CMG AdvisorCentral

Tactical investing news, views and resources for financial advisors

Debt and Demographics – Two Powerful Ds

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From On My Radar (September 29, 2017):

The global economy continues to improve.  Recession probability for the U.S. remains minimal in the next six to nine months.  Europe’s economy is on better footing.  Risks persist, including North Korea, a sharp slowdown in China, fiscal dysfunction in the U.S. (e.g., tax cuts, fiscal spend), and growing protectionist risks to global trade.  Debt remains a significant headwind to growth as can be seen in this next chart.

Total Credit Market Debt-to-GDP

Here’s how to read the chart:

  • The chart looks at a number of growth factors.
  • For example, nominal GDP (before inflation is factored in) is lowest when Total Credit Market is above 318% Total Debt-to-GDP.
  • The blue line tracks the Total Debt-to-GDP ratio over time.
  • Note the upper dotted “high debt” line at 318%.
  • The yellow highlights show the growth when in the high debt zone.
  • Note how much better growth is when in the low debt zone. Also note that Total Debt-to-GDP peaked in late 2009 but remains high.

Source: Ned Davis Research

Also note the very last data box “Non-Financial Productivity.”  Overall GDP growth comes from the total number of workers multiplied by their collective productivity.  More workers producing more equals greater growth.  With aging demographics (typically people moving into their lower spending years… they have a lot of stuff and kids out of the house) and fewer workers… you can see the pressure it can put on growth.  And then with debt to be repaid, how much extra money is there to spend on things.  Growth suffers.

Two Ds: Debt and Demographics are headwinds to growth.  It is going to be hard for corporations to grow earnings much faster than GDP.  Some will, of course, but in the aggregate, it’s a headwind and we are seeing it consistently in the low growth GDP stats.  What we really need is Dedication, Determination, and Discipline.  Let’s tell that to our representatives in Washington.

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Fed Leaves Interest Rates Unchanged; Expresses Confidence in Economy

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Following a two-day meeting of the policy-making Federal Open Market Committee (FOMC), the Federal Reserve held current interest rates steady, but the central bank is likely to raise rates in the coming months (possibly in mid-June).  Fed officials are not worried about the slow pace of growth during the first quarter of 2017.  (U.S. GDP grew at an annualized rate of 0.7 percent.)  The Fed said the slowdown was “likely to be transitory.”

“Inflation measured on a 12-month basis recently has been running close to the committee’s 2 percent longer-run objective,” the Fed said.  Household spending rose “only modestly” but the fundamentals underpinning consumption growth “remained solid.”

Declines in the unemployment rate has been the primary driver behind the Fed’s recent rate increases.  The unemployment rate fell to 4.5 percent in March, the lowest level since 2007.  (The Labor Department will release the April jobs report on Friday.)

A Look at U.S. Domestic Debt

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Total Credit Market Debt in the U.S. is 352.4% of GDP.  Post the peak in 2008 at north of 380%, this chart shows deleveraging has begun.

Recall the Reinhart/Rogoff study that debt greater than 90% of GDP slows growth.  We’ve certainly witnessed slow growth in the 2% range for the last 16 years.  Debt’s a drag on growth.

0210-06

Source: Ned Davis Research

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Real Implications of Reduced Pension Fund Returns

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pension_cartoon1Last week, the investment staff of CalPERS — the $300 billion California pension fund — announced that they want to reduce its target of 7.5 percent annual returns.  According to Chief Investment Officer Ted Eliopoulos, achieving a 7.5 percent annual return is no longer realistic.  Holy cow!

The implications of this proposal, if adopted, are significant and “would trigger more pain for cash-strapped cities across California and set an increasingly cautious tone for those who manage retirement assets around the country.”

Can you imagine how many people are going to be affected?  Here’s the bottom line.  The pension system, across our great nation, is underfunded and in trouble.

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Dalio: Are We at the End of a Long-Term Debt Cycle?

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10-21-00Ray Dalio established Bridgewater Associates in 1975.  With $150 billion under management, Bridgewater is the largest hedge fund in the world.  The firm has approximately 350 institutional clients, including public and corporate pension funds, university endowments, charitable foundations, supranational agencies, sovereign wealth funds and central banks.

In 2015, Bridgewater published Economic Principles, a research paper discussing the driving forces behind the economy, and explains why economic cycles occur by breaking down concepts such as credit, interest rates, leveraging and deleveraging.  Here at CMG, our interns are required to read Economic Principles, among other books.  Though lengthy, it is the best working model on global economic cycles, debt, education, inflation and more I have read.

Dalio was interviewed by CNBC’s Andrew Ross Sorkin at last month’s CNBC Institutional Investors Delivering Alpha Conference.  In this week’s On My Radar, we summarize the interview and address Dalio’s question, “Are we at the end of a long-term debt cycle?”

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The Quest for Yield

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Yields are at 5,000-year lows.

71% of the world’s government bonds are yielding less than 1%.  33% yield less than 0%.  In a picture it looks like this:

10-07-12

Source: Bloomberg; JPMorgan Asset Management, BofA Merrill Lynch

Risk is being overlooked in HY bonds.  Yields on high yield debt are close to the same yields on less risky loans.  The chase for yield has driven investors to riskier asset classes.

I am anticipating a once-in-a-generation buying opportunity in HY bonds.  While the trend this week is up, continue to invest with the trend.  Move to the safety of cash or Treasury Bills when the trend crosses down.

Click below for a great chart showing what a 1% increase in interest rates does to bond prices.  Show it to your clients!

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Global Debt Jubilee?

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When you borrow from tomorrow to spend today, that leveraged spending is good for growth.  At some point, you reach an end to just how much debt you can take on.  Reinhart and Rogoff suggest that threshold, based on hundreds of years of study, is 90% debt-to-GDP.  At some point, you cross a line. Take a look at the chart below.

9-16-9

I believe we are in a low growth, deflationary-pressured world until we solve and reorganize the debt mess.  A global debt jubilee?  We have a serious problem to solve and there is little motivation at this point to get started.  The markets may just force that hand.

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A World Awash In Debt

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Chinatown San Francisco Steve Blumenthal CMG Capital Management Group Inc.By Steve Blumenthal, CEO, CMG Capital Management Group

I walked through Chinatown in San Francisco last week.  Block after block, store after store, all selling the same stuff (t-shirts, trinkets, etc.).  Each looked exactly like the other.  Susan and I were heading to rent bikes for a trip across the Golden Gate Bridge.  That was wildly fun (and so was the wine and calamari in Sausalito).  Susan asked, “How do they all survive?”  The short answer is that not all will.  I tried to explain it to her this way.

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China Flashing Red Part II

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PJ Grzywacz President, Chief Compliance Officer, CMG Capital Management Group

PJ Grzywacz
President & CCO
CMG

In last month’s post, we highlighted real estate and slow growth warning signs of what seems to be an inevitable economic crash in China. The scariest part about these flashing signs is that there are plenty more indicators we hadn’t touched on. Let’s look deeper into some of the unemployment and debt issues China faces as it moves towards a tipping point of what could be an economic crisis.

  • Fewer workers moving to cities:  The workforce contracted in 2012 and 2013 by 3.45 million and 2.27 million workers, respectively. The Japanese bank, Nomura, states that the number of migrant workers has halved from 12.5 million to 6.3 million over the past four years.
  • Debt, debt and more debt:  Total bank debt has grown from $14 trillion in 2008 to $25 trillion today.  This represents the equivalent of adding the entire US banking system in the past 6 years.  A recent S&P report in June announced that China now has the largest corporate debt market in the world (although there are some questions regarding the validity of data).  Furthermore, the Bank for International Settlements, has indicated in its recent annual report that China’s financial system is “flashing red” as private sector debt to GDP is 23% higher than its long run norm.

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