re: Discussion of Fed Liquidity’s Impact on Equity Markets

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Another aspect of this is when you reflate bond values by clicking buttons you allow risk parity and the 60/40 active crowd to buy equities when in reality they should be selling them if bond prices weren't fixed.

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Recessions are either deeper or longer lasting when a very high percentage of the world’s economies are contracting rather than when they are centered on a limited number of countries.

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Confirming economic research regarding diminishing returns of the overuse of debt, each dollar of debt generated only 38.5 cents of GDP in the first quarter of this year. This result is defined as the marginal revenue product of debt (MRPD), which is down from 40 cents at the end of 2019. Each dollar of debt has generated only 13 cents of GDP growth for the past four quarters, compared with less than one-half of the 26.5 cents generated during the final four quarters immediately before the recession that started in late 2008.

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The rising debt levels and subsequent result of falling MRPD will produce two major macroeconomic consequences. First is diminishing returns, a conclusion that is derived from the production function. This idea is that unless offset by the contribution from technology, demographics or natural resources, the overuse of debt will lead to a further weakening economic growth, thereby placing downward pressure on inflation. The second macro-economic effect of weaker MRPD will be the continued downward pressure on the velocity of money.

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The U.S. business sector continues to ignore Benjamin Graham’s dictum for sound corporate financial management: sell company shares when stock prices are high and use the proceeds to pay off debt and buy shares when stock prices are low by issuing debt. In the first quarter, corporate debt jumped to a record 48.7% of GDP, more than 300 basis points higher than during the Lehman crisis. The surge in corporate indebtedness coincided with a profits recession that was evident even before the coronavirus hit. Real corporate profits after tax with IVA and CCA, which were unchanged from 2012 at the end of 2019, fell in this year’s first quarter to the lowest level in nine years. The situation will be considerably worse after the figures are tabulated for the spring quarter. The stressed corporate income statement and balance sheet circumstances strongly indicate that the reopening rebound in capital spending will simply not have staying power.

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Considering the depth of the decline in global GDP, the massive debt accumulation by all countries, the collapse in world trade and the synchronous nature of the contracting world economies the task of closing this output gap will be extremely difficult and time consuming. This situation could easily cause aggregate prices to fall, thus putting persistent downward pressure on inflation which will be reflected in declining long-dated U.S. government bond yields.

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