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Many sacred cows have been slaughtered these past few years. Beliefs held as obvious, incontrovertible even, were crushed to dust.
Take, for example, the notion that the United States was due to implode under the weight of accumulated debts. In a recent issue of the Strategic Intelligence Report, we completely dismantled this false notion, which fails to consider the asset side of the USA balance sheet.
(For a very quick eye-opener, consider this piece from the Institute for Energy Research, “Federal Assets Above and Below Ground.” It is hard for Uncle Sam to be broke when his asset-based net worth, let alone his annual cash flows via the power to tax, runs to the hundreds of trillions.)
To be clear, we are no fans of prolonged market meddling from central banks. Such is not “money printing” — that phrase is so grossly misused it should be banished — but has significant negative impacts as explored here.
With that said, there is a powerful takeaway from the recent stretch of years. Markets — both financial markets and economic systems on the whole — do not care about the poor. And by that we mean they really, really don’t care.
The functional attitude is “Let them eat cake,” as Marie Antoinette supposedly said. Except in the real world it is “Let them eat iPads” — and there are no subsequent uprisings or beheadings.
In other words: It is wholly possible for a free market economic system to survive, and even thrive, as those on the lower rungs of the economic totem pole see their personal prospects threatened, flattened, or even flat-out crushed. Nobody cares about the poor, not really. Not on Wall Street and not in Washington. The Federal Reserve indeed wants to help the middle class, but they can only do so by helping the rich first (and then hoping for the best).
The iPad and iPhone are instructive examples of this (and as of this writing we are still long AAPL). These devices add significant value and productive GDP to the economy, but only via those who can shell out serious bucks for an expensive piece of technology. This is all well and good in practical terms. Those who spend help the system to mend. Those with empty pockets on the bottom rungs (and increasingly the struggling middle rungs) can be safely ignored.
This is not a moral observation. It is simply an observed aspect of harsh reality. In fact the lack of morality in respect to capitalist systems is often an essential point. When we recently argued for the robust nature of US recovery, one of the objections received was that “50 million Americans are on food stamps.” The number may actually be higher than that. But does it matter from a pure functioning-of-the-system perspective? Perhaps not at all.
Consider the feudal system that dominated the Middle Ages. A system of “Lords, Knights and Serfs” dominated for centuries. Why could it not dominate again? Many years ago, we pointed out a growing phenomenon of “Digital Feudalism.” In 21st century Digital Feudalism, the “Lords” are holders and wielders of capital. The “Knights” are white collar knowledge workers (who in turn have a shot at becoming Lords themselves). And the “Serfs” are everyone else.
If you understand that markets do not care about the poor — and that free market economic systems can function well while ruthlessly suppressing the bottom half, or even the bottom two thirds, of the economic stratum — then you are closer to understanding why activity of the past few years has generated an overall picture of economic success for the United States (if not for other countries).
The Federal Reserve set out to save the big banks first and foremost, which exist at the center of the system, by quarantining toxic assets (taking them onto its own balance sheet). The Fed then sought to create a “wealth effect” — as openly admitted by Bernanke and Yellen — via ZIRP (zero interest rate monetary policy) and the blatant encouragement of asset appreciation and financial engineering.
This was maddening from a moral perspective, leading to phrases like “socialism for the rich”. The non-rich, meanwhile, who did not participate in paper asset appreciation — for lack of anything but spare change in their retirement accounts — saw the return on their interest-bearing savings accounts asymptote above zero, even as wages stagnated and labor hours were cut.
The hard, brutal, Darwinian fact here — as based on empirical evidence — is that saving an economy by stimulating the assets and prospects of the wealthiest asset holders, which includes top-end corporations, is a strategy that to real degree actually works. Consider the spending patterns of the top 30% of the US class pyramid, for example, as contrasted against the bottom 70%. Wal-Mart and payday loans aside, who do you think keeps the retail sector humming? The top 30% do.
Active market participants, who wish to actually make a profit from investing and trading, do not have the luxury of coloring their decisions with emotional sentiments. It may be unpalatable, sickening even, to consider the possibility that the free market system on the whole is geared toward elevating the haves rather than the have-nots, often at direct expense of the have-nots.
But if such is true, well, then what’s true is true. Darwinism in nature, at its most stark and brutal, is also a morally unpalatable phenemenon. That has no bearing on the reality of things.
What, you may ask, does this have to do with markets and trading? Well, it may turn out that wage suppression is the key — the hidden solution piece — to fully unlocking the market puzzle.
Via the lead article in this week’s links, Gavyn Davies of the FT makes a fascinating observation, by way of a paper from Morgan Stanley. The basic line of reasoning runs like this:
Real wage growth has grossly lagged productivity growth.
Wage growth has been suppressed via globalization, technology, and other means.
Suppressed wage growth leads to outsized corporate profits…
But also to sluggish economies via lack of spending from workers…
And thus to perpetually low interest rates in a deflation-prone, low-inflation world…
With perpetually low rates fueling the financial engineering cycle…
Plus perpetually higher profits and expanded multiples on those profits.
That is a brilliantly elegant argument chain, is it not?
The working masses can’t keep their wages up. As a result, corporations have fatter profits. As a further result we get sluggish, molasses-like recoveries… which cause central banks to keep interest rates low… which in turn feeds the financial engineering cycle as wealthy companies borrow cheaply and spend the money on share-pumping schemes (which yield-chasing investors, spurred by near-zero rates, happily snap up).
And then, because these companies are primarily spending on buybacks and dividend payouts, future productive economic growth is stymied (which suppresses the long-run jobs outlook). The upper echelons win again through greater leverage applied to paper assets, showing up as higher multiples here and now. The economic masses are once again left out in the cold — no accumulated paper assets to speak of, no fair rate of return on their interest-bearing savings account (on what little they have saved), and no wage growth in their pockets.
Long-term globalization trends only cement this phenomenon further. When jobs can be outsourced or automated, the deflationary impact on wages is multiplied. Corporations win because they mainly cater to the top thirty percent (bottom seventy percent more or less who cares)… and suppressed wages keep profit margins high as productivity increases… and low interest rates in perpetuity via lack of inflationary pressures seal the self-reinforcing deal.
America is indeed rich. The richest country in the history of the world in fact. It just so happens the distribution of those assets is incredibly Darwinian. And yet there are no clear arguments as to why this state of affairs has to change (except one as we shall soon touch on).
Are the American masses — the lower seventy percent — going to rise up and facilitate economic revolution because of wage stagnation? No, that is wishful thinking in the extreme. As someone tweeted regarding the 2014 mid-term elections: “That wasn’t an election, it was a Game of Thrones finale” — a pun on the sea of Republican red that washed over the United States. The dominating corporate welfare state is under no threat from the serfs.
Digital Feudalism is a binary prospect. For the top thirty percent, the future is wonderful and bright. It is an amazing time to be alive. For the bottom seventy percent, however, one is reminded of the bleakest line from Orwell’s 1984: “If you want a picture of the future, imagine a boot stamping on a human face — forever.”
Except the story is not that cut and dry — because it is not clear that wage suppression lasts forever.
There is, in fact, evidence that wage pressures in the United States could be returning… and are now in the process of returning. Supply and demand pressures may be finally shifting the picture.
And that would change everything.
In this week’s links, you will find an argument from Jim O’ Sullivan, chief economist at High Frequency Economics, that US wage growth is accelerating. You will also find a series of FRED charts, accumulated by Conor Sen, showing that slack in the labor market is falling. Even those with no high school diploma are seeing unemployment rates plummet.
Wage growth has been flat-to-sideways these past few years. It is one of the reasons the US recovery has felt utterly disappointing to the masses (even as paper assets soared). It is also one of the reasons inflation pressures have been all but non-existent. You need wage pressures to really get an inflation cycle going. (In the high inflation environment of the 1970s, unions had massive negotiating power and regular wage-boosts were built into employment contracts.)
Here is where the argument gets quite bearish for elevated paper assets, and thus for all equities (including US equities)…
The entire market is now leveraged to outlier levels of corporate profits. This corporate profits to GDP chart tells the story. And as Bajinath Ramraika and Prashant Trivedi point out in this week’s links, there is ample evidence that elevated corporate profit margins are simply not sustainable. Closing tax loopholes will have a notable impact. Rising debt service costs will have yet further impact.
And the return of wage growth pressures is what makes it all happen…
Wages may be the key to everything, or so we argue here. The Federal Reserve has keep rates at near-zero levels to try and bring a return of positive inflation and positive wage growth to the US economy. To the degree that the Federal Reserve succeeds in getting wages to rise, they have managed success in their mandate.
But rising wages, if we see them, further implies a normalization of interest rates. And that, in turn, means the forced unwinding of all the gross excesses built up over the years, by way of market distortion and multiple expansion in a near-zero interest rate world, where a combination of financial engineering and profit-boosting wage suppression took equity valuations far above non-manipulated sustainable levels.
And of course, as we noted last week, a rising US dollar makes everything worse for the rest of the world. The return of wage growth in the United States means widening interest rate differentials in favor of huge capital flows toward the United States, be they into equities, munis or treasurys — even as Europe lurches toward crisis, Japan flails at the precipice of demographic deflationary doom, and China reaps the wages of a construction-driven ponzi bubble feeding hidden trillions worth of non-performing loans.
Those differentials then make the dollar yet stronger, we anticipate, with brutal impact on multinational outlooks as described. And small caps, meanwhile, still enjoy historically rich valuations… and will be hit with wage pressure too if such comes to pass, even as speculative energy plays blow up (plummeting crude oil anyone?).
The old cliches sometimes have merit. All things move in cycles. What goes up must come down. Pipers must be paid. Excess leads to consequence. Now we understand how a reckoning may look in paper asset terms.
A pattern of wage suppression that radically accelerated post-financial-crisis, leading to a period of multiple expansion in a zero interest rate world, is now so precarious that any real evidence of a normalized rate environment, or a return to such via the return of wage pressures, could cause the whole leveraged structure to come crashing down.
In result, we believe there will be many excellent shorting opportunities in 2015. Those unprepared for a change in the wage paradigm — and a potentially very different world of normalizing rates — could be in for a world of hurt.
By the way: If you appreciate our analysis in these weekly links pieces, then you absolutely must consider the Strategic Intelligence Report.
We are not just high-minded thinkers or armchair prognosticators. We are active traders in both the macro and micro space. In addition to delivering high quality analysis 47 weeks per year, the SIR delivers excellent investing and trading ideas, both long and short, while covering the gamut of major macro trends impacting all asset classes.
Quite simply, we feel justified in saying the SIR is one of the most unique and powerful publications in the marketplace today. And at a price point of as little as $19 per month, with a no-risk money-back guarantee, we can’t figure out reasons NOT to subscribe. To browse the back issues of the SIR archives (and find out how to subscribe), go here:
www.mercenarytrader.com/SIR
Mercenary Links November 15th: Wage growth may soon accelerate… bullishness at 95th percentile extremes… potential for a global recession in 2015… Google’s terrifying robot, landing on a comet, and more.
Lower real wages fuel suppressed interest rates and higher profits
Why Jeremy Grantham is Right about Corporate Profit Margins
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Measures of Wage Growth Show Stagnation, But Slack Is Falling Quickly
O’Sullivan: US wage income is accelerating
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Who’s Afraid of Fed Raising Rates? Not These Bond Buyers
Market Hears Earlier Rate Hike in What Fed Doesn’t Say
Fed’s Rosengren says fight for higher inflation should be vigorous
Fed Concern With Repeat of 1937 Blunder Echoed by Markets
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US earnings boost masks revenue fears
When AAII Bullishness is Above 95th Percentile
October jitters are just a taste things to come
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Large global benefits from the 2014 oil shock
Retail Sales Poised for a Holiday Run
Reversal of fortunes as US munis surge
~~~
Predictors of ’29 Crash See 65% Chance of 2015 Recession
The US is a huge hedge fund
~~~
11 Warhol Paintings Sell for $200 Mil at Christie’s Record $852 Mil Auction
Art Selling Like Hot Cakes in New York Auctions
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Germany refuses to adopt boom policy that would help eurozone
Yellen Calls E.C.B. Review of Banks a Confidence Booster
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Albert Edwards Most Important Chart Is Dollar Yen
Yen drops to seven-year low vs dollar as Japan election talk picks up
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Bank of England warns inflation could drop below 1%
Alleged Sarkozy plot rocks French political establishment
Hard Lessons for Borrowers in Hungary
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Thawing Out Lessons From the Cold War
Russia braces for long economic war with the West
CNN pulls out of Russia, citing new media laws
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Russia ends dollar/euro currency peg, moves to free float
Sanctioned Russian Banks Said to Woo Exporter Dollars
Russians buy dollars, hoard cash on rouble fears
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Russia to Fly Bombers to U.S. Gulf as Ukraine Escalates
Putin’s War Games Are Setting Off Alarms Worldwide
Russia is a bigger problem than Isis for Obama
Russia-Iran nuclear reactor deal raises eyebrows
~~~
Million-Dollar Homes in Sydney Highlights RBA’s Dilemma
Australian dollar drops after hints at intervention
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U.S. may significantly hike number of troops in Iraq
ISIS, Al-Qaeda Join The M&A Bubble
Isis declares its own currency
Islamic State leader urges attacks in Saudi Arabia
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Putin builds China links as ties with west fray
Putin snubs Europe with Siberian gas deal that bolsters China ties
Putin Hits on China’s First Lady, Censors Go Wild
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Putin stockpiles gold as Russia prepares for economic war
China hoarding gold to challenge U.S. dollar?
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Few Signs of Construction at Yujiapu, China’s Manhattan Replica
China Hunger for Clean Energy to Leave No Rooftop Behind
China outbound investments projected to top inbound this year
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China to Debut Fighter Jet as U.S. Brass Attends Airshow
With a Stealth Fighter, China Tries to Gain Attention
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Crude Prices Pressured Anew
Oil falls below $80 mark, first time since 2010
Cash-Burning Bets on Oil Rebound Surge in U.S. ETF Market
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Saudi oil chief dismisses ‘price war’ claims
Transocean warns of offshore oil downturn
Oil’s dive set to transform LNG market
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North Dakota to Require Producers to Treat Crude Before Shipping
Halliburton in Talks to Buy Baker Hughes
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US shale pioneers circle the wagons
IEA warns low oil prices threaten US shale investment
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Grain futures stay strong despite Wednesday’s early soy reversal
Commodity Curves Bury Passive Investors
Corn multi-year lows and lower USDA forecast should feed bulls
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Growing Economy Doesn’t Guarantee Stock Gains
GDP Leaves False Trail in Emerging Equities
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Twitter CEO Dick Costolo Struggles to Define Vision
Twitter given junk bond rating by S&P
~~~
Hachette Looks Like the Winner as Its War With Amazon Ends
Exclusive: DogVacay raises $25 million
GoPro launches $800 million offering, CEO to sell some shares
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Jeff Gundlach Profile: Glory To The New Bond King
Great Investors Think in Terms of Probabilities
Harold Hamm to Pay One of the Biggest Divorce Settlements in History
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Shipping Regulators Go Full Speed Ahead on Emissions Controls
Why the U.S.-China Emissions Pact Is a Climate Change Breakthrough
Pursuing a Shipping Revolution as Big as His Airship
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Six Banks to Pay $4.3 Billion in First Wave of Currency-Rigging Penalties
Goldman Sachs elevates 78 to partner cadre
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Warren Buffett powers up $4.7bn Duracell deal
Buffett Set to Save More Than $1 Billion on Taxes in Swap
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Robotic Legs for the Disabled
Terrifying two legged giant robot being developed by Google
Breakthrough in stem cell treatment for Parkinson’s
~~~
For Guccifer, Hacking Was Easy. Prison Is Hard.
Alex From Target: The Other Side of Fame
Taylor Swift and Big Machine Are the Music Industry
Landing on a Comet, 317 Million Miles From Home
Recent Mercenary Links (scroll for archives)
(select a post)
Mercenary Links: Let Them Eat iPads
Mercenary Links: The Dollar is a Lawnmower and The World is Grass
Mercenary Links: Hawkish
Mercenary Links: The Financial Engineering 500
Mercenary Links: Inflation Already Happened
Mercenary Links: Get Used To It
Mercenary Links: No Soft Landing
Mercenary Links: Buyback Idiocy
Mercenary Links: Don't Party Like it's 1999
Mercenary Links: 57-year High
Mercenary Links: Falling Prices Ahead
Mercenary Links: Crackdown
Mercenary Links: Hey Ma
Mercenary Links: Forty-Seven Percent
Mercenary Links: Dollar Pressure
Mercenary Links: If it's Nae Scottish, it's Crap
Mercenary Links: "We Are Done"
Mercenary Links: That Sinking Feeling
Mercenary Links August 29th: Ahem, Nukes, Cough
Mercenary Links August 26th: Everything is Expensive
Mercenary Links August 22nd: Pushing Europe into Depression
Mercenary Links August 19: Betting On Collapse
Mercenary Links August 15th: Convoy Attack
Mercenary Links August 12th: Pretext for Invasion
Mercenary Links August 8th: Bombs Away
Mercenary Links August 5th: Major Warning Signs
Mercenary Links: Growling Again
Mercenary Links: $29 Billion
Mercenary Links July 25th: Big Doubts
Mercenary Links July 22nd: Stupid Deals
Mercenary Links July 18th: Escalation
Mercenary Links July 15th: Gold in the Cold
Mercenary Links July 11th: October
Mercenary Links July 9th: The Everything Bubble
Mercenary Links July 1st: Bulk For Sale
Mercenary Links June 27th: Loosening the Ban
Mercenary Links June 24th: In Yellen We Trust
Mercenary Links June 20th: Dangerously Overvalued
Mercenary Links June 17th: Run of Calm
Mercenary Links June 6th: Passing the Peak
Mercenary Links June 5th: Via Negativa
Mercenary Links June 4th: Calling Super Mario
Mercenary Links June 3rd: Shock and Awe
Mercenary Links June 2nd: Sharp Curbs
Mercenary Links May 30th: Hot Clip
Mercenary Links May 29th: Shrinkage
Mercenary Links May 28th: Look Ma, No Steering Wheel
Mercenary Links May 23rd: Already Forgotten
Mercenary Links May 22nd: Military Coup
Mercenary Links May 21st: Let's Make a Deal
Mercenary Links May 20th: Lingering Woes
Mercenary Links May 19th: The Walter White of Central Banking
Mercenary Links May 16th: Storming and Sweeping
Mercenary Links May 15th: Nervous Time
Mercenary Links May 14th: Euro-Stimulus
Mercenary Links May 13th: Demographic Bid
Mercenary Links May 12th: Modi Mania
Mercenary Links May 9th: Fresh Beats
Mercenary Links May 8th: Slow Night at the Auction House
Mercenary Links May 7th: Pot Pressure
Mercenary Links May 6th: Rich List
Mercenary Links May 5th: Wage Pressures
Mercenary Links May 2nd: Kicking Into Higher Gear
Mercenary Links May 1st: Most Affluent Eh
Mercenary Links April 30th: Slowing to a Crawl
Mercenary Links April 29th: Labor Shortages
Mercenary Links April 28th: Crisis Watch
Mercenary Links April 25th: Flash Boys STFU
Mercenary Links April 24th: Losing Steam
Mercenary Links April 23rd: Shorting Cool Kids
Mercenary Links April 22nd: Middle Class Blues
Mercenary Links April 21st: Sluggish Resilience
Mercenary Links April 17th: Ramping Up
Mercenary Links April 16th: Power Drain
Mercenary Links April 15th: 1990
Mercenary Links April 14th: Sizzle
Mercenary Links April 11th: Tiger Soup
Mercenary Links April 10th: Selloff
Mercenary Links April 9th: Confusing Markets
Mercenary Links April 8th: Sabotage
Mercenary Links April 7th: Busy Week
Mercenary Links April 4th: End of an Era
Mercenary Links April 3rd: Dovish Draghi
Mercenary Links April 2nd: Disaster Payouts
Mercenary Links April 1st: Ford Tough
Mercenary Links March 31st: Dovespeak
Mercenary Links March 28th: Don't Believe the Hype
Mercenary Links March 27th: Rumor and Panic
Mercenary Links March 26th: Lipstick on a Candy-Coated Pig
Mercenary Links March 25th: The Bundesbank Said What?
Mercenary Links March 24th: High Output
Mercenary Links March 21st: Nothing At All
Mercenary Links March 20th: Unintentionally Hawkish
Mercenary Links March 19th: Minsky Cometh
Mercenary Links March 18th: Developer Blues
Mercenary Links March 17th: Expensive
Mercenary Links March 14th: Switch-Up
Mercenary Links March 13th: Relentless Rise
Mercenary Links March 12th: QE and its Discontents
Mercenary Links March 11th: Shadow Halt
Mercenary Links March 10th: What's Up Doc
Mercenary Links March 7th: $80.7 Trillion
Mercenary Links March 6th: Hello Nakamoto
Mercenary Links March 5th: Chicken Kiev
Mercenary Links March 4th: Putin Blinks
Mercenary Links March 3rd: Cock the Hammer
Mercenary Links Feb 28th: The New Great Game
Mercenary Links Feb 27th: Gigafactory
Mercenary Links Feb 26th: Tension
Mercenary Links Feb 25th: Electric Boogaloo
Mercenary Links Feb 24th: Fresh Record
Mercenary Links Feb 21st: Transcripts
Mercenary Links Feb 20th: $19 Billion
Mercenary Links Feb 19th: Putin's Nightmare
Mercenary Links Feb 18th: Hoover Dam
Mercenary Links Feb 14th: Inflation, is that you?
Mercenary Links Feb 13th: Deflationary Vice
Mercenary Links Feb 12th: Killer Glitch
Mercenary Links Feb 11th: Dovin' It
Mercenary Links Feb 10th: Waning Magic
Mercenary Links Feb 7th: Undeterred Fed
Mercenary Links Feb 6th: The Poverty Economy
Mercenary Links Feb 5th: Ok Janet, Now What
Mercenary Links Feb 4th: No Pause For You!
Mercenary Links Feb 3rd: War Drums
Mercenary Links Jan 31st: End of an Era
Mercenary Links Jan 30th: Wobbly House of Cards
Mercenary Links Jan 29th: $10 Billion
Mercenary Links Jan 28th: Hut, Hut, Hike
Mercenary Links Jan 27th: 1997 Redux
Mercenary Links Jan 24th: Capital Flight
Mercenary Links Jan 23rd: Dragon Rattle
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