Bond Prices
Bond yields are being pushed higher by Treasury auctions to fund government spending and tax cuts, by quantitative tightening, and by investor fears of each of the aforesaid (causing investors to avoid bonds, putting further upward pressure on yields). The yield curve (referring to the curve created by 2-year and 10-year Treasury yield differential), may, otherwise, be much flatter[1]. “True” investor sentiment may be getting masked by government interventions.
If there is little to no inflation (very little, or none, has yet been shown to exist), leaving investment capital in cash is a fine choice for investors if bond prices are under pressure by the government, and by related investor concerns. This may be just what many investors are electing to do.
Consumers’ Incomes and Costs
The demand side (consumers) is seeing stagnant wages (so far), higher gas prices, and, potentially, higher consumer product prices due to higher raw material costs caused by fiscal stimulus, and, in particular, by capex bonus depreciation rules.
Supply-side capex investments are not leading to wage growth- so far. Supply-side economics only works if there is trickle-down to the demand side in the form of income growth for employees (a/k/a consumers) so that product sales to consumers can grow; otherwise such supply-side capex just amounts to bad investments sans a positive ROI.
Consumers may suffer a potential “quadruple whammy” of stagnant wages, higher interest rates, higher oil and gas prices, and higher consumer product prices (though, probably not much higher, because of the Amazon effect). Any further dollar weakness will also create a lower real wage.
Business Costs
Businesses may suffer from higher input/commodity costs in their normal manufacturing processes (and/or in the wholesale prices they pay for goods) caused by businesses taking advantage of accelerated capex depreciation and, thus, demanding more raw materials.
Business/supply-side capex investments will have difficulty being profitable without a consumer/demand-side to afford more products[2].
Businesses may experience the “quadruple whammy” of potentially higher input/raw material costs due to new capex rules, higher costs of capital due to higher interest rates, a more constrained consumer with higher debt loads and tighter budgets due to stagnant wages and what amounts to higher taxes (i.e. higher gasoline prices and higher interest rates), and lack of pricing power to pass through higher costs, due to the Amazon affect (which is why as the PCE price index goes higher, you could see declines in consumer spending; businesses may have trouble passing their growing expenses through to consumers, who could be resistant to higher prices).
Earnings and/or guidance and future earnings expectations have not been great so far, and some of the good EPS results have been due to share buybacks.
Signs of Slowing?
Costs are going up for everyone, and incomes are not (recent average hourly wage gains have been modest, and recent data may have been pushed artificially higher by weather related factors).
Company earnings, per many companies’ own guidance, will not, necessarily, be, organically, growing. And let’s remember that earnings are not just for public companies. Private businesses have earnings, too, of course. But, we have no way of knowing what earnings have been for smaller private businesses in various industries. Public company earnings are about the stock market, not the entire economy. Wages, commodities prices, tariffs, and interest rates, obviously, affect the thousands of private businesses across America, too. So, just because companies such as Amazon and Walmart have good earnings does not mean that thousands of private retailers are not suffering from poor earnings or going out of business … and they are.
Looking ahead, tell me what looks good. Chip stocks (and/or guidance) are not looking good. Manufacturing is showing a slowdown. Facebook’s growth has been due to misusing our data and invading our privacy- which will stop. Caterpillar, Qualcomm, and Twitter, among others, have warned about earnings going forward. Europe has slowed. China is slowing. Sure, unemployment is low- but this may reflect that fast-growing large companies (like Amazon and Home Depot) are growing at the expense of smaller competitors that they are putting out of business and then hiring away their labor for longer hours, and at lower wages. Certainly, the employment and wage numbers, taken together, indicate, or actually prove this out.
The U.S. dollar- despite some recent minor strength (some of which may be caused by a safe-haven trade)- is weak.
If capex by many companies, or any other factor(s), significantly pressures commodities prices upward without growth in consumer incomes and without [organic] earnings growth for businesses, that would be “stagflation”- bad for businesses and bad for consumers (and even, eventually, bad for commodity producers, which would see prices crash before too long as demand dries-up in a resulting recession).
GDP was lower in the previous quarter (compared to the end of 2017 quarter). Business spending has been higher- but “profitable” spending requires a strong consumer to buy the resulting products. Some of the GDP number attributable to business spending was due to inventory build-ups, most likely due to businesses’ fears of rising commodity costs and/or access to necessary raw materials. Inventory build-ups are never a good sign, especially as GDP and consumer spending decline. Government spending was higher- almost never a good thing. The one bright spot is that we saw slightly higher wages in March, something I consider vital to growth. But, as GDP and consumer spending are down, this is not a good time for wage-costs for businesses to rise, as raw materials and interest rates are also going higher, and GDP is lower. Wages need to increase while GDP is growing– and it needs to cause consumers to spend more. Neither occurred last quarter.
Amazon, Microsoft, and other technology companies’ earnings-growth do not necessarily reflect positive dynamics in the overall economy. Companies may be shifting to the cloud in an attempt to lower costs wherever possible- which benefits Amazon and Microsoft, as leaders in cloud computing. Also, capex spending on technology is being done by companies to take advantage of the new bonus depreciation provision in the tax law, and may make companies more efficient- without adding jobs or higher wages. Same goes for consumers who shift all their spending to Amazon to get the lowest possible prices (to the detriment of other retailers, especially those brick and mortar ones in their communities). It’s all about cost-cutting.
As for real estate- that’s for a whole other article. (In short, an economy where no one can afford the home to which they aspire, so, they, therefore, can’t leave the home in which they live, is not the definition of a healthy market or of the American dream. The housing market is very distorted due to the housing crisis and quantitative easing. Wages remain stagnant as interest rates are rising due to government actions. Imbalances, creating a value bubble in housing, may, soon, correct to an equilibrium. Plus, retail properties are sitting idle all across the country because of e-commerce.)
Some theorize that a slowdown will occur due to the Fed raising rates with the goal of moderating or fighting inflation. But, it’s not that rosy. The Fed is hiking interest rates where there is no inflation- which is far worse. There is no real wage inflation, businesses can’t pass-through their rising costs to consumers, rising crude prices are related to supply and political issues, and, possibly, capex expectations- and GDP is lower. The Fed should not be hiking interest rates … unless it believes that assets, namely housing, is providing a risk to the economy, where wages and housing prices have disconnected. So, you have a Fed hiking the Fed funds target rate where inflation, and, perhaps, even growth, are in question. The Fed’s slowing-down of an economy where recent numbers already show a slowing economy- lower GDP, stagnant wages, slower consumer spending, higher crude prices as a tax on consumers- is not comforting. At least if wages were rising, and prices were rising, and consumer spending was rising, and GDP growth was evident, we’d have higher interest rates along with higher growth.
So, can you blame the yield curve for being nearly flat- and wanting to be flatter (or inverted)?[3]
“True” Investor Sentiment?
The Fed has not indicated any plan or intention to slow the pace of quantitative tightening; just the opposite, if anything.
Future Treasury funding will necessitate that overseas investors be buyers of U.S. Treasury bonds; and that capital will demand higher and higher yields.
Even with growing consumer and business costs, lower GDP, lower consumer spending, the Fed’s intention to continue raising the federal funds target rate, and downside risks to future earnings and real estate values, would you buy bonds knowing that the U.S. Treasury and the Federal Reserve are on the other side of the trade?
The yield curve may be trying to speak … but has the hands of the government covering its mouth.
_____________________________
- The frequently-used term “flat yield curve”, in my judgment, is an oxymoron. A “curve” can be steep, and a “curve” can be inverted- but a “curve”, by definition, can not be flat or straight.
- We may see very little capex by businesses, which, could, on one hand, help keep commodities prices in-check, while, on the other hand, limit supply-side stimulus from tax cuts, and, therefore, contribute to continued wage stagnation.
- I do not think that the economy is, necessarily, “about” to crash, since supply-side stimuli (tax cuts and decreasing regulation) should delay what would, otherwise, be the end of the economic expansion. I do believe that the consumer is weaker or more stretched than is being recognized, and business expenses are rising- which could lead to higher consumer product prices and/or layoffs, in which case, wages would be stagnant as unemployment rises. The yield curve may be forecasting “eventual” sluggishness in the economy from these and other forces.
Neil S. Siskind, Esq., President
The Siskind Law Firm
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