The Orange Swan Cometh, Part 1

Well, the stock market was priced for perfection. The S&P 500, for example, was trading at 18.4X reported earnings. So it might well be asked whether there was any headroom left for something to go wrong in the world?

There was not.

We know that because we are referring here to the S&P index at 1565 way back on October 9, 2007, which was the day it tagged the tippy-top of the last cycle. The S&P index was then trading at the above cited 18.4X its peak June 2007 LTM earnings of $85 per share.

Then again, exactly 18 months later, the S&P 500 had cliff-dived by 57% to 670 at the March 2009 bottom, and reported earnings (GAAP) had plunged by 91% to $7.50 per share.

Needless to say, some bad stuff happened in the interim, otherwise known as the subprime mortgage collapse of 2007-2008, which forewith led to the Wall Street meltdown of September 2008 and what became known as the Great Financial Crisis (GFC) thereafter.

The latter apparently got the all caps GFC designation from authorities on both ends of the Acela Corridor as some kind of back-handed form of reassurance to the unwashed masses of Flyover America and especially the unbowed phalanx of financial masochists otherwise known as Jim Cramer’s homegamers.

That is, the GFC was soon stipulated to represent an utterly improbable once in 100-years flood event; and besides that, owing to Bernanke & Co’s courage to print, the problem was allegedly all fixed years ago—meaning that it was once again safe to buy-the-dips. Over and over again.

At length, however, the stock market became, apparently, priced for perfection again—-this time at 23.6X reported S&P 500 earnings as of last Friday’s close. We are referring to the fact that with about 85% of Q1 earnings now posted, the reported LTM earnings number is running at $132.75 per share, which equates t0 $125 per share on the old tax rate (35%) which was in effect on October 9, 2007.

In as word, the casino has upped it top-of-the-cycle capitalization rate on apples-to-apples earnings from 18.4X to 23.6X or by about 30% over the last 12 years. So the question at hand is for what earthly reason why?

After all, on any measure of financial health you please, the fundamentals of the US economy are in far worse shape today than they were in October 2007. For instance, the public debt was $9.o trillion compared to $22.4 trillion today.

Likewise, the Fed’s already bloated balance sheet back then was about $900 billion and had room to expand. That compares to $3.9 trillion today and still shrinking at $50 billion per month.

And when it comes to the total debt burden crushing the main street economy—public and private combined—there is no contest at all. Notwithstanding the alleged wake-up call presented by the GFC with respect to America’s soaring indebtedness, it’s only been off-to-the-races since the dark economic winter of 2008-2009.

In fact, total debt—business, household, government and finance—is up by nearly $21 trillion or 40% to $72.1 trillion. And that represents $3.75 of new debt for each dollar of added nominal GDP over the last 12 years.

The question recurs, therefore, as to whether the US economy can keep piling on debt at a 3.75: 1 ratio and not incur growing risks of instability and structural barriers to growth; and whether or not 12 more years of attempting to borrow our way to prosperity has created hidden risks that make the pricing of equities to perfection an even more foolish undertaking today than it was in October 2007?

Needless to say, we believe the answer is a thundering yes, and not the least because the Donald’s China Trade tweetstorm on Sunday represents a threat to economic stability far more consequential then the subprime mortgage breakdown that catalyzed the last bubble collapse.

After all, even back then the problem wasn’t subprime home mortgages per se. As shown below, between the dotcom crash in 2000-2001 and the 2006 subprime peak, outstandings grew by about $800 billion.  That turned out to be the straw on the camels back, but the problem was that by then the US economy had become so burdened with debt that it had no capacity to absorb what was in the scheme of things a mild shock.

That is, subprime loans outstanding represented less than 9% of GDP at the peak, and the ultimate losses of about $400 billion on the subprime inventory amounted to less than 3% of GDP.  So even back then, the rot down below was the real problem.

Image result for images of subprime mortgages outstanding

In fact, between Greenspan’s arrival at the Fed in August 1987 and the pre-crisis peak, the main street economy had buried itself in Easy Al’s cut rate debt (dark shaded area in the chart). During that interval, total household debt outstanding rose from $2.8 trillion to $14.2 trillion or by 5.1X.

Needless, to say that was nearly double the 2.7X gain in wage and salary income during the same 20 year period. So what happened was that the household sector reached Peak Debt in 2007, but in the 12 years since then has hardly deleveraged at all.

In fact, currently household debt has risen by a further $1.4 trillion to $15.6 trillion; and represents 1.75X wage and salary income compared to just 1.20X when the Greenspan era of monetary central planning incepted back in August 1987.

In Part 2, we will elaborate on  several other structural weakness of the US economy which have gotten far more severe since October 2007. But for now suffice it to say that today’s catalyst for activation of the rotten foundation below is far more formidable than the subprime hammer.

We are referring, of course, to the Orange Swan in the Oval Office. That’s because his weekend tweetstorm was not some kind of strategic 3D chess board maneuver to extract some last minute concessions from Beijing; to the contrary, it was a glandular outburst of the Donald’s blithering ignorance about the economics of trade and his unhinged megalomania that equates the trade balance with winning or losing.

Notwithstanding the pathetic rationalizations and attempted reassurances that came out of the Wall Street buy-side this AM, you only need to look at the plain words of the Donald’s latest tweets. This is the mental flaying about of someone who has no idea what he is talking about:

The United States has been losing, for many years, 600 to 800 Billion Dollars a year on Trade. With China we lose 500 Billion Dollars. Sorry, we’re not going to be doing that anymore!

For 10 months, China has been paying Tariffs to the USA of 25% on 50 Billion Dollars of High Tech, and 10% on 200 Billion Dollars of other goods. These payments are partially responsible for our great economic results. The 10% will go up to 25% on Friday. 325 Billions Dollars….of additional goods sent to us by China remain untaxed, but will be shortly, at a rate of 25%. The Tariffs paid to the USA have had little impact on product cost, mostly borne by China. The Trade Deal with China continues, but too slowly, as they attempt to renegotiate. No!


As one commentator noted, the headline reading  robo-traders, which have been feeding on White House leaks and reassurances for months now, were caught with their algorithms down:

“The market was caught on the wrong foot as everyone expected talks were heading in the right direction and almost close to finishing,” said Daniel Lenz, a rates strategist at Commerzbank. “This was totally out of the blue and the reaction is that we have more risk aversion today.”

No, not at all.

It has been evident from the beginning that the Donald is bound and determined to use the vast discretionary authority of the 1962 and 1974 Trade Acts to pursue an economy-wrecking policy of statist mercantilism that does not remotely address the underlying cause of the nation’s massive trade deficits.

That is to say, back at the last stock market bubble peak in October 2007, US exports to China were $63 billion and imports were $321 billion, leaving a trade deficit with the Red Ponzi of $258 billion.

Fast forward to 2018, and exports had crept up to $120 billion, while imports had soared to $662 billion. That left a deficit of $442 billion and it had nothing to do with bad trade deals or even Chinese cheating.

It was actually a product of Bad Money at the Eccles Building—the very thing upon which the Donald now demands to double-down.

Special Deal:

Peak Trump