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Reality Check? Flat GDP vs. Market Excess, Record-High PE Ratios and a Bond Bubble. Investor Beware?

reality check
The Smug

Since Adam met Eve, history tends to confirm that spoiled kids and rich uncles don’t produce the best long-term results… Too many handouts tend to makes the beneficiaries a bit…well: “goo-ey.” When I think of Uncle Bernanke and Aunt Yellen bailing out those TBTF banks (which, despite the best MBA’s of our shiniest schools, somehow managed to over-lever [and pay] themselves in sub-prime horse-crap masquerading as investment grade magical beans), the image of a smug kid in loafers holding a melting ice cream cone comes to mind.

Since 08, Uncle B and Aunty Y have expanded the Fed’s balance sheet 5X, from $900B to $4.5T with money created literally with the click of a mouse over at the Eccles Building. (See: A Fat Fed.) The pundits from CNBC to NPR (most of whom never took econ) then declared the result of this thin-air-created steroid a “Recovery.” To add a few more sprinkles to the ice cream, Aunty Y cranked interest rates to the zero-bound for 100+ months, thereby encouraging the C-suite smug to borrow, borrow and borrow.

The result of these low rates and “magical money” has been the greatest market bubble I’ve ever seen—and not just in tech (2000) or real estate (06) or mortgages (08)—but in everything: from equities to credits, houses to Picasso’s. Mega Bubble. In short: Wall Street and the loafer-crowd are enjoying a helluva punch-bowl effect. (Academics call this the “wealth effect.”)

Today, the bond market (especially Junk Grade Bonds and long-duration credits) is the “goo-iest” kid on the block, offering almost no yield for unspeakable risk (interest rate, default, and inflation) and today’s median stock price is currently trading at the highest multiple of earnings in history. That’s right: in history. In short, the party (and stock & bond bubble) rages on and on for the spoiled nephews of Wall Street.

Party Stories

But most of us know what happens when the punch bowl is spiked and too much has been consumed: the hangover loometh. Vision starts to blur, words slur, and money worries vanish, credit-cards fly, and everyone looks attractive even as they stumble toward the water-closet. Simply put: drunkards do silly things.

Since 08, our markets are drunk and her participants are silly. Ugly stocks with bloated PE’s (based on Ex-Items accounting rather than GAAP Net Income) are bought en mass with no regard for risk management or common sense. Cost is no option, so companies borrow trillions at low rates to buy back their own shares (at peak prices) to artificially sweeten their EPS reports by drinking (buying) their own Kool-aide.

Bond investors are no wiser: they go further and further out on the risk branch in search of minimal yields (junk bonds hover around 5% while certain sovereign bonds are posting negative yields overseas). It’s bizarre. And the moment investors start to sober up or worry about the leverage party ending, they call up their rich aunt at the FOMC for more low-rate punch.

Today, the gross notional value of the derivatives market is at a staggering 9X of global GDP—which is an over-looked market DUI in the making. Prudence is being pushed aside, and drunken euphoria has taken over. Think of S&P zombies like Macy’s; just as sales dropped by greater than 25%, it announced a $1.5B stock-buy-back (using borrowed money) despite already showing $7B of debt on their balance sheet. Or think of Nieman Marcus. It holds almost $5B in debt, lost over $400M in sales YTD, and couldn’t even pay its 8.75% notes.

So how did this spoiled nephew solve his debt problem? By issuing more debt… Nieman is now issuing 9.5% coupons to pay off its 8.75% paper (akin to using a Visa to pay American Express). And so “greater-fool” investors, smug from rich uncle support, only see the pretty coupon and not the makeup hiding the risk. This beer goggle investing is like beer-google dating: it ends in regret.

The Real World

But even as Wall Street and the smug party on, we see that Main Street (i.e. the real world) is hurting as usual. 45 million are on food stamps (today’s invisible bread lines); 110 million are out of work and the so-called “full employment” touted by the BLS is based predominantly on part-time or minimum-wage jobs. The number of actual “bread-winner” jobs (the kind that can support a family) are lower today than prior to the 08 crisis.

In short, the facts coming out of DC are just as bogus as the subprime bonds that came out of NYC. But even the official facts are getting direr. The GDP Index has shown 28 months of declines with Q1 GDP showing a mere 0.4% growth despite a stock market up double digits since Trump’s November election.

Drive by any mall in America and you’ll see empty parking spaces and stores closing, hundreds and hundreds of them: Payless, RadioShack, BCBG, American Apparel, CVS, Macy’s, Sears, Abercrombie, etc. And we can’t just chalk this all up to ecommerce and the Amazon effect. It’s darker than that. People are struggling—many of whom desperately voted for Trump, who, regardless of your politics, has very little to do with the middle class, and since coming to office, has been “cleaning the swamp” with three Goldman Sachs alumni who weren’t even Republicans and are quite comfortable in swamps.

These angry voters and empty stores are the real symptoms of a recession, despite the party on Wall Street. If you still don’t think so, just look at the one figure even the Ken and Barbie pundits can’t twist into a fiction: tax receipts. The LTM moving average of Federal receipts has plunged into the negative territory—something we haven’t seen since the last recession.

This gap between Main Street and Wall Street is as stark as it is disturbing. At some point, of course, the real economy will have the last say on the party in the trading pits and CFO offices. Investors need to be aware of managing their portfolios as the party wanes and the risk climbs.

How Parties End

No one likes a downer at the party. And I’m a downer. The fundamentals of today’s credit and equity markets are just fascinating in their bloated levels of distortion and broken price discovery—all consequences of rich uncles and aunts—at the US central bank as well as those in the EU, Japan, the UK, and China, where balance sheets have collectively grown to $21T—up 20X since 1996.

Yet as cynical as I am about this debt-induced bacchanalia, there’s still a bullish case to be made for a continuation of the market party. Central banks in Switzerland and Japan, for example, are actually buying stocks now (see Zero Hedge: Central Banks are Buying Stocks!) – that’s rich uncle support beyond even the most drunken QE policies; trillions of investor dollars are in cash and could come back into the US markets, perceived (the ironies abound) by the rest of the world as potentially one of the best horses in the global glue factory.

But even if such rising scenarios play out and markets climb from nose-bleed levels to lunar levels, the end result of a world awash in $225T of debt, weak to flat GDP growth, and massive asset bubbles always ends in the same way drunken-binges do: with a puking sound.

The question today (and for many days prior) is how long will this party last and when do we quietly call for a cab?

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