This is an equity rally driven by one simple factor: the growth of debt. In this entry I will show charts and give explanations that should leave very little questions on why I see the end results of this being a flight from capital markets.
1) A 20-year chart of the S&P 500 Nominal Price, in blue vs. the S&P 500 Nominal Price / 10-year US Treasury yield ratio (or ticker $TNX) in white.
The chart above shows that the 10 year yield has dropped significantly, thus pushing up the ratio. It has dropped so far in fact that the ratio has roughly 4x greater gains than the S&P 500 price alone. This would mean being long bonds AND being long equities has paid off big time in the past 20 years, even in inflation adjusted terms.
However, as everyone knows, the S&P 500 is forming a potential triple top, revisiting the highs of 2000 and 2007. With each on these tops, the equity/bond yield ratio has moved further away from the S&P 500 price. This simply indicates it is taking more and more debt to sustain the price of equities. In this occurrence, the main buyer of debt has been the Federal Reserve via their QE and Operation Twist programs.
2) US Buybacks have been driven by Corporate Debt Issuance.
If you dig through corporate cash flows you will see a pattern: stock being retired (buybacks) while new debt being issued. Concerning? Absolutely, especially considering when you look at some of these companies operating earnings. Buybacks occurring using operating earnings are understandable, but propping up your stock price by taking advantage of these low rates at present is either a) knowingly lying to yourself/ others about the debt sustainability and low rate environment or b) just being plain stupid. I choose A on many of these occassions.
3) Market Value of Equities / Total Credit Market Debt Owed Ratio
The market value of equities versus total debt (public and private) is alarming. As the S&P 500 is near all time highs, this ratio has failed to reach it's 2007 level and further more, is well behind it's 2000 peak. Why? Because it has taken more and more debt to sustain equity prices (see a pattern here?) Debt creation is outpacing equity values, but these are, again, the market value of equities. If we are having a debt fueled equity rally, what is the real value of these equities? Another story for another time.
4) Household Net Worth / Total Credit Market Debt Ratio
The decline in the net worth of households relative to the amount of debt owed speaks volumes itself. There is not much of an explanation I can give here except I do not see a change occurring any time in the near future. What we have unleashed upon ourselves is manufactured economic growth through credit expansion while organic growth (steadily growing wages after taxes and inflation, production/consumption balance ex. credit) is long gone and dead.
In summary, we have:
1. The need for more debt after each economic downturn to help spur equity prices higher and even more of that debt to "stabilize" those equity prices.
2. Some corporations are unable to use operating earnings to buyback company stock and therefore are issuing new debt for buybacks. With the thought process of a low rate environment and forgoing the ramifications of artificially low rates, corporations are setting themselves up to implode their balance sheets.
3. As the market value of equities rise, the debt outstanding rises even faster. This is the crux of a debt fueled equity rally. This is simply unsustainable in the long term.
4. The net worth of households contract relative to the amount of debt they take on. Whether this is living above our means or because they are assuming new debt to just "make it by", the reasoning is irrelevant. What is relevant is that as more and more debt is created and thus helps the household acquire assets that build their net worth, once the amount of debt contracts, expect the same for their value of their assets (real estate, stocks, etc).
The thought of deleveraging is just that, a thought. No sector (public or private including the business or consumer) has actively deleveraged. In fact, pull up federal, business, and consumer debt and we find that in all three cases, the quantity of debt outstanding is at all time highs - higher than the peak before the housing/financial bubble.
And so goes my 2013 motto: Assets Prices = Time Delayed Grenade. This won't end with a conversation about rotation from stocks into bonds but will end with a flight from capital markets. Meaning, expect both stocks and bonds (prices) to drop together. Where that money goes - into real assets, into money markets, or under the mattress - should be interesting to watch.
'Til next time...
The chart of the S&P 500 Weekly, $SPX, SPY, crested February 11, 2013, at 152.11, in an Elliott Wave 5 High. And World Stocks Weekly, ACWI, crested January 28, 2013, at 50.34, in an Elliott Wave 2 High.
ReplyDeleteThe failure of the stock value Eurozone periphery nation states, that is the PIIGS, traded as Ireland, EIRL, Italy, EWI, Greece, GREK, and Spain, EWP, as investment vehicles, is the defining pivotal event in world investment history as the paradigm of Liberalism transitions into Authoritarianism. Nation State Investment, EFA, and Small Cap Nation Investment, IFSM, is failing, and World Stocks, VT, are trading lower. Volatility, VIXM, is turning up as investors are starting to derisk out of stocks and delever out of commodities.
It is reasonable to believe that a see-saw destruction of wealth will now commence. Total Bonds, BND, which have fallen in value two percent since December 6, 2012, will be going higher for a while, as the Major World Currencies, DBV, and Emerging Market Currencies, CEW, trade lower in competitive currency devaluation. Needless to say, investing in IPOs, FPX, will be a losing endeavor. Expecting a return of capital from investing in Dividend Appreciation, VIG, is an unreasonable expectation.
Money is no longer cheap as bond vigilantes have called for a steepening of the 10 30 US Sovereign Debt Yield Curve, $TNX:$TYX, as is seen in the Steepner ETF, STPP, steepening since December 6, 2012, when Bonds, BND, traded lower. One of the defining attributes of the shift from Liberalism to Authoritarianism is the end of ZIRP, as the Interest Rate on the Ten Year US Note, ^TNX, has risen to 2.01% from its September 14, 2012 low. The weekly chart of International Treasury Debt, BWX, seen in this Google Finance Chart shows a 4% loss since its September 14, 2012, high.
Money, and moneyness, as it has been known, is going to be literally dissolved away by the loss of national sovereignty of the EU periphery nations, and the failure of the European Financial Institutions, EUFN. On Friday February 15, 2013, disinvestment out of European Financials, EUFN, stimulated derisking out of a numer of stock sectors such as Solar, KWT, -1.8% and Copper Miners, COPX, -07%.
Debt deflation, that is currency deflation, is going to pick up. An unwinding Euro Yen Currency Carry Trade, EUR/JPY, will be stimulating nation disinvestment which will be reflected in Nation Investment EFA, trading lower.