by Lee Adler, Wall Street Examiner
The chart of real business investment has always followed the stock market. From 1993 to 2012 real business investment tracked stock prices almost perfectly. That makes sense because corporate decision makers take their investment cues from stock prices.
They say that correlation does not prove causation. What has happened since 2012 demonstrates that, because the correlation has broken down since then.
Please share this article – Go to very top of page, right hand side, for social media buttons.
That breakdown also disproves the Trickle Down dogma of the economic priesthood. Economism dogma said that rising stock prices lift business investment. That was the religious gibberish that Pope Bernanke used in 2010 as the excuse for restarting QE. He turned emergency QE into QE infinity based on that single false premise.
But the premise was BS. Just look at what has happened since 2012.
I developed this chart of real business investment by combining commercial and industrial construction with non-defense capital goods orders. I use the PPI for durable goods as the deflator.
But what about before stripping out inflation? You have probably seen the charts where inflation makes it seem that business investment is growing. They look like this one. Look Ma! New Highs! Maybe a lot slower than in the past, but new highs, nevertheless. No problem, right?
The Chart of Real Business Investment Has Been Dead In the Water
Yes. Problem. Ex-ing out inflation, wee see that the unit volume of real business investment has barely grown at all since 2012. It even fell slightly from February 2018 to February 2019. The old stock market magic hasn’t worked since 2012, when QE was just becoming a way of life for the high priesthood of central banking and Economism.
But economists don’t give a crap about facts and reality. They only care about their insane mythology. They could have seen by 2014 that their beloved theory was useless. Instead they remain married to it today, facts be damned.
Obviously, zero interest rates and QE stimulated something, but it wasn’t real business investment. It was stock prices. That was intentional, given the Trickle Down theory. Only there was no trickle.
Historically, corporate CEOs saw rising stock prices as a signal to invest in the expansion of their businesses. But with ZIRP and QE, they saw the stock market as the end in itself. In 2013 and 2014, they ran wild borrowing free money to buy back their stocks.
Why make costly and risky investments in plant and equipment when you could just buy back your own stock with free money from the Fed? There was no carrying cost for that decision. And with the Fed printing money ad infinitum to guarantee rising stock prices, the perception rightly became that there was no risk either. The belief in a Fed put was backed up by… wait for it… Voila! The Fed put!
So instead of investing in plant and equipment, CEOs engineered stock buyback schemes as a means to skim billions for themselves. They issued stock options to themselves and their C-Suite cronies and borrowed free money to buy back their stock and give themselves nice big fat multimillion dollar checks in the process. While they reaped the benefits, millions of workers were phased out of traditional jobs as employees with wages and benefits, to contract gig workers, with no guarantee of even a regular paycheck.
Short Term Divergences Are the Immediate Issue
The negative divergence between real business investment and stock prices suggests a growing problem. The problem is hollowing out of the US economy behind the illusion of health that the stock market spawns.
The big picture is useless as a market timing indicator, but short term negative divergences may mean something. Such divergences developed in 1999-2000, and 2006-2007. Both were precursors to major bear markets.
A new negative divergence has been developing since 2017. It’s now as old as the two that preceded the last 2 bear markets. The annual growth rate has turned negative. In the past two divergences, stock prices collapsed soon after the real business investment growth rate fell below zero.
Maybe the past won’t be prologue this time. But the risk is there. We need to keep that in mind while relying on technical analysis for market timing.
Published on Wall Street Examiner 26 April 2019.
Update
Published on Wall Street Examiner 29 July 2019:
The Fed has long espoused that rising stock prices drive real business investment. As part of that, low interest rates are supposed to stimulate both investment in stocks, business credit, real business investment, and ultimately a growing economy that will benefit the greater good.
In essence, that’s the trickle down theory.
Nice theory. In practice… not so much.
In the past 25 years we’ve only had three periods of falling interest rates. One was from 1995 through 1998. I don’t know if you can really call that a period of falling rates. The Fed Funds rate only went down from a little over 6% to 4.75%.
It’s virtually unthinkable today that rates could be that “high.” 4.75% was the bottom! Today, economists, the Fed, the Wall Street media, and the Trump regime are all terrified with the Fed Funds rate at 2.4%. That’s what happens when you build a monster that’s addicted to free money and a constant flow of new debt for its very survival.
Back during 1995-98 we had a booming economy, thanks to the beginnings of the internet revolution and a tech boom. Remember WWW? Real business investment boomed. Commercial and Industrial lending boomed. The stock market boomed. 4.75% was no problem.
Then the Fed decided to raise interest rates. The Fed Funds rate rose from 4.75% to 6.5% in 1999 and 2000. What happened? Real investment continued to boom! C&I lending boomed! The stock market boomed through Q1 2000! Rising rates stimulated!
Then from late 2000 until mid 2003, we had our second run of falling interest rates. The Fed Funds rate dropped from 6.5% all the way to 1%. What happened? Was that stimulative?
Nope. Commercial and Industrial lending collapsed. Stock prices plunged. Business investment collapsed.
It got so bad that the Fed took rates all the way to zero, and eventually started printing money so that securities dealers could buy stocks. That’s right, buy stocks. The financial war criminal Ben Bernanke, said it outright in his November 2010 Washington Post editorial justifying QE 2. The Fed’s money printing would stimulate higher stock prices, he said.
With that policy Bernanke burned millions of American seniors’ savings to death while he handed out cash to securities dealers so that they could buy stocks. Never mind the loss of consumption spending because seniors and other savers had no interest income.
When some observers complained, Bernanke smirked and said all monetary policies have winners and losers. He chose our parents and grandparents who worked hard and put money into risk free savings all their lives to be the losers. He chose bankers and speculators to be the winners.
But I digress.
ZIRP and QE – money printing directed at banks and leveraged speculators – worked. Stock prices soared, commercial and industrial lending boomed. Real business investment rallied.
But during the entire period of ZIRP and QE from 2009 until 2014 when the Fed ended QE, real investment on average never got back to the peak levels of 2006 and 2007. In fact, it barely exceeded 2007 levels.
Then, with ZIRP staying in effect, business investment actually began to contract in 2014. Suddenly ZIRP was no longer stimulating real business investment.
Meanwhile, curiously, Commercial and Industrial Lending continued to soar! And so did stock prices rising by more than 30% above the peak levels of 2000 and 2007. Do you think that there might have been a connection between that soaring business borrowing and the levitating stock prices?
With the ending of QE in late 2014, stock prices began to stall out. Real business investment had already turned down. Rates were still near zero.
Stock prices stalled through 2015. The Fed raised the Fed Funds rate a tiny bit in late 2015, but rates were still near zero. Despite that, business lending dried up in 2016, election year.
Late in 2016, animal spirits returned with a vengeance. Investors sensed that a guy who loved debt financing might be good for the stock market. Stocks broke out. Real business investment began to rise again.
Commercial and industrial borrowing was muted through that year and 2017 however. The Fed had begun raising rates in earnest.
Then, right in the middle of that rising rate cycle, Commercial and Industrial Lending began to skyrocket again. But a funny thing happened. Real business investment stalled again. Business investment peaked just as the Commercial and Industrial lending business began to boom.
Where was all that money going? Along with the stall in business investment, the rising stock market balloon had hit some jagged edges, plunging in February 2018 before rising to new highs in the second half.
Business borrowing continued to surge. But the stock market had an even bigger swoon late in the year. By then, real business investment had been contracting for 3 quarters despite booming corporate finance.
Under pressure from the Trump Regime, which loves low interest debt financing for useless speculative development, Jerry Powell caved and ended the rate rise cycle.
So where are we now? Interest rates, at least superficially, are about to head down, according to those who should know. We have stock prices at an all time record level. Business borrowing appear to be starting to flatten out.
And real business investment remains in a slump. It’s not only well below last year’s level, it’s below the levels of 2006 and 2007. It is even below the 2008 level, when the Great Recession was beginning.
So let’s consider. Real business investment measured as of May is below the level of May 2008. In May of 2008 the S&P 500 was at 1500. Today it’s at 3000. Put that in your pipe and smoke it. The stock market has doubled since 2008. The US has 10% greater population than in 2008, but businesses are investing in plant and equipment at no more than the levels reached in 2008.
That’s scary. The last two bull markets in stocks were supported by constantly expanding real business investment. Today the bull market is supported by extremely volatile speculative gas – debt financing.
What’s even scarier is what history tells us about what happens when debt implodes and rates fall. Stock prices fall, and the commercial credit that contributed to the increase in stock prices and drove the booms in business investment, dries up.
So if you’re a bull, the last thing you want to see now with stocks unhinged and business investment weak, is the beginning of a Fed rate cut cycle.
Follow my regular updates of Commercial and Industrial Lending, Interest Rates, Real Business Investment and Stock Prices 7 times each month. Subscribe to read Lee Adler’s Liquidity Trader risk free for 90 days! Satisfaction guaranteed or your money back.
.
