we have previously described as the mother of all bond market collisions. There is virtually no way that the FY 2019 borrowing requirement will come in much under $1.2 trillion—given the $700 billion baseline deficit, $280 billion revenue loss from the tax bill and upwards of $200 billion of additional defense, disaster aid, ObamaCare subsidies and domestic appropriations that are now certain to happen.
With the Freedom Caucus having vacated its prior posture of resistance to the fiscal tidal wave now cresting, the on-going CR battles—a few weeks at a time—amount to a little more than a Washington Kabuki dance; it's designed to shuffle through the legislative sausage grinder this massive spending outbreak a few pieces at a time.
In short, the two financial arms of the Imperial City—-the central banking branch and the US Treasury— are about to dump $1.8 trillion of debt on the global bond markets. And we are quite sure that the law of supply and demand has not been repealed.
Nevertheless, ignoring these inexorable developments entirely and marching happily to the tune of cans being kicked and bouncing down the road, the stock market keeps trucking steadily higher.
And we do mean higher. At yesterday's peak moment, the Russell 2000 was valued at 139X earnings and the S&P 500 at 25.3X LTM earnings. And that figure still tallies to 24.5X the earnings now projected for the full year 2017 at the start of the Q4 earnings season.
So suppose the improbable occurs and they actually make the current estimate of $110.50 per share for CY 2017 (just two weeks ago it was $114.45). In a word, it would be exactly nothing to write home about.
That's because this current year estimates compares to $85 per share posted way back in June 2007 at the pre-crisis earnings peak. The 10-year peak-to-peak growth rate, therefore, would amount to a mere 2.5% per year growth rate.
That is to say, the revilers and momo chasers are buying the third oldest business cycle in history (at month #103) at a nosebleed PE multiple so late in the cycle that the next recession is palpable. And they are doing so after chalking up the lowest earnings growth trend in modern history.
During the 2000-2007 cycle, for instance, peak-to-peak earnings growth for the S&P 500 was 8%, and for the 1990-2000 cycle it was 9.5%.
The above cited PE multiples are based on reported GAAP earnings, of course, because that's the only way to honestly and consistently measure results. The notion that one-time charges for goodwill write-offs, plant and store closures, employee severance and restructuring charges and the like don't count is simply a Wall Street scam: All of these so-called "ex-items" charges consume corporate cash or waste corporate capital.
That's why they are included in GAAP based filings with the SEC, which CEOs and CFOs must certify as correct upon penalty of jail time. Moreover, always recall that these street based ex-items hockey sticks also have a way of deflating rapidly near the end.
For example, as recently as March 2016, the Wall Street consensus for S&P 500 ex-items earnings for CY 2017 was $136 per share. But after being lowered every quarter since then, it is now down to $125 per share and still dropping.
So even if you value the market at earnings less anything inconvenient, its still trading at a 21.7X PE multiple for 2017.
But here's where the delirium part comes in. Even at Wall Street's ex-items number for CY 2017, S&P 500 profits have essentially flat-lined during the last three year, rising by just 2.9% per annum since September 2014. The ballyhooed outbreak of "growth" during the last several quarters, therefore, represents nothing more the commodity inflation and deflation cycle moving through the numbers in pig-in-the-python fashion.
This time is apparently different, however, because Wall Street's ex-items hockey sticks are projecting growth of 20% in 2018 and a further 11% in 2019.
What they aren't projecting, of course, is the huge headwinds to earnings growth implicit in the aforementioned collision of the Fed's unprecedented QT program and the massive $1.2 trillionborrowing requirement of the Treasury next year.
Soon the "yield shock" will hit the equity markets with full fury. That's because the trillions of leveraged (on repo) private capital, which have been front-running the central banks' bond-buying campaigns, will also pivot: The realization will dawn that picking up nickels from selling what the central banks are selling is a sure way to mint money—just as the opposite was true during the run-up of central bank balance sheets from $2 trillion to $22 trillion over the last two decades.
Needless to say, the history books are very clear about what happens during a blow-off top that hits it asymptote. To wit, during the first 60 trading says of 2000, the NASDAQ 100 climbed by 27%—-rising from 3700 to 4700 on March 27.
Alas, 12 trading days later, this entire bubble top gained had been wiped out—with the index down by 23% to just 3600—-and on its way 18 months later to 850. That is, an 85% wipeout.
What's different this time, of course, is that there will be no rapid monetary reflation or other bailout from Washington.
As we are learning from the latest shutdown contretemps, it has now become the big bloated engine that can't.
