Think back to the Fall of 2014. The S&P 500 had marched from a 2008 low of 666 to 2,018 with barely a hiccup. Tim Cook had just announced the much hyped Apple Watch, and when combined with Carl Icahn’s shameless pumping, retail (and hedge fund investors) were busy pushing the world’s largest stock to even more absurd levels. Earlier that summer, Yellen had warned about “substantially stretched” valuations in biotech and social media stocks, but the bulls just laughed off her worries. Biotech was in the midst of a rally that would send the XBI Biotech ETF up 52% in the year following Yellen voicing her concerns. And to epitomize this invincible feeling that had enveloped the market, UBS strategist leaned right in with a line that will be forever immortalized in the annals of high profile bad market calls.
I have to admit picking on Richards a little. But when you hop on national TV and make a statement like that, you are kind of asking for it. I give the guy credit for letting it hang out there, but his timing was atrocious. Sure, stocks grinded marginally higher in the month following his call. But that was small comfort as the big dips of the summer of 2015 and January 2016 proved to be the next big moves.
That moment in the Fall of 2014, proved to be the point of maximum bullishness. From then on stocks have disappointed and gone absolutely nowhere.
Expectations were so high in the Fall of 2014, but have disappointed so badly, we have to ask what happened.
I believe the answer to be rather easy. The Federal Reserve tightened too quickly, withdrawing US liquidity and sending the global economy into a credit destroying vicious circle of a rising US dollar and falling commodities. Most others blame China or Europe for the global slowdown. I think they were factors, but Yellen’s desire to stamp out this excessive speculation in the stock market and remove the US from the ZIRP policy was the main culprit.
Regardless of the reasons, I don’t see any point arguing too much about blame. Maybe I am right, maybe I am way off base - who cares? The important thing to realize is that it happened, and to figure out where we are going from here.
Which brings me to my main point. The Federal Reserve is living in a fantasy land regarding the US economy’s strength.
In the Fall of 2014 what were the two areas making the US stock market the envy of the world? What were the bright spots making America the cleanest white shirt in the dirty laundry pile?
The first one is an easy answer - technology. Whether it was the fabled Unicorns, Apple and the other listed go-to names, or even biotech, money was flowing into this area at an astonishing rate. There were plenty of stories reminiscent of the DotCom bubble days. Decadent parties, frivolous spending, funding based on absurd business models, it created an unbelievable boom in tech. All you needed to do was look at the mind boggling rises in the price of real estate in San Francisco and the Bay Area to know the economy was getting a large boost from this bubble.
But the second US economic bright spot is not quite so easy to remember. In the Fall of 2014, crude oil was still $85. It had fallen from $110, but it was still high and the idea it was about to collapse was far from most investors’ minds. At the time the US was in the midst of another boom. But this one was in Texas and North Dakota. For example, this report from Forbes sums up the extent that US job growth depended on the energy industry:
…during the 24 month period from July 2009 through June of 2011, Texas created 49% of all new jobs created in the United States, and the vast majority of those jobs were either directly or indirectly the result of the state’s oil and natural gas boom, centered in plays like the Eagle Ford in South Texas, the Permian Basin of West Texas, and the Granite Wash play in the Texas Panhandle.
With the help of the Tech Bubble 2.0 and the shale energy zaniness, the United States managed to outperform the rest of the world, both from a stock market return and actual economic growth point of view. No wonder capital kept flowing into the US. Have a look at this great chart from Charlie Beilello from Pension Partners:
Obviously it is much more complicated than this, but at its heart, these two economic bright spots were dramatic contributing factors for the US outperformance of the past half a dozen years.
But what now?
It is no coincidence the stock market bull market petered out in the Fall of 2014. The rally in the US dollar was six months old, but in the next year the rally accelerated viciously.
The US dollar rally screamed out the Federal Reserve was too tight. Yet Fed officials were relentless with guiding tighter interest rate hike expectations.
In doing so, they ushered in a devastating global economic slowdown. Sure they managed to stop the speculative excesses Yellen was worried about in the United States, but it was at the expense of the global economy.
And most importantly, since then both US economic bright spots have rolled over. The American energy industry has gone from adding the most jobs to being the largest source of layoffs. There is no way this previous shining light will be leading the American economy forward anytime soon. In fact, the US will be lucky if the economic devastation doesn’t drag those regions into brutal recessions.
As for the tech industry, it too appears shaky. I have a buddy who lives in northern California and he has been warning me for months their economy is quickly slowing. He lived through the 2000’s DotCom bust and he claims the similarities are glaringly obvious. All you need to do is look at the increasing number of write downs in the price of the fabled Unicorns to know money is no longer flowing as freely. If that isn’t enough to convince you, how about the collapse in the amount of ping pong sales in tech areas:
In the first quarter of 2016, sales of ping-pong tables dropped by 50% compared with the previous quarter, according to Billiard Wholesale, a store in San Jose, California that supplies tech companies in the area. In the same period, venture-capital funding of startups dropped by a quarter, the WSJ noted.
I ask you, if both of the areas that previously led the US tremendous economic outperformance have now entered a slump, where is the growth going to come from? Finding American economic growth will be even more difficult with an elevated US dollar, and a Federal Reserve itching to raise rates at the first sign things are even remotely decent.
Although I am not nearly as bearish as most other investors, I am skeptical US markets will lead the next leg higher. That is not conventional thinking as the rest of the world is generally viewed as an unfixable basket case.
Yet as long as the Federal Reserve is like the dog in the picture above, stuck but pretending everything is still fine, the US economy will have trouble getting out of the bush. Everything is not fine. The Fed killed the two areas that were contributing all the US growth of the previous six years. This recent poor employment report is just the start of what will prove to be a series of disappointing US economic reports. The US market is crowded with too many investors who do not realize growth will be anemic, the Fed is still too tight, and that the best parts of the American growth story have disappeared. On a relative basis, almost any other country’s risk asset offers a better alternative.
Thanks for reading,