Yes, the stock market is on a roll with the Dow recently piercing the 26,000 mark. And the S&P500 index has pierced the 2,800 mark. Of course, the massive Federal Reserve intervention (along with other global central banks) has certainly thrown gas on the fire.
Looking at price levels alone is not meaningful. So, let’s look at two stock market adjusted indices.
First, there is the S&P Peak PEG ratio. It is a price to peak-earnings multiple, adjusted for long-run trend growth. It is at the all-time high.
Second, we have Bob Shiller’s CAPE (Cyclically Adjusted Price-Earnings) ratio that is now at the second highest peak (after the Dot,com bubble) and above the notorious Black Tuesday of 1929.
But it is not just the stock market that may be overheated. How about home prices … again?
And if we adjust home price growth by hourly earnings by the majority of the population, we see that home prices YoY are growing 3 times faster than hourly earnings YoY.
This might help explain why The Fed is so timid about unwinding its balance sheet.
I attended an investors presentation last week. Having given presentations to investors in the past, I thought I knew what to expect. I was dead wrong. The presentation was one chart, M2 Money Stock, and why the US economy is doomed because of rampant inflation. The sales pitch was to buy gold and other precious metals because the world is ending!! I just rolled my eyes.
Here is the chart (not their chart, but the same one from the Federal Reserve of St Louis).
M2 is a measure of the money supply that includes all elements of M1 as well as “near money.” M1 includes cash and checking deposits, while near money refers to savings deposits, money market securities, mutual funds and other time deposits.
To be sure, The Federal Reserve has ramped-up M2 Money Stock, particularly starting with the Clinton Administration and Alan Greenspan’s Fed. I suggested plotting M2 Money growth and population growth on the same chart.
But if we look at the same chart in Year-over-year (YoY) terms, you will see that US population growth has declined from 1992 to today. Yet starting in 1995, M2 Money Stock growth soared (although it has been declining over the past year).
But what about M2 Money VELOCITY (M2 Money/GDP)? M2 Money VELOCITY peaked shortly after Greenspan’s Fed started to rapidly expand M2 Money Stock. But M2 Money Velocity has kind of died (lowest in recorded history).
What about the “runaway inflation”? He made it sound like The Weimar Republic is coming next! I requested that he plot M2 Money growth YoY on the same chart as Core PCE Prices YoY (core inflation). M2 is growing at 4.7% while Core PCE Prices are growing at … 1.5%.
Besides, if one is worried about inflation, you can purchase Treasury Inflation Protected Securities (or TIPS).
And The Dow just broke 26,000 for the first time!
The real problem is the growing Federal Budget deficits.
With exploding healthcare costs (as in Medicare), spending is rapidly diverging from tax revenue.
And with over $20 trillion in public debt, the US is facing hard decisions on spending and taxation.
M2 Money growth is NOT causing Weimar or Venezuela like inflation. But Gold is still a good alternative to Fiat currency.
Bloomberg News — China added to bond investors’ jitters on Wednesday as traders braced for what they feared could be the end of a three-decade bull market.
Officials in Beijing reviewing the nation’s foreign-exchange holdings have recommended slowing or halting purchases of U.S. Treasuries, according to people familiar with the matter. Benchmark bonds reversed earlier gains on the news, with the yield on 10-year Treasuries climbing for a fifth day.
China holds the world’s largest foreign-exchange reserves, at $3.1 trillion, and regularly assesses its strategy for investing them. It isn’t clear whether the recommendations of the officials have been adopted. The market for U.S. government bonds is becoming less attractive relative to other assets, and trade tensions with the U.S. may provide a reason to slow or stop buying American debt, the thinking of these officials goes, according to the people, who asked not to be named as they aren’t allowed to discuss the matter publicly. China’s State Administration of Foreign Exchange didn’t immediately reply to a fax seeking comment on the matter.
“With markets already dealing with supply indigestion, headlines regarding potentially lower Chinese demand for Treasuries are renewing bearish dynamics,” said Michael Leister, a strategist at Commerzbank AG. “Today’s headlines will underscore concerns that the fading global quantitative-easing bid will trigger lasting upside pressure on developed-market yields.”
The Chinese officials didn’t specify why trade tensions would spur a cutback in Treasuries purchases, though foreign holdings of U.S. securities have sometimes been a geopolitical football in the past. The strategies discussed in the review don’t concern daily purchases and sales, said the people. The officials recommended that the nation closely watch factors such as the outlook for supply of U.S. government debt, along with political developments including trade disputes between the world’s two biggest economies when deciding whether to cut some Treasury holdings, the people said.
The yield on 10-year Treasuries was four basis points higher at 2.59 percent as of 12:16 p.m. in London, reversing a decline to 2.54 percent earlier Wednesday. The rate on comparable bunds was one basis point higher at 0.53 percent.
Any reduction in Chinese purchases would come just as the U.S. prepares to boost its supply of debt. The Treasury Department said in its most recent quarterly refunding announcement in November that borrowing needs will increase as the Federal Reserve reduces its balance sheet and as fiscal deficits look set to widen.
“It’s a complicated chess game as with everything the Chinese do,” said Charles Wyplosz, a professor of international economics at the Graduate Institute of International and Development Studies in Geneva. “For years they have been bothered by the fact that they are so heavily invested in one particular class of U.S. bonds, so it’s just a question of time before would try to diversify.”
Some investors said that the market could take the China news in its stride considering the nation’s net purchases of Treasuries have already slowed “significantly.”
“If China ceases to be a net purchaser of U.S. Treasuries, this is unlikely to have a significant impact on the overall yield curve unless China divests a large share of its total holdings in a short time period,” said Rajiv Biswas, Singapore-based chief Asia-Pacific economist at IHS Markit.
Yields were already climbing this week amid expectations the improving global economy will boost inflation pressures round the world, just as major central banks scale back their asset purchases.
Markets are also braced for a deluge of debt supply this week. The U.S. is scheduled to reopen $20 billion of 10-year debt later today, followed by $12 billion of 30-year bonds on Thursday. Germany sold 4.03 billion euros of 0.5 percent 10-year bonds on Wednesday with syndications in Italy and Portugal to follow.
Yes, China is the largest holder of US Treasuries AFTER the New York Federal Reserve, followed by Japan and Ireland.
But since 2012, both China and Japan has slowly decreased their holdings of US Treasuries while the New York Fed has greatly increased their position (better known as QE3).
Yes, the Chinese government is comtemplating an Escape from the New York (Fed) in the face of rising interest rate and trade squabbles with Washington DC. We shall see if it is bluff by China or not.
Another indicator, commercial and industrial lending from commercial banks, is approaching a flat stall. Even real estate lending is slowing again YoY.
Throw in our Federal government debt of over $20 trillion and skyrocketing consumer debt,
So, The Federal Reserve was wildly successful in terms of lowering interest rates and encouraging the Federal government and households to gorge on debt. Wait, households are responsible for the Federal debt!
The Federal Reserve doesn’t activley manage its interest rate exposure on its over $4 trillion balance sheet. Yet it purchases and sells Treasury Notes/Bonds and Agency Mortgage-backed Securities (AgMBS) in a measured way to impact interest rates.
[W]hen it is time for us to sell, or even to stop buying, the response could be quite strong; there is every reason to expect a strong response. So there are a couple of ways to look at it. It is about $1.2 trillion in sales; you take 60 months, you get about $20 billion a month. That is a very doable thing, it sounds like, in a market where the norm by the middle of next year is $80 billion a month. Another way to look at it, though, is that it’s not so much the sale, the duration; it’s also unloading our short volatility position.
… we look like we are blowing a fixed-income duration bubble right across the credit spectrum that will result in big losses when rates come up down the road. You can almost say that that is our strategy.
I hope Powell’s messaging skills have improved since 2012 when he uttered these words. He does sound more like billionaire Thurston Howell III than a future Fed Chair.
Yes, The Federal Reserve can manipulate interest rates through its policies and INFLUENCE the volatility and duration of Treasuries and Agency MBS. (He should have made that clear, particularly for Agency MBS).
Here is a chart of U.S. JP Morgan Treasury Investor Sentiment Active Client Net Long positions are The Fed has been SLOWLY unwinding its Treasury Note/Bond portfolio over the past year. Notice that net long sentiment is in negative territory.
For Treasury shorts, the investor sentiment has been rising with the slight T-note/bond unwind.
10-year Treasury Note volatility remains repressed despite the teeny sales of The Fed’s balance sheet.
It really does look like The Fed is scared to actually try to unwind its balance sheet, particularly for Agency MBS extention risk where duration (risk) rises with rate increases. Particularly since we are in a low rate environment where small rate increases can crush note/bond/MBS prices.
Here is a photo of the next Fed Chair, Jerome Powell.