We live at a time where the unthinkable has become common

By Steve Blumenthal

“We live at a time where the unthinkable has become common.”
B. Scott Minerd, Managing Partner, Guggenheim Partners

Do you remember the story book The Little Engine That Could?  The best known version of the story was written by “Watty Piper,” the pen name of Arnold Munk, who was the owner of the publishing firm Platt & Munk.  Arnold Munk was born in Hungary, and as a child, moved with his family to the United States, settling in Chicago and later moving to New York.  Platt & Munk’s offices were at 200 Fifth Avenue until 1957 when Arnold Munk died.

In the tale, a long train must be pulled over a high mountain.  Larger engines, asked to pull the train, for various reasons refused.  A request is sent to a small engine, who agrees to try.  The engine succeeds in pulling the train over the mountain while repeating its motto: “I think I can.”  (Source)

My favorite part was when the small engine neared the top of the mountain, the steepest part, while losing energy and puffing smoke kept saying, “I – think – I – can.”  Digging even deeper inside, the engine succeeded and crossed the top.  As it moved down the other side of the mountain the small engine said, “I thought I could, I thought I could.”

Look, we can and we will… succeed.  But the mountain of debt is steep and the engine, while not so small, is using up a lot of energy.  The excessive level of debt is the most significant drag we have on growth.

This from Bloomberg this morning:

The U.S. economy grew less than previously reported last quarter on lower government outlays and a bigger depletion of inventories, capping a sluggish first-half performance propped up mainly by consumer spending.

Gross domestic product, the value of all goods and services produced, rose at a 1.1 percent annualized rate, down from an initial estimate of 1.2 percent, Commerce Department figures showed Friday in Washington. Household spending, the biggest part of the economy, was revised higher on used-car sales.

The economy’s failure to develop a sustained pickup has helped keep Federal Reserve policy makers from pulling the trigger on an interest-rate increase so far this year. Economists project a third-quarter rebound driven by household purchases and more stockpiling, and the report showed wages and salaries were revised sharply higher, indicating consumers have the wherewithal to continue spending.

Economists have consistently missed the mark.  We’ll wait and see.

A client asked me how economic growth post the great financial crisis compares to other prior periods.  I did some digging and found this from Ned Davis Research, “Currently in its eighth year of growth, this expansion is the fourth longest of the postwar period.  Early next year it will be number three.  The longest expansion was ten years, which ended in March 2001 and encompassed the technology boom.”

Here is a look at the data from 1947 to present:


Lowest and fourth longest.  OK – not so great.  Expansions die because of tighter Fed monetary policy (raising interest rates) or a systemic economic or financial event.  My best guess on this expansion’s ultimate age is it ends with a 2017 recession, but that is really a guess.  Data dependent I say.  Sounds kind of weak… right?  I agree.

Federal Reserve Chair Janet Yellen promised us today that the Fed has the tools to fight off recession.  And Greenspan didn’t think housing was in a bubble and completely missed the subprime mess (we didn’t).  So call me a skeptic!  As I shared last week, “In the Realm of Economics, No Government Can Play God.”  Onward we march.

Back to the data.  Pay particular attention to the highlighted 2.1% annual GDP gain since the start of the last expansion in 2009.  The latest GDP annualized number coming in at 1.1%.  “I think I can, I think I can.”  Something is structurally wrong here and that other, really large engine (our beloved elected officials), like the large engines in the story, remain unwilling to do the fiscal work.

‘I can’t; that is too much a pull for me,’ said the great engine built for hard work.  Then the train asked another engine, and another, only to hear excuses and be refused.  In desperation, the train asked the little switch engine to draw it up the grade and down on the other side.  ‘I think I can,’ puffed the little locomotive, and put itself in front of the great heavy train.  As it went on the little engine kept bravely puffing faster and faster, ‘I think I can, I think I can, I think I can.’

Yellen is not just saying, “I think I can;” I think she is saying, “I know I can.”  Oh, dear God!  Like Greenspan before her, I have my doubts.

Risk on remains the theme.  Debt remains the mountain we must cross as the Fed and the rest of the developed world’s central bankers grit their teeth and fight like mad to summit the peak.  More debt on top of debt, to me, is a short-term easy answer but not the right answer.

My two cents is that eventually some form of default cycle is a certainty.  When?  The next recession… When’s that?  Not just yet.  There are high probability indicators that may help as time moves forward.  More on this in a future letter.

Today, I have a few great charts for you (Charts of the Week) and share commentary from Guggenheim’s very bright Scott Minerd.  His theme is “The demand for new monetary policy strategy and greater fiscal action is growing.”  Scott concludes, “We live at a time where the unthinkable has become common.”  He tells us to brace for lower interest rates for a very long time.

Nominal GDP is perhaps the best indicator of what’s going on in the economy.  We are experiencing the weakest recovery since 1935.  I too remain in the lower-for-longer interest rate camp but ultimately I believe that supply and demand dictates price and price behavior can help us stay on the right side of interest rate trends.

So I keep the Zweig Bond Model “on my radar” (sorry).  I look at it daily and post it for you each week in Trade Signals (link below).  Not perfect, no guarantees, but pretty darn good.  Like most of 2014 and 2015 when the majority on Wall Street was looking for higher rates, the ZBM signaled lower rates and maintains that signal today.

Ultimately, ultra-low interest yields are not good for savers, pension plans and insurance companies. Like Fed policy and their confidence pre-sub-prime, we have to question the potential unintended consequences of unconventional central bank policy and use tools available to us to risk manage the risks we investors must take.

Included in this week’s On My Radar:

  • Charts of the Week
  • “A New Policy Orthodoxy Is Emerging,” by B. Scott Minerd of Guggenheim Partners
  • Trade Signals – Sentiment Too Bullish, S&P 500 Annualized Return Since 12/31/99 to Present just 2.41% (Wow!)

Charts of the Week

47% of global sovereign bonds yield less than 0%.  80% of global yields are under 1%.  96% are yielding less