Monday, April 18, 2022

It looks very scary!

Imagine being on an intercontinental jumbo flight, which is full with passengers, the pilot has just announced the power to all the engines are lost and they are about to crash land into an open space on the earth, nose down. What would be in the minds of the fellow passengers?

Anyone who is remotely aware of the US bond market carnage of last month can contemplate this same feeling about the fragile US economy that is about to crash land with assured causalities. It is almost certain there is going to be a crash landing. What is hoped for, there is a some kind of safe landing where only some get affected. It is almost impossible to save all of them or at least majority of them.

The bond market has been virulent in the last 4-8 weeks. Yields rising more than 100 bps within a month or so in both short and long-term bonds. There is literal blood-bath. The total return value on the bonds has not lost this much value within this kind of a short time span in recent memory. Jim Bianco says, this is the worst bond market blood bath in our lifetime so far.  Unfortunately there isn't a stop on the horizon. There is no bottom coming. As of this morning, the 30-year is knocking on the 3%, trading close to 2.96%. The 10-year, isn't far off at 2.86%.

The yields on the bonds move opposite to its price. With rising yields there are no enough takers. Peter Schiff says, It is right, the bond market is pricing in a recession ahead of us. The recent inversion of the yield curve rightly suggests that. What they are not realizing is how high the yields are going and how fast it's going to happen.

The carnage in the bond market is not being noticed by the stock market. If the yields on the bonds keep going this way for say another 3-months., the yield on the 30-year may well go past 5%. This obviously is a negative for the stock market because people would opt for risk-free returns than the risky bet on the stock market at current high valuations. The yields going further would cause a bond market crash. Once the yields go past these smaller numbers, existing bonds would lose a lot of value. With the Fed going from a net buyer to a net seller - There wouldn’t be any takers for the bonds. With planned deficit budget and trade deficit for the coming year, the government is only going to  borrow more.

The vanguard bond portfolio is down more than 8% similar to the stock portfolio YoY. If the so-called, bond safe haven can lose 8% within a quarter, just imagine how much the risky assets possibility of huge falls. The yield on the 30-yr is going to rise further and further. The only thing that can stop this is a stock market crash. If the stock market doesn't crash, the bond market definitely will and that will crash the stock market too. There isn't lot of good possibilities actually. The Fed has promised to raise interested rates by 50 bps, when they meet in first week of May. The Fed is very late already. The bond investors know it. What they don't know now but will eventually know later - is that the Fed will give-up on its inflation fighting goal to save the economy.

The inflation picture now in the US is abnormal to this generation of people. The American public has lived in a no to low inflation zone for the past 40 years. Paul Volcker raised interest rates to 20% to tame the high inflation of the late 70s and early 80s. Since then the bonds had been in a bull market. Alan Greenspan introduced the American public to low interest rate regime during his tenure at the Fed. The housing boom was caused by it. Once the interest rates started going up, the housing bubble burst causing the great financial crisis in 2008. As part of the recovery from the financial crisis, the economy was boosted with even more of lower interest rate regime and multiple quantitative easing (QE) also called stimulus - to create multiple bubbles under Ben Bernanke. Everything was OK until the US saw inflation creeping up. The inflation in Feb 2021 was a 2 handle. The YoY is now up to 8.5%. The rapid ascent in inflation is relatively unheard of in recent US history. It has brought jitters all over.

Import/export data came in last week. This is probably more accurate than the CPI because it is not manipulated by the method of measurement. It's just plain dollar amount of prices. They run more than 12% YoY. The retail sales up by 0.5% ., and just 0.2% excluding Food & Fuel - confirms the customer is thinning out and isn't spending as usual. The true inflation is really biting the American household.

Without a fundamental shift in asset prices, the economy cannot be resolved to its neutral value. For this to take place - interest rates need to go higher and got to go higher faster. In all of this., the Fed has just started. It is moving interest rates by 0.25 is too slow compared to the unfolding price increases across all products and services. Of all industries the tech seems will get hit first.

Tech-bubble has already been pricked. After the smaller tech being hit hard, now the darlings of the last decade are getting whacked. We have seen the big-tech (FAANG) now getting hit. Most of them are already in bear market territory or just be there soon. Other non-FAANG darlings like nvidia for example is down more than 35% from its recent highs. The Banks are getting killed too. They are all trading well below their recent highs, some to an extent of even down 40%. With mortgage rates now staying more than 5% - the bottom trend in housing is just round the corner, probably it's in the next slide.

We can say the one and the only thing - that is going the Fed's way is that the unemployment figures are lower at 3.6% and the job creation is OK every month. As the stock market and the bond market bleeds in blood., it is just a matter of time - the layoffs starts. Eventually this would happen. Markets keep going down and jobs being created every month don't go together. Also, the worker productivity has gone significantly lower since the pandemic after the "work from home" habit. With workers sitting in their living room couches, innovation (workplace creativity) is not triggered. Direct interactions with team members, discussions, working at arms-length create an innovative work culture.


The Fed will raise interest rates until something breaks. At this moment, it doesn't have any other option to save its face. It wants the market to correct significantly but at the same time doesn't want the economy to enter a new long painful recession that could run for years. If the stock or the bond market crash even before the anticipated rate hike - it would put Fed in a really bad spot. At one point or another - To make the market happy, the Fed has to backtrack and go back to accommodating monetary policy again. That may create all sort of new problems along with history!

Friday, January 14, 2022

Easy money Hard pains

 For the past 20 years or so, America has solved its economic problems by doing pretty much just one thing - printing new money (USD).

 

Alan Greenspan, after the burst of the dot com bubble reduced interest rates to 1%, left it there for longer and thereby causing the housing boom. Without the 1% cheap money from the FED, the housing prices wouldn't have risen. The housing boom burst in 2007 causing the financial crisis in 2008, and Ben Bernanke reduced interest rate to 0%. When growth didn't improve much until 2011 - he did multiple QE s and interest rate manipulations like operation twist. In simple English - America printed new money and funded the economy in the last 2 decades.

 

To climax that out, once the pandemic hit, printing new money was so rampant, the American tax payers just became irrelevant. The usual tax deadline of April 15 was postponed as it wasn't necessary. Some even suggested, we abolish the IRS and America can print its way out to any growth levels. Of course - it can't.

 

What was surprising during this time was - None of these new dollars caused inflation - officially. This is because of changes to the methodology of how the CPI was measured, lot of dollars ended up being outside the United States rather than within the country primarily because of import dependent economy.

 

With endless money printing, US seems to have reached the end of the rope now. Out of all the problems it can solve with money printing, one thing it cannot solve is to fix the problem of "domestic inflation".

 

Domestic inflation now in the US is 7% as per the CPI data released this week. The PPI inflation is more than 9%.

 

The Fed has come out with its reaction - they will trim the monthly Stimulus and stop it by March. Then they would raise interest rates through this year and next year. They say - we will be just under 2% Fed funds rate by end of 2023. The problem with this argument is - how come a 7% inflation problem be solved by 2% interest rate 2 years from now. It sounds really dumb. Cruelly no one is questioning that enough. Fed is clearly behind the curve here. They are trying to play catch-up. It looks too little, really late.

 

Any rolling back of easy money policy will cause economic crisis. It looks the tech-bubble and the crypto bubble have already been pricked as a result of the Fed's change of course. We need to see through 2022 to validate that.

 

If you took S&P 500 since the pandemic hit - it's up 30%. If you remove the momentum stocks FAANG out of that (meaning S&P 495) - The S&P is up 0%. That is the harsh reality of it. As stock market veteran says - The soldiers get killed first and then they come for the Generals.

 

One other clear sign of topping - Apple is a 3 trillion company in market cap. It is more than the Russel 2000 put together (all two thousand companies put together). India is a roughly 3 trillion economy. Apple, a mere cell phone/laptop making company replacing an economy of a billion people explains how big the bubble has got. So really looks the top this time.

 

The tech-savvy NASDAQ hit a correction territory already this week for a dead cat bounce. It will head down to it again soon. Of course, to go to the bear market, it needs to go to the correction territory first. Without an assurance of further easy money - I don't see how the already leveraged tech-industry can go higher still.

 

The crypto also seems to have topped. Bitcoin and Ethereum - top couples seems to be breaking down on critical levels. With the bond yields increasing - the backbone seem to be bending. What out for this one - the market seems to be crumbling down with no bottom in sight. The total recall (bond price + its remaining yields) crashed most last week, a level unseen in history.

 

Milton Freedman told inflation is completely and everywhere, a monetary phenomenon. Rising prices are consequences of monetary expansion.

 

What exposed the underlying sick US economy was the covid pandemic. With no savings in American families, the US government didn't have an option but to send people bank-checks, that they can cash in to survive the pandemic period. Without which people would have ended up in the streets without job prospects during a pandemic in play in the entire world.

 

If easy money pumped up asset prices, then by definition rolling them back would reduce asset prices.

 

The problem of inflation cannot be solved by any other means but by sucking out dollars in circulation. The trick would be to do that without causing a recession. Doing this is impossible taking into account the current outstanding debt.

 

Fast depleting worker productivity of the US worker is very concerning. No society can keep on consuming without producing the commodity. The labor productivity crashed, to a low of 60 years recently.

 

What is going to happen in 2022 is going to be interesting. This would be first year since the financial crisis - we have a really hawkish Fed with a job on its hand to solve the inflation mess. It's affecting all people and the ruling Democrats want to minimize the pain before the mid-term elections in November.

 

Doing the right thing now - is not monthly quarter percent hikes over the next couple of years. What is needed is interest rate going to a number more than the 7% inflation number, say 8%. On top of that, roll back all QE programs and Fed has to reduce its balance sheet meaning instead of being a net buyers of US Treasuries, they need to be net sellers. The sad fact is - none of this is possible without crashing the whole economy that would make 2008 great financial crisis look like a walk in the park. On the other side - what if inflation goes to 10% or 15% or 20% ? That would need a even more bitter medicine to a even sicker economy. The Fed has really trapped itself to a corner and it doesn’t have a painless option. More than anything else - the credibility of the Fed is challenged. They had to go back on the word "inflation is transitory". It was a big miss when you have 800 PHDs in your payroll. It was absolutely clear - inflation was persistent and nowhere transitory. To save a daily insult - the chairman had to go out of the way to "retire" the term transitory for everyone. Reminds us all about Ben Bernanke - who infamously told the US Congress, the subprime crisis was tiny and will not affect the housing prices - only to see the entire mortgage market was toxic to its core triggering a global financial crisis unseen in generations.

 

Overall 2022 will be the year of rampant inflation. The 7% is just the start. The FED has to raise interest rates very aggressively than they think. Every time this has happened - something broke causing a crisis. This time is no different.

Wednesday, January 12, 2022

The desk jobs

 A fundamental truth in mankind existence - a thing cannot move from one place to another, unless a human labor is involved. An object stays in its place forever unless someone acts on it. Also its true -> an individual cannot do anything by himself alone, no matter what. Even a genius scientist who finds a medicine for a deadly sickness, uses a table and chair for his experiments, things made by someone else. If he wrote his findings - someone made the paper and someone else made the pen. So the fundamental unit of change is human labor.

 

Most of world's history - individuals worked for themselves only - in the form of finding his basic necessities like food, clothing and shelter for his own survival. With his life being threatened by wild animals and other components of nature, he determined that he has to associate himself with a group of people, like a family or a working community. The search for needs was discovered to be easier when done in groups. Group ism created more bounty for the individual effort, with common wisdom from experiences of all.

 

Later on as tools and machinery got invented, the labor moved from being physical to being less-physical. The nature of jobs moved from agriculture to manufacturing to providing services eventually.

 

During this transition in the last couple of centuries, some individuals within the group became smarter and smarter compared to the rest - they began to work for others for a "reliable" income. Employer-employee relation would eventually become an organized mode of extracting human productivity after the invention of needed tools, that workers will be trained to operate over time.Eventually the employers became co-ops, companies & corporations.

 

Western economies of the last 2 decades have become service economies for the most part, with very little trace of manufacturing (producing products). 

 

Gradually the western world has evolved to basically this - Bulk of the employment is "desk jobs". It's like people playing some kind of video games from their chairs. Apparently they are ALL creating value doing that. I wonder in most cases - they aren't. At least not in its fullest definitely. Are you asking, if all of them are unproductive - no. Some of them definitely are. But desk jobs cannot be 100% replacement for real manly jobs that need hard physical activity. Machines have replaced most of those jobs - which is definitely welcome, but the so called 20th century jobs are definitely way inferior to what mankind ever knew.

 

How did a superb performing US economy, which pioneered production manufacturing lines making household products (that improved quality of life for all humans across the globe), reach this pathetic state. Surprisingly all this happened in spite of a purely capitalistic model - It's all private owned. Productivity was keen.

 

Human resources as any other resources available in the world are scarce. It is hard to get people with specific skills and importantly with the needed attitude. They need to be utilized right and productively. Labor is precious.

 

The services industry has grossly mis-allocated resources, the way it is practiced.

 

It can be said almost with certainty that a factory unit, producing a product is 100% productive. They will never manufacture anything that is not needed. Products produced will be consumed in one form or the other. If they produce something the market doesn't need - they will change course right away. Workers would be made to do something else - that will be used by someone else no matter what. A badly made apparel in a Tirupur factory will at least be used as a waste cloth for years. Unfortunately you cannot say that in your desk jobs. Not all of the things that are produced are really used somewhere usefully. In desk jobs, it's very common for workers to do products (documents, reports, software, analysis etc) - that no one uses. They lay on broken hard disks. What was the cost of money & time to accomplish it? More importantly, who paid for it?

 

When I went to the US in 2005, I would see this on TV often, George W Bush, then US President would come on prime time and would say that the Americans are getting ready for the 21st Century jobs. He would say this when asked questions about the depleting manufacturing base and loss of blue collar jobs across the country. It was like the average American worker will not participate in producing day-to-day needed products like - toothbrush, paste, soap, table, chairs, sofas, beds, pen, pencil, books, fans, washing machines, tv, electric appliances, etc. These things need resource intensive mode of production - and thus can be done by people from poorer countries. American workers would do only cutting edge items like - building airplanes, rockets, military submarines, R&D, high-end technology and similar jobs that need expertism. In theory - it would be correct. In practice - it just didn't work that way. Doing difficult things is being productive. What really happened - most American workers were not ready for the so called "21st century jobs" and their standard & quality of life started falling. Bulk of them left the labor force because they couldn't hold on to their jobs. The labor force participation rate has been going down for years now & right now, it's around a pitiable 60%. 

 

In the US, Women made the bigger work force than Men in last couple of years. Leaving aside the gender discrimination aspect of it - a quick dissection that will lead to an arguable thought -> Women have a different physiology and cannot do lot of things like men. One obvious thing - A man starts his "working career" sometime in his 20s and will be in the work force continuously until they retire in their 60s. But the women - they cannot be in labor force similar to men. They take career-breaks during pregnancy. They take care of kids after that. By nature, they raise families. Their role there as a mother & wife is very unique. This distracts them from focusing fully on their jobs. Because of this, employers tend to pay them lesser which is understandable. For the society - more women being in work force compared to men is a sign of falling productivity and not increasing productivity.

 

I was talking the other day to someone at work. With the covid restrictions kicking-in, they were getting a count of who will be in office and who would work from home. He just said - he will be in office. Turned to me and said, when at home, and sitting before a computer all day - his mother doesn't even consider that as a labor happening. It is very common for them to ask him - Can you please go and do this errand for me. I just see you sitting before the computer and unsure, what you can possibly be doing. It looks there is a whole generation of people who think -> sitting in a table/desk in front of a computer screen is void of any labor activity. The productivity is undefined and obviously unnoticeable. The invent of Social Media (SM) over the internet is a considerable distraction for desk jobs too. You could spend hours and hours looking at SM pages scrolling down & down and not benefit anything at all from it all day. For many people - it turns out to be addictive.

 

The covid pandemic has come as a huge storm into the existing way of employer-employee relationship. With things back to falling in place now slowly - the old way of operation is probably gone. There is going to be a new kind of set-up. One thing that the pandemic has challenged - there are some jobs that can be executed remotely. If they can be executed remotely - what difference would it make to do the remote work from New York City or Nigeria. It doesn't make any difference as long the "same work" gets accomplished. Also the time zone in which they operate is not simultaneous but sequential. This ought to bring more efficiency.

 

One word that was used more frequently and not being in use at-all these days is - globalization. This term essentially referred to the employer going global leaving out the employee of the region. If the jobs are essentially desk jobs - what is going to happen is, the employee is going to go global sitting from his chair. He is no longer tied to his employer in his geographic region. He can work for anybody. This will play out eventually in the following years. This wave is coming and it's going to shift the employer-employee set-up we all know.

 

The pandemic of the last 2 years, has redefined many things. We just sent all employees home for 2 years which is quite unheard of. Things are holding up still, if not normal. It doesn't look like we are going back to 2019 when the pandemic is gone. People's preferences have changed. There is going to be a lot of give-and-take in the employer-employee set-up. Ultimately the market is the best judge. Market has & will always do a good job of allocating resources. This time at the global level. Weaker links get broken, stronger resources get better. The post-pandemic world has more surprises waiting for us. It's interesting times.