Economics gets interesting as the economy darkens while stocks bubble

Summary: These economic status reports grow more interesting as the data shows slowing while the stock market bubbles. It’s nothing like 2007, except in our blindness to events and disinterest in preparing for obvious risks. When the recession arrives (we can’t know when), I believe it will mark the start of a new economic order. The next generation will listen with astonishment to tales of these days.  {2nd of 2 posts today.}

“In a nutshell: Things are looking better — in fact, they’re looking downright good. The economy is showing solid momentum and there’s good news in virtually every sector. I expect U.S. growth to be about 2½% in real GDP. I see the continued improvements in the economy pushing wages and prices up, and inflation moving back toward its target.  I expect to reach full employment by the end of the year.”

— John C. Williams (President of the San Francisco
 Fed), 23 March 2015. Be very afraid when you hear such things while the indicators tumble.

Contents

1. One of the big indicators: new orders durable goods.
2. GDP on recession watch.
3. Stocks: bubbling again because we don’t learn.
4. A bear market will wreck the investment biz.
5. For More Information.

(1)  One of the big indicators: new orders for durable goods

The February numbers were weak, as they have been so often during this long slow expansion. The big picture is that they have been flat during the past 2 years (easily missed if you read the news by the hyperventilating over the little swings). They’re the same level as September 2006, and 5% below the pre-crash peak of December 2007. Almost unchanged from a year ago, any breakdown from here will warn of an imminent recession.

(2)  GDP on recession watch

GDP forecasts are notoriously inaccurate (we have good estimates of GDP in the 3rd release, in the 3rd month after the quarter ends). But they’re too important to ignore, especially the trend of the forecasts. In this cycle forecasts have tended to drop over time; this quarter the drop has been fast and large. Much slowing from the current +0.3% estimate gives us a negative print for Q1, which would be the 3rd red number since the recession ended in 2009.

(3)  Stocks: bubbling again because we don’t learn

Markets long ago decoupled from fundamentals, as investors embraced our centrally planned economy where the central bank manipulates not just interest rates, the money supply and lending, but also risk preferences (the target for quantitative easing) and “animal spirits” (aka public confidence).

Valuations are quite mad for such a slow growing economy, late in the business cycle, with profit margins at historically peak levels (they have always reversed back to average levels). People tend to forget that the price to earnings ratio represents what you pay for future earnings, so comparisons to the past when America grew faster will mislead you. The carnage will be immense when this bubble pops (more about the consequences on another day). This is too obvious to warrant discussion, so I’ll just point to reports giving the details.

• “Median NYSE Price/Earnings Multiple at Post-War RECORD“, James W. Paulson, Wells Capital Management, 8 January 2015.
• “The Fuzzy, Insane Math That’s Creating So Many Billion-Dollar Tech Companies“, Bloomberg, 17 March 2015.
• “Hedge Funds Are Boosting Tech Valuations to Dangerous Heights“, Bloomberg, 22 March 2015.

More specific indicators are the stratospheric valuations of social media stocks, investor euphoria over Tesla, and — my favorite — investors’ love for profitless biotech stocks. Zero Hedge has an excellent article looking at the NASDAQ biotech index, showing that it’s a “hope and change” index betting on the development of new drugs. Past history says that many or even most of these will fail, as their drugs either do not receive FDA approval or don’t earn marketplace acceptance. For details see “Forget the tech bubble. It’s the biotech bubble you should worry about“.

Here is a graph of the S&P Biotech Index: showing the classic parabolic rise of an investment mania.

For about this see Don’t ask if there’s a biotech bubble. Ask why we have another bubble.

(4)  A bear market will wreck the investment biz

The finance sector is ripe for disruption as the combination of new technology and new business methods will rip its profitability, producing massive overcapacity. The status quo has been supported by the bull markets in stocks and bonds, plus negligent regulation. I suspect that a bear market will reveal that they (including me) have been walking on air for years. The drop will be painful, but produce a financial sector better able to serve America. More on this coming soon.

(5)  For More Information

If you liked this post, like us on Facebook and follow us on Twitter. See all posts about economics, monetary policy, and stimulus programs. Of special interest are these about the state of the economy:

1. Dreams of a boom fade & attention turns to secular stagnation.
2. Highlights of the jobs report, the good news & the bad.
3. New economic data only deepens the mystery.
4. Updating the recession watch; & what might the government do to fight a slowdown?
5. Economic status report: good news plus chaff from doomsters.

About the bubble:

• Let’s ignore another warning from the BIS. Do we enjoy paying for burst bubbles?
• How we’ve become accustomed to bubbles bursting the economy, instead of fighting them.
• We see a stock market bubble but prefer to close our eyes.