wknd notes: Where the USA is Heading

“The economy is roaring,” said Vice President Pence, unemployment having just hit a 50yr low of 3.6%. “The President is very interested in bringing fresh ideas to the Fed. People with a renewed and fresh perspective. People who understand the dynamic approach to this economy that he’s been putting into practice,” he said. “When I was in congress, we had a debate about the Fed’s dual mandate. It might be time to revisit that, having the Fed focus on monetary policy, and just watching inflation,” he added. “This is exactly the time not only to not raise interest rates, but we ought to consider cutting them.”

Overall: “China is adding great stimulus to its economy while at the same time keeping interest rates low,” tweeted Trump. Chinese fiscal stimulus this year is on track for a +4.25% jump (up from +3% in 2018). Their local governments are authorized to issue $320bln worth of special purpose bonds to fund infrastructure this year, a +59% jump from 2018. And new bank loans jumped $860bln in Q1 alone. Chinese 7-day interest rates are +2.55%, with real GDP growing at +6.4% and nominal GDP expanding +8.7%. Their stock market leads the world in 2019, surging +26% priced in dollars. “Our Federal Reserve has incessantly lifted interest rates, even though inflation is very low, and instituted a very big dose of quantitative tightening. We have the potential to go up like a rocket if we did some lowering of rates, like one point, and some quantitative easing,” continued our President, fingering his iPhone. Our Federal Reserve balance sheet surged from $870bln in Aug 2007 to $4.5trln in Jan 2015 and has since contracted to $3.9trln through quantitative tightening. They hiked overnight rates to +2.5% to normalize policy, with core PCE inflation now +1.6%. “Yes, we are doing very well at 3.2% GDP, but with our wonderfully low inflation, we could be setting major records & at the same time, make our National Debt start to look small!” concluded Trump, the S&P 500 +17.5% year-to-date, our national debt surpassing $22trln (slightly larger than US annual GDP). But if you subtract the debt owned by the Fed, our true debt is rather smaller than our economy. And if our central bank resumes buying debt, while government borrowing/spending expands the economy, then our true national debt/GDP declines further still. And that is exactly where the United States of America is headed. 

Week-in-Review (expressed in YoY terms): Mon: ISIS leader al-Baghdadi appears in 1st video in 5yrs (vows to fight on), Russia’s Gazprom delivers record natural gas volume to Europe (doubles profits to $26.6bln), Italy’s Salvini says EU budget rules will no longer apply after next month’s EU Parliamentary elections, Spanish socialist party wins general election, EU industrial optimism hits 5yr low, US consumer spending rebounds, core PCE inflation +1.6%, Rod Rosenstein resigns, S&P +0.1%; Tue: China Caixin-Markit PMI manu -0.6 to 50.2 (exp 51.0), China official PMI manu -0.4 to 50.1, Japan’s Emperor abdicates, Taiwan GDP slows to +1.7% (3yr low), Italy exits recession (GDP remains 5% below pre-2008 levels), Guaido calls for popular/military uprising in Venezuela, Mexico Q1 GDP -0.3 to +1.4%, Pompeo claims Russia encouraged Maduro to remain in Venezuela, Google misses (stock loses $70bln mkt cap), US home prices +4.0% (slowest gains in 6.5yrs), Trump/Pelosi/Schumer agree to $2trln infrastructure plan (don’t specify how to fund it), S&P +0.1% (record high, +3.9% in April); Wed: China/US end “productive” trade meetings, Macau gambling revenue -8.3% (declines at fastest pace since 2016), Japan’s Crown Prince Naruhito ascends to the throne, South Korea exports -2.0%, Russia dismisses US claim that Moscow encouraged Maduro to remain in Venezuela, Putin signs law to create a “sovereign internet” isolating Russia’s internet from global web, US manu ISM -0.5 to 52.8 (2.5yr low), ADP employment +275k (exp +180k), Fed leaves rates unch but lowers IOER by 5bps and says ‘soft inflation is transitory and Fed stance is appropriate right now,” S&P -0.8%; Thur: Asean PMI +0.1 to 50.3 (5mth high), Hong Kong Q1 GDP -0.7 to +0.5%, South Korea CPI +0.2 from 3yr low to +0.6%, Gold demand +7.7% in Q1 (driven by Russia/China central banks), BOE rates unch at 0.75% (lifts 2019 GDP forecasts +0.3 to +1.6%), Senate fails to overturn Trump veto on ending support for Yemen war, US oil inventories post biggest weekly gain in 2019, US factory order rise most in 7mths, Facebook bans far-right figures for hate speech and terms them “dangerous individuals,” S&P -0.2%; Fri: Turkey CPI -0.1 to +19.5%, EU CPI +0.3 to +1.7% (energy prices +5.4%, service prices +1.9%), EU core CPI +0.3 from 2yr low to +1.3%, Junker is open to Gemany’s Weidmann succeeding Draghi as ECB chief, US payrolls +74k to +263k (unemployment rate -0.2 to 3.6%), avg hrly earnings +0.2 to +3.2%, ISM services -0.6 to 55.5 (exp 57.5), Fed’s Bullard “rates are a little bit tight and open to a rate cut” should inflation remain below target after summer, S&P +1.0%; Sat/Sun: North Korea launches short range missiles (1st test since 2017).            

Manufacturing PMI (high-to-low): Greece 56.6/54.7, Hungary 54.9/52.5, Norway 53.82/56.32, UK 53.1/55.1, United States 52.8/55.3, Vietnam 52.5/51.9, Netherlands 52/52.5, Spain 51.8/50.9, India 51.8/52.6, Russia 51.8/52.8, Brazil 51.5/52.8, Sweden 50.9/52.5, Indonesia 50.4/51.2, Singapore 50.3/50.8, China 50.2/50.8, South Korea 50.2/48.8, Mexico 50.1/49.8, France 50/49.7, Canada 49.7/50.5, Japan 49.5/49.2, Austria 49.2/50, Italy 49.1/47.4, Poland 49/48.7, Switzerland 48.5/50.3, Taiwan 48.2/49, Turkey 46.8/47.2, Czech Republic 46.6/47.3, Germany 44.4/44.1. Services PMI: Germany 55.6/55.4, Ireland 54.7/55.3, US 53/55.3, France 50.5/49.1, UK 50.4/48.9, Australia 46.5/44.8.              

Weekly Close: S&P 500 +0.2% and VIX +0.14 at +12.87. Nikkei +0.0%, Shanghai -0.3%, Euro Stoxx -0.2%, Bovespa -0.2%, MSCI World -0.6%, and MSCI Emerging +0.1%. USD rose +0.5% vs Chile, +0.5% vs Sweden, +0.5% vs Indonesia, +0.4% vs Russia, +0.4% vs Turkey, +0.3% vs Australia, +0.2% vs Brazil, and +0.1% vs China. USD fell -10.4% vs Bitcoin, -9.1% vs Ethereum, -2.0% vs Sterling, -1.1% vs India, -0.4% vs Yen, -0.4% vs Euro, -0.3% vs South Africa, -0.3% vs Canada, and -0.1% vs Mexico. Gold -0.6%, Silver -1.1%, Oil -1.5%, Copper -2.4%, Iron Ore +3.8%, Corn +2.4%. 5y5y inflation swaps (EU +3bps at 1.40%, US -6bps at 2.26%, JP flat at 0.11%, and UK +5bps at 3.61%). 2yr Notes +5bps at 2.33% and 10yr Notes +3bps at 2.53%.

April Monthly Close: S&P 500 +3.9% and VIX -0.59 at +13.12. Nikkei +5.0%, Shanghai -0.4%, Euro Stoxx +3.2%, Bovespa +1.0%, MSCI World +3.4%, and MSCI Emerging +2.0%. USD rose +7.1% vs Turkey, +2.1% vs Sweden, +0.7% vs Australia, +0.6% vs India, +0.5% vs Yen, +0.3% vs China, +0.3% vs Canada, +0.1% vs Indonesia, flat vs Euro, and flat vs Sterling. USD fell -22.3% vs Bitcoin, -10.4% vs Ethereum, -2.5% vs Mexico, -1.7% vs Russia, -1.4% vs South Africa, -0.4% vs Chile, and -0.1% vs Brazil. Gold -0.9%, Silver -1.4%, Oil +5.2%, Copper -1.1%, Iron Ore +18.7%, Corn -1.0%. 5y5y inflation swaps (EU +7bps at 1.42%, US +4bps at 2.28%, JP -1bp at 0.11%, and UK +7bps at 3.62%). 2yr Notes flat at 2.27% and 10yr Notes +10bps at 2.50%.

YTD Equity Index Returns: China +26.1% priced in US dollars (+23.4% in renminbi), Greece +23.4% in dollars (+26.3% in euros), NASDAQ +23%, Russell 2000 +19.7%, Saudi Arabia +19.3% (+19.3%), S&P 500 +17.5%, Canada +16.9% (+15.2%), Russia +16.4% (+8.9%), Italy +16.2% (+18.8%), HK +16.2% (+16.4%), Ireland +15.9% (+18.6%), Germany +15% (+17.6%), France +14.7% (+17.3%), Euro Stoxx 50 +14.1% (+16.7%), Netherlands +14% (+16.6%), Israel +13.8% (+9.3%), South Africa +13.6% (+13.5%), Colombia +13.3% (+12.8%), UK +13.1% (+9.7%), Austria +13.1% (+15.6%), New Zealand +13% (+14.2%), Taiwan +12.8% (+14.1%), Belgium +12% (+14.5%), Portugal +11.9% (+14.5%), Australia +11.9% (+12.2%), Switzerland +11.9% (+15.6%), Sweden +11.5% (+18.7%), Singapore +10.7% (+10.5%), Mexico +10.2% (+6.3%), Japan +10% (+11.2%), Norway +10% (+9.7%), Denmark +9.9% (+12.3%), Thailand +9.5% (+7.4%), India +8.7% (+7.8%), Philippines +8.2% (+6.7%), Spain +7.7% (+10.2%), Brazil +7.4% (+9.2%), Czech Republic +7.2% (+9.4%), UAE +6.7% (+6.7%), Finland +6.1% (+8.4%), Indonesia +3.9% (+2%), Hungary +3.9% (+6.7%), Korea +2.9% (+7.6%), Chile +2.9% (+0.5%), Poland +1.6% (+3.6%), Malaysia -3.2% (-3.2%), Turkey -8.7% (+2.9%), and Argentina -9.1% (+7%).

In the Future: “Investing is about looking forward,” said the CIO. “In the future, we’ll look more like today’s Europe than we’ll look like America’s past,” he continued. “Which means our rates are at least 100bps high.” US overnight rates are +2.5%, with 2019 nominal GDP forecast at +4.5% (200bp spread). EU rates are -0.40% with 2019 nominal GDP forecast at +3.6% (a 400bps spread). “In the next recession, US rates will fall 100bps quickly. Then go to zero. And after that, we’ll just have to see what direction we go,” he said, “But that’s probably to MMT.”

Splitting Atoms: “MMT is entirely valid and has been embraced by Japan, even if they don’t call it by name,” said the CIO. Japan’s debt to GDP ratio stands at nearly 250%, but the central bank owns half of it and continues buying. Overnight interest rates are -0.10%, 10yr bond yields are -0.06%, the currency is stable and there’s barely any inflation. “Lots of people scoff at MMT because they think it’s the equivalent of opening Pandora’s box. But that’s like denying the existence of nuclear physics because you think humans can’t be trusted with atomic weapons.”

Splitting Atoms II: “In Japan, they chose to suppress inflation to protect older people,” continued the CIO. “The older Japanese own the property and assets. So they’ve made the younger people have to work harder to buy these things from them.” That’s what the rentier class in every society has always done and will always do. “Japan could have made different policy choices as they deployed MMT. But the economic structure they chose has protected the status quo, while getting the most work out of young people. That’s how the world generally works.”

Splitting Atoms III: “We are quite obviously headed to MMT in the US, Europe and China,” said the CIO. “But it is still not clear how it’ll be deployed.” In Warren Mosler’s construct, MMT is best used to run an economy efficiently, supporting full employment and investment in expanding a nation’s productivity and productive capacity. “History tells us that the rentier class coopts policy to enhance their position. So while MMT is a framework suited to get people out of poverty, by the time we’re finished, it’ll probably be used to further expand inequality.”

Easy Money: “One of the neat things about the past decade is that capital markets subsidized innovation,” said the CIO. “I no longer own a car. I pay $6 to get home and apologize to my driver that it’s such a cheap ride. But he says: No sweat, I get a $100 bonus for every 10 rides.” It’s great for consumers today but long-term value-destructive for suppliers of capital, even though equity markets don’t reflect that destruction now. “And this will continue as long as markets reward top line growth, and executives who ignore the bottom line get paid in stock.”

Anecdote: “This next phase will require real vision,” said Lithium, handsfree on Highway One. “Getting here, to a place where Tesla, Uber, Lyft and their ilk are selling lots of stuff while burning through billions was a forecastable thing,” he explained. “If you had predicted 5yrs ago that Uber would have 4mm drivers, at a loss of $4bln per year, and people were going to love it, the only true foresight would’ve been that people were going to love it. That was investment genius.” Lithium banked hard, the Pacific swell to his left, Malibu’s sandy cliffs to the right. “If you’re willing to incinerate that kind of money, you can do almost anything.” You just can’t do it forever. “But if you’re telling me they’re going to make a ton of money in ten or fifteen years, or they’re going to get the transition to autonomous driving just right. Well, that’s an infinitely greater challenge,” he said, shifting into ludicrous mode. “For so many disruptive companies today there isn’t a realistic winning scenario. By the time ride-hailing firms get close to profitability, you have to believe that driverless technologies will have arrived. And this will be an incredibly disruptive thing for their models. But you need to believe they’ll ‘own’ driverless transportation, and there’s no strong case for why they will,” explained Lithium. “Maybe in a couple years Uber will only burn $2bln, then $1bln, then autonomous will arrive and they’ll burn $15bln.” That’s what the transition will look like. “Five years ago, you knew Tesla would get here, and you’d be crazy to go short until this time came. But you could also forecast that from here, it would get really hard.” And it has. “So here we are now, and where’s the road to profitability? Not clear. So to profit in this next phase, you’ll need the vision to see who will actually make money.”

Good luck out there,

Eric Peters

Chief Investment Officer

One River Asset Management

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