In an historical rarity, the Dow Jones Industrial Average and the S&P 500 Index are both below where they were five years ago. In contrast, the price of gold and the price of Treasury bonds have each soared. The combination of gold rising along with silver and many other commodities while at the same time Treasurys and all other classes of bonds have seen much lower interest rates (much higher bond prices) is new in anyone’s memory.
What’s going on, and what comes next?
The top-down view goes back to the extensive bankruptcies in the mortgage and banking systems that led to a crash in global economies and markets in the late summer and fall of 2008. The massive nature of these bankruptcies and near-failures proved that huge misdirections of capital had occurred, leading to gigantic mis-matching of the putative value of assets that financial institutions carried on their balance sheets and their real value in relation to other values. Real estate was the major culprit. Too many homes had been built; they were too large; they had too much imported marble and granite; they had been constructed due to cheap credit, poor lending standards, over-optimism, and so on. Thus the past years have seen no real recovery in that sector. Similar considerations apply to commercial real estate.
However, and this is the “Japanese” part of the current (or, recent) economic expansion, immense governmental (including the Fed) have gone into sustaining the “guilty” parties and keeping real estate from dropping to a price at which a typical buyer could afford to purchase the home. The typical buyer of most homes in America has always been couples either with a child or two, or with plans to start a family, who “need” larger quarters. But too many can’t qualify to buy a house at today’s still-inflated prices at any interest rate, even a mildly negative one, because they lack either the income to qualify for a mortgage or the savings to provide a down payment.
Thus it is that in the four-year quest by the authorities to preserve the existing order– which is the usual response to financial crises throughout history– the authorities have encouraged a more fundamental problem– lack of babies. The American economic engine has always required an expanding population to fill this vast country. Four years of ZIRP, four years of declining births.
In fact, per the Center for Disease Control (CDC), the general fertility rate for the U.S. set an all-time low in 2011. Here’s the link, which shows numerous records for lowest frequency of births having been set last year. A brief discussion of this long report can be found at Calculated Risk, who wrote (this is just part of his post):
Births have declined for four consecutive years, and are now 8.4% below the peak in 2007 (births in 2007 were at the all time high – even higher than during the “baby boom”). I suspect certain segments of the population were under stress before the recession started – like construction workers – and even more families were in distress in 2008 through 2011. And this led to fewer babies.
This defines the demographics of Japan, which underpins the chronic low interest rates there. Lest one thinks that the U.S. is different because of immigration, those days are long gone. Not only are the days of rapid immigration into the U.S. long gone, the combination of governmental policies toward “undocumented” aliens and improving economic opportunities south of the border relative to the U.S. may have led to a shrinking of the number of this class of people. (Of course, detailed measurements are impossible.)
In this setting, we now have a business expansion that has been supported by unusually aggressive fiscal and monetary measures. The profits of U.S. publicly-owned corporations are now roughly flat year-on-year, which means they are probably down adjusted for inflation. The Fed is now known to be “all in”, so that’s been discounted. Thus, fiscal policy is the great unknown. With declining corporate profits, it just may be that private credit demands may be declining, which would be bulllish for Treasurys.
The demographics discussed above, in association with the views expressed by bloggers with great track records (CR and Mark Hanson, whose web site appears to be down) which range from predictions of stagnation (CR) to a new downturn to be in evidence starting very soon (Hanson), suggest that the widely-anticipated bear market in the price of bonds is likely not going to happen yet. In support of that view, the impressive Jim Rogers was featured on one of the mainstream sites yesterday with the headline that he (once again) is short Treasurys. He has announced this strategy publicly before during this bull market in the prices of Treasurys. Why he should not continue to be a contrary indicator is unclear to me.
The problem with “old-fashioned” Austrian thinkers such as Rogers on the topic of bonds involves this point: They refuse to understand that the monetary inflation created by the Fed is going into, or staying in, the prices of bonds. Not only are bonds a momentum play, they have two powerful factors on their side. One is governmental approval/preference for high bond prices (low interest rates). The other is the evolving American demographics. In addition to the decline in births, we also have people living longer. A greater percentage of wealth perhaps than ever before is held by the older set, given limited wage and employment trends in the younger age groups for several years already. While gentlemen prefer blondes, older people prefer bonds. (Sorry, couldn’t resist that one!)
The current weak trend in corporate profits that was seen beginning in Q2 and that is intensifying in Q3 has wrong-footed the mainspring, though not readers of this and other “think different” blogs. In cleaing out papers yesterday, I came across this article from Bloomberg.com from April 23 of this year (around the peak of enthusiasm asjudged by the Russell 2000): “Durable U.S. Recovery at Hand as Growth Drivers Shift”. Here is the lede, with the quote from a mainstream investment man named Joseph Carson:
Almost three years after it began, the U.S. recovery may (Ed: always that mealy-mouthed qualifier to avoid actually “predicting” anything!) strengthen as autos and housing begin to reemberge as mainstays of growth.
“The traditional engines that tend to give you a recovery are kicking in now… we’re seeing confirmation of sustainability from all sides. That’s a real business cycle.”
Hmmm… Just as corporate profits were flattening out in nominal terms and getting ready to decline in real terms. Just as the Fed was getting so concerned that this was not a “real business cycle” (moving upwards) that it felt forced to announce QE 3 in the absence of a recession and shortly before a presidential election. Just as the single best predictor of the short-term direction of economic activity, the stock market, was in the process of what would have been peaking absent the monetary steroids of “QEternity” (my opinion).
The study of economics is the study of how we stay alive. My bias is thattt everyone should be studying it to the extent they can, because it affects how much one works, borrows, saves, and spends. It affects whether one rents or owns a home. It affects those lucky enough to be in the investor class.
The problem is that even an investment genius such as Jim Rogers can mostly “get it right”, can be an adherent of the “alternative” Austrian school of economics, and get an important trend– interest rates– wrong. (Of course, the “Keynesians” who advised President Obama got almost everything wrong. Their prescription was followed: stimulate, then declare the next summer “Recovery Summer”. They meant it, they believed it, and promptly they were proven so wrong that QE resumed less than two months after QE 1 had ended, suppposedly forever.)
I follow data where it leads. I look for dogs that should bark but do not (“Silver Blaze”).
Once the impossible has been ruled out, whatever remains, however improbable, should be considered as being correct (The Sign of the Four).
Improbable though it seems given yet another round of quantitative easing, the market gods might just fool people again and produce yet one more move lower in Treasury rates.
(Note: long EDV, TLT)