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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Equities are seeing a summer stock surge

I want to explain the markets in really simple language, since there are some very basic problems in the largest securities market in the world and the projections associated with what is going on.

Fed chair Janet Yellen is in a tough spot. Yellen & Co. wants to raise rates but the rate of inflation is not growing. The Fed’s tools for the economy are to control inflation from getting too high, by raising rates.

Late last week Yellen gave the markets all they need to know by intimating that a pause in rate rises is on the table after seeing prices stagnating and retail prices are falling fast.

On Monday morning the 30-year US bond is 2.9% yield and the 2-year US paper is 1.35%. The difference between the two rates is too tight for the 28 years of duration. That is called flattening of the yield curve. Bank stocks hate tightening since that squeezes the profits on loans.

When there is little inflation — like now — raising rates can cause deflation. Deflation or stagflation (a less sever form of deflation) is when prices fall because too few dollars chasing goods.

The Fed was said to be raising rates quicker recently in order to have the ability to lower rates later in the event of economic slowdown like a deflationary hiccup.

So what does the stock market see? A celebration.

As I have often said here, capital goes where it is treated best. So look for stock indices to set all-time highs on just about a daily basis, since little cash will go into debt with the diminished returns.

Another factor in the summer stock surge is equities are buoyed by low inflation. Shares always move higher in a low-inflation environment. So we have a perfect storm in the markets.