Margin – I can’t believe it’s not butter!
The data is out and now we wait. The Job’s Data was not great and not bad. There was enough in there to cherry pick your view, whether it be optimistic or pessimistic. The most important question to answer is, was there enough in there to justify a pause or slow-down in the Taper? By itself, I don’t think it would be enough for Yellen to justify slowing or halting the taper. However, couple it with GDP revisions, weekly claims, the previous month’s Labor Report, durable goods, and a host of other data, and I think she can certainly justify slowing the taper. The Job’s number has left economists on the fence about what to next expect from the Fed.
Margin – I can’t believe it’s not butter!
We all know that margarine is not good for you, but what about margin?
As we await to see what the Fed will do in a couple of weeks, more stories related to margin and debt are surfacing. It’s no secret that the stock market rally has also accompanied one of the fastest and biggest growing margin debt expansions. This time it isn’t just investors, but also the Federal Reserve who have pushed bond prices to all-time highs with their QE program (printing money to buy assets).
When you listen to Yellen or other Fed members speak (or those that support Fed policies, like Paul Krugman), they refer to bonds and mortgage backed securities (MBS) that the Fed accumulates as “assets”. In some ways they are assets, by definition, but ultimately they are “credit”. The Fed purchased something that they expect to receive back both principal and interest in return. However, “assets” that are based on credit can quickly become liabilities. It becomes a semantic argument, but the math doesn’t change – the Fed is owed money, lots of money. The Fed has faith that it will be paid back; however, a few people have asked why the Fed doesn’t just forgive all the debt (erase it). It sounds absurd; however, I am sure it has been considered – if the market (global market) could withstand such a write-down. It’s hasn’t been seriously considered, though, because it would confirm that “assets” are not credit worthy and would also ultimately destroy the value of the dollar. So we wait and watch their ‘asset’ balance sheet grow at a rate of about $1 trillion per year.
Courtesy of Nikki Heyman Speech and Language
While the Fed is certainly in an interesting and unique situation, in which it could theoretically add “assets” indefinitely (simply because it can print money), the rest of the world doesn’t have that luxury. The NYSE margin debt level has reached all-time highs, surpassing $450 billion. The last time we saw these levels of margin debt excess was in 1999 and 2007. In fact, the acceleration of margin debt on the NYSE has started to reach a parabolic rate, which goes hand-in-hand with the recent rally. This rate is alarming because investors are borrowing more money than ever before. One way to view this is that the NYSE market is built on over $450 billion in credit.
Courtesy of Forbes
Consumer debt rose the most last quarter than it has in six years. Household debt increased 2.1% ($241 billion) to $11.52 trillion. That is still below the $12.68 trillion peak in 2008, but the rate of debt is accelerating fairly quickly. We are seeing the same trends in both mortgages and auto debt.
Now the question remains, is the debt serviceable? That is, do those with debt generate enough income to pay their interest and principal obligations? This is the most important factor when determining if the debt growth rate is sustainable.
Courtesy of Bloomberg
Debt, who cares?
Keynesian economic theory is less concerned with debt or if the debt growth rate is sustainable based on its serviceability. In fact, to them none of that really matters. What they measure everything on is whether the “equity” value is increasing at an even or faster pace than the debt. They are effectively betting (hoping) that demand will continue to drive prices higher, increase equity values and forever outpace debt accumulation. That can further be fueled by increasing inflation, which the Fed has targeted at 2%.
The Fed want’s inflation and says some inflation is good. The reason is simple – it helps fuel their theory to increase asset prices, which will outpace debt growth. They have also spun that deflation is bad. So why do people believe that and has the Fed made a convincing argument? Actually, I don’t think they have and I think it is more of an excuse to justify massive debt accumulation. The fact is, if you are a saver and trying to build your wealth, you would ALWAYS prefer a modest amount of deflation – your dollar buys more and your savings earn more. In reality we don’t want too much of either, but inflation is always far worse since you lose buying power. By the Fed’s own measure (CPI), the dollar has lost over 25% since 2000, each dollar only buys about $0.73 worth of goods today. That is the current modified CPI calculation, if we use the pre-1990 model without the hedonics, geometric weighting and substitution; we have lost over 50% buying power.
We can’t ignore the debt or the inflation aspect. We need to make sure we hedge our assets against both inflation risk and also when (not if) the debt gets called in. We have seen this happen twice since 2000, once during the dot.com bubble and once in the housing bubble, yet here we are AGAIN re-inflating the bubble and have not learned our lesson.
Those that champion Bernanke’s QE policy as having saved the economy, while blaming Greenspan for creating the housing bubble that destroyed the economy, are fairly ignorant. After the dot.com bubble, Greenspan lowered interest rates to 1% and helped spur credit and lending in orderto jump start the economy, just as Bernanke did in 2009. They are both using the same play book. You can’t blame one and champion the other – they are doing the same thing.
Insanity: doing the same thing over and over again and expecting different results.
Courtesy of NPR
Support & Resistance
We are holding up fairly well, the Labor Report gave us a little to keep the optimism going, but there were some concerns buried in the report. I would look at 16,250 as support and I think we could see some retracement this week.
The NDX started moving from 3200 to 3700 in a parabolic manner in late 2013. There are certainly some strong stories in some of the tech sector; however, some of the bigger names continue to have some forward growth issues. I think one has to be selective and expect volatility in this index.
The SPX rocketed higher and has stalled. The VIX continues to hover in the high 13′s and mid 14′s, which means the market remains slightly concerned about this rally. I would expect a pull back to 1850 in the near-term.
The one bright spot of confidence is the RUT, which is the broadest index and showing broad market order flow. The RUT will lead the market. Continue to use this as a general guide to market order flow.
The margin debt is building and the hidden inflation bubble is expanding. The question is not if, but when will we see this generate volatility in the markets and broader economy? The Fed is in the game now and they can keep it going for a while, so it will most likely be a loss of faith in the currency from an import/export trade nation that would bring any real shock to the markets.
For now the faith remains strong, but we are seeing the Euro move higher against the dollar, despite the geopolitical volatility.
If you haven’t seen it, watch Ray Dalio’s How the Economy Works