Tuesday, March 10, 2020

Gary Shilling warning about the Markets from October 2019



Click here if the above video does not play

Tuesday, February 18, 2020

Jerome Powell is a practical Fed Chairman

The U.S. economy has experienced its slowest recovery from a recession in the post-World War II era, and the longer it lasts the more evidence there is that normal cyclical patterns are missing. And their absence means market participants shouldn’t rely on them to divine the economy’s future.

Consider the myriad developments that are atypical, or even the reverse of normal economic and financial market behavior. The Federal Reserve shifted from easing credit to tightening following past downturns, with its target federal funds rate normally raised within a year or so of the recession’s trough, eventually precipitating the next economic contraction. This time, the central bank kept its policy rate at the recessionary low of essentially zero until Dec. 2015, 78 months into the recovery. And then, after nine quarter-percentage point increases, it reversed course early this year with three rate cuts.

Far from the Fed’s normal worries about an overheating economy and inflation, the central bank frets that low and even declining consumer prices will spawn deflationary expectations. Buyers will hold off in anticipation of lower prices. Inventories and excess capacity will mount, forcing prices down. The price cuts confirm suspicions and purchases are delayed even further, sparking a deflationary spiral. The glaring example is Japan, with deflation in most years in the past two decades and tiny real GDP annual growth of 1.1%.

Also, despite the plunge in 30-year fixed mortgage rates from 6.8% in July 2006 to the current 3.7%, rate-sensitive single-family housing starts have been muted. They fell from a 1.8 million annual rate in January 2006 to 350,000 in March 2009 as the subprime mortgage market collapsed, but have only recovered to 940,000.

Mortgage lending criteria have tightened and prime-age first-time homebuyers don’t have the necessary downpayments. The net worth of households headed by 18-to-34-year-olds dropped from $120,000 in 2001 to $90,000 in 2016, a 44% decline adjusted for inflation. Also, they learned from the last recession that for the first time since the 1930s, house prices nationwide can fall.

In past business recoveries, the U.S. household saving rate fell as consumer spending grew faster than incomes.  In this expansion, it’s the reverse, leaping from 4.9% to 7.9% in November, retarding spending.

Past postwar recessions spawned financial problems, but nothing like the 2008 crisis. The government’s reaction was equally severe with the enactment of the 2010 Dodd-Frank Act and other stringent regulations for financial institutions that are only now being slowly relaxed.

In earlier business upswings, a drop in the unemployment rate of anything like the plunge from 10% in October 2009 to the current 3.5% would have spawned massive wage inflation. This time, real wages are barely growing.

Globalization transported many high-paid manufacturing jobs to China. With the growing “on demand” economy—think Uber Technologies Inc. —many people trade flexibility in working hours for low pay. The payroll jobs that are being created are mostly in low-wage sectors such as retailing and leisure & hospitality.

For years, foreign policy was bipartisan and expanding trade was considered highly desirable. Now, globalists have been overcome by protectionists, spurred by voters upset over stagnant purchasing power and rising income and asset inequality in G-7 countries. Trump’s 2016 election along with the U.K.’s “Brexit” from the European Union are among the results. Then there’s also the demise of global trade deals, which are being replaced by bilateral agreements or no pacts at all.

The U.S.-China trade dispute will no doubt persist because China, with a declining labor force as a result of its earlier one child-per-couple policy, needs Western technologies to grow and achieve its worldwide leadership ambitions. But the U.S. is opposed to the technology transfers China wants.

The dollar’s slide from 1985 until 2007 encouraged U.S. exports, curbed imports and gave U.S. multinationals currency-related boosts to profits. Since then, the dollar index has rallied 33% amid a global demand for haven assets. And it should continue to, given the relatively faster growth of the U.S. economy, its huge, free and open financial markets and the lack of meaningful substitutes for the greenback.

Disinflation has reigned since 1980, but real interest rates were positive until the last decade.  But for 10 years now, real 10-year Treasury note yields have been flat at zero (see my Nov. 19, 2018 column, “Zero Real Yields Are Tripping Up Investors”).  This and the flat yield curve have pushed state pension funds and other investors far out on the risk curve in search of real returns, bidding up stocks to vulnerable levels.

Earlier, the Fed was run by Ph.D. economists who clung to widely-held theories even though they didn’t work. Fed Chairman Jerome Powell is proving to be much more practical, backing away from rigid Fed policies such as the 2% inflation target and a zero-bound policy rate as well as unsuccessful forward guidance.

In this different economic climate, it’s hard to time the end of the current recovery. Still, it will end, due either to Fed overtightening or a financial crisis, like the 2000 dot-com blow-off or the 2007-2009 subprime mortgage collapse. In the current excess supply-savings glut-deflationary world, it’s likely a recession will unfold due to a shock before the Fed overtightens.

No financial crises are in sight, but there are possibilities such as excess debt in China and among U.S. businesses, a trade war escalation, consumer retrenchment resulting in widespread deflation, and disappointing corporate profits measured against sky-high stock prices. Watch for specific imbalances, not typical past patterns.


via aawsat, bloomberg


Monday, August 19, 2019

Why the US China trade war is happening

China has been making serious progress to becoming a world class economy financially and militarily. Donald Trump appears to recognize this and has launched a Trade War against China. Gary Shilling explains this dynamic in his new post on bloomberg.


The escalating trade war between the U.S. and China has reached a fever pitch, with financial markets seeming to lurch on every new development no matter how insignificant. That’s understandable, but what investors need to know is that in a world of surplus goods and services, the buyer has the upper hand.

Sure, both sides are under considerable pressure to reach a deal. President Donald Trump faces re-election next year, and the longer the trade disruptions drag on, the bigger the potential for a steep stock market selloff and the deeper the recession I think the U.S. economy has already entered. Xi Jinping, China’s de facto president-for-life, is strapped with a slowing economy, with the 6.2% rate of expansion reported for the second quarter probably double the truth. Also, some Communist party elite fret over Xi’s power and his provoking the U.S. and other countries with aggressive military expansion and the heavy-handed Belt and Road program.

Nevertheless, the basic issue is China’s challenge to the U.S. for global supremacy and the importance of technology in this struggle. China’s growth has depended on Western equipment and cheap local labor to produce inexpensive goods that could be freely exported to North America and Europe. With slower growth in the West and muted demand for everything, including imports, that game is over. So, too, is Chinese growth through infrastructure spending. The result has been excess capacity, ghost cities and a huge increase in debts.

So China must turn to domestic growth, but with the earlier one child-per-couple policy, the labor force will be shrinking for decades. Hence the need for technology-driven productivity. But China is only starting on domestic technology development and therefore desperately needs help from the West. For years it has been demanding the transfer of technology as the price of Western firms doing business in China. Trump seems well aware of China’s long-run game plan and determined to retard it.

Meanwhile, the slide in China’s economy will intensify as Chinese and foreign producers accelerate their shift to even-lower-cost Asian countries that are out of the line of the U.S.-China trade war fire. These include Vietnam, India, Malaysia, Taiwan and Thailand. Already, the direct and indirect effects of the trade spat have dropped China from being America’s largest trading partner to third place behind Mexico and Canada. U.S. bilateral trade with China fell 14% in the first half of 2019.

Declining imports from China have been offset by purchases elsewhere. U.S. imports from Vietnam leaped 33% in the first half. In June, exports to the U.S. from South Korea, Taiwan, Japan and Singapore rose by a combined 9% from a year earlier, using a three-month moving average, while their exports to China fell 9%. Singapore’s shipments to China plunged 23% in May from a year earlier, the fourth drop in five months. Much of those imports are components that China assembles for final export to the West.

But despite Trump’s hopes, manufacturing is not returning to the high-cost U.S. Manufacturing output dropped 1.1% in June from its December peak, and the Institute for Supply Management’s manufacturing index fell again in July, this time to its lowest level since 2016.

Rising costs in China have encouraged manufacturers of apparel, footwear and other low margin consumer items out of China in recent years, but now the departure of electronics and other high margin products are troubling Beijing. And Chinese leaders are aware that once these operations leave and labor is trained and supply chains established elsewhere, they are unlikely to return.

Foxconn, which assembles Apple’s iPhones and iPads, mostly in China, is considering shifting production elsewhere. It has plants in Brazil, Mexico, Japan, Vietnam, Indonesia, the Czech Republic, the U.S., Australia and other countries. Only 25% of its manufacturing is outside China, but Young-Way Liu, the head of Foxconn’s semi-conductor business group, recently said the company’s manufacturing capacity outside China is adequate to supply Apple and other customers with products for the U.S. market, and that production could be expanded at facilities worldwide “according to the needs of our clients.”

Meanwhile, Apple is asking suppliers to consider moving final assembly of some products out of China. This would involve a third of production for some devices, including iPhones, iPads and MacBooks, and destinations under consideration include other Southeast Asian countries. Nintendo is shifting some output of its Switch video game console to Southeast Asia from China. Japan’s Sharp, which is controlled by Foxconn, said in June that it planned to move personal computer production to Taiwan and Vietnam from China.

So, while China suffers from the departure of high margin production, the U.S. will still enjoy low-cost imports from other Asian countries—and emerge from the trade war on top.  But the long-term gain to American consumers that follows the short-term pain of the trade war may be limited by China’s determined challenge for world domination.