Tuesday, September 27, 2016

Structural Growth & 
Dope Dealers On Speed-Dial
"Investors have been slow to recognize the implications of declining structural growth precisely because of the opium-like qualities of the Federal Reserve policies that are responsible for it. Fed policy has amplified the feedback loop of weak growth on interest rates, driving short-term rates not only to low single-digits (where historical relationships suggest they ought to be here), but all the way to zero. In turn, the discomfort with zero interest rates has provoked persistent yield-seeking speculation by investors, driving the most historically-reliable equity market valuation measures to offensive extremes. This yield-seeking behavior has also encouraged heavy issuance of low-grade 'covenant lite' debt in order to satisfy investor demand for more 'product' (just as we observed during the mortgage bubble). Corporate debt has never been higher as a fraction of corporate gross value-added. The result is an enormous volume of overvalued financial securities that rely on the cash flows generated by an increasingly stagnant economy. All of this may feel good, but it’s only a temporary high in a fatal cycle, and the members of the Federal Reserve Board are just dope dealers on speed-dial. The second outgrowth of a structurally deteriorating economy, which investors have taken as a permanent sign of strength, emerged in the wake of the mortgage collapse and the accompanying global financial crisis. See, it’s an accounting identity that gross domestic savings (household + government + corporate + imported foreign savings) must equal gross domestic investment, and deficits in one sector must show up as surpluses in another. The record profit margins we observed in this cycle were largely an artifact of a profound post-crisis deficit in the government and household sectors, coupled with a QE-induced plunge in the value of the U.S. dollar that prevented the usual deterioration in the current account (the import of “foreign savings”) as gross domestic investment rebounded. These macroeconomic drivers of corporate profits may not be obvious without a bit of arithmetic, but the upshot is that the temporary surge to record profit margins was heavily debt-financed."
- John Hussman
LINK HERE to the essay

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