Webcast #4 - The US will be experiencing diminishing marginal growth.

Full script:

Good day, ladies and gentlemen!

Welcome to our Singapore Macro Strategist channel!

Our webcast topic today is, “The US will be experiencing diminishing marginal GDP growth.”  Let’s take a look at some economic statistics and market data to check the US economic pulse and also to substantiate our opinion.

Before we start the ball rolling, we shall recap something in our previous videos first.

The US is experiencing decades of high equity inflows in 2021 which are caused by its stimulative packages and these equity inflows are unsustainable because the US will be conducting contractionary policies soon due to the excess liquidity in the financial system.

I will give you a moment to look at the chart first.

The overnight reverse repo market epitomized the excessive liquidity by hitting almost US$1T a few days ago.

As stated previously, the US FED wanted to inject US$120B on a monthly basis through mortgage-backed securities (MBS) and US treasury purchases.  

Instead, the US FED is draining away more than US$700B on a daily basis now.

Moreover, the M2 trend gap chart also showed a US$3.5T excess in M2 supply.

Prior to our discussion on the US GDP growth, we need to understand how the real economy works in the first place.

Let’s take a look at the following flow chart now.

In the real economy, inflation or deflation will prompt the central bank to use its monetary policy to manage the inflation or deflation so that the economic activities won’t be affected adversely which will impact the growth of the country.

In economic terminology, the central bank will use CPI and/or PPI to detect inflation or deflation.  Then, the central bank will manipulate the money supply (M1 & M2 spread) and/or yield spread (3-month & 10-year yield spread) to manage the inflation or deflation with the hope that the PMI won’t be affected negatively since the PMI will impact the GDP growth significantly.

Since we had been discussing the US inflation in our previous 3 videos, we would like to talk about the PMI in this video.

Let’s take a look at some PMI charts now.

The prices had increased to 92.1 because of the persistent high freight costs, higher crude prices, and rising material prices which still maintained the supplier’s deliveries at a high level of 75.1, and a higher delivery figure indicated slower deliveries.  The producers seemed to be stocking up on inventories (51.1) in anticipation of rising inflation which increased import (61)  but the local raw material declined (estimated -6.7) because of supply shortages.

The employment fell to 49.9 despite an increase in production to 60.8 which might denote some problem in increasing production.  This could be due to difficulties in retaining and finding workers.  The production increased because of a rebound in customers’ inventories to 30.8 that was affected by the new order.

The new order decreased to 66 because of rising new export order (56.2) but the local order decreased (estimated -1.8) due to consumers reining in their spendings and this was reflected in the May retail sales (-1.3%).

As the producers increased their production to meet the customers’ demand, the backlog of order fell significantly to 64.5.

All the above factors caused the PMI to decrease to 60.6 (-0.6) which was the lowest since February 2021.  In conclusion, the June PMI indicated that the US economic growth was in a downward trajectory and would experience a diminishing marginal GDP growth in the future.

Let’s take a look at the correlation between the PMI and GDP.

The Markit PMI chart is showing a high correlation between PMI and GDP.  The chart is also showing that the Markit PMI has already passed its inflection peak and will pull the GDP down in the future since PMI is a leading indicator.

Interestingly, the ISM PMI also shows a strong correlation between PMI and S&P 500 index.  The chart is showing that the S&P index has reached a turning point and is looking set to fall soon.

Simultaneously, the truck tonnage chart is also showing that the S&P index is overvalued.  The truck tonnage chart has a high correlation to the S&P index but the truck tonnage has deviated from the S&P index. This means that the S&P index has been trending higher despite declining physical goods transactions in the real economy.  What does this mean?  It means that wall street is doing extremely well but main street is not.  Therefore, there is a higher propensity for the S&P index to fall in the foreseeable future.

Furthermore, Bank of America predicted that the global earnings had passed their peak in April 2021.  Goldman Sachs also projected that the S&P earnings yield would fall in 2021 and 2022. Thus, the stock market looks set to fall in the future.

Although the US durable goods order increased in May 2021 on a month-on-month basis, it actually declined significantly on a year-on-year basis.  The durable goods order excluding transportation also had been trending down recently which corroborated the declines in physical goods transactions portrayed by truck tonnage.

Besides the low base GDP effect in 2020, the exceptional rebound in GDP growth in 2021 is also caused by surges in margin debt as depicted on the chart due to FED’s QE programs.  Consequently, the margin debt boosted the S&P 500 index to a record high since margin debt had a strong direct correlation with the index.  Likewise, the FED’s QE tapering will cause the stock market to fall too.

Since the employment sub-index in the ISM PMI decreased in June 2021, let’s take a look at the real employment situation in the US now.

The ADP June employment report indicated a jobs gain of 692,000 and most of the gains were in the services sector.  Furthermore, the non-farm payrolls also reported a gain of 850,000 and indicated the same phenomenon in the services sector.  Thus, the decline in the employment sub-index in the ISM PMI reflected the correct employment situation in the manufacturing sector.

Although the US is a service-oriented economy, the manufacturing sector will still indicate a correct employment trend over a long period because it has a strong direct correlation with the total employment situation.

As the employment situation has rebounded in the services sector and wages have risen strongly, the US consumer confidence continues to trend higher since the US consumers have a high savings rate now.

Is the US stock market really overvalued now?

Let’s take a look at 2 eminent indicators first: Warren Buffett Indicator and Shiller Price Earnings Ratio.

The Warren Buffett indicator is indicating that the US stock market is significantly overvalued at 206.5% which is an all-time high.

The Shiller P-E Ratio is also indicating that the US is significantly overvalued at 38.3 which is about 100% above its 20-year average.

Next, we shall take a look at the correlation between Warren Buffett Indicator and S&P 500 index.  We can notice from the chart that a stock market fall will usually happen when the Warren Buffett indicator is at its peak.  Therefore, it is likely that the S&P 500 index is at its peak now or will be approaching its peak soon because the US FED will be conducting contractionary policies soon.

The household equities to disposable personal income value had just passed its peak which indicated there was not much upside left for S&P 500 index.  Consequently, the S&P 500 index is currently above its long-term mean which is at decades high.

Simultaneously, the high presence of zombie companies is a worrying sign for the financial market, particularly the stock market because of impending default risks when the interest rates begin to rise and bank lendings start to tighten.  These zombie companies, also known as loss-making firms, also had raised record amounts of debts through share offerings.  Therefore, the financial markets will face a domino effect when these zombie companies start to crumble under their own debts.

Will the interest rates be rising soon?

Let’s take a look at the 10-year yield or risk-free rate forecasts by Goldman Sachs.

The 10-year yield is projected to exceed 2% in 2022 and thereafter and this will cause the lending rates to increase too.  When the risk-free rate is higher, many financial assets will be revalued lower at much higher discount rates which will lead to lower valuations.  The IMF has also projected the US FED to raise its benchmark rates by the end of 2022 at the earliest time.

Last but not least, China will continue its monetary tightening into 2022 and this will cause China's credit impulse to decline further.  Please watch our previous video for China's credit impulse effects on the US.

Like we had stated in our introductory opinion, the US would be experiencing diminishing marginal GDP growth.  The US GDP growth forecast chart by the New York Fed also corroborated our opinion.

In conclusion, we think that the US has overfed itself for too long with QE and low-interest rates.  Not only does the US need to wean itself off the QE programs, but it also has to catheterize itself by raising interest rates to reduce its debt burdens.

Finally, we have come to the end of our video.  We had spent tremendous time and effort sifting through many reports and charts to create informative and educational videos for our audiences.  Therefore, please remember to subscribe, like, and share our videos to show your support for us.  Thank you very much!