Stocks, Bonds, Gold and Bitcoin ALL UP; M2 and Money Velocity DOWN!

By the Curmudgeon with Victor Sperandeo




While the U.S. and global economy have slowed precipitously this year, equities, bonds, gold and even Bitcoin are all up.  Aren’t some of those assets supposed to “zig” while others “zag?”  Or are we in a totally new era where non correlated (or inversely correlated) asset classes all go up at the same time without serious corrections or bear markets?  If so, there is nothing to hedge or sell short?

Meanwhile, the number of IPOs and amount they raised are surging.  Despite a few notable failures (e.g. Uber and Lyft), IPO price performance has been spectacular. In the second quarter, 62 IPOs raised $25 billion, the most active quarter by deal count in four years and the most capital raised in five years, according to Renaissance Capital. The average return was an eye-popping 30%. The IPO pipeline now contains 60 companies looking to raise about $11 billion, roughly half of which have filed or updated in the past 90 days.  Normally, the additional supply of all this IPO stock would drain overall demand for equities, but not so far in 2019.

Bonds vs Stocks Conundrum:

Sharp gains in both equities and fixed income are unusual since rising bond prices — or declining yields — are usually seen as a signal that an economic slowdown looms ahead. Bonds are seen as a safe haven in times of economic turmoil. Stocks, meanwhile, usually produce much higher returns than bonds when the economy runs smoothly.

“While the relationship between the performance of equities and U.S. Treasuries has changed over time … positive equity performance has coincided with weaker performance in Treasuries and vice versa,” Bespoke said in a note to clients. “This year has bucked that trend.”

James Paulsen, chief investment strategist at The Leuthold Group wrote in a research note: “Bonds have risen all year despite a stock market which continues to trend higher. The stock market appears optimistic about the future of this recovery, whereas the bond market is acting increasingly nervous.”  

Can both markets be right, or can financial markets have it both ways regarding their perception of economic growth?

Today’s Markets Corroborate the All Markets Upside Trend:

Stocks closed higher today (July 2nd), with the S&P 500 notching another record close to extend its year-to-date gain to 19%, while rates continued to dive with the 10-year yield falling to 1.976%.  That’s the lowest since the November 2016 elections!

Gold jumped 2% to $1,413 an ounce to erase yesterday’s losses.  The VIX closed at 12.93 – the first time below 13 since May 3rd.  Bitcoin closed at 10,685.89, up +93.48 today and almost 202% in 2019 YTD.  Only oil and energy stocks were down on the day.

U.S. Economy Continues to Slow Down:

U.S. consumer confidence dropped to its lowest level in nearly two years in June, The Conference Board said last Tuesday. IHS Markit reported last week that U.S. manufacturing growth slowed down to its slowest pace in nearly a decade. U.S. jobs grew by just 75,000 in May, widely missing expectations.

Economist David Rosenberg (@EconguyRosie) tweeted today: “The real key yesterday was the move in the 'nominal ISM' back into contraction territory to 49.8 for the first time in three years, from 52.7 in May and 5 points shy of the 54.8 nearby high last March. This metric correlates well with profits and bond yields.”

Last week, Rosenberg wrote: “The Kansas City Fed manufacturing survey sagged to a 31-month low in June; and what is really disturbing is the sharp slide in vendor delivery delays to its most contractionary level since September 2015.”

For the “nail in the coffin,” Shadowstats’ John Williams believes recession signals are accelerating. He wrote in a note to clients:

·       Consumer Liquidity Continues to Deteriorate: May 2019 Real Median Household Income Dropped by 0.6% (-0.6%),

·       May Construction Spending Showed Deepening Year-to-Year Declines, Last Seen at the Onset of the Great Recession

·       Second-Quarter Real Construction Spending Is on Track for a Fourth Consecutive Annual Decline

·       First-Quarter Gross Domestic Product was unrevised at 3.1%, despite Extreme Internal Revisions

·       Quarterly Growth in Gross Domestic Income Continued to Collapse, revising down to 1.0% from 1.4% (GDI Is the Income-Side Equivalent to the Consumption-Side GDP)

·       May 2019 Real New Orders for Durable Goods Sank Month-to-Month and Year-to-Year,

·       Retail Sales Benchmarking Showed Weaker Sales Volume 2016 to date

Curmudgeon Analysis:

With all the “free money” global central banks have created along with negative nominal and real interest rates, it appears that markets are no longer governed by fundamentals and especially not economic growth (which largely determines corporate profits).  Instead, there is a maniacal obsession with what the U.S. Fed will do and what FOMC members say in speeches or interviews.  Markets have rallied strongly in 2019 despite no Fed interest rate cut or halting of its balance sheet reduction runoff.  So there is HUGE anticipation of much lower short term interest rates to justify current financial asset prices.

Leuthold’s Paulsen wrote on July 1st:

“The Federal Reserve usually sucks all the oxygen out of the national economic-policy conversation. And, why not? It is comprised of a small elite group who hold conferences in exotic locations (Jackson Hole), have regular strategy meetings culminating in ‘must-see’ press conferences, make dot-plots sound interesting, and, between meetings, members regularly spout-off contradictory opinions.”

John Davi, chief investment officer at Astoria Portfolio Advisors, notes there is a lot of time for economic data before the Fed’s July meeting such that the Fed might not raise rates at its July 30-31st meeting.  Davi told CNBC last week: “I don’t think it’s a done deal that the Fed is going to cut rates in July.  If you get a resolution between Trump and China and the data is OK and the market keeps rallying, why would the Fed need to cut? The whole point of cutting is the (economic) data is weakening. If we get a resolution at the G-20 meeting and positive data, then the Fed doesn’t cut. Then, the market sells off.”

Victor’s Comments:

According to press reports, June 2019 was the best month (+7.2%) for the Dow Jones Industrials in the last 81 years. This was based on two main fundamental hopes:

·       The first was that the U.S. and China would show positive results during the trade discussions at the G-20 meeting in Japan.  While no trade agreement was reached, they concluded that the negotiations can now continue.

·       The second was based on the assumption that the U.S. Federal Reserve would prove they have the stock market’s back, and would lower the Fed Funds rate.

According to the CME Fed Watch tool on July 3rd, Fed Funds Futures are predicting a 74.4% chance of a 25-bps cut (to 2.0 to 2.25%) and a 25.6% chance of a 50-bps reduction (to 1.75 to 2.0%).  David Rosenberg, a well-known and respected economist who believes the U.S. is headed for a recession, is also predicting a 50-bps cut.

Certainly, the debt market yields are saying the 100% futures market prediction is correct, as Treasury yields are down 25 to 50 bps since this past April.

However, the Fed would merely be following the markets, not leading (e.g. the Fed is “behind the curve”). This is because the economy is slowing in the U.S. and worldwide (see related section above).  But in reality, what is the Fed really doing?

The magician’s standard tactic to fool the observer is misdirection. This same ploy is being used today by the Fed. Looking for “rate cuts,” which the Fed has hinted, appeals to most people, especially President Trump who has been criticizing the Fed and demanding it. 

But no one mentions Money Supply Growth.  Why not? The Fed’s Balance sheet has been declining ~5% a year since just before Trump was elected President (starting mid 2016). That, in turn, means M2 (most common used metric used to measure money supply), has grown at very low rate (1/23/17-6/17/19 of only +4.4%) compared to past economic growth periods. Couple this with the fact the Fed pays interest on excess reserves (since 10/1/11), which suggests to banks: do NOT loan money or extend credit to the economy, as we will pay you.

That caused the velocity of money (M2 velocity)  to decline/crash 11.7% below the 1964 lows, to the lowest levels over 60 years as per the St Louis Fed website. Money velocity is currently 1.4 which is a 60-year low!  In economics 101 we learned that inflation and economic growth are a direct function of money supply turnover (i.e. the velocity of money).  Is low money supply growth and low inflation a new, unpublicized Fed goal/ mandate?

Very low inflation facilitates very low interest rates, and thereby high and historically over valued equity prices. GDP was a very low 2.1% from the June 2010 recession low to when Trump took office, which equated to the weakest economic recovery in American history (2010 - 2016).  At the same time, we have had the longest bull market for equities in U.S. history, with returns compounding in the mid-teens. This begs the question: who benefits?

The Fed seems to follow the orders of the truly rich: large equity insiders, the banks, and wealthy foreign families. In my view, the Fed is afraid of President Trump, like every other establishment institution. Certainly, Fed Chairman Powell is scared of what President Trump might do to undermine the Fed’s power, as the verbal war between the President and the Fed could blow up into something larger. The Fed can’t keep the game of low interest rates and rising equity prices with inflation under 2% alone. The President has blamed the Fed for raising rates too fast in the last quarter of 2018. It is an accepted economic fact that printing money while lowering interest rates operates with an estimated 18-month lag. 

Powell’s huge error in the last quarter of 2018 was reversed with accommodating words early in 2019 as we noted in this Curmudgeon post: Fed Chair Powell Sets New Record: 180 Degree Flip Flop in 15 Days!

However, the Fed continues to reduce its balance sheet (by not re-investing proceeds of maturing bonds, which are then remitted to the U.S. Treasury, aka the “runoff”).  That, in turn, decreases the money supply and GDP. Debt markets know this.  Yields have declined substantially as the economy is slowing.

The Atlanta Fed is estimating a 1.5% GDP growth for 2019’s second quarter, so the July 31st rate cut has no true meaning other than perception, and if it is a 50bps cut there is also a psychological boost.

Otherwise, the moment the Fed interest rate cut takes place the markets will focus on when the next cut will happen. In other words, the Fed’s (assumed) July rate cut is saying watch this hand, not my other hand.

The goal of the establishment is keeping inflation low, asset prices high, and that means slowing GDP (see the 2010 -2016 U.S. real GDP growth). Therefore, the Fed is targeting asset prices rather than 2% inflation and low unemployment (which has already been attained).  That likely means continued low inflation and low interest rates.

Closing Quote:

The talk of Fed funds and not of money supply and money velocity is an attempt to deeply mislead the investor.  Henry Hay described such a central act of conjuring as "a manipulation of interest:" 

Magicians misdirect audience attention in two basic ways. One leads the audience to look away for a fleeting moment, so that they don't detect some sleight or move. The other approach re-frames the audience's perception, distracting them into thinking that an extraneous factor has much to do with the accomplishment of the feat when it really has no bearing on the effect at all. Dariel Fitzkee notes that "The true skill of the magician is in the skill he exhibits in influencing the spectators mind." Additionally, sometimes a prop such as a "magic wand" aids in misdirection.

From The Amateur Magicians Handbook, by Henry Hay. 

Hello, Fed Chairman Jerome Powell.  Have you read this?


 Good luck and till next time

The Curmudgeon

Follow the Curmudgeon on Twitter @ajwdct247

Curmudgeon is a retired investment professional.  He has been involved in financial markets since 1968 (yes, he cut his teeth on the 1968-1974 bear market), became an SEC Registered Investment Advisor in 1995, and received the Chartered Financial Analyst designation from AIMR (now CFA Institute) in 1996.  He managed hedged equity and alternative (non-correlated) investment accounts for clients from 1992-2005.

Victor Sperandeo is a historian, economist and financial innovator who has re-invented himself and the companies he's owned (since 1971) to profit in the ever changing and arcane world of markets, economies and government policies.  Victor started his Wall Street career in 1966 and began trading for a living in 1968. As President and CEO of Alpha Financial Technologies LLC, Sperandeo oversees the firm's research and development platform, which is used to create innovative solutions for different futures markets, risk parameters and other factors.

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