Your Turn

Posted On May 30, 2019 By Dave Gonigam

  • Clear economic sailing, or battening down the hatches?
  • The 5 gives the floor to the readership today
  • Jay Powell’s confidence-inspiring take on corporate debt (not)
  • Thriving truck drivers and valets
  • Is it really the ’50s again?

“Corporate debt is the looming iceberg that keeps me up at night,” a reader writes.

Yesterday we tackled a proposition that brings new meaning to the word “contrarian” — that a recession and bear market might still be several years away.

We connected a few dots of supporting evidence and then we asked for your input — your “ground truth.” Are you feeling skittish about the market? Are businesses hiring where you live? How does now feel compared with other times in your experience?

The response was overwhelming… and it reaffirmed our belief that The 5 has the most engaged and informed readership of any financial e-letter.

So we’re doing a first in our 12-year history — an all-mailbag episode of The 5. (Well, we think it’s a first. Do this long enough and you start forgetting things, heh…)

We’ll get to corporate debt shortly, but we’ll tackle a few other contributions first.

“Well, I’m not making any predictions either, but this could be a case of ‘This time it really is different’… in some respects.”

This reader thoughtfully runs down our list of items suggesting “no recession/bear market soon” with her own take…

  1. Inflation: I’m not buying that inflation is low to nonexistent. Fuel prices haven’t gone up much, but it seems to be getting more expensive by the day to eat and buy toilet paper. The healthier you eat, the more expensive it is.
    But according to some of your own experts, the reason the Fed’s money printing orgy hasn’t resulted in hyperinflation is that the new money hasn’t been released into the general economy. It’s not moving. It has either sat at the Fed in the form of reserves (on which the big banks are earning interest) or it has gone to Wall Street, where it has fueled the bull market in stocks for the past 10 years or is still lying in wait to buyback more stocks. That’s not where the money has gone in previous expansions.
  1. Oil prices: I’m no expert, but during each of the previous recessions you cited, wasn’t the U.S. a net importer of oil? It seems to me that oil prices have become much less sensitive to geopolitical shenanigans.
  1. Where’s the bubble? Corporate stock buybacks?
  1. Mom and pop on the stock market sidelines: Or is it that this time mom and pop don’t have anything to invest in the stock market because they have not been the beneficiaries of the past 10 years of expansion? I know I don’t have any money to put in stocks. None of my siblings or their friends do. What money my mom and pop have to invest is already in the market and has been for longer than 10 years.

“Just my two-tenths of a cent worth… ’cause that’s all I’ve got after the (almost) longest expansion in history.

“Love my daily dose of The 5!

The 5: To be clear, the issue isn’t about inflation per se but whether inflation is accelerating. It’s the trend, not the absolute level.

So let’s look at the real-world inflation numbers from Shadow Government Statistics. Economist John Williams says the most recent peak came last July at 10.8%. From there, it fell nearly every month until bottoming out in February at 9.2%. By April, the most recent figure available, it ticked up to 9.7%. Give it a couple more months and we’ll see…

Meanwhile, the United States is not yet a net energy exporter. In January the Energy Department forecast we’ll get there by the fourth quarter of next year (a suspiciously precise forecast, but we digress).

It’s true that buybacks have fueled much of the stock market rally since 2009. But to call it a “bubble”? Hmmm…

You raise a good point about how mom and pop might not have the resources to plow into the stock market. But if anything, that reinforces the thesis: If we avert recession for another couple of years, mom and pop might feel flush enough… and the market will be rising steadily enough… that the ol’ FOMO (fear of missing out) will finally kick in.

“From my perch here in SoCal,” submits our next correspondent, “I see the following.

  • Huge amounts of unfilled commercial space everywhere. Strip malls and plazas with upward of 40% vacant space. All or most were previously retail
  • Large shopping malls also growing more vacant, with many of their anchor stores closing up shop
  • Restaurant failures that exceed the norm of 50% in 5 years
  • Existing housing prices that continue to climb, yet houses are not in short supply
  • Huge effect here from the trade war as Chinese tourism takes a massive hit, especially those multiple busloads of shopping tours that clean out luxury brands in a day
  • Huge effect from the trade war on those that sell to China. It doesn’t matter if you ship by air. Unless it’s something essential, it’s sitting in customs for 40 days
  • Chinese investment in the U.S. has pretty much dropped to zero, and that includes individuals. They just cannot get their money out
  • I do a lot of shopping in Chinese supermarkets for the great variety, but prices are rising significantly. I used to buy er guo tou (112-proof liquor) for $9.95. It’s $11.99 now. Oh, and where the pricing hasn’t changed the size or quantity for the price has
  • The only bubble I’m aware of is in corporate crap, err, junk bonds.

“I don’t see any one trigger, and perhaps it won’t be just one unless it’s a huge one. Of course, if our dear old POTUS doesn’t quit snowflaking around on and off Twitter, we might get to that trigger sooner rather than later. My money (literally) is on a rare earth embargo as a nice big trigger with huge ripple effects. Must suck to be Tesla right now…”

The 5: Very interesting — especially hearing from one of those coastal locales that have disproportionately benefited from the Fed’s post-2008 largesse.

The pain in retail might not reflect an economic slowdown, however. We were talking “retail apocalypse” even as the market and the economy were steadily on the rise in 2017. It’s a combination of the “Amazon effect” and the gargantuan debt many retailers took on because the Fed fooled ’em with ultra-low interest rates. (We’re looking at you, Toys R Us.)

So now we pivot into corporate debt…

“If I were going to guess where the most likely bubble is going to pop, I would guess in low-quality corporate debt, the infamous BBB corporate bonds,” writes a Platinum Reserve member from his perch in Latin America.

“If one sets out to find a publicly traded company that is struggling to keep up with its debt, it’s not hard to find candidates. And since much of this debt is ‘covenant lite,’ the bondholders may find their losses are greater than was the case in previous bubbles.

“As soon as this debt starts getting downgraded, there will be a rush for the exits, accelerated by the retirement and other funds that hold much of this debt but cannot hold debt lower rated than BBB.

“The stock price of companies that cannot pay their debts — or roll it over, more likely — tends to approach zero rather rapidly, and the panic spreads from a few companies to most of them in a flash. Even companies that should be solvent may be denied credit in the panic and collapse as a result.

“So that’s my candidate — low-quality debt.”

The 5: It’s the most plausible candidate for us too. We’ve been periodically wringing our hands about corporate debt since late last year. And our concerns only grew last week when Fed Chairman Jay Powell went out of his way to say corporate debt does not pose a threat to the system the way subprime mortgages did in 2007–08.

Nor is that the first time Powell whistled past the corporate-debt graveyard, it turns out.

A reporter from the public radio program Marketplace posed this question at Powell’s January press conference: “Are you worried that by taking a pause in raising interest rates — we’ve had low interest rates for so long — you are contributing to a bubble in corporate debt?”

The first word out of his mouth in response was not reassuring. (We’ll get back to our mailbag shortly. But we can’t help ourselves…)

“So we did — we’ve called out corporate debt as a risk — more of a macroeconomic risk, I think, than a financial stability risk, the sense of that being that if you have companies that are highly levered and we do go into a downturn, they’re going to be less able to weather that and keep serving their customers and, you know, may have to do layoffs and things like that. So they can amplify, in effect, a negative downturn. So we watch that.

“We also watch carefully for the exposure of the financial system to these companies. In other words, banks are arranging a lot of these loans. The question is what is their exposure? Do they retain big pieces of the loans? Do they have obligations to underwrite loans, which build up in a pipeline? So we monitor those risks very carefully. And frankly, the banks monitor them much better with our support and help than they did before the crisis. So it’s a concern. It’s something that we’re watching.”

None of that should instill confidence, but we’re struck by the first word of his response. As we’ve pointed out for several years now, starting a response to an uncomfortable question with “so” tends to telegraph a lack of confidence in what you’re saying. It was a regular tic of Powell’s predecessor, Janet Yellen. It betrays how the faux “science” of monetary policy is just so much snake oil.

OK, back to the mailbag and some “microeconomic” snapshots…

“Consumer spending dictates highway traffic,” writes a truck driver. “I can confidently tell you that heavy truck traffic is thick.

“People are buying daily life products, businesses are buying large stationery products and agriculture is shipping tons of products now. Judging shipping from my perspective, America is busy, busy, busy.”

“I’ve been working for a pizza shop and a valet service,” writes our next contributor.

“Both places are very, very busy. My wages have gone up recently in both cases. In the case of the pizza it’s not cheap, so people are still willing pay more for better quality, which is a good sign. In the case of the valet business, it’s hard to keep good people, and the wages and tips really aren’t bad! This tells me there are other employment options. To sum it up, I’m not worried one bit!”

“It has been feeling a lot like the 1950s,” writes our final correspondent today.

“Following the rationing of WWII, there was availability of everything we needed so that then we could just work and send the kids to school. Gasoline was 15 cents a gallon, as was a quart of milk delivered to our doorstep.

“Now China produces every possible item and gizmo that we could ever need, and we just do our best to keep a job, no longer looking for fast promotions or those whiz-bang stock options or IPOs. What a relief to be done with the financial and technological miracles that simply gave us a big helping of Toffler’s Future Shock.

“Now everyone has a smartphone and everything comes to our doorstep from Amazon instead of the milkman, bread man, paperboy, Sears Roebuck or Montgomery Ward. Two hundred TV channels give us no more satisfaction now than Channels 2 through 13 did then. Health care came from the doctor who practiced three blocks away and charged $5 for a house call. One used car was all that we needed or could afford. Keep working, pay the rent and enjoy three squares a day around the kitchen table.

“That is still all we need and we have it. We are more people now with more complicated problems, and we keep working them out. We have little more to fear about the future now than we did then. Pogo was right.”

The 5: [Whistling the Leave It to Beaver theme as we wind down today…]

Best regards,

David Gonigam

Dave Gonigam
The 5 Min. Forecast

P.S. The markets today? Meh…

The major U.S. stock indexes are in the green, barely. At last check, the S&P 500 stands at 2,785. Gold is up a bit to $1,286. Crude is more or less where it was yesterday at $57.51.

The Commerce Department’s latest guess at first-quarter GDP growth is an annualized 3.1%. But the forward-looking estimates for the current quarter are lousy — 1.3% according to the Atlanta Fed, 1.4% by the New York Fed’s estimate.

Average out the first and second quarters… and we’re about on par with the weak growth of the last 10 years. Same as it ever was…


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