Home » Money » It’s a Downer Kinda Thang

It’s a Downer Kinda Thang

“Never forget that the stock market is just a market for stocks.”
– Herman Miller, an old accountant I knew when I was a kid

The bloodletting on Wall Street may have paused, but no one is taking any chances. We’re not technically in a bear market yet – the S&P500 would have to break its resistance around 1863 before that happens. But the world is braced for it. Morgan Stanley has told its investors to hold on at least into the third quarter – exactly what Barataria said a few weeks ago.

Why all the negative sentiment? After all, China’s loss can only be our gain if you believe what you hear in politics. Then again, investors aren’t that gullible. It’s one big financial world and what goes ‘round comes ‘round. While there are some good reasons to take a six month or so pause, most of the reasons for this downturn are indeed lousy. It’s time to run through, and over, these arguments.

Every story on China has to have a scary looking soldier for a pic.  It seems vaguely racist.

Every story on China has to have a scary looking soldier for a pic. It seems vaguely racist.

The big fear is that a huge meltdown in China will spread around the world. We’ve already discussed how capital is fleeing the dragon, but none of this has much to do with either the Chinese economy or the world economy. It was never a particularly real thing all around, which is to say that their stock market was even more tenuously related to the real economy than ours. It could collapse tomorrow and hardly anyone would notice.

The real problem is China’s banking system – which was never properly connected to international banking in the first place. That’s their problem. The potential for melt-down is as limited as the potential for melt-up in the first place.

Given that we don’t depend on exports to China and the only real problem is that the US Dollar will increase in value there isn’t a lot of downside for us as money flees for a safe harbor. Investors may be nervous at the appearance of risk, but that’s very different from actual risk.

Demand for oil didn't rise as fast as expected, so supply got ahead of it.

Demand for oil didn’t rise as fast as expected, so supply got ahead of it.

Speaking of risk, away from misleading headlines the collapse of oil stocks is what really has the market spooked. The problem was first noticed here a bit over a year ago – oil wells drilled 3-4 years ago were financed primarily with junk bonds and now they are all worthless. The possibility of a financial “contagion” that rips through the banking system has everyone nervous for what appears to be good reasons. Citigroup recently added $250M to the reserves to cover their share of this debt.

Yes, $250M to Citigroup is a drop in the bucket. It’s pretty obvious that this is well covered.

The other concern is that corporate profits are indeed down. Where two years ago they were at an all time peak no matter how you measured it, they are returning to normal levels. A decline in earnings is a good reason for the stock market to take a pause, after all, since it’s really all about the Price to Earnings Ratio (PE) in the end – lower E means higher P which means sell, right?

Workers of the World, Unite!

Workers of the World, Unite!

Then again, the recent wave of hiring and the decent rise in worker’s wages seen in 2015 tell us a little about what’s going on. We can also turn back to our old friend capacity utilization, which we last visited a year and a half ago, to see what’s happening. Where we were at a nearly full-up 79% then we’re down to 76% now. Is that a recession in the works?

No, it’s a reflection of the investment that’s been put into businesses over the last few years. Capacity has been growing at a real (inflation adjusted) rate of 3% a year since 2013, a streak not seen since this Depression started in 2000. Businesses are re-investing in both equipment and people, which is to say that the downturn in profits comes from a positively bullish, not bearish belief.

Strong capital investment today looks like a net negative on Wall Street.  But the benefits come later.

Strong capital investment today looks like a net negative on Wall Street. But the benefits come later.

It’s entirely possible that this may pause in 2016, given the downturn in the stock market, but that seems unlikely. 2015 was also a record year for venture capital, topping $72B for the first time since 2000 – despite a bit of a pause at the end of the year. That investment is not going to pare back for the purposes of looking good but will more likely charge ahead this year.

If anything, the stock market rout is hitting larger cap companies in the S&P500, which is down almost 7% for the year. The total market is down only 5.8%, meaning small companies are holding their own. Given that the market for venture capital just beneath that is hot we can see that this is less about a full retreat than it is a turnover in who is driving the economy.

Like the job market, it’s going be all about smaller cap companies when sentiment finally turns.

So why is the market down? China’s problems are nothing but good for us. Oil patch defaults will be large but are already priced in. Profits are down, but only because there has been a solid investment in future growth.

The stock market is down right now because the stock market needs to be down. The fundamental economy is doing fine – never great, but fine. If anything, Wall Street’s loss will be Main Street’s gain as the benchmark 10yr treasury finally starts breaking resistance and yields below 2.00%.

30 thoughts on “It’s a Downer Kinda Thang

  1. We are in a recession right now. And we are in a bear market. Don’t believe the hype coming from Erik Hare.

    The real reason the stock market is going down is because the fed raised rates. By raising rates when they should not have, the fed is signaling it is not sure what economic statistics to look at.

    There is thought to be a trade-off between unemployment and inflation, but we are in uncharted territory now because inflation is too low.

    We all know that increasing inflation is supposed to kick start the economy, but that hasn’t happened and now the fed is all of policy tools.

    So the point is if the fed can’t diagnose the situation, it will not apply the correct policy tools.

    Janet Yellen receives a grade of D.

    Another reason the economy is tanking is because private equity start ups are not performing well in Silicon Valley.


    The other reason we are in a bear market is that baby boomers are getting older and they just don’t need as much stuff now. Look at the weakness in retail over how many years now–

    Sad to say but 2017 will not be the year everything changes. How can it when labor force participation rates have been declining?

    • I think it’s good to have your own troll. It means you’ve gotten somewhere.
      We’ll see if the Fed raises again this month, but I think there will be a pause. As for Yellen, well, I still believe her over you. So there.
      Oh, and those declining labor force participation rates? That’s the secret, man, the real secret. They really area good thing. 🙂

      • The reason I do my spiel is because you do your spiel : )

        It’s like Paul Krugman. You already know where he is coming from, he’s a progressive Democrat yada yada yadao. But Krugman is good when he is not doing his yada yada.

        It’s like in 2016 how many times are you going to tell us there was a managed depression. It’s not like we are in kindergarten here. : )

      • OK, fair enough.
        But notice that we’ve reached the point where something is the “biggest since 2000” and not 2006? It’s now the benchmark.

    • Manufacturing is still a problem and will be as long as the Dollar is this strong – I will feed my troll this one. That’s a potentially big problem. But it’s such a small part of our economy now it matters much less than before. Where it hurts is in opportunity for young people that pays decent.

  2. In terms of the year 2000, I was just looking at industrial production and the Wilshire 5000 and there is a steeper trend line up until about April 2000.

    So there is some truth in the retrenchment after 2000.

    But it was certainly not reflected in the housing market. So it is kind of contradictory to say people were euphoric in the housing market even as a war was going on and the economy is in a type of continued depression 2000.

    Part of what I am saying is that we all deluded ourselves in believing that the housing market couldnt crash. That buying a bigger home, getting more 1st time buyers in homes, and building more homes was the way to go. On the ground level in the Twin Cities people were wetting their pants to make bids on a nice home. Parade of Homes blah blah blah.

    So when I hear unwarranted optimism about the US economy I just shake my head because the real unit of analysis should be the world economy. All the optimism feeds on itself and people start thinking that the economic environment can’t suddenly tank or slowly tank because of structual problems in some sector.

    • Yes, housing followed the bubble. There was a small retrenchment but the real bubble came 2004-2007.
      As for the World Economy … you are right. 100%. There are walls between countries, but they are thin. People don’t cross them easily but money and materials do. Supply chains don’t change overnight, but they do move.
      I do not know exactly how to take into account the world economy versus ours. We are clearly doing much, much better than Japan and Europe for the Developed World prize, but the Developing World comes and goes. Mexico is doing well in part because we are, in part because the rest of the hemisphere is.
      So it’s perfectly valid to say, “You haven’t taken into account global transfers” or some such and you’ll have a point. This is an issue that my read says even the Fed doesn’t know what to do about.
      So yes, let’s talk about that.

  3. Trying to cover the world economy from a somewhat different angle than what we see in the Wall Street Journal, New York Times or the BusinessInsider.com is certainly a daunting task.

    We went from being excited about the progress of the BRICs to not being so excited.

    So if we were to stay on this topic I suppose the first step would be to look at each country sort of before and after the excitement. I suppose you would write it–but maybe we could just find one reliable article on each nation and we all comment.

    The other part is American cultural knowledge and attituges about these nations. Does an American with available income want to travel to China, Russia, India or Brazil? What is the fertility rate and family size in each? Who is a popular musician in each of those countries?

    With regard to China, it is still hard for me to grasp why they dont have representative democracy. You mentioned banking, so the question is–how is capital allocated in their system? How are their property rights similar or different?

    Russia is negatively affected by low oil and it cant be good for the world economy that there are sanctions against, but I’m not sure what monetary impact the sanctions are having.

    I suppose another question in the world economy is whether one region prospers when others are not doing as well. And that would apply to the US great recession. St. louis fed had an article about this and I will post the link later.

    • Quite interesting discussion here, but if you view it from afar perhaps the takeaway is sadly that it’s not just the Fed that doesn’t understand what’s going on, but possibly there is no entity, governmental or private, that has a the slightest clue as to what needs doing. I think Harry illustrates the institutional blindness well when he writes:

      “With regard to China, it is still hard for me to grasp why they dont have representative democracy.”

      Perhaps the answer is that China doesn’t have representative democracy because their oligarchs won’t let it happen. Does Russia have “representative democracy”? Does the U.S. have representative democracy? I think a good case can be made that “representative democracy” is a “feel good” term for oligarchy. In the same sense that all the political/economic “Isms” are invented to soothe peoples minds to the chaos of their lives. In the end all forms of human government are really oligarchies, with the differences coming in how closely the actions of individuals in the masses of its peoples are controlled and monitored. I would venture to opine that there has never been anyplace in any time of human history where oligarchy hasn’t been the standard.

      If I’m correct, then there is no political or economic theory that correctly models the doings of nations, nor their interrelationship with each-other on a global basis. The problem is not any of the measurements developed via economists economic models, nor is it to be found in any of the Business Schools that educate our managerial class. It is not to be found in studying Marx, nor Von Mises, nor Krugman. The problem is one of human psychology and how humans interact socially, including a study of the doings of the bureaucracies of corporations. While economics can be fascinating to study it misses the fact that the way of the world is money and power, all else is illusion.

      Lest you think the above is the ravings of an old man, as he contemplates life from his eighth decade, you’d miss the point. My life has been/is good, as have the lives of those I love. My passion for changing things for humanity has never ebbed and my cautious optimism for the future remains. However, in order to solve the continuing human riddle of how we create a world that is not constantly on the verge of destruction and devastation, we first must see it clearly. In this sense politics and economics actually contribute to our lack of awareness.

      I apologize for my intervention, but sometimes I find myself unable to keep my mouth shut. 🙂

      • I’d like to go back to the most recent Davos World Economic Forum, which I wrote about last week. The leaders of the world clearly “get it”. They know that what we have is not sustainable and isn’t going to carry us into the next wave – what they call the Fourth Industrial Revolution.
        So where is it all really going? They didn’t have that many answers, frankly. A lot of good questions but that was all.
        What struck me is that they are trying. I don’t know how much that counts but it was heartening to know.

    • I feel obliged to learn more about China, but to be honest I’ve only recently run into people writing about how things really work there. It’s utterly fascinating – it feels pre-industrial almost. It is worth putting that one together.
      How they got as far as they did with essentially no financial infrastructure is rather amazing. But it is all centrally planned, so the money follows the edicts.

    • That would probably be best, yes. But it’s hard to ignore a big downturn (which this isn’t yet) and a change in momentum (which this isn’t really yet either). What was my point? 🙂

  4. The equities markets don’t like Janet Yellen, so until central bankers worldwide get the message the trend line may be downward for stocks.

    The thing is that Europe, Japan and US are out of sync, so this is a problem. It is mostly President Obama’s fault but Democrats don’t like to hear this. Their focus was previously on John Boehner.

    By the way Apple, Boeing, Intel, and AMD all believe China is causing the world economy to slide.

    The thing with China is that we don’t know if they will have a soft, medium or hard landing.

    Houston we have a problem…

    • Equities markets are kind of like petulant teens – if the Fed Chair doesn’t give them enough attention they whine. Yellen doesn’t care about them and they know it. Should she care more? My money is still on “no”, but I can see where you’d have a different opinion.
      The out of sync nature of the whole world is indeed a problem. The developing world is also out of sync right now with a wide variety of different issues plaguing each of the BRICS. Nothing really makes sense. So there is indeed risk as money moves around so freely.
      There is little doubt in my mind that large-cap companies are going to feel some pain from China, yes. But what does that do to the rest of the US economy? Given that small and medium companies have been the drivers of growth since 2008 and the influx of a lot of new venture capital I’m frankly not all that concerned. I do see turnover, yes, but in terms of what benefits the US and its population I just don’t see a lot of risk. When money comes back from China it will probably flow into a wide variety of things including safe real estate and maybe some more venture capital so what really is the downside?
      Will China have a hard landing? Soros thinks so. I’m more worried about the resulting political turmoil from that than anything economic.

      • It is popular to say that the financial economy is separate from the real economy, but we have to remember the financial economy drives the prices of goods, services and long lived physical assets.

  5. The stock market is so incredibly over rated. You could have stopped at the quote and left it there. It is brilliant and says it all. But you have to expect an accountant to see through all the BS! That’s what we are here for. 🙂

  6. Just want to mention I think the decline in the yuan’s value is the world recession since nobody thought that would happen.

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