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Market Top's In? Why Buy-The-Dippers Can't Get It Up

Submitted by David Stockman via Contra Corner blog,

I am sure some chart reader can explain the S&P 500’s laborious struggle since September 2——the day it crossed the 2000 barrier—-as a classic “wall of worry”. But that event occurred nearly seven months ago and the market has dipped 15 times since then and has actually plunged six times (by more than 3%). And all it had to show for its exertions going into today’s opening was a 50 point or 2.5% gain. In this bull market, that’s a rounding error.

So we have arrived at a precarious place. After the Fed has spent six-years inflating a new and even more stupendous financial bubble—-the third this century—-the market top is in.  And after five-and-one-half years of so-called recovery from the recession’s end in June 2009, the bottom is now falling out of the economy—-both abroad and here, too.

In that context, a new form of danger arises. The Keynesian pettifoggers at the Fed have painted themselves into an epochal corner. After 78 months of ZIRP they have no idea about how and why they got here; and now,  mired deep in the lunacy of free money, they are clueless about where they are going next.

But here’s the thing. During its long descent into ZIRP, consensus at the Fed came from the Easy Button. Once they got to the zero bound in December 2008, it was always possible to find one more reason for delaying the day of  interest rate normalization and to persuade any reluctant members of the FOMC that the economy had not quite emerged from its slump, even if “escape velocity” into full employment was just around the corner.

But now they have been banging the Easy Button continuously since the first discount rate cut in August 2007. Folks, that was 91 months ago! That duration of madcap monetary expansion is nearly double the length of the average business cycle recovery since WWII and its 4-5X longer than most previous periods of continuous easing.

Even Greenspan’s peddle-to-the-metal rate cutting spree after the dotcom bust lasted for only 54 months. That included 30 months of outright rate reductions between December 2000 and June 2003 (from 6% to 1%); and another 2 years of “hang time” at 1% before the first rate increases in June 2005.

Needless to say, an heart-stopping episode called the GFC (great financial crisis) proves how well that one worked out. Likewise, at no time during the NADAQ boom of the 1990s did continuous periods of hitting the Easy Button last more than 24 months or result in a money market rate below 3%. That one didn’t work out so well, either.

That’s why the corner in which the Fed has now implanted itself is so dangerous. The Eccles Building has been so petrified of a Wall Street hissy fit that it has cowered its way right into the worst central bank error in recorded history: Namely, it is finally attempting to wean Wall Street from its addiction to free gambling money just in time for the tepid post-crisis business cycle recovery to exhaust itself.

So it will be “tightening”—-even if via only a few 25 basis point pinpricks from zero—at a time when the US economy is visibly rolling over. And that means that the Fed consensus around the Easy Button will now shatter. The casino’s management will soon be having real food fights in public. The Easy Button Fed will become the new Cacophonous Chorus.

So believe this. The headline reading algos will go full-tilt spastic.The buy-the-dippers will be looking for their heads in a bloody basket. The Fed is about to become your fiend, not your friend.

The US economy is faltering. Today’s three-peat of monthly industrial production declines was just one more piece of evidence on top of soaring business inventories, faltering retail sales, sub-prime saturated auto sales, plummeting activity and jobs in the shale states where all the job growth since June 2009 has actually occurred and the limpid state of wage growth and consumer finances generally.

Just consider February’s index number for manufacturing production. At 101.3 not only is it rolling over from last November’s cyclical high, but its also now below the October 2007 pre-crisis peak. Yes, manufacturing output in physical terms has not gained one inch of ground since the eve of the GFC. The ridiculous narrative of the Keynesian priesthood and the bubblevision talking heads simply assumes that you were born yesterday—–and that the monthly climb from the deep hole occasioned by the Fed housing bubble and bust represents progress.

No it doesn’t. What is cyclical in the current US economy is not the massive component of GDP called health care output—-that’s essentially a fiscal and tax-driven variable. Nor is it the $1.3 trillion housing services component of GDP because that’s imputed anyway. The government statistical mills just make it up and smooth it out.

No, what’s really cyclical and quasi-honestly measured, and what is necessary for economic growth even in our wait staff and Twitter driven economy, is manufacturing output. But the 7-year path back to square one depicted below never happened before; is not the slightest measure of “recovery” in the historical cyclical sense; and it had nothing to do with the Fed’s 75 months of ZIRP.

The 20% plunge  of manufacturing production after the pre-crisis peak occurred due to drastic inventory liquidation during the GFC. And the rebound since then reflects merely the regenerative capacity of capitalism and the C-suite once again over-doing the inventory build-up in response to the Fed’s stock market bubble and their own soaring stock options.

This is nothing like a real cyclical recovery. During the post-dotcom recovery—-artificially goosed buy the subprime housing bubble as it was—-manufacturing output grew by 10% during the seven years after the 2000 peak. And during the long boom of the 1990s,manufcaturing output soared by 53%, even as much of the industrial economy was falling victim to the “China price” and being off-shored. So flat-lining this time around is flat-out not a “recovery” in any meaningful sense of the word.

Yet with production now rolling over, it is not surprising that the ratio of business inventories to sales is soaring. Indeed, last weeks’ report on January business sales is striking. The latter includes everything——manufacturing, wholesale and retail.  The total sales number for January was $1.306 trillion and it was down measurably from the $1.340 trillion average for Q4 and even more from the mid-2014 peak. At the same time, inventories have continued to grow—–actually boosting reported GDP in 2014. In fact, on a year-over-year basis, business inventories were up by $57 billion compared to an actual $4 billion Y/Y decline in sales.

US Total Business Sales Chart

So the arithmetic of the matter is pretty straight forward. At 1.47X sales, the total I/S (inventory/sales) ratio for US business is now at its highest level since October 2008. As I argued last week, the C-suite is again over-doing its build up of stocks of goods and labor, just as it did during the Greenspan/Bernanke bubble which proceeded the GFC.  The US economy has now became victim to the Great Immoderation because the Fed’s massive inflation of the financial markets inevitably gives rise to excessive bullishness among stock-option obsessed corporate executives.

US Total Business Inventory/Sales Ratio Chart

Owing to the central banks regime of false pricing in the financial markets, the C-suite gets drunk on the Cool-Aid and fails to see the storms brewing in the real economy or to take defensive action if they do. Just look at the executives at US Steel, for example. As the Wall Street Journal story this morning made clear, there is a massive headwind blowing in the steel industry owing to the deflationary bust now underway in global materials and industrial markets.

In this case—-and steel is only one typical example—- the relentless financial repression campaigns of the world’s central banks since the turn of the century has lead to a massive build-up of excess mining, manufacturing, transportation and distribution capacity. Moreover, since this “malinvestment” was driven by an unprecedented credit bubble that took the world’s outstanding credit market debt from $80 trillion to north of $200 trillion——hugely indebted companies in China and throughout the EM have no choice but to produce for cash flow, despite exploding P&L losses.

Stated differently, the world’s industrial economy has become unhinged by the money printing central banks. First it vastly over-invested; now it will chronically over-produce. Thus, China’s steel exports are now running at a 110 million ton annual rate compared to just 50 million in 2013. What’s worse, China has in excess of 1.1 billion tons of capacity and after nearly tripling production to satisfy its construction binge, its current 750 million tons of domestic demand has nowhere to go except down.

In short, there will be a flood of “dumping” like never before—–and not only in steel, but also in almost all the major raw materials categories and most especially petroleum where US production continues to rise not withstanding a breath-taking collapse of the domestic rig count from 1609 last October to well less than 900 last week..

Needless to say, this global deflationary tide will kill profits, growth and jobs as it unfolds. And as I discussed further on Bloomberg this AM, there is not a chance the US economy has decoupled from the rest of the world. The great credit-driven boom was universal and fueled by out of control central banks.

Click here for clip (Bloomberg embed code is useless)

Now comes the bust phase, and these same money printing central bankers have no clue what to do about it.Stayed tuned to America’s monetary Delphic oracle latter this week. Like Pythia of ancient Greece, she will utter gibberish—–which the high priests of Keynesianism will interpret as enigmatic reassurance.

Don’t believe them. The monetary politburo and all its oracles are lost. Soon even the robo-traders will understand that baleful reality.