The Madness of the Machines: Orange Is The New Black (Monday)
We don’t think the one-year S&P 500 graph below is the work of any carbon units (at least sane ones)—much less the “pricing-in” of a rosy future of pro-growth economic policies. Instead, it simply reflects the relentless bid of the algos, which are programmed to buy the most recent up-tick and then the next and the next and the next.
As always, sell-side pitchmen make up the reasons afterwards and peddle them on bubble vision. This time the rationalization for the present eruption of sheer “irrational exuberance” is known as the Trump Trade.
Needless to say, the latter is not merely to be disrespected. It’s to be sold!
That’s because it won’t be long before the last silicon unit’s momentum bid hits the last uptick in the last dark pool. Then there will be a thundering implosion because the market is 50% over-valued and is booby-trapped with accelerants and FEDs (financial explosive devices). Together they make the relatively primitive portfolio insurance of the original Black Monday look tame by comparison.
Back then there were no ETFs and now there are $3 trillion; there were also no quant hedge funds and now upwards of $1 trillion of hedge fund money is traded by lightening fast machines. Back then, too, the junk debt market was nascent and parked mainly in a small stable of Michael Milken clients and raiders; now its girth is $3 trillion domestically and $5 trillion globally—-and is the rocket fuel which has driven the equity market via stock buybacks, M&A deals, LBOs and leveraged recaps.
Likewise, in 1987 Silicon Valley was a tiny financial precinct that funded inventions. Today it is a $80 billion per year Ponzi scheme under which venture dollars fuel a whole eco-system of “start-up” companies, jobs, procurements, rents, advertising and other emissions of commerce that don’t earn their keep and will disappear down a black hole of negative GDP when the music finally stops.
Back then former pork belly traders executed portfolio insurance in the Chicago futures pits; now math PhDs design entire doomsday trading regimes like Bridgewater’s $80 billion risk parity fund called “All-Weather” that will indeed become a Category 5 selling storm when the market breaks.
Similarly, in 1987 the global economy was mildly dependent, at best, on a cartelized debt and speculation ridden engine of state-directed capitalism domiciled on the Japanese archipelago. Today, on the margin, the entire growth impulse of the world economy utterly depends upon the bright red state socialism just now being celebrated by Mr. Xi—-even as his newly conferred dictatorial powers are no match for China’s precarious $40 trillion house of debt, speculation and monumental malinvestment and waste.
That’s but a sampling. Who knows, for instance, what lurks in the $500 trillion of currency, debt and credit swaps outstanding or what financial temblors they might triggering in the unwinding.
That gets us to the chart below and the catalyst that will trigger the above accelerants and implosions. Technically, it is what we described yesterday with respect to 1987. That is, a soaring public deficit in an allegedly full-employment economy is again running smack into a central bank unwilling to monetize the latest outpouring of Treasury paper.
Back in 1987, this collision triggered a market shattering eruption of yields—-even if the gamblers caught unawares in the 22% downdraft of October 19 insisted they had been blindsided by a Black Swan.
This time they will blame the same kind of sucker punch because self-evidently the Wall Street gamblers cannot see the bright Orange Swan circling the casino. Yet it was clear from the very beginning that the Donald would be a one-man fiscal wrecking crew in the improbable event of his ascension to the Oval Office.
Now, having shocked the nation’s ruling class in the burned out precincts of the rust belt, he has blundered into the Imperial City, hurtling hard upon a tower of public debt that was already listing heavily on November 8.
To that inherited condition, Trump has brought a mindless fiscal policy that amounts to more—much more–of the same red ink that would already lift the public debt to $31 trillion by 2027. That latter figure is CBO’s, not ours, and reflects nothing more than current tax law and the automatic spending of $3 trillion of annual entitlements and interest on the public debt—and also a major economic miracle.
That is, the assumption that the domestic and world economy will run for 207 months without a recession—-or double the longest business expansion on record and triple the average expansion since 1950 (61 months).
We think the chance of that in a world of central bank QT (quantitative tightening) and where the Red Ponzi is sure to explode before 2027 is somewhere between slim and none. So factor in several trillions more of borrowings owing to recession or some other macroeconomic upset somewhere on the planet and upwards of $2 trillion for phony spending cuts and revenue increases built-into the CBO baseline.
At that point, you are ready for the Donald’s fiscal agenda, which adds up at minimum to another $5 trillion over the next decade. That’s easily what he has already proposed for defense, veterans, border control, law enforcement, infrastructure and the biggest tax cut ever.
Moreover, that’s with nary a dime to be excised from the giant entitlements of social security and medicare; and it’s also with Medicaid/Obamacare running wild because the Trump/GOP government has already proven beyond a shadow of doubt that it has no plan and no stomach for reining it in.
In short, what the “Trump Trade” actually amounts to is a bet that the Imperial City can finance an implicit $40 trillion of public debt (150% of GDP) without any bond yield eruption over the next decade—-and do so largely in the capital markets, not at the open market desks of the central banks.
Needless to say, it didn’t work thirty years ago when the world’s debt was hardly $30 trillion and only a tad more than global GDP. But after 30 years of Bubble Finance, the vast falsification and inflation of financial asset prices (10X on average) and the accumulation of $230 trillion of debt around the planet that just ain’t going to happen.
Moreover, while the 30% spike in the Treasury yield back then did cause massive bond portfolio losses, it required a rise from 7.0% to 10.0% over the first nine months of 1987. By contrast, today a 30% spike (or even 50%) would mean ten-year Treasuries at just 3.0% to 3.5%.
At the same time, the macroeconomic carnage would be vastly greater. That’s owing to the 8X explosion of world debt; its insinuation into every nook and cranny of the global economy; and the massive prospective fixed income losses and un-refinanceable condition of vastly over-extended corporate and household balance sheets.
Most importantly, the 1987 meltdown was over within a few months because the balance sheets of the Fed and other central banks were still relatively pristine, permitting the world to print its way out of trouble.
Not now. After taking the collective central bank balance sheet of the world from $500 billion on Black Monday to $22 trillion today, even the most rapid Keynesian are not about to suggest another 44X expansion or even 4X.
Nevertheless, with European state deficits running at 3% of GDP, the US at 5%, China at 15% (when you count everything) and Japan at 40%, combined state deficits around the world are running at $7 trillion annual rate or higher, and would hit $10 trillion when the next recession finally hits.
Stated differently, even if the central bankers wanted to monetize all those debt emissions—which they clearly don’t and can’t if the Fed stays the course— the doubling-time of the world’s central bank balance sheets would probably be less than 4 years.
At the end of the day, there is absolutely no reason why the S&P 500 index should be up 22% from its year ago low(November 1), which occurred at a time when every single poll said Trump would be wiped-out.
The very idea that this one-man fiscal wrecking crew should be good for stock prices is itself overwhelming evidence that the Fed and other central banks have destroyed honest price discovery during the 30-year print-a-thon since October 19, 1987.
What remains now is only for the machines to bid the last tick.
Nor would our long-standing expectation that the GOP establishment will eventually show the Donald to the Dick Nixon Memorial Helicopter for his ride to Gonesville make any difference.
That’s because in their absolute desperation to put a tax bill victory on the legislative scoreboard, the Senate GOP last night officially threw in the fiscal towel once and for all.
To wit, they gave a 51-vote shield to $1.5 trillion of deficit financed tax cuts over the next decade but on the spending side you need a microscope to find the number. In fact, the budget resolution contained reconciliation instructions for just $1 billion—with a “b”—-of spending cuts.
We are loath to compute the percentage that represents of the built-in CBO spending baseline over the next decade, but here it is: From a cumulative spending total of $53.1 trillion, the GOP Senate has ordered itself (via reconciliation instructions) to cut 0.002%!
It’s actually worse—if that’s imaginable. The Senate Budget resolution itself is an exercise in pure political fraud. It presumes that more than $5 trillion of deficit reductions will be undertaken over the next decade, but with no mandate to any committee or other any other responsible congressional body to report a single shred of legislation to that end.
Stated differently, entitlements and mandatory spending will total $34 trillion over the next decade, and every dime of that will flow out the door automatically—unless some committee is instructed to change the law.
Likewise, the Warfare State budget is $7 trillion without the Donald’s add-ons and hundreds of billions more with them.
Even interest on the debt—–which is surely automatic—– will cost $5.6 trillion by the lights of CBO. That is, under its Rosy Scenario forecast, the 10-year Treasury rate is forecast to be just 3.0% in 2020—even after the Fed has shrunk it balance sheet by upwards of $2 trillion and the fast money traders of Wall Street have piled on by front-running sales of the same bonds that the Fed will be selling.
You can’t make this stuff up, and you can’t grow your way out of this fiscal calamity, either.
Once again, we must remind that what drives the deficit in a low-inflation environment where the tax code is indexed is nominal GDP and the resulting nominal wages and profits which are garnished by the IRS. Indeed, there is almost no spending side elasticity to jobs and real GDP growth any more because upwards of 110 million people live in households getting means-tested (welfare) benefits. Jobs essentially don’t matter when it comes to the $1 trillion annual cost.
So here is the last 10-years of nominal GDP growth, as represented by the shaded blue area. That resulted in the reported $18.87 trillion of nominal GDP reported for Q4 2016 compared to a starting point of $14.1 trillion in Q4 2006.
Here’s the thing. Had the nation been so fortunate to achieve the nominal GDP growth rate in the current CBO Rosy Scenario forecast for 2018-2027 (orange line) during that period, nominal GDP would have ended up $2 trillion higher and Federal revenues $400 billion higher than were actually collected.
Yet the actual growth rate of 3.0% (blue shaded area) occurred during a period of continuously falling interest rates and the most fantastic injection of monetary stimulus in recorded history.
So it will be a push and then some to even hit the CBO growth rate forecast for nominal GDP in the next ten years, which is actually 33% higher than the actual during the past decade. That’s especially true when the US economy will be laboring under $66 trillion of starting public and private debt (and counting)—compared to a starting level of $45 trillion back in 2006.
To wit, the US economy will start with nearly 50% more debt to service in a rising yield environment, not the falling, essentially zero interest rate aberration of the last decade.
Still, that ain’t all as they say on late night TV. What is built into the Trump and Senate budget forecast is essentially the gray line. That is, a cumulative nominal GDP growth rate (5.0%) that would have produced $23.4 trillion of GDP by the end of last year—a $4.4 trillion higher level than actual, which, in turn, would have generated about $900 billion more revenue per year.
Needless to say, the yellow line (4% real growth) advocated by the greybeards of supply side is just plains nuts.
But for want to doubt, consider the true meaning of the chart below.
During the course of this century, corporations have repurchased upwards of $7 trillion of their own stock. In light of that, is it even remotely rational to believe that business in America is suffering from a lack of incentive to invest on main street owing to the statutory corporate tax rate? And one that virtually no company pays except for those that are land-locked in the malls, construction sites and personal service establishments?
We think not. We think they are investing in their own stock on Wall Street because the Fed not the IRS is the real impediment to growth and jobs. It has simultaneously bloated the cost structure and price/wage level of the American economy in its misguided pursuit of 2.00% inflation—even as it has caused the C-suites of corporate America to morph into financial engineering joints and gambling dens in their own stock.
To be sure, we’d just as soon eliminate the corporate income tax, which generates only $350 billion per year, and replace it with spending cuts or a consumption tax.
But we are quite sure that if any tax bill emerges at all, it will amount to a deficit financed cut in the corporate rate. But that would merely shower Wall Street with even more stock buybacks and dividends, while doing nothing at all for jobs and growth.
So, yes, the coming collision of the Trump/GOP soaring deficits and the new era of central bank QT will indeed make Black Monday look like a Sunday School picnic.
The shame of it is that as the current machine madness lures homegamers back into the casino for another slaughter, the Orange Swan is right there in plain sight.
You don’t even need to watch CNN to keep up; it’s all right there on your Twitter feed.