The Beast Awakens
CPI was always going to be the market killer – the one number which the legions of day-traders and private investors took as the proof that the New Era snake oil salesmen really were pedalling the cure for all known ills. There has been plenty of evidence from other quarters, for those who wished to look, that the monetary inflation of the past five years had finally percolated through from asset prices into more tangible goods, but the Earth was only revealed to be round when this flawed and belated measure of the economy registered it, live on the Nation's airwaves. Rising at 5.6% annualized over the last three months and 4% over the last six, this is the worst since 1990 and opens up the way for a savage reassessment of the mental construct into which asset valuations must fit.
Here are a few others. Margin debt has risen $96.3 billion dollars in the blow-off phase, meaning a cool $192.6 billion of officially leveraged holdings are, on average, now underwater. The blandishments of a worried professional community will be that this is 'healthy', a 'much-needed correction' and that, as a percentage of market capitalization, it is a minor concern. That would be so if America were only geared up through this route, or if it had a cash balance sufficient to pony up when required. However, this last extraordinary five-month period of the Bull Cycle has seen retail sales run at a 15.5% annualized rate and consumption overall has barrelled ahead at nearly 11% annualized, twice the rate of growth of disposable income. Savings have plunged to a paltry $55.5 billion at an annual rate, being slashed by two-thirds since the blow off began in October. At this rate, Americans are putting aside for a rainy day roughly 50 cents per person per day! Not much to offset your losses in Cisco there!
Not just margin debt either. Consumer credit has risen by 11.8% annualized to February, or by an amount equal to the current savings rate. Indeed, total household liabilities have increased by nearly half, or an 8.2% compound rate in the Bubble years – acccelerating to 12.7% in Q4'99 - while personal disposable income has only managed a 5% gain. Liabilities have thus moved from 87% of income to over 100% now.No wonder that, despite lower interest rates, the debt service burden on households is at 13.5% - the highest since the last cycle ended in 1989.
Critics will argue that household net worth has gone up even faster in this period. We have repeatedly countered this by pointing out that unless you can persuade your creditors to index your outstanding borrowings to the stock market when it declines, you had better find the wherewithal to service and amortize your debt from some other source than the paper pyramid.
Even if the stock market plunge stabilizes here (or is stabilized, overtly or covertly by the powers-that-be), consumption may still come to a juddering halt, especially since the legacy of the last few years must mean every kitchen, every living room and every garage is brimful of shiny new appliances (with leases and finance still outstanding, no doubt). Credit markets are already in disarray, the IPO route for the New Era Cash Bonfire companies will surely be closed off. If established firms, already struggling with a financing gap, find capital scarce, credit expensive and prospects uncertain, they may begin to cut back on business investment also. A slowdown in the mighty $17 trillion B2B end, coupled with a buyer's strike in the $7 trillion B2C market, could leave an awful lot of Mega Caps in the Tech sector short of sources for double-digit earnings growth. Not the place to be long an 'incubator' either. CMGI or Blue Ridge Corporation, take your pick.
We said Friday morning that a bad CPI number would do more harm to stocks than bonds. That was certainly borne out on the day and if the West now begins to readjust its balance sheets, that process may yet have room to run. The quality end of fixed income has had its prayers answered, but it still remains to propitiate the fickle Furies of the Forex market. Bunds, at the year's narrowest discount to US Treasuries, may have had the torch passed to them. Swiss bonds, too, now that the SNB has stopped fighting the currency's appreciation, may enjoy a little safe haven status.
20 April 2000