Currently, once again Wall Street analysts (especially CNBC cheerleaders) are
projecting record stock markets in 2021, with stock prices rising another 14%
to 24% and earnings surging into new record levels. Such is the question I have
discussed previously, given the incessant hype that the so-called “the stock market
is ultimately a reflection of the economy.” The detachment of the stock market
from underlying profitability guarantees poor future outcomes for
investors. But, as has always been the case, the markets can certainly
seem to remain euphoric and irrational longer than logic would expect; said
massive detachments never last.
The stock market is NOT the economy. But the economy reflects the very thing that supports higher asset prices “real corporate profits” this detachment is now a key factor for real policymakers and investors as we head into this new year. Throughout last year, we have experienced a sharp widening of an already massive gap between financial markets and the economy. A rapid rise in asset prices from the March 23rd lows took major US indices to record levels into the end of 2020, even before the news on Covid-19 vaccines. Combined with even more and more accommodative central banker policies, these policies enabled record debt issuance at historically low levels of compensation for creditors.
There is no doubt that corporations [many – many zombie firms] took the FED up on both near-zero interest rates and a guaranteed buyer of bond issuance. In 2020, investment-grade bond issuance hit a record with total non-financial debt soaring to all-time highs. Such was occurring at a time when revenues and profits were plunging off a cliff.
That data includes the record levels of “junk bond” issuance. Issuance in 2020 was up 87% year over year. Of course, the issue is that over the next few years, there is a mountain amount of debt coming due. If rates rise markedly, as if the market demands payment for the massive increased relative risk, refinancing could become problematic. Also, if the economy fails to have a real robust economic recovery as the cheerleaders on Wall Street expect.
There is a significant contagion currently which I discussed
last weekend “Zombies-firms” they are firms whose massive debt servicing costs
are higher than their proforma profits but are kept alive by relentless
borrowing at near 0% a massive macroeconomic contagion. Zombie firms are far less
productive, and their existence lowers investment in better well-positioned
firms, and employment at more productive firms. In short, a huge negative side
effect of central bankers keeping rates low for a long time is it keeps quite unproductive
firms alive which in turn lowers the long-run growth rate of the actual real economy.
The number of “Zombie” firms in the market has hit another new high in 2020. The massive FED interventions, bailouts, and zero rates provided much-needed life support that failing firms needed. From a market perspective, the FED’s massive liquidity flows increased voracious speculative appetites, and greed-based investors piled into “zombies” with reckless abandon. These firm’s survivability is based upon a low-interest rate environment, a robust debt market, and a real economic recovery to ensure their ability to repay their ballooning debts! Now for the bad news, I believe the so-called incessantly CNBC hyped “recovery” may not be nearly as brisk and robust as the Wall Street pundits and so-called gurus expect. Even with a weaker “2nd Stimulus package” the underlying erosion of real economic growth from rapidly rising massive debt-loads and deficits leaves little room for error.
Unfortunately, our economy requires
increasing levels of massive debt to generate lower rates of economic growth.
Such is why the FED has found itself in a massive lame-ass “liquidity
trap.” Now interest rates MUST remain low, and debt MUST increase faster than “bogus manipulated” GDP, to keep
the economy from stalling out in real time!
I sincerely believe that the vast herd of market participants have been
lulled into a false sense of security. Currently, investors are due to (FOMO)
are paying astronomical prices for “risky” assets. At the same time,
they are forced to accept historic low rates on “high yield” debt (aka
junk bonds) relative to the risk of default.
The vast number in the herd “investors believe” they
have an insurance policy against and “risk.” And it is showing up in a
significant manner as nothing is more reassuring to investors than the knowledge
and belief that central bankers, with deeper pockets, will buy the securities
they own particularly when these buyers are willing to do so at any price
and have unlimited capital. The rational investor response has been to
front-load their buying but also to look for related opportunities. The
result is not just seemingly endless liquidity-driven rallies regardless of the
real fundamentals and deteriorating economy. This seems to have been the case this
year (2020) and last (2019) until an unexpected exogenous event occurs, or if
the FED tries at all to normalize monetary policy.
The resulting destruction of REAL household net worth requires a usual immediate response by the FED of zero interest rates and liquidity. Subsequently, they are forced to create yet another “bubble” to offset the deflation of the last bubble. What the FED did accomplish these past few years was creating a massive demand for “risky” assets by distorting market functions and real price discovery (if it even exists anymore). While investors may continue to surf a highly profitable FED massive Tsunami liquidity wave, for now, things are likely to get far riskier as we move further into 2021. Central banker’s deepening distortion of markets will be harder to defend in a likely recovering economy (if the vaccines actually work and combat Covid-19) amid increasing inflationary expectations. Recent surveys that show an extremely high level of investor exuberance despite the underlying detachment from reality and fundamentals is enormous.
Former Fed-Chief Greenspam in a December 1996 speech on “Irrational Exuberance” was ignored for almost 3+ years...as whenever such detachments between the real economy and markets have occurred, investor outcomes have been very unkind to the herd and in my opinion, it is unlikely this time will be different; it will likely be far nastier in my opinion!
A crying shame...When the FED inserted itself into the economic equation to help their masters (the elite, most wealthy and corporations, and TBTF bankers) their intervention and manipulation has led to a massive rise in imbalances between the economic classes (poor, working-class and vanishing middle class). Over the past 12+/- years, as the stock indexes and stocks soared due to free-flowing liquidity, household net worth reached historic levels. If you only looked at that one line in the data, you could infer that the economy was booming. However, for the vast majority of Americans, it is not.
It is stunning to see that the median net worth of
households in the middle 20% of income rose 4% in inflation-adjusted terms to $81,900 between 1989 and 2016. For
households in the top 20%, median net worth more than doubled to $811,860; now wait for it...the top 1%, the
increase came in at over 180% exceeding $11,500,000.
The study I read in the WSJ showed
that the value of assets for all U.S. households increased from 1989 through
2016 by an inflation-adjusted $58 trillion. A
full 34% of that gain or over $20 trillion went to the wealthiest
1%, according to a Journal analysis of the FEDs data.
This 12+/- year massive great disconnect has continued much
longer than even I expected. This illustrates, yet again, the unintended
consequences of a central-banker ill thought policy approach.
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