Good Friday Morning! This week is a vacation edition for me. It seems appropriate to take a vacation after dealing with a week of the Mueller report. And since we’re essentially past all the things relating to the Mueller report, I wanted to switch tracks this week and talk about a subject I’ve followed for a while, but not written about because other stories have come up: the economy, and more importantly the next recession. There are trend lines that are worth watching as the current expansion grows ever longer in the tooth. Links follow.
Where you can find me this week
Make sure to sign up for the Conservative Institute’s daily newsletter. You can also go to their Facebook page. You can join Ricochet here. And I do recommend their ever-growing network of podcasts, which you can find on all popular podcast platforms. They have a show for every topic you can imagine, and the list continues to grow.
Two columns on the Mueller report this past week. The first column covers the overall report and some of the highlights. And the second column covers the Mueller report in conjunction with the infamous Steele dossier.
The next recession will be worse than the last one
I am unconvinced we ever dealt with the structural problems from the 2007-08 recession. Our economy, and more specifically the stock market, is not moored on anything firm but rather a sugar high of accommodative policy. Take this report of the stock market from the New York Times this week, covering the record highs of the market:
The bull market lives, thanks to the Federal Reserve’s new, more relaxed approach to interest rates.
The economy is softening, profit growth is slowing, and a trade war between the United States and China is grinding on.
Stock investors don’t mind.
The S&P 500 rose to a record on Tuesday, surpassing a high last set in September. The day’s gains topped off a rally that has pushed the stock benchmark up 17 percent this year.
That’s the index’s best start to a year since 1987, and one that has confounded those who anticipated that 2019 would be a difficult time for stocks. After all, fear of slowing growth and deteriorating corporate fundamentals — the very same factors that investors are brushing off today — helped trigger a stock market meltdown in December.
There is a clear reason for this change in tune. The rally began after the Federal Reserve all but promised investors that it wouldn’t raise interest rates further and risk tipping the economy into a recession. Such “easy” monetary policy, to use the jargon of the markets, provides a helping hand to the economy and caps returns on bonds, the main investment alternative to stocks.
Everyone in the markets says there are underlying issues that could tilt the economy into a recession. But no one wants to deal with those issues, so instead, we’re going to continue to push accommodative policies that stimulate stock market returns. The problem is that those very accommodative policies are glossing over real issues and inflating the peak of what could be a massive crash.
The Great Recession officially ended in 2009. We’ve been riding a growing market for the last decade. And every time the markets hint at a sneeze like they did this past year, the Federal Reserve immediately does something to ease up on the markets. The Fed got away with taking any action last year because of the new tax law that lowered rates and put more cash into companies and the economy.
That stimulus is gone now. The markets were beginning to feel gravity and reality pull them back down, so now instead of trying to keep the market healthy, and Fed is juicing things again, promising steady or potentially lower rates.
What we’re also seeing is that earnings per share for companies are going up — but real productivity and sales are mostly flat; meaning, we have a strange situation where companies are saying they have more earnings, but they’re not producing or selling more. How is this happening? Stock buybacks. Ben Hunt had this take on it:
The reason companies aren’t investing more aggressively in plant and equipment and technology is BECAUSE we have the most accommodative monetary policy in the history of the world, with the easiest money to borrow that corporations have ever seen. Why in the world would management take the risk — and it’s definitely a risk — of investing for real growth when they are so awash in easy money that they can beat their earnings guidance with a risk-free stock buyback? Why in the world would management take the risk — and it’s definitely a risk — of investing for GAAP earnings when they are so awash in easy money that they can hit their pro forma narrative guidance by simply buying profitless revenue? Why in the world would companies take any risk at all when the Fed has eliminated any and all negative consequences for playing it safe?
In essence, what this means is that we are not experiencing real economic growth. The markets are growing in value, sure, but real economic growth is not pushing this economy: easy money is. What is happening now is that stock buybacks are spiking again, while earnings are starting to flatline:
This is a chart of S&P 500 buybacks per share (in blue) imposed over the ratio of S&P 500 earnings-to-sales in green. You’ll see that share buybacks spike after profit margins spike. You’ll see that share buybacks spike before and during recessions.
When do stock buybacks accelerate dramatically?
In 2006 and 2007, when management is rolling in record profits and profit margins, despite meager productivity growth.
In 2018 and 2019, when management is rolling in record profits and profit margins, despite meager productivity growth.
The chart is in the link, and Hunt is a great read.
What I’d add is this, unlike the 2008 crash, which dealt with the housing market debt bubble, which grew from the dot-com bubble, the next recession will have multiple bubbles pop. The era of cheap money has juiced the economy, but it’s done so at a cost, and it’s juiced two broad sectors: student loans and corporate debt.
You know all about the student loan debt bubble, and I won’t belabor it here. But suffice it to say, federal loans and laws relating to colleges have disconnected the cost of advanced degrees from market forces. The cost of a college degree has exploded beyond any attachment to reality. And as a result, new graduates are immediately saddled with massive debt to start their career.
Vice has a pretty decent look at what a student loan debt bubble bursting would look like in a recession.
But that’s not the only bubble. The other bubble that’s developed is the corporate debt bubble. Because the Fed is keeping interest rates at near record lows and has done so for the better part of a decade, the smarter move has been to take that money, buy back stocks, and pump up the earnings line for your company. As illustrated in this piece:
Corporate executives and directors are apparently bereft of ideas and the confidence to make long-term investments. Rather than using record profits, and record amounts of borrowed money, to invest in new plants and equipment, develop new products, improve service, lower prices or raise the wages and skills of their employees, they are “returning” that money to shareholders. Corporate America, in effect, has transformed itself into one giant leveraged buyout.
Consider Apple, the world’s most valuable enterprise. As a result of a $100 billion share buyback announced last month, Apple will have returned $210 billion to shareholders since 2012. How much is $210 billion? As Robin Wigglesworth of the Financial Times reminded his Twitter followers, that’s enough to buy up the bottom 480 companies of the S&P 500.
And Apple is not alone. Last year, public companies spent more than $800 billion buying back their own shares and, thanks to all the cash freed up by the recent tax bill, Goldman Sachs estimates that share buybacks will surge to $1.2 trillion this year. That comes at a time when share prices are at an all-time high – so companies are buying at the top – and when a growing global economy offers the best opportunity to expand into new products and new markets. This is nothing short of corporate malpractice.
Now, I don’t take the line that stock buybacks are conclusively evil, as some do. I think CATO makes a decent argument that stock buybacks can do some good things.
My point is that companies are doing this because debt is cheap and, in the process, are taking on a lot more debt. And when you have high debt, with the market getting juiced by cheap debt, across all sectors of the economy, not just housing, I don’t see positive economic growth. I see a sugar high. And every time we start coming off the sugar high, even a little bit, the markets start getting shaky and deflating fast. Take this recent report from the WSJ:
The U.S. economy’s narrative has changed. First-quarter gross domestic product was looking downright putrid a couple months ago. The government shutdown, consumer caution, bad weather, the fading effects of fiscal stimulus, higher interest rates and slowing growth abroad seemed ready to push the first-quarter pace of growth down to the lowest level in years. The Atlanta Fed’s GDPNow tracker kicked off with an estimate of 0.3% growth. But since March, it’s improved markedly as new data arrives. The latest forecast: 2.8%.
We kicked off this year with a horrid outlook, and most everyone believed we were heading towards a recession, if not in 2019, in 2020. But as soon as the Fed agreed they’d be more accommodative, the markets jumped right back up and are marching higher.
So what does all this mean?
Sugar highs can’t last forever. Gravity eventually takes over.
And when that sugar high stops — when we have easy money and accommodative/dovish/stimulating Fed — the crash will be worse. It will be worse because debt isn’t a bubble in one sector — it’s everywhere. And due to how student debt is designed, if there’s a crash on the corporate side, there will also be a crash for individuals as individual debtors won’t be able to pay back their student loans (and can’t get rid of them in bankruptcy court).
We should have used the last decade to deal with the structural issues underlying the economy. Instead, we’ve ridden a sugar high to a peak more massive than the 08-09 mountaintops.
One last point: the reason people like AOC are insane in their proposals is that they answer the question, “how will you pay for this?” by putting the current easy money Fed policies on steroids. It won’t work.
Links of the week
Joe Biden Announces 2020 Run for President – Alexander Burns, The New York Times
Top 10 things the media got wrong about ‘collusion’ and ‘obstruction’ – Sohrab Ahmari, The New York Post
1 big thing: The science case for returning to the Moon – Miriam Kramer, Axios
Sisterhood of the Gun: What I saw at A Girl & A Gun’s 2019 national conference – Stephen Gutowski, The Washington Free Beacon
What’s So Great about Western Civilization: Telling people they’re bigots for taking pride in the civilization that brought them forth better than any other is like taking a sledgehammer to your own soapbox. – Jonah Goldberg, National Review
Another Warning Sign – Yuval Levin, National Review
Chalking Tires and the Fourth Amendment: A markedly interesting case from the Sixth Circuit. – Orin Kerr, The Volokh Conspiracy
The Scruton tapes: an anatomy of a modern hit job: How a character assassination unfolded on Twitter – Douglas Murray, The Spectator
The Memory of the Armenian Genocide Should Be Preserved – Marlo Safi, National Review
Donald Trump Is Weak and Afraid—The Mueller Report Proves It – David French, Time
In the Census Litigation, the Trump Administration Should Prevail – David French, National Review
“Fixer Upper” Is Over, But Waco’s Transformation Is Just Beginning: HGTV stars Chip and Joanna Gaines helped convert a sleepy Texas town into a tourist mecca. But not everyone agrees on what Waco’s “restoration” should look like. – Anne Helen Petersen, Buzzfeed News
How a tiny endangered species put a man in prison: The Devils Hole pupfish is nothing to mess with. – Paige Blankenbuehler, High Country News
Satire piece of the week
Some people think Hillary Clinton is robotic and hard to sympathize with, but even our hearts went out to her on this one.
On a special politicians’ episode of Wheel of Fortune, failed presidential candidate Hillary Clinton nearly took home the grand prize. She was on the last puzzle of the regular rounds of the game, which read, CHRISTI_N. The audience began to cheer as it appeared Clinton had finally won something.
But, as is usual for Clinton, she snatched defeat from the jaws of victory, and shouted “Easter worshiper!” instead of the obvious answer, which was “Christian.”
Thanks for reading!