Thursday, January 31, 2013

Avoiding recession is all that matters

When yields on risk-free assets are close to zero, it only makes sense to hold those assets if you need liquidity and/or are highly concerned about the potential for losses in other assets, most of which are yielding substantially more. From a macro perspective, the fact that significant assets are being held with virtually a zero yield can be interpreted as a sign that the market is very worried about a recession, since that is the one event most likely to create widespread losses in risky assets. 

This has been the case for most of the past 4 years (during which time the yield on 3-mo. T-bills has averaged about 0.1%), yet the economy has avoided a recession and the returns on almost all alternative assets have been astounding. The returns on cash have actually been negative in real terms, since inflation has averaged 2.2% a year over the past four years. Cash, the risk-free asset, has produced an annual loss of purchasing power of over 2% for four years running. The S&P 500 index, on the other hand, has produced annualized total returns of 16.8% for four years running.

With almost $7 trillion sitting in bank savings deposits earning practically nothing, and with tens of trillions invested in risk-free assets around the world, there are therefore many millions of people and investors who need a recession to justify their current asset allocation.

Are there any signs of a budding recession? None that I can see in the recent data.


Weekly unemployment claims are volatile around this time of the year since the seasonal adjustment factors can be large. The 4-week average of claims, which eliminates a good deal of this volatility, is now at a post-recession low. No sign here of any recession or even an economic slowdown, to judge by this relatively fresh and sensitive indicator of conditions in the jobs market.


No sign here either of a recession, to judge by the Challenger tally of announced corporate layoffs. There is no sign of any unusual downsizing.


Meanwhile, it's almost certain that a housing market recovery is well underway. As the above chart shows, the stocks of major home builders are up over 100% in the past 16 months, and they are up 270% since their recession low. Housing starts are up 77% since the beginning of 2011. 

The zero growth reported for the fourth quarter of last year was the result of a downsizing of defense spending and a slowdown in inventory accumulation. Reduced government spending is not necessarily a bad thing, since it frees up resources for the private sector. Inventory investment is quite likely to bounce back, having been depressed in recent months by the uncertainty of the "fiscal cliff" which has since been resolved.


All of this is being repeated on a global scale. The value of global equities has more than doubled since their early-2009 low. $25 trillion has been earned by the holders of those equities, compared to a loss on the purchasing power of the tens of trillions that was held in cash over the same period.

Investors are notorious for following the money rather than anticipating where the money will be made, and $25 trillion in gains ought to be enough to get a lot of people's attention. We may finally be at the point where the private sector stops trying to deleverage and begins to releverage; when investors stop taking money out of equity funds in order to add to bond funds; and when investors try to reduce their cash balances in favor of riskier assets. The Fed and all other major central banks have been trying very hard to make this happen, and it would be foolish to think they won't be successful. By keeping interest rates on risk-free assets extremely low, the Fed is trying to destroy the demand for those assets, and trying to encourage money to find its way into other more riskier asset classes. The money can't actually  leave cash, but the attempt by the private sector to reduce its cash exposure (and/or increase its borrowings) in favor of equities or real estate could unleash a powerful change in relative asset prices. Ultimately, the yield on cash will rise significantly, while the yield on other assets will decline as their prices rise.

All it takes for this to happen is to simply avoid a recession. 

11 comments:

marcusbalbus said...

your fetishistic need to pillory, ridicule and hector those who prefer risk free assets is tiring.

Fullcarry said...

Long term ratio chart of the S&P 500 index to Savings Deposits http://twitpic.com/bxeblv

Gloeschi said...

At least you now seem to admit that the "cash on the sidelines" does not disappear when invested - it simply changes hands. Following your line of thought equities should never ever go down since the same money on the sidelines will chase them higher and higher.
$25 trillion "earned"? Please. It's all on paper.

AAA said...

Scott,

Thank you for what you do. It truly helps me with my job. I have the utmost respect for you, especially with how you choose to deal with some individuals on here.

Dr William J McKibbin said...

My suspicion is that most of the $7 trillion being held by major banks is being held to cover undisclosed losses caused by the commingling of bank and customer assets -- the MF Global outcome was astounding ($1.6 billion went "poof") -- my information is that vast sums will be realized as losses once the commingling problem comes to light -- said another way, the $7 trillion supposed being held by banks is already gone -- "poof" -- we the little people need to accept the reality that Wall Street collapsed long ago, and whatever cash that banks claim to hold is long gone.

William said...

At this link entitled "A market Without Optimism" is a very dramatic chart from the Investment Company Institute showing mutual fund flows since 2007. $1.2 Trillion into Taxable Bond Funds and $600 Billion out of US Stock funds.

http://seekingalpha.com/article/1148361-optimism-s-re-emergence-could-shake-up-2013-s-performance?source=google_news

Joseph Constable said...

Which comes first, the stock market or the increase in velocity?

If velocity, policy should be directed to those who can, which is those making over $400,000 a year, probably the most productive among us. Oh wait. We did target them.

Joseph Constable said...

The problem in the U.S. isn’t that people don’t have enough money, it is that things cost too much.

Kill the cartels, kill the lawyers (in a nice way of course), set all regulations including discrimination to where they were 15 years ago. Have a five year moratorium on any new laws.

Benjamin said...

As usually, very solid wrap-up by Scott Grannis, even if I , or some other commentators ,disagree with certain points.

Grannis always does a great job---so what if I have a different opinion? If you want to be in an echo chamber, write your own blog and read that.

I wonder if interest rates will go back up. They never did in Japan. Well, never being 20 years and counting.

Seems like this economy needs a much higher type of octane.....


William said...

If the DOW Industrials close where they are trading now - 14012, a new NEW Bull Market will be confirmed by the strictest interpretation of the DOW THEORY since the DOW Transportation Average has already made new highs!

theyenguy said...

Smart investors were Risk On and invested in a number of things, such as Retail, XRT, and Casinos and Resorts, BJK.

Today Hedged Japan, DXJ, Japan, EWJ, traded higher, on a lower Yen, FXY, but Japan Small Caps, JSC, traded unchanged, its Investment Brokerage, NMR, its Credit Provider, IX, its banks, MTU, SMFG, and MFG, its large cap stocks, such as KUB, traded higher. Asia Financials, FEFN, traded higher. And Clean Energy, PBD, Biotechnology, IBB, Pharmaceuticals, PJP, traded higher.

Gold Miners, GDX, and Silver Miners, SIL, traded lower, on lower Precious Metal, JPP, prices.

Utilities, XLU, traded lower on a higher US Ten Year Note Interest Rate, and Mortgage REITS, REM, such as IVR, AGNC, MRLN, PMT, HTS, traded lower, on lower US Government Bonds, GOVT, and lower Mortgage Backed Bonds, MBB.

China, YAO, and Chinese Financials, CHIX, traded lower.

India, INP, India Small Caps, SCIN, and India Earnings, EPI, traded lower

Russia, RSX, and Russia Small Caps, ERUS, traded lower.

Emerging Market Financials, EMFN, traded lower.

Spain, EWP, and the European Financials, EUFN, traded lower; while the National Bank of Greece, NBG, and Greece, GREK, traded higher. Greek Crisis Net relates The Financial Times report Top hedge funds bet on Greek bank.

Liberalism's grand finale rally featured a pursuit of yield; but now under Authoritarianism, most of the market leading yield bearing ETFs, PSP, UJB, KBWY, ROOF, DRW, AUSE, DBU, XLU, REM, IST, SEA,BRAF, FNIO, REZ, PGF, IYR, KBWD, DTN, TAO, FLOT, seen in this Finviz Screener traded lower today, reflecting that the world central bank’s monetary policies have crossed the Rubicon of sound monetary policies allowing bond vigilantes to call interest rates higher globally commencing the destruction of credit, AGG. Another word for credit is trust. Under Liberalism, investors trusted in the world’s sovereign nation states and their central bank chiefs, Ben Bernanke, Mario Draghi, and Hiroki Kuroda/Shinzo Abe, policies of Global ZIRP, to leverage up both equity and debt investments. That trust is beginning to evaporate now that currency traders are calling currencies lower, and the bond vigilantes are calling interest rates higher.

Liberalism’s moral hazard has finally come of age and has soured investment trust. Debt deflation is underway destroying fiat wealth. Shrewd investors are no longer risk on, ONN, they are risk off, OFF.

Jesus Christ is operating in dispensation, that is operating in the household administration of God, Ephesians 1:10, terminating Liberalism, and introducing Authoritarianism, where people will with increasing occurrence trust in regional sovereign leaders diktat to provide seigniorage, that is moneyness.

With the exception of DGP, the market vane ETFSs, DGP, OFF, STPP, UUP, EUO, JGBS, indicate that the market direction is now down. Confirmation of the commencement of a bear market comes form both Transports, XTN, and Industrial, XLI, trading lower.

Today, Monday May 13, 2013, likely marks the end of Liberalism’s speculative leveraged investing, as the closed end equity fund, CSQ, ran higher, to a market top; while closed end debt fund PTY, ran lower.