A popular conception about Abenomics — Japan's new drive for economic recovery — is that it's all about weakening the yen and boosting exporters.
But this really isn't the play at all. The real idea is to reduce real interest rates, so as to stimulate domestic demand, unlocking dormant investment and consumption spending. Remember, in deflation, it makes sense to horde cash, because prices will be lower tomorrow, potentially leading to a deflationary/recessionary spiral. Abenomics seeks to break this, stoking inflation, and creating an encouragement to spend and invest today.
A quick look at the Japanese trade picture shows that improving the economy via exports is not the play.
Japan's trade deficit just came in surprisingly high.
Japan's nominal exports in July rose 12.2% y-y and nominal imports were up 19.6%. Market consensus forecasts (Bloomberg survey medians) had called for 12.8% growth in nominal exports and 16.0% growth in nominal imports. The trade deficit came to ¥1,024.0bn, larger than the consensus forecast of ¥773.5bn. On a seasonally adjusted basis, the deficit was ¥994.0bn, again wider than the consensus forecast of ¥741.3bn and also larger than the June deficit of ¥663.2bn. There had been signs from the beginning of 2013 that the trade deficit would stop expanding and start contracting, but the data have continued to fluctuate and we have yet to see any clear trend of contraction.
2 - Japan Debt Deflation Spiral
US RECESSION - Minimally in the Back Stretch of the Recovery
As I sat down to do my regular tradition of reading and research I was hit by a CNBC article in which Jim Cramer was discussing his views on why a market reset was looming. He stated that:
"A 'giant reset' is looming for the markets because the improving economy is simply not trickling down to companies' bottom lines. Macro is great, but when you have to go deal with companies, it's bad."
He goes on to say:
"We have to deal with the four walls of the corporate canvas, and they are simply not able to turn this macro positive into micro earnings gains, and that's a real conundrum, particularly when the 10-year is signaling that happy days are here again."
Is Jim right?
Does a disconnect exist between the economy and corporate balance sheets?
Moreover, are interest rates really signaling that "happy days are here again?"
The Great Disconnect
I find the first statement by Jim the most interesting, and perplexing, with regards to the improving economy. While there has undoubtedly been some economic improvement from the recessionary lows; that current data suggests that the economy has likely peaked for this current expansionary cycle. The 4-panel chart below shows annual rate of change in incomes, employment, production and overall GDP.
While quarterly data, when viewed solely from one quarter to the next, may show some improvement - these improvements have only been bounces within the context of a longer term down trend. When you look at the charts above it is quite evident that the expansion of the U.S. economy ended in 2011. Since then the rate of growth has been on the decline.
However, I have to disagree with Jim's statement that the economy is not trickling down to companies' bottom lines. The chart below shows corporate profits as a percentage of GDP.
With profits, as a percentage of GDP, near record levels it is hard to claim that corporations are not able to turn the "macro positive" into "micro gains." The reality is that they have done this exceptionally well. However, unfortunately, they have done this at the expense of the American worker. The chart below shows the ratio of corporate profits to employees.
The use of technology, increases in productivity, running lean work forces and suppressing wages has led to a level of profits per employee that are historic levels. This drive to generate profitability by reductions of workforces and increases in productivity has also been a primary driver behind the "labor hoarding" effectwhich is why falling initial jobless claims is not translating into higher employment.
In Jim's defense he is focusing his attention on the current trend of weakening profitability and weak forward guidance. However, this is a bit myopic given that the economy is already more than four years into the current expansion, economic growth is clearly showing signs of weakening and cost inputs have been increasing. Furthermore, as I addressed in the "4 Tools Of Corporate Profitability:"
"The problem with cost cutting, wage suppression, labor hoarding and stock buybacks, along with a myriad of accounting gimmicks, is that there is a finite limit to their effectiveness."
In all likelihood what we are witnessing, and what Jim is missing, is that this is more than just a "soft patch" in the economy. It is highly likely, due to the weakening trends in the underlying data, that we are in a late stage economic cycle. My friend Cullen Roche recently commented on this issue stating:
"We’re in the backstretch of the recovery. We’re now into month 47 of the current economic recovery. The average expansion in the post-war period has lasted 63 months. That means we’re probably in the 6th inning of the current expansion so we’re about to pull our starter and make a call to the bullpen. The odds say we’re closer to the beginning of a recession than the beginning of the expansion."
Good Times Are Here Again?
Jim went on to state that:
"It's almost like the CEOs are saying 'whoa' to the market bulls, because the boots on the ground—the companies providing guidance—are seeing that things are just 'OK' and 'inconsistent.'"
The guidance that corporations are providing is based on the income data, and demand, that they are dealing with. My recent NFIB survey analysis quoted Bill Dunkleberg, Chief Economist, clearly stating this issue:
"The amazing stock market continues to surge ahead, even as prospects for earnings growth fade. On Main Street, there is no evidence of profit growth. The economy remains bifurcated, exports turned in a good performance, mostly activity for the large manufacturers, energy companies and agribusiness. Sales for small businesses, especially at service firms, continue to languish. Job openings improved, signaling a tightening in labor markets due as much to departures from the labor force as to the creation of new jobs (of which there were few). But this puts downward pressure on the unemployment rate. Plans to create new jobs also advanced, in spite of pessimistic views of future sales growth, but still historically low and not typical of periods of economic growth."
For Jim, the disconnect between the fantasy of Wall Street, which has been artificially inflated through trillions of dollars of liquidity being pushed into the system, and the reality of underlying economic fundamentals remains a mystery. As Jim stated above, for him, the conundrum is why corporations are struggling when the rise in interest rates are signaling "happy days" are here.
The problem is that when you have an economy that is growing at below 2% annually, real unemployment remains high and wage growth weak - rising interest rates, particularly when driven by artificial influences rather than increasing demand for credit, is historically an economic anathema. Furthermore, it is also important to keep the recent rate "spike" in perspective which has been nothing more than a bounce within a 30 year downtrend.
The rise in interest rates negatively impacts corporate profitability, raises borrowing costs, reduces capital expenditures, slows housing and decreases consumption. With the economy and inflation already trending lower it is unlikely that the recent increase is rates will last for long. As shown above, historically, rates closely track the direction and trend of the overall economy and inflation.
One of the main reasons that investors so often get caught up in major market meltdowns is due to the short-sighted, near term, focus of market analysts and economists. The data has to be analyzed with relation to the longer term trends and a clear understanding that all things, despite ongoing central bank interventions, do eventually end. The problem with the current environment is that the artificial inflations have detached the market from the underlying economic fundamentals which has historically led to larger than expected reversions and outright crashes.
As an investment manager we remain currently invested in the markets because we must avoid suffering career risk. However, it would be naive to neglect the rising risks of the technical extensions, deviations from underlying fundamentals and weakening momentum that exists currently. Yet, despite all the evidence to the contrary, investors are piling into equities in the "hope" that the markets will continue to advance indefinitely. As Yogi Berra once stated:
"You've got to be very careful if you don't know where you are going, because you might not get there."
THESIS & THEMES
STATISM - Governments Continue to Increase Repression of Civil Liberties
While the much publicized Sunday morning detention of Glenn Greenwald's partner David Miranda at Heathrow on his way back to Brazil, in a stunning move that as we subsequently learned had been telegraphed apriori to the US, could potentially be explained away as a desperate attempt at personal intimidation by a scared, and truly evil empire in its last death throes, it is what happened a month earlier at the basement of the Guardian newspaper that leaves one truly speechless at how far the "democratic" fascist regimes have fallen and fondly reminiscing of the times when dictatorial, tyrannical regimes did not pretend to be anything but.
For the fully story, we go to Guardian editor Alan Rusbridger who, in a long editorial focusing on the tribulations of Greenwald, his partner, modern journalism and free speech and press in a time of near-ubiquitous tyranny when the status quo is questioned, happened to let his readers know that a month ago, after the newspaper had published several stories based on Snowden's material, a British official advised him: "You've had your fun. Now we want the stuff back."
It gets better: after further talks with the British government, Rusbirdger says that two "security experts" from Government Communications Headquarters, the British NSA equivalent, visited the Guardian's London offices and in the building's basement, government officials watched as computers which contained material provided by Snowden were physically pulverized. One of the officials jokes: "We can call off the black helicopters."
Reuters adds that according to a source familiar with the event said Guardian employees destroyed the computers as government security experts looked on.
What is shocking is that as Rusbridger explained to the gentlemen from Whitehall, they had no jurisdiction over the forced destruction of Guardian property as it has offices in New York, that Greenwald himself was in Brazil, and that future reporting on the NSA did not even have to take place in London. That did not stop the UK government's punitive measures, and obviously neither did pleas, before the computers were destroyed, that the Guardian could not do its journalistic duty if it gave in to the government's requests.
In response, he wrote, a government official told him that the newspaper had already achieved the aim of sparking a debate on government surveillance. "You've had your debate. There's no need to write any more," the unnamed official was quoted as saying.
What is most shocking is that the UK government was apparently dumb enough to think that by forcing the Guardian to destroy its own hardware it would actually destroy some of the underlying data. It is this unprecedented idiocy that is most disturbing, because when interacting in a game theoretical fashion with an opponent one assumes rationality. In this case, what one got instead, was brute force and sheer, jawdropping stupidity.
Yet that is precisely what happened, and is why the stakes have suddenly been drastically higher: because the opponent now suddenly finds himself hurt, bleeding, ready to lash out at anything and everything without regard for the retaliation, and just happens to be dumb as a bag of hammers.
Miranda, a Brazilian citizen in transit from Berlin to Brazil, said he was released without charge after nine hours of questioning but minus his laptop, cellphone and memory sticks.
The detention of Miranda has rightly caused international dismay because it feeds into a perception that the US and UK governments – while claiming to welcome the debate around state surveillance started by Snowden – are also intent on stemming the tide of leaks and on pursuing the whistleblower with a vengeance. That perception is right. Here follows a little background on the considerable obstacles being placed in the way of informing the public about what the intelligence agencies, governments and corporations are up to.
A little over two months ago I was contacted by a very senior government official claiming to represent the views of the prime minister. There followed two meetings in which he demanded the return or destruction of all the material we were working on. The tone was steely, if cordial, but there was an implicit threat that others within government and Whitehall favoured a far more draconian approach.
The mood toughened just over a month ago, when I received a phone call from the centre of government telling me: "You've had your fun. Now we want the stuff back." There followed further meetings with shadowy Whitehall figures. The demand was the same: hand the Snowden material back or destroy it. I explained that we could not research and report on this subject if we complied with this request. The man from Whitehall looked mystified. "You've had your debate. There's no need to write any more."
During one of these meetings I asked directly whether the government would move to close down the Guardian's reporting through a legal route – by going to court to force the surrender of the material on which we were working. The official confirmed that, in the absence of handover or destruction, this was indeed the government's intention. Prior restraint, near impossible in the US, was now explicitly and imminently on the table in the UK. But my experience over WikiLeaks – the thumb drive and the first amendment – had already prepared me for this moment. I explained to the man from Whitehall about the nature of international collaborations and the way in which, these days, media organisations could take advantage of the most permissive legal environments. Bluntly, we did not have to do our reporting from London. Already most of the NSA stories were being reported and edited out of New York. And had it occurred to him that Greenwald lived in Brazil?
The man was unmoved. And so one of the more bizarre moments in the Guardian's long history occurred – with two GCHQ security experts overseeing the destruction of hard drives in the Guardian's basement just to make sure there was nothing in the mangled bits of metal which could possibly be of any interest to passing Chinese agents. "We can call off the black helicopters," joked one as we swept up the remains of a MacBook Pro.
Whitehall was satisfied, but it felt like a peculiarly pointless piece of symbolism that understood nothing about the digital age. We will continue to do patient, painstaking reporting on the Snowden documents, we just won't do it in London. The seizure of Miranda's laptop, phones, hard drives and camera will similarly have no effect on Greenwald's work.
The state that is building such a formidable apparatus of surveillance will do its best to prevent journalists from reporting on it. Most journalists can see that. But I wonder how many have truly understood the absolute threat to journalism implicit in the idea of total surveillance, when or if it comes – and, increasingly, it looks like "when".
We are not there yet, but it may not be long before it will be impossible for journalists to have confidential sources. Most reporting – indeed, most human life in 2013 – leaves too much of a digital fingerprint. Those colleagues who denigrate Snowden or say reporters should trust the state to know best (many of them in the UK, oddly, on the right) may one day have a cruel awakening. One day it will be their reporting, their cause, under attack. But at least reporters now know to stay away from Heathrow transit lounges.
Needless to say both Hitler and Stalin are spinning in their graves.
Below is a photographer's rendering of what it would look like if the UK government were the Nazis and Macbook Pros were books.
MOST CRITICAL TIPPING POINT ARTICLES THIS WEEK - August 18th - August 24th
After 5 weeks of range trading, US Treasury yields have resumed their bear trend. US 10yr yields target 2.951%/3.045% before greater signs of top emerge. Bulls need a break of 2.730% to invalidate the bearish potential.
While the above is nothing more than a few squiggly lines and their extrapolations, in the New fundamental-less Normal self-fulfilling prophecies (i.e., technicals) have a way of, well, self-fulfilling. The only problem with a blow out in yields to north of 3% is that not only does it kill any mythical housing recovery, it outright obliterates any hopes of a continuing GDP tail wind from the housing market, even from investors, speculators and flippers. We are confident we are not the only ones to notice that the APR on the 30 Year Fixed FHA from Wells just soared to over 6% - a level that has no place in an economy that is "growing" at 1.5%.
But before we lament the end of the great 30 Year bond market, we will simply recall that what is happening now is a carbon copy of what happened two years ago, when all it took for yields to plunge over 100 bps was a 20% drop in equities following the Great Debt Ceiling fight and the US downgrade.
Because there is nothing easier for Bernanke to do (in 15 minutes or less) than to enact a wholesale scramble out of stocks and right back into bonds, when he needs it.
e use the 20+ Year T-Bonds ETF (TLT) as the surrogate for long bond timing. As of 5/20/2013 TLT is on a Trend ModelNEUTRALsignal, which means that the model has been out of bonds but not short. The LT Trend Model, which informs our long-term outlook, is on a SELL signal as of 5/29/2013, so our long-term posture is bearish.
The weekly chart shows a support zone between 105 and 106, and TLT has violated that zone in a move that is becoming decisive. Note also that the PMO (Price Momentum Oscillator), which is used to estimate when prices have become overbought or oversold, has dropped below the bottom of the five-year PMO range. That range was established during a long-term rising price trend, and it will become irrelevant as the long-term trend turns down. In fact, if a down trend persists, over the next five years or more, the PMO range will shift downward from +7 to -1 to something like +1 to -5.
For the time being we are ignoring the possibility of a large head and shoulders pattern forming (the right shoulder being the only element remaining to complete the pattern); however, an extended bounce is not out of the question once the bears are fully committed.
While bullish talking heads are quick to point out that corporate earnings have never been higher, they tend to get very quiet the second corporate cash flow generation is mentioned. The reason is simple: where non-GAAP earnings, much of which are vaporware such as exclusions and other adjustment involving addbacks for "non-recurring" events such as Cisco's now annual mass termination announcement are indeed at nosebleed levels, actual corporate cash generation is a shadow if its former self which peaked in 2007 and has never been retraced. We showed this a month ago.
The problem is that since corporations generate less cash, they also spend less cash. As the following chart confirms, corporate capital use which peaked at a little over $1.8 trillion in 2007 has yet to be surpassed.
But perhaps what is more interesting is what corporations spend their money on. As we have pointed out in the past (usually when lamenting the lack of CapEx spending), there are five things corporations spend money on: CapEx, R&D, Acquisitions, all of which fall into the "growth category", and Dividends and Buybacks, which are the opposite, and represent shareholder-friendly actions which take from a company's growth potential and distribute dividend, literally, here and now.
Here is the same chart as above, shown on a percentage of total basis.
There are two key observations here, both of which go the heart of what is ailing the US economy.
First, just like in 2006 and 2007, when activist shareholders and overeager management teams were scrambling to engage in buybacks and artificially boost earnings per share, so now the last bastion of corporate "growth" is using cash, usually in conjunction with leverage, to buy back one's own stock. Naturally, as can be seen on the chart above, shortly after peaking at 34% of total in 2007, buyback activity crashed following the Lehman bankruptcy as cash hoarding became the norm. Is there a causal link between buybacks, and especially levered buybacks, and systemic instability? Unclear, however the more leverage companies utilize to pretend they are growing, and the more cash is used for shareholder friendly activities, the less real growh potential there is.
Second, and a point we have belabored since early 2012: capex spending is plunging. According to Goldman estimates, in 2014, CapEx will only account for 33% of total cash use: the lowest proportion since Lehman, and represents an unmistakably declining trendline. Furthermore, declining CapEx spend tells us two things: corporations, who know their business better than most, are spending less on growing their business in an organic fashion because they realize there is simply not enough demand they need to satisfy. Which is why they prefer to spend corporate cash on M&A and other fast-IRR generating shareholder activities, such as buybacks and dividends.
Putting all this together confirms that the bleak picture of a second consecutive quarter of declining revenues will continue. Without a boost in capital spending, there can be no organic growth for the S&P500 and instead any and all "growth" will come at the expense of balance sheet fudging, as had been the case for the past 5 years. However, now that interest rates are once again rising, corporations will be far less willing to spend cash on levered buybacks since the interest of such activities will soon be prohibitive if not already. Which ironically leaves CapEx investment as the best option for CFOs. However, absent true economic growth and a pick up in end demand for corporate products and services, this cash will not be spent and corporate contraction will continue.
The biggest irony in all this, which goes without saying, is that all of this capital misallocation is the direct result of the Fed's actions: something we observed in April of last year, and which only now is starting to filter through the mainstream media. The paradox is that as long as the Fed is there, insuring there is no "capital market" risk, corporations will opt to grow on the back of the Fed's balance sheet instead of actually risking capital and venturing to grow organically. And with this behavior continuing for year after year, very soon the entire premise of top line and cash growth becomes meaningless.
Which leads us to the point #1: if the Fed is truly looking for the culprit of why the economy is not growing, why the consumer's disposable income is at multi-year lowers, why corporations are stuck in space and corporate revenues are in a "recession", it should look in the mirror. Because the biggest culprit why the Fed's actions are having the opposite effect of that disclosed, at least for popular consumption is, well, the Fed.
11 - Shrinking Revenue Growth Rate
MACRO News Items of Importance - This Week
GLOBAL MACRO REPORTS & ANALYSIS
US ECONOMIC REPORTS & ANALYSIS
CENTRAL BANKING MONETARY POLICIES, ACTIONS & ACTIVITIES
TECHNICALS & MARKET ANALYTICS
COMMODITY CORNER - HARD ASSETS
PRIVATE EQUITY - REAL ASSETS
2013 - STATISM
2012 - FINANCIAL REPRESSION
2011 - BEGGAR-THY-NEIGHBOR -- CURRENCY WARS
2010 - EXTEN D & PRETEND
CORPORATOCRACY - CRONY CAPITALSIM
GLOBAL FINANCIAL IMBALANCE
STANDARD OF LIVING
STANDARD OF LIVING - The Destruction Of America's Middle Class
While hardly news to frequent visitors, especially those who recall the following list, anyone who needs a 7 minute refresher into why the US middle class is on collision course with extinction is urged to watch the following brief video which highlights all the salient facts such as:
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