Thoughts from the Frontline: A Bubble In Complacency
By John Mauldin
Many are still trying to digest the massive amount of useful and original information that was offered at last week’s Strategic Investment Conference. In this week’s letter I will recap some of what I learned, but in a little different manner. I find it quite instructive to listen to and read what other people have to say about their takeaways from the conference. I have come across several very good summaries and reviews that I am going to excerpt rather liberally, along with sharing some of my own thoughts.
Nearly everyone noted that there was somewhat of a divide in the opinions as to whether things in the US and global economies are getting better or getting worse. Upon reflection, I think that John Nicola (my Canadian partner of the eponymous wealth management firm who sent me his comments) had it right. If we all examine a glass that is filled up to the mid-level, some of us will describe it is half-full, and others will describe it as half-empty. And of course there is plenty of data to back up either the optimistic or the pessimistic position.
The simple fact is that we are in what I call a Muddle Through Economy. Things aren’t terrible, but they are not great, either. We’ve come through a devastating Great Recession caused by a crisis in the financial sector. It is quite typical for the effects of such a crisis to linger for a decade or more. So compared to where we were at the bottom of the Great Recession, the glass is half-full. But compared to the expectations we have for economic recovery and the resumption of vibrant growth, half-full seems like an exaggeration. And for many people, the glass is simply empty, while for others it is spilling over.
Steve Moore sent me a graph demonstrating that net new jobs since the onset of the Great Recession have come, in large measure, from the energy sector. Those are generally high-paying jobs, but the rest of the country and many industries have not done so well. According to a new report from the National Employment Law Project, the quality of the jobs that have been created since the end of the last recession does not match the quality of the jobs that were lost during that recession:
- Lower-wage industries constituted 22 percent of recession losses, but 44 percent of recovery growth.
- Mid-wage industries constituted 37 percent of recession losses, but only 26 percent of recovery growth.
- Higher-wage industries constituted 41 percent of recession losses, and 30 percent of recovery growth.
Yes, unemployment is down, but so is labor participation, and the simple fact is that outside of the petroleum sector new jobs are not being created to anyone’s satisfaction. In my presentation at the conference, I showed a chart that illustrates the fact that we are losing businesses faster than we are creating new ones – an unprecedented statistic. This is a glass not only half-empty but leaking:
Richard Lehmann and Marty Fridson attended the conference and wrote an exceptionally well-done review in Forbes. (I was honored that they attended.) They started with the optimistic note that my good friend David Rosenberg offered as the very first speaker at the conference:
David Rosenberg, chief economist and strategist at Gluskin Sheff, sees reduced unemployment as a positive sign for the economy, despite objections that the decline in the unemployment rate reflects an unusually low participation rate. For one thing, says Rosenberg, the number of discouraged workers is down by 40% from the peak. At the margin, he adds, people are choosing to stay out of the work force in response to government incentives to remain idle.
The number of people collecting disability benefits, using food stamps, or collecting welfare payments is at a record high. Three-quarters of the reduction in the participation rate, says Rosenberg, is attributable to demographics, as the number of Baby Boomers reaching age 65 is rising dramatically.
Rosenberg further notes that unfilled job openings are at a five-year high. The U.S. government is granting fewer visas, college students are graduating without marketable skills, and the skills of many workers who have been laid off for long periods have become outdated. If all of the current openings could be filled, unemployment would drop to 4%.
The bottom line for Rosenberg is that the current recovery/expansion is in the fourth inning. Business cycles never die from old age, he maintains. He puts the probability of recession in 2015 at close to zero….
Richard Yamarone, senior economist at Bloomberg Economics, takes a less sanguine view on unemployment than David Rosenberg. He argues that the type of jobs being created makes a difference. Currently, job creation is skewed toward low-skill, low-income categories. To circumvent the Affordable Care Act’s requirement to provide health care to full-time employees, retailing, health care and food service employers are cutting workers’ hours. Consequently, new jobs are being created for people who now have to hold multiple part-time jobs, but that does not constitute a genuine increase in employment or GNP.
Yamarone’s view of the labor market leads to a comparatively bearish outlook on the economy. Since GDP began to be reported in 1947, he points out, the U.S. economy has slid into recession every time GDP growth has fallen to 2%, a level below which it currently stands.
Yamarone also reports unfavorable readings in four of five special data series that he has found to be accurate indicators of the economy—dining out, casino gambling, jewelry and watches, cosmetics and perfumes, and women’s dresses….
Lacy Hunt, executive vice president of Hoisington Investment Management, contends that the Fed’s strategy for boosting the economy is not working. Little wealth effect (the tendency of people to step up their spending when their wealth increases) has been observed. Hunt explains that the monetary policy cannot influence the economy unless the market rate of interest (represented by the Baa corporate bond yield) is below the natural rate of interest (the nominal rate of GDP growth). That has not been the case at any point during the recovery. Until it is, Hunt contends, consumers will have no incentive to take on debt to finance spending and economic growth will consequently remain sluggish.
Lacy believes all major developed countries are going to have deal with their “Minsky moments,” because not enough of their overall debt is productive. When all debt (government, corporate, and personal) is added up, it equals 350% of GDP in the US and 440% in developed countries on average. Lacy kept emphasizing his conviction that any number over 275% results in limited growth and eventual deflation.
David Zervos expects the Fed to keep interest rates low until it gets either inflation or solid economic growth. In fact, the private sector has been growing at more than 3% annually since 2010. His view is that savers will continue to be punished, because the interest rates they receive will remain artificially low. Gary Shilling was decidedly more upbeat and felt solid economic growth is at hand. (Nicola)
I noted an interesting theme in several speeches. Millennials, Jeff Gundlach noted, are different. They are less acquisitive. Neil Howe also talked about this and noted that we are in the middle of a “Fourth Turning,” which is a typically an isolationist period. He also notes that Millennials (1981-1994) like to rent (not just homes but cars, recreational property, clothing, etc.) They have less stress, often live at home with their parents, and are looking for meaningful work where they can be mentored. Ian Bremmer echoed Neil’s theme and stated that one of the important geopolitical trends at play is that the US is becoming more isolationist.
And Ian, who is a geopolitical analyst with the Eurasia Group and an NYU professor, also noted that the huge increase in US oil and gas production means much less dependence on Mideast oil and suggests that the US will eventually become a net energy exporter. As a result the US will not want to get entangled in the Middle East, and this reluctance will increase the risks in that region. Regarding the Ukraine situation, Ian feels the US made a mistake in trying to put sanctions on Russia that it couldn’t back up (a sentiment echoed by several speakers). He also expects Israel and the US to make a deal with Iran in the next twelve months – and if they do, Iran will bring 1.5 million additional barrels of oil to world markets. The big winner of the Ukraine crisis? Ian argued very cogently that it’s China. Ian continues to impress me every time I hear him or talk with him.
Jeffrey Gundlach was quite negative on US housing but positive on multifamily rental real estate, because rentals increase as home ownership drops. Home ownership has dropped from 69% of households to 65%. One well-known US investor, Sam Zell, expects it to drop to 55%. A 1% drop means 1.2 million additional households are looking for rental accommodations. Another speaker had mentioned that over 1 million millennials are living with their parents, which is a major factor in the reduction of household formation. Jeffrey does not like the risks associated with high-yield bonds but does like emerging-market debt and mortgages on a risk-adjusted basis. He expects the US to see deflation before inflation makes a comeback. (Nicola, et al.)
Grant Williams made a comment during a discussion about global markets that I thought was excellent. There is a bubble, he asserted, in complacency. He is very concerned with shadow banking in China (currently 60% of GDP) and with unaffordable housing. Many investors in wealth management products (WMPs) will lose a lot of money unless government bails them out. Overall there is a credit bubble in China. Japan is even worse at almost 250% of GDP for government debt alone. Grant feels Abenomics is not working and that little structural reform is occurring. Notwithstanding that, Japanese 10-year bond rates dropped from almost 1% to 0.6% in the last year. Kyle Bass stated that he thinks Japanese 10-year rates will rise to 2.5%.
There was a very consistent theme in a number of presentations: no one is sanguine about China. The comments ranged from quite concerned to worried to very alarmed. (Next week this letter will focus on China.) There was not much that was positive to be said about Europe and Japan. Thoughts on the emerging markets varied a great deal and at the end of the day were very specific to particular markets.
John Nicola offered this summary to his clients:
As you can see, there are definitely two camps but also some common themes. Let me wrap up with our own thoughts on what we learned and how it might change our investment strategies…
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