Below we look at the inverted relationship between the Main Street economy and the Wall Street bubble in the backdrop of recession concerns.
Not My Father’s Markets
In my father’s markets, long before the Greenspan Fed took price discovery and supply and demand out of the conversation, the share price of companies trading on Wall Street’s flowing tickers was based predominantly upon archaic concepts known as profits and losses.
But in those good ol days of balance sheets rather than bubblvision, high frequency algorithms, zero-bound rate policies, trillions in fiat money-printing stimulus, and a fundamentals-based (rather than sell-side) financial media, Wall Street was a small space of experts who marked the net present value of earnings streams and hence stock prices.
Those reality-based stock price mechanism are gone, just gone.
Today, Wall Street has increasingly become a circus of product peddlers, speculation and salesmen, with less and less risk discussion or blunt fiduciary advice.
In market mania’s like this, the mean old hedge funds or active managers who actually “hedge” risk are seeing over $26B in outflows, because they’ve been worrying about volatility for the last five years, and yet there’s been nothing but up-and-to-the-right (credit-drunk) markets with little to no volatility.
But what’s the mystery there? When central banks pour martini’s into a market, the binge feels good. And as any binge drinker knows, reason slips away as euphoria kicks in.
That’s why risk-focused managers look like chicken-littles as the sell-side keeps telling us the economy is doing great! Who needs those hedgers, those chicken-little types? Pass the bottle!
In fact, the real economy, despite the headline making employment numbers and crazy raging markets, is not doing so great. Wall Street yes, but don’t confuse that with Main Street. Quite simply, today’s employment data is as distorted as our markets, for it ignores the multitudes who’ve simply disappeared from the labor force.
This post will not dive into these labor distortions in detail, but the fact that over 50% of average American’s can’t afford a $500 “emergency” is more than enough evidence that Wall Street’s rise is ignoring Main Street’s reality. And that much-touted $7T year-to-date increase in “household net worth” went mostly to the 1%, not to the rest of America.
And if you’re wondering why we don’t have inflation or fears today, it’s because Main Street manufacturing, wages and prices are going down. It’s deflation folks, and not even the Fed can admit that deflation like this is a bad sign for Main Street, not proof of a “recovery.” One look at the S&P’s year end chart is proof enough where our “recovery” went—straight into a Wall Street bubble.
The Economy First, Wall Street Second
In the past, if the economy was strong, company earnings were strong, which typically meant profits were strong, and hence Wall Street was strong. In essence, the real economy drove Wall Street, which was a valuable and reliable indicator of Main Street.
Yep. Main Street USA. That thing we all live and breathe through each day in the Sturm und Drang of life—schools, homes, health matters, loves, losses, lessons etc. Mortgages, bridge tolls, groceries, Christmas gifts, anniversary presents, soccer camps, weekend get-a-ways, medical emergencies, car repairs, vet bills, beer tabs. You get the drift…
But Main Street is no longer the heartbeat of the US economy. Wall Street is. Instead of the economy driving the markets, the markets drive the economy. This inversion is dangerous, because in the final analysis, a Wall Street bubble is not going to save anyone.
Almost unconsciously now, from Fed Governors and Hill politicians to MSFM journalists, we keep hearing that the “economy is strong,” because, alas, the stock market is at crazy highs. That is, the stock market is the real topic, not the economy.
Again, this is dangerous, because confusing Wall Street with Main Street reduces the public’s ability to consider the risk of a recession, sometimes even a necessary recession. After all capitalism, like a healthy body, needs an occasional illness to rebuild its immune system.
But in today’s central-bank driven stock markets (here and overseas), the body (Wall Street) never gets sick because the central banks never stop dispensing antibiotics (QE and low rates) each time the market sniffled, coughed or even got a high fever.
But we all know what happens if you rely too much on antibiotics. Your immune system loses its natural strength as well as limits. The same is true of markets that are perpetually and artificially supported by fiat money and promiscuous credit expansion: they lose their ability to naturally adjust to natural conditions or limit their over-stretched reach.
Instead, markets just keep growing and growing until, of course: they suddenly pass out, almost without warning.
In other words, recessions no longer happen gradually from a Main Street thermometer that gauges industrial production, business investments, housing data, retail sales or corporate profits, thereby offering us a chance to brace for “high fevers.”
Those indicators mean little today. Rather, in an era in which central banks rather than Main Street, steer markets, recessions erupt seemingly out of nowhere.
But in fact, the growing volcano is plain to see. Our Market History Series bluntly shows how central-bank credit expansion always results in equity and bond bubbles which erupt—i.e. “pop,” suddenly and violently.
The financial “lava” which flows from these imploding market bubbles then pours down upon an otherwise innocent Main Street.
2008 is the perfect example of this pattern in action. The Greenspan Fed of the post 2001 dot.com crash had cranked rates down to re-stimulate the markets (i.e. via credit expansion). This led directly to a real estate and sub-prime bubble, which later popped in 08.
Thereafter, the markets crashed, banks failed and soon enough, Main Street USA took it in the gut, with retail sales plunging by greater than 50% annualized rates. In short, Wall Street’s woes triggered Main Street’s woes. You the taxpayers then bailed out the banks that punched you in the spleen.
But why didn’t our Fed see this coming? Why didn’t Treasury Secretary Paulson see this coming? Why didn’t the MSFM see this coming?
Because they were looking at the old Main Street indicators rather than in the mirror or the market time-bomb they created.
The “experts” were tracking their old-reliable Main Street indicators like retail sales, which in the 17 months leading up to the Great Recession of 08, were trending with no measurable signs of concern, because, quite frankly, Main Street was not the problem.
Meanwhile, Wall Street leadership was ignoring the very landmines they were laying from coast-to-coast.
The hidden threat wasn’t the real, Main Street, economy, it was a Wall Street gone wild on the steroids of a Fed-induced credit expansion, unregulated derivative instruments and a subsequent credit bubble. When that bubble popped, an innocent Main Street got clobbered.
Insanity: Expecting a Different Reaction from the Same Actions
And what was the Fed’s reaction to the last toxic Wall Street bubble and subsequent recession it alone created? Well, they created another toxic Wall Street bubble, the one we are experiencing right now.
In the rubble of 08, Bernanke (and then Yellen) cranked rates back to zero and added trillions in stimulus from the top down (i.e. from DC to Wall Street) rather than allowing a natural yet painful (and necessary) recession to play itself out and allow a slow recovery from the bottom (i.e. Main Street) up.
So here we are again. Sitting on a massive credit and equity bubble, looking at Main Street indicators (mostly distorted BLS data as to old-school inflation and employment memes) while ignoring the Wall Street land mines hidden beneath the surface of the great American sidewalk…
So don’t look at the Fed’s macro data if you want to measure our new reality. Don’t bother with the data from retail sales or even your local shopping market; just look at the bond markets.
Central bank distortion of the credit markets is a topic we’ve addressed many times. Compression of yield due to massive Fed credit expansion has created grotesquely thin spreads between junk and investment grade bonds, having contracted by more than 700% basis points since the Fed stepped in to “save” Main Street in 09 after clobbering it in 08.
This post-08 credit expansion template has also resulted in the funding of trillions into bad LBO’s and levered re-caps in the junk credit sector which is nothing more than a paper castle. But again, we’ve seen this movie before.
Furthermore, trillions more of easy credit has led to debt-driven stock-buy-backs from the C-suits and more dividends for an inflated equity market. If you really think the new corporate tax cuts (no surprise) are going to Main Street workers rather than to more Wall Street buy-backs and dividends, you’re ignoring Wall Street’s M.O.
We now have a $6T corporate bond sector, which is twice its pre-08 size. Think on that.
In other words, a new credit bubble/volcano is well underway…
When this market volcano erupts/pops—from any number of triggers—the slide will be swift and steep, because the size of the credit expansion that preceded it was swift and high. As von Mises reminds us, a credit slide is always equal—if not greater—in proportion to the credit expansion that created/preceded it.
Given that this is the greatest credit expansion ever recorded, the eruption to come should be of obvious concern. Of course it’s hard to look at or discuss this today, because we are currently enjoying the drunken highs…
Adding to the speed of this slide will be the proliferation of the ETF vehicle, which has mushroomed from an $800B to a $4T market since the 08 “recovery.” This 8X ramp up could easily morph into an 8X ramp down as sell orders replace bid orders in the next recession.
On top of these market-slide accelerants is the VIX (or volatility trade) of which I’ve written extensively. At the first sign of VIX spike, volatility sellers will be covering shorts and thus adding to the depth and pace of a market decline.
In the last market crash—and hence the recession it created—the S&P dropped by 58% from September 1 to November 20th of 2008, reducing the broad market of 40% of its capitalization in less than 50 trading days.
Then came the layoffs and the Main Street pain caused by a Wall Street binge. Car sales plunged, retail sales plunged, and housing sales plunged, employment numbers plunged, stock prices plunged… You remember.
By 2009, America was in peril, not because Main Street took us there, but because Wall Street, supported by the falsely-heroic Fed, took us there.
The same will happen again. It’s the law of credit expansion, history and natural markets, which the Fed can post-pone, but not eliminate.
But the next recession portends to be much worse, as the bubble we now enjoy is much greater than the one that preceded the 08 crash. Furthermore, the trade instruments (ETF’s) and strategies (shorting volatility) are more dangerous today, and will add to the size and speed of the next market decline and hence the next recession.
Most importantly of all, unlike in 08, today’s Fed won’t have enough gas in the tank (or credibility in the markets) to print more money or lower rates to past zero.
By the way, if you’re wondering why the Fed is targeting more rate hikes for 2018, and moving from Quantitative Easing to Quantitative Tightening, it’s because they know darn well they’ll need to have something to lower in the looming recession ahead, be it in 3 weeks or 3 years.
We at Signals Matter, however, are concerned that may be be too little, too late. The next recession, like the last recession, has one source—the Fed, Wall Street and exaggerated credit expansion, yet, and ironically, we keep looking for the same foxes to guard our Main Street hen-house.
Do you still have faith in central-bank-driven markets and Wall Street guidance? In good times it’s easy to think so, no?
Well, we’re keeping an eye on the Signals Matter Recession Watch for one simple reason: history is telling us to…
Yet we hear you—we sound like gloom and doomers, bla-dee-bla-bla-bla. No one likes a kill-joy in the height of a party.
We’re not kill-joys, we’re investors, not gamblers. Nor are we perma-bears or terrified traders. In fact, we are turning out exceptional returns. But that doesn’t mean we are drunk on fantasy or ignorant to market history and market forces.
Subscribers who see our constantly updated Trend Watch, Recession Watch and Signals Watch can daily review our net bearish, net bullish, and net neutral percentage data, based on market facts not clever blogs. The guts of our analysis comes from the market facts, not just jaded macro opinions.
Meanwhile, our risk adjusted trade signals remain safe and profitable. Come join us, our signals more than pay for themselves and make money safely, intelligently and bluntly.
In the interim, be careful out there.