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Looking Beyond “Can Kickers United”

Fed missing again, backtracking again

“Can Kickers United”

Fed now criticizes the Fed!

What is the Fed really doing?

The car market accident begins

Retail Zombies

Equity risk – Corporate cash flows more leveraged than ever before

What does an investor do?


Fed missing again, backtracking again

The chart shows that for the sixth year in a row Wall Street Concensus has learnt nothing from the “over-promise and under-deliver” policy experiment of the Federal Reserve. In how many ventures would this kind of failure rate be acceptable? I can’t think of any.

Yet here we go again. It is now baked in the cake that 2015 will fall into the same pattern with perhaps an even greater miss. Economic growth forecasts have already been slashed this year, and the latest data is tracking below 1.5%, which would be weakest outcome since 2009.

Nevertheless, until the Wednesday FOMC minutes were released, the Fed was still making strong guidance about rate rises even in September. Now the Fed has started back-pedalling as usual, as is clear from the following  statement from the minutes:

The Committee concluded that, although it had seen further progress, the economic conditions warranting an increase in the target range for the federal funds rate had not yet been met. Members generally agreed that additional information on the outlook would be necessary before deciding to implement an increase in the target range.”

Of just as much concern is that the US central bank looks no worse than all the other economic policy institutions around the world. It is becoming increasingly clear that economic policy since the financial crisis in 2008 has failed to deliver a sustainable recovery, and may even be compounding long term economic issues that remain unresolved.

“Can Kickers United”

The one claim these policy makers can make is that they have managed to “kick the can down the road” by halting immediate collapses. In the longer term, however, this isn’t enough. David Stockman summarizes the current dismal state  of global policy with a quick review of what the members of the “can kickers united” group are now doing:

“The real danger comes from the loose assemblage of official institutions which claim to be running the world.

They might better be referred to as “can kickers united.” It is now blindly obvious that they have lapsed into empty ritualism, contrivance and double-talk in the face of a global economy and financial system that is becoming more unstable and incendiary by the day.

Who in their right mind would pile $95 billion of new debt on the busted remnants of Greece? Likewise, how can Japan possibly consider enacting still another round of fiscal stimulus, as did Prime Minister Abe’s chief advisor recently, when it already has one quadrillion yen of debt? And what geniuses are trying to fix the bankrupt finances of China’s local governments by swapping trillions of crushing bank loans for equivalent mountains of new municipal bonds?

But it is on the home front where kicking the can has been taken to an egregious extreme. By what rational calculus can it be said, as the Fed did in its meeting minutes today, that 80 months of free money has not quite yet done the job?

Fed now criticizes the Fed!

The  credibility of this “loose assemblage” took another hit this week as, not only has the BIS heavily criticized central bank policy, but now even Federal Reserve researchers are having a go.

After 6 years of QE, and a $4.5 trillion balance sheet, research from the St Louis Fed admits that not much, if anything, has been achieved. The key lines are:

There is no work, to my knowledge, that establishes a link from QE to the ultimate goals of the Fed, inflation and real economic activity.”

“Thus, the Fed’s forward guidance experiments after the Great Recession would seem to have done more to sow confusion than to clarify the Fed’s policy rule.”

What is the Fed really doing?

What has really been learnt from the Fed’s policies over the last 6 years? Essentially they are using two approaches in an attempt to “solve” the economic problems. They are boosting liquidity to support asset prices, and encouraging credit growth to help strengthen the economy.  Unfortunately, their central planning schemes are not working out too well. Trying to force things to happen does not seem to work as well as they hoped.

Much of the liquidity has massively benefitted the banks and Wall Street, but very little seems to have reached main street. Providing liquidity to bail out preferred companies may stop an immediate collapse, but it also weakens the imperative for necessary resolutions of failed institutions.

Furthermore, forcing credit growth can only produce short term bubbles. For the most part this just borrows growth from the future and gets a great number of people in trouble. Temporarily credit becomes too easy, in order to induce the boom, with the effect of spreading too much too widely. Then credit almost completely dries up when the inevitable bust happens, as we saw in the housing boom, trapping millions in very poor circumstances.

Similar circumstances are happening once again. Here are two great examples from two key sectors of the economy, autos and retail. They do a great job of showing how these policies produce an inflated, but eventually only temporary form of dysfunction, which initially looks like growth, but in reality is an unsustainable accident waiting to happen.

The car market accident begins

One key driver of the US economy recently has been the auto market. No surprise when you take a look at the terms available for car loans, which are increasingly lowering qualifying FICO scores. All the credit records are being broken.

“We’ve talked until we’re blue in the face about the lunatic terms being extended to buyers in the auto market, but the following bullet points (derived from Experian’s Q1 data) are always worth recapping:

  • Average loan term for new cars is now 67 months — a record.
  • Average loan term for used cars is now 62 months — a record.
  • Loans with terms from 74 to 84 months made up 30%  of all new vehicle financing — a record.
  • Loans with terms from 74 to 84 months made up 16% of all used vehicle financing — a record.
  • The average amount financed for a new vehicle was $28,711 — a record.
  • The average payment for new vehicles was $488 — a record.
  • The percentage of all new vehicles financed accounted for by leases was 31.46% — a record.”

Now that supply is massively exceeding demand, even under these extremely easy credit conditions, and inventories are building, what do you think will happen next?

Retail Zombies

In another area there are major retail chains, where investment and expansion has far surpassed spending and bears no relation to international norms in terms of space. Easy credit and eager investment demand has come together to create excessive investment far beyond what is likely to be supportable over time. This analysis takes the example of 4 major retailers – Macy, JC Penney, Sears, and Kohls.

“So here’s the long and short of it. Owing to the Fed’s bubble finance, traditional retailers like the four zombies spotlighted above face endless competition from internet competitors like Amazon and every manner of new bricks and mortar retail concept that entrepreneurs and financiers can dream-up. But much of that new age competition is not on the level economically because it is based on ultra-cheap capital available in both the equity and debt markets.

It does not take much analysis to see that this fantastic proliferation of retail capacity—-both on-line and in the mall—does not represent sustainable prosperity unfolding across the land. For example, around 1990 real median income was $56k per household and now, 25 years later, its just $53k—-meaning that main street living standards have plunged by about 6% during the last quarter century.

But what has not dropped is the opportunity for Americans to drop shopping: square footage per capita during the same period more than doubled, rising from 19 square feet per capita at the earlier date to 47 square feet for each and every American at present.

This complete contradiction—declining real living standards and soaring investment in retail space—did not occur due to some embedded irrational impulse in America to speculate in real estate, or because capitalism has an inherent tendency to go off the deep-end. The fact that in equally “prosperous” Germany today there is only 12 square feet of retail space per capita is an obvious tip-off, and this is not a teutonic aberration. America’s prize-winning number of 47 square feet of retail space per capita is 3-8X higher than anywhere else in the developed world!”

Equity risk – Corporate cash flows more leveraged than ever before

Another problem has emerged which has massively distorted the entire US equity markets – stock buybacks.

John Hussman points out that this is also a feature of the buyback bonanza in the US equity markets themselves. In bold type below he points out that leverage within the stock market is much higher than most investors realize.

“So not only is the equity market at the second most overvalued point in U.S. history, it is also more leveraged against probable long-term corporate cash flows than at any previous point in history. As we observed during the housing bubble, yield-seeking by investors opens the door to every form of malinvestment. The best way to create a debt-financed wave of speculative and unproductive activity is to starve investors of safe return. In 2000 that wave of speculation focused on technology. The next Fed-induced wave of speculation focused on mortgage securities, which financed a housing bubble. In our view, the primary avenue of speculation in the current cycle has been debt-financed corporate equity purchases.

Over the completion of this cycle, we fully expect that many companies and private-equity firms will be forced to reverse this activity through involuntary debt-equity swaps, with a corresponding dilution in the ownership stakes of existing shareholders. Indeed, the group that led the largest-ever leveraged buyout in the oil and gas sector in 2011 announced last week that its ownership stake would be handed over to lenders. Back in 2011, profit margins were elevated in the energy sector, making the new debt burdens seem easy to handle. But part of the signature of an emerging global economic slowdown has been pressure on energy and industrial commodity prices (see the February 2, 2015 comment, Market Action Suggests an Abrupt Slowing in Global Economic Activity). The grandiose leveraged buy-outs of 2011, now facing Chapter 11, are the canaries in the global economic coal mine. In the words of Bad Company, “It ain’t the first time baby… baby it won’t be the last.”

What does an investor do?

The central banks are slow to adjust and are typically reactive. This means that investors can be successful by being proactive. It has been clear from the first quater that the economy was missing again for the sixth year in a row. Although, the Fed and concensus has failed to see this, these notes have consistently advocated a Quad 4 (lower growth and inflation) portfolio stance.  This has taken time to play out but it has now begun and will likely continue for some time.

It seems that not even the policy making community itself believes in the economic policies of recent years any more. So it is now very unclear what policy makers will do next. Long term risks remain very elevated as very little has been resolved in recent years. Central banks have even enabled additional unsustainable problems to compound.

In the short term this resolution will take time and has much further to go. In the longer term there will be significant benefit to leaving behind these failing central banks policies. As soon as this is done the real recovery can begin.



Best Practice is a matter of your Best Interest.

Education and a Commitment to Informed Consent is an Obligation.

Chris Belchamber is an IRMAA Certified Planner

Medicare’s IRMAA impacts every retirement plan. Learning how to mitigate it is available via IRMAA Certified Planners designation.

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