Weekly Economic Update 05-26-2017

Stated Income Car Loans on the Rise
You might think we’d learn from the subprime housing crisis that No Income No Job No Assets (NINJA) loans are a bad idea. While you and I can probably agree that those loans were a bad idea, it hasn’t stopped the automobile finance industry from taking up where the housing market left off.

Santander Consumer, one of the largest subprime auto lenders, recently reported that they verified income on a mere 8% of all loans. I don’t know about you, but if I was loaning out money on a depreciating asset that I might want to verify a borrower’s income. Apparently, Santander didn’t feel that was necessary. And why should they; it certainly didn’t stop investors from buying up these loans.

Recently those loans were packaged up into a one-billion-dollar bond and sold off to eager investors. For those who invest in high-yield bonds, debt like this will most likely make its way into those funds. If you’re wondering why I have been avoiding high-yield debt, it’s because it’s filled with junk like this. Since the subprime auto finance market is larger than the subprime housing market, there’s little question of what will happen to these loans when the economy falls into a recession.

It’s at that point we’ll find out the true value of high yield debt on a depreciating asset in a market that is swamped with inventory. My guess is those bonds won’t be worth much. When the economy is late in the business cycle that it’s important to know what you are really investing in. Just because things are going up in value now, doesn’t mean that they can’t quickly plummet in value later.

Auto Loan Delinquencies on the Rise
As if it isn’t bad enough that lenders are offering stated income auto loans, 90-day delinquencies in auto loans just hit a four-year high. And that’s with the unemployment rate at 4.4%. Care to take a guess of what will happen to delinquencies if the unemployment rate rises? Or what will happen to the banks and investors holding these loans? Just think back to the 2008 subprime housing collapse and you’ll have a good idea of the damage it will do.

And did I mention that the last time auto loan delinquencies were this high that the unemployment rate was 7.6%?

US Liquidity is at Dangerously Low Levels
For the past few months, I’ve been warning that a falling money supply, falling business lending and falling consumer lending would lead to big problems. Nobody listened. The stock market has literally laughed at me as it sits near its all-time highs while liquidity in the U.S. dries up.

This week the financial news media started taking notice and running articles warning investors that a falling money supply and a contraction in the lending market could be a problem. The reason I point them out in my videos each week is that when all of them contract they lead to a recession and sometimes when things are really inflated (like they are now) a contraction in those metrics can quickly lead to a financial crisis.

In a recent report on global liquidity, it showed total global liquidity is rather weak. The United States is second to the bottom, with very low levels of liquidity. When liquidity is low it puts the economy and equity assets (i.e. stocks) at risk of dropping in value. Given that liquidity isn’t much higher than it was when the stock market bottomed just before the election, it suggests that stocks are overvalued and ripe for a correction.

Are Corporate Profits Really That High?
The news is full of reports on how earnings are beating analyst estimates – and on a side note, analyst estimates aren’t anything to put any stake on. They can, and do adjust their predictions right up until the earnings announcement. In turn, the stock market has ballooned by 22% over the past three years while corporate profits are only up 7% over the same period. That’s three times multiple.
The analyst projections have also been wrong, but you wouldn’t know that. Current Earnings Per Share (EPS) is at $123. In 2014 the projection for 2015 was $133 EPS. In 2015 the projection for 2016 was $136 EPS. In 2016 the projection for 2017 was $138 EPS. Mind you, we are still at $123 and below the projections for the past three years.

And if that doesn’t put things into perspective, 2018 projections are at $147 EPS, a full 19.5% higher than the $123 EPS today. That’s a bold call. Since stocks are pushing multiples that are three times earnings growth, that would mean the stock market is going up 60% in the next year. Given this is the third highest valued market in history, I find it hard to believe that the S&P 500 that is now at 2,400 is going to be at 3,840 by the end of 2018.

It appears that the analysts are making profits out to be more than they really are, especially since we haven’t even caught up to the 2014 EPS predictions. And they’ve certainly set the bar high for 2018. If corporations miss expectations then that puts the stock market is a dangerous position.

Legendary Hedge Fund Manager Raises Billions
Legendary hedge fund manager Paul Singer raised 5 billion in new investor money in less than 24 hours. He’s been outspoken saying that “all hell to break loose” when referring to the US economy. The 5 billion raised is “dry powder” to use to deploy during the next market correction. In a letter to his clients where he’s describing the policy mistakes of the Fed and the overinflated market, he says about where things are headed, “…a lamentable scenario that will nevertheless present opportunities that are likely to be both extraordinary and ephemeral. The only way to take advantage of those opportunities is to have ready access to capital.

Fed Sounds Afraid
Even though I don’t think the Fed should be hiking rates this year, they are. And they are likely to continue. In recent speeches and public appearances, members of the Fed have been hawkish about further raising rates. When asked about the weak first quarter, they are quick to say that it is “transitory” and not likely to persist. I think they are getting worried that if the economy doesn’t pick up that they may have boxed themselves in with their easy money policy.

In a recent speech by Patrick Harper, President of the Philadelphia Federal Reserve Bank, he said, “And if something were to happen, if another crisis were to occur, further asset purchases may prove less effective, or perhaps even more difficult to execute, with a large balance sheet in place.” Given we are moving into the ninth year of this expansion and there are cracks forming everywhere, the Fed is hoping the economy can hold on for a few more years for them to raise rates and unwind the 4.5 trillion-dollar balance sheet they accumulated from successive quantitative easing programs. That’s another reason why I have said this next recession will be one of the worst because the Fed will have a limited ability to react. They will likely lower rates back down to zero, pour money into the economy and ask Congress to take rates negative. And even if they do all of that, they still may not be able to save the economy from a deep recession when this credit cycle and debt bubble pops.

Canadian Housing Bubble is Cracking
Toronto is experiencing a housing bubble like our 2008 housing bubble. After a year-over-year jump in prices of 33%, prices fell 3.3% last month and listings jumped 47% over a year ago. Get this, the largest Canadian alternative mortgage lender that focuses on giving loans to new immigrants and subprime borrows that have been turned down by other banks – (I’m not making this up!) is running a risk of failure as a run on deposits hits the bank. The Canadian central bank is has issued warnings and suddenly the Canadian real estate industry is concerned about contagion.

Not to be outdone, Australia and I think Sweden are also in the midst of unsustainable housing bubbles. There’s little doubt in my mind that if the Canadian bubble pops that it will be felt globally. We have a subprime auto bubble. Other countries have other bubbles which have all be created by central banks’ easy money and low-interest rate policies. As we know this won’t end well for these countries and the spillover could easily hit our shores. This time the central bankers don’t have the ammunition to fix the problem as quickly or easily as they have in the past.

Rally is Down to 5 Stocks
The stock market is shrugging off each little dip as investors perceive a dip as a buying opportunity. Don’t be fooled by this, the market is now being supported by five large blue chip technology companies. Most other stocks have already or are starting to give up support. If you say this sounds like the tech bubble in 2000, well it’s worse. The tech bubble was supported by more than five stocks. When these five go down, so will the rest of the market.

Chart of the Week
This week’s feature chart in the bonus section is a comparison of the percentage of banks tightening commercial real estate lending standards compared to the 4-week moving average for initial job claims. This chart shows how the initial job claims data lags the tightening of lending standards by about two to three years. To give you a preview, about three years ago lending standards started tightening. If the correlation holds true, unemployment claims should start to rapidly rise soon.

Client Update
This week the major stock indices made new highs, but only slightly and have been largely flat since early March. While it’s possible they can go higher the strength in this market is down to five large tech stocks. When they give up their leadership the market will start to move down which will create an opportunity to short the market. Following MSA’s research, we are being provided both short and mid-term momentum targets which I will show on this week’s graphs. A weekly close below the momentum targets opens the door to taking on short positions on the S&P 500 and Nasdaq-100.

I’ve audited MSA’s publications on the 2000 tech bubble. Their momentum work caught the downturn of the market before the large move down began. They alerted their clients then and will do the same again this time.

Mining stocks are in a holding pattern. Not making any strong moves up or down. The data shows the public or retail month has been big sellers this week, supporting the view that the public sells most at the bottom, suggesting the bottom can be at hand. MSA has provided momentum targets and updates them every week. I update my charts accordingly.

The narrative from other traders who follow gold is like mine. I have stated that prices on the miners are in a dead zone with no clear direction on prices going up or down. Given they can move several percentage points in a day, I must be more concerned about downside risk than upside. Given that, many others think that the miners are near a technical breakout and I have reviewed many other charts supporting that view. Those traders, like me, are also waiting for prices to break over their trendlines as we are waiting for a break over the momentum line or some form of signal that the big money is going to push prices over the momentum line.
Interest rates are starting to move back down and now many experts are saying that 2% or 1.8% are the next major moves for yields. As you may recall I indicated those points a month or so ago. That means yields are headed down and if they reach 1.8% it increases the likelihood that we will see a new all-time low in yields, as I predicted more than a year ago.

Prices dropped on agricultural commodities this week and there hasn’t been a strong support of buyers. It’s possible the selling may have exhausted and I came close to beginning our move in on Friday. Right now, prices are trading below the momentum line, but looking at the macro picture of the underlying commodities, there are bottoming trends forming. If prices do dip then I’ll look to start buying in or if prices can show some upward movement, then it will give me confidence that prices are not heading back down to their all-time lows. Either way, we have a hard target on the momentum structure on when to buy if all else fails.