Now we fast forward to 2016 and the chief aim is to never experience a bust / recession / depression or deflation ever again. Central Banks (CB’s) have taught us that they are all bad things and that we must avoid them at all costs.

These CB’s have tried multiple policies and even some new experiments like negative interest rates in attempt to keep the global economy from experiencing a slow down or any amount of deflation. How bad is it really if the price of everyday items like food, rent and fuel becomes 1 or 2% cheaper each year. For the average income earner around the world their money will be allowed to go further if prices fall.

The more we have tried to control every aspect of the market, capitalism and the economy, the harder its becoming to not lose total control of these very things. However I believe we are already in the process of losing control of one of the most important things, the real economy. Presently all the Central Banks have done an excellent job at keeping the Financial assets Ie Stocks and Bonds markets up at or near record highs , while the actual economy has been unable to improve in real inflation adjusted terms over the last 10 years.

Real Assets At All Time Lows

If we take a look at the chart below, it illustrates perfectly the complete distortion of over 85+ years of controlling mechanisms, policies and Central Bank experiments have done to the relative value of real assets compared to financial assets.

[drizzle]This chart goes all the way back to 1925 and currently we are at an all time low, for real assets (Houses, commodities, fine art, jewellery etc) relative to financial assets of stocks and bonds. All the stimulus and attempts at controlling the markets and economy have only influenced the price of financial assets. Financial assets are more easily influenced and controlled through electronic exchanges, rather than real tangible assets which are much harder to manipulate on a global scale.

Real Assets to Financial assets chart
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In the video below, Ray Dalio and company deliver a frank assessment on how we have reached the physically limits of the system. As we have artificially pushed markets and demand higher through debt accumulation, lowering interest rates to zero and by ballooning the derivatives market.

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Increasing Volatility And Valuation Divergence
The chart below provides a good understanding on the ever increasing huge swings in volatility the financial markets have experienced. Central Banks began to introduce and try new stimulus and policy ideas in the early 2000's to reduce the busts / recessionary periods, causing large swings in the prices of the financial market as well as the valuations.

The most recent round of stimulus that began in 2009 with Zero Interest Rate Policy (ZIRP), followed by QE 1, 2, 3 and negative interest rates have stretched out the valuation of the S&P 500 relative to US productivity. Up to 1995 / 96 US productivity moved in sync with the S&P 500 stock market. This is clearly no longer the case as the chart indicates a strong divergence in valuation.

S&P 500 Vs US Productivity

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This week we received the latest monthly industrial production number in the US and showed that the year on year figure remains negative.
Since mid 2014 you will notice that industrial production data used to coincide with the value of the S&P 500 index very well. Now industrial production has been falling for 2 years and the stock market is near nominal all time record highs.

US industrial production vs S&P 500 index

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One of the policies that the Central Banks have utilized to try and control the economy, markets and financial assets values is to physically adjust interest rates up and down. Since the 1980's when Paul Volcker raised interest rate to around 18% to combat high inflation, we have been steadily lowering them all the way to zero.
Why Lower Interest Rates No Longer Work?

Presently the federal funds rate is at 0.25% as you can see from the chart, however lower interest rates are no longer having the desired effects to stimulate the real economy anymore. One of the reasons for this is the fact we have reached the limits of our debt bubble cycle. We can no longer leverage ourselves any higher despite having interest rates at close to zero .

US Effective Funds rate chart

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Leveraging Corporate America
One of the many side effects of lowering the federal funds rate to close to zero, has been the leveraging of US companies to levels higher than the 2007 and 2008 peak before the GFC crisis. Debt to equity is approaching 60% for non-financial companies, as the incentive to load up on debt has never been so high. But is it really helping corporate America?


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What Is The Debt Being Utilized For?
The accumulation of more debt relative to assets would be ideal in the short term if companies were utilizing the debt to fund new innovation, capital expenditure and additional capacity for future growth.

The reality is that a large majority of the debt accumulation has been utilized to fund buybacks of company stocks to artificially boost earnings per share (EPS) which in turn helps stock prices rise despite the company profit not actually growing from this strategy.

The chart below shows that share buybacks have more than doubled since 2012 to $161 Billion in the 1st quarter of 2016, as more companies engaged in artificial growth strategies rather than invest in their own business models.

US Stock Buybacks

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IBM a large technology company that has been an consistent innovator issuing several thousand new patents each year. However even though IBM still continues to issue several thousand patents, the company has been steadily increasing its debt levels (See chart below) to allow it to participate in stock buybacks.
IBM Net debt in $BN

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IBM Increasing Debt & No Growth
These higher debt levels has allowed IBM to engaged in stock buybacks with the additional funds at their disposal. Unfortunately for IBM the stock buybacks have not helped the actual company as  it has struggled to grow over the last few years.

The chart below is a perfect example how a large company has tried to control its EPS through artificial boosting its profits with stock purchases funded through debt. However the actual result is that IBM's revenue (which can't be artificially adjusted through stock buybacks) has been falling since 2012 as the company continues to struggle to grow its top line and bottom line numbers.

IBM Revenue Y/Y change

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Netflix, which is relatively young technology company that provide online streaming of TV content, is a company that has been investing large

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