Weekly Relative Value - Alloya Corp · Wealth Inequality: Why It Matters Classic measures of inequality in the U.S. have widened since the early 1970s; the share of income going to

Weekly Relative Value

www.alloyacorp.org/invest

WEEK OF JANUARY 21, 2020

Tom Slefinger SVP, Director of

Institutional Fixed Income Sales

Wealth Inequality: Why It Matters

Classic measures of inequality in the U.S. have widened since the early 1970s; the share of income going to the top 10% of income earners in the country has skyrocketed to levels not seen in 90 years.

After all, who hasn’t seen charts such as the one below, showing the tremendous divergence in income earned by America’s Top 1% at the expense of the middle and lower classes? Even if we have seen modest income growth at the lower percentiles recently, the disparity across income groups is still staggering.

Share of Income Earned

Source: The World Wealth and Income Database

Or how about the fact that the top 10% now own 70% of all the U.S. wealth, the same as the middle and lower classes combined? This is up 10% from the 60% of wealth they controlled in 2000.

While some don’t believe income/wealth inequality is an economic and social issue, I have some news for you. Roughly 60% of Americans think it is a problem. So, unquestionably, the issue is important and relevant. Don’t forget that one reason Mr. Trump won the last election is because he convinced the masses at the low-end of the income strata that they had been left behind due to immigrants and trade policy. In reality, it had much more to do

THIS WEEK • WHY INEQUALITY MATTERS

• INFLATION, WHERE IS THY STING?

• WHOSE TURN TO COOK?

• CANARY IN THE COAL MINE?

• REALITY GAP

PORTFOLIO STRATEGY

“When all experts agree, something else is bound to happen.” – Bob Farrell

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with inadequate fiscal policy. In addition, the Fed’s monetary policy – concentrating its efforts on “wealth effects” and “credit stimulation” – obviously haven’t helped matters.

The Top 10% Own 70% of the Wealth


Take a look at the graph below. There are two distinct points in history when wealth inequality was so extreme. The most recent was in the 1930s (Gilded Age and Robber Barons) and just before the Great Depression. Before that it was in advance of the French Revolution, when most of the French “Top 1%” literally lost their heads.

Top 0.1% Owns as Much as the Bottom 90%


Thus, as inequality rises to extreme levels such as what we’ve seen in the U.S., there are dangerous implications for social/political cohesion and economic growth. To be sure, the issue of wealth and income inequality is shaping up as the most sensitive topic not only during the Democratic primary race, but the entire 2020 presidential race, with one of the most salient questions emerging: who can tax the richest the most?

Reducing inequality through wealth redistribution is a key platform promise of top Democratic presidential candidates (Bernie Sanders, Joe Biden, Elizabeth Warren). This includes higher capital gains taxes, dividend taxes, taxes on share buybacks, higher tax rates on top personal incomes and wealth taxes. And there seems to be growing momentum within the Democratic Party to establish a guaranteed minimum income policy.



Comparing Tax Plans of Presidential Candidates

Source: DB Global Research

The chart below shows the betting market for the Democrat nomination. Joe Biden (orange) leads. Bernie Sanders (red) is second. Should Sanders win Iowa and New Hampshire, as the table above suggests, Biden will likely see two weeks of terrible press and Sanders will enjoy two weeks of positive headlines. These probabilities could dramatically change.

Biden is Favored Now

Source: Bianco Research

Many in the financial community believe that Trump is a shoo-in to win the 2020 election. However, in FiveThirtyEight’s January 13th national general election polling numbers, Trump is trailing four of the top five Democratic candidates. However, as we saw in 2000 and again in 2016, we also know that polls are often wrong; at the end of the day, it is the electoral college vote that counts in the final analysis. From my vantage point, it will come down to how the Independents feel on this issue.

Regardless of who wins, we should all be thinking about how the wealth and inequality divide is righted. We don’t want to become a “winner take all” country or Banana Republic where only the elite benefit from the economy. Or do we?

Frankly, I believe the policy medicine may well entail some form of “Robin Hood” fiscal policy to attain a better balance to ensure that capitalism and democracy can maintain their coexistence in this great 243-year-old experiment called



America. Heck, would it be so bad if the low-end consumer had more cash in hand? With millions of Americans with cash in hand, they will shop more and provide another tailwind to U.S. economic growth.

INFLATION, WHERE IS THY STING?

For the past decade I have heard that the money printing machines will eventually be the cause of higher inflation. But here’s the reality. Since this expansion started over 10 years ago and after round after round of quantitative easing (QE), free money, and two massive fiscal stimulus packages, this is all we get? Core inflation (excluding food and energy) appears to have peaked at 2.4%. That 2.4% was the lowest peak since the 1930s, undercutting the 2.9% “peak” in the prior cycle in 2006, when it was the lowest “peak” since the 1950s.

The secular forces of aging demographics, excessive debts tend to suppress aggregated demand. All the Fed-induced money supply growth in the world can’t stop these deep-rooted trends.

Has Inflation Peaked?

Source: Bloomberg

Further, even though unemployment is at a five-decade low of 3.5%, wage growth has remained extremely tepid this cycle. And wages are key to inflationary trends.

What you have to remember is the unemployment rate as a stand-alone statistic tells you nothing about job security or insecurity. The record-low share of organized labor and the lack of any cost-of-living allowances today have totally disrupted the wage-price equation. Let’s not forget technology and the impacts that robotics, electronic check-out counters and tellers, and the sharing economy are exerting on worker wage demands. Finally, globalization.

Since the recovery commenced over a decade ago, the U.S. economy has created an unprecedented 22.6 million jobs. But not all jobs are created equal. According to the Brookings Institute, there were 53 million people in low wage jobs as of 2016 (44% of all workers aged 18-64). The majority were adults in their prime working years. These aren’t university and high school students working part time while in school, or young people starting careers at lower rungs of the ladder. Fully 42% of the low-wage workers in America were between the ages of 25 and 55 without a college degree. While the study acknowledges these numbers are a little stale, they also make the case that the composition of the economy likely has not shifted all that much in the past two years.



So, given that 42% of U.S. workers are classified as low income, is it any surprise to see everyday, non-discretionary items (housing, food, healthcare) consuming an ever-increasing chunk of the paycheck? As such, for almost half of the country, there’s nothing left over for discretionary expenditures. Thus, while having a job is certainly better than no job at all, the composition of the labor force isn’t one that suggests a build-up of aggregate demand necessary to push up prices. These demographics help explain the long-term downward secular disinflationary trend.

And as shown below, this supposedly great labor market has done nothing more than generate flat, or modestly negative numbers in each of the past four months ─ during which inflation-adjusted work-based pay has actually contracted at a 1.2% annual rate. In fact, since mid-2019, the year-over-year trend in real average weekly earnings has slowed markedly from +1.2% to zero.

Withering Earnings

Source: Bloomberg

While some argue the consumer price data are distorted and do not reflect the true cost of living, there isn’t any reason for households not to tell it like it is

Will Inflation Expectations be Self Fulfilling?

Source: Bloomberg

The University of Michigan monthly consumer survey has been around for 70+ years and despite the stock market reaching new highs on the back of the Fed-induced liquidity, the median 5-10-year inflation expectation measure dipped to a record low of just 2.1%. Can you fathom that? This is lower than any inflation estimate in any recession in the post-



WWII era, and some of those included periods of double-digit unemployment. And consumer inflation expectations today are half of what they were when the jobless rate was last at 3.5% five decades ago.

The same theme is present in business surveys as well. To wit: the National Federation of Independent Business (NFIB) poll of small company sentiment shows that a mere 1% say inflation is at the top of their list of concerns.

I’m guessing that when we get to the bottom of the next economic and market cycle, monetary and fiscal policymakers will once again take aggressive action (anything goes) that will make negative-interest rates and QE seem like a walk in the park.

When the time comes and the long bond yield is 1% or lower, and we see full-fledged globally coordinated outright debt monetization, we will then have the chance to break this relentless decline in money velocity – which has failed to turn around because we have too much debt and policy aimed at creating more debt instead of extinguishing the massive debt load. It will be then and there that we say, “goodbye to an old friend,” as in the Treasury bond.

In the meantime, if I am right and the looming recession, whenever it starts, takes the 10-year Treasury note yield to zero, then the long bond goes to 1%. That would be a nifty fifty percent return!

No Velocity = No Inflation

Source: Bloomberg

WHOSE TURN TO COOK?

December retail sales were better than expected. The headline came in as expected at +0.3%, but what excited Wall Street was the above-consensus reading of +0.5% on the “core control” component, which is a direct input into GDP. The only caveat to what appeared to be a strong report were the downward revisions to October (-0.3%) and November (-0.1%). The downward revisions were so significant that real inflation-adjusted retail sales in fourth quarter actually contracted modestly at a -0.4% annual rate. This is quite the decline from +3.9% in the third quarter and +4.6% in the second. And the “core control” number, deflated by the core Consumer Price Index (CPI), declined at a 2.4% annualized pace. This is the weakest performance since the depths of the Great Recession in the second quarter of 2009 even in the face of a ripping stock market.

Further, when sifting through the data, what really stood out to me was the very modest 0.2% rebound in restaurant activity. This is the single best leading indicator of discretionary consumer spending and the three-month trend is running at a super-soft -2.2% annual rate. Meanwhile, over the past three months, grocery sales have advanced at a



3.6% annual rate. So, reading between the lines, the all-powerful and all-important consumer may be turning a touch more frugal as we start the year.

In other words, whose turn to cook?

Dining Declines

Source: Bloomberg

At any rate, in the wake of the retail sales data, the Atlanta Fed GDPNow forecast was trimmed to a 1.8% annual rate from 2.3%; the consumer contribution declined to 1.1% from 1.6%. And as you can glean from the graph below, the New York Fed is already way ahead of the game, at +1.1% for the fourth quarter and just +1.2% for first quarter this year. Ordinarily, this “growth recession” would have the Fed thinking about another rate cut, but it is boxed in by this speculative surge in the equity market.

GDP Downshifts

Source: Bloomberg



CANARY IN THE COAL MINE?

The latest Job Openings and Labor Turnover Survey (JOLTS) report last pointed to a picture that might suggest the U.S. labor market hit a brick wall. Why? Because according to JOLTS, traditionally former Fed Chair Janet Yellen’s favorite labor market report, job openings in November plunged by a massive 561,000, to 6.8 million, the lowest monthly total since February 2018, the biggest sequential drop since August 2015 and the biggest annual drop since the financial crisis.

Source: Bloomberg

That said, there is a silver lining: even at 6.8 million job openings, this was still well above the total number of unemployed workers. In fact, November was the 21st consecutive month in which job openings surpassed unemployed workers.

Regardless, the near-record plunge in job openings is a warning shot across the bow and may signal that something is breaking in the labor market. Should the trend continue, then the next logical escalation is a surge in layoffs as U.S. employers retrench and force their existing workers to boost their productivity further.

Source: Bloomberg

REALITY GAP

The gap between the real and financial economy has rarely, if ever, been so wide. In fact, nobody seems to care too much about what’s happening in the real economy. Manufacturing employment, shipping, industrial production and the Producer Price Index (PPI) are all screaming the same word. The word is RECESSION. Negative real retail sales



growth in the U.S. and the downgrade to fourth quarter GDP from the Atlanta Fed didn’t cause anyone to bat an eyelash.

And corporate earnings be damned. Earnings estimates over the past year have declined from +11.4% year-over-year growth for the fourth quarter to -2.0% presently in one of the biggest downswings of all time. This is the fourth straight quarter of earnings contraction, yet investors have bid up the price by an incredible 24%. So, we’ve had a situation where earnings have gone absolutely nowhere but down, and the markets have gone straight up. The chart below shows fourth quarter 2019 earnings expectations. Currently, it shows 484 estimates and just 16 actual results. As companies report, the estimates are replaced with actual results until all 500 companies report. Analysts expect earnings declined 1.64% (blue line).

Earnings Sill Heading Lower

Source: Bianco Research

Wall Street says earnings will rise going forward. Keep in mind they always forecast higher earnings. Always!

And much was made of President Trump and Chinese Vice Premier Liu He signing Phase 1 of their historic “Bean Deal” this past week. Investors rejoiced sending equity markets to new all-time highs.

You think it’s the POTUS? The trade deal? The economy? Retail sales? In this world of “new math,” the ONLY thing that matters is three Fed rate cuts and a renewal of QE. It’s the Fed, stupid. The Federal Reserve is inflating asset prices, pure and simple. Nothing else matters in today’s financial climate. Nothing!

Source: Bank of America, Merrill Lynch, CNBC



The biggest increase in “money printing” by the Fed happened between 2008 and 2015 – with $3.6 trillion of new money added. But that was said to be an “emergency” caused by the crisis of 2008-09. Reluctantly and sluggishly, the Fed then began “normalizing” by raising rates and reducing the money supply.

The normalization program came to an end in July of 2019 when the Fed began to cut rates again. And then, on September 17, without a cloud in the sky, it “cranked up the presses” to add about $100 billion a month over the next four months.

This is the reality. U.S. stock market investors have gained some $20 trillion over the last 10 years. And as shown below, market cap-to-GDP is highest on record and still rising fast. However, take away Fed support, and most of that money could disappear in a matter of minutes.

Wilshire 5000 Market Cap to GDP

Source: Wilshire

But who wants to sell? In fact, bullish sentiment is at an all-time high despite extreme valuations.

Everyone is convinced that stocks will continue their meteoric rise. There is no alternative. Or so I have been told. The Fed has their back. Equities are a protected asset class. I have heard it all. And heck, some of this might be true.

But please also consider this scenario. If a broker in the late 1920s advised his clients to start reducing risk in the fall of 1928, how do you think history would treat him today? He would be a hero! A savior! But, at the time, as he convinced you to trim your exposure, I’m sure investors were furious because the market rallied another 40% over the next 12 months ending September 1929, a month ahead of the crash. Fast forward. Today’s myopic investor will surely fire their manager if this happens, because the focus today, sadly, is on noise and short-term performance and not asking why it makes no sense for large cap companies with no profits (Tesla, anybody?) to see their share prices skyrocket.

In the meantime, melt-up is the word and a bubble is forming in the equity market.

Amazingly, nobody seems to mind, or care, that nearly 11 years into this economic expansion, the economy and investors remain in dire need of both monetary and fiscal support for their success.



MARKET OUTLOOK AND PORTFOLIO STRATEGY

Before investors begin to rejoice about a global economic rebound, perhaps they should pay attention to what the International Monetary Fund (IMF) had to say about economic growth. It’s not that great by the way. On top of the IMF release, PWC conducted a survey of 1,600 CEOs from 83 different countries that had a very similar message ─ more than 50% of respondents indicated that they expect economic growth to slow in 2020.

As we move forward, financial markets are about to get very interesting– Bean Deal or no Bean Deal! Recession risk has not abated, and growth is now flirting with a zero handle. But don’t take it from me. Per the latest Deloitte Q4 CFO Survey, 97% of U.S. CFOs believe a slowdown has already begun or will commence in 2020. A whopping 82% of CFOs anticipate taking more defensive actions like reducing discretionary spending and headcount, as a way to stave off the looming headwinds. Go back and look at the JOLTS data.

Cliff Dive

Source: Hedgeye

So how should credit unions invest their excess cash?

I believe the next Federal Open Market Committee (FOMC) rate decision will be to eventually lower the fed funds rate. Timing is obviously difficult but by mid-summer the economy should be showing signs of stress. As such, excess cash will be a sub-optimal strategy and negatively impact investment portfolio returns. As always, we recommend a fully-invested, diversified, high-quality, risk-appropriate ladder strategy. As shown in the table below, a simple ladder strategy has stood the test of time throughout the past five decades.

Source: Crestmont Research



PREMIER PORTFOLIO

Alloya Investment Services’ online trading platform, Premier Portfolio, has been making a positive impact at credit unions across the corporate’s membership since its launch in 2018.

Visit www.alloyacorp.org/premierportfolio to learn more about Premier Portfolio and how it can benefit your credit union!

MORE INFORMATION

For more information about credit union investment strategy, portfolio allocation and security selection, please contact the author at [email protected] or (800) 782-2431, ext. 2753.

Tom Slefinger, Senior Vice President, Director of Institutional Fixed Income Sales, and Registered Representative of ISI has more than 30 years of fixed income portfolio management experience. He has developed and successfully managed various high profile domestic and global fixed income mutual funds. Tom has extensive expertise in trading and managing virtually all types of domestic and foreign fixed income securities, foreign exchange and derivatives in institutional environments.

At Alloya Investment Services, Tom is responsible for developing and managing operations associated with institutional fixed income sales. In addition to providing strategic direction, Tom is heavily involved in analyzing portfolios, developing investment portfolio strategies and identifying appropriate sectors and securities with the goal of optimizing investment portfolio performance at the credit union level.

“Premier Portfolio is user-friendly and modern. It allows us to browse current offerings and make immediate purchases at any point throughout the day. The tracking mechanism in Premier Portfolio is very hand. Since the system knows what dollar amount is currently owned in a financial institution, there is no room for error. We love the ability to check term and rate on a single summary. Premier Portfolio takes the guessing out of the equation. It is a highly useful tool and would recommend to anyone using Balance Sheet Solutions (now Alloya Investment Services).” – Darin Higgins, President of Western Illinois Credit Union

“While it’s always great to connect with our Balance Sheet Solutions, (now Alloya Investment Services), Account Executive one-on-one, Premier Portfolio is an amazing and easy tool to use in purchasing investments. We have access to statements, online trading and the ability to look at all of the offering in one place. I highly recommend trying this out!” – Shawn Nikkel, Finance Director of Denver Fire Department FCU

“Premier Portfolio’s online services allows me to access statements and overall market analyses, review a list of available security offerings, as well as purchase SimpliCD’s and Alloya’s certificates. Premier Portfolio is convenient, easy, secure, and has become my go-to place for investing!” – Rhonda Schroeder, CEO of Blackhawk Area Credit Union

http://www.alloyacorp.org/premierportfolio

mailto:[email protected]



The views and opinions expressed herein are those of the author and do not necessarily reflect the views of Alloya Corporate Federal Credit Union, Alloya Investment Services (a division of Alloya Solutions, LLC), its affiliates, or its employees. The information set forth herein has been obtained or derived from sources believed by the author to be reliable. However, the author does not make any representation or warranty, express or implied, as to the information's accuracy or completeness, nor does the author recommend that the attached information serve as the basis of any investment decision and it has been provided to you solely for informational purposes only and does not constitute an offer or solicitation of an offer, or any advice or recommendation, to purchase any securities or other financial instruments, and may not be construed as such. Information is prepared by ISI Registered Representatives for general circulation and is distributed for general information only. This information does not consider the specific investment objectives, financial situations or needs of any specific individual or organization that may receive this report. Neither the information nor any opinion expressed constitutes an offer, or an invitation to make an offer, to buy or sell any securities. All opinions, prices, and yields contained herein are subject to change without notice. Investors should understand that statements regarding prospects might not be realized. Please contact Alloya Investment Services* to discuss your specific situation and objectives. *Alloya Investment Services is division of Alloya Solutions, LLC.

Documents

Weekly Relative Value - Alloya Corp · Wealth Inequality: Why It Matters Classic measures of inequality in the U.S. have widened since the early 1970s; the share of income going to