The chart of real business investment has always followed the stock market. From 1993 to 2012 real business investment tracked stock prices almost perfectly. That makes sense because corporate decision makers take their investment cues from stock prices.
They say that correlation does not prove causation. What has happened since 2012 demonstrates that, because the correlation has broken down since then.
Liquidity moves markets!Follow the money. Find the profits!
That breakdown also disproves the Trickle Down dogma of the economic priesthood. Economism dogma said that rising stock prices lift business investment. That was the religious gibberish that Pope Bernanke used in 2010 as the excuse for restarting QE. He turned emergency QE into QE infinity based on that single false premise.
But the premise was BS. Just look at what has happened since 2012.
I developed this chart of real business investment by combining commercial and industrial construction with non-defense capital goods orders. I use the PPI for durable goods as the deflator.
But what about before stripping out inflation? You have probably seen the charts where inflation makes it seem that business investment is growing. They look like this one. Look Ma! New Highs! Maybe a lot slower than in the past, but new highs, nevertheless. No problem, right?
The Chart of Real Business Investment Has Been Dead In the Water
Yes. Problem. Ex-ing out inflation, wee see that the unit volume of real business investment has barely grown at all since 2012. It even fell slightly from February 2018 to February 2019. The old stock market magic hasn’t worked since 2012, when QE was just becoming a way of life for the high priesthood of central banking and Economism.
But economists don’t give a crap about facts and reality. They only care about their insane mythology. They could have seen by 2014 that their beloved theory was useless. Instead they remain married to it today, facts be damned.
Obviously, zero interest rates and QE stimulated something, but it wasn’t real business investment. It was stock prices. That was intentional, given the Trickle Down theory. Only there was no trickle.
Historically, corporate CEOs saw rising stock prices as a signal to invest in the expansion of their businesses. But with ZIRP and QE, they saw the stock market as the end in itself. In 2013 and 2014, they ran wild borrowing free money to buy back their stocks.
Why make costly and risky investments in plant and equipment when you could just buy back your own stock with free money from the Fed? There was no carrying cost for that decision. And with the Fed printing money ad infinitum to guarantee rising stock prices, the perception rightly became that there was no risk either. The belief in a Fed put was backed up by… wait for it… Voila! The Fed put!
So instead of investing in plant and equipment, CEOs engineered stock buyback schemes as a means to skim billions for themselves. They issued stock options to themselves and their C-Suite cronies and borrowed free money to buy back their stock and give themselves nice big fat multimillion dollar checks in the process. While they reaped the benefits, millions of workers were phased out of traditional jobs as employees with wages and benefits, to contract gig workers, with no guarantee of even a regular paycheck.
Short Term Divergences Are the Immediate Issue
The negative divergence between real business investment and stock prices suggests a growing problem. The problem is hollowing out of the US economy behind the illusion of health that the stock market spawns.
The big picture is useless as a market timing indicator, but short term negative divergences may mean something. Such divergences developed in 1999-2000, and 2006-2007. Both were precursors to major bear markets.
A new negative divergence has been developing since 2017. It’s now as old as the two that preceded the last 2 bear markets. The annual growth rate has turned negative. In the past two divergences, stock prices collapsed soon after the real business investment growth rate fell below zero.
Maybe the past won’t be prologue this time. But the risk is there. We need to keep that in mind while relying on technical analysis for market timing.