John J. Xenakis
End of sequestration signals explosive new spending splurge in Washington
The Iraq war had nothing to do with the federal deficit
We have governments around the world spending like drunken sailors. Japan and Europe are planning enormous quantitative easing programs, and the new radical far-left government in Greece is demanding that many of its debts be erased so that it can go on a new spending binge.
America's experiment with "sequestration" was truly mind-boggling. It was proposed by President Obama as a stunt, thinking that the Republicans would never agree to let it be applied to defense spending, and then when the Republicans signed on, we could all enjoy a few rounds of Schadenfreude watching Obama try to squirm out of it.
What was mind-boggling about it is that it did cap spending in Washington for a while, something akin to pigs flying, and something that could only have happened by accident -- in this case the unexpected outcome of Obama's stunt.
But now many Republicans are pointing to unrest in the Mideast and the militaristic rise of China with concerns for the defense budget, while Obama would like to join Greece in going on a new spending binge.
A major part of that spending binge is on Obamacare, which is a financial disaster but is being held together with duct tape and astronomical subsidies. In 2014, 87% of federal Obamacare enrollees got subsidies. For the silver plan, out of an annual $4,140 premium, the subsidy amounts to $3,132, leaving the patient only $828 to pay out of the $4,140. And even with that, a typical deductible is $5,000-15,000, which means that most of these insured are effectively uninsured, since they'll have to pay all their own medical expenses anyway. So there may be more "effectively uninsured" people today than there were uninsured people in the past.
Then there's CNBC, where the analysts lie constantly about stock valuations. I used to quote analysts doing this, hoping to name and shame them. (See, for example, "14-Apr-12 World View -- Wharton School's Jeremy Siegel is lying about stock valuations" from 2012.) But now criminal fraud is so entrenched in the culture that no one has any shame. And they're just taking after the Obama administration that brings criminal investigations against reporters they don't like, and uses the IRS to attack political opponents with a level of criminality that goes far beyond what Richard Nixon ever dreamed of or was threatened with impeachment for. Congress is just as bad, with massive insider trading and fraud conducted by both parties and both branches of Congress, as exposed by former Breitbart editor Peter Schweizer, covered at length on the CBS show 60 Minutes.
By the way, according to Friday's Wall Street Journal, the S&P 500 Price/Earnings index (stock valuations index) on Friday morning (January 31) is still at an astronomically high 19.79. This is far above the historical average of 14, indicating that the stock market is in a huge bubble that could burst at any time. Generational Dynamics predicts that the P/E ratio will fall to the 5-6 range or lower, which is where it was as recently as 1982, resulting in a Dow Jones Industrial Average of 3000 or lower.
I've been around for a long time, but I never thought I'd live to see the current massive level of criminality in Washington and on Wall Street.
With sequestration likely to be thrown out, and a new spending binge approved in Washington and around the world, this is a good time to go over some interesting facts about the federal deficit. AP and Guardian (London)
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We're going to look at the above graph, step by step, to show where the federal budget deficit comes from.
Almost everybody believes that the large federal budget deficit was caused by the 2003 invasion of Iraq. Nothing could be farther from the truth. In fact, since the deficit began in the year 2000, so the Iraq war couldn't have caused it.
So start by looking at the above graph. To begin, focus on the blue line - government expenditures:
- Government spending was $600 billion in 1980, and $3.9 trillion in 2014.
- Notice that there is NO BULGE in 2003 at the start of the Iraq war. Spending increased at the previous rate. That's because there was no draft, and no new troops were recruited. Troops working on other projects were reassigned to Iraq, so there was no increase in expenditures.
Government receipts plunged when the bubbles burst.
- Notice that the blue line levels off in 2011. That's because of sequestration. That's the only time that government spending was not increasing rapidly.
Next, in the above graph, focus on the red line - government income / tax receipts:
- Tax receipts were $340 billion in 1980, and $1.8 trillion in 2014.
The high federal deficit is caused by bubbles bursting, not the Iraq war.
- Tax receipts plunged in 2000, because of the tech crash in the stock market. They start to recover in 2004, thanks to the real estate and credit bubbles. Then they plummet sharply again in 2008, as the real estate bubble collapses. Tax receipts rise again in 2010, because of quantitative easing and the new stock market bubble.
Finally, in the above graph, focus on the green line - government surplus or deficit (surplus increase upward, deficit increases downward):
- Federal surplus = income - outlays. Deficit = outlays - income.
- The deficit has not been affected by outlays or government spending, even by spending on the Iraq war.
So the government surplus at the end of the 1990s was caused by the tech bubble. The government deficit in the early 2000s was caused by the crash of the tech bubble. The reduced deficit in the mid-2000s decade was caused by the real estate bubble. The deficit increased when the real estate bubble crashed. Now the deficit is coming down because of the new stock market bubble.
- The deficit went down when income went up, and vice versa. The deficit depends entirely on tax collections, and tax collections have depended on the real estate and stock market bubbles.
As I wrote above, the S&P 500 Price/Earnings ratio is at astronomically high levels. It will fall to about 5-6 or lower at some point, and the stock market index will fall by 75% or more.
At that point, the deficit will soar to unsustainable levels, and all these new spending programs will have to be canceled, except those on which the survival of the country depend.St. Louis Fed - Fred graphDYI Comments: This is a very real possibility however don't be confused into thinking this will be a 1929 to 1932 event. While often cited as an example of a bear market, that drop is the exception rather than the rule, thus confusing many investors since the Great Depression. As popular as those notions of a 1929 - 1932 bear a more likely time frame taking equities from overvaluation to undervaluation is around ten years. Then into a trading range for years before the next bull market. This is exampled by the 1907 to 1922 bear and the 1966 to 1982 market decline.
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After prices for stocks dropped to undervalue the market went into a multiple bull and bear cycles within a secular bear market. This period of time is called the "accumulation stage."Those who were young(er) in the accumulation stage of their life could dollar cost average into an ever increasing dividend yield continuously. Or those with a bit more savvy would take money from savings and lumped sum every time the market went back into it's cyclical bear.
To show this clearer an inflation corrected chart of the Dow.
August of 2000 the market peaked (based on dividend yield) with a miniscule yield of 1.11% or price to dividends of 90 to 1. At that time those investing in stocks would have a duration of 90 years in order to obtain the long term return of that market(around 9%-10%). Institutions such as Harvard or Yale with endowments going back before this country become a nation would have an impossible justification buying at those levels.
The cyclical bottom for yield of the 2000 tech smash on February of 2003 didn't provide any relief, as the dividend yield only climbed to 1.93%! Those buying stocks at those high levels were playing the bear market rallies, as opposed to investing.
The cyclical bull returned the market topped (based on dividend yield) with a small 1.72% yield in March of 2007. Notice this top's yield is greater than the previous secular top for equities at 1.11%. The bear returns driving down share prices bottoming in March of 2009 with an almost reasonable yield of 3.60%, marking a lower low with a fatter dividend yield.
As of July and November of 2014 dividends peaked, if we have seen the top, at 1.91%. When the bear returns stocks will be driven down low enough to best the 2009 if history is any guide. Before the secular bear market ends there will be two or three more bull/bear cycles to go. The bottom of the secular bear will be marked by a disdain and more importantly total disregard for equities by the investing public. The value player, either the old timer with gray hair or the young but savvy historically informed will be in a candy store buying corporate assets most likely 30% or less to their liquidating value. That is correct a 70% plus discount! Dividend yields of 5%, 6% and 7% will be common place.
The Great Wait Continues!
DYI
Capitulation
Short term bonds will join money market funds at the opposite spectrum of long term bonds at Max-Pessimism. When that occurs short term bonds and money funds will be a buy as we approach the inflationary 2020's the conservative investor/saver will have some chance of maintaining their purchasing power as interest rates play catch up to inflation as the Fed's attempt to suppress interest rates. Let's not get too far ahead of our selves the next 4 to 5 years will be deflationary despite the Fed's money printing.
DYI
The cyclical bottom for yield of the 2000 tech smash on February of 2003 didn't provide any relief, as the dividend yield only climbed to 1.93%! Those buying stocks at those high levels were playing the bear market rallies, as opposed to investing.
The cyclical bull returned the market topped (based on dividend yield) with a small 1.72% yield in March of 2007. Notice this top's yield is greater than the previous secular top for equities at 1.11%. The bear returns driving down share prices bottoming in March of 2009 with an almost reasonable yield of 3.60%, marking a lower low with a fatter dividend yield.
Estimated 10yr return on Stocks
As of July and November of 2014 dividends peaked, if we have seen the top, at 1.91%. When the bear returns stocks will be driven down low enough to best the 2009 if history is any guide. Before the secular bear market ends there will be two or three more bull/bear cycles to go. The bottom of the secular bear will be marked by a disdain and more importantly total disregard for equities by the investing public. The value player, either the old timer with gray hair or the young but savvy historically informed will be in a candy store buying corporate assets most likely 30% or less to their liquidating value. That is correct a 70% plus discount! Dividend yields of 5%, 6% and 7% will be common place.
The Great Wait Continues!
DYI
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John P. Hussman, Ph.D.
The combination of widening credit spreads, deteriorating market internals, plunging commodity prices, and collapsing yields on Treasury debt continues to be most consistent with an abrupt slowing in global economic activity. Generally speaking, joint market action like this provides the earliest signal of potential economic strains, followed by the new orders and production components of regional purchasing managers indices and Fed surveys, followed by real sales, followed by real production, followed by real income, followed by new claims for unemployment, and confirmed much later by payroll employment. Stronger conclusions, particularly about the U.S. economy, will require more evidence, but from a global perspective, these pressures are already quite evident.
Now, my impression is that yields may move even lower over the next few quarters if the economy weakens, in which case we might even see a 1-handle on the 30-year bond and a 0-handle on the 10-year. But bonds are already priced at speculative levels in the sense that one must expect virtually no normalization of yields at all, for years to come, if one is to avoid net losses on purchases at these levels. As usual, our own approach leans toward seeking longer duration on upward spikes in yields, and avoiding long-duration exposures on overextended retreats in yield. In short, 10-year Treasury bonds are priced to be feeble long-term investments, as are nearly all other investment classes thanks to years of yield-seeking speculation. But the assets that will be hit first – and hit hardest in any normalization of yields or risk premiums – are likely to be junk, then equities, then seemingly credit-worthy corporates, with Treasury debt at the tail end of that normalization.
With median valuations for the average stock higher now than in 2000 on the basis of price/revenue, price/earnings, and enterprise-value to EBITDA; with numerous historically reliable valuation measures more than double their pre-bubble historical norms; and with the S&P 500 now beyond the peak valuations of every market cycle on record (including 1929) except for the final quarters surrounding the 2000 bubble, understand that stocks are no longer an investment but a speculation. There are times that such speculation tends to work out – but those times require risk-seeking preferences among investors, which can be inferred from features of market action that are not in place at present. I expect that these distinctions will serve us greatly over the completion of the present cycle and in those to come.DYI Comments: DYI's sentiment indicator for long term bonds is one notch from the very top, as I've stated many times when the next recession arrives treasury yields will be driven down to absurd low levels moving our indicator to Max-Optimism.
Market Sentiment
Capitulation
Short term bonds will join money market funds at the opposite spectrum of long term bonds at Max-Pessimism. When that occurs short term bonds and money funds will be a buy as we approach the inflationary 2020's the conservative investor/saver will have some chance of maintaining their purchasing power as interest rates play catch up to inflation as the Fed's attempt to suppress interest rates. Let's not get too far ahead of our selves the next 4 to 5 years will be deflationary despite the Fed's money printing.
DYI
