Financial Strategist: Trade War Could Usher In Dire Financial Crisis MUCH SOONER

According to a Societe Generale strategist Albert Edwards, a trade war would bring about a financial crisis a lot sooner than anyone expected. Edwards has warned in the past that currency devaluation could spark an economic recession worse than 2008, and now he’s sounding the alarm about Donald Trump’s trade policies.

Edwards now points to the Trump administration’s trade policy as yet another catalyst that could hasten the next crisis. Recent tariffs the US imposed on steel and aluminum imports threaten a full-scale trade war, he claimed.  While tariffs and taxes always get passed onto the American consumer in the form of higher costs for goods, it is unfortunate that the tariff talk is ongoing.

The US could also turn on other trading partners as Trump continues to advance his “America First” agenda, reported the Financial Tribune. “Boiling away in the background is Germany’s, and now also the eurozone’s, outsized trade surpluses” with the US, Edwards said. He added, “Expect Trump to soon turn his protectionist fire on both Germany and the EU. That will be messy.”But there is some good news many in the mainstream media continue to ignore:

While much of what Trump is announcing today has already been leaked, here are the details of the import tariffs Donald Trump formally adopted on steel and aluminium imports which allow US allies to negotiate and apply for exemptions, a sign of the growing concern that the president was alienating America’s closest international partners, and that 2 of the 4 largest foreign suppliers of steel will be exempt. –Zerohedge

“A trade war and competitive currency devaluation was always going to be the end game in our Ice Age thesis as a global deflationary bust destroyed wealth, profits, and jobs,” Edwards said in a note on Thursday. “But it looks as if it might be arriving sooner than we had anticipated.”

China exports just 1.1% of its steel to the United States, therefore, the tariffs are considered unlikely to do any serious damage to Chinese businesses. The more immediate fuel for a trade war, Edwards said, is retaliatory action against China by the US for alleged intellectual property theft. The Nikkei Asian Review reported Wednesday that the US was set to impose tariffs on $60 billion worth of Chinese products as punishment. Yet remember, a tariff isn’t going to punish the Chinese; it will punish the American consumer as prices go up to cover the cost of the new tax.

A White House official says there will be no significant downstream price effects, and thus no significant downstream job effects, according to Zerohedge. But that expectation counters multiple statements and prognostications from several companies and industry groups that use steel and aluminum, as well as lawmakers representing them, who have warned the tariffs will harm their businesses or industries.

Bank Of America: "This Is A Sign Of Irrational Exuberance"

Two weeks ago, when discussing a recent Albert Edwards piece, we said that the word that has come to define the new normal better than all others, is "paradox", as in nothing makes sense, or rather everything makes sense if one only flips logic and reason 180 degrees. A "paradox" was on full display in the latest Bank of America Fund Managers Survey which found that once again, the percentage of respondents saying equities are overvalued hit a new record high of 45%; and yet the average cash levels continue to fall as one professional after another - whose year end bonus depends on whether they outperform the market - rush to allocate funds to equities, which most now agree are an asset bubble.

And while we call this "paradox", Bank of America has another, more familiar name for the phenomenon: "this is a sign of "irrational exuberance"."

Yet while breakneck allocation to stocks continues apace, there has been notable rotation within the sector, and as the next chart shows,  the November rotation shows buying of cyclicals and value, and selling of 2017 winners such as EM, Japan, Tech. It is unclear what is going on in December when everything appears to be bought.

Also of note: the tech sector allocation appears to be rapidly declining, and in December fell to 24% overweight, "the long-term average and the lowest z-score for tech in 3½ years."

But while the "growth" narrative may be fading for now, Goldilocks remains the consensus view for the global economy, with 54% of investors surveyed expecting above-trend growth and below-trend inflation in the next 12 months, just 2% lower than last month’s record high. As BofA adds, "Goldilocks is now the consensus view for the global economic outlook" while the "below-trend growth/ inflation" outlook rose 2ppt to 27%, close to May"11 lows & a total reversal from Jun"16.

Meanwhile, the yield curve reaches its flattest levels since the GFC as net 0% investors say they don"t need fiscal stimulus, the highest since 2011.

And speaking of the yield curve, net 8% of investors surveyed expect the U.S. yield curve to flatten in 2018, the highest level in 18 months

Separately, as reported earlier, "Long Bitcoin" is again considered the most crowded trade (32%) for the second time this year, followed by Long FAANG+BAT (29%) and Short volatility (14%)

As also noted, a central bank error, i.e. "policy mistake" by the Fed/ECB continues to be the top tail risk cited by investors (23%); the top three are rounded out by a crash in global bond markets (15%) and a Chinese debt crisis (14%)

When asked about the consequences of the GOP tax bill, a whopping two-thirds of respondents, a stunning consensus for this survey, expect tax reform to result in higher bond yields and higher stocks, while only 3% think tax reform will lead to lower yields and lower stocks.

 

Also, just 7% of investors say global interest rates will be lower in the next 12 months; 77% say interest rates will rise.

Translation: one year from now stocks and yields will be far lower.

Also, in December global investors favored banks, technology, industrials, insurance and discretionary while avoiding staples, telecoms and utilities. Which means the contrarians should do the opposite.

Here is how Michael Hartnett summarizes the big picture themes from the December FMS:

• Golditrumps: consensus still smitten by Goldilocks...54% expect "high growth, low inflation" in 2018. Almost 2/3 investors believe US tax reform will induce higher stocks & rates, but fiscal stimulus has coincided with lower, not higher profit expectations, and that will need to change given EPS leads relative performance of cyclicals by 3 months (Exhibit 10).


• Pro-cyclical Consensus: Investors are long macro "boom", short "bust"; long stocks, EU/Japan/EM stocks, financials (2nd largest ever), materials (highest since 2/2012) vs short government bonds, US stocks, healthcare & utilities. Pro-cyclical consensus entrenched by US tax reform across asset classes, bar, intriguingly, leading tech sector where allocations dropped to lowest since June 2014.


• FMS Crowded Trades: ...#1 long Bitcoin (32%), #2 long FAANG+BAT (29%), #3 short volatility (14%), while expectations for a "flatter yield curve" surged (highest in 18 months), all trades vulnerable to higher inflation & aggressive ECB/BoJ Quantitative Tightening in 2018.


• Contrarian Recession Trades: ...a recessionary bust even more contrarian than inflationary boom, lower rates more contrarian than higher rates, making short equities-long bonds, short banks-long utilities, short EAFE-long US stocks the most contrarian trades of all heading into the new year.

Finally, when asked when this bubble finally ends, investors were split on the expected timing of equity markets peaking in 2018: 25% see a peak in Q1, 30% in Q2, and 28% in the second half of the year

Albert Edwards: "Clients No Longer Care About Overvaluation; They Are Concerned About Triggers And Timing"

"How do you know when an asset price rise has turned into a bubble?" That"s the rhetorical question Albert Edwards leads his today"s Global Strategy Weekly note, and responds that in the non- virtual world, valuation is often a good starting point. "A bubble can also be identified by the steepness and persistence of any price ascent as doubters and naysayers are swept away in a tidal wave of bullish froth." We showed as much two days ago when we brought our readers the latest chart from Convoy Investments, showing that Bitcoin has now surpassed "Tulip Mania" in terms of sheer exponential price action.

Well, according to Edwards, it"s not just bitcoin: the vertical price ascent "is something the main S&P Composite Index certainly shares with Bitcoin." And whereas one justification for the surge in stocks is a profits recovery, Edwards counters that "the underlying profits recovery looks increasingly fragile and indeed on some key measures a rapid deceleration is underway. With equities over-valued, overbullish and now also over-bought, the boring old profits cycle still needs watching."

All of which brings us to a fundamental question: why do people avoid bubbles in the first place if - by definition - so many other investors are actively buying them up?

According to Edwards, the answer is that "investors generally agree, usually through hard experience, that to avoid or short an asset class on perceived overvaluation alone is to risk buying a one-way ticket to ruin. That is not to say that investors do not accept the basic investment principle that the primary determinant of long-term investment returns is their entry valuation. But as we have seen with equity markets in recent years, the market can stay expensive and irrational far longer than most investors can stay solvent, or indeed longer than most investment managers can retain their jobs in the face of underperformance."

Which brings us once again to a point that Citi touched on in June, namely that every asset class iw now a bubble as "the principal central bank transmission channel to the real economy has been... lifting asset prices." That has required continuous CB balance sheet growth. Meanwhile, as financial markets scramble to maximize every last ounce of what central bank impulse remains, we get such bubbles as London real estate, bitcoin and vintage cars, or as Citi puts it: "the wealth effect is stretching farther and farther afield." Yes, bitcoin is merely one of the side-effects of the biggest bubble in history that central banks have blown over the past decade.

And here Stanley Druckenmiller was spot on when he told CNBC on Tuesday that the bitcoin bubble will burst - as all bubbles eventually do - but only after the far bigger central bank bubble has also finally exploded and central planning is no more:

Druckenmiller: Bitcoin, art, wine, equities, credit, you name it. everything is one way up and there are huge distortions taking place, and it’s all in the name of this 2% inflation target. And when you get a misallocation of resources, it really hinders growth over the longer term.

Going back to Edwards, he naturally agrees with Druckenmiller and Citi, and explains that clients are forced, as Chuck Prince of Citigroup famously said, to keep dancing while the liquidity mood music is playing. In fact, the SocGen strategist claims that "clients are no longer concerned with overvaluation; they are more concerned about timing and triggers."

But instead of focusing on Bitcoin, Edwards then once again takes aim at his favorite nemesis - equities - and notes that "two key additional indicators to undermine the equity market have now fallen into place."

As well as  overvaluation, we showed recently that the extreme bullishness currently prevailing among professional advisors has not been seen in markets since (just before) the 1987 crash. In addition, amid all the focus on the parabolic rise of Bitcoin it has gone almost unnoticed that, following its rapid ascent, the main S&P Composite index is now most overbought since 1995 (see chart below).  Yet even this overvalued, overbullish and overbought market might not be enough to unleash the dormant bear (see for example, John Hussman?s excellent writings).

Still, to justify his gloom, Edwards usually has some basis in reality besides merely price action, and the same is true this time, when he notes that while US EPS seems on most measures to be running at around a 10% annual clip and in the latest Q3 national income accounts (NIA), whole economy profits data confirms a 10% rise...

... if one scratches the surface, all is not well. Looking at only domestic, non-financial companies (ie companies selling in the US), profits have barely rebounded on an economic basis (ie adjusting for inventory gains and putting depreciation on an economic, rather than tax basis).

Edwards goes on to show two more cases in which US-based national profits continue to be quite anemic, and certainly not keeping up with the market"s euphoria, but his coup de grace chart is one which we recently showed courtesy of UBS, and which demonstrated that ex-energy investment, US growth has been the lowest since 2010.

And here is Edwwards:

"in addition to our concern that domestic, non-financial profits growth is so much more anaemic than headline stock market profits growth suggests, we also note that much of the rebound is driven by the recovery in the oil price. Excluding energy, the post-2015 profits surge is already decelerating (see chart below). And in an over-valued, over-bullish and overbought market, this profits deceleration might yet prove to be highly significant."

With the oil price at 2 year highs, with net oil specs at record levels, and with US shale production set to surge in the coming weeks, the recent torrid ascent in oil prices is set to end with a bang. And, if Edwards is right, it will drag the rest of the economy - and market - with it. The good news for crypto fans is that since virtual assets are by definition removed from the underlying non-virtual reality, their ascent can continue, and in fact it will, at least until central banks finally throw in the towel and stop i) their unconventional stimulus and ii) printing money.

We won"t be holding our breath.

Albert Edwards: "Here"s Why The Current Situation Is Even Worse Than The 2008 Crisis"

Back in May, we first reported that Goldman became the first bank to dare to ask if the Fed has lost control of the market, if in slightly more polite terms of course. This is how Jan Hatzius phrased it: "Despite two rate hikes and indications of impending balance sheet runoff, financial conditions have continued to loosen in recent months. Our financial conditions index is now about 50bp below its November 2016 average and near the easiest levels of the past two years." Several months later, after the third rate hike, Goldman found that once again, paradoxically, financial conditions eased further, and the market rose even more in direct opposition of what Fed rate hikes are supposed to do!

Fast forward to this weekend, when we reported that that lovely word which describes the new normal so well - "paradox" - made a repeat appearance, this time in the last quarterly report by the Bank of International Settlement, which for the n^th time issued an alert on the state of the stock market, an alert which will be summarily ignored by everyone until after the crash, and reminded everyone what happened the last time financial conditions eased instead of tightening when the Fed hiked rates (spoiler alert: biggest crash in modern history). This is what the BIS" chief economist Claudio Borio said (among other things)"

Hence a paradox. Even as the Fed has proceeded with its tightening, overall financial conditions have eased. For instance, a standard indicator of such conditions, which combines information from various asset classes, points to an overall easing regardless of the precise date at which the tightening is assumed to have started. Indeed, that indicator touched a 24-year low. If financial conditions are the main transmission channel for tighter policy, has policy in effect been tightened at all?  (We can see from the BIS chart below how, unlike the last 12-month period, the Chicago Fed Financial Conditions Index did actually tighten in the May 2004-May 2005 period, and especially in the January 1994-January 1995 period.)

“In fact, this paradoxical outcome is not entirely new… it is reminiscent of the Fed policy tightening in the 2000s - the phase that spawned the now famous "Greenspan conundrum". Then, overall financial conditions hardly budged, and in some respects eased, as the Federal Reserve progressively raised rates. The experience contrasted sharply with previous tightenings, not least the one in 1994. At that time, long-term rates soared, the yield curve steepened, asset prices fell, corporate spreads widened, and EMs came under pressure. 

 

Today"s experience is reminiscent of the repeated reassurance of the 2000s" "measured pace", except that the adjustment has been, if anything, even more telegraphed. If gradualism comforts market participants that tighter policy will not derail the economy or upset asset markets, its predictability compresses risk premia. This can foster higher leverage  and risk-taking. By the same token, any sense that central banks will not remain on the sidelines should market tensions arise simply reinforces those incentives. Against this backdrop, easier financial conditions look less surprising.

Today, it was SocGen"s grumpy "permarealist" Albert Edwards" turn to focus on this peculiar "paradox" in which the more the Fed tightens, the higher markets rise in the process "poisoning the market."

Picking up on what Bank of America showed yesterday, namely that central banks broke both volatility and the market itself some time in 2013/2014...

... in his latest "weekly" note (published about 3 weeks after the last one), Edwards writes that "so scared (or is that scarred) were central bankers after the summer 2013 taper tantrum, they have now gone out of their way to reassure financial markets. Thus recent tightenings of monetary policy, whether by the Fed, ECB or Bank of England, were all perceived by markets as "dovish" tightening - and hence led to even more buoyant financial markets. Policymakers are so scared the financial bubbles they created might burst that today what might be good for the economy is subservient to the needs of Wall Street."

He then brings up our favorite new normal word - "paradox" of course - and lays out the problem on the chart below, stating that "the current situation is even worse than in the run-up to the 2008 crisis. At least back then rate hikes did not lead to easing financial conditions the way they do now! The Fed"?s desire to soothe the nerves of the financial markets has made a mockery of their tightening cycle."

Naturally, Edwards was just getting started, and the furious rant continues:

You don?t have to be a genius to reach the conclusion that central banks? dovish tightening really means there has been no tightening of monetary policy at all for Wall Street. But for Main Street, interest rate hikes do have an economic impact that will ultimately end in recession, and like an increasingly stretched elastic band this tension will eventually snap with disastrous financial market consequences. Many clients we meet have similarly apocalyptic views to our own but remain fully invested. They cannot see an immediate trigger for the financial Armageddon that they accept is heading slowly our way.

And yet, despite central bankers" best intentions to kill the free and efficient market, this time something may be changing, and may soon unleash that "shock" event that is so critical for the market to determine just what the new strike price of the Fed put is as BofA explained: that something is China.

Making the "China" case, Edwards refers to a post we published recently, and cautions that "investors are convinced that China?"s policymakers remain firmly in control of economic events." Here"s why that is no longer the case.

But Gordon Johnson of Axiom Capital notes it may be that the China credit multiplier, after years of diminishing returns, is finally exhausted. He writes, “given what we’ve seen this year – ie 101.7% new credit issuance growth YTD through Oct. 2017 (see chart below) – it seems the level of credit necessary to stimulate growth in China could prove elusive at this point. We don’t recall any economist’s forecasts exiting 2016 pointing to China’s new credit issuance more than doubling Y/Y in 2017, yet that’s exactly what’s happened. Had this been our base case, we would have expected all economic indicators in China to be moving substantially higher at this point in the cycle.”

Edwards then goes full circle to reach the same conclusion we have referenced so many times: the next crash will come out of China, and it will be at Beijing"s doing:

On this view if China?s policymakers are now pressing hard on the policy brakes after their politically expedient puffing up of the economy, a soft landing might prove more elusive than almost any investor currently assumes. Could this yet be the trigger that blindsides investors?

It could, especially since it was -ironically enough - China which in early 2016 halted what then appeared to be a global risk crash:

... it was this February?s Shanghai G20 deal that marked the point when global investors totally removed China from their watch list of things to be concerned about. That G20 meeting saw an agreement not to engage in further competitive devaluation and helped reverse the period of sustained dollar strength that had been exacerbating the renmnibi""s problems (weaker US economic data in the face of huge dollar bullishness also helped reverse the dollar?s prior relentless rise). Hence investors are very relaxed about China at exactly the point they should not be.

Which is why it would be so delightfully ironic once the next global crash originates out of China, the same country that saved the world with its gargantuan credit creation first in 2008/2009 and the second time in 2016/2017. Ironic, or perhaps the right word is paradox...

Albert Edwards On The Selloff: "Comparisons With October 1987 Are Entirely Justified"

Last week, when equities were still blissfully hitting daily record highs, we showed the one "chart that everyone is talking about", or if they weren"t they soon would be: the sharp, sudden disconnect between the junk bond and stock market ...

... a disconnect which - as we showed at the time - was last observed in mid-August 2015, just days before the infamous ETFlash crash. Fast forward to day, with stocks suddenly hitting air pockets around the globe and rapidly catching down to junk yields...

... when this enveloping divergence between the conflicting narratives by equities and bonds was the center piece of Albert Edwards latest letter to clients. In it, the SocGen strategist highlights the ZH chart and, ever the pragmatist, wonders why it took not only stocks, but junk bonds so long to react to the steady deterioration in underlying balance sheet quality, a topic discussed most recently by his colleague Andrew Lapthorne...

...  who showed that "interest coverage for the smallest 50% of US companies is near record lows, at a time when interest costs are extremely depressed and when profits are at peak." Lapthorne"s conclusion, which echoed what the IMF said earlier in the year, "It is difficult to envisage a scenario in which this ends well."

Albert picks up on this theme in his latest note released today, and writes that "investors are beginning to punish the corporate debt and equity of highly indebted US companies. We have highlighted consistently that excess US corporate debt is probably the key area of vulnerability that could bring down the QE inflated pyramid scheme that the central banks have created."

To demonstrate this point, Edwards shows another bizarre "balance sheet debauchment" divergence, one between surging leverage, and record low junk bond yields, to wit:

... we think the high yield corporate bond market should have been revolting against balance sheet debauchment some time ago. That would be the normal state of things with net debt/profit ratios so very high (see chart below but note bottom-up data shows a far higher peak than this top-down Fed data but peaks normally occur as profits fall in recession).

As the chart above suggests, junk bond yields would have to be double current levels to be aligned with "fair value" as imputed by the current state of the corporate balance sheet, however with the ECB purchasing billions in corporate bonds every month, this clearly won"t happen for a long time.

Edwards also show a chart revealing why the US is unique among the major developed regions: only there has corporate debt bloated to levels last seen during the great financial crisis. As for the reason, we just discussed it earlier: all bond issuance has been used to fund stock buybacks, pushing the S&P to all time highs.

And speaking of the final frontier, i.e. equities, which are always the last to get any memo, Edwards"s biggest concern is the sheer euphoria and that various sentiment indices - such as the record expectations of higher market moves 12 months forward as per UMich - have reached extremes of bullishness which have rarely been seen. One among these is the Investor Intelligence Sentiment Survey.

CNBC reports that “the roaring stock market has professional investors riding high, so much so that it"s rekindling memories of the 1987 crash. In terms of sentiment, the difference between bulls and bears hasn"t been this high in 30 years, according to the latest Investors Intelligence reading… Investor Intelligence editor John Gray noted, sentiment readings have roughly followed their 1987 pattern. Then the bulls  peaked (near 65%) with initial market highs early that year and they returned to above 60% levels months later after more index records. In 1987 stocks crashed a few months after that. A repeat of that scenario suggests potential significant danger for over the remainder of 2017!" – see see chart below. Strangely we only recently compared the current conjuncture with 1987 in terms of valuation excess combined with extreme macro and market bullishness .?

Between the recent reality check for junk bonds, and the sudden decline in equities, Edwards believes that "comparisons with October 1987 are entirely justified." Still, there have been so many headfakes in the past 9 years, could this be just the latest one? Here are Edwards" 2 cents on how to decide:

"the market itself can signal a top. For example, I remember in early 2000 our then Japan Strategist, Peter Tasker, warning that the tech heavy Jasdaq index had turned down sharply ahead of the Nasdaq March 2000 peak. I also remember our technical analyst pointing out the significance of the Nasdaq Composite failing to follow the lead of the Nasdaq 10 to make a new high at the end of March 2000. These proved to be early warning signs of the subsequent September peak in the S&P. In short, the 2000 bear market was clearly flagged if you knew how to read the technical and macro runes. The same was true in 2007. Is the market?s current behaviour already ringing a bell to warn investors intoxicated by risk appetite that the party is over and it is time to head to the exits before the stampede starts?"

Not to put too fine a point on it, Albert, but everyone would like to know the answer.

Jail, Drugs And Video Games: Why Millennial Men Are Disappearing From The Labor Force

Last week, Goldman Sachs pointed out a very disturbing trend in the US labor market: where the participation rate for women in the prime age group of 25-54 have seen a dramatic rebound in the past 2 years, such a move has been completeloy missing when it comes to their peer male workers. As Goldman"s jan Hatzius put in in "A Divided Labor Market", "some of the workers who gave up and dropped out of the labor force during the recession and its aftermath still have not found their way back in." In fact, the labor force participation rate of prime-age (25-54 year-old) women has rebounded quite a bit and is now only moderately below pre-crisis levels, but the rate for prime-age men remains well below pre-crisis levels.

While Goldman did not delve too deeply into the reasons behind this dramatic gender gap, BofA"s chief economist Michelle Meyer did just that in a note released on Friday titled "The tale of the lost male." As we have discussed previously, and as Goldman showed recently, Meyer finds that indeed prime-working age men - particularly young men - have failed to return to the labor force in contrast to women who have reentered. According to Meyer, while this reflects some cyclical dynamics, including skill mismatch and stagnant wages, what is more troubling is that there are several new secular stories at play such as greater drug abuse, incarceration rates and the happiness derived from staying home playing games.

The macro implications, while self-explanatory, are dire: with the labor force participation rate among young men unlikely to rebound, the unemployment rate should fall further and cries of labor shortages will remain loud, even as millions of male Americans enter middle age without a job, with one or more drug addition habits, and with phenomenal Call of Duty reflexes. Here"s why.

First the facts

The overall LFPR is at 62.7%, up from the lows of 62.4% in 2015 but still considerably below the peak in 2000 of 67.3%. BofA estimates that more than half of the decline in the LFPR is due to demographics - as the population ages, the aggregate participation rate naturally falls. However, even after controlling for demographics, the participation rate of prime-working age individuals has failed to recover. As shown by Goldman above, and in BofA"s Chart 1 below, "this reflects the fact that men have not returned to the labor force. This is not a new phenomenon as the participation rate for prime working aged men has been on a secular downshift for the past several decades. However, it stands in contrast with the participation rate of women of the same age cohort which has rebounded nicely."

Looking at age cohorts, the weakness among men is particularly acute among 25-34 years old where the rate has continued to slip lower. This is offset by a modest uptrend in participation among men aged 45-54 years old (Chart 2). In other words, the millennial men have remained on the sidelines of the labor market.

Now the theories

Why haven"t men - particularly millennial men - returned to the labor market? According to Meyer, on the one hand, there are the typical business cycle explanations which center on the mismatch in skills. There is also the theory of stagnant wages which may discourage new entrants into the labor market. On the other hand, there are secular changes for men, including the rise in pain medication usage (opioid drug abuse), incarcerations, and prioritization of leisure (think video games).

BofA reviews each in order, starting with the story of mismatch

The recession resulted in more severe job cuts for men than for women, in part due to the nature of the downturn; indeed, male employment fell by a cumulative 6.9% vs a 3.2% drop for women. The goods-side of the economy shed workers, particularly in construction and manufacturing, which tend to be more male-dominated. Both sectors were slow to recover, leaving workers to become detached from the labor market with depreciating skills. Moreover, the destruction of jobs in these sectors discouraged the younger generation from attaining the skills necessary to enter these fields. A prime example is the construction sector: the average age of a construction worker increased to 42.7 in 2016 from 40.4 pre-crisis, reflecting the fact that there were fewer young workers becoming trained in the discipline. By mid-2013, builders started to complain about the difficulty in finding labor, particularly skilled workers. This illustrates how the Great Recession displaced workers and led to a mismatch of skills.

Logically, there is also the influence of rising wages - or the lack thereof - on the incentive to work. Wage growth has been slow to recover on aggregate with only 2.4% yoy nominal wage growth as of October. However, there are differences by education with relative weakness for less educated men (Chart 3). This shows the demand shift away from this population, leaving them on the fringe of the labor force. Accordingly, the labor force participation rate for men with only a high school diploma has declined by 6.2% since 2007 vs. the 5.3% drop in the college educated cohort.

The pain from opioids

Moving to the more depressing narratives, BofA next explores the possibility that the rise in drug abuse - particularly opioids - is leaving men unemployed and displaced from the labor force. Recent work from Alan Krueger found that the rise in opioid prescriptions from 1999 to 2015 could account for about 20% of the decline in the male labor force participation rate during that same period. Referencing the 2013 American Time Use Survey - Well-being Supplement (ATUS-WB), 43% of NLF prime age men indicated having fair or poor health, a stark contrast with just 12% for employed men. The same cohort also reported significantly higher levels of pain rating, with 44% having taken pain medication, opioids particularly, on the reference day. It is hard to prove causality - is the increase in pain causing more dependence on opioids, leading to a drop in the labor force participation, or did the lack of job opportunities lead this population to drug abuse? Either way, it seems to be a factor keeping prime aged individuals from working - both men and women, according to Kreuger"s analysis.

Incarceration on the rise

The rising number of incarcerations imposes another issue. Although prisoners are not counted toward the total civilian non-institutional population when calculating the LFPR, the problem associated with the labor market goes beyond prisons. The growing number of incarcerations has left more people with criminal records, making it difficult for them to reenter the workplace. Indeed, the share of male adult population of former prisoners has increased from 1.8% in 1980 to 5.8% in 2010 (Chart 4). The Center for Economic and Policy Research has also found that people who have been imprisoned are 30% less likely to find a job than their non-incarcerated counterparts. Not surprisingly, a look into the details by demographic cohort finds that men make up nearly 93% of all prisoners, of which one third are between the ages of 25 and 34.

Why work when you can play video games

Finally there is the question of preference - is it possible that we are seeing more young men choosing leisure over labor? According to the ATUS (time use survey), between 2004-07 and 2012-15, the average amount of time men aged 21-30 worked declined by 3.13 hours while the number of hours playing games increased by 1.67 and the hours using computers rose by 0.6 (Chart 5). Once again there is a question of causality - are young men playing video games because it is hard to find work or because they prefer it over working? Using the 2013 Supplement ATUS, Krueger finds that game playing is associated with greater happiness, less sadness and less fatigue than TV watching and it is considered to be a social activity. This can create a loose argument that the improvement in video games has increased the enjoyment young men get from leisure, putting a priority on leisure over labor. It also begs the question over whether welfare benefits for the unemployed aren"t just a touch too generous, but that is a discussion best left for another day...

Whatever the reasons behind the collapse in male - and especially Millennial - labor force participation, the undeniable result has led a number of industries to report persistent labor shortages. To get a sense of this, BofA compares the ratio of the rate of job openings to hires across major industry using the JOLTS data. All major sectors have witnessed an increase in the ratio (Chart 6). (Note that due to trend differences across industries, it is more important to look at the relative changes in ratios instead of their absolute values). The biggest relative increase was in construction followed by transportation and utilities. This is the goods side of the economy where men tend to be a larger share of the working population, therefore highlighting the challenges in the economy from the shortage of men participating in the labor force. This is consistent with Beige Book commentary which highlighted in the latest edition that "Many Districts noted that employers were having difficulty finding qualified workers, particularly in construction, transportation, skilled manufacturing, and some health care and service positions."

There are two implications: number one, the unemployment rate is set to fall further. In October we already touched 4.1% and are just a few thousand workers away from a 3-handle on the unemployment rate. The second is that wages should be rising. As Meyer writes, while it has yet to translate to a decisive higher trend in wage inflation, "we continue to argue that further tightening in the labor market will gradually succeed in generating faster wage growth." To be sure, modest upward pressure on wages - especially if it is felt across industries and education levels - could encourage some return of labor, but it will likely be slow given the structural challenges addressed above. The consequence: cries of labor shortages will remain loud, even as wages finally rebound from chornically, and troublingly, low levels. In fact, some speculate that the wage rebound - once it emerges - could be sharp and destabilizing, and ultimately, as Albert Edwards predicted, could result in a "nightmare scenario" for the Fed (and capital markets) which will suddenly find itself far behind the tightening curve.

SIGNIFICANT DEVELOPMENTS IN THE PRECIOUS METALS MARKET: Where We Go From Here

By the SRSrocco Report,

As the U.S. Stock Market Bubble continues upward toward a giant pin, there are some interesting developments that precious metals investors will find quite interesting.  Yes, there"s still a lot of life left in the precious metals, even though pessimistic market sentiment has frustrated a lot of gold and silver investors.

Also, even though precious metals investment demand in the U.S. has fallen 40+% compared to the same time last year, it continues to be strong in other parts of the world.  For example, German physical gold bar and coin demand increased 8% in the first half of 2017 versus the same period last year, while U.S. fell by 45%.  Moreover, flows into European Gold ETF"s hit a record during the second quarter of 2017:

Now, if we look at what is going on with gold and Central Bank demand, Russia takes the first place.  According to the article by Smaulgld, Russia Steps Up Gold Purchase With Massive Buy In September:

In September 2017, the Central Bank of Russia added 1.1 million ounces (34.2138 tons) of gold to her reserves, raising her total to 1779.119 tons or 57.2 million ounces.

Central Bank of Russia has added 5.3 Million ounces (approximately 165 tonnes) in 2017 through September.

If you haven"t already checked out Louis"s work at Smaulgld.com, I highly recommend you do.  So, as the German public and Russian Central bank continue to increase their gold holdings, Americans have cut back considerably, or worse... have been liquidating.  Furthermore, the U.S. gold market is suffering another supply deficit this year.  As of July 2017, U.S. gold mine supply and imports totaled 288 metric tons (mt) while exports were 290 mt.  Thus, we have exported ALL of our gold mine supply and imports overseas.  (NOTE:  1 Metric Ton = 32,150 troy oz.)

You see, the Federal Reserve and Wall Street have done a marvelous job in totally lobotomizing the American public in regards to gold as money.  American citizens have no idea that the printing cost of $1,300 worth of $100 bills (13) costs $1.95, whereas one ounce of gold valued at $1,300 production cost is $1,150-$1,200.   The U.S. Dollar was backed by gold up until 1971 but is now backed by the $20+ trillion in debt.

Surge In U.S. Debt Props Up Stock Market

As I mentioned in a previous article, it was uncanny how the ONE-DAY $318 billion increase in the U.S. debt on Sept 8th marked the peak in the precious metals prices while the Dow Jones Index bottomed.    The next two charts show how an increase in debt impacted REAL MONEY negatively while it pushed the DOW JONES further into bubble territory:

You will notice in the GOLD chart that the Dow Jones Index remained flat right up until Sept 8th.  Since Sept 8th, the Dow Jones Index increased 1,670 points (+8%) while gold fell $85 (-6%) and silver declined $1.30 (-7%).   I get a laugh at the news how the U.S. hit an astonishing 3% GDP in the third quarter.  It"s amazing what debt can do to prop up markets and GDP.

So, how much has the U.S. Debt increased since Sept 8th?  According to the figures at the TreasuryDirect.gov, a bunch:

In just seven weeks the wizards at the U.S. Treasury increased the total government debt by a whopping $600 billion (actually $595 billion to be exact).  Again, amazing things can be done to the economy when you pump $600 billion into the market.  Who the hell knows where this money goes, but I can guarantee that it continues to allow Americans to buy cars, homes and the millions of products and gadgets we most certainly can"t live without.

UPDATE:  The folks at TreasuryDirect.gov just updated the total public debt for Oct. 26th.  I thought you would like to know they added another $14 billion yesterday, to $20,453 billion up from $20,439 billion on Oct 25th:

So, another $14 billion to make sure everything continues to run smoothly... or they hope and pray.

U.S. Interest Expense On Its Debt Hits Record In 2017

The downside to printing money and increasing debt is the little annoying problem called rising INTEREST PAYMENTS.  Even though the Fed has been successful in lowering the interest rate, the U.S. Government paid the largest amount of interest expense ever this year.  In fiscal 2017, the U.S. Treasury forked out $458 billion worth of the American"s hard earned money just to cover its interest expense:

If we look at the historical data on the annual interest payments, this year"s $458 billion was not much higher than the $454 billion in 2011.  The reason for that was the average interest rate on our debt in 2011 was 3.1% versus the 2.3% for fiscal 2017.  Thus, a falling interest rate on rising debt levels keeps the interest payment from surging higher.

For example, in 1988, the interest expense was $214 billion on total public debt of $2.6 trillion.  However, the average interest rate on our interest expense was much higher at 8.2% in 1988.  Can you imagine what the interest expense would be today at an 8.2% rate?  It comes out to be a cool $1.67 trillion.  Well, that just couldn"t fly, could it?  If the U.S. Treasury had to pay $1.67 trillion to service its debt today, it would go belly up.

Now, there"s a good reason I selected 1988 interest rate and expense as an example.  It has to do with the next section and the 1987 market crash.

U.S. Stocks Setting Up For Another 1987 Market Enema All Over Again

Investors who have been around for a while, certainly remember the 1987 market crash.  In just one day, the Dow Jones Index lost 25% of its value.  I bring this up because there seem to be some striking similarities between the market today and the time leading up to "Black Monday," in 1987.

According to the Zerohedge article," The Nightmare Scenario" Revisited: Albert Edwards Lays Out The Next Black Monday:

A retrospective macro-narrative was inevitably wrapped around the "Black Monday" 19 October 1987 equity market crash. My 30-year recollection is pretty good: 1987 saw a buoyant equity market rising briskly through most of the year as the oil price recovered from the previous year"s collapse (from $30 to $8, see chart below). After a year in the doldrums the US economy started to accelerate notably through 1987 as the impact of 1986 interest rate cuts and a lower dollar worked. By the time of the Oct crash the US ISM had surged from 50 at the start of the year to over 60 - a level seldom ever reached (see chart below). Amazingly the ISM has just last month exceeded 60.0 for only the second time since 1987. Spooky!

I am clear in my mind both at the time and now, that the US equity market was priced for a continuation of rapid economic and profit growth and this was under threat. The Dow was on nose-bleed valuations, especially as it had ignored the bond sell-off for most of 1997 (was it really 30 years ago that US 10y yields briefly crawled back above 10% - the last time we would see double-digit yields). None of this would have mattered if the US equity market had been cheap. In my view the record 25% ‘Black Monday’ October 19 decline was due to a horrendously expensive equity market suddenly confronted with the fear of recession. Equity valuations matter.

To summarize Albert Edwards, he shows that the rebound in the oil price allowed the markets to recover in "86 and "87 as manufacturing (ISM) improved significantly.  Furthermore, he says the ISM manufacturing number last month has exceeded the 60.0 mark, only for the second time since 1987.

Edwards concludes by saying the 1987 "Black Monday" crash would not have taken place if equity valuations were "cheap."  Unfortunately, for the investors today, the valuation of the Dow Jones Index is most definitely in NOSE-BLEED territory (and then some), as Edwards suggests.

While mainstream investors and many frustrated precious metals holders have totally dismissed fundamental valuations, all bubbles come to an end.  However, it seems to many; this one will go on forever.  It won"t.

Again, we can"t forget about the $600 billion worth of U.S. Treasury Green Juice that was pumped into the market over the past seven weeks.  To put that $600 billion into perspective, look at the following:

What $600 billion would buy:

2.0 million new homes worth $300,000  (New home sales Sept 2017, annualized = 677,000 units)

17.9 million new vehicles worth $33,560 (Total U.S. vehicle sales 2016 = 17.5 million)

15,000 metric tons of gold or five years of global mine supply (482 million oz)

The $600 billion pumped into the market over the past seven weeks would have purchased two million new homes or three years at the annual rate of 677,000 units.  Furthermore, it would have purchased 17.9 million vehicles, more than the 17.5 million sold in 2016.  Lastly, it would have purchased 15,000 metric tons (482 million oz) of gold.

Just think about that for a minute.  The $600 billion of U.S. Treasury Green Juice would have purchased a year"s worth U.S. citizens" vehicle purchases and three years worth of new homes.  That"s one hell of a lot of propping.... AND IN LESS THAN TWO MONTHS... LOL.

When the stock market finally does a nose-dive as its nose-bleed valuations finally succumb to investor FEAR, the price of gold and silver will head in the opposite direction, and violently.  Yes, I realize it has been a bit of a long haul and a lot of frustration, but it will be worth it.

Lastly, if you haven"t checked out our new PRECIOUS METALS INVESTING section or our new LOWEST COST PRECIOUS METALS STORAGE page, I highly recommend you do.

Check back for new articles and updates at the SRSrocco Report.