Charting The Course
All Fun and Games until Someone Loses an Eye
By Mitch Siegler, Senior Managing Director
In this season of political nuttiness, it’s odd that we’re just now hearing the term “kakistocracy”. We looked it up so you won’t have to. It’s from the Greek “kakistos” meaning “worst” and it means “government by the least qualified or most unprincipled citizens.” Seems fitting for the state of our American politics, huh?
In this corner, in the red trunks, is a fellow frequently described as obnoxious, hot-headed, egomaniacal, embarrassing and misogynistic. And you should hear what they say about his barber! In the other corner is his opponent, who gains style points for hair (but gives some back for her pantsuits). She also ranks low on the trustworthiness scale and operates as though the basic ground-rules don’t apply to her, her inner circle, PAC (er, foundation) and computer servers.
On one level, it’s mildly entertaining – when you can bear to watch or read about it. Take heart, friends – it should all be over in just 59 days, but who’s counting? The 2016 election seems to be shaping up as a giant mess and not one of the Pottery Barn (“you broke it, you bought it”) variety. We’ll all have to live with the consequences for years to come. Meanwhile, it’s well before the election and we’re seeing rather large cracks in our economic fine china, with obvious investment implications. Five examples:
1. Dysfunctional Lending/Financial Services Environment – Our banker friends report that bank regulators have never been tougher, especially with “high-volatility commercial real estate (HVCRE) lending, like for new construction. Higher capital reserves for this sort of lending is the order of the day and banks have been dealing with an unforgiving environment for some time, what with Basel III, Dodd-Frank and a myriad of other post-Great Recession rules and regulations. And that’s before Elizabeth Warren gets out of bed. Private lenders have been stepping in to plug the hole – from “hard money” secured lenders displacing banks in real estate lending to a plethora of peer-to-peer lenders giving credit card companies a run for their money. These groups have higher rates and fees, of course, but they’re offering credit to folks who might not get it otherwise. Some bright spots there but largely an indictment of the traditional financial services system and regulatory environment, which just aren’t working like they should.
2. Weak Economic Growth and Decelerating Inflation – In late July, the Census Bureau reported that the Gross Domestic Product (GDP) grew at an anemic 1.2% annualized pace in the second quarter after adjusting first quarter GDP down from 1.1% to just 0.8%. Three straight quarters of sub-2% growth and a decelerating pace of growth. Taking a wider view, while GDP has declined over the past four years from 4.3% to 4.1% to 3.0% to 2.4%, inflation has plummeted in parallel – from 1.9% to 1.6% to 1.5% to 1.1%. This despite pallet-loads of helicopter money (Quantitative Easing is the official term). Safe to say money printing isn’t working and may be exacerbating the situation. A pilot might call this stall speed. We believe the headwinds of an aging population and their attendant lower consumer spending, a reluctance among younger people to marry, have kids and buy homes and the macro environment in which central bankers worldwide are easing has a lot to do with this.
3. The Fed Seems Unable to Raise Interest Rates – Anemic growth and low inflation are hardly the recipe for higher interest rates, as we’ve been saying for ages. The futures market concurs – it puts the odds of an increase by December at just 50% and only 60% by March, per Bloomberg. Recall that in January, Fed officials were signaling four quarter-point rate hikes for 2016. Official validation of a protracted economic slowdown and a near-empty central bank toolkit – and this may just be the warm-up act.
4. Central Bankers Have Painted Themselves into a Corner – It was widely reported in July that former Fed Chair Ben Bernanke, a student of the Great Depression, met Japanese Central Bank Governor Haruhiko Kuroda and advised him to issue perpetual, zero coupon bonds that the Bank of Japan would buy. This – permanent zero coupon bonds – goes beyond über-low interest rates, quantitative easing and other forms of helicopter money. It’s an awesome gift considering that the BOJ already owns 40% of Japanese government bonds. With perpetuals, Tokyo would be freed from the pesky details of ever having to repay the bonds. In a flash, Japan would have more breathing room to stimulate growth without increasing its already stratospheric debt levels and risking credit downgrades. Sure, it could work in stemming the tide on Japanese deflation, though free lunches are pretty hard to find and nothing else has really worked for the Japanese economy in the past 30 years. And across the pond, there are increasing concerns about the impact of Brexit (“new headwinds”, according to a European Central Bank statement on August 19th) on the European economy.
5. Other Canaries in the Coal Mine – Jobless claims have been rising. Inventories are at their highest levels since 2009; the inventory liquidation sale that lies ahead will be deflationary and reduce the need for factory workers. Corporate profits have fallen for six straight quarters. Low interest rates pressure pension funds and retirees. Credit card delinquencies are up. Business bankruptcies are up 25% over the same period last year according to BankruptcyData.com. Employment growth is a lagging indicator and all of these factors suggest job growth will slow in the months ahead. And that’s before any election-related economic uncertainty.
As the Sergeant on Hill Street Blues would say, “Let’s be careful out there.” Cause you wouldn’t want your investment portfolio to lose an eye.
Mitch Siegler is Senior Managing Director of Pathfinder Partners, LLC. Prior to co-founding Pathfinder in 2006, Mitch founded and served as CEO of several companies and was a partner with an investment banking and venture capital firm. Reach him at email@example.com.