Foreign Aid

Ron Paul: “Foreign Aid is taking money from the poor people of a rich country and giving it to the rich people of a poor country”

Something’s Going To Break

From past experience, we can be pretty sure that the bear market doesn’t begin until the inverted yield curve returns to a positive slope. Usually this happens because of a major disruption in the financial markets. Here are some of the opportunities for breakage.

• The average 30-year mortgage rate, as of today, is 7.13% according to Bankrate.com. Housing affordability has dropped to what Redfin deputy chief economist Taylor Marr calls the “lowest level in history.”
• Office occupancy in major city centers is ranging from 40-60% as a result of WFH practices. Pressure on bricks-and-mortar retailers from online shopping continues to build. The overall US CMBS delinquency rate jumped 18 basis points in February to 3.12%. (The all-time high on this basis was 10.34% registered in July 2012. The COVID-19 high was 10.32% in June 2020.) . Giga-investor Blackstone just defaulted on $562 million of CMBS.
• CPI/PCE inflation continues. While energy prices continue to be contained by withdrawals from the SPR, labor prices continue to increase. Fed chair Powell says that his primary measure of inflation is core PCE less housing, which implies a heavy weight on labor costs when evaluating inflation.
• The Fed continues to raise short-term interest rates to reduce business activity and therefore reduce inflation. So far with little success. Financial markets are busily fighting the Fed’s attempts to tighten financial conditions. History says this does not end well.
• There’s a war on, into which black hole the US continues to pump money and armaments. These will need to be replaced at great cost. Defense spending will be increased. The big risk is of further escalation, which could include the use of nuclear weapons.
• The primary source of inflation is deficit spending by government. Half of the government’s debt has a maturity of less than five years. The Fed’s rate increases are quickly running up the government’s interest bill, which of course will increase the deficit – that’s how the black hole works. Interest is already nearly as large a budget item as defense spending.
• China’s recovery from its draconian COVID policies is limping badly after a small initial surge. In addition, the US is actively hampering the development of technology in China and relations are a historic lows. There is a significant risk of another war, this time over Taiwan, where TSMC is the crown jewel of semiconductor manufacturing. All this means that China is unlikely to be the source of cheap manufactures goods that have helped quell inflation for the last twenty years or so.
• The US stock markets remain highly overvalued and not investable as the flood of liquidity during the COVID era has supported speculation. The options market has grown to be larger than the equity market of which it is supposedly a derivative, leading to extreme gambling activities such as 0DTE options..

Get the idea?

Good Advice But…

The cancel culture was a little more brutal back then. Cicero was beheaded by order of Mark Anthony.

Kumquat

Recession is here. The official dating will come later, much later. But the economy is slowing quickly. Commodity prices are falling due to lack of demand. Property – real estate – is slowing. China is struggling with Covid – and trying to infect the rest of the world with whatever variants they have incubated over the last couple of years. Europe is struggling with the Ukraine war and self-inflicted wounds from sanctions and immigration.

But equity markets don’t care. The S&P 500 looks to be making a bottom at a level that was the May bottom. The Dow seems to be heading for all time highs. Only the NDX seems to be close to a new low as some hypervalued “tech” stocks have been clobbered.

Something Is Rotten

Dr. John Campbell, who does a daily medical video, commented today that the real reason for China’s opening was not the white paper protests, but the reality that infections were already soaring. According to Dr. Campbell, people were bribing the labs or the lab employees in order to obtain a negative test, which then enabled the testees to go about their daily lives without restriction. However, they were spreading infection, which gave the virus a strong head start long before the Dec. 7 opening date.

Of course, this, if true and I certainly find it plausible, renders the PCR test requirement for travel to the US useless as it can easily be faked.

Here We Go Again

Having concluded that he could not control the spread of whatever Covid variant is raging in China, Xi is sending untested people abroad to ensure as best he can that the rest of the world shares China’s misery. Just as he did with the Wuhan outbreak. Italy reports that more than 50% of arriving passengers from China are infected. The southern border must be closed as well as the other ports of entry.

Edit: The Biden administration announced that, starting Jan 6, arriving passengers from China must have a clean PCR test within the previous 48 hours. Fat lot of good that will do. This is China. Everything is fake. There are strong suspicions that testing labs have been receiving government money, not only not performing the testing but creating outbreaks to increase demand.

What Happens Next

Well 2022 is just about over. I traded badly this year but that is behind me, I hope. Especially annoying since I have been expecting this bubble to burst for a long time. The big question is, where do we go from here. Some thoughts:

• Housing. Sales volumes are falling very rapidly because affordability is poor, but prices are holding as sellers are reluctant to drop their expectations. In the last housing bubble pop, it took a year and a half for this process to work through so that sellers finally acknowledged that prices could actually fall. This means that housing costs, which make up a disproportionate share of CPI, will be sticky.
• Employment. The pandemic significantly reduced the labor pool as many people retired or just dropped out. In China, the pandemic and measures to suppress it have badly damaged the economy and look to continue to do so. It seems likely that the offshoring that reduced labor demand in the US is over, and will be replaced by onshoring and relocation of production. Either way, labor demand is likely to remain relatively strong well after consumption growth falls. Labor looks to reclaim at least part of the loss of its share of economic output, at the expense of capital, i.e. profits.
• Energy. The idiocy of belief that minor reductions in CO2 output will have a material affect on the climate is hampering investment in energy sources. Of course this will throttle growth in energy production and keep prices high, even as a slowing economy will reduce demand for other commodities. I was amused to find that DNA recovered from northern Greenland revealed that during the region’s warm period, when average temperatures were 20 to 34 degrees Fahrenheit (11 to 19 degrees Celsius) higher than today, the area was filled with an unusual array of plant and animal life, including aurochs and mastodons. Then of course there are the (hopefully temporary) supply constraints that have been caused by the sanctions on Russian production.
• Food. The good news is that more CO2 in the atmosphere helps food production. But modern farming depends heavily on diesel fuel for big equipment and natural gas for fertilizer production. Fossil fuel prices directly affect food prices, because even though yields may be good, farmers will not plant crops on which they cannot make a profit. In addition to high prices, shortages of some crops will develop as farmers pivot to crops which require less of these costly inputs.
• Interest Rates. It seems that no-one believes that Fed Chair Powell will actually carry out the attack on inflation that he has outlined. Some argue that a recession will “force” him to abandon his current goals and resume ZIRP and QE, redefining his goals in the process to accept a higher level of inflation on an ongoing basis. Others believe that the recession will cause inflation to fall quickly and make the question moot as his goals, such as positive real rates across all maturities, will be automatically met.It is certainly true that this long-suppressed business cycle is moving fast, but there is a long way to go to normal. My personal view is that his vision for his legacy is an economy that does not depend on massive growth of debt relative to GDP as has been the case in recent years, and he will do “whatever it takes” to get there

In summary, inflation will prove sticky although not runaway, and Powell will accept a recession. But as the recession gains hold, it will accelerate as defaults reduce credit availability regardless of Powell.

China Property

Price to Rent ratio compares median sales price to median annual rents for similar properties. Here (read off a chart so approximate, then annualized) are price to rent ratios for major cities in China:

1. Shenzhen: 58
2. Shanghai: 53
3. Beijing: 51
4. Guangzhou: 48

Here, from Yahoo Finance, SmartAsset reports Price to Rent ratios for the top 50 cities in the US.

1. San Jose: 42
2. San Francisco: 37
3. Long Beach : 33
4. Seattle: 33

While in San Jose it takes 42 years of rent to buy the property, which is expensive enough, in Shenzhen it takes 58 years. Comparing the top four cities, China is around 45% higher – or more speculative. And you thought that we had a real estate bubble.   At the other (cheapest to buy) end, in the US, you can buy the property for as little as 6 years rent:

1. Detroit: 6
2. Cleveland: 8
3. Baltimore: 12
4. Milwaukee: 14

And of course this ratio uses gross rent and, unlike the “cap rate” often used to evaluate rental properties, does not take into account the expenses of operating a rental property, such as taxes, maintenance, security, insurance, etc.

Housing Collapse Redux

Take a look at this chart:

That is a collapse in process. An unprecedented collapse in modern times. Perhaps 1346-53 showed something similar. It will take 4-6 months to work its way into the hard data, but it is coming. Recall Stephanie Pomboy’s observation that in July of 2008, inflation was at 5.6%. By July of 2009, it was at -2.1%. There’s a Fed pivot of some kind. Now look at John Hussman’s pivot chart:

Which clearly shows that the real bear market will follow the pivot. Then contemplate another of Hussman’s charts which shows the potential losses from here:

Now look at the international context. China has its own housing bubble collapse going on, to say nothing of choking its economy with a stupid Covid strategy because a dictator like Xi cannot admit error. Europe is seized with political correctness, internal division over immigration from Africa and an energy catastrophe. Oh and there’s a proxy war with Russia going on and another with China waiting in the wings, to say nothing of a demented President. Just don’t choke on that turkey.

A Star

If you are tired of mealy-mouthed, politically correct politicians, you need to listen to Italy’s new prime minister, Giorgia Meloni.She speaks with passion and conviction, and so clearly that with only a little Italian you don’t need the subtitles. This is a leader. Remember that there are only two capitals in Europe that have ruled the world. Rome is one.