Financial Outlook August 2019

J.P. Morgan's global manufacturing index peaked in December 2017. Today, with the value of June (49.4) lower than that of May (49.8), it is in full contraction for the second consecutive month (less than 50 = contraction).

As if that weren't enough, the latest US GDP growth data was 2.1%. Higher than the expected 1.8%, but well below 3.21% of last quarter and the 2.87% interannual. This quarter, a deflator lower than the reported inflation was used again, hence the GDP value is not representative of real or nominal growth, but an intermediate invention. Unlike the previous quarter, this time the push did not come from a strong increase in inventories, but from government expenditures, which contributed 0.85% of the number reported. To put it in perspective, It is the largest number since 2009 and one that rarely reaches 0.5%. Despite all this, the US economy is officially in slowdown, something that today shares with China that -despite drawing their numbers and drowning their economy with financial stimuli- today has the lowest growth rate of the last two decades.

Perhaps for these reasons the U.S. Bureau of Economic Analysis lowered its estimates for the fourth quarter to 1.1% from its previous 2.2%... expectations have to be lowered to be able to beat them, right? The V recovery of a few months ago died quite quickly.

Something similar is happening with earnings, analysts are heavily correcting their predictions down. So far this quarter, the S&P 500 exceeded strongly trampled expectations, but there are early signs of a recession in earnings, because the same as with the number of GDP, the improvement over expectations comes mainly from share buybacks. Europe is much worse, unable to show results despite massive stimuli and negative rates.

In this scenario of better-than-expected earnings (but with a marked slowdown), the only indices that are reaching new highs (measured in dollars) are US indices; the rest peaked months ago, as shown by Octavio Costa, from Crescat.

One may wonder, what is “priced in” in these prices? What future scenario do they correspond to?

From a valuation perspective, the indices are in historical records, and those who argue that the Price to Earnings are in fair values are not considering that the Price / Earnings to Growth worsened considerably. Earnings are adjusting down, which means that the Price to Earnings is at the edge of the abyss.

From a rate of change perspective, today the total economy is slowing down. this means that what grew a lot now grows little, what grew little now has no grow, and what had no grow is now in contraction. I speak of production, commerce, sales and profits.

There remains that human aspect that is the investor mood, or sentiment. Much more difficult to analyze because it responds strongly to irrational aspects, to the construction of narratives by central banks and governments. This includes the resolution of the US-China trade war, the infallibility of central banks and the hope for a rapid recovery of economic problems.

To invest based on sentiment is to submit to the cyclothymic mania of the masses, where today all bad news is an excuse for markets to rise further, and tomorrow any news is reason for everything to collapse.

While S&P relies on the myth of the infallible central bank, the debt market assumes that the worst is yet to come. In June, global debt with negative yield was almost 25% of the total market, this is almost 13 trillion dollars (Gold total Market Cap is close to 9.5 Trillion). But sovereign bonds are not the only ones to lie on the negative spectrum. The nonfinancial corporate debt in negative territory is almost 500 billion dollars -a fairly smaller number, but equally worrying.

What happens to capitalism when the time-value of money goes negative? We will find out in a few decades, but judging from the past, the answer is less recessions at the cost of ever-decreasing growth as shown by the "The Economist" chart, and of course, a growing decline in the purchasing power of all currencies.

William McChesney Martin said "interest rates are prices which perform vital economic functions and they should be responsive to basic supply and demand." Something that central banks are in charge of destroying, to the point of bringing ZIRP, NIRP and continuous QE.

Perhaps the most terrible of all this is that central banks can’t "normalize". After lowering rates to zero and issuing trillions of dollars for a decade, they can barely sustain exhausted economies by increasing their balances and favoring huge deficits with cheap credit. The illusion remains with more and more debt, free money and share buybacks.

For August 2019:

• Metals: I maintained exposure to precious metals and mining companies. I still have a bullish vision for metals and mining companies, perhaps with a pause in these values, waiting for the central banks to continue destroying the value of their respective currencies.
• US Indices: I kept the short positions for the Russell 2000, the S&P500 and the Nasdaq, in that order (higher risk).
• Bonds: I maintained positions in US bonds throughout the curve.