The Sorry State of the World Economy

Data released in January paint a bleak picture of advanced-economy prospects. Even if some emerging economies – which face serious challenges of their own – manage to pick up some of the slack, the world economy will remain encumbered by the combination of economic interconnectedness and political balkanization.

Kaushik Basu  




NEW YORK – January is traditionally a time for assessing the developments of the previous year, in order to anticipate what the new one has in store. Unfortunately, even though we may be at a turning point for the better politically, the data that have emerged in the last month do not paint a promising picture of the global economy’s short-term prospects.

The tone was set early in the month by the World Bank’s Global Economic Prospects, along with the accompanying articles. The report paints a picture as bleak as its subtitle – “Darkening Skies” – and cuts the growth forecast for the advanced economies in 2020 to 1.6% (down from 2.2% in 2018).

Moreover, last week, the European Central Bank sounded the alarm over the eurozone economy. Between the prospect of a disorderly Brexit and rising protectionism, exemplified by the trade war between the United States and China, Europe is subject to increasing uncertainty.

Making matters worse, Germany is facing a growth slowdown. According to its own official data, the economy contracted by 0.2% in the third quarter of 2018, while the Purchasing Managers Index for manufacturing sank to 49.9 – a four-year low. Given Germany’s role as the backbone of the eurozone economy, its economic struggles are likely to cascade beyond its borders.

This is particularly problematic, because, after more than a decade of fighting crisis and recession, the advanced economies have depleted their ammunition for countering a slowdown. With the ECB’s benchmark interest rate at zero, there is little room for a cut. The Bank of England has not risked raising interest rates since August. Even the US Federal Reserve signaled that it was slowing down the pace of its rate hikes. A new crisis would thus leave the advanced economies fumbling for fresh monetary instruments.

The future is somewhat brighter for the emerging world, though dark clouds loom there, too. As the World Bank report emphasizes, emerging economies are increasingly strained by government debt, which has risen by 20 percentage points of GDP, on average, since 2013, with payments owed largely to private creditors demanding high interest rates.

Africa is on a promising trajectory. As the African Economic Outlook 2019 notes, the continent has had a challenging few years, with growth falling from close to 5% annually in 2010-2014 to only about 2% in 2016. Yet, last year, growth climbed back to 3.5% in 2018, and next year, it could surpass 4%, propelled by some of the world’s fastest-growing economies, such as Ethiopia and Rwanda, which are posting annual growth rates well above 7%. Nonetheless, with major players like Nigeria and South Africa punching well below their weight, Africa is not yet in a position to pick up the slack left by the ailing advanced economies.

The situation is more promising in Asia. China has played a major role over the last 30 years, but currently it is clearly in an adjustment phase, as it shifts to a higher-wage lower-growth economy. In 2018, Bangladesh, India, and Indonesia grew by an impressive 7.9%, 7.3%, and 5.2%, respectively, and the World Bank estimates that, in 2020, growth will exceed 7% in South Asia and 6% in East Asia.

But, again, there are serious challenges ahead. In India, an employment crisis is looming, rooted in the country’s focus on the big players and its failure to convert economic growth into good jobs, particularly for its educated youth.

Given this, the budget that will be presented to India’s parliament on February 1 – just months before the general election, expected to be held between April and May, – will require extremely skilled policy design that creates programs to boost demand and employment, without running up the deficit. I believe monetary policy also has a significant role at this juncture. With inflation under control, the Reserve Bank of India could help stimulate the economy with a small cut in interest rates.

In Indonesia, President Joko Widodo – commonly known as Jokowi – is facing mounting criticism for failing to achieve the 7% growth target he set when he took office in 2014. In fact, Jokowi’s target was always overly ambitious for Indonesia, an economy with a per capita income of over $10,000 (adjusted for purchasing power parity).

Still, the government has important tasks to carry out. For one, the central bank’s response to the depreciation of the rupiah – six interest-rate hikes in the last three quarters – may have been excessive, even though the currency reached a 20-year low against the US dollar last year. Moreover, there needs to be better coordination of policies across local governments, which have been competitively raising the minimum wage, undermining Indonesia’s ability to take over low-cost manufacturing from China.

Yet Jokowi – who will seek another five-year term in the April election – remains a source of hope. Illustrating his commitment to inclusivity, he is among the few political leaders in the developing world who have spoken up in favor of LGBTQ+ rights. If he is able to leverage his valuable personal qualities – which include a commitment to secularism and modesty that is becoming increasingly rare among political leaders – to push for needed structural reforms, Indonesia can achieve 6% annual GDP growth, making it a powerful driver of regional and global economic performance.

Even if some emerging economies manage to secure strong growth, however, the world economy will remain encumbered by the combination of economic interconnectedness and political balkanization. At a time when the world urgently needs to improve the coordination of monetary, fiscal, and trade policies, it has, instead, been rolling back what little coordination previously existed. This is a direct result of worsening leadership in major economies, especially the US under President Donald Trump.

It is impressive what US institutions – from the Fed and the judiciary to state governments, the media, and academia – have been attempting during these trying times. One also hopes voters globally will recognize the folly of nationalism and xenophobia in a deeply interconnected world.1

If none of this happens, my advice is simple: adopt the brace position.


Kaushik Basu, former Chief Economist of the World Bank, is Professor of Economics at Cornell University and Nonresident Senior Fellow at the Brookings Institution.

The Centuries Long Contest for the Black Sea

By Xander Snyder

Summary The 2014 Winter Olympics. The 1945 Yalta Conference. Anton Chekhov’s 1899 story “The Lady With the Dog.” These are but a few testaments to the enduring geopolitical and cultural significance of the Black Sea. But the region’s history isn’t all sports, seaside romances and peace negotiations – far from it. Over the centuries, the Black Sea has time and again been the focus of competition and conflict as its littoral states, namely Russia and Turkey, vie to protect critical security interests there. These powers and others have fought over, won and lost territory in and around the sea – some of them more than once. And as Russia’s interventions in the Crimean Peninsula and in Georgia attest, the struggle is alive and well in the 21st century. This Deep Dive will look at why the Black Sea and its surrounding shores have been the subject of so much strife and how the power distribution among its littoral states today propagates the cycle of conflicto.   Water Worth Fighting For Of the six states that border the Black Sea, Turkey and Russia are primarily responsible for the course of the region’s development over time. The two have spent most of their history in a bitter rivalry, despite their recent alliance of convenience over short-term endeavors, such as the war in Syria. Over hundreds of years, the Russian and Ottoman empires fought numerous wars – each of which traced back in one way or another to the issue of territorial control of the Black Sea. In terms of geography, the region offers plenty of features worth fighting over. The Bosporus and Dardanelles straits – which connect the Black Sea to the Sea of Marmara, and from there to the Aegean, the Mediterranean and the wider maritime world – have inspired several battles for their control. During World War I, for example, Ottoman and allied British, Australian and French forces fought over the Dardanelles at Gallipoli. On the opposite side of the Black Sea lies the Sea of Azov, situated between Russia and Ukraine. The Don and Kuban rivers flow into the sea, linking it to the Russian heartland as well as the Caucasus. Connecting the Sea of Azov and the Black Sea at the tip of the Crimean Peninsula is the Kerch Strait, the site of a newly constructed Russian bridge and a recent dustup between Russia and Ukraine. The Black Sea itself is no less strategic than the waterways that surround it. The Dniester, Dnieper and Danube rivers flow into the sea and have made for strategic transit routes dating back to Ottoman times. (click to enlarge)   A History of Violence Conflict between Russia and the Ottomans dates back to the 16th century, but the competition began in earnest only toward the end of the next century. At the time, Russia faced threats on multiple fronts. To the west, there was Poland, which had gone to war several times with Russia in the 17th century and even occupied Moscow during a particularly tumultuous period in Russian history. To the south were the Tatars, who controlled the Black Sea and often conducted raids into Russian territory on behalf of the Ottoman Empire. Russia signed a truce with Poland in 1667 that gave it control of Ukrainian territory east of the Dnieper River. Russia also gained control of Kiev, strategically positioned on the river, for two years and wanted to make it permanent. At the time, Poland was at war with the Ottomans. Having pushed them out of Vienna, Poland, along with its allies in the Holy League (which included the Holy Roman Empire and the Venetian Republic) tried to drive the Ottomans back out of Eastern Europe. Russia, which had cordial relations with the Ottomans in the recent past, initially stayed out of the war but ultimately decided to join the fight in exchange for Poland ceding control of Kiev beyond the initial two-year arrangement.  (click to enlarge)   The effort had strategic benefits beyond putting a stop to the Tatar raids. The main objective of Peter the Great’s rule was to catch Russia up with Western Europe so that it could compete as an economic and military power. Gaining greater access to the outside world was a critical part of this endeavor. And for that, Russia needed a reliable year-round port, unlike Arkhangelsk, its biggest port up until that point, which lay so far north that its waters stayed frozen much of the year. St. Petersburg, established in 1703 on the Gulf of Finland, eventually drew much of Russia’s maritime traffic, but it, too, froze in the frigid winter temperatures, as did the Neva River that flowed into it. To obtain a true warm-water port, Russia would have to look south. Russia seized control of the Sea of Azov in its operation in the late 17th century, beginning the gradual erosion of Ottoman control of the Black Sea. But the area was traded back and forth between the Russians and Ottomans for over half a century. Russia lost control of the Sea of Azov in a short war with the Ottomans in 1710-11 and then regained partial access in another conflict from 1735 to 1739. It was granted the right to build a port there but was not allowed to sail its naval fleets on either the Sea of Azov or the Black Sea It wasn’t until the Russo-Turkic war of 1768-74 that Russia ousted the Ottomans from their post on the sea. The Treaty of Kucuk Kaynarca, which ended the conflict, enabled Russian fleets to move freely in the Sea of Azov, through the Kerch Strait and into the Black Sea. It granted the Crimean Khanate independence from the Ottoman Empire, making it a smaller, weaker foe and, in effect, securing Russia’s Black Sea coast. The treaty also declared Russia the protector of Christians in the Ottoman Empire, a position it used repeatedly in the following centuries to justify wars with Turkey, and set an enduring precedent for Russian intervention in defense of Orthodox Christians in the Balkans and the Caucasus. But for all Russia’s efforts over time to control the Black Sea, the strait that links the body to the seas beyond, the Bosporus, has always stayed beyond its grasp. The Bosporus has been and remains Turkey’s ultimate point of leverage over Russia. Russian vessels can sail the Black Sea all they want, but without Ankara’s consent, they can’t leave it. This is no idle threat for Russia. During World War I, the Ottoman Empire crippled the Russian economy by cutting Russian commerce off from the Mediterranean through a blockade of the Bosporus. Turkey wielded that power as a critical part of NATO’s containment line in the Cold War, keeping the Soviet Union hemmed in at the Black Sea. Since the Soviet Union’s collapse, the contest for the Black Sea region has continued. Ukraine’s independence in 1991 introduced the possibility that the country would align with the West, an intolerable risk for Russia – and one the 2014 Euromaidan uprising in Ukraine has only reinvigorated. Today, Russia supports separatist groups in eastern Ukraine and has reasserted its control of the Crimean Peninsula, which it annexed nearly five years ago. It also built a bridge across the Kerch Strait with such a low clearance that it prevents Ukrainian vessels from passing; Russia detained several Ukrainian sailors in November after a confrontation between Russian and Ukrainian naval vessels in the strait. If Russia escalates its intervention in Ukraine, Turkey may face a difficult choice between allowing NATO forces into the Black Sea, counter to the terms of the Montreux Convention (which governs access to the Bosporus Strait), or defying its allies in the bloc by denying their passage through the Bosporus.   (click to enlarge)   Though Russia’s naval base at Tartus, Syria, gives it access to the Mediterranean, it’s of little concern to the Turks. Under its agreement with Syria, Russia can deploy up to 11 warships at the base. Moscow has also been investing in support infrastructure to house a larger flotilla there. But the base doesn’t present much of a threat to Turkey because, in case of a war, Russia would still need to bring supplies to the base through the Turkish-controlled Bosporus.   The Competition for Other Shores Ukraine isn’t the only Black Sea state that has weathered competition between Russia and Turkey. The two powers have also vied over the centuries for control of the South Caucasus region, including Georgia. Georgia’s strategic value is its role as a buffer along Russia’s southern border. Just over a decade ago, Russia invaded the former Soviet republic, an otherwise minor player in the region’s maritime activities. Georgia at the time was considering a bid for NATO membership. It was also dealing with a separatist uprising in the territory of Abkhazia, which broke away in a war in the early 1990s. Russia intervened on Abkhazia’s side, and by the end of its dayslong war with Georgia, it recognized the territory, as well as the breakaway region of South Ossetia, as an independent state. It has occupied the two territories ever since. Russia’s involvement in Abkhazia gives it access to a few additional ports on the Black Sea: Sukhumi – Abkhazia’s capital and main port – Ochamchire, Gagra and Novy Afon. (click to enlarge)   The remaining littoral states of the Black Sea – Bulgaria and Romania – are also part of the competition between Russia and the West. Today, they are NATO members, but their ties to Russia and Turkey date back centuries. Bulgaria and Romania were members of the Warsaw Pact. Long before that, though, the Russian and Ottoman empires struggled for dominance over the states. Most recently, Bulgaria has been caught in a competition over energy supplies between Russia and Ukraine. Bulgaria depends on natural gas pipelines that run from Russia through Ukraine, and when Moscow cut supplies to Ukraine in 2009, it didn’t receive enough natural gas to meet domestic demand. The construction of the TurkStream pipeline, which runs through the Black Sea, will enable Russia to use natural gas supplies as leverage over Ukraine without jeopardizing the access of importers down the line, including Bulgaria and states in Eastern and Southern Europe. Bulgaria is even planning to invest about $1.6 billion in the construction of an additional link to Turkey, the pipeline’s terminus and, as such, an essential partner in the TurkStream endeavor. (As the only alternative route to European markets, the pipeline also gives Turkey some leverage over Russia, though Russia is Turkey’s top supplier of natural gas and, therefore, still has the upper hand in this regard.)   (click to enlarge)   Earlier in its history, Bulgaria was embroiled in a more violent regional struggle, as Russia and the Ottomans fought cyclical wars, including the 1877-78 Russo-Turkish war. The peace deal the two powers reached in that conflict, the Treaty of San Stefano, granted Russia so much territory that Germany intervened to mediate a solution more palatable to Europe. An ascendant Russia, after all, would have posed enough of a threat to the weaker Austro-Hungarian Empire to upset the balance of power on the Continent. (Were Austria-Hungary to fall, Germany would have no ally to its east to help fight or insulate it against Russia.) The revised agreement, the Treaty of Berlin, vastly curtailed Russia’s land acquisition and turned Russia against Germany, leading to the Franco-Russian alliance and laying the groundwork for World War I. It also established Bulgaria as an independent state for the first time since the Ottomans conquered it in 1396. (click to enlarge)   In the years that followed, conflict in the Balkans, including the discord that gave rise to World War I, frequently distracted Bulgaria from its Black Sea interests. And as a NATO member, Bulgaria plays a modest role in the region, hosting a small contingent of Italian jets and four U.S. military bases, one of which Washington plans to upgrade this year, investing about $5 million. Romania, by contrast, is home to a substantial NATO force at its air base in Constanta, where the Danube connects with the Black Sea by way of a canal. The base, which regularly houses an armored brigade combat team, is the only installation in the Black Sea region that supports U.S. forces, according to Lt. Gen. Ben Hodges, former commander of the U.S. Army Europe. For missile defense, Romania has installed the Aegis and Patriot systems and recently placed its second order in two years for more of the latter system. (The Danube itself is a possible vulnerability for Romania, though it’s also a potentially important transport link for commerce. NATO’s bombing campaign against Serbia in 1999, for example, destroyed several bridges along the Danube, forcing the river’s closure and costing Romania hundreds of millions of dollars in lost trade.) For centuries, the multiple axes of competition in the Black Sea have made it a site of repeated conflict over the same strategic passages. The contest has been most pronounced between Russia and Turkey, which have fought countless wars to secure access to the Black Sea and its surrounding waters. Threats from the West have driven Russia to intervene in Ukraine, which can draw Russia into conflict with Turkey. Whether the competition manifests in Russian military intervention or in energy disputes, the struggle continues to this day.

Did An Irresistible Force Meet An Immovable Object?

Summary

 

- As we have discussed previously, price movements are very much confined by the "physics" of technicals.

- We lifted profits at the 200-dma and added hedges to the Equity and Equity Long/Short portfolios.

- What will be critically important now is for the markets to retest and hold support at the Oct-Nov lows, which will coincide with the 50-dma.

- A failure of that level will likely see a retest of the 2018 lows.

     

    

Since the day after Christmas, the markets have been in a surge very similar to what we saw in January of 2018.

 

Here is January 2018:

 

 

And 2019:

 

 

 

Of course, in February 2018, the rally ended.

 

While I am not suggesting that the markets are about to suffer a 10% correction, what I am suggesting, as I wrote this past week, is that the markets have been "Too Fast & Too Furious."

"Short-term technical indicators also show the violent reversion from extreme oversold conditions back to extreme overbought."

As we have discussed previously, price movements are very much confined by the "physics" of technicals. A couple of weeks ago, we drew out what we expected to be the movement over the market over the next couple of weeks.

We said then the most likely target for the rally was the 200-dma. It was essentially the level at which the "irresistible force would meet the immovable object."

 

The chart below is updated through Friday afternoon:

 

 

 

 

As noted, we lifted profits at the 200-dma and added hedges to the Equity and Equity Long/Short portfolios.

 

What will be critically important now is for the markets to retest and hold support at the Oct-

 

Nov lows which will coincide with the 50-dma. A failure of that level will likely see a retest of the 2018 lows.

 

A retest of those lows by the way is not an "outside chance." It is actually a fairly high possibility. A look back at the 2015-2016 correction makes the case for that fairly clearly.

 

 

 

But even if a retest of lows doesn't happen, you should be aware that sharp market rallies are not uncommon, but almost always have a subsequent retracement.

 

The point here is that the move off of the December lows is likely now complete, for now.

 

Thomas Thornton from Hedge Fund Telemetry had a great note out this past week on this point.

"The strong move off the lows in December is complete. As you have seen I've moved from a very high exposure level of 90% net long from mid December to now net short.  

Various internals are overbought, sentiment is back in the elevated zone, and price targets have been achieved. There have been 45 new DeMark sell signals and only 2 buy signals so far in February. Recall in December there were 225 buy signals and 25 sell signals which had an average gain together of 11.5% since. In January there were 72 total signals with the majority 53 sells/19 buys with only a gain of 0.5% since. It's telling me a shift is coming and that's lower. How low? As of now, I'm not saying new lows but higher lows but that could change if some Trend Factor levels break and we see downside Countdowns start."

 

 

SentimenTrader also recently noted market performance when the VIX hits a three-month low with the S&P under the 200-day. Performance is very negative going forward.

 

 
 

Signs Of Caution

 

As we noted last Tuesday, there are a litany of things that are worth paying attention to. To wit:

It is too early to suggest the "bear market of 2018" is officially over. 

But, the rally has simply been "Too Fast, Too Furious," completely discounting the deteriorating fundamental underpinnings:

• Earnings estimates for 2019 have sharply collapsed as I previously stated they would and still have more to go. In fact, as of now, the consensus estimates are suggesting the first year-over-year decline since 2016.

• Stock market targets for 2019 are way too high as well.
• Despite the Federal Reserve turning more dovish verbally, it DID NOT say it actually WOULD pause its rate hikes or stop reducing its balance sheet.
• Larry Kudlow said the U.S. and China are still VERY far apart on trade.
• Trump has postponed his meeting with President Xi, which puts the market at risk of higher tariffs.
• There is a decent probability the U.S. government winds up getting shut down again after next week over "border wall" funding.
• The effect of the tax cut legislation has disappeared as year-over-year comparisons are reverting back to normalized growth rates.
• Economic growth is slowing as previously stated.
• Chinese economic has weakened further since our previous note.
• European growth, already weak, will likely struggle as well.
• Valuations remain expensive

Despite recent comments that "recession risk" is non-existent, there are various indications which suggest that risk is much higher than currently appreciated. The New York Federal Reserve recession indicator is now at the highest level since 2008.

 

 

 

 

Also, as noted by George Vrba recently, the unemployment rate may also be warning of a recession as well.

"For what is considered to be a lagging indicator of the economy, the unemployment rate provides surprisingly good signals for the beginning and end of recessions. This model, backtested to 1948, reliably provided recession signals. 

The model, updated with the January 2019 rate of 4.0%, does not signal a recession. However, if the unemployment rate should rise to 4.1% in the coming months the model would then signal recession."

 

 

The point here is that ignoring the "risks" leaves you "exposed." If you think it's going to rain, you carry an umbrella.

 

This is why we recently raised cashed and added hedges to portfolios - just in case it rains. And, right now, it seems to be sprinkling a bit. As John Murphy via StockCharts.com noted on Friday:

"It looks like the 200-day averages that we've all been watching have managed to contain the 2019 rally. Chart 1 shows the S&P 500 pulling back from that red overhead resistance line. That's not too surprising considering the steepness of the recent rally which put stock indexes in a short-term overbought condition. The upper box in Chart 1 shows the more sensitive 9-day RSI line falling to the lowest level in a month after reaching overbought territory above 70. That also shows loss of upside momentum. The lower box shows daily MACD lines in danger of turning negative for the first time in a month. All of which suggests that the early 2019 stock rally has failed its first attempt to regain its 200-day moving average."

 

 

However, one of the biggest "warning flags" we are watching currently, and why we have taken a more cautious stance in portfolios, is because "bonds ain't buyin' it."

 

As shown in the chart below, the market has not only broken out of its rising wedge, but also yields have been dropping sharply as "risk on" is rotating to "risk off."

 

 

 

While the bulls clearly took charge of the market in late December, the question is whether or not they can maintain control.

 

The weight of macro evidence is going to weigh on the markets sooner than later, which is why we are opting to hedge risk and hold on to higher levels of cash currently.

 

The rally we discussed on December 25th has hit all of our targets, and then some.

 

Don't be greedy.

 

See you next week.

 

The Real 401(k) Plan Manager

 

A Conservative Strategy For Long-Term Investors

 

 

 

There are four steps to allocation changes based on 25% reduction increments. As noted in the chart above, a 100% allocation level is equal to 60% stocks. I never advocate being 100% out of the market, as it is far too difficult to reverse course when the market changes from a negative to a positive trend. Emotions keep us from taking the correct action.

 

 

Looking For Support

 

Over the last several of weeks, we have watch a sharp rally in stocks as Washington, the Fed, and global central banks have put their best foot forward to provide a "put" underneath stock prices following the rout last year.

 

That rally ran into our target resistance at the 200-dma last week and stocks are taking a breather. We continue to recommend taking some action in plans if you haven't done so already.

• If you are overweight equities, reduce international, emerging market, mid-, and small-capitalization funds on any rally next week. Reduce overall portfolio weights to 75% of your selected allocation target.
• If you are underweight equities, reduce international, emerging market, mid-, and small-capitalization funds on any rally next week but hold everything else for now.
• If you are at target equity allocations, hold for now.

 

Continue to use rallies to reduce risk towards a target level with which you are comfortable.

 

Remember, this model is not ABSOLUTE - it is just a guide to follow.

 

Unfortunately, since 401(k) plans don't offer a lot of flexibility and have trading restrictions in many cases, we have to minimize our movement and try and make sure we are catching major turning points.

 

We want to make sure that we are indeed within a bigger correction cycle before reducing our risk exposure further.

 

Current 401(k) Allocation Model

 

The 401(k) plan allocation plan below follows the K.I.S.S. principle. By keeping the allocation extremely simplified, it allows for better control of the allocation and a closer tracking to the benchmark objective over time. (If you want to make it more complicated you can, however, statistics show that simply adding more funds does not increase performance to any great degree).

401(k) Choice Matching List

The list below shows sample 401(k) plan funds for each major category. In reality, the majority of funds all track their indices fairly closely. Therefore, if you don't see your exact fund listed, look for a fund that is similar in nature.

 

Dalio's Fear Of The Next Downturn Is Likely Understated

by: Lance Robert

Summary

 

- Dalio made the remarks in a panel discussion at the World Economic Forum's annual meeting in Davos on Tuesday where he reiterated that a limited monetary policy toolbox, rising populist pressures and other issues, including rising global trade tensions, are similar to the backdrop present in the latter part of the Great Depression in the late 1930s.

- However, while the markets are celebrating the very clear confirmation that the "Fed Put" is alive and well, it should be remembered these "emergency measures" are coming at a time when we are told the economy is booming.

- As Dalio noted, one of the biggest issues facing global Central Banks is the ongoing effectiveness of "Quantitative Easing" programs.

          

"What scares me the most longer term is that we have limitations to monetary policy - which is our most valuable tool - at the same time we have greater political and social antagonism." - Ray Dalio, Bridgewater Associates

 

Dalio made the remarks in a panel discussion at the World Economic Forum's annual meeting in Davos on Tuesday where he reiterated that a limited monetary policy toolbox, rising populist pressures and other issues, including rising global trade tensions, are similar to the backdrop present in the latter part of the Great Depression in the late 1930s.

 

Before you dismiss Dalio's view Bridgewater's Pure Alpha Strategy Fund posted a gain of 14.6% in 2018, while the average hedge fund dropped 6.7% in 2018 and the S&P 500 lost 4.4%.

 

The comments come at a time when a brief market correction has turned monetary and fiscal policy concerns on a dime. As noted by Michael Lebowitz yesterday afternoon at RIA PRO

"In our opinion, the Fed's new warm and cuddly tone is all about supporting the stock market. The market fell nearly 20% from record highs in the fourth quarter and fear set in. There is no doubt President Trump's tweets along with strong advisement from the shareholders of the Fed, the large banks, certainly played an influential role in persuading Powell to pivot. 

Speaking on CNBC shortly after the Powell press conference, James Grant stated the current situation well. 

"Jerome Powell is a prisoner of the institutions and the history that he has inherited.  

Among this inheritance is a $4 trillion balance sheet under which the Fed has $39 billion of capital representing 100-to-1 leverage. That's a symptom of the overstretched state of our debts and the dollar as an institution."

As Mike correctly notes, all it took for Jerome Powell to completely abandon any facsimile of "independence" was a rough December, pressure from Wall Street's member banks, and a disgruntled White House to completely flip their thinking.

 

In other words, the Federal Reserve is now the "market's bitch."

 

However, while the markets are celebrating the very clear confirmation that the "Fed Put" is alive and well, it should be remembered these "emergency measures" are coming at a time when we are told the economy is booming.

"We're the hottest economy in the world. Trillions of dollars are flowing here and building new plants and equipment. Almost every other data point suggests, that the economy is very strong. We will beat 3% economic growth in the fourth quarter when the Commerce Department reopens. 

We are seeing very strong chain sales. We don't get the retail sales report right now and we see very strong manufacturing production. And in particular, this is my favorite with our corporate tax cuts and deregulation, we're seeing a seven-month run-up of the production of business equipment, which is, you know, one way of saying business investment, which is another way of saying the kind of competitive business boom we expected to happen is happening." - Larry Kudlow, Jan 24, 2019.

Of course, the reality is that while he is certainly "spinning the yarn" for the media, the Fed is likely more concerned about "reality" which, as the data through the end of December shows, the U.S. economy is beginning to slow.

"As shown, over the last six months, the decline in the LEI has actually been sharper than originally anticipated. Importantly, there is a strong historical correlation between the 6-month rate of change in the LEI and the EOCI index. As shown, the downturn in the LEI predicted the current economic weakness and suggests the data is likely to continue to weaken in the months ahead."

Limited Monetary Tool Box

 

As Dalio noted, one of the biggest issues facing global Central Banks is the ongoing effectiveness of "Quantitative Easing" programs. As previously discussed:

"Of course, after a decade of Central Bank interventions, it has become a commonly held belief the Fed will quickly jump in to forestall a market decline at every turn. While such may have indeed been the case previously, the problem for the Fed is their ability to 'bail out' markets in the event of a 'credit-related' crisis."

"In 2008, when the Fed launched into their "accommodative policy" emergency strategy to bail out the financial markets, the Fed's balance sheet was only about $915 Billion. The Fed Funds rate was at 4.2%. 

If the market fell into a recession tomorrow, the Fed would be starting with roughly a $4 Trillion dollar balance sheet with interest rates 2% lower than they were in 2009. In other words, the ability of the Fed to 'bail out' the markets today, is much more limited than it was in 2008."

But it isn't just the issue of the Fed's limited toolbox, but the combination of other issues, outside of those noted by Dalio.

 

The nonprofit National Institute on Retirement Security released a study in March stating that nearly 40 million working-age households (about 45 percent of the U.S. total) have no retirement savings at all. And those that do have retirement savings don't have enough. As I discussed recently, the Federal Reserve's 2016 Survey of consumer finances found that the mean holdings for the bottom 80% of families with holdings was only $199,750.

 

Such levels of financial "savings" are hardly sufficient to support individuals through retirement. This is particularly the case as life expectancy has grown, and healthcare costs skyrocket in the latter stages of life due historically high levels of obesity and poor physical health. The lack of financial stability will ultimately shift almost entirely onto the already grossly underfunded welfare system.

 

However, that is for those with financial assets heading into retirement. After two major bear markets since the turn of the century, weak employment and wage growth, and an inability to expand debt levels, the majority of American families are financially barren. Here are some recent statistics:

1. 78 million Americans are participating in the "gig economy" because full-time jobs just don't pay enough to make ends meet these days.
2. In 2011, the average home price was 3.56 times the average yearly salary in the United States. But by the time 2017 was finished, the average home price was 4.73 times the average yearly salary in the United States.
3. In 1980, the average American worker's debt was 1.96 times larger than his or her monthly salary. Today, that number has ballooned to 5.00.
4. In the United States today, 66 percent of all jobs pay less than 20 dollars an hour.
5. 102 million working age Americans do not have a job right now. That number is higher than it was at any point during the last recession.
6. Earnings for low-skill jobs have stayed very flat for the last 40 years.
7. Americans have been spending more money than they make for 28 months in a row.
8. In the United States today, the average young adult with student loan debt has a negative net worth.
9. At this point, the average American household is nearly $140,000 in debt.
10. Poverty rates in U.S. suburbs "have increased by 50 percent since 1990".
11. Almost 51 million U.S. households "can't afford basics like rent and food".
12. The bottom 40 percent of all U.S. households bring home just 11.4 percent of all income.
13. According to the Federal Reserve, 4 out of 10 Americans do not have enough money to cover an unexpected $400 expense without borrowing the money or selling something they own.
14. 22 percent of all Americans cannot pay all of their bills in a typical month.
15. Today, U.S. households are collectively 13.15 trillion dollars in debt. That is a new all-time record.

Here is the problem with all of this.

 

Despite Central Bank's best efforts globally to stoke economic growth by pushing asset prices higher, the effect is nearly entirely mitigated when only a very small percentage of the population actually benefit from rising asset prices. The problem for the Federal Reserve is in an economy that is roughly 70% based on consumption, when the vast majority of American's are living paycheck-to-paycheck, the aggregate end demand is not sufficient to push economic growth higher.

 

While monetary policies increased the wealth of those that already have wealth, the Fed has been misguided in believing that the "trickle down" effect would be enough to stimulate the entire economy. It hasn't. The sad reality is that these policies have only acted as a transfer of wealth from the middle class to the wealthy and created one of the largest "wealth gaps" in human history.

 

The real problem for the economy, wage growth and the future of the economy is clearly seen in the employment-to-population ratio of 16 to 54-year-olds. This is the group that SHOULD be working and saving for their retirement years.

 

 

The current economic expansion is already set to become the longest post-WWII expansion on record. Of course, that expansion was supported by repeated artificial interventions rather than stable organic economic growth. As noted, while the financial markets have soared higher in recent years, it has bypassed a large portion of Americans NOT because they were afraid to invest, but because they have NO CAPITAL to invest with.

 

To Dalio's point, the real crisis will come during the next economic recession.

 

While the decline in asset prices, which are normally associated with recessions, will have the majority of its impact at the upper end of the income scale, it will be the job losses through the economy that will further damage an already ill-equipped population in their prime saving and retirement years.

Furthermore, the already grossly underfunded pension system will implode.

 

An April 2016 Moody's analysis pegged the total 75-year unfunded liability for all state and local pension plans at $3.5 trillion. That's the amount not covered by current fund assets, future expected contributions, and investment returns at assumed rates ranging from 3.7% to 4.1%.

 

Another calculation from the American Enterprise Institute comes up with $5.2 trillion, presuming that long-term bond yields average 2.6%.

 

The massive amount of corporate debt, when it begins to default, will trigger further strains on the financial and credit systems of the economy.

 

Dalio's View Is Likely Understated.

The real crisis comes when there is a "run on pensions." With a large number of pensioners already eligible for their pension, the next decline in the markets will likely spur the "fear" that benefits will be lost entirely. The combined run on the system, which is grossly underfunded, at a time when asset prices are dropping will cause a debacle of mass proportions. It will require a massive government bailout to resolve it.

 

But it doesn't end there. Consumers are once again heavily leveraged with sub-prime auto loans, mortgages, and student debt. When the recession hits, the reduction in employment will further damage what remains of personal savings and consumption ability. The downturn will increase the strain on an already burdened government welfare system as an insufficient number of individuals paying into the scheme is being absorbed by a swelling pool of aging baby-boomers now forced to draw on it. Yes, more Government funding will be required to solve that problem as well.

 

As debts and deficits swell in the coming years, the negative impact to economic growth will continue. At some point, there will be a realization of the real crisis. It isn't a crash in the financial markets that is the real problem, but the ongoing structural shift in the economy that is depressing the living standards of the average American family. There has indeed been a redistribution of wealth in America since the turn of the century. Unfortunately, it has been in the wrong direction as the U.S. has created its own class of royalty and serfdom.

The issue for future politicians won't be the "breadlines" of the 30s, but rather the number of individuals collecting benefit checks and the dilemma of how to pay for it all.

 

The good news, if you want to call it that, is that the next "crisis," will be the "great reset" which will also make it the "last crisis."