by David Stockman, David Stockmans Contra Corner:
Since last November 8th the Russell 2000 has risen by 30% and the net Federal debt has expanded by an astounding $1.0 trillion dollars.
In a rational world operating with honest financial markets those two results would not be found in even remotely the same zip code; and especially not in month #102 of a tired economic expansion and at the inception of an epochal pivot by the Fed to QT (quantitative tightening) on a scale never before imagined.
And we do mean exactly those words. By next April the Fed will be shrinking its balance sheet at $360 billion annual rate and by $600 billion per year as of next October.
Altogether, the Fed’s balance is scheduled to contract by upwards $2 trillion by the end of 2020. And it’s apparently on a path that is so locked-in—-barring a recession—that Janet Yellen affirmed in her swan song that the Fed’s giant bond dumping program (euphemistically called “portfolio runoff”) would no longer even be mentioned in its post-meeting statements.
So the net of it is this: The Fed will sell more bonds in the next 3-4 years than had been accumulated by all of the central banks of the world in all of recorded history as of 1995!
That prospect alone might give a rational stock market at least some cause to pause. After all, the Fed’s $2 trillion bond selling campaign (likely to be joined by the ECB in 2019 when a German replaces wild-man Draghi) is on automatic pilot unless there is a recession.
So stock prices are either going to be battered by slumping profits if the business cycle hasn’t actually been abolished; or, in the alternative, rising bond yields will sharply inflate the carry cost of $12.5 trillion of US non-financial business debt (e.g. a 200 basis point increase in rates would lower pre-tax business profits by $250 billion or 15%) even as PE multiples shrink and stock buybacks are sharply curtailed.
And that’s not all, as the late night TV man says. There is literally a fiscal red ink eruption heading straight at the Fed’s balance sheet shrinkage campaign that will rattle the rafters in the casino.
As detailed below, Uncle Sam’s borrowing requirements are likely to hit $1.25 trillion or more than 6% of GDP in FY 2019 owing to the fact that the tax bill is so heavily front-loaded and the GOP’s wild spending spree for defense, disasters and much else.
Needless to say, this impending bond market collision has not fazed the dip-buyers in the slightest. Financial markets are in the blow-off stage of the third great central bank bubble of the present era and are therefore entirely in the grip of momentum chasing robo-machines and day traders. The latter are processing price action alone—-to the complete exclusion of a swelling tide of facts and threats which sharply contradict the bullish mania of the moment.
For instance, the now booming Russell 2000 (RUT) wasn’t exactly a laggard when the Trump Trade incepted in the wee hours of election night. At that point it traded at 1190 and was already up by 230% from the March 2009 bottom.
But at yesterday’s record 1549 close, these small and mid-cap domestic companies had a combined market cap of $4.45 trillion. That represented not only 440% of the RUT’s $1.0 trillion market cap at the March 2009 bottom, but also reflected utterly absurd multiples of the current earnings and dividends attributable to its constituent companies.
To wit, the RUT companies generated just $60 billion of dividend payments during the LTM period ending in September. In what sane world does a GDP-hugging basket of main street companies trade at 74X their dividend?
Worse still, the RUT companies are apparently borrowing money to pay even that miserly 1.35% dividend.
That’s right. Net income during the LTM period was slightly under $42 billion or just two-thirds of the RUT’s dividend payout. So this also means that America’s main street businesses are being valued at a preposterous 107X earnings.
These absurd valuations would be troublesome enough if the fiscal and monetary context were stable rather than heading for a thundering dislocation. But there is no other word for a fiscal equation which is unraveling at lightening speed as we head for the onset of FY 2019 next October 1.
Under the CBO’s baseline projection of last June, the picture was already bad enough. Federal outlays were projected to rise from $4.0 trillion in the year just ended (FY2017) to $4.38 trillion in FY 2019. Notwithstanding revenue growth of 11% under current law over the two year period, the resulting baseline deficit still computed to nearly $700 billion.
But Trump has already signed into law a defense authorization bill which will raise baseline outlays from $625 billion to $700 billion. And on top of that, the House yesterday approved an $81 billion disaster aid supplemental for the hurricanes and wildfires, which will bring total spending for this year’s disasters to a staggering $133 billion.
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