Central Banks Are Committing To Intervention, As Earnings And GDP Growth Continue To Decline. 

Central Banks Are Committing To Intervention, As Earnings And GDP Growth Continue To Decline. 

“Monetary policy can no longer be the main engine of economic growth, and other policy drivers need to kick in to ensure the global economy achieves sustainable momentum,” the Bank for International Settlements (BIS) writes in its Annual Economic Report published June 30, 2019.

“A sustainable flight path requires the long-overdue full engagement of all four engines of policy, rather than short-term turbo charges.” 

“Time to ignite all engines, BIS says in its Annual Economic Report”
https://www.bis.org/press/p190630.htm

Central banks seem committed to extending all policies at their disposal. They hope that taken all together they will somehow eventually work, even as they admit they have reached the limits of monetary policy alone. 

Even if their policies seem to be failing, they recommend just doing more with every tool they have. 

Certainly global money supply took off before the end of last year. The chart below shows how it rescued the S&P 500. This now seems to be the tightest correlation of any macro economic data with the S&P 500. The central banks remain silent on the issue of distorting asset prices, perhaps it is because it is their purpose.

https://twitter.com/zerohedge/status/1195464829068304386

Nevertheless, despite this intervention, global growth has continued to weaken both over the year and since the BIS report.

“Global growth is forecast at 3.0 percent for 2019, its lowest level since 2008–09”

https://www.imf.org/en/Publications/WEO/Issues/2019/10/01/world-economic-outlook-october-2019

So, as advertised, both the ECB and the Fed accelerated money supply aggressively from September. The Fed even went further than any previous QE. The chart below shows a massive rate of change going from -30bn per week, to 25bn per week. A 55 bn rate of change even exceeds what they did in 2008.


https://econimica.blogspot.com/2019/

The Fed’s balance sheet went from negative to up around 300 Billion in just 2 months! That is about a 1.5 Trillion annualized rate of balance sheet increase!

https://dailyshotbrief.com/the-daily-shot-brief-november-15th-2019/

Yet the Fed chairman refuses to call it QE and describes it as  “technical measures”! 

“These actions are purely technical measures to support the effective implementation of monetary policy as we continue to learn about the appropriate level of reserves. They do not represent a change in the stance of monetary policy.”

https://www.federalreserve.gov/newsevents/testimony/powell20191113a.htm

Plainly, the Federal Reserve does not want to even talk about what is really happening. Better to stick to the stock market narrative, as they increasingly seem to control the S&P 500. It’s a better story to tell as long term policy continues to fail. The record shows that the more they intervene with debt and balance sheet growth the more long term growth has declined.


https://fred.stlouisfed.org/

The Trump tax cuts seem to have only boosted buybacks and the stock market. In my opinion, it is hard to see any lasting economic impact.

The trade talks will likely end up much the same, as a best case. Remember that even if there is a complete trade deal, which  removes all trade tariffs, this will only return trade conditions to where they were in 2017. It’s another narrative.

The chart above shows that even with economic policies operating at record levels of debt expansion and Fed balance sheet growth, it is clear that central bank activism over the last decade has produced the weakest growth since 1950. It is also cumulatively declining even before more challenging demographics kick in.

https://twitter.com/LanceRoberts/status/1195314161519091718

All the intervention has achieved is the separation of asset prices from core profitability similar to the 2000 bubble. Notice that core profits are around 20% higher than the 2006 peak, while the S&P is around double its 2007 peak. Also notice that core profitability has barely increased at all for the last 7 years.

https://realinvestmentadvice.com/the-market-soars-as-corporate-profits-slump/

Now the outlook for Q4 2019 looks even worse for the economy. Not only is Q3 2019 reporting negative earnings growth, but factset reports the same for Q4.

https://www.zerohedge.com/economics/q4-gdp-crashes-us-economy-growing-slowest-pace-4-years

Current estimates of Q4 2019 GDP are also barely above zero.

Investment implications

The call to arms by the central banks in the BIS 06/30/2019 report sets the direction of policy, which already the Fed and ECB have begun to implement. The outlook will be shaped by the following questions:

At what pace will the central banks continue to expand their policies?

After the 2019 experience, have they now inverted the historic relationship between GDP growth and the S&P 500?

Does weak growth mean money supply will increase until the S&P 500 rises?  

What are the limits of what they can do? 

How much will these policies influence growth and inflation, both in the short and long term?

I believe investing has become much more complex and in the long term far more uncertain. I would argue that the central banks are in danger of departing far beyond their mandate and understanding. Distorting prices with failing policies in my opinion increases long term instability and price discovery impairment, which, I believe, will decrease economic efficiency and productivity.

However, in any system capital will always move to where it’s treated best, and that will remain the case.

Investment strategies will have to adapt and examine central bank activity more closely. Cycles will still be important, indeed central bank activity is essentially part of a bigger cycle.

Investment Strategy must also adapt.

If intervention is the driving force for markets, it is much harder to gauge than other macro economic data. Central banks don’t report in a timely fashion, and don’t even acknowledge the significance, as Chairman Powell has confirmed. This means that not only has strategy become more complex, but it is also more opaque in these conditions. To avoid gambling lower risk strategies are appropriate.
Short term volatility is being suppressed, while long term instability is exploding. Long term positioning is therefore where risk concerns need to focus. Short term positioning can be agile and take advantage of conditions, so long as the complexity can be effectively engaged.

“Short” positions where negative views on assets are taken has become much more difficult in conditions where liquidity is accelerating.

For now it seems that Q4 2019 is increasingly likely to be quad 3, a stagflationary environment. It is possible that heightened activism of central banks may lead to more stagflationary conditions, in the long term also, with similarities to the 1970s.

Standard long term allocations may need significant adjustment to be more optimally adjusted to current circumstances.

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