A US economic snapshot in the middle of 2018 — not all is well

Let’s take a quick look at the US economy and where it may be headed in the near term.

While unemployment is said to be very low, the rate is still artificially low due to the uncounted Americans no longer in the workforce because of chronic joblessness.

Producer and consumer pricing are rising — not because of tariffs as the left will cite — due to the excessive capital washing out of the stock and bond market. The stock price run up over the last three years was engineered by the Federal Reserve’s quantitative easing capital finding safe haven in stocks and bonds.

Now that capital is exiting the security markets and finding better treatment with private equity firms that are buying out manufacturing and consumer brand companies, which drives up prices in order for the new owner — the PE firm — to make money from the investment through putting the brands deeper into debt to make special payments to them.

So this capital is not from the average American, but the repercussions are being felt by these average Americans through higher prices. Look at the biggest PE firms raising record amounts for new funds.

Taking a quick look at the US bond market to see where the real problems are. The difference in return rates between lending Uncle Sam money over 2 years versus 30 years.

The 2-year return is 2.61%, the 30-year interest rate is 2.96%. The delta between these two 0.35 percentage points return over 28 years. This is what is called a flat yield curve, since the interest curve is very shallow.

In the environment of the bond market capital is not treated well at all with artificially low returns, so this is pushing additional big money out of the public capital markets and into the private funding markets.

What is the down side of this move? Look at the number of bankruptcies in the retailing sector over the last year. These stores: Toys R US and a dozen or so women’s apparel stores are all closed or limping along because these companies were so leveraged up on debt that they could not pay off their huge debt levels imposed on them by their private equity owners.

But don’t worry about these PE firms because they took their money upfront and more than likely owed some of the companies bonds, which were paid off in the bankruptcy.

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Values of US malls are now 50% off

The fallout in retail continues as a result of the horrible holiday sales for brick and mortar stores.

Roughly a dozen top retail executives have been let go since the new year including Wal-Mart’s Sam Club CEO and the head of Lane Bryant and Catherines.

All this churn as a result of disastrous sales, is having dramatic effecting on the malls of America. The value of commercial mortgage back securities offerings are crashing as large retailers, which anchor many of these properties, are closing.

Some $3.1 billion in CMBS debt is not current on its payments, according to data provided by Trepp, a CMBS analytical firm.

In 2010, homeowners would mail the keys into the bank called jingle mail and walked away from the property. Now some mall landlords are doing the same with their properties as Class C malls, which are the lower level malls with few national retail chains, are the first to get hit.

But look for the higher-end properties to pull back from keeping their properties up, nevermind making improvements.

Perhaps Amazon can use some of these properties for their regional distribution centers?


The churn in the US bond market has been dramatic since President Trump took the oath of office.

The buying of Friday and early Monday shifted to selling Monday afternoon and continued through Wednesday morning.

Look at three-day chart shows a deep V-shape as peak to trough and back to peak with over 30 basis point moves in most offerings.

These bond moves are far more important and need to be watched, since the debt markets are far larger than the stock market.

As yields rise the way they have so quickly, it tells you the selling is deep and across all maturities.

 

Well Mr. Bond what's your hurry to exit?

There’s a big bifurcation in the markets.

It’s not the hot-shot stock traders bidding up stocks on the premise that no equity market will go much lower in this environment.

No it’s the adults in the room as I like to call the bond market participants.

The sovereign debt market is magnitudes larger than stocks in valuation, with far stronger ties to the health of an economy, rather than Dow Jones industrial average, which Obama administration loves to cite as a good barometer of the robust growth of the US economy.

The maxim that the US 10-year rate marches in step with growth in the economy, appears to be dislocated in the government bond pits.

The US economy recently printed -0.7% annualized growth. Meaning no growth. Yet the US 10-year treasury note is moving toward 2.3% yield.

You really can’t say its a forward-looking rate, since Q2 “growth” is trending toward flat at best.

Even a cursory look at the Q1 number suggests that “growth” would have been closer to -3.0% if not for a vast inventory build during the quarter.

That figure on product built but not shipped can only depress next quarter’s number, since it did not move into the delivery pipeline.

So how does the bond traders arrive at a 10-year note of 2.2%?

The easy answer is there is a crowd exiting Uncle Sam’s IOU market for greener pastures where capital is treated better.

Could the bulge bank players be curtailing supply on the allocations in order to steepen the yield curve slightly in order to increase profits, since the Fed can’t move on rates? We won’t know the answer to that for sometime, but it’s worth a mention.

The scarier thought is that the crowd will grow larger and stampede out of US government debt. For now it’s a measure that needs to be watched.


 

A quick mention on the ADP report this morning of 201K private jobs in May.

ADP runs payroll for many of the largest service companies in America. Think McDonald’s, AppleBee’s and the like.

So while it says 201K private jobs, many of those new positions could come with the task of asking “Do you want fries with your order?”

That seems to be the trend in this “recovery.”

Pre-market ramp

Pre-open equities are soaring on the believe that there is movement afoot to kick the can down the road and provide more heroin to their coffers.

Yet the larger bond market doesn’t see the same light at the end of the tunnel. Yields are moving higher as institutional investors sell off short to medium bonds and bills.

Perhaps the adults in the room — bonds — see the light, but know its a train barreling into the markets.

Either way Treasury chief Jack Lew is to testify before Senate Finance panel in 20 minutes, which could take so of the wind out of the Dow and S&P futures.