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What Now?

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Markets are pricing in a big recovery. They are neither cheap nor expensive (depending on your outlook for earnings)
But there are many cracks in the foundation, none of which are going to improve anytime soon:

1. Consumer spending
- its not there. Anywhere. It is not snapping back to old levels anywhere in the world. I do not believe the numbers coming from China.
2. Consumer Credit - its declining. People are afraid, and reducing debt. The rate of mortgage defaults is terrifying people. They do not want to lose the equity in their homes, so they will (sometimes irrationally) pay down their mortgage as quickly as possible, sometimes to zero.
3. Total Manufacturing Capacity Utilization - 68% in the US. No figures from China, but the last I heard, there were signs in Dongguan saying, "Will manufacture for food".
4. Structural Unemployment >8% is here to stay - With US consumers saving 5%, and the US consumer being roughly 35% of global GDP, this implies a 5%*35% ~1.5% decline in global consumption. These jobs - think Las Vegas construction and hotel work - are gone, and will not return.
5. Expectations of a "Rainy Day" are keeping cash balances everywhere at unreasonably high levels - deposits at the Fed are 50% in excess of minimum requirements. In the '88-'92 recession, they were 4%, which was an historic high. In addition, dividends are being cut and all CFO are husbanding cash. The turn around time for manufacturing has tripled in many cases as a result i.e. while it used to take 3 weeks to manufacture a widget, it now takes +10 weeks, as nobody wants to finance inventory, and nobody wants to extend credit to customers. So the supply chain slows to a game of hot potato.
6. Policy makers are at a loss to try to stimulate demand - Sweden -025% interest rates are the most visible attempt to stimulate lending by punishing savings.

If you think global GDP will rise 1%/pa, then markets are expensive. However, they could stay at these levels, gyrating wildly, for years. We worship at the altar of "The Marketplace", and for the coming wave of retirees, their only hope for a better retirement are returns in the marketplace. They have not saved enough to stop working, they do not have enough equity in their homes, the surrender value of their life insurance policies is not sufficient, and Social Security will not cover their living expenses. So they will pour money into various investment vehicles in a mad dash for some sort of prosperity in their waning years.
If they lose heart, watch out. The bottom will fall out. Sentiment is extremely fragile, as so many people are "talking a good game" now. A lack of skepticism is always a sign of a hoped-for outcome.

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Guest Monday, 25 May 2020