Economy, Markets

Even More Signs Of A Possible Reversal In The Wealth Effect

“If you build a bridge it has to reach the other side. So I think a bridge that relies on wealth effects, you better hope that you got enough growth to justify the asset price increase which created the wealth effect in the first place. So there is some sort of virtuous cycle that gets kicked off which becomes self-fulfilling over time. The alternative is you kick off the wealth effect now, but over time people realize the wealth ain’t coming and then you have an asset price adjustment.” –Raghuram Rajan, current head of the Reserve Bank of India and former chief economist at the IMF

There is no doubt the Fed achieved its goal of boosting the prices of risk assets over the past several years. Whether the Fed was able to create a, “virtuous cycle,” of growth that validates the gains in stocks is another question entirely. From the looks of equity values relative to their earnings, I’d have to say it now appears that, just a Rajan suggested, “the wealth ain’t coming.”

This is most evident in the recent fortunes of the most wealthy. CEO pay is falling at the fastest rate since the financial crisis. This is mainly because corporate earnings and profit margins are falling and the efforts of CEO’s and CFO’s aimed at engineering better financial results just aren’t enough to overcome these headwinds.

In addition to the public executive suite, it appears startup founders and their venture capitalist backers are feeling the heat from a broad shift in risk appetites.

This doesn’t just affect Silicon Valley. Startup hotbeds in places like Seattle, Austin and others are even feeling more pain right now than the Bay Area.

Still, Silicon Valley is the single largest startup market on the planet by far and the weakness there is already apparent in their real estate market.

It’s not just the ultra-high-end of that real estate market that’s feeling pressured. Real estate prices broadly declined in San Francisco last month.

On the other side of the country, the pressure on the wealthy is coming from troubles in investment banking. Like the troubles in VC, this is mainly due to a broad shift in risk appetites (mainly in the credit market’s unwillingness to fund deals).

It appears hedge fund managers are also feeling the pinch of waning risk appetites.

In a recent piece, I noted the weakness in market for real estate in the Hamptons as a direct result of this pressure on the wealth there. But it appears they may be selling their winter homes, too.

Beyond real estate, there’s a common theme now of weakening sales across virtually every luxury retailer, as well.  I recently wrote a bit about Sotheby’s issues. LVMH had a similarly rough first quarter.

…as did Burberry.

If the Fed’s theory regarding the wealth effect is correct the weakness at the very high-end that we are now seeing could be a very good leading economic indicator. And it might not take long to see this weakness, “trickle down.” In fact, it may already be apparent in auto sales. As a direct beneficiary of zero-percent interest rates, this has been a bright spot for the economy… until now.

Car makers now have so much inventory, both new and used, they are getting desperate to offload it.

Weakness in autos is also starting to show up in credit, which has underpinned the entire boom in the sector.

All in all it seems there is reason to worry about the consequences of the Fed-engineered wealth effect in recent years. If it is now unwinding, “an asset price adjustment,” as Rajan suggested, may now be looming.


Is America Insolvent? Are You An Idiot For Even Asking?

The latest issue of Time magazine is causing quite the to do. It leads with an article titled, “Make America Solvent Again,” written by Jim Grant.

Economist Paul Krugman is already out ripping the piece, mainly via ad hominem attack on the author:

Investment Adviser Barry Ritholtz perpetuates a similar ad hominem on the publication itself along with repeating Krugman’s genetic fallacy in a similar post:

At the same time, you have former Fed insider, Danielle DiMartino Booth, with a plea this week very similar to Grant’s:

And the greatest money manager alive has been singing Grant’s song for quite some time now:

So who do you believe?

Forget my own logical fallacy (appeal to authority) here for a minute. Personally, I find the sheer volume of disdain for this article alone to be very troubling. It’s a shame that what could be the most important issue facing our nation can’t even be discussed openly among adults without immediately devolving into personal attacks. But the fact that it does suggests to me these critics must feel a great deal of insecurity about their own position. Why else would they give up on it and resort to these sorts of epithets and fallacies so quickly?

Charts, Economy, Investing, Markets

Stocks And Bonds Are Saying Totally Different Things About The Economy Right Now

They say the markets are forward-looking, discounting what will happen in the near future rather than what has already happened in the recent past. I believe this is true. However, some markets are better at this than others.

And right now two major markets appear to be discounting totally different outcomes. The stock market has rallied hard off of its recent lows, suggesting fears of recession and a concomitant bear market were overblown.

At the same time, long-term interest rates, after falling along with stocks earlier in the year, have failed to match the recent equity rally. In fact, they’ve reversed right back to their lows. This suggests the bond market is as worried about low growth and inflation as ever.

So who’s right?

Personally, I’m leaning toward believing the bond market. The stock market might not care about the current earnings recession but history shows it leads to an economic one 81% of the time:

Economy, Posts

Here’s The Perfect Metaphor For Recent Fed Policy

Last week I came across this quote via John Hussman:

“The spread of fire-suppression mentality can be linked to the establishment of forest management in the United States, such that by the early 1900s forests became viewed as resources that needed to be protected – in other words, burning was no longer allowed. The danger of this approach became tragically apparent in Yellowstone, which was recognized by the late 1980s as being overdue for fire; yet smaller blazes were not allowed to burn because of what were perceived to be risks that were too high given the dry conditions. And so smaller fires were put out, but in the end could not be controlled and converged into the largest conflagration in the history of Yellowstone. Not only did the fire wipe out more than 30 times the acreage of any previously recorded fire, it also destroyed summer and winter grazing grounds for elk and bison herds, further altering the ecosystem. Because of fire suppression, the trees had no opportunity or reason to ever replace each other, and the forest thus grew feeble and prone to destruction… In 1995, the Federal Wildland Fire Management policy recognized wildfire as a crucial natural process and called for it to be reintroduced into the ecosystem… Central bankers, too, could learn a thing or two from their forestry brethren.” -Mark Spitznagel, The Dao of Capital

What a brilliant metaphor for the central bank policies we have witnessed for at least the past several decades! The Fed has been desperately trying to prevent or put out fires only to make the markets and the economy that much more vulnerable to them by encouraging every greater debt accumulation and risk taking. It reminds me of this New Yorker article which also utilized an insightful fire-based metaphor and originated the term, “Minsky moment.”

“Twenty-five years ago, when most economists were extolling the virtues of financial deregulation and innovation, a maverick named Hyman P. Minsky maintained a more negative view of Wall Street; in fact, he noted that bankers, traders, and other financiers periodically played the role of arsonists, setting the entire economy ablaze. Wall Street encouraged businesses and individuals to take on too much risk, he believed, generating ruinous boom-and-bust cycles. The only way to break this pattern was for the government to step in and regulate the moneymen.” -John Cassidy, The New Yorker, Feb. 4, 2008

Rather than rein Wall Street in, the Fed, via policies aimed at stimulating a wealth effect, has only encouraged the arsonists to create more imbalances and greater instability. What will it take for them to finally take a page out of the forest management playbook and realize they can’t banish the business cycle?

For more Spitznagel insights see this video of his appearance on Bloomberg television from a couple of months ago:

Economy, Investing, Markets

More Signs Of A Possible Reversal In The ‘Wealth Effect’

A couple of weeks ago I proposed the idea that the Fed’s efforts to stimulate a wealth effect in recent years could now be at risk of a reversal. There are growing signs that the ultra-wealthy in both Silicon Valley and on Wall Street are beginning to feel a bit of a pinch on their massive pocketbooks.

Maybe the best sign I’ve seen recently is in a new bond issue from Spotify. The company decided to issue debt rather than equity in order to avoid a down round that would be discouraging to the company’s equity investors. However, the terms of the deal are so onerous that it’s very possible it may hurt the company’s equity investors even more than a new equity offering would have. I would be hard pressed to find a better anecdotal symbol of the shift we are now seeing in risk appetites toward both startups and corporate debt.

Certainly, Spotify is not alone in seeing pressure on its equity valuation. Most unicorns now find themselves in that unenviable position.

And their investors have to be feeling a bit less optimistic about their ability to realize their gains as prices begin to reverse and the public market begins to shun them like never before.

This is only reinforcing the cycle of risk aversion in the sector.

Even Google, it seems, is now succumbing to the broad change in sentiment.

As I wrote in the earlier piece, this weakness in Silicon Valley appears to be taking a toll already on the high-end real estate market there. It’s probably only a matter of time before this is reflected in the broader real estate numbers.

The shut down of the IPO market not only hurts Silicon Valley, it hurts Wall Street, as well. And there’s another force working against these fat cats’ bank accounts: The market for mergers and acquisitions. Between the IPO and M&A markets, investment banking fees look to be hammered recently.

In the prior piece, I highlighted the slowing market for high-end homes in the Hamptons as a reflection of this weakness on Wall Street and as a clear risk to the wealth effect. We are now seeing a very similar pattern in the city, as well.

This sort of weakness is also showing up in high-end Miami condos that recently sold for as much as $850 per square foot. No longer.

And that other financial capital across the pond is also starting to see its high-end real estate market begin to weaken in very similar fashion to the Hamptons and Manhattan.

As I wrote last time:

If the Fed’s efforts in recent years were primarily focused on creating a, “wealth effect,” to stimulate the economy, they should be increasingly concerned now to see these growing signs of a reverse, “wealth effect.” Because if the economy does operate from the top down, as this theory proposes, these could be very important leading indicators.

Is the Fed paying attention? I would guess so and this could be one reason why we recently saw one of the most dovish Fed meetings in history.