The road is long
With many a winding turn
That leads us to who knows where
Who knows when
But I’m strong
Strong enough to carry him
He ain’t heavy, he’s my brother

So on we go
His welfare is of my concern
No burden is he to bear
We’ll get there
For I know
He would not encumber me
He ain’t heavy, he’s my brother

He Ain’t Heavy, He’s My Brother,” by The Hollies (1969)

He sure feels like he’s heavy. From The Wall Street Journal this morning, “U.S. Growth Starts Year in Familiar Rut.” “A sharp pullback in business investment and weak global demand dragged down an already-lackluster U.S. economy in the opening months of 2016, the latest setback in a bumpy expansion entering its seventh year.” That marked the economy’s worst performance in two years. More here.

Last week we looked at structural issues. Specifically, the oversupply glut of 3 billion workers competing for the work that 800 million workers were doing before the internet opened the world to the emerging market supply chain. Think China’s massive infrastructure build out – the excess manufacturing and labor capabilities and also think about Korea, Singapore, Taiwan and India. Fifteen dollar per hour wages are not going to fly when there are people doing the same thing for $15 per day.

The big consumers are the developed countries and some of the biggest consumers (well, you and me) are here in the U.S. But older we get and the demographic winds require more savings and less spending. We already bought a lot of the stuff.

Last week I promised you a “Cliffs Notes” version of Lacy Hunt’s latest letter as well as some thoughts from Gary Shilling. They are two of my favorite analysts. So let’s jump on in and make this week’s letter a quick and to the point read. Grab that coffee and find your favorite chair.

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Included in this week’s On My Radar:

  • Lacy Hunt
  • Gary Shilling
  • We Are Heading Towards Negative Interest Rates
  • Trade Signals – Fed Leaves Rates Unchanged

Lacy Hunt

Here are a number of bullet point highlights from Hunt’s April letter:

  • The striking aspect of the U.S. economy’s 2015 performance was weaker economic growth coinciding with a massive advance in nonfinancial debt.
  • Nominal GDP, the broadest and most reliable indicator of economic performance, rose $549 billion in 2015 while U.S. nonfinancial debt surged $1.912 trillion.
  • Accordingly, nonfinancial debt rose 3.5 times faster than GDP last year. This means that we can expect continued sub-par growth for the U.S. economy.
  • The ratio of nonfinancial debt-to-GDP rose to a record year-end level of 248.6%.
  • During the four and a half decades prior to 2000, it took about $1.70 of debt to generate $1.00 of GDP. Since 2000, however, when the nonfinancial debt-to-GDP ratio reached deleterious levels, it has taken on average, $3.30 of debt to generate $1.00 of GDP.
  • This suggests that the type and efficiency of the new debt is increasingly non-productive.
  • Debt is always a shift from future spending to the present.
  • Thus, while the debt helped to prop up economic growth in 2015, this small plus will be turned into a longer lasting negative that will diminish any benefit from last year’s debt bulge.
  • Household debt was lower.
  • Last year, business debt, excluding off balance sheet liabilities, rose $793 billion, while total gross private domestic investment (which includes fixed and inventory investment) rose only $93Thus, by inference this debt increase went into share buybacks, dividend increases and other financial endeavors, albeit corporate cash flow declined by $224 billion.
  • When business debt is allocated to financial operations, it does not generate an income stream to meet interest and repayment requirements. Such a usage of debt does not support economic growth, employment, higher paying jobs or productivity growth.
  • Thus, the economy is likely to be weakened by the increase of business debt over the past five years.
  • In 2015, the ratio of business debt-to-GDP advanced two percentage points to 70.4%, far above the historical average of 51.7%.
  • Only once in the past 63 years has this ratio been higher than in 2015. That year was 2008.
  • The jump in corporate debt, combined with falling profits and rising difficulties in meeting existing debt obligations, indicates that capital budgets, hiring plans and inventory investment will be scaled back in 2016 and possibly even longer.
  • Indeed, various indicators already confirm that this process is underway.
  • U.S. Government gross debt, excluding off balance sheet items, reached $18.9 trillion at year-end 2015, an amount equal to 104% of GDP, up from 103% in 2014 and considerably above the 63-year average of 55.2%.

SB here: I’d like to make special note of Lacy’s next point:

“The divergence between the budget deficit and debt in 2015 is a portent of things to come. This subject is directly addressed in the 2012 book The Clash of Generations, published by MIT Press, authored by Laurence Kotlikoff and Scott Burns. They calculate that on a net present value basis, the U.S. government faces liabilities for Social Security and other entitlement programs that exceed the funds in the various trust funds by $60 trillion. This sum is more than three times greater than the current level of GDP.”

  • They substantiate that, although these liabilities are not on the balance sheet, they are very real and will have a significant impact on future years’ budget deliberations.
  • According to the Congressional Budget Office, over the next 11 years, federal debt will rise to $30 trillion, an increase of about $10 trillion from the January 2016 level, due to long understood commitments made under Social Security, Medicare and the Affordable Care Act.
  • Any kind of recession in this time frame will boost federal debt even more.
  • More than a dozen serious studies indicate this will drain U.S. economic growth as federal debt moves increasingly beyond its detrimental impact point of approximately 90% of GDP.
  • Over-indebtedness Impairs Global Monetary Policy: The Federal Reserve, the European Central Bank, the Bank of Japan and the People’s Bank of China have been unable to gain traction with their monetary policies.
  • Excluding off balance sheet liabilities, at year-end, the ratio of total public and private debt relative to GDP stood at 350%, 370%, 457% and 615%, for China, the United States, the Eurocurrency zone, and Japan, respectively.
  • Lacy concludes:

Our economic view for 2016 remains unchanged. The composition of last year’s debt gain indicates that velocity will decline more sharply in 2016 than 2015. The modest Fed tightening is a slight negative for both M2 growth and velocity.

Additionally, velocity appears to have dropped even faster in the first quarter of 2016 than in the fourth quarter of 2015. Thus, nominal GDP growth should slow to a 2.3% – 2.8% range for the year. The slower pace in nominal GDP would continue the 2014-15 pattern, when the rate of rise in nominal GDP decelerated from 3.9% to 3.1%.

Such slow top-line growth suggests that spurts in inflation will simply reduce real GDP growth and thus be transitory in nature.

Acordingly, the prospects for the Treasury bond market remain bright for patient investors who

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