Running of the Bulls

Prince, Bowie, or Metallica? I’m still trying to figure out what will be the theme song for 2021. I’d been thinking “Party Like It’s 1999” by Prince until last week, when I suggested that “Space Oddity” by David Bowie might be more relevant if stock prices continue to hurtle into outer space. Either song would be consistent with a continuation of the bull market in stocks. Alternatively, perhaps I need to consider a far more pessimistic theme song like “For Whom the Bell Tolls” by Metallica.

There’s an old stock market adage: “They don’t ring a bell at the top.” My study of financial history suggests that the adage isn’t true: Credit crunches serve as bells. More specifically, financial crises that trigger a widespread credit crunch tend to cause bear markets in stocks as investors correctly anticipate that the credit crisis will cause a recession (Fig. 1). During credit crunches, the S&P 500 VIX, a measure of stock market volatility, tends to soar along with the yield spread between high-yield bonds and the 10-year Treasury bond (Fig. 2).

While the VIX doesn’t rise on a predictable schedule as does the sun, its rising can also shed light. In addition to rising during bear markets, it also rises during stock market corrections and minor panic attacks (Fig. 3 and Fig. 4). Since the start of the bull market in 2009, Joe and I have counted 69 panic attacks. The latest one occurred when the Nasdaq fell 10.9% from February 12 through March 8, mostly on jitters over the backup in bond yields. By the way, we count last year’s selloff as a panic attack rather than an outright bear market. (See Table of S&P 500 Panic Attacks Since 2009.)

The unusual frequency of panic attacks during the current bull market suggests that investors have remained jittery ever since the last bear market during the Great Financial Crisis (GFC) and prone to hear warning bells. Ernest Hemingway, who wrote the novel For Whom the Bell Tolls (1940), suffered from tinnitus, a constant ringing in his ears as a result of injuries sustained in World War I. Similarly, investors traumatized by the GFC remain easily convinced that another bear market is imminent.

No alt text provided for this image Yet despite their propensity to panic, stock market investors are reveling in a festive mood with the bulls stampeding. Hemingway’s The Sun Also Rises (1926) portrays American and British expatriates who travel from Paris to the Festival of San Fermín in Pamplona, Spain, to watch the running of the bulls and the bullfights; merrymaking in the festive atmosphere provides them with an escape from reality, for the time being.

Contrarians aren’t indulging in the stock market’s revelry; they see too many indicators flashing that stock market sentiment is unduly bullish. For them, the sun will soon set, providing a good reason to take profits before darkness.

On the other hand, there is plenty of liquidity to drive stock prices higher without a significant correction. M2 is up by an unprecedented $4.2 trillion y/y through February (Fig. 5). Furthermore, over the past 12 months through February, personal saving totaled a record-shattering $3.1 trillion. All that occurred before the third round of relief checks ($1,400 per eligible person) was sent by the Treasury to over 250 million Americans since mid-March.

MAMU, here we come! In my latest book, The Fed and the Great Virus Crisis, I predicted that MMT + TINA = MAMU, where MMT = Modern Monetary Theory, TINA = there is no alternative to stocks, and MAMU = the Mother of All Meltups. (See the relevant excerpt.)

That might turn out to be the new adage for our times. Now let’s have a look at the latest running of the bulls:

(1) Party like it’s 1999. The Nasdaq continues to party like its 1999 (Fig. 6). The tech-heavy index is up 104.8% since March 23, 2020 through Friday’s close. The Nasdaq bottomed on October 8, 1998 following the Russian debt and LTCM crisis. It was up 113.4% on a comparable temporal basis to the current bull run. If the Nasdaq’s bull run is about to turn into a stampede, as happened during the last leg of the 1999/2000 bull market, then it could double in value over the next six to nine months as it did back then. The S&P 500 is up 87.1% since March 23, 2020 through Friday’s close. That’s well ahead of 1999, when it was up 33.4% on a comparable temporal basis (Fig. 7).

(2) Stretched valuation. The S&P 500’s forward P/E continues to fluctuate around 22.0, as it has over the past year. That’s not far off its record 25.7 valuation multiple during April 1999. On the other hand, the forward price-to-sales ratio of the S&P 500 has been setting new record highs for most of the past year, rising to 27.9 on Friday (Fig. 8).

(3) Bullish sentiment running wild. The Bull/Bear Ratio compiled by Investors Intelligence was relatively elevated at 3.77 during the week of April 13 (Fig. 9). By historical standards, the percentage of bulls was particularly high at 63.4%. Bears are relatively scarce at 16.8%, as are investors expecting a correction at 19.8%.

The running of the bulls is even more discernible in the Bull/Bear ratios based on survey data compiled by the American Association of Individual Investors (Fig. 10).

(4) Fun for almost everyone. Measures of market breadth show that the bull market has broadened since early last September. The ratio of the equal-weighted to the market-cap weighted S&P 500 stock price indexes has been rising since it bottomed on September 1 (Fig. 11). The percentage of S&P 500 stock prices above their 200-day moving averages (dma) rose to 96.2% on April 16, exceeding the 96.0% reached on October 16, 2009 (Fig. 12). The S&P 500 was 15.4% above its 200-dma yesterday (Fig. 13). That’s a relatively high reading. During April 16, the percentage of S&P 500 companies with positive y/y stock prices changes was 93.1%, around previous cyclical highs (Fig. 14).

(5) Another adage. Here’s another old stock market adage: “Sell in May and go away.” While doing so might make sense this year since bullish sentiment is so high, I’ve never been a fan of this adage. It doesn’t always work, and even when it does, the investor is left with the problem of determining when to get back into the market. Proponents of the adage say to come back after October, but there have been plenty of times when that advice would have meant missing a summer rebound that followed a selloff in May.

(6) Speed bumps. The meltups in some asset prices are starting to run into some regulatory headwinds. We anticipated this might happen in the SPAC market. We last did so in the March 16 Morning Briefing. We wrote: “The bottom line is that a few of the speculative excesses in the market are under scrutiny by the regulators. The SEC is warning about SPACs with conflicts of interest, and the major central banks are warning about cryptocurrencies being used for illegal activities.”

On April 21, CNBC posted an article titled “SPAC transactions come to a halt amid SEC crackdown, cooling retail investor interest.” It noted: “After more than 100 new deals in March alone, issuance is nearly at a standstill with just 10 SPACs in April, according to data from SPAC Research. The drastic slowdown came after the Securities and Exchange Commission issued accounting guidance that would classify SPAC warrants as liabilities instead of equity instruments. If it becomes law, deals in the pipeline as well as existing SPACs would have to go back and recalculate their financials in 10-Ks and 10-Qs for the value of warrants each quarter.”

Cryptocurrencies also have had a bad case of the jitters over the past week or so on rumors that the Treasury Department could be looking to crack down on financial institutions for money laundering using cryptocurrency. During her congressional nomination hearing on January 19, Treasury Secretary Janet Yellen suggested that lawmakers “curtail” the use of cryptocurrencies such as bitcoin. Her concern is that they are “mainly” used for illegal activities, including “terrorist financing” and “money laundering.”

Adding to the jitters in most financial asset markets was President Joe Biden’s plan, announced Thursday, April 22, to raise the capital gains tax from 20.0% to 39.6% for taxpayers earning over a million dollars. Since capital gains are also subject to the 3.8% Medicare tax, the new capital gains rate would be 43.4%. Larry Lindsey, who worked for the Bush administration, described this proposed increase as a “punitive” tax on the wealth.

On the other hand, Goldman Sachs opined on Friday, April 23 that the end version likely will be something considerably less severe, which explains why stock prices rebounded that same day following the previous day’s selloff on the Biden proposal.

Outcome Rather Than Outlook; Reacting Rather Than Preempting

The Fed I: Backward Looking. Just in case we didn’t get the Fed’s memo on the change in its monetary framework, Fed Governor Lael Brainard explained it very clearly in a speech on March 23 titled “Remaining Patient as the Outlook Brightens.” Throughout her talk, she stressed very important distinctions in meaning between “outlook” and “outcome” and between “preempting” and “reacting.” She concluded her speech with her punchline: “By taking a patient approach based on outcomes [emphasis added] rather than a preemptive approach based on the outlook, policy will be more effective in achieving broad-based and inclusive maximum employment and inflation that averages 2 percent over time.”

Brainard acknowledged that the efforts of public health, fiscal, and monetary policymakers “have contributed to a considerably brighter economic outlook.” However, she stated that the Fed’s “reaction function” had changed in response to the pandemic. The Fed governor explained: “The FOMC has communicated its reaction function under the new framework and provided powerful forward guidance that is conditioned on employment and inflation outcomes. This approach implies resolute patience while the gap closes between current conditions and the maximum-employment and average inflation outcomes in the guidance.”

In effect, the Fed’s policy responses will be backward looking rather than forward looking. In an April 11 interview on CBS 60 Minutes, Fed Chair Jerome Powell reiterated this message as follows:

(1) Inflection point. He started with a very upbeat outlook: “What we’re seeing now is really an economy that seems to be at an inflection point. And that’s because of widespread vaccination and strong fiscal support, strong monetary policy support. We feel like we’re at a place where the economy’s about to start growing much more quickly and job creation is coming in much more quickly.” He concluded the interview by saying “I’m in a position to guarantee that the Fed will do everything we can to support the economy for as long as it takes to complete the recovery.”

(2) Recovery redefined. Got that? The Fed will keep policy ultra-easy until the recovery is complete. But wait a minute—real GDP is likely to be back in record-high territory by the second quarter. It is on the verge of a complete recovery. That’s true, but Powell and Brainard said that “broad-based and inclusive maximum employment” is one of the outcomes they want to see before the Fed starts tightening. Both also want to see inflation moderately above 2%. Powell explained: “And the reason for that is we want inflation to average 2% over time.”

(3) Fed funds rate staying put. Once the Fed achieves this outcome, “that’s when we’ll raise interest rates,” Powell said. When asked whether interest rates might remain unchanged around zero through year-end, Powell said, “I think it’s highly unlikely we would raise rates anything like this year, no.”

The Fed II: Ghost of Greenspan Past. What about asset inflation? In his interview, Powell was asked about it and responded: “[W]e do look at asset prices. And I would say, you know, some asset prices are elevated by some historical metrics. Of course, there are people who think that the stock market is not overvalued, or it wouldn’t be at this level. We don’t think we have the ability to identify asset bubbles perfectly. So … what we focus on is having a strong financial system that’s resilient to significant shocks, including if values were to go down.”

What about Archegos? This hedge fund, disguised as a “family office,” blew up earlier this month when its speculative bets in the stock market crashed and burned, leaving billion-dollar craters in the earnings of a few of its brokers. Powell’s response gave me an unsettling sense of déjà vu all over again. He said:

“This is an event that we’re monitoring very carefully and working with regulators here and around the world to understand carefully. What’s concerning about it … and surprising, frankly, is that a single customer, client, of one of these large firms could result in such substantial losses to these large firms in a business that is generally thought to present relatively well understood risks.”

That reminds me of the following remarks by Alan Greenspan for his October 23, 2008 testimony before the House Committee on Oversight and Government Reform at a hearing on the role of federal regulators in the Great Financial Crisis:

“As I wrote last March: those of us who have looked to the self-interest of lending institutions to protect shareholders’ equity (myself especially) are in a state of shocked disbelief. Such counterparty surveillance is a central pillar of our financial markets’ state of balance. If it fails, as occurred this year, market stability is undermined.”

During his Q&A exchange, Greenspan acknowledged the error of his ways: “I made a mistake in presuming that the self-interest of organizations, specifically banks and others, [was] such [that] they were best capable of protecting their own shareholders and their equity in the firms.”

(For more thoughts regarding that testimony, see my 2020 book Fed Watching for Fun and Profit, particularly Chapter 5 titled “Alan Greenspan: The Great Asset Inflator.” Chapter 8 is titled “Jerome Powell: The Pragmatic Pivoter.” When and if I write a second edition, I might have to change that to “Jerome Powell: Another Great Inflator.” His policies have the potential to inflate not only asset prices but also consumer prices.)

The Fed III: New Monetary Policy Approach. All this amounts to a backward-looking, rather than a forward-looking, monetary policy approach. Ironically, all the talking Fed heads now are saying that their “forward guidance” is no longer relevant since that was based on their outlook, which has not been relevant since the pandemic started. What matters now is the outcome, which can only be known after it happens!

Forward-looking guidance has now morphed into backward-looking guidance. In effect, Fed officials are saying, “We’ll let you know when we are ready to raise interest rates after we get the outcome we were seeking.”

Confused? If not, you should be. Now take a deep breath and try to fathom the following Fed speak from a March 25 speech by Fed Vice Chair Richard Clarida:

“The changes to the policy statement that we made over the past few FOMC meetings bring our policy guidance in line with the new framework outlined in the revised Statement on Longer-Run Goals and Monetary Policy Strategy that the Committee approved last August. In our new framework, we acknowledge that policy decisions going forward will be based on the FOMC’s estimates of ‘shortfalls [emphasis added] of employment from its maximum level’—not ‘deviations.’ This language means that going forward, a low unemployment rate, in and of itself, will not be sufficient to trigger a tightening of monetary policy absent any evidence from other indicators that inflation is at risk of moving above mandate-consistent levels. With regard to our price-stability mandate, while the new statement maintains our definition that the longer-run goal for inflation is 2 percent, it elevates the importance—and the challenge—of keeping inflation expectations well anchored at 2 percent in a world in which an effective-lower-bound constraint is, in downturns, binding on the federal funds rate. To this end, the new statement conveys the Committee’s judgment that, in order to anchor expectations at the 2 percent level consistent with price stability, it will conduct policy to achieve inflation outcomes that keep long-run inflation expectations anchored at our 2 percent longer-run goal.”

You can come up for air now.

The Fed IV: By the Numbers. The Fed’s balance sheet continues to expand to infinity and beyond. That’s been happening since the Fed adopted QE4ever on March 23, 2020. Here are the mind-boggling relevant stats since then through the April 7 week:

(1) Assets. The assets side of the Fed’s balance sheet is up $3.0 trillion over this period to a record $7.7 trillion (Fig. 1). The Fed’s holdings of securities is up $3.2 trillion to a record $7.1 trillion. The difference between these two series is composed mostly of the assets held by the Fed’s emergency liquidity facilities, which has declined $167 billion since March 23, 2020 (Fig. 2). It remains $260 billion above last year’s low during the week of February 26.

(2) MMT. Over the past 12 months through March, the US federal budget deficit totaled $4.1 trillion (Fig. 3). The Fed financed 51% of this deficit by purchasing $2.1 trillion in US Treasury securities over this period. As of March, the Fed held a record 25.6% of the total of marketable US Treasury debt (Fig. 4). That’s Modern Monetary Theory (MMT) on speed and steroids.

(3) Notes and bonds. Over the past 12 months through March, the Treasury issued $2,081 billion in notes and bonds (Fig. 5 and Fig. 6). Over that same period, the Fed purchased $1,615 billion in the Treasury’s notes and bonds. It bought them in an effort to keep a lid on bond yields. The 10-year Treasury bond yield has rebounded nonetheless, but it would probably be higher today but for the Fed’s purchases.

(4) Reserve balances. As a result of the Treasury’s record budget deficit and the Fed’s record purchases of securities, the total deposits at all US commercial banks has increased $2.4 trillion y/y to a record $16.7 trillion through the March 31 week (Fig. 7). Another result of T-Fed’s MMT on speed and steroids is that reserve balances with the Fed has jumped $1.2 trillion y/y to a record $3.9 trillion during the April 7 week (Fig. 8). That well exceeds the impact of the previous three QE programs on reserve balances.

(5) The others. Meanwhile, the assets on the ECB’s balance sheet also continue to soar. During the April 2 week, this series was up €2.3 trillion y/y to a record €7.5 trillion (Fig. 9). The BOJ’s assets rose 18% y/y to a record ¥714 trillion during the March 26 week (Fig. 10).

I also track the assets of the People’s Bank of China (PBOC). However, we believe that China’s bank loans data are a more useful measure of the PBOC’s ultra-easy monetary policy since the Great Financial Crisis. From the end of 2008 through March 2021, they are up a staggering $23.3 trillion from $4.4 trillion to a record $27.7 trillion (Fig. 11). Over the past 12 months through March, these loans are up a record $3.1 trillion (Fig. 12).

All together in US dollars, the assets of the Fed, ECB, and BOJ are up $6.9 trillion y/y through the March 26 week to a record-high $23.1 trillion (Fig. 13 and Fig. 14).

The Myth of Stagnating Real Wages

In the past, I often have observed that, contrary to popular belief, inflation-adjusted wages have been expanding rather than stagnating for many years. Wage stagnation has been a popular myth perpetuated by progressives bemoaning workers’ plight to promote their own political agenda.

Naturally, progressives want even more progressive income taxes on higher-income workers and more social benefits for lower-income ones. Their goal is to redistribute income to reduce income inequality. They’ve actually succeeded in doing so, but they never seem to be satisfied. They always want more taxes and more benefits. The result is more “big government.” For now, let’s update the data that belie their basic claims:

(1) The wrong measure of inflation-adjusted wages. One measure of real wages seems to confirm the progressives’ stagnation thesis. Inflation-adjusted wages—defined as AHE divided by the CPI—peaked at a then-record high of $23.49 per hour during January 1973 (Fig. 1). It remained below that level until April 2020. That’s over 47 years! As of February 2021, it was only 1.4% above the 1973 peak. That’s pathetic.

I mean that analysis is pathetic. The CPI is widely known to be biased to the upside. A far better measure of consumer prices is the PCED. When we use that series to deflate the AHE series, we find that inflation-adjusted wages did stagnate during most of the 1970s through the mid-1990s. But it started moving higher around 1995 and has been achieving new highs since January 1999, rising along a trend line of 1.2% per year (Fig. 2).

(2) Rising standard of living. That represents a very solid increase in the purchasing power of consumers and in their standards of living! The real wage has increased 38% over the past 26 years from $16.18 during February 1995 to $22.34 during February 2021. Keep in mind that I am using AHE for production and nonsupervisory workers, who account for roughly 80% of private payrolls. This series certainly isn’t upwardly biased by the earnings of higher-wage workers.

Data available since 2006 show that AHE for higher-wage workers, on an inflation-adjusted basis using the PCED, rose 12.0% from the start of that year through February of this year (Fig. 3). Over the same period, AHE rose 19.5% for lower-wage workers.

Any way we slice or dice the data, the conclusion is the same: The income stagnation story is a myth. Standards of living have been rising for most Americans most of the time.