PUSHING AGAINST THE BIG WAVE
2018-05-07 9am EDT | #bonds #economy #velocity
One of the greatest traders of all time, yet probably one of the least well known, once said, “win or lose, everybody gets what they want out of the market.” Easy for Ed Seykota to say as he sits on his deck overlooking Lake Tahoe sipping a nice California cab. Yet as I struggle to make sense of this great game we all love to play, I wonder if maybe Ed is correct. I know his comment might seem a little preachy, but the older I get, the more I realize that a trader’s biggest obstacles lie in the dark recesses of their thoughts, not in the day-to-day zigs and zags of the markets.
So I wonder. Not only do we all get what we want, but do we only see what we want to see?
The other day, one of the biggest bond bulls out there posted the following chart:
I was confused by Raoul’s comments because as I examined the chart of M2 Money Velocity versus US Labour Force Participation, it only made me more bearish on bonds. But to Raoul and all the other deflationists, this chart demonstrates the futility of battling the overpowering forces of demographic deflation.
Before we go any further, I am about to commit the cardinal sin of trading - mixing timeframes. Bonds are hugely oversold on shorter-term charts and everyone is leaning short. It wouldn’t take much of an economic pause to cause a massive short covering rally. Therefore I am by no means advocating leaning hard on bonds down here for a trade.
Yet as an investment, bonds are a terrible risk-reward. And ironically, Raoul’s chart provides the reason.
Let’s assume that monetary velocity is affected by labour participation. Not a hard leap to make. The more people that are working, the more likely they are to borrow and spend.
But what has happened to labour over the past couple of decades? With the fall of the Iron Curtain, combined with China’s WTO admission, and topped off with a demographic bulge of baby-boomers, the global economy has been subject to a massive labour supply glut. This has driven down the cost of labour as a percentage of GDP to multi-generational lows:
This relentless deflationary force has made monetary policy increasingly less effective. It’s obviously not this simple as the increasing debt load is also a large factor muting monetary stimulus. And there can be no denying that the neutering of discretionary governmental fiscal spending during the last economic downturn only worsened the situation.
Yet both factors are no longer headwinds. Trump’s deregulation push and pro-business policies have encouraged banks and other lenders to once again extend credit. And the tax cut bill is providing fiscal stimulus as opposed to tightening.
But most importantly, the labour supply glut is finally getting worked through. China is no longer the cheap cost provider competing in a race-to-the-bottom on wages. Globalization is now headed in reverse with tariffs and other trade impediments being applied.
So I ask - what are the chances that labour participation continues declining? Even if it just stabilizes, this might allow the velocity of money to stop its relentless plummet.
And if the money velocity stops declining, and god forbid, even increases, what will happen to the mountain of monetary stimulus that has been administered over the past decade?
I don’t know if I am just seeing what I want to, but when I look at Raoul’s chart of M2 velocity versus the Labour Participation Rate, all I can do is worry about what happens if velocity follows the participation rate higher. Instead of just assuming this trend will continue forever lower unabated, I am preparing for the day it bottoms and turns everything we know on its head.
Ed would probably tell me that all of this analysis is most likely moot. It’s way more productive to listen to what the market is saying,
“If you want to know everything about the market, go to the beach. Push and pull your hands with the waves. Some are bigger waves, some are smaller. But if you try to push the wave out when it’s coming in, it’ll never happen. The market is always right.”
I have been worried about the oversold nature of bonds, but maybe the market knows better. Maybe this is one of those bigger waves you shouldn’t push against.
Thanks for reading,