“V” My Eye, Part 2

It doesn’t get any stupider than this. The S&P 500 is up 47% since the March 23 intra-day low, but the stupid part is not just the stock index level; it’s also the Wall Street claim that the stock market’s got it right and is discounting a brilliant future on the other side of the V.

In fact, we even heard one perma-bull on bubble vision this AM, Jack Ablin, claiming it doesn’t matter how deep the bottom of the V is or whether it takes until 2021 or 2022 to get to the other side.

By Ablin’s lights that’s because the market is discounting the long-term future of corporate free cash flows and the next year or two only accounts for 5-10% of the NPV (net present value) of those cash flows.

So, actually, lockdowns, recessions, depressions–no problem!

They don’t count. Just buy the Wall Street hockey sticks because earnings will always revert back to prior path.

Well, that’s not just nonsense. It’s idiotic drivel!

Does it mean that if the market were valued at 50X earnings before the unexpected V-shaped plunge that you would just revert back to prior path?

More importantly, is it possible that the V-shaped plunge or the monetary and fiscal medications which are applied to ameliorate it may leave the growth capacity of the economy permanently—even severely— impaired?

Well, now that the macro-mavens at the NBER have officially declared that the longest, and most feeble, business cycle expansion in history ended in February at the ripe old age of 128 months and that we are actually in the third month of recession, the empirical test is easy enough to apply.

To wit, how does the peak-to-peak real growth rate during the cycle just ended (red bar) compare with the previous cycle and the one before that?


After all, if the peak-to-peak growth trend is steadily and significantly falling, how can you assume that the other side of the “V” goes back to trend?

And that’s especially the case when it is self-evident that the state-assisted dig-out from the 2020 Lockdown Recession now underway is being purchased via an even more incredible new eruption of public and private debt?

As to the growth rate, debt is not its friend. The annualized growth of real final sales, which is the same as real GDP but excludes short-term inventory swings impacting beginning and ending quarters, were as follows:

  • Q2 1990 to Q1 2001: 3.57%;
  • Q1 2001 to Q4 2007: 2.61%;
  • Q4 2007 to Q1 2020: 1.52%.

That is, the trend growth rate has been falling for 20 years, and during the cycle just completed it clocked in well less than half the rate of the 1990s expansion.

Needless to say, the implications for corporate profits and therefore stock market prices are profound because the laws of compounding, among others, have not been repealed—not by Wall Street, not by the Fed.

For example, real final sales in Q1 posted at $19.82 trillion (2012 constant $). But suppose the growth rate during that record 128 month span had reverted to the 1990s trend or even the 2001-2007 path.

In that case, real final sales in Q1 would have been $25.3 trillion and $22.6 trillion, respectively, meaning that actual final sales in Q1 2020 were somewhere between 22% and 12% below prior trends.

That did make a big time difference for corporate profits during the 2007-2020 cycle. If you were simply discounting the long-term path of corporate free cash flow at the time of the 2008 macro-economic plunge based on either of these prior trends, then you would have been sorely disappointed.

Going forward there is a second risk in addition to a further faltering of the trend growth rate, which we think is a dead-to-nuts certainty. Namely, the distinct risk that today’s elevated profits share of GDP will revert to lower historical levels.

As shown in the chart below, we have been at the tippy-top of the known financial universe. After peaking at 10% of real gross value added in late 2006, the profits share of output made one more run for the nosebleed section of history, peaking at 12.3% in Q4 2014.

Since then it has fallen steadily to just under 10% recently, but is still well above the historic average. So what likely awaits on the other side of the putative “V” is both a lower growth rate of output due to a massive uptick of additional debt and at best a stabilization of the profits share or even a continued slide downward toward the historical 5% share.

Either way, what happens during the current recession with respect to its depth, length and collateral consequences is the opposite of one of the Wall Street “probably nothing”  memes.

It actually accounts for everything in terms of discounted future cash flows—a future about which Wall Street remains resolutely deaf, dumb and blind.

Indeed, what is driving this V-shaped stock index melt-up has absolutely nothing to do with the economy, the outlook for profits or anything else which is supposed to factor into the the market’s “wisdom”.

The facts on the ground, of course, include massive debts, swollen malinvestment and speculation, the brutal lockdowns and now the uprising of the house-arrestees in their millions and tens of millions.

So there is only one way to explain the massive gyration of the stock indices as embodied in the S&P 500 index on the illustrative dates below, or the NASDAQ index which has now vaulted to another new high on the very day the 2020 recession was declared, and, for once, very early in the process.

That is, at a time when passing a bogus $20 bill can apparently get you killed, ascribe the hideous “V” depicted below as the bastard child of the Fed’s massive counterfeiting spree and be done with it:

  • February 19: 3,390;
  • March 23: 2,200 (-35%)
  • June 8: 3,225 (+47%)


As David Rosenberg noted, the above is merely the final apotheosis of a Wall Street casino that has become un-moored from the real world:

It’s the mother of all “money illusion” rallies. In 3 months, the Fed juiced up M2 by a cool $2.5T, and the S&P 500 mkt cap surged dollar for dollar. Who needs earnings? Who needs productivity? Who even needs buybacks anymore? MMT arrived early and with a Republican in office!!

He got that right. During the 84 days since March 11 when the Fed last reported before the Lockdown Nation plunge incepted, its balance sheet stood at $4.31 trillion, which has since ballooned to $7.17 trillion as of the June 3 reporting date (last Wednesday).

But as near as we can figure based on an assumed 12.5% plunge in GDP during Q2 (@ 50% at an annualized rate), total nominal GDP during that period was about $4.40 trillion.

That is to say, the Fed has pumped freshly minted liquidity into the canyons of Wall Street at the astronomical rate of 65% of the running GDP generated during the period.

Self-evidently, all of this madcap money printing never left the canyons of Wall Street, fueling, instead, the most lunatic stock index melt-up yet.

By contrast, here is the real world as printed by the BLS itself last Friday. The chart measures total private sector hours worked during the month relative to the index base in 2002. Like all BLS data, it is highly estimated, imputed and modeled, and subject to revision in the years ahead.

But unlike the ridiculous headline “job count” number, which counts all job slots the same from low-paying 10 hour per week gigs to high paying 50-hour per week (with overtime) jobs in the energy patch, the hours index is at least an apples-to-apples metric.

Of course, what happened in response to Lockdown Nation is that it literally plunged into the molten center of economic earth, dropping from 119.8 in February to 97.4 in April. That amount to nearly a 19% decline and there is literally nothing even remotely close in the record books.

Now, the “V” that is being priced-in following Friday’s “gangbusters” report for May would be that hook on the right-hand margin of the chart…..( deploy your magnifying glass here).

Except, if you are not blinded by recency bias, you can’t see the hook because it is a rounding error in the scheme of things.

To wit, after May’s alleged powerful labor market rebound, the single most valuable metric reported by the BLS stands at 102.4 or the level first crossed in October 1999.

So, does the US economy have a lot of wood to chop in the months ahead?

We’d say, considerable and then some since even after Friday’s report it will be attempting to dig itself out of a 21-year economic set-back.

Indeed, even the tiny invisible hook at the bottom of the above chart for May is not all its cracked up to be. That’s because upwards of two-thirds of the gain in May came form the Leisure and Hospitality sector, which self-evidently was ground zero for the lockdowns.

So some of the drastic 53% plunge in hours workers during April versus February in this ultra-labor intensive sector came back as ad hoc re-openings began to happen. But there is still a long, long way to go—since even after the ballyhooed May rebound in these sectors, the index of hours worked still stood fully 24% below the lowest point recorded during the Great Recession in April 2009.

Moreover, the grudging 25%-75% re-opening orders being issued by the Virus Patrol authorities in many instances will simply amount to a delayed death sentence for the millions of businesses and jobs impacted.

Index of Aggregate Hours, Leisure And Hospitality Sector

If anything, the Leisure and Hospitality sector was an anomaly because nearly the entirety of the sector and the 17 million jobs reported as of February had been deemed “unessential” by the Virus Patrol.

By contrast, the transportation and warehousing sector is upwards of 2X larger in in terms of value of output and payroll checks generated. Yet after plunging by nearly 13% in April from the February high, the upward hook in May was truly tiny.

Only 8.4% of the aggregate hours lost thru April were recovered in May.

Needless to say, the Wall Street V-shaped rebound meme assumes that in slicing thru years and decades of labor input growth in exactly 60 days, Lockdown Nation left nothing behind to sweat about. Like a tree falling in an empty forest, no worker, consumer, entrepreneur, corporate executive or CapEx investor even heard it happen!

It was just here, and then gone!

We beg to differ, profoundly. The American economy after 128 months of debt-fueled faux recovery in February was a ragged, hand-to-mouth cripple that was destined to be knocked over by the flapping of a butterfly’s wings, had not Dr. Fauci and the mad doctors of Lockdown Nation come along first.

Now, two giant cliffs loom exactly ahead. First, we seriously doubt that the July “free stuff” cliff upon the exportation of the helicopter grants, the $600/week UI bonus and the $650 billion PPP bailout for small businesses and payrolls will get extended on a timely basis, if at all.

After a coast-to-coast eruption of the Woke Left, which suddenly was green- it to flee home arrest by the George Floyd event, we doubt whether then House Dems and the Donald’s foaming-at-the-mouth Law & Order Republicans will come to agreement on the next trillion dollar installment of Bailout Nation—or at least on a timely basis and in the magnitudes that would assure continuity with the current huge flow of walking around money from Washington.

Needless to say, once the soup-lines begin to close down or significantly diminish their munificence, there were be a second wave of economic distress across the land.

Secondly, regardless of the timing of the next wave of income and spending interruption, there is another “V” that about ready to erupt. Except, it has the opposite connotation to what the market is allegedly discounting.

To wit, the dotted blue line means that the soaring delinquencies and defaults which peaked in 2008-2009 will be back with a vengeance. As Zero Hedge recently noted,

All that was missing was a catalyst, one which according to Bloomberg arrived in late May as retail landlords started sending out thousands of default notices to tenants, who in turn experienced a collapse in foot traffic, sales and cash flow due to the COVID-19 pandemic, and were simply unable to pay their debt obligations.


Indeed, according to one industry observer, a tsunami of credit turmoil is barrelling down the pike:

The default letters from landlords are flying out the door,” said Andy Graiser, co-president of commercial real estate company, A&G Real Estate Partners. “It’s creating a real fear in the marketplace…….

An estimated $7.4 billion in rent for April hasn’t been paid  while May numbers which have yet to be released will be far worse. So already about 45% of what’s owed, according to a recent analysis by CoStar Group, has not been received by landlords, but the default party is just getting started.

And it’s not just malls and hotels. As the always perceptive Chris Whalen recently noted, there is a second derivative effect.

That is, the crash in the energy sector will take down the heavily leveraged and massively over-valued commercial real estate that grew up all around the debt-fueled drilling binge in the Shale Patch:

So how big is the impending commercial real estate bust in the US? Bigger than the residential mortgage bust of the 2000s and also bigger than the commercial real estate wipe-out of the 1990s, including the aftermath of the Texas oil boom of the late 1970s and 1980s.

Commercial real estate as a mortgage asset class is half the size of the $11.5 trillion market for residential homes, but the losses this cycle could be far larger per dollar of assets. That’s big. Both markets are fundamentally affected by interest rates above all.

Last week, the Financial Times reported that Chesapeake Energy Corporation, the pioneer of shale oil created by Aubrey McClendon, is on the brink of bankruptcy. This not only signals the end of the US oil boom, but another surge in real estate speculation in the areas affected. From the New York border southwest along the Appalachian Mountains to Texas and as far west as California, shale exploration and production financed a period of giddy real estate investment that is now suddenly ended.

In this regard, it is important to recall that the equity REITs own more than $2 trillion of physical real estate assets in the U.S. including more than 200,000 properties in all 50 states and the District of Columbia.

The equity REITs are generally funded with equity rather than debt, but individual assets are routinely encumbered with mortgages to increase returns.

Next comes the commercial banks which hold $948 billion of CRE debt, and then agency GSE portfolios and MBS at $744 billion, life insurance companies at $561 billion and CMBS, CDO and other ABS issues at $504 billion.

So overall, commercial real estate is funded at $5.2 trillion on a staggering mountain of debt, secondary leverage and equity market speculation. And it will crater in the months ahead.


These impending default waves are already showing-up in the bankruptcy fillings. US bankruptcy courts recorded 722 businesses nationwide filing for chapter 11 protection last month, a yearly increase of 48% from 487 businesses in May of 2019.

In addition to numerous small and medium business, numerous larger iconic companies also filed for bankruptcy last month, including retailers J.C. Penney, Neiman Marcus and J.Crew along with the management company behind two leading Lasik surgery brands, the U.S. division of Le Pain Quotidien, Gold’s Gym and drugmaker Ako.


But in the “they never learn” category, corporate issuers have not been loath to stampede into even more next-to-free debt enabled by the fools in the Eccles Building.

Thru the end of May, both investment grade (IG) and high yield (HY) is running way ahead of last year, and now total more than $1.2 trillion in just five months; and the full year 2019 itself was off-the-charts historically.


Nor is this Fed fueled speculative blow-off only a domestic affair. The G4 central banks now all have their printing presses running red hot.

Needless to say, when the white line goes parabolic, as it has during the last 10 weeks, an accident of biblical proportions is fixing to happen.