Still Chop, Chop, Choppin' At The Fed's Front Door

Today's S&P close at exactly 2100 marked the culmination of a whole lot of choppin'. In fact, about six months worth, given that the big cap index first crossed the 2100 mark back in early February.
^SPX Chart

^SPX data by YCharts

But do not be troubled, we are told by Wall Street. What the above chart signifies is a healthy market correction. That's right-----a correction in time, not price!

The healthy part, according to the sell-side pitchmen, is owing to the fact that market's can't go down unless there is a recession, but none is remotely in sight. So relax, count your winnings and get refreshed for the next push higher.

But here's the thing. We are now in month 74 of the current so-called recovery, and by the standards of post-war business expansions this one is getting long in the tooth.

In that regard, the abundant evidence from the "incoming" data that this cycle is nearing its exhaustion point is outlined below. But the contextual point is that none of the three slightly longer expansions shown in the graph are remotely relevant to our current circumstances; they provide no comfort whatsoever that a visitation by the grim ripper of recession has been given an indefinite stay.

Historical Length of Recoveries - Click to enlarge

Historical Length of Recoveries

The 105 month expansion of the 1960s, for example, is a testament to LBJ's guns and butter economics which eventually pushed the US economy into a red hot boil owing to the massive industrial mobilization for the Vietnam War and space program. When the Kennedy-Johnson expansion finally ended in 1968 it took nearly three years of sub-par economic growth to stabilize the macro-economy and purge the inflationary fevers that had been unleashed.

It is also a reminder that clean balance sheets are a sitting duck for statist monetary and fiscal stimulus measures that essentially steal from the future in order to goose spending today. The long expansions of the 1980s and 1990s, in fact, were in large part fueled by cheap mortgage and consumer credit and what amounted to a collective LBO by main street households.

From a historically stable ratio of household debt to wage and salary income of about 75%-80% prior to 1980, the ratio went nearly vertical during the next 25 years. But as is also self-evident, households reached a condition of peak debt at the time of the financial crisis. Now they are not remotely in a position to re-leverage, and spend the US economy into an indefinite expansion.

Household Leverage Ratio - Click to enlarge

Household Leverage Ratio - Click to enlarge

Not only is the US economy still saturated with $59 trillion of total public and private debt, and therefore unable to gallop upward indefinitely on the back of rambunctious domestic credit expansion, it also faces unprecedented headwinds from the global economy.

As we have demonstrated repeatedly, this time is truly different. During not one of the post-war business cycle expansions shown in the graph above, did an off-shore frenzy of construction, investment, borrowing and speculation come close to matching the extravaganza staged by the Chinese rulers of red capitalism and their EM raw materials and supplier base since 2008.

So what we have now is staggering excess capacity on a planet-wide basis. That means gale force deflation is being propagated outwards from China and its supply base as they desperately attempt to ship materials and goods at any price which will produce positive cash flow after variable costs, and thereby service the towering pyramids of debt that have been erected in the last two decades.

Among other things this means that the modest lift to US GDP from exports since the Great Recession is now over. As shown below, the June level of exports was already down 6.4% from prior year.

But when you unpack the top line number, the implications for future shipment trends are truly discouraging. That because some substantial part of the export lift after the 2008 plunge of world trades was in processed commodities and capital goods-----both of which were being sucked into the great maw of the China/EM boom which is now over and done.

Thus, US exports of industrial supplies and materials are down by a thumping 18% from their Q2 2014 peak. Likewise, capital goods exports have also rolled over, and, if Caterpillar's foreign dealer sales trends are any indicator, the real plunge is yet to come.

To be sure, the Keynesian apologists for the status quo and their Wall Street confederates argue that the buckling of US exports is just a temporary phase owing to the dollar's recent strength. But they couldn't be more drastically wrong.

The now gathering global deflation cycle will actually devastate US export trade. That's because China and the EM economies are entering a prolonged period of plunging demand for capital goods and raw materials as they attempt to unearth from the building and investment frenzy of the last two decades.

At the same time, moreover, the giant "dollar short" in the EM economies reflected in the $4.5 trillion of dollar denominated debt outstanding will generate a desperate scramble for dollars. That is to say, what has been an extended scramble for yield will now turn into a panicked flight from EM debt as losses and cash shortages mount among EM borrowers.

Accordingly, the dollar has just begun its ascent, and that has sweeping implications for domestic capital spending, as well. To wit, the current global crack-up boom embodies a classic cycle of immense over-investment and malinvestment in capital goods on a worldwide basis. Between the drying up of demand for exports and the impending flood of dumped imports of steel and related industrial goods, the incentives for domestic capital spending will be sharply curtailed.

That is already evident in the sharply eroding trend of orders for non-defense capital capital goods ex-aircraft. As indicated by the most recent monthly release, the June figure was 6.4% below prior year.


Once again, unpacking the headline reveals even more dislocations below. Self-evidently a major contributor to the capital spending pick-up after the 2009 bottom was soaring investment in the domestic oil and gas patch, and to a lesser degree in coal, iron ore and other extractive industries. Needless to say, CapEx spending in these recently red hot precincts has now turned stone cold, with Q2 outlays down by 35% in real terms from their Q4 2014 peak.

Stated differently, energy and mining CapEx doubled between 2009 and 2014 but is now cliff-diving in the face of the global commodity bust and accelerating industrial deflation.

In fact, the real bad news is that gross CapEx in equipment is rolling over after barely getting off the ground during the last six years of so-called recovery. That is, total real equipment spending is already down from its Q2 2014 peak----- even though cumulative nominal growth since late 2007 has averaged only 2% per year and virtually nothing at all in real terms.

The recession deniers, of course, tend to blithely dismiss the self-evident headwinds in the export and capital spending sectors, and ignore the fact that government sector spending is blockaded by peak public sector debt. Supposedly none of this matters because the household consumer is allegedly the energizer bunny of the US economy. Yet as Lance Roberts point out in an adjacent post today, even the trend in real PCE does not conform to the blue sky theory of the current business cycle.



The reason for the above tepid trend is not hard to identify. Most households are still not in a position to increase their leverage, and are therefore constrained to spending what they earn.

Accordingly, it should come as no surprise that July was the third month in a row in which the average American spent less than they did in the same month a year ago, as recorded in the Gallup Daily consumer spending survey. Indeed, of the seven months in 2015, five have seen a decline in consumer spending year over year.

The fact that Q2 total employee compensation came in at the lowest level ever recorded surely has something to do with the tepid trends in consumer spending recorded by Gallup.

But at the end of the day, the real evidence that wage and salary dependent consumers are reaching the end of their spending ropes is found in the one "incoming" data series that doesn't lie. Namely, the daily withholding tax data published by the US Treasury.

As shown below, the boon to Uncle Sam from recovering incomes and the end of certain tax cuts in 2012-2014 has reached its limit. The three-month rolling average of withholding taxes collected is now heading down sharply. At 3.5% on a year-on-year basis, it is barely positive after inflation.

Growth of Federal Withholding Tax Collections - Click to enlarge

Growth of Federal Withholding Tax Collections

So what's actually in sight is falling exports, weakening CapEx, tepid consumer spending, faltering wage and salary incomes and withholding taxes, and, as shown below, a build-up of business inventories not seen since the eve of the Great Recession.

So the chop, chop, choppin' of the stock market may not be about a "correction in time" after all. The more probable meaning is that the stock market is facing a recovery that is running out of time, and a central bank that is out of dry powder.

That's hardly the kind of pause that refreshes.



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