Unfortunately the employment numbers lately have been disappointing and the job openings number this morning was very worrying, down 14% on a year-over-year basis.
Initial and Continuing Unemployment claims have also been rising on a year-over-year basis.
So we have unemployment starting to tick higher and hiring slowing – two things seen at the beginning of recessions. The next shoe to drop will be consumer spending. But how do we differentiate all those mid-cycle blips where claims were rising but it didn’t lead to a recession? By looking at the yield curve. Keep in mind that we’re now in a post curve-inversion world so any worrying data points should not be taken lightly.
The employment data has been weakening for the past 4 or 5 months now which has left the economy right on the edge and in a fragile state. I was trying to stay open minded about seeing things stabilize and hopefully pick up again but then the Coronavirus outbreak began. Unfortunately I think it is going to be the external shock that pushes us over the edge. Global travel and trade has already ground to an absolutely halt and with this virus being different in that it’s contagious during the incubation period it’s going to take another month or two before we actually know the severity of the situation and how far it’s spreading.
But Nick, the stock market continues to make new all-time highs! Yes, it is… because that’s what happens when the Fed and PBOC begin expanding their balance sheets at record paces again. What’s worrying me is that this added liquidity is causing the stock market to completely diverge from economic reality. Remember that job openings chart shown at the beginning of this post? Here’s that number compared to the S&P 500 on a YoY basis.
This added liquidity has been pouring into the most liquid names – the big tech stocks – making the Nasdaq 100 ground zero for concern. I’ve shown charts before illustrating that accelerative blow-off type moves are what concern me the most. They typically don’t end well.
I have not seen the typical deterioration in internals yet so I’m not saying that this can’t continue higher. But I do believe that the climb higher since September has been 100% central bank liquidity driven and is 100% unsustainable in real terms. Let me show you what I mean.
The following is an excerpt from my latest letter to clients:
Given its history as a reserve asset, gold is the purest way to measure and separate real growth from monetary inflation. Here in the US we think of everything in US dollars because that’s our currency. But if we wanted to see the effect of currency devaluation over the long run we should look at things priced in gold instead. I think the chart below is the most important chart to follow right now for an understanding of the current environment as it greatly influences portfolio positioning. The chart shows a ratio of the S&P 500 Index to gold. When the line is rising, US stocks are outpacing gold, and when it is falling, gold is outperforming US stocks.
Next is the S&P 500 Index (priced in dollars) in the top pane vs the same S&P-to-gold ratio in the bottom pane. What we can see is pretty telling. Since economic growth started to decelerate in the summer 2018, stocks priced in gold have been falling (i.e. gold is outperforming stocks). What this implies is that the gains in the S&P 500 index over the last year are from monetary inflation and not real economic growth. The last time we were in a regime like this, the ratio fell (gold outperformed stocks) for nearly 12 years and the nominal total return of the S&P 500 Index was barely positive (blue circles in top pane).
When we’re in a period of monetary debasement, real assets tend to outperform everything else. I consider real assets to be things of finite supply like commodities, real estate, rare art, classic cars, bitcoin, etc. This next chart shows the performance of a few asset classes from the point the stocks-to-gold ratio peaked in July, 1999 to when the ratio bottomed in August, 2011. The asset classes chosen are a simple representation of real assets and non-US dollar assets. Gold (yellow line) was up roughly 650%, Emerging Market stocks (green line) were up over 200% and US REITs (red line) were up about 125%. While US stocks (black) were roughly flat for 12 years. I should remind everyone that past performance is not indicative of future results… but, I largely expect a similar outcome with all three of these asset classes outperforming US stocks over the next 5 to 10 years.
While this might seem like I’m negative on stocks, I’m actually not (well, maybe some where there are excesses). History and the experience of other countries tells us that many stocks can and often do rise during periods of monetary debasement. This is because stock represents ownership of an actual company that owns real assets. As long as the business model isn’t crushed by rising inflation, a company’s stock should hold up. I believe that stocks will always be the best generators of wealth over the long-term since it’s the owners of a company that make the most money by sharing in the profits. I just think that the environment we’re heading into requires a much more balanced approach within portfolios that isn’t so stock and bond heavy, and I think most portfolios in the US (i.e. pensions, your standard 60/40 model, target date funds, etc.) are not prepared for this.
Thanks for following!
-Nick
Thanks very much, Nick!