Minsky, Myopia, & Why The S&P 500 Is A Bloated Corpse

Authored by Raul Ilargi Meijer via The Automatic Earth blog,

According to Hyman Minsky, economic stability is not only inevitably followed by instability, it inevitably creates it. Complacent humans being what they are. If he’s right, and would anyone dare doubt it, we’re in for that mushroom cloud on the financial horizon. We know that because market volatility, as measured for instance by the VIX, the Chicago Board Options Exchange (CBOE)’s volatility index, is scraping the depths of the Mariana trench.

Two separate articles at Zero Hedge this weekend, one by NorthmanTrader.com and one by LPLResearch.com, address the issue: it is time to be afraid and wake up. And that is not just true for investors or traders, it’s true for ‘everyone out there’ perhaps even more. Central bank policies, QE and ultra low rates, have distorted the financial system to such an extent -ostensibly in an attempt to save it- that the depressed, compressed volatility these policies have created can only come back to life with a vengeance.

Feel free to picture zombies and/or loss of heartbeat as much as you want; it’s all true. Financial markets haven’t been functioning for years, and there have been no investors either, only gamblers and profiteers, as savers and pensioners have been drawn and quartered. Central bankers have eradicated price discovery, nobody knows what anything is really worth anymore, be it stocks, bonds, housing, gold, bitcoin, you name it.

If you make interest rates ‘magically’ disappear anyone can spend any amount of money on anything they fancy buying. And it’s not just traders and investors either. Scores of people think: look, I can buy a house, others think they can buy a bigger house, many will get into stocks and/or bonds, because prices just keep going up. Even savers and pensioners are drawn into the central bank Ponzi, often in an effort to make up for what they lose when their accumulated wealth no longer pays them any returns. Shoeshine boys are dishing out market tips.

Crypto may or may not be a new tulip, but many Silicon Valley start-ups -increasingly funded by crypto ICO’s- certainly are. There’s so much money sloshing around nobody can tell, or even cares, whether they are actually worth a penny. It’s all based on gossip multiplied by the idea that they will be smart enough to get out in time in case things go awry.

People mistakenly think that a market’s heartbeat can be found in for instance rising stock prices, the Dow, the S&P. But that’s simply not true. The S&P is a bloated corpse increasingly filling up with gases that will eventually cause it to explode, with guts and blood and body parts and fluids flying all around.

The US stock market’s heartbeat manifests itself in volatility, and the overall economy’s heartbeat in interest rates. Rising and falling volatility and interest rates is how we know whether a market is in good health, or even alive at all. They are its vital signs.

That follows straight from Minsky. Ultra-low rates and ultra-low volatility, especially if they last for a longer period of time, are signs of trouble. The markets the central banks’ $20+ trillion QE and ZIRP have created are bloated corpses that no longer have a heartbeat. They are zombies. But markets, unlike natural bodies, won’t die, they can’t. They will instead rise from their graves and take over Wall Street, the City, and then everyone else’s street.

Bernanke, Yellen, Draghi and Kuroda are sorcerer’s apprentices and Dr. Frankensteins, who have created walking dead monsters they have no control over. But the monsters won’t turn on them personally; that’s the tragedy here as much as it is the reason why they have worked their sorcery. They themselves won’t go bankrupt, other will. No skin in the game.

Enough with the metaphors. First, here’s NorthmanTrader:

Flatliners

In the movie Flatliners aspiring medical doctors tried to unlock the mysteries of death by, well, killing themselves. It was meant to be a controlled death of course, to flat line on the heart rate monitor for a few minutes to find out what wonders where to be found “on the other side” only to then return safe & sound thanks to medical intervention. Well, they soon found out the other side wasn’t everything it was cracked up to be and the main character soon got regular beatings as the sins of his past came back to haunt him.

 

In my view markets find themselves in a very similar script. The promise of investor nirvana where the pains of real life no longer matter. If you only pay attention to the record highs headlines it all looks rather fantastical these days. [..] any trader staring at the tape knows that we find ourselves in the most compressed price environment in history. This is not normal, there’s no heartbeat:

As I’m writing this I’m fully aware I may be viewed as the bear who cried wolf. After all I’ve been outlining structural risk factors for a while and markets have moved past my technical risk zones of 2450-2500 and most recently 2530. That’s what bubbles do. They blow past anyone’s expectations, they make believers of the unbelievers, make bears look like idiots and the most reckless look like geniuses. But an extreme market that only becomes more extreme is not any less extreme, it is just more extreme. As no risk is apparent these extremes are then dismissed as the new normal. Yet momentum driven price appreciation has absolutely zero predictive value of future price appreciation, it only appears as such at the time.

 

We find ourselves in a very unique point in history and in a world dominated by false narratives. It is a challenge to keep an analytical grip on reality, but I’ll try to tie a few threads together here to put everything in a macro context. Firstly the underlying base reality: Free money, easy money, whatever you want to call it, permeates everything we see in financial markets. Indeed I would argue price appreciation has been paid for with unprecedented and, in my view, unsustainable volatility compression. A couple of charts really highlight this. Most clearly perhaps is the precise trend line tagging we can observe in the correlated picture of price appreciation and volatility compression since the February 2016 lows:

The $VIX’s corollary, the inverse $XIV, embarked on an explosive near one way journey since the US election coinciding with over $2 trillion central bank intervention in just the first 9 months of 2017:

And it has continued to this day and just made another all time high this past week on a massive negative divergence. It is the magnitude of this volatility compression that explains the current trading environment we find ourselves in.

 

[..] Debt expansion at low rates continues to sustain the illusion of real prosperity for the 90%:

And then LPLResearch with another indicator that goes to show we’re dealing with a zombie here: stock prices are not moving, either up or down. Or rather, they’re moving up all the time, but in too small increments. Yeah, like that bloated corpse.

Where Did All the Big Moves Go?

There have only been eight moves of at least 1% for the S&P 500 Index so far this year—the least since 13 in 1995. The all-time record was an incredible three in 1963. What about a big move? The last time the S&P 500 moved at least 4% was nearly six years ago. In fact, the S&P 500 had four consecutive days with 4% (or greater) changes in August 2011. Other than 2008 and the crash of ’87, that is the only other time since the Great Depression to see four consecutive 4% changes. That isn’t anything like today’s action.

 

As the chart below shows, so far in 2017, big moves have been nonexistent; and even 1% changes have been rare. Per Ryan Detrick, Senior Market Strategist, “If you had forecast that the 11 months after the 2016 U.S. presidential election would be one of the least volatile periods ever, you would be in the minority. Then again, the last time we saw a streak of calm like this was the year after John F. Kennedy was assassinated in November 1963. Once again proving that the market rarely does what the masses expect and usually surprises us.”

You want a heartbeat. That tells you if a body or a market is alive, healthy, functioning. We don’t have one. We haven’t for years. But we will again.

Natural bodies can tend towards equilibrium, i.e. death. Markets cannot. They’re doomed to flatline, and then to always come back from near death experiences. They tend to do so in violent ways though. When volatility at last returns, so will price discovery. It won’t be pretty.

“The Prices Are Insane”: You Know It’s Bad When Used Private Jet Prices Are Crashing

America’s wealthiest have never been richer, thanks to 9 years of Federal Reserve “wealth creation” which has favored the top 1%, leading to an imbalance in wealth accumulation that has resulted in a record split between the haves and have nots. In fact, as the Fed admitted two weeks ago, the top 1% of Americans are 70% wealthier than the bottom 90%. But even though the number of millionaires and billionaires living in the US is at an all time high, and is on track to increase by nearly 700,000 a year between now and 2021 – assuming the market does not for the next 4 years – an influx of new potential buyers has done little to alleviate a supply glut that has been weighing on used jet prices for years.

As Bloomberg reports, sales prices for used private jets have fallen as much as 16% over the past year – and more than 35% over the past 3 years – with the average price falling from $13.7 million in April 2014 to $8.9 million as of this summer, according to research by Colibri Aircraft, which specializes in the marketing, resale and purchase of pre-owned private aircraft. And, as a glut of planes came on to the market in the wake of the economic downturn, owners have lost millions on the value of their existing business jets. The resale price of a Bombardier Global XRS, which sold for $50m, has dropped from $31.3m to $20.4m — down just under 35%.

While most major manufacturers, including Gulfstream and Bombardier have modestly pared production in the last couple of years as demand for private jets slumped, it has been nowhere near enough to shrink supply in line with the collapse in demand, and as a result it has not been enough to halt declines in aircraft values, say consultants for the $18 billion industry quoted by Bloomberg.

And with bargains aplenty on machines with few flight hours, including various new timeshare startups which have made it even more economical to rent than to own, manufacturers are slashing prices and cutting deals to entice buyers to purchase new planes. Meanwhile, they keep churning out aircraft and introducing new models.

It is this excess production glut that has sent prices tumbling by double-digits. “It’s a question of who wants to blink first,” Rolland Vincent, a consultant who puts together the JetNet iQ industry forecast, told Bloomberg. “Nobody – because whoever blinks, loses share.”

In the latest, just released long-term outlook on the state of the Business Jet Aviation, Honeywell forecast up to 8,300 new business jet deliveries worth $249 billion from 2017 to 2027, down 2-3%  points from the most recent 10-year forecast released one year ago.

And unfortunately for makers of private jets, a rebound in demand for new company planes, which would help stabilize the market, isn’t in the cards. Corporate plane-buying plans have hit a 17-year low, according to an annual survey by Honeywell International Inc. of more than 1,500 flight departments. Companies expect to replace or add planes equivalent to 19 percent of their fleets on average over the next five years, down from 27 percent in last year’s survey.

“Declining used aircraft prices, continued low commodities prices, and economic and political uncertainties in many business jet markets remain as near-term concerns for new jet purchases, leading to a modest growth in 2018,” said Ben Driggs, president, Americas Aftermarket, Honeywell Aerospace. Driggs noted that the declined was most significant in Chinese and Russian purchase plans; Brazil remains a bright spot by recording strongest new aircraft purchase plans in survey from a major aircraft market though overall buying plans also declined year over year.

Meanwhile, all those “aspirational” buyers who hoped to impress someone with their full-priced toy purchase, are seething said Barry Justice, founder and chief executive officer of Corporate Aviation Analysis & Planning Inc.

And so, to stimulate some demand, Gulfstream slashed as much as 35% off the price of its G450, which is being phased out as the new G500 aircraft nears arrival, Vincent said. The G450 had a list price of about $43 million, according to the Business & Commercial Aviation guide.

Others are similarly liquidating: Bombardier has offered discounts of as much as $7 million on the Challenger 350’s list price of about $26 million as it fends off competitors entering the super midsize space, he said. The weakness across the industry in private-jet sales is adding to the pressure on Bombardier, which is also struggling to sell its C Series commercial planes. The U.S. government slapped import duties of about 300% on the single-aisle jetliner in the last two weeks after a complaint by Boeing.

But what is most surprising is that the corporate aircraft segment – the one catering exclusively to the world’s richest, i.e. those who have explicitly benefited from central bank policies in the past decade, the global market hasn’t fully recovered from the last U.S. recession, when plunging demand popped a bubble that had flooded the industry with more than 1,000 new jet deliveries in both 2007 and 2008. A nascent recovery in 2013 and 2014 fell apart after the price of oil and other commodities collapsed, drying up sales in emerging markets such as Russia and Brazil.

Deliveries of new private jets are forecast to drop to 630 this year, from 657 last year and 689 in 2015, according to JPMorgan Chase & Co. The number is forecast to rebound slightly to 640 next year.

According to Bloomberg, the more conservative pace has done little to relieve the glut, creating a buyer’s market for used aircraft. A five-year-old jet sold in 2016 was worth only 56% of its original list price, on average. That’s down from 64% in 2012, according to a report by plane broker Jetcraft. The value retention was as high as 91 percent in 2008.

Prices for used aircraft right now are “insane,” said Justice. And yet, prices are only going to get even more insane.

“There’s a vast overproduction of large-cabin airplanes and there are only so many people in the world who are going to step up and pay $60 million-plus,” he said. “What happens is, people are going to that pre-owned market.”

Of couse, none of this should be a surprise, as the collapse of the private-jet bubble isn’t a new phenomenon, though the markdowns that some owners face are probably even larger than what Bloomberg is reporting: Back in 2015, we reported that Delta purchased a used Boeing 777 for just $7.7 million, equivalent to a 97.2% discount off its list price of $277.3 million.

Delta CEO Richard Anderson raised eyebrows, and caused smirks among industry “experts”, that October when he said there was a “huge bubble” in used widebody aircraft, pricing a 10-year-old 777-200 at $10 million. Anderson said that the market would be “ripe” for Delta to buy used 777s. To be sure, Boeing CEO Dennis Muilenburg was among those who pushed back against Anderson, saying the Delta CEO was valuing used 777’s much too low. Turns out, Anderson’s estimate was $2.3 million too high.

To be sure, the supply of new jets has fallen sharply in the past decade. In 2008, 1,313 business jets were delivered, compared with 661 in 2016, and less expected this year. But the drop hasn’t been fast enough to balance out oversupply in the used-jet market.

The silver lining is that the chartered private plane industry stands to benefit as more owners give their planes up for charter. The rise in available planes hasn’t had much of an impact on the price of a charter hour, which has changed little in the last decade. “It has been exactly the same price to charter a private jet for the past 10 years,” said Adam Twidell, chief executive of PrivateFly, a global booking service for private aircraft hire.

However, it is just a matter of time before the primary cost deflation spreads to the services segment and who knows: at this rate of plunging prices, it may soon be (much) cheaper to charter a seat in a private jet than to fly commercial first (or even business) class.